CaptainJJack

Where the Wild Things Are (Portfolio Edition)

What I still do not get with the dollar carry trade: where is the leverage?

I thought I understood this in 2006 and 2007 when banks were lending to hedge funds and investment banks at 40 to 1 in what was, either explicitly or implicitly, yen denominated loans.

This made all kinds of sense to me since the loan was at a low interest rate in a currency that was expected to stay stable or fall.

I understand that the transaction can be structured so that the bank holds the securities the hedge fund has invested in as collateral, but I find it impossible to believe the banks didn't learn anything from last fall: things happen (e.g. the AAA collateral you are holding has dropped 20% in value) and 40 to 1 (or even 20 to 1) is a spooky place to be when they do.

But without a LOT of leverage I cannot see how the hedge fund plays can generate the 25%+ ROEs that they need to justify their fees.

The Oil Casino: SEC Heading for Monte Carlo, Part I

I use Monte Carlo methods in testing my portfolio allocations, and I see nothing wrong in using them here, per se.

The way I understand the efficacy of the Monte Carlo method is that it makes no predictions about the future other than it will unfold in a random way.

While there is usually a model and model parameters, the nice thing about Monte Carlo is that the model itself does not have to do any predicting.

But, it is not quite random, and here is the rub: You DO have to make assumptions about the volatility, and, in some cases, the "drift".

After all, you are trying to replicate what you think the real world looks like, and natural occurring things usually follow some type of distribution.

If assume a parameter that is wrong, or you pick the wrong distribution, you get bad results.

But, you can deal with a lot of this by including what Graham calls "a margin of error" e.g. you might assume a lot higher volatility.

Ethanol vs. Natural Gas or Coal: Comparison Not Even Close

While I agree with the comments on Ethanol, I have to say that there is a closely related compound, Methanol, that is far, far more promising.

Methanol for fuel is an idea that is 100 years old. The original process was developed by the Germans using coal, and it is what drove their war machines in the world wars.

Methanol is usually made from natural gas, today, but it is also being used in recycling wood products

I became interested after reading a book by George Olah: THE METHANOL ECONOMY. Olah was awarded the Nobel prize in Chemistry in 1994.

Olah is currently working on making methanol by adding hydrogen atoms to carbon dioxide, using pure hydrogen developed from cracking water at very high temperatures thereby addressing the cost issues with hydrogen production, and addressing global warming.

As a by product, he is solving the ultimate storage and transportation problems involved in a transportation fuel.

Essentially, all fuels are mechanisms for transporting hydrogen. Oil, gasoline, and natural gas are far superior as carriers to alternatives, especially ethanol and hydrogen.

But, methanol isn't bad both in terms of energy in versus energy out, and in ease of storage and transportation.

The hydrogen process Olah is looking at produces hydrogen as a by product in a nuclear reactor (i.e. the reactor produces HEAT for both electrical generation and for hydrogen generation --electrolysis is NOT used)

Buffett's Holdings Outperforming in Q4

I believe the market values of the banks will fluctuate a lot, and we should expect to see prices fall for a while.

But, for me, there is a difference between market fluctuation and risk. Real risk is actually losing money, and the ONLY way you deal with this is not to overpay.

For example, anyone who bought at the 1999 top ACTUALLY lost money.

I deal will market fluctuations differently. Here the issue is psychology and the fact that humans are hard wired to sell when the market bottoms and buy at market tops. The issue is not the value of my portfolio, it is how disciplined I am.

Most investors due far worse than either the pros or the overall market because they tend to buy at market tops and sell at market bottoms. Even a little of this kind of trading will KILL your overall returns.

As Graham pointed out often, it is relatively easy for a disciplined individual investor to consistently achieve adequate (i.e. market plus some nominal amount) returns, but it is very, very difficult to achieve superior (defined as > market + 5%, annually) returns.


On Nov 18 12:17 PM Crude Oil Trader wrote:

> I admit, even though I am a day trader I am sitting on some BRK.B
> in my Roth IRA and have been surprised it has held up as well as
> it has. My concern is the collapse of Wells Fargo and Bank of America
> taking the fund down. SP 500 @ 1130 is an area of great concern for
> all of these names.

Buffett's Holdings Outperforming in Q4

I have owned BRK for years, now, and I am amazed at how few people understand it.

Many, many years ago, conglomerates were all the rage. The sale was that you got "top managers" to oversee the business and allocate capital. Since "management skills" were guided more by the financial results than process results, you did not need to have industry experts, the argument went, you just needed people with discipline.

