FEAR?

 

 

F.E.A.R. by Janice Dorn, M.D., Ph.D. Collective fear stimulates herd instinct, and tends to produce ferocity toward those who are not regarded as members of the herd…Bertrand Russell Our ancestors lived in a constant state of fear– their lives in constant jeopardy from the elements, wild animals or climate changes that threatened to kill them. In the modern age, we know that some dangers

are still very real. If you are walking across the street and a large bus careening out of control comes bolting toward you at high speed — you are in real fear. In this case, the bus is the predator, and you are the prey. Death is literally staring you in the face, and your body goes into fight or flight mode as it tries to avoid it. This is real, tangible fear, and many of you have faced situations where bodily harm or death was literally staring you in the face.

In the markets, the fear predators are what force us to take action. Fear is the hunter, and we are the prey. We want to make money, and the predator that pushes us to do that is greed. Markets move up because people are buying and down because people are selling. We do not know the motives of these millions of people, but we infer that they are acting in their best interests to make money or minimize losses. Thus, buying or selling begets more buying or selling as the herd reacts to the predators of fear and greed.

To experience fear is human. With the exception of individuals who have certain brain lesions or are highly medicated with potent psychotropic medications, everyone alive feels fear. It is the emotion that binds us together, and it is the emotion that the media, public relations and advertising use to drive powerful messages directly into our limbic brains.

Paranoia strikes deep
Into your life it will creep
It starts when you’re always afraid
You step out of line, the man come and take you away…
“For What It’s Worth” by Buffalo Springfield

The major fears of traders are based on one simple premise: We do not like to be wrong! We don’t want to make a mistake–and having made one, we don’t want to admit it. At some point, the pain of realizing that we have made a mistake is too great to bear, and we get rid of our position at any cost. This is why short squeeze rallies (shorts buying at any cost just to get out so that they don’t have to take the pain that literally feels like their insides are being squeezed) are so powerful. This is why long squeeze declines (longs selling out at any cost just to get out so that they no longer have to tolerate the pain of descent into complete despair) are equally breathtaking.

The four major fears of traders and investors: fear of losing, fear of missing out, fear of leaving money on the table and fear of being wrong–are really some combination of fear and greed. The bottom line here is that fear is the predator. It chases after us, it hunts us down, it makes us captive to it and it causes us to act in ways that are not necessarily in the best interest of our equity curve. The fear of dying from a bus coming at you full force is very real. The fear of dying from selling a losing position or from leaving money on the table is quite different. The former is a rational fear of a real danger that is stalking us. The latter is not entirely rational, yet we allow it to stalk us.

The best thing we can do with less-than-rational fears is to turn them around completely. In other words, rather than letting fear be the predator and stalk you, adopt another attitude of action. Do not be paralyzed and frozen by fear. Become the predator and stalk it. Face it full on. Look at it and ask yourself if it’s really all that frightening. As long as you continue to allow yourself to be stalked by fear, your world will shrink, and you will become smaller and smaller as you retreat into a space of trying to protect yourself. Fear has you exactly where it wants you.

If, instead, you begin to move in the direction of your fears–slowly and steadily–you will find that they have less and less power over you. Your world begins to expand. You understand that fear is really False Evidence Appearing Real (F.E.A.R.). You begin to see that you have the power within you to face these fears and to control them. They are real only if you allow them to be real. By using the tools of position-sizing and money management, you control your risk as you move closer and closer to that fear. Once you are able to keep moving toward it, fear begins to diminish and you see it for what it really is, rather than what you imagined it to be.

You gain strength, courage, and confidence by every experience in which you really stop to look fear in the face. You must do the thing which you think you cannot do…Eleanor Roosevelt

Janice Dorn, M.D., Ph.D.
www.jtrader.us

About high yield Bonds

Warning by David Kotok:

Quote

I do not feel that way today for the reasons outlined above.  There are significant risks facing investors today, as David Kotok has so eloquently warned in his writings on the European debt crisis.  For once, however, those risks do not come from weak credit quality or overvaluation in the U.S. high yield market.  Ms. Pomboy was incorrect in her assessment, and the last thing the high yield bond market needs is its own Meredith Whitney moment.

Junk Bonds Are Fairly Valued
July 26, 2012

 

 

Michael Lewitt is a portfolio manager and heads the opportunistic credit section of Cumberland.  His bio can be found at www.cumber.com.  His email is michael.lewitt@cumber.com.

 

The great economic historian Charles Kindleberger described a bubble as follows:

 

“What happens, basically, is that some event changes the economic outlook.  New opportunities for profits are seized, and overdone, in ways so closely resembling irrationality as to constitute a mania.  Once the excessive character of the upswing is realized, the financial system experiences a sort of ‘distress,’ in the course of which the rush to reverse the expansion process may become so precipitous as to resemble panic.   In the manic phase, people of wealth or credit switch out of money or borrow to buy real or financial assets. In panic, the reverse movement takes place, from real or financial assets to money, or repayment of debt, with a crash in the prices of commodities, houses, buildings, land, stocks, bonds – in short, in whatever has been the subject of the mania.”  (Manias, Panics and Crashes, 1989)

 

In recent years, we have seen this process occur with respect to internet stocks (late 1990s), the nation’s housing stock (mid-2000s), and twice with respect to corporate credit and the high yield bond market (2001-2 and 2008).

 

Last weekend, we were warned that the high yield bond market is experiencing a bubble.  Unfortunately, the warning was completely misplaced despite coming from a highly respected source, MacroMavens’ Stephanie Pomboy.   Ms. Pomboy argued in Barron’s that high yield bonds meet “all the standard criteria of a bubble.”   I don’t know which criteria she is referring to, but I would respectfully suggest that Ms. Pomboy reread her Kindleberger.   The reality is that today’s high yield bond market exhibits none of the characteristics of a bubble.

 

Investors’ desperate search for yield in today’s zero interest rate environment could lead them to look for yield in all the wrong places.  The Federal Reserve’s zero interest rate policy has now persisted for four years and there is no end in sight.  Today, however, the high yield bond market is not one of the wrong places to look for yield, as it has been so many times in the past.  There are several reasons why that is the case.

 

The most important reason is that corporate default risk today is extremely low today.  It is also likely to stay that way.  Thus far in 2012, the corporate default rate is below 3%, far less than the historical average of 4.6%.  High yield issuers have strong cash balances, healthy working capital positions, and manageable debt amortization schedules.   Prior to earlier high yield bond market collapses in 2001 and 2009, there were many warning signs that corporate defaults were going to skyrocket.  The market did not disappoint.  In 2001, defaults reached 10.5% and in 2009 they hit 13%, the highest corporate default rates the U.S. had seen since the Great Depression of the 1930s.  Conditions today are a far cry from then.

 

The second reason why the high yield bond market is not in a bubble is that valuations are not unreasonable.  Ms. Pomboy argues that “spreads are hovering at 2005 lows” (Barron’s, July 23, 2012, p. 33), but that is simply not true.  In fact, spreads are much wider today than they were in 2005.

