CM in MA

Why Can't the Dow Join the Party?

The DJIA is like comfort food. It is familiar and reminds of long ago times when the world seemed a simpler place. It is also a quaint anachronism. As a narrow, price-weighted index it is far more flawed than the broader, market-cap weighted S&P 500 and Nasdaq Composite. Seems to me the DJIA gets so much play in the media simply because it is a large number. The point moves in the Dow sound more dramatic than the point moves in the others. For the most part, the DJIA can be safely ignored by investors.

The U.S. Economy After the Bailout

Gabe B. Let me know when you have your hedge fund investors lined up behind your projections / future certainties. I'm certain they'll throw billions at you to invest on their behalf. Only the government, and apparently you, could still believe in alchemy.

The U.S. Economy After the Bailout

www.bobbarr2008.com/pr.../

October 2, 2008 10:39 am EST

Originially published at the Washington Times ...

Just one week ago, Treasury Secretary Henry Paulson was demanding that Congress grant him unprecedented, unreviewable authority to spend $700 billion or more to bail-out Wall Street. But in a major rebuke to the administration and to both the Republican and Democratic congressional leadership, the House voted down the 110-page plan that emerged from last weekend´s frenzied — if not unseemly — effort by Mr. Paulson to salvage a bailout deal.

The Dow dropped some 10 percentage points in reaction to the House vote and, while that was less than a third of the massive percentage drop it suffered in 1987, it shouldn´t surprise anyone that Wall Street was upset at being denied at least $700 billion of taxpayer´s money to practice more of what got it into trouble in the first place — buying up over-valued mortgage-based securities. A majority of members of Congress correctly concluded that the leadership-backed bailout bill was, to put it mildly, bad and that the closed-door sessions that spawned it were deeply flawed as well.

Perhaps at long last, some basic understanding of economics is seeping into the Capitol. Dare we hope that some members now understand the fact that Congress can only redistribute, not eliminate, the pain of an economic downturn? At a minimum now, as a result of the House “no” vote, Congress has time to seriously consider alternative strategies and it needs to press its advantage.

The starting point should be private market adjustment. With the knowledge that an easy government bailout is no longer around the corner, the markets can get serious about working through the mountain of bad debt that imperils homeowners, banks and companies alike.

Unfortunately, artificial booms inevitably lead to painful busts, but these can be productively addressed. Today, this means a mix of bankruptcies, company workouts, and takeovers as we are seeing in the banking sector and outside investors buying large pieces of companies, such as Warren Buffett´s $5 billion investment in Goldman Sachs. This process will reward more responsible firms and encourage them to move early to correct past mistakes.

Many companies also will have to sell mortgage-backed securities. Obviously, companies holding over-valued mortgage-based securities (MBS) prefer to dump bad securities on the government than sell them in a down market. But there is a market even though asset values are uncertain. Merrill Lynch liquidated its MBSs in July.

Bailout advocates simultaneously tell us that these assets are “toxic” and are destroying firms, but which magically at the same time are possessed of value that will ultimately make money for the government if it is allowed to buy them with taxpayer funds. However, good business leaders know that private investors are better able than government officials to dig out that hidden value. Private buyers, too, could participate in reverse auctions and hire asset managers on their dime, not the taxpayer´s. This adjustment process should be carried out in the marketplace — not behind closed doors in Washington.

Both Congress and the administration should focus on cleaning up the mess, not making it potentially far worse. Federal and state authorities need to begin to aggressively prosecute fraud in private markets; fraud that has resulted in trillions of dollars of grossly and deliberately, if not criminally negligently, overvalued mortgage paper. The goal is not to create scapegoats, but to keep markets clean. At the same time, we need a thorough investigation of the misbehavior of public officials in spurring Fannie Mae and Freddie Mac, for instance, to engage in reckless lending. Many of the politicians leading the attack on Wall Street for its failures worked overtime to create the subprime lending debacle.

Congress should rein in the Federal Reserve System. Over the last decade the Fed has followed an easy money policy designed to spur economic growth. But this encouraged irresponsible lending and inflated property values. Increasing the money supply is a bit like mainlining heroin — it´s pleasant while you´re doing it, but it´s extremely painful when you finally stop. Yet as currently configured, the Fed is neither transparent nor accountable.

Congress must say never again with Fannie Mae and Freddie Mac, which lowered mortgage standards and pushed people into new or larger homes than they could afford. These government-sponsored enterprises must be privatized; there must be no more implicit or explicit public guarantees for mortgage lending.