The reality was much different. They performed well, initially, as management skills and discipline really do make a difference, but it wasn't long before things fell apart.

First, there was a tendency to centralize, and this created massive bureaucracy and decisions often became political more than analytical, especially since the founder was usually charismatic and tended toward empire building.

Secondly, and related, overhead and "home office" staffs and costs skyrocketed.

Third, in order to keep the party going, they had to keep buying at ever higher prices.

Wall Street started to figure out, that the investor could do his/her own capital allocation without all this, and that conglomerates were adding nothing. They were, in effect closed end mutual funds with far higher costs.

But. what if you could hire one of the world's greatest capital allocators for $100,000/year, and he was so sure of his own skills, he put virtually ever dime he had into the deal.

What if, instead of having a huge bureaucracy, you had a "home office" consisting of 18 people.

What if the person almost never over paid for a business or a CEO to run the business ( the main exception being Conoco).

What if the person managed the businesses with far more discipline than any other manager you know -- again for $100,000/year, e.g. sitting on $50 Billion in very low yielding cash even when it clearly hurt.

I own Buffet's stock because it is by far the lowest cost mutual fund I can buy, and that he manages businesses as though he personally owns them.

For the most part, he does.

Whitney Gets Bearish: Will She Be Right Again?

I have a question:
When was Meredith Whitney ever bullish?

Meredith Whitney: 'I Haven't Been This Bearish in a Year'

I agree.

Meredith Whitney has NEVER been bullish.

After the market ran up 40% she came out with a "gutsy" call -- buy Goldman -- which she retracted about 2 months later.

What galls me about her is that she adds nothing. There is no research or data that she brings to the table that hasn't already been discussed on CNBC thousands of times before.

She and Roubini keep calling for clouds and storms ahead, and damn, sooner or later, we get one.

Frankly, I do not know who pays her for this stuff. She is clearly useless for determining an investment strategy -- unless you think the market will always go down.


On Nov 17 08:47 AM Ferdinand E. Banks wrote:

> Great article. Complete nonsense, but served up in only 5 lines.

Why Warren Buffett Loves Wells Fargo

I remember when I first got into the investment world, in the early 1980s. This is what guys like you were saying:

The dollar was worthless, given 12%+ annual inflation

Gold was going to $1500/once

The US debt was skyrocketing, and the US was becoming the largest debtor in the world.

The US trade balance was the worst in history, and getting even worse

The US was no longer making anything

The major banks were going to go under because of their enormous holdings of Latin American debt.

Japan was going to rule the world

Diamonds were clearly the best investment because the prices were controlled by DeBeers, and they were the perfect hedge against a worthless dollar.

Oil will rise to at least $50/barrel by the end of the decade.

Stocks were dead money investments -- only a fool would invest in US stocks.


I am SURE there will be a crisis of some kind in our future. I do not know when or how.

But, I do know that it will almost certainly not play out the way all the doom and gloom gold bugs think it will.


On Nov 16 02:03 PM Mark Anthony wrote:

> But let me make it clear:
>
> I do not advocate shorting banking stocks. I do not advocate shorting
> anything at all. To short any position also means to hold a long
> position in US dollars (long cash), which is not right. The only
> thing that needs to be shorted is the US dollar.
>
> At some point when more people see the coming of hyper-inflation.
> There WILL be chaotic bank runs. Such bank runs are not due to worry
> about health of individual banks, but due to worry about the health
> of the US dollar itself. When you are losing purchase power fast,
> it makes no sense to leave cash in a bank.
>
> Will the government impose daily cash withdraw limit? You bet. It
> is better to get your cash out while you still can and while there
> is still not a significant limitation. Put into real assets like
> precious metals.

Stock Market Still Riding a Thermal Wave

While I cannot argue that the stock market is likely going to correct at some time, I think it is more do to future GDP expectations being too high than it is due to excess liquidity.

The issue is not the STOCK of money, which we all know is VERY high, it is the FLOW of money, which has been very, very low.

Contrary to all the gold bugs, just because Treasury floats a lot of debt, and the Fed buys that debt, does NOT mean there is excess liquidity in the system. All that means is that the banks have a lot of money to lend, but if they do not lend it, the system liquidity is unchanged.

When the banks start ACTUALLY lending money, THAT'S when there will be excess liquidity in the system, and every thing I read says they are not lending to the private sector.