 

	5/31/2007	7/24/12	Difference
Avg. Yield-To-Worst	7.48%	7.01%	-0.47
High Yield Index Spread	238	613	+375
BB Spread	168	451	+283
B Spread	228	588	+360
CCC Spread	378	1027	+649

Based on Barclays/Lehman High Yield Index option adjusted spreads.

 

Ms. Pomboy is certainly correct to point out that the absolute yields on high yield bonds are uncomfortably stingy today.  As hybrid securities that combine the characteristics of equity and debt, high yield bonds should offer investors an appropriately high return for taking equity risk.  That risk, however, is much higher in a CCC-rated bond than a BB-rated bond. But  CCC-rated bonds offer average yields of 11% today, which compares very favorably with what is on offer from many stocks today.  That is certainly not the sign of a bubble.  This is particularly true with respect to the CCC-rated bonds of large leveraged buyouts that date from the mid-2000s.  Moreover, despite their low ratings, many of these bonds are attractive investments today for too many reasons to outline here.

 

The third reason that high yield bonds are not experiencing a bubble is that there are few signs that the new issue market has reached the silly season.  In fact, the quality of new bond issuance is far superior today to what it was in the periods that preceded previous market crashes.  The internet bubble of the late 1990s-early 2000s was fueled by telecommunications and internet companies selling debt, while the private equity bubble of the mid-2000s was fed by the large buyout firms.  In both periods, these borrowers flooded the markets with tens of billions of dollars of highly speculative deals of dubious credit quality: bonds rated CCC+ or lower; holding company bonds; pay-in-kind or toggle notes (bonds that have the option of paying interest in cash or kind); dividend recapitalization financings; and covenant light bank loans.  Most new issuance today is related to the refinancing of existing debt. Very few new LBOs are being done, and telecommunications, technology and internet companies are financing themselves in the equity markets, where they belong.

 

Those familiar with my track record and writings know that I have never been an apologist for high yield bonds.  In fact, I have spent much of my career warning investors about their risks.  My approach to investing in this asset class is different than that of most managers based on my dour view of these securities and the private equity firms that are among their largest issuers.  In both 2001 and 2007, I warned investors to exit the high yield credit market in my newsletter, The Credit Strategist (www.thecreditstrategist.com).   I do not feel that way today for the reasons outlined above.  There are significant risks facing investors today, as David Kotok has so eloquently warned in his writings on the European debt crisis.  For once, however, those risks do not come from weak credit quality or overvaluation in the U.S. high yield market.  Ms. Pomboy was incorrect in her assessment, and the last thing the high yield bond market needs is its own Meredith Whitney moment.

 

Michael Lewitt, Vice President and Portfolio Manager

 

Resources:
To sign-up for Market Commentaries from Cumberland Advisors: http://www.cumber.com/signup.aspx
For Cumberland Advisors Investment Portfolio Styles: http://www.cumber.com/styles.aspx?file=styles_index.asp
For personal correspondence: michael.lewitt@cumber.com

Twitter: @CumberlandADV

Think with your Mind

Abandon Hope by Janice Dorn, M.D., Ph.D. Hope in reality is the worst of all evils because it prolongs the torments of man…Friedrich Nietzsche Take an old pair of jeans and cut a hole in one of the pockets. Now, start pouring sand into that pocket. What happens? Sand runs down your leg and to the ground. What do you do? Keep pouring until the

sand is up to your ankles? Your knees? Your waist?

At what point do you realize and act on the fact that no matter how much or how fast you pour sand into the empty pocket, you have a hole in your pocket? When do you come to the conclusion that you either have to stop pouring sand or just throw your pants on the ground and run away as fast as you can?

Sadly, many of you will keep pouring until you are up to your neck in sand. Suddenly, it begins to feel like quicksand and you are trapped–can’t or won’t get out. At this point, you feel like you are being pulled down into the quicksand, unable to breathe, choking and suffocating in the murky slime.

This is how it feels to lose. The hole in your pocket is the losing position. The sand is your mental, emotional, physical, financial and spiritual capital pouring out until you are drained, have nothing left to give and are literally sinking in a quagmire of your own creation. The pain of loss is excruciating, like a knife stabbing through you. Everything feels quite different when you are in a losing position. The experience of time changes and seems to slow down to a snail’s pace. Physical health deteriorates due to the outpouring of stress hormones that weaken your immune system. In the same manner that going long in the markets is not the inverse of going short, losing is much more than just the absence of winning.

The feeling of losing is persistent, relentless and devastating. It eats away at you like a cancer that metastasizes to every part of the body, killing one cell after the other. If it is not contained, losing truly feels like death. How does deterioration of psychological and physical capital with focus on a losing position manifest itself? Irritability, sleeplessness, continual searching for something or someone to affirm your position (confirmation bias), anxiety and dysphoria, tick-itis (the toxic habit of watching every tick of the position day after day), rumination, self-deception, impairment of social and family activities and a litany of other unpleasant emotional and physical states. Perhaps the worst aspect of this is the spiritual decay that manifests as self deception and lying to family and friends. One is rarely capable of owning true feelings of guilt, shame and inadequacy and shifts into a mind morph where a failed trade becomes a hold and hope investment.

Of the gamut of emotions that flood traders and investors on a daily basis, the most risky is hope. It borders on delusional to believe that the markets are kind, loving and give you money if you just keep your pants on and hang in there. If this is what you are thinking, it might be a good time to reassess why you are in the financial markets– among the most cruel, bloody and dangerous games that humans play.

The most rigorously honest thing that I can say in response to this type of thinking is: abandon hope. As extreme as this may sound, it is the only way to be consistently successful. Attachment to a losing position is a recipe for more misery and illness than any one of you deserves. Eschew complacency and mediocrity, both in trading and life. Cut losers quickly and do not sit around waiting for the markets to rescue you. 80% of all traders are out of the game within six months because they don’t have the discipline to manage risk by cutting losing positions.

Who can say what is waiting for you at the bottom of the slippery slope of hope? Stop pouring sand into the hole in your pants before it is too late. Suffering is optional and you are in control. Take your power and use it to make yourself strong in the service of living and breathing with freedom to play another day.

The trouble with most people is that they think with their hopes or fears or wishes rather than with their minds… Will Durant (American Historian and Philosopher…1885-1981)

Janice Dorn, M.D., Ph.D.

www.jtrader.us

Text Copyright: Janice Dorn, M.D., Ph.D. 2012 All Rights Reserved

Public governance in LIBOR

Updates from my friend David Kotok

LIBOR and Public Governance

July 23, 2012

 

This commentary was written by Bill Witherell, Cumberland’s Chief Global Economist.  He joined Cumberland after years of experience at the OECD in Paris.  His bio is found on Cumberland’s home page, www.cumber.com.  He can be reached at Bill.Witherell@cumber.com.

 

 

Recently I wrote about the sorry state of corporate governance in some leading financial institutions that is being revealed by the still-developing LIBOR scandal. We now have, in addition, the US Senate report charging that the lax guidelines of HSBC affiliates worldwide failed to guard against money laundering, doing business with firms linked to terrorism, and bypassing sanctions against Iran. Thus we have more damage being done to confidence in the major global banks. In this note we turn to some public governance issues raised by the LIBOR scandal. Did central banks and the relevant regulatory bodies, along with the international bodies responsible for overseeing the global financial system, respond to the problems in the ways we should expect?

