One of the changes that I will make for the future is to be extremely circumspect about any investment in a sector that has proved, over and over again, to have a strong propensity to blow up. I am currently living through my third cycle where the future of the banking system is in doubt. My first vivid memory of a near death experience for the large banks was in the early 1980s when all them had loans to Latin American countries go sour at about the same time. The second time was in the late 1980s and early 1990s, during the S & L debacle, when real estate loans were the main culprit. And, as we all know, the third recent death experience with the banks is happening now and it is the most serious of the three. It seems that the earnings reported by the banks in prior years was due to taking irresponsible risks that simply created the mirage of earnings. Vast fortunes were made made those responsible for taking those risks based on the a temporary illusion of being profitable activities. Some of these activities included the expansion of subprime and Alt-A mortgage lending activities, development of esoteric financial products understood by no one, bridge loans to fund leveraged buyouts with the downside assumed by the banking institutions and the upside taken by the buyout firms, and temporary profits generated by dramatic increases in leverage to fund ill-advised risks rarely fully understood or controlled by management. The individuals paid hundreds of millions of dollars to generate this crisis were in it for themselves, and none have had to pay for the consequences of their actions. The tab is picked up the 300 or so million people who did not benefit from their greed, what some call socialization of the risk and privatization of the benefits, except the number of those receiving the private benefits pale into insignificance compared to the hundreds of millions harmed by them. So, what am I saying. Banks stocks can not be viewed as long term holds. They are not reliable dividend vehicles. They are in constant danger of blowing themselves up based on substantial risks that are probably outside the shareholders' knowledge. From now on, if I decide to invest in one, it will be no more than a short term trade.
One interesting article that I read over the weekend can be found in the New York Times Magazine written by David Leonhardt. NYTimes.com The article was interesting on many issues but I was intrigued by his discussion of a book written by Mancur Olson called "The Rise and Decline of Nations". I have not read it yet but intend to find a copy. Olson discussed several examples of how affluent and stable societies start to decline. Successful nations spawn the creation of powerful interest groups that are able to curry favor with the government basically at the expense of everyone else. It is not only that these groups end up with a disproportionate share of the nation's income but their actions in furtherance of their parochial interests actually retards growth. In our society today, the financial industry is one of those groups that has taken a disproportionate share of the nation's wealth, and it now appears that they have destroyed far more than they have ever created.
The article also contained an interesting statistic about the stimulus package and growth. If part of the stimulus could be structured to generate long term growth, then the added growth would have to be just 1/10th a percent over 25 years to generate enough tax revenue to pay for a 800 billion dollar stimulus. There have been many long term stimulus plans that have had a long term impact on growth including the expansion of public education and the building of the interstate highway system. Several aspects of the Democrats stimulus plan are looking at longer term impacts on the economy. Some of those programs are related to education and others to funding the development of clean energy and facilitating the transition to digital hospital records. The article points out that digital hospital records will lower medical costs in a variety of ways for years to come.(There are some investment options in some of these programs.)
While I agree with many of the criticisms of this bill, as mentioned in prior posts, I also recognize the transformational possibilities of many of the spending programs. My representative, Marsha Blackburn, has only one idea, to cut taxes. www.tennessean.com | The Tennessean
She argues that spending by the federal government does not create jobs, which is more than idiotic. It is just patently false. Her only thought is to cut taxes more, but the GOP has been cutting taxes for eight years and where has that gotten us. The annual economic growth during the Bush years was the slowest since the 1930s. Why would Marsha focus on a single year in her opinion piece rather than the entire eight years. As a result of those patently failed policies, she argues for more of the same. We are facing the worst economic crisis since the 1930s. Yet, as demonstrated by their response to this crisis, the GOP has yet to engage in any introspection into their own failures, the role of their regulatory views on creating the current problem, and to formulate any alternative other than more of the same. Marsha is simply not capable of thinking about how the government can play a role in helping to facilitate additional economic growth. The DNA of the Republican party prohibits any thoughts along those lines. Yet the history of our country is filled with government funded initiatives creating or helping to facilitate long term growth in the nation's economy. This would include public education, infrastructure projects like the interstate highway system, the defense department's involvement in developing the internet, the space program and its related commercial benefits, and many more. If Marsha and the republicans could actually come up with better ideas about how to involve government intelligently in facilitating transformational growth, then let's hear them. I am tired of hearing from every single member of that Tribe that even more tax cuts, primarily for the wealthy, is their one and only idea. The current stimulus plan is need of improvement of course. But the improvements need to focus on transformational spending for long term growth and spending for a two year jolt to the economy where the taxpayer receives the most bang for the buck, and then balancing those two purposes into a coherent package. Some of the contemplated spending, which is all Marsha wishes to focus on when criticizing the package, has no relationship to either objective.