As I see it, there are two problems: people quit buying things, and banks are worried about the loans they hold now -- they are worried about capital adequacy.

If you want to worry about something, worry about this: by implicit agreement with the Fed, the banks are borrowing (deposits) from the Fed (I.e. the excess money supply), and they are buying long US government bonds. This is a common strategy employed by the Fed to recapitalize the banks.

It is also providing a convenient back door way the monetize the debt, temporarily, as the banks buy what the Fed would have had to buy if it wanted to monetize the debt, as the gold bugs fear. Treasury is happy, too, because it has a buyer to fund the US deficits (i.e. banks ARE lending, but only to the US government)

BUT, this is a very dangerous game. The Fed has little real control over the long end of the curve, and if the long rates start to increase, the banks could face HUGE losses in their long bond portfolio.

And THESE losses are marked to market immediately.

Finally, I have to admit, I do not understand the carry trade. I used to think that it was a way to get LEVERAGE in a country whose interest rates are low and whose currency is expected to remain stable or weak.

While the dollar debt would make sense, GIVEN the ability to borrow against your capital, I cannot imagine why a bank would want to lend to a hedge fund on this basis without requiring so much overcapitalization that the trade makes no sense.

Erosion in the M2:M1 Relationship and the Burgeoning Eurodollar Bubble

The carry trade is only a piece of the puzzle. The key, to me, is leverage.

If I take a $1million of treasury bond and use it as collateral for overnight borrowing, I haven't increased my leverage.

As I understood the Japanese Carry Trade, a hedge fund would BORROW at 35 to1, AND THEN take the money and use it as collateral to borrow in Japanese Yen and Japanese interest rates.

Without the initial leverage, the transaction doesn't make much sense to me.

The question I have, then, is who is lending to the hedge fund at 35 to 1?

Or do I have this wrong?

Too Big to Fail Banks: A Simple Solution

Let me add my support to your ideas.

Glass Steagall should be reinstated.

Regulation should focus on leverage.

In general, leverage ratios should be set with a view, not of risk, which gets confused with market fluctuation, but the CONSEQUENCES of failure; i.e. not IF this deal goes bad, but what if this deal DOES go really bad?

The more that there is ANY implicit or explicit government support, the lower the leverage ratio.

So, any bank offering FDIC insurance should have very low leverage ratios. Any financial institution that has had any access to the Fed lending facilities should have low leverage ratios.

Goldman and Morgan Stanley have commercial banking subsidiaries.

They should be divested immediately. However, higher leverage ratios should be allowed, and the primary regulation should be that the I-Banks are required to mark to market daily.


On Nov 11 01:49 AM bob adamson wrote:

> Mr. Lindmark, there are two significant factors that your article
> does not fully address:
> 1. The US and UK are pre-eminent global investment banking centre
> and Australia and Canada are not, and
> 2. The role of risk in investment banking is different than in other
> banking roles.
> Arguably in the modern world the pre-eminent global investment banking
> centres are comprised of banks, hedged funds and other ‘near banks’
> and insurance bodies to back-stop investment banking. The focus of
> investment banking is properly on accepting and managing risk of
> a nature and extent that is very different than what is acceptable
> for the other, properly ‘boring, banking functions.
>
> Can’t a good case not therefore be made that the following needs
> to be done?
> 1. The first need is to decide to segregate ‘boring banking’ from
> investment banking by creating a modern version of Glass-Steagall.
>
> 2. A regulatory and governance framework analogous to those in Canada
> and Australia should be created for boring banks.
> 3. The US and UK (and other significant global investment centres)
> should in consultation devise a regulatory and governance framework
> for the banks, hedged funds and other ‘near banks’ dedicated to investment
> banking and for insurance bodies that back-stop investment banking.
> This framework needs to encompass the facts that (a) globalization
> and information technology have both increased the possibility that
> unforeseen risk will arise and the means for its better management,
> (b) it is often difficult and unnecessary to distinguish banks, hedged
> funds and other ‘near banks’ dedicated to investment banking from
> each other by role or function and therefore the new framework needs
> to cover them all, and (c) given the nature and extent of risk involved,
> the fact that a banks hedged fund or other near bank dedicated to
> investment banking or one of their insurers becomes insolvent can
> not be allowed to endanger the solvency or ongoing functioning of
> the system generally.
>
> It might be argued that the demarcation line between investment banking
> and boring banking isn’t as clear as the forgoing implies. This is
> true and it follows that the modern version of Glass-Steagall alluded
> to above should therefore forbid banks that assume specified classes
> of investment risk to engage in boring banking and require that they
> be registered within the investment banking regime described above.
>
>
> No doubt you and other commentators can improve on the forgoing suggestions
> but my basic point is that investment banking is unique and requires
> segregation and unique forms of regulation and governance.