 

One broad measure of what we should expect at the public governance level can be found in the OECD Principles of Corporate Governancethat I cited in my previous note. Recall that these Principles have been endorsed by the governments of the 34 member countries of the OECD, including the US and the UK, as well as the World Bank and the IMF.  Principle I.D states, “Supervisory, regulatory and enforcement authorities should have the authority, integrity and resources to fulfill their duties in a professional and objective manner. Moreover, their rulings should be timely, transparent and fully explained.” We will focus on the second sentence of this Principle.

 

It has become evident that a number of national regulatory agencies and central banks were aware of the problems with LIBOR and the possibility of abuses well before the present year.  My colleague Bob Eisenbeis has written about staff members of the New York Federal Reserve Bank having discussions on the matter with staff of Barclays in December of 2007. The then President of the NY Fed, Timothy Geithner, “spoke briefly” (his words) on the subject with Mervyn King, Governor of the Bank of England, in Basel, Switzerland, where both attended the monthly gatherings of central bankers at the Bank for International  Settlements (BIS), considered to be “the central bank for the central banks.”  On June 1, 2008 Geithner sent an email to King offering six “Recommendations for Enhancing the Credibility of Libor” that had been developed by the staff of the New York Fed.  King replied that the recommendations “seem sensible to us” and that he was passing them to the British Bankers Association (BBA), which is responsible for the daily LIBOR fixing.  On May 1, 2008 the New York Fed also briefed the Federal Reserve Board and relevant regulatory bodies, in particular, the Commodities Futures Trading Commission, which had already opened an investigation the previous month, and the Securities and Exchange Commission.   As far as these steps go, they are commendable. But did they go far enough?

 

On July 20 the Bank of England released on its website a large amount of correspondence between the Fed, the BOE, the BBA and the UK’s Financial Services Authority (FSA) that sheds information about the BBA’s review of LIBOR in 2008. Clearly in the period following the receipt of Geithner’s recommendations, the BOE and the Fed continued to interact with the BBA, seeking to shape the final results of the Libor review while not wishing to be seen as endorsing those results. The BBA did not seem to think anything was really wrong with LIBOR but they recognized they had a serious perception problem that they needed to be seen as addressing. The BOE appeared to be more concerned that LIBOR had deficiencies that needed to be addressed in order to make sure that LIBOR would not be replaced by a New-York based alternative. There are no indications in this correspondence that anyone felt they were dealing with a problem of systemic importance. Nor is there any suggestion that either the Fed or the BOE were unsatisfied with the modest results of the review, which only partially took on board the Fed’s recommendations.

 

Last week, Mervin King, under fire for not acting sooner, charged that Geithner gave no indication of malpractice in their 2008 exchange. In their July 20 posting on their website, the BOE  adds “At no point did the FRBNY draw the attention of the Bank to evidence of wrongdoing in the setting of BBA Libor.  Indeed, with the exception of the memorandum sent by Mr. Geithner to the Bank in early June 2008, none of the other documents published on June 13 2012 by the FRBNY had been shared with the Bank.  These showed, inter alia, that back in April of 2008 a Barclay’s staff member advised a New York Fed staff member that the bank in the UK was low-balling rates to avoid appearing weak.  Fed Chairman Bernanke testified last week that in 2008 they had no information that bank traders had tried to manipulate rates “for profit.” However, both the Fed and the BOE certainly should have been aware by then of the potential for such manipulation.

 

In addition to warnings in academic papers and the NY Fed’s own research, it is notable that the March 2008 issue of the BIS Quarterly Review included an article, “Interbank rate fixings during the recent turmoil,” by two BIS economists, Jacob Gyntelberg and Phillip Wooldridge.  They say the following:

 

“The widespread use of fixings as reference rates also gives contributing banks an incentive to misquote.… For example, market participants with large positions in derivative contracts reference a rate fixing might seek to move the fixing higher or lower by contributing biased quotes. Alternatively, they might indirectly influence the accuracy of the fixing by choosing not to join the contributor panel.”

 

The scope for such strategic behavior to influence the fixing can to some extent be limited by trimming, in which biased or extreme quotes are disregarded. However, even trimmed means can be manipulated if contributor banks collude or if a sufficient number change their behavior.”

 

Last week Bernanke testified that, “The LIBOR system is structurally flawed … It is a major problem for our financial system and for confidence in the financial system … we need to address it.” He emphasized that this will require an international effort.  We would agree. It seems doubtful, however, that either US or UK authorities recognized until very recently that the problem was major, of systemic importance, even though regulatory investigations have been underway since 2008 in the US; and now reportedly at least 10 enforcement agencies globally, including those in Canada, Japan, Europe, and Korea have investigations underway. There appear to have been no efforts to raise the issue in key international financial forums, in particular, the BIS, the Financial Stability Board, the IMF, or the OECD, all of which could have been used to increase awareness of the problem and exert pressure for reform.  Until the recent revelations, there has been no effort of which we are aware to inform investors or the general public that a benchmark rate central to the plumbing of the financial system was structurally flawed.

 

Indeed, the opposite signal was given as the Fed continued to use the LIBOR as a benchmark. In September 2008 the NY Fed extended to AIG an $85 billion line of credit with an interest rate based on the LIBOR. In November 2008, when the Fed established the Term Asset-Backed Securities Loan Facility, it again used the LIBOR to set the interest rate. Now, five years after the first warnings were given, all the relevant public-sector institutions are picking up the ball. Regulatory and enforcement bodies are carrying out investigations, some of which are well-advanced. Mervyn King has arranged for a meeting September 9 in Basel, bringing together central bankers to discuss LIBOR deficiencies and consider “radical reforms.”  Also, Mark Carney, governor of the Bank of Canada and chairman of the Financial Stability Board, said the FSB will look for long-run solutions to the LIBOR problem.  The FSB brings together bank regulators, finance ministers, and other financial supervisors under a mandate to coordinate at the international level the work of national financial authorities to develop and promote the implementation of effective regulatory, supervisory, and other financial-sector policies that have implications for financial stability.

 

It is a pity that it took five years and the Barclays case to bring this degree of attention to the issue. Referring back to the governance Principle cited in the second paragraph, we certainly cannot give a high grade for transparency. As for timeliness, the NY Fed got off to a good start, but the follow-up by the Fed after 2008 was lacking. As for the Bank of England and the UK’s Financial Services Authority, the defense that the US did not provide a sufficient warning about deficiencies in the LIBOR seems weak to us.  It is unfortunate that the Bank of England apparently was not informed by the NY Fed of information it had obtained about practices at Barclay’s in London. However, as the LIBOR system is based in the UK, the BOE and the FSA must have been aware of the structural flaws, but apparently did not recognize their systemic importance.

 

Bill Witherell, Chief Global Economist

 

Resources:
To sign-up for Market Commentaries from Cumberland Advisors: http://www.cumber.com/signup.aspx
For Cumberland Advisors Investment Portfolio Styles: http://www.cumber.com/styles.aspx?file=styles_index.asp
For personal correspondence: bill.witherell@cumber.com

Twitter: @CumberlandADV

Decision Matrix

Succinctly put by my good and dear friend :

Beware The Biases

by Janice Dorn, M.D., Ph.D.

