Crocodilian

Calpers Sues Rating Agencies for Bad Investment Advice

Author writes: "I’m sorry but I don’t buy that load of bull shit. If Calpers couldn’t figure out what the risks were and if , indeed, the securities were so opaque as to defeat its attempts at due diligence then they shouldn’t have bought them"
----------------------...

Your headline "Calpers Sues Rating Agencies for Bad Investment Advice" is inaccurate, as is the statement above.

Calpers was not receiving "investment advice". Ratings agencies are not stockbrokers' making "buy" and "sell" recommendations-- they are a paid consultant, providing specialized, legally required, financial "inspection" services-- not unlike a home inspection. If the home inspector didn't look at the roof, and later on the roof leaks, you can sue him . . . "you coulda checked it yourself" is not a defense against failure to perform a contracted service.

The ratings agencies are paid fees to perform financial evaluation services, and their ratings have a quasi-official status (in a way that, say, brokerage house recommendations do not). Many funds, Calpers included, are legally only permitted to purchase securities with certain ratings-- making the rating process something very different than "advice"

If they were paid the fees, and failed to perform the services that they were paid for, and plaintiff suffered a loss as a result, then they should win.

Whether Calpers' claims are persuasive isn't something that can be determined from a secondary source (newspaper article). You can read the actual complaint from the California Superior Court at:
tinyurl.com/m94lqn

Reading the complaint, there's a _lot_ more data than the article you reference.

Washington's Dilemma: This Isn't a Recession, It's a Collapse

Washington _should_ bail out the States. If one believes in the logic of counter-cyclical spending in a recession/depression, then it makes no sense to have the Federals put money into new programs, as the States fire people and make cuts.

The easiest way to put Federal dollars into, say, highway infrastructure, is to make sure that CalTrans doesn't shut down projects (which they will do). These projects are not merely "shovel-ready" -- they're actually under way, employing people today who're paying mortgages and so on. Far better to keep those projects going, than to have California shut them down, and to wait for some Federal project to start "later".

In fact, one could make a case that _all_ stimulus spending should be done through the states. Its also a politically far more palatable way of doing a "second stimulus". The votes probably aren't there in Congress to do another _Federal_ stimulus package-- but a State bailout would be much easier (which California Reps would vote against it?)

Winter's Coming for the Boomers: Part 2

Author has a remarkably high opinion of his prognostications and their drama-- he has distinctive names for our condition, and to let us know that these are major events, he capitalizes them, viz "the Unraveling" and "the Crisis".

Talleyrand, who'd seen and fled a "Crisis" or two, the kind that ended up with the King's head severed and millions dead across Europe, had a convenient summary, which applies to author's melodrama:

"Plus ca change, plus c'est la meme chose"

In other words, we've seen this before and its unlikely to be anywhere near so dramatic as author makes out. Incremental adjustments to behavior and lifestyle are all that's needed to bring our economy and environment into better balance.

No comfort to the Chicken Littles of the world, but the sky won't fall, and their promiscuous capitalization will prove more melodrama than forecast.

Housing Boom and Bust More About Productivity than Bubbles

Its a good argument, and probably applies most to the most desirable areas, with proximity to the high value added occupations.

We've seen pretty much that scenario: Manhattan and Atherton haven't fallen much, Stockton and Tampa have. Places that seem likely to continue to attract the most valuable professionals will do better than those which don't.

Its important to include demographics into the equation: the nation is aging, and household formation is falling. The median age in the US is now 39 -- which means that "the median American" has already had, or will soon have, their last child . . . a major drag on demand for housing.

No One Saw This Economic Crisis Coming?

Saw "it" coming? Really depends on what the "it" is.

It is painful and expensive to be "right" too soon. In fact, its so painful and expensive that its little different from being wrong. So the temporal aspect of the calculation is critical; particularly for a policy maker.

A second aspect of "it" is that so far as I'm aware, no one saw clearly the web of derivative products that had increased implicit leverage far higher than we understood-- I'm thinking specifically of AIG. One reason that we didn't see AIG coming, was that like Enron, they'd structured their business to make it hard to see the parts that were contributing risk.

The FIRE sector didn't get modeled as Brezmer notes-- but not because people didn't want to. It couldn't modeled because AIG had purposefully established AIG Financial Products in a domicile outside of the Fed's ambit, and as such the Fed simply didn't have data to model their exposures. If you don't have AIG CDS exposure (and the similar exposures of counterparties) in your model, how _could_ you see "this" coming?

This is what is famously called the "shadow banking system". The essence of the shadow banking system is that it represents the movement of capital -- and leverage -- from the traditional, observable, regulated financial institutions to an alphabet soup of opaque entities.

We created a perverse set of incentives for the FIRE entities to move their risks to precisely the place where we couldn't see them clearly.

Mark Andreessen and Thoughts on the Venture Capital Industry

The venture capital industry has been spectacularly unsuccessful. Once you get beyond the very top of the heap (Sequoia) the returns have been lousy, and the liquidity nil. You need look no further than Andreeson's own startup (Loudcloud) to see why: smart people with a great track record plus a lot of venture money = not much.

Google skews everyone's view, but remember there were _many_ search companies, and by and large most haven't made any money at all. In a winner-takes-all business, if you don't have a share of the winner, you have nothing. What's more, you could have waited for Google to go public as a profitable company to invest in it. Investors who bought the Google IPO will end up doing far better than venture investors as a class.

The venture capital "business" has a considerable burden of proof in establishing that they have a business purpose -- and not mere vanity-- for their existence.

4 Drivers of the Exploding Federal Deficit

A thoughtful article, with useful data. The data suggest two things to me: one hopeful, the other not.

Hopeful: Much of the deficit is being driven by the recession. A return to "normal" economic activity, tax levels, and employment erase hundreds of billions of dollars of red ink.

