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Alex Trias
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  • Stock in...... Me
    If the economic crisis of 2007-2011 (and beyond) highlights anything, it is the distinct inability of people to accurately price debt. Ratings agencies cannot seem to get it right when it comes to figuring out how likely a pool of mortgagees will be to repay their debts in a timely manner. The credit default swap market also seems somewhat suspect when it comes to pricing out a debtor's likelihood of default, for like all markets in traded securities, the credit default swap market is prone to distortions.  And both borrowers and lenders alike seem to share this remarkable inability to accurately price debt. Lenders are prone to lend at "incorrect" rates of interest, and borrowers, from corporations to governments to individuals, seem consistently prone to borrowing far beyond their means.

    Let's drill down on that concept a moment - to "borrow beyond one's means". What does that actually mean? Well, it simply means you have mismatched your cost of paying down debt to your income.  A simple example is the prospective law student, who borrows a quarter of a million dollars for law school, expecting that he will be earning $160,000 a year upon graduation, and that his income will dramatically outstrip his costs of living, leaving plenty left over to service his school debts. The problem is simply this: while income may fluctuate, debt obligations are fixed. And when income fluctuates downward, or fails to come in when or at the level expected, and you combine that with fixed debt obligations, the result is always the same: absolute misery on the part of borrower and lender alike.

    We live in a world where almost everything can and does fluctuate, so you have to wonder, should debt even have much of a place in our system? The question seems naive, to be sure, and the facile answer is "well, yes, people need capital to accomplish projects." True enough, but must the capital come in the form of debt? Why shouldn't individuals and governments, for example, take a page from the private corporate sector, and issue stock, instead, to raise capital? I'd argue that approach would solve most of the problems the world is seeing with the credit crisis because equity, unlike debt, has the virtue of tying distributions to the equity owner to the profitability (or lack thereof) of the issuer.

    How would that work, if governments and individuals simply issued stock instead debt? Well, if I wanted to fund my law school education and didn't have the cash on hand to do so, I could simply issue stock in myself. An investor would pay me cash in exchange for my stock and I, as the issuer, would agree to pay a fixed percentage of my future income for life. My obligations would obviously fluctuate according to my income, but one thing is certain: my obligations would be tied, directly, to my ability to repay whoever believed in me enough to invest in my future. 

    Governments could adopt a similar approach, issuing stock that would entitle the holder to, for example, a share of all future tax revenue. If government finances deteriorated, so too would their obligations to make equity payments, and on the other side, in flush economic times, the cash flow on government issued equity would adjust higher. 

    The main issue with equity, verses debt, is that some investors require a steady, predictable income stream, something debt promises and that equity cannot. Perhaps that is why so much more debt is floating around our capital markets than equity. But as we have seen, this promise of certain repayment that even highly rated debt is completely illusory.  The reality is that when the ability of the obligor to repay is compromised, lenders get pennies on the dollar at best - effectively, all the downside associated with equity, and none of the upside. Sadly, this lesson is likely to play out over and over for the next many years, and one lasting impact may very well be that investors will come to accept that debt is just as risky as equity when times are tough. Indeed, debt is likely even riskier than equity, thanks to the asymmetry between what these securities offer an investor when times are flush verses when times are tough. If that realization starts to sink in, we will be looking for alternative ways to finance law school educations for individuals, or to bankroll government spending.  It could well be that offering a share of future profits, as opposed to a nominally guaranteed interest and principal payment regimen, could be a solution that is less crazy than appears today.  

    Jan 13 9:28 PM | Link | Comment!
  • Annecdotal Evidence of What?
    So, I get these calls from brokers at "A Certain, Well-Known, Swiss Asset Management Firm" all the time. The callers always say something like "you have been selected as a member of an elite group to receive our bank's financial research." Somehow, when someone wants to rip you off, they seem to think that the best way to do it is to make you feel like you've got privileged access to something. This "special access" story is exactly how Bernie Maddoff seems to have defrauded investors out of billions of dollars. Now, I am not saying that this Certain Well-Known Swiss Asset Management Firm is running Ponzi schemes or doing anything illegal - I wouldn't know because I don't do business with these places. What I am saying is that the "you can get special access ploy" which this bank is using has an eerily familiar ring to it.