It is interesting to hear the financial wizards whine and complain about only receiving 18 billion in bonuses in a year that their firms have not only lost money but also had to receive tens of billions from the government to stay afloat. Compensation is not tied in any meaningful way to long term performance of those receiving the bonuses or to the overall profitability of the firm. Instead, they are viewed as entitlements by those who create nothing, build nothing, and whose risk taking is done with other people's money. We now know who ends up holding the bag when the bets turns sour.
Another interesting article is about how the SEC handles a situation where an investor criticizes the accounting practice of a company. Rather than investigating the company to determine whether the allegations have merit, the SEC brings in the messenger and gives them the third degree, treating the critic as the criminal. Then the SEC lawyer who does the grilling goes to work as a lobbyist for the firm whose accounting was the subject of the critique. NYTimes.com
The performance of the SEC enforcement chief, Linda Thomsen, at the recent Congressional hearing was just farcical. Yes, she defended the good work the agency did investigating Bernie. There needs to be a housecleaning at that agency particularly in the enforcement division.
I have started to read Taleb's book titled " The Black Swan: The Impact of the Highly Improbable" Amazon.com: The Black Swan: The Impact of the Highly Improbable: Nassim Nicholas Taleb: Books
The gist of his idea is that the outlier events are rare and unpredictable and are the most important events for investors. Investors place too much reliance on history repeating itself. If you had only seen white swans, you would think that all swans are white until that day the black swan first appears to you. He gives an analogy to a turkey who is treated like a king by humans for 1000 days. Then without warning and totally outside the turkey's power to predict, it is killed and eaten on the 1001st day. Most of my discussion has been about whether certain events relating to the current financial crisis could be characterized correctly as black swan events. An example would be the assumption built into the model by the AIG wizards in its Financial Product Unit that AIG would always have a AAA credit rating or failing to take into account other known variables that would impact the pricing and even the wisdom of issuing credit default insurance on mortgage pools. Possibly, their failures to model correctly had to do with unpredictability of events and an over reliance on models that did not factor outlier or even all possible events. I find that hard to believe as the culprit behind their failure which caused the demise of the largest insurance company in the world. I would posit another explanation-GREED. The persons working in the unit writing the credit default insurance that depended on AIG maintaining a AAA credit rating were making hundreds of millions of dollars. They were able to make that money by putting none of their own capital at risk. They assumed no risk. All of the risk was born by AIG and ultimately as it turned out by the U.S. taxpayer. These few individuals did not have to return their compensation, even in part, in the event of failure. If they changed the model to reflect known and possible outcomes, their percentage take from writing credit insurance would have gone down, possibly to nothing for certain securities. In short, their financial motivation was to ignore any variable in the risk model that would interfere with their compensation. So, they apparently excluded the risk of a credit downgrade of AIG on the contracts that they wrote. They would not have included in their models a decline in home prices caused by easy credit inflating housing prices to unsustainable levels, and the concomitant and unavoidable mortgage defaults that would thereafter occur in such circumstances, even though this was a generally known risk. I have also talked about the Black Swan event as it relates to other subjects in the current economic crisis. When the consequences of the risk is borne by someone other than the person responsible for the creation of the risk, there are other explanations, more potent, than Black Swan to explain why it happened. RYN vs. IP/Morgan & Madoff/Asset Managers/ Dell & Textron Doldrums/Option Arm Mortgages Were Not Black Swans
I discussed without referencing Black Swan the disassociation of risk from consequences of the risk taking in these posts:
No comments:
Post a Comment