It is one thing to show a man that he is in an error, and another to put him in possession of truth…John Locke

Cognitive biases describe the way you think–the operative words here being cognitive (thinking) and biases (prejudices). You tend to hold on to your biases, even when they don’t serve you well.This causes you to make trading mistake after trading mistake. Also, since your brain is hard-wired for biases, it is difficult to change them without experiencing some type of internal discomfort.  Resistance to change and acting out of biases have two effects on your trading and investing: You do the same thing over and over again, and you expect different results every time you do it. This is–as you are aware—Albert Einstein’s definition of insanity.

In order to push through the biases that are holding you back from becoming a profitable trader and investor, you must be aware of them and make appropriate changes. How do you make changes? You retrain your trading brain. This is done through consistent coaching and practice. It takes time, but it is completely doable—and it works!

The human brain uses biases to protect against assaults on your self-esteem. The self-attribution bias describes the tendency for good outcomes to be attributed to skill and bad outcomes to be attributed to just plain hideous bad luck.

A decision matrix for self-attribution bias looks something like this:

Good Outcome

Bad Outcome

Right Reason

Skill

Bad luck

Wrong Reason

Good luck

Mistake

This type of thinking is one of the biggest obstacles you must push through in order to become successful. Why? Because the only way to gain consistent profitability as a trader is to recognize and take full responsibility for your own mistakes. This is yet another reason to keep a detailed trading journal and to analyze each trade in context of self-attribution. In this way, you will come to a better understanding of where you were skillful and where you were lucky.You will also find that mistakes are essential to learning—both in the markets and in life. The takeaway is to accept a mistake as a mistake, not blame anyone else, and learn from it so as not to make it again.

Here are some questions for you to ponder as they pertain to self-attribution bias and how it is interfering with your trading success:

1. When are you lucky and when are you skillful?

2. Are you right for the “right” reason, or are you right for some other reason?

3. Does it matter, as long as you are right?

4. How do you measure and “fess up” to mistakes—i.e., recognize mistakes as mistakes by taking personal responsibility and accumulating regret?

5. Is it important to do this, and why or why not?

6. What are some other biases that affect your trading results?

You should examine yourself daily. If you find faults, you should correct them. When you find none, you should try even harder…Israel Zangwill

Thanks and Good Trading!

Janice Dorn,M.D., Ph.D.

Scorpion v Frog

THE SCORPION AND THE FROG

 Janice Dorn, M.D., Ph.D.

http://jtrader.us/

 A scorpion and a frog meet on the bank of a stream and the

scorpion asks the frog to carry him across on its back. The

frog asks, “How do I know you won’t sting me?” The scorpion

says, “Because if I do, I will die too.”

The frog is satisfied, and they set out, but in midstream,

the scorpion stings the frog. The frog feels the onset of

paralysis and starts to sink, knowing they both will drown,

but has just enough time to gasp “Why?”

Replies the scorpion: “It’s my nature…”  Aesop’s Fables

No matter who you are, how intelligent or how much education you have, if you keep doing the same thing over and over again, expecting different results, you are suffering from the most insidious form of insanity. This is self-delusion of the highest degree. Years ago, when I first started to trade, I was so optimistic that I could make money consistently. I was smart, educated, a successful physician, and always had been able to study hard and master anything I put my mind to. I could do it and nothing was going to stop me. I would work longer and more intensely than anyone else, and show wonderful profits month after month.

Little did I know what I was facing, and that I was about to come head on with the most challenging task of my lifetime. Simple—maybe–but not easy.  Not easy at all. After a few months, I found myself dancing as fast as I could; yet running on a treadmill going nowhere and suffering from vertigo, headache and a severe case of tick-itis. I studied and read everything I could lay my hands on, subscribed to service after service looking for the Holy Grail and struggling to make consistently successful trades. Why couldn’t I do it? What was wrong?

Is this so difficult? What about all the people who have returns of greater than 80% a years? They couldn’t be exaggerating, could they? After all, it’s in print and on a heavily subscribed website, so it must be true. Mustn’t it? So I studied more, subscribed to more services, learned new indicators, bought books, joined some chat rooms and saturated myself with information. This produced more vertigo, headache and sleep deprivation. I was on total information overload. I started sleeping sitting up so that I would not sleep too deeply and could awaken more easily at 4:30AM (having gone to sleep at around 1:30 AM) in order to study and watch the markets before they opened at 6:30 AM.

I was in total immersion, so why couldn’t I make consistently successful trades? I became paranoid, thinking it was a kind of conspiracy since every time I took a position it went against me. I knew the stop and was stopped out in my minds, but we didn’t take the stops because I had faith that the position would come back. It was some kind of a misunderstanding or misinterpretation by the market that was responsible for the price spiraling downward.

Buy more. That’s it. Average down and keep averaging down and eventually, I will get it right. Eventually, the price will come back up and I will be justified. Why isn’t the price coming back? I know it has to. After all, I studied it, charted it, listened to the gurus, read everything on every bulletin board, and it absolutely HAS to come back. Oh, that news that just came out…. Ugh! Must be false or overstated because there is no reason that the stock should be selling off like that.

I know it is coming back, so I will buy more. Wow!! Look at the size of the position now. Hmmmm. I better kick it up a notch and start participating in every message board and study every report and watch every tick every day for signs that life is returning and I can get back from underwater. Most of you know how this feels. I do. I have been there, lived it, and suffered losses from it. Life was miserable this way. I became depressed and irritable. I walled myself off from the rest of the world just trying to figure out what to do. I had dug a really deep hole and the only way out was to sell and take the losses. OR- wait and be in agony day after day, watching my account and my self-esteem (what was left of it) erode like shifting sands.

I tried too hard, studied too much, and pushed myself to the point of both physical and mental exhaustion. Why? Why did I not honor the stop, continue to hold on and even average down? I had to figuratively kill the frog and kill myself in the process. In order to be reborn, I had to destroy the internal self-defeating programming and start all over again. I had to step back, look at what I had done with a sharp and penetrating glare in the bright light of day. I decided to take the loss, to stop trading for a while, to take a vacation and center myself. My health returned. The dizziness and headache went away. I didn’t care so much about watching the flickering ticks (so, at least, I was in remission from a severe case of tick-itis).

It was not the market, the charts, the software, the gurus or anyone/anything else. It was me! I was my worst enemy. Nothing was going to change until I got right with myself.

The most exquisite paradox is that as soon as you give it all up, you can have it all.

As long as you want power, you can’t have it. The minute you don’t want power, you’ll have more than you ever dreamed possible… Ram Dass

 

Janice Dorn, M.D., Ph.D.

http://jtrader.us/

 

 

Text Copyright:  Janice Dorn, M.D., Ph.D., 2012 All rights reserved

Illustration Copyright:  http://tinyurl.com/cvwgl5c

Libor – Costs & Victims

This is serious….

The Libor Scandal: Costs and Victims
July 17, 2012

Readers are seeing a series of Cumberland commentaries about the Libor Scandal.  We do not intend to bore you.  We do intend to explore it in detail, from various perspectives, seeking out the nuances, and asking as many questions as we answer.