Congress needs to repeal the Community Reinvestment Act. The CRA effectively forces banks to lend to poorer communities irrespective of the creditworthiness of borrowers. Many of the same legislators who demanded increased bank lending in the inner-city now criticize banks for making “predatory loans.” Agencies such as the Securities and Exchange Commission need to suspend the mark-to-market accounting standard and reconsider its application. The rule makes sense for trading assets, especially where values are well established; however, the standard has a perverse impact when applied to long-term income-producing assets in a volatile market. A single major, bad sale can force a major corporate write-down, artificially crippling an otherwise creditworthy firm.

We need better, more streamlined regulation, not more regulation. There are a multitude of government financial regulators, leaving us with expensive controls, but without the transparency most needed by customers and investors.

Finally, we must control federal spending. Where is the $700 billion or more for a bailout supposed to come from, in a government already drowning in deficit spending and a spiraling national debt? Who will bail-out the federal government when investors at home and abroad refuse to buy its paper Instead of attempting to ram through a new version of this bad bill, the president and congressional leaders should announce that a government bailout is off the table. Companies and institutions must focus on systematically working through their problems, in a transparent, focused effort, utilizing the tools in the government´s already-massive quiver of tools.

We must learn from today´s economic disaster lest, to paraphrase George Santayana, we repeat this painful experience in the years ahead.

Bob Barr, a former Republican congressman from Georgia, is the official candidate for president of the Libertarian Party.

Portfolio Planning and the Lost Decade

Geoff--thanks for the link to the DALBAR study. I gave it a quick look, but will read it in detail.

I was in the TSP while in the military. I think it is a great program. Keeps things simple. Many 401k/403b plans could (and do) do worse than use the TSP as a model.

Portfolio Planning and the Lost Decade

ok, I give up: I typed "reallocating" correctly twice and both times it changed to reallocati...

Portfolio Planning and the Lost Decade

above should have read: "folks were rebalancing/reallocati... too frequently"

Portfolio Planning and the Lost Decade

Geoff--yeah, don't know if the equal weighted portfolio would be a good benchmark or not. Seems to me, though, the only other choice would be to lock in the original P20 allocation as the benchmark for subsequent changes. My rationale for that is the need to isolate the effects of future reallocation decisions. After all, once the portfolio strays from equal weighting, it becomes an exercise in index/sector timing and rotation.

On a related topic, are you familiar with the government's Thrift Savings Plan? www.tsp.gov The reason I ask is that it is potentially a giant laboratory to study investor behavior vis-a-vis asset allocation decisions and results. As of Nov 2007, there were 3.8 million participants with $231.5 billion in assets. The TSP provides three asset class choices: equities (large-cap, small/mid cap, international), bonds, cash. There are some recently introduced lifecycle funds consisting of these choices. Awhile back, there was some discussion of including other asset classes, but that has not happened yet. For all intent and purposes, reallocation is cost-free, so that removes a factor from the decision process. It is interesting that limits were recently established for interfund transfers--folks were rebalancing/reallocati... too frequently and driving up plan costs for other participants. So, even with just five choices, it would seem there were some people attempting to time the swings in the markets rather than using some basic asset allocation to smooth the long-term ride. Anyway, I couldn't say whether the government has ever studied the results plan participants have achieved, or whether they'd even be interested in doing so. However, it strikes me as a well-controlled experiment in investor behavior.

Portfolio Planning and the Lost Decade

Geoff--no vitriol from me. I don't find your approach to diversification at all objectionable. Sure, diversifying beyond the S&P 500 (or any other index) makes sense, but doing so via funds that represent other indexes (either market or sector) means that there are, at the very least, four certainties: 1) the portfolio will never outperform the leading index or sector, 2) the portfolio will never underperform the trailing index or sector, 3) the portfolio will experience less volatility than the most volatile index or sector, and 4) the portfolio will experience more volatility than the least volatile index or sector. Again, there is nothing wrong with damping volatility in this manner, so long as that is the objective within the investing universe the portfolio encompasses. It does not, and cannot, guarantee positive returns over any time period be it short, intermediate or long. Moreover, taking the approach you describe means that it is no longer valid to look at portfolio return against the S&P 500. The returns would need to be weighed against an equal weighted blend of the portfolio constituents to determine the advantage of the weightings found in P20.

Berkshire, or more specifically Buffett, doesn't look at risk premiums or benchmarks. Nor, I suspect, does Buffett care about diversification as it relates to returns during any time period. He simply seeks to buy good companies at reasonable prices. The reasonable price approach addresses the risk you are trying to reduce via diversification because any index/sector approach is not a business oriented approach to investing. From a business perspective, there is no inherent margin of safety in buying an index or sector fund. It is comparing apples to oranges. Whatever the measure of diversification within Berkshire's portfolio turns out to be, Buffett would likely consider the measure a curiosity at best.