Reinstituting Glass-Steagall: Not as Easy as It Sounds

The issue is leverage.

If you do not allow investment banks to lever up, they cannot make an ROE sufficient enough to stay in business. It is risky, the margins are thin, given the risk, and the good ones mark to market their entire portfolios every day, but if the ROEs are there, they do not need retail charters.

On the other hand, Commercial Banks had generally been in higher risk loans, concentrated regionally, using retail deposits. Their margins are much higher, there is much more book value accounting, versus mark to market, and prudence dictates that they keep low leverage ratios.

The beauty of Glass Steagall was that it established clear boundaries between the two, and I believe it was tossed out as part of a larger effort to allow banks to operate in more than one state.

The other argument that G-S makes the US less competitive is nonsense. Anybody who has followed Investment Banking knows that it is a business of celebrities, and Commercial Banks have not been very effective competitors. And, the only foreign banks that have done well in the investment banking area are those that focus on investment banking.

Finally, allowing Investment Banks to accept retail deposits is setting us up for disaster. The Goldman and Morgan Stanley Commercial bank charters should cease to exist ---like tomorrow.

And Bernanke Didn't Think Unemployment Would Reach 10%

Come in waves, do they?

You must be very rich. After all, since these waves come around so often, you must have been in short term Treasuries before this last crisis, and since it was a wave, you must have bought around the bottom knowing it will eventually turn up.

In 1982, Barrons ran story showing that if you bought a single interest rate futures contract in 1975, and ALL YOU DID was call the right DIRECTION of interest rates in each of the successive three months, and kept rolling over your gains, you would have been worth $3 BILLION.

They went on to say that since they didn't see a lot of 3 billionaires walking around Wall Street, it might have been harder than it looked.

By the way, when are we going to get the next wave?


On Nov 08 11:48 AM Michael Clark wrote:

> Check back in 2019 and we'll see if they really avoided the Depression.
> These things come in waves.
>
> In the 1930's:
> 1929-1932: depression wave.
> 1932-1935: recovery wave.
> 1936-7: depression wave.
> 1937-38: recovery wave.
> 1939-45: world war depression wave.
> 1944-46: recovery wave.
> 1946-47: depression wave.
>
> Don't be surprised when the next wave hits: 2010.
>
> Don't give any Nobel Prizes out just yet to Bernanke and Hank Paulson
> (Paulson will go down in history as the greatest Plunder Artist in
> the history of the world). He has his own place in Hell reserved
> for him, next to Crassus and Plutus.

And Bernanke Didn't Think Unemployment Would Reach 10%

Well, let's see.

The alternative plan promoted by the Republican house was a tax cut bill that amounted to $400 billion split between individuals (2/3) and business (1/3).

The current stimulus has about $250 billion in individual tax cuts and very little business tax cuts.

However, since businesses lost money, last year, and since over 90% of small business file as individuals anyway, the effect would be about what we are seeing now.

Further, since most investments are in qualified plans, Capital gains taxes no longer have any significant effect, it is hard to argue that ANY cut in capital gains taxes would do much.

SO, I conclude that Obama administration underestimated the mess we were in, but they did a FAR better job than Bush and Republicans would have done.

If we would have followed the Republican plan, we would have decimated our capital stock FAR worse than we have already done. Creative destruction is one thing, but allowing whole industries to disappear, together with all the skills involved, is quite another.

As for the deficit, Bush was racking up trillion dollar deficits, but like all good politicians, he hid a third of it in Off Balance Sheet items.

While Bernanke and Paulson should have done more to prevent this mess, I would give them both Presidential Medals for avoiding a Depression.

By the way, when you compare today with the Depression, remember to include the fact that the unemployment numbers in the Depression INCLUDED unemployed farm workers.

Finally, I could find THOUSANDS of quotes that could embarrass either side of this debate.

Your analysis adds very little.

What Buffett's Burlington Northern Buy Really Means

I picked up the wrong numbers in calculating Warren's cost basis.

He owned 22,5% ( thought he owned a lot more), before the bid.

So, I am now guessing his basis is in the mid 90/share.