 

Why are we doing this?  We believe the Libor scandal is systemic and worldwide.  It is not idiosyncratic to Barclays.  The UK has seven other firms under investigation right now.  Barclays was the first to reveal a settlement.  The nature of the settlement itself indicates that the scandal is huge.

 

The implications of the Libor Scandal are significant in many ways.  They will certainly alter the global direction and scope of regulation and supervision.  The outcome will not be known for years.  There are good reasons why Fed Chairman Bernanke used words like “weakens confidence” and “fundamentally flawed” in his testimony today.  We was asked repeatedly about the Libor Scandal.  Note how he could not give “full assurances” to Senators that Libor pricing today was trustworthy.

 

There are multiple questions and issues involving different national jurisdictions.  My colleagues and I have already written about some differences between the US and the UK.  However, the Libor-setting entities include banking institutions worldwide.  Libor-type, rate-setting mechanisms are in place for the world’s major currencies.  The investigation is underway in several countries, not just the US and the UK.

 

The amounts tied to Libor are monumental.  That suggests the claims asserted by plaintiffs in class-action suits are likely to be enormous.  We expect the alleged damages to be in the trillions.

 

What happens when those claims are resolved over time?  Who pays whom?  How much?  Some estimates suggest the claims will be a severe blow to the banking system, require recapitalization of certain large banks, and lead to a new version of TARP.  We think that is extreme but, of course, no one knows at this juncture.  The worst-case estimate has Congress capping the liabilities of US-based banking institutions.  Others suggest similar actions will take place in Europe and elsewhere.  Who knows?

 

The best-case scenario is that there is no liability.  We see many arguments being proffered to blunt the plaintiffs’ attacks.  Some argue that the Libor-setting estimates were just that: estimates.  There were warnings to that effect.  They say that these were not fraudulent transactions.  The trimmed-mean method means the high and low are not included in the final pricing, so a bad estimate is in the group that is thrown out.  In due time, we will find out how valid these arguments are.  At Cumberland, we doubt these defenses will prevail.

 

In the end, legal systems around the world will be making decisions on liabilities.  They are different systems and their legal constructions are quite distinct as to the nuances.

 

Let me offer a thought-provoking calculation.  Many estimates center on $350 trillion in derivatives, securities, and debt pricing tied to Libor.  Assume that number is correct.  Suppose a claim is asserted by a class action that ultimately results in a judgment of 1 basis point in damages.  That’s right, for this example we will assume only a single basis point.  One basis point on $350 trillion dollars is a very large sum.  It is $35 billion.  That is the damage for only one year.  The Libor Scandal covered many years.

 

The highest estimates of total global exposure to US-dollar Libor are close to $850 trillion.  Some claims are asserting that the Libor-rigging distortion was as high as 80 basis points.  Remember, this was a multi-year scandal and these are the numbers for one year.  Bottom line, the liability is potentially quite large.  Also, remember: these are estimates for US-dollar Libor.  What about the other currencies?

 

At Cumberland, we believe that this Libor scandal involves two elements.  One of them is the retrospective of how the system operated in 2007-2009.  We already see evidence of disclosure of things we did not know existed.  My colleagues have been working on them, so I will not repeat them here.  See www.cumber.com for the Libor-related commentaries.

 

Other issues with the Libor Scandal involve other asset classes.  For example, we know billions in US housing-finance mortgages are tied to Libor.  That number has been estimated as approximately $275 billion and covers an estimated 900,000 mortgages.  Cumberland staff is among the potential plaintiffs.  Do those borrowers have a claim?  Were they overcharged?  Were they undercharged?  If they were overcharged, did the recipient of the payments have a windfall?  Should it be returned?  Is there a claw back provision that would be implemented by a judge in the settlement of the claim?

 

What about the foreign exchange market?  Libor is instructive, indicative, and relied upon in order to set foreign exchange rates and the placement of funds.  Global corporate treasurers look at two things (or at least they did): the Libor maturity schedule from one day to one year, and the foreign exchange market forward rates for the same period of time.  The corporate treasurer has to decide in which currency he will deploy cash.  Does he deploy monies in Currency A or Currency B; which way does he maximize his yield?  He then goes to his commercial bank and puts on the position that is perceived to be the most beneficial to his company. In many cases, that bank is also on the Libor-setting committee for one of the currencies.  Some of those banks are primary dealers with the Federal Reserve.  The positions taken are transactions based on good faith.  For years, they were “trusted.”

 

What if one of those rates is rigged?  The whole game changes.  Billions may have been deployed based upon assumptions that are now questioned.

 

Our Cumberland team will explore these issues over the coming weeks and months.  We need to know what was real and what was rigged – that is obvious.  We also need to know what indicators, what tests, what market-derived pricing was faulty.  For example, if you depended on the TED spread to make your stock market investment decisions in 2007-2009, you may have made decisions on faulty information.  Now you know that information is suspect.  You are aware that activities in the UK were/are flawed.  You also know that the system of governance has not been changed.  Can you depend on these market-based indicators today?  If not, you should be questioning other indicators as well.

 

Where does this end?  None of us knows.  This is an unfolding revelation.  We are going to learn piece-by-piece as the onion layers are peeled back.

 

We will close this commentary with a personal note.  We feel badly for some of our friends at Barclays and at other firms.  Those individuals had nothing to do with the Libor Scandal.  They are economists and analysts and they do excellent research.  They publish some of the finest work in the world.  They are now likely to feel some angst because their institutions have been tainted with reputational risk.  From our conversations, we know that they carry psychological pain.

 

To them we add this note.  You did not do anything wrong.  You did your best in the research sphere.  You assessed economics and finance.  You reviewed published market data.  You did so in good faith.  Now, you have to carry a burden that you did not create.  That is unfortunate.  You, too, are a victim of the Libor Scandal.

 

To be continued…

 

David R. Kotok, Chairman and Chief Investment Officer

Follow-up on LIBOR

MORE INFORMATION COMING IN FROM MY FRIEND DAVID KOTOK:

What Did They Know, When Did They Know It, and What Did They Do? Part II (REVISED)
July 16, 2012

Bob Eisenbeis is Cumberland’s Chief Monetary Economist. Prior to joining Cumberland Advisors he was the Executive Vice President and Director of Research at the Federal Reserve Bank of Atlanta. Bob is presently a member of the U.S. Shadow Financial Regulatory Committee and the Financial Economist Roundtable. His bio is found at www.cumber.com.  He may be reached at Bob.Eisenbeis@cumber.com.

 

Since the release of the commentary “What Did They Know, When Did They Know It and What Did They Do?: Part II,” additional facts have come out concerning follow up actions by the Bank of England in the LIBOR fixing scandal and are now reflected in the revised version below.