Worrying: the practice of financing very large amounts of new debt with short terms obligations raises new challenges for Federal finances. Today there is little commercial demand for credit, so financing the deficit is relatively easy. One would prefer to see the Government increasing duration at this point, even at the risk of higher interest expense to avoid the problems of rolling over debt in a more challenging environment.

T. Boone Pickens' Epic Wind Fail

How could the transmission line problem have been a surprise? What kind of a bonehead starts leasing land and putting in orders for generation equipment without knowing how, if or at what cost he can get his "product" to market? If you were an investor of his, you'd have the right to be furious with that kind of carelessness

More likely, the collapse in energy prices changed the economics of everything to do with generation.

Is a Case of Quant Trading Sabotage About to Destroy Goldman Sachs?

@rrtzmd: " ..."32 megs of...code"????...32 MEGAbytes of code??...so a program the size of an average Nintendo DS game controlled Goldman's quant trading???"
----------------------...

That's a lot of code. Games are large, because graphics are large. There are no graphics in source . . .

Without graphics, 32 megabytes is (very roughly) 3-500,000 lines of source code. That's more than enough for trading algorithms.

California - And by Extension the U.S. - Headed for Permanently Smaller Economy

"Permanent" is long. Short of a plague, the prediction "US headed for a permanently smaller economy" _has_ to be wrong.

We have heard from the Gloom Brigade many times before-- when I was in college, everyone was reading the Club of Rome's report "The Limits to Growth" (1972). They made all the predictions you make, and and forty years later, they're still wrong.

Have we passed "peak autos"? I certainly hope so. We're also past "peak horse and carriages", "peak muskets", and "peak schooners".

The US economy is adjusting. Our problems today have today with the remarkable productive power of our economy: When in history has a nation collapsed because it produced too much food and too much housing?

Use ETFs Until 10-Year Returns Return

@ author
"I'm addressing Ten Year Returns, because that is, or WAS, the industry standard reporting "long term returns." Are you trying to obfuscate that fact?
----------------------...

No, I'm pointing out that you're erroneously concluding that the 10 year return number in some way indicts index strategies, when in fact it doesn't.

1) The 10 year number is valuable for comparing different funds to one another. Very few managed funds have outpeformed the indexes in the 10 year or any other periods.

2) The problem with using the 10 year number as you are doing should be obvious from considering the following:
- at the end of 1999, the SPX stood at just under 1500
- 2 years later, the SPX stood at 850, more than a %40 decline

What that means is that we _know_ that if the market remains flat for the next two years, the 10 year return will improve dramatically, even if an investor makes zero dollars, that's just the "rolling window" of the ten year horizon.

So that's why you can't use that figure as you're doing. Its useful as a metric for comparing between funds, but understanding the returns an investor can expect is a very different calculation.

Typical index investment strategies are nearly always averaging strategies, so an investor with an index portfolio today will have bought some SPX in 1999 at 1500, and some in 2001 at 850: your entire piece is based on a scenario where the investor puts all his money in at a market high, and then cashes out ten years later at a market low. That _would_ produce a lousy return, but its highly atypical.

Use ETFs Until 10-Year Returns Return

Author is making the error of picking one point -- a market high in 1999 -- as the entry, and another point -- a market low in 2009-- as the exit.

But that's not what long term investors do: they typically invest small increments over time. An index fund investor who invested throughout the 1990s and 2000s is doing as well or better than any other investor.

Are Airlines Going Bankrupt Again?

Author writes: "it is obvious air fares are simply too low to support the on-going fixed and variable costs of one of this country’s most important business sectors."
----------------------...

Um . . .head scratching . . . if the airlines aren't filling the seats with these cheap fares, how do you think they'd do with higher fares?

The problem with the airlines is not "cheap fares" -- its too much capacity.

Why is there excess capacity? For the same reason that there are too many condominiums in Las Vegas: far too much credit, on much too easy terms.

The Debate About 'Green Shoots'

One of the least appreciated bits of "healing" going on is the culling of the weak hands, and the transfer of their assets to stronger entities.

This aspect of a recession is under-appreciated. Balance sheets strengthen, collectively, when the weakest players get taken out and liquidated or reorganized.

This doesn't really fit the "green shoots" metaphor-- its more like "weeding".

But its striking to see: there are a ton of companies with a lot of cash and no debt, and strikingly they're in the more competitive sectors of the economy.

Relatively speaking Google, Microsoft, Apple, Hewlett-Packard, Adobe and Intel have supplanted "the weeds" as America's foremost companies.

And within crummy sectors, like real estate, the weakest hands and their inventory are being liquidated. Whoever's left in a few years will be minting money.

These are not "green shoots", but they are necessary structural adjustment, and in that light it will be heartening to see GM and Chrysler get out of bankruptcy. If they can start making cars profitably, then we will have turned an important corner.

Justin Fox on Regulatory Reform and Market Irrationality

"Efficient" and "Rational" do not mean the same thing.

The market is demonstrably efficient. This means that it discounts information known at the time, such that no party without the benefit of non-public information has a statistically significant probability of outperforming the market. That's what the numbers reveal. Despite the massive numbers of professional managers, no more than a handful outperform the market -- the same number of outliers that chance would predict. As Burton Malkiel pointed out, if you get a million people flipping coins, someone's going to flip "heads" many times in a row-- that doesn't make him a "genius coin flipper", that's just the way probability operates.

"Rational"? If by that one means "making appropriate allocations between sectors in society", then the answer is "no"-- but few have ever claimed that it was. Making allocations of resources for the benefit of society is a political act, a choice between values ("more stuff now" vs "more tanks" vs "more healthcare later") that are not part of economic calculation.