    Sometimes, when stock brokers from this bank call me up at work they say something like "I have a meeting with several of your partners next week at your office, and wondered if I could just stop by your office while I am there". See, the thing is, that's a lie. Lawyers at my firm don't book up a conference room for personal matters, and generally speaking are too busy to meet with stock brokers. I'm baffled by this line, frankly, because if some broker is willing to lie to me within three seconds of getting me on the phone, I'm supposed to think he's trustworthy enough that I'm going to hand him my money to manage? In a pig's eye.

    When brokers call my office, if my secretary picks up the call, they usually ask for me by my first name, to try and make it sound like they're old friends of mine. I'm happy my secretary is smarter than these guys - she dumps the calls and then tells other secretaries who the caller says he is. Oftentimes when they call, the stock brokers  from this Certain Well-Known Swiss Asset Management Company just go down the roster of lawyer names, so when one person slams down the phone on them, they just move down their list to the next name.

    What does it mean, when sleazy stock brokers are going around beating the bushes for new accounts? I don't have an answer, but I feel somehow it cannot be auspicious.

    No positions mentioned

    Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
    Dec 14 2:14 PM | Link | 1 Comment
  • The Treasury Market Doesn't Like This Tax Cut Idea One Little Bit
    It may surprise some of you to know that here in America, we are in a new stage of  democracy. In this new stage, how individuals behave at the polls is not relevant when it comes to governing the country. What matters is how people buy and sell assets, and how asset prices reflect the public's ire or pleasure with the way Congress and the Executive Branch are running the country. In that sense, we are not directly a democracy per se, but rather, a financial instrument-intermediated democracy. We are, to give it an official-sounding acronym, an FIID.
    Now, in a FIID, such as ours, it doesn't matter what individual voters say they want (individuals are, after all, prone to hyperbole and whining), or how individuals express their political desires through the polls (whether actual voting polls, or merely public opinion polls). Nor does it matter what economists might warn (economists are prone to doom, gloom, error and disagreement amongst themselves).  It does not matter what a politician reasonably feels would be in the long-term, medium term or indeed, short-term best interests of the country. After all, who is to say what "best interests" means or whether one policy or another is in the country's "best interests"? Who, that is, but the capital markets - which in an FIID act as "The Voter". Substantial scholarly research proves that the capital markets are highly efficient when it comes to digesting information and predicting future outcomes. You can bet that what The Voter says is likelier than not to be correct, which is why it actually makes sense for politicians to ignore economists, their constituents, and their own common sense and simply do what The Voter tells them to do.
    Accordingly, if Congress does something and The Voter registers displeasure (for instance, by sending bond yields soaring), you can assume Congress has acted foolishly and, in fact, Congress should quickly reverse itself (as we saw during the TARP debacle of 2008). If The Voter registers pleasure, or perhaps, only a muted reaction to whatever Congress has done (or failed to do), then Congress has actually gotten it right and all the politicians can pat themselves on the back and take credit for causing the Dow Jones to run up higher (which we saw Senator Kerry do just this past weekend when he pointed out that since the Dow Jones is up 60%, it follows that Obama must be doing a great job).
    Now that we have established that America is an FIID, it's clear why we must now turn to The Voter and see what The Voter has to say about the new tax cut proposal. Well, Treasury yields seem to have exploded around 10% higher in the past few days, while stocks have sort of tread water.  This is how The Voter expresses displeasure with higher deficits.  The Voter is, in the loudest terms possible, giving two big thumbs down to Congress and our President. Thus far, nobody on Capital Hill is paying much attention to The Voter, but not to worry. As we have seen now in multiple examples around the globe, from Ireland to Greece to the EU at large, The Voter doesn't quit that easily.

    Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
    Tags: TLT, DIA, SPY
    Dec 08 5:12 PM | Link | Comment!
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