 

Last Friday the Federal Reserve Bank of New York released about 100 pages of emails and internal documents from both its own staff and Barclays concerning the LIBOR-fixing problem.  The redacted Barclays documents cover parts of 2007 and 2008, while the FRB NY documents cover only 2008.  It is tempting to jump to conclusions about what did or did not happen and why; but there are still some missing pieces of the puzzle, and the FRB NY has not been as forthcoming as it might have been, as will be detailed below.  Some commentators are already criticizing Treasury Secretary Geithner’s handling of the events while he was president of the FRB NY but one should reserve judgment for the time being.  We will clearly learn more when he and Chairman Bernanke testify on the issues.  For now it is important to look first at the evidence that is presently available and try objectively to sort through the issues as they now appear.  For this author, who was a former Federal Reserve Bank of Atlanta official, it is hard to maintain a totally unbiased view on the issues, but we’ll try.

 

Fact number one is that questions about the LIBOR fixing have existed for a long time.  Potential problems with the structure of the LIBOR-fixing process were examined by a Federal Reserve Board staff member as far back as 1998. (See Jeremy Berkowitz, “Dealer Polling in the Presence of Possibly Noisy Reporting,” Federal Reserve Board, 1998.)  Berkowitz’s research suggests that as few as four inaccurate submissions could bias the reported LIBOR rate. .  Others have shown that the rate could be manipulated, with even one biased submission.

 

The LIBOR-fixing process is clearly flawed, since it isn’t based upon actual transactions, and the structure is prone to incentive conflicts that are obvious and should have been corrected by the British Bankers Association (BBA) years ago.    The whole process has a clubby tone that one might expect when a trade organization is responsible for compiling and releasing a key interest-rate statistic on behalf of its constituents.  Such a system relies upon trust and honesty that can be challenged when market access and earnings pressures exist, and a trade group is not in a strong position to either police or correct the behavior of its members.  The BBA bears a heavy responsibility for the current problems, which raises the issue of whether the process should be taken over by the Bank of England or some other responsible, unbiased authority.  Indeed, even after the scandal broke, the BBA website continues to contain two substantively different descriptions of what LIBOR actually is.[1]

 

Fact number two is that regulators were aware of possible anomalies in the daily submissions. When they were brought to the attention of the British authorities, namely the Bank of England, as a result of a 2008 Wall Street Journal article, nothing of substance was done.  Nor was there significant follow up when Mervin King, Governor of the Bank of England, was presented with a set of recommendations by the Federal Reserve Bank of New York.  Reportedly the Bank of England did forward the Fed’s recommendations to the BBA, but no changes were made in response.  Indeed, the FRB NY documents also call into question the Bank of England’s Deputy Governor Paul Tucker’s claim that he was unaware of the problems until much later in 2009 since he was copied on the 2008 email exchange between Governor King and President Geithner that expressly stated that he had been instructed to look into the matter with the Manager of the Desk.

 

Fact number three is that staff members of the Markets Group at the FRB NY were clearly aware of problems with LIBOR postings, particularly in the dollar LIBOR rate, long before it was apparently brought to the attention of then-President Geithner.  Transcripts of conversations as early as December of 2007 between staff of the Markets Group and Barclays’ staff raised questions about the LIBOR fixing, and a subsequent April 2008 transcript of conversations contained admissions of intentional misstatement of the rate by Barclays and possibly that other firms were also fudging the numbers.  The tone of the transcript conversations raises a cultural concern.  Both parties to the conversation seemed to view themselves as part of a closed club in which the exchange of information was freely given with little concern for confidentiality or the risk that such discussions might be viewed by outsiders as inappropriate.

 

In assessing these conversations, it is important to understand the role of the Markets Group, how it fits into the NY Fed, and what its function is for the FOMC.  The Group reports to the Manager of the System Open Market Account, who is responsible for managing the day-to-day transactions with the Primary Dealers as part of the Manager’s responsibility to keep the Federal Funds target interest rate where the FOMC has directed.  Each day there is a telephone call involving the staff of the Markets Group, members of the Division of Monetary Affairs of the Board of Governors, and one of the presidents who is a voting member of the FOMC.  There is a briefing on market developments during the previous day and in overnight foreign financial markets, most if not all of which is irrelevant to the decision to be made that day on the volume of securities or repo transactions to be undertaken.  The daily program is most heavily influenced by Treasury balance conditions, draws on the Treasury tax and loan accounts, and events that might have affected the flow of payments through the payments system the previous day, all of which could influence the reserve positions of banks that day.  It would be interesting to know whether any questions were raised in the course of the daily phone discussions, which might or might not have been recorded, about the efficacy of the LIBOR fixings, and whether any such concerns might have been transmitted to the FOMC.

 

The Markets Group is mainly a market monitoring and service group.  It does not perform market regulatory functions, although it does provide several other types of services to the Treasury as well as other central banks.  The Manager is appointed by the FOMC, but the Group and the Manager are lodged within the FRB NY and technically report to the bank’s First Vice President, although the Group essentially operates autonomously.  In addition, it is totally separate from the NY Bank’s supervisory staff and does not conduct institutional surveillance activities.  Whether it should is another matter and one that relates to the nature of the relationship between the Markets Group and the primary dealers with whom it transacts its daily open-market business.

 

The Primary Dealers are central to the transmission mechanism of monetary policy under the current structure, and there is a close relationship among those dealers, the Desk, and the Fed as demonstrated by the numerous emergency liquidity support mechanisms put in place to keep the dealers afloat during the financial crisis.  There is clearly a symbiotic relationship between the Desk and the Primary Dealers, including Barclays – a relationship that one would not characterize as regulatory or supervisory.  In fact, we noted in earlier writings that in 1992 the FRB NY President Gerald Corrigan expressly orchestrated a pull-back by the FOMC in the Desk’s surveillance of the Primary Dealers because of the belief that the relationship between the Desk and the dealers conveyed upon them an implicit subsidy that was inappropriate.  Subsequent events during the financial crisis, however, revealed that the subsidy and special position did indeed exist, but with an absence of oversight.

 

One other point is worth mentioning.  Although the Manager of the Desk customarily makes presentations on general money-market conditions to open each FOMC meeting, review of past publicly available transcripts suggest that these presentations were at best tangential to monetary policy discussions or its formulation.  Those transcripts suggest that LIBOR and its structure and role in financial markets did not play a central or critical role in the presentations.  We don’t know if that was true during the financial-crisis period, because those meeting transcripts are not yet public.  Given that that the Fed viewed the strains in financial markets during the period between the fall of 2007 and the fall of 2008 as mainly due to liquidity issues rather than solvency problems, concern would have been mainly focused on how information was or was not being processed by the market and whether reported rates might generate runs on the dealers, rather than concern about how the LIBOR was being fixed per se.  Again, there is room for more transparency on this point by the Fed.  Also, it suggests that there may be an inherent regulatory conflict, both within the Fed and for British regulators, between concerns about market stability and the interests of investors and borrowers whose costs of funds and returns could have been significantly affected by misreported rates.  Again, the available information suggests that institutional traders had the necessary incentives and actively tried to influence LIBOR fixings to affect their own profit and loss positions.  This issue was the subject of a 2009 paper by Snider and Youle, who provided estimates of what the potential gains might have been for LIBOR-submitting institutions. (See Connan Snider and Thomas Youle, “Diagnosing the LIBOR: Strategic Manipulation and Member Portfolio Positions,” December 2009, http://www.econ.umn.edu/~bajari/undergradiosp10/LiborManipulation.pdf.)