Portfolio Planning and the Lost Decade

Geoff--an interesting article as far as diversification goes. One reminder to ETFers, though, check the portfolio in the ETFs for overlap. IGE and IVV (23% of the portfolio) have 20% overlap in their top 10 holdings. To be fair, P20 doesn't appear to have a great deal of overlap overall.

In down (and flat) markets, the wonders of diversification are always trotted out. Not that any of us, myself certainly included, can lay claim to the mantle of Warren Buffett, but he had this to say about diversification: Diversification serves as protection against ignorance. If you want to make sure that nothing bad happens to you relative to the market, you should own everything. There is nothing wrong with that. It’s a perfectly sound approach for somebody who doesn’t know how to analyze businesses."

Remember, the website is Seeking Alpha.

Payrolls Drop - And You Ain't Seen Nothin' Yet

"Clinton put pressure on financial organizations to come up with creative ways of increasing home ownership amongst the poor..."

Really? See below. Bush not only instigated the subprime crises, he and his lieutenants stood by while the very dangers he identified took hold. He's led his home ownership initiative about as well as every other thing this administration has touched. Which is to say he has been asleep at the wheel. And some folks seem to think more government regulation of the financial sector will fix things. Frankly, we need more regulation on government!

Source: www.whitehouse.gov/new...

For Immediate Release
Office of the Press Secretary
June 18, 2002

President Reiterates Goal on Homeownership
Remarks by the President on Homeownership
Department of Housing and Urban Development
Washington, D.C.

.................We are here in Washington, D.C. to address problems. So I've set this goal for the country. We want 5.5 million more homeowners by 2010 -- million more minority homeowners by 2010. (Applause.) Five-and-a-half million families by 2010 will own a home. That is our goal. It is a realistic goal. But it's going to mean we're going to have to work hard to achieve the goal, all of us. And by all of us, I mean not only the federal government, but the private sector, as well.

And so I want to, one, encourage you to do everything you can to work in a realistic, smart way to get this done. I repeat, we're here for a reason. And part of the reason is to make this dream extend everywhere.

I'm going to do my part by setting the goal, by reminding people of the goal, by heralding the goal, and by calling people into action, both the federal level, state level, local level, and in the private sector. (Applause.)

And so what are the barriers that we can deal with here in Washington? Well, probably the single barrier to first-time homeownership is high down payments. People take a look at the down payment, they say that's too high, I'm not buying. They may have the desire to buy, but they don't have the wherewithal to handle the down payment. We can deal with that. And so I've asked Congress to fully fund an American Dream down payment fund which will help a low-income family to qualify to buy, to buy. (Applause.)

We believe when this fund is fully funded and properly administered, which it will be under the Bush administration, that over 40,000 families a year -- 40,000 families a year -- will be able to realize the dream we want them to be able to realize, and that's owning their own home. (Applause.)

The second barrier to ownership is the lack of affordable housing. There are neighborhoods in America where you just can't find a house that's affordable to purchase, and we need to deal with that problem. The best way to do so, I think, is to set up a single family affordable housing tax credit to the tune of $2.4 billion over the next five years to encourage affordable single family housing in inner-city America. (Applause.)

The third problem is the fact that the rules are too complex. People get discouraged by the fine print on the contracts. They take a look and say, well, I'm not so sure I want to sign this. There's too many words. (Laughter.) There's too many pitfalls. So one of the things that the Secretary is going to do is he's going to simplify the closing documents and all the documents that have to deal with homeownership.

It is essential that we make it easier for people to buy a home, not harder. And in order to do so, we've got to educate folks. Some of us take homeownership for granted, but there are people -- obviously, the home purchase is a significant, significant decision by our fellow Americans. We've got people who have newly arrived to our country, don't know the customs. We've got people in certain neighborhoods that just aren't really sure what it means to buy a home. And it seems like to us that it makes sense to have a outreach program, an education program that explains the whys and wherefores of buying a house, to make it easier for people to not only understand the legal implications and ramifications, but to make it easier to understand how to get a good loan.

There's some people out there that can fall prey to unscrupulous lenders, and we have an obligation to educate and to use our resource base to help people understand how to purchase a home and what -- where the good opportunities might exist for home purchasing..........

Lost Decade for Stocks?

For some, it's potentially worse than the authors illustrate. If a person had the worst timing in the world, and invested in the S&P 500 at the start of year 2000, their annualized return (including dividends) to date would be 0.03%. Of course, this means that if the first 20 years of this century are going to revert to 8% return levels, then there's going to be a heck of a bull market sometime during the next decade. For those wondering, to get approximately 8% annualized during the period 2000-2020, the S&P would need to reach roughly 6600 by 2020. To get 8% annualized from 2002-2022, the S&P 500 would need to reach just 3725. As Warren Buffett has long noted, the price paid determines the rate of return.