 

Fact number four, which is actually missing, is information on where within the submitting institutions the LIBOR fixings originate.  This information is important, because it may help to highlight what is emerging as another example of problems associated with regulatory overlap and conflicting jurisdictions when institutions operate cross-border.  Presumably, for UK and foreign banks, the submissions would either come from their home offices or London offices.  For UK institutions this is obviously a UK matter.  For US submitting institutions, we don’t know whether the submissions emanated from NY or from the institutions’ London offices.  If the former, then there may be some justification for concern on the part of the NY Fed about those submissions; but given the institutional structure and split between the Markets Group and other parts of the NY Fed, it is not clear when and how the submission issues would have been raised.  In that regard, some detail on how the issue finally got to then-President Geithner’s desk, and the thinking behind Geithner’s letter to the Bank of England’s Governor King, would be especially enlightening.  Current FRB NY President Dudley could clearly enlighten us here, since he was the Manager of the Markets Group and Open Market Desk during the 2007-2008 period in question.  If the submissions came from the US banks’ London offices, then again, the issue is first and foremost a problem for the BBA and Bank of England.  As for the conversations between the Markets Group staff and Barclays, it is again relevant to know where the Barclays staff was located.  If they were in the UK, then the problem was first a UK issue.  If the staff was in Barclays NY office but the LIBOR data were reported from London, then the conversations were arguably second-hand accounts of what was being done in the UK, and this would not at first blush seem to be a US issue.

 

These are but a few of the additional questions that come up as the slow release of information on the LIBOR fixings proceeds.  For now, some tentative conclusions seem appropriate.  First, the UK must fix how LIBOR is set, and perhaps the Bank of England should take the activity over from the BBA, which has clearly done a poor job.  Too many decisions and the financial interests of too many borrowers and lenders are at stake for the present system to continue as is.  Second, we still don’t know much about what the US regulatory involvement was.  As a side note, while the Fed may have lacked the authority to intervene or to police the LIBOR fixing, two things are clear.  The Fed could have used its leverage on the Primary Dealer system to get more information on the LIBOR submissions, but didn’t.  Also, the Dodd-Frank legislation has clearly broadened the authority of US regulators to monitor and police markets in addition to institutions.  Little has been done on this front, and the responsible agencies need to be pushed.  Finally, if it wasn’t clear before it is now, that the FOMC’s 1992 decision authorizing the Markets Group to cease its surveillance activities was a huge mistake and should be revisited.  We are sure that more issues will surface as time goes on, and we will continue to amend and expand upon our observations as more facts become available.

 

[1] On the BBA LIBOR home page it states that “It is calculated each day by Thomson Reuters, to whom major banks submit their cost of borrowing unsecured funds for 15 periods of time in 10 currencies.”  However, when one looks at the actual question to which the banks are asked to respond, it is clear that the submitted rate is not an actual transaction rate.  The question asked is, “At what rate could you borrow funds, were you to do so by asking for and then accepting inter-bank offers in a reasonable market size just prior to 11 am?”  This is followed by “… bbalibor is not necessarily based upon actual transactions …”

 

Bob Eisenbeis, Chief Monetary Economist, email: bob.eisenbeis@cumber.com

 

Resources:
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Twitter: @CumberlandADV

INSANE as defined by Einstein.

As in  trader education, we often quote Einstein in respect of insanity, so with the Fed, wrote David Kotok.

LIBOR, the Fed and the TED
July 9, 2012

 

“Insanity: doing the same thing over and over again and expecting different results.”  Albert Einstein

Somehow, the insanity of the present unsupervised system involving the Federal Reserve’s primary dealers continues.  The Fed had “surveillance” in place during the Drexel Burnham failure and the Salomon Brothers affair.  There were no market meltdowns attributed to either event.

Then, in the early 1990s, under the Corrigan initiative and with the approval of the FOMC and Chairman Greenspan, the Fed ceded the surveillance issue to the other regulators.  Since this policy change, the toll of primary dealer casualties has grown to include Lehman Brothers, Bear Stearns, Merrill Lynch, MF Global, Countrywide, and now Barclays.

How many more market shocks will we have to endure before the Fed reverses one of the worst decisions it ever made?  Until the Fed ceases shirking its supervisory responsibility and restores a more formal surveillance and oversight role, there is no reason to expect things to be any different; and Einstein’s remark applies.

Below is a direct quote from the website of the Federal Reserve Bank of New York.  Readers please note that the NY Fed sets the rules for primary dealers.  It does not take Congress to change this.  The Fed could make this change tomorrow if it chooses to do so.

“The Federal Reserve Bank of New York trades U.S. government and select other securities with designated primary dealers, which include banks and securities broker-dealers. Weekly transaction, market share data and primary dealer lists are updated periodically. Much of the information is submitted voluntarily. The Bank expects primary dealers to submit accurate data, but the Bank itself does not audit the data.”

The LIBOR affair gives the Fed a chance to restore some “audit” of the data.

Below is the latest list of primary dealers, as copied from the NY Fed website (July 8, 2012).  We have cross-checked this list against the list of institutions represented on the committee that provides data for the American dollar LIBOR rates.  Different institutions sit on other currency-setting committees.  Because this commentary is focused on the Fed, we are ignoring the other currencies.  In addition, readers may note that some of the firms on the NY Fed list are not banks and therefore would not be involved in setting LIBOR.

Where we could establish a connection between primary dealer status and LIBOR rate-setting status, we have marked a “YES” next to the institution name. If we are unsure of a connection or could not find one, we marked it “NO”.  (A special hat tip to Dick Bove of Rochdale Securities for excellent research on the LIBOR scandal; he provided the American LIBOR committee list.)

Bank of Nova Scotia, New York Agency-NO;
BMO Capital Markets Corp.-NO;
BNP Paribas Securities Corp.–YES;
Barclays Capital Inc.–YES;
Cantor Fitzgerald & Co.-NO;
Citigroup Global Markets Inc.–YES;
Credit Suisse Securities (USA) LLC–YES;
Daiwa Capital Markets America Inc.-NO;
Deutsche Bank Securities Inc.–YES;
Goldman, Sachs & Co.-NO;
HSBC Securities (USA) Inc.–YES;
Jefferies & Company, Inc.-NO;
J.P. Morgan Securities LLC–YES;
Merrill Lynch, Pierce, Fenner & Smith Inc.–YES (through Bank of America affiliate);
Mizuho Securities USA Inc.-NO;
Morgan Stanley & Co. LLC-NO;
Nomura Securities International, Inc.-NO;
RBC Capital Markets, LLC–YES (through Royal Bank of Canada);
RBS Securities Inc.–YES (through Royal Bank of Scotland);
SG Americas Securities, LLC–YES (through Societe Generale);
UBS Securities LLC.–YES (through UBS AG)

That’s right, the majority of Fed’s primary dealers also set LIBOR.

Okay, where are we going with this?  We are going to the US dollar-based TED spread.

There is a widely reported global investigation underway into the LIBOR rate-setting mechanism.  Britain’s Barclays was the first revelation but is unlikely to be the last.  The British Banking Association is independent of the Federal Reserve.  BBA is investigating in conjunction with the Bank of England and the British Financial Services Authority.

We are interested in the US response.  We seek to track the behavior of primary dealers that are doing daily business with the NY Fed.  We are looking to see if players other than Barclays participated where one side of the trade was rigged.

Why?

Spreads between LIBOR-based rates and US Treasury securities’ yields are potentially arbitraged in large amounts.  Every student of financial markets learns the importance of the TED spread – it’s the differential between LIBOR and T-bill rates.  If one side of the TED is rigged, all of it is in doubt.  The TED is critical, or was critical.  It was (is) used to indicate the market-based assessment of risk in the global banking system.  A rigged TED was an unthinkable act.  So much for “unthinkability.”

Would Fed oversight and surveillance have prevented Barclay’s actions?  We cannot say.  Would the threat of losing primary dealer status been a sufficient deterrent?  We cannot say.  But we wonder what message would be sent if the NY Fed now took Barclays out of the primary dealer lineup for a penalty period.   And we wonder what the market will think if the NY Fed does nothing.

We cannot prove any counterfactual about what might have happened if the Fed maintained surveillance.  We can say that the record since surveillance stopped reflects poorly on the Fed’s decision.

In her Sunday column (“The British, At Least, Are Getting Tough,” July 8, 2012), NY Times journalist par excellence Gretchen Morgenson closed with this paragraph:

“With each new financial imbroglio, the gulf widens between Main Street’s opinion of Wall Street and the industry’s view of itself.  When Mr. del Missier, the former Barclays chief operating officer, took over as chairman of the Securities Industry and Financial Markets Association last November, he said: ‘We will continue to work on maintaining and burnishing the level of confidence investors have in our markets, in our financial institutions, and in the general economic outlook for the future.’ ”

That’s right; the new chair of SIFMA is one of the Barclays executives who just resigned over the LIBOR scandal.  SIFMA is a regulator of some of the brokers who are not bank affiliates but who are primary dealers.

Albert Einstein also said, “We cannot solve our problems with the same thinking we used when we created them.”  Einstein was at Princeton before Bernanke.  We can only hope that the elder Princetonian’s principles influence the younger one to re-impose meaningful surveillance and thereby restore confidence in a system that sorely lacks it.

 

David R. Kotok, Chairman and Chief Investment Officer

 

Resources:
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For personal correspondence: david.kotok@cumber.com

Twitter: @CumberlandADV

CRAZY!!

 Reminds me of

http://youtu.be/PZY0J1YoTgs

Crazy by Julio Iglesias

Thanks for the memory, David Kotok.

What a crazy week?
July 7, 2012

Markets reacted to this crazy week of discredited, ADP-based employment forecasts, LIBOR revelations and central bank fizzle.  The result is plain ugly.

In Europe, post-ECB, credit spreads widened.  Good-guy yields declined; bad-guy yields rose.  See our updated EU contagion series at www.cumber.com.  Note how Swiss yields are negative until the 5-year maturity (which is a whopping 7 basis points).  For new readers, see our archives on why the Swiss 10-year government bond is now the de facto benchmark for the eurozone.  The European Central Bank demonstrated too little, too late.  This week’s Draghi Q&A did not help matters.  We continue to underweight Europe.  It is still too soon to bottom fish.

In the US, the employment statistics release shows an ongoing but weakening, very slow recovery.  A plus 80 thousand nonfarm jobs is better than minus 80 thousand.  We see nothing to alter this slow but marginally positive growth outlook.  The Fed’s additional “Twist” is a whimper, not a shout.  In fact, that is probably a good thing, since monetary policy has its limits, and we are near them.  We expect no more from the Fed for the rest of this year unless there is a seriously negative event.  In our US ETF accounts we are still holding a cash reserve.  In managed taxable and tax-free bond accounts we are slowly bringing in duration and using tactical hedging where appropriate.  Our newly launched US high-yield debt strategy is developing well.

LIBOR-gate, as Michael Lewitt titled it, is a mess.  It is potentially huge.  We expect more ugly revelations.  Other institutions may be implicated.  Critics of emerging-market governance standards need to look in the mirror.  The so-called developed markets now exude a rising stench.

We will end this weekend missive with an email exchange.

Steve wrote, “David, Do you have any insight into this article?  To what degree is it true / false?”  He furnished this link to a Business Insider piece that discusses corruption in China.

My answer follows.

Steve, we have continuing questions about reporting from China.  It takes on-site anecdotes to gain a picture that reveals trends.  We do that by obtaining data from sources we know and trust.  For example, one can count containers on ships or coal inventories or financial holdings at public institutions.

But why is the writer looking at China?

Business Insider penned this opening:  “[Other articles have described the] widespread fraud that has become apparent, both in mainland and US listed Chinese companies…..an extraordinary number of the Communist Party and the military cadre  had massive unexplained wealth …”

Let’s take a different approach.  I have rewritten his sentence into a different context.  Suppose you, Steve, were an honest Chinese observer, reading the following sentences about the United States.

“Widespread fraud has become apparent in the Mainland US and among US-listed financial firms.  Extraordinary numbers of political figures and public appointees have massive wealth.  Examples include (1) Dick Fuld, who was a director of the Federal Reserve Bank of NY until his firm, Lehman Brothers, went into bankruptcy.  He has not been charged with any crime.  He denied knowledge of any accounting irregularities.  (2) Former US Senator Jon Corzine’s firm was a Federal Reserve primary dealer before it failed.  Huge balances of client funds are unaccounted for at MF Global.  Corzine says he does not know what happened. (3) No one knows the counterparties of the transactions that cost JPM billions.  (4) Members of Congress and their staffs trade on insider information and are not violating US law because of the congressional exemption that Congress legislated for itself.”

Steve, I could lengthen this but you get my point.

I will stop with my own personal observation about the LIBOR scandal.  My colleagues Michael Lewitt, Bob Eisenbeis, and Bill Witherell have written about it this week.  (www.cumber.com)

The LIBOR rigging is systemic. For evidence see a Bloomberg report from May 29, 2008, under the headline, “Libor Banks Misstated Rates, Bond at Barclays Says.” (Yes, the article ran more than four years before Barclays’s $453 million settlement last month with U.S. and U.K. authorities for manipulating Libor.)

Steve, this scandal is going to take down many more than just Barclay’s leaders.  The claims are likely to be in the trillions.

Imagine the board meeting at Barclays.  The general counsel says, “I have a settlement proposal.  We can pay 1/2 billion in fines to the US and UK authorities now; and you, Mr. Chairman, and you, Mr. CEO, and you, Mr. COO, will resign at once.  Others will also resign or be dismissed.  Gentlemen, I can make this deal right now and settle it or we can have a prolonged investigation.  In my opinion, paying the half billion now and taking the resignations early is the cheapest way out of this mess.”  The board votes yes.

Steve, the insiders on that board know the facts.  Watch out for what is coming.  It  may dwarf allegations about Chinese corruption.

The US and UK systems were once the models for the world.  They are now sick and corrupt.  We are five years into a financial crisis and nothing has changed.  Who are we to throw stones at others?

David R. Kotok, Chairman and Chief Investment Officer

Resources:
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For personal correspondence: david.kotok@cumber.com

Twitter: @CumberlandADV