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Wall St.: Yup, They’re At It Again!

 By Shlomo Maital

  

 

 Frank Partnoy was a Wall St. insider who wrote two powerful books, showing how greed and deceit have corrupted our crucial financial markets, leading to the disastrous 2008 financial crash and ensuing economic crisis.

       Hard to believe but – he now reports (in the Financial Times) that the same skullduggery that sank the world in 2008 has begun anew, with slightly different disguises.

   The central culprit this time is the collateralised loan obligation. Like its earlier esoteric cousins, a CLO bundles risky low-grade loans into attractive packages and high credit ratings. In May, there were two deals of more than $1bn each, and experts estimate that $75bn worth are coming this year. Antares Capital recently closed a $2.1bn CLO, the largest in the US since 2006 and the third-largest in history. Although most of the loans underlying these deals are of “junk” status, more than half the new debt is rated triple A. Sound familiar?   During the early 2000s, similar highly rated deals called collateralised debt obligations were popular. At first, they seemed harmless, or at least not so big that their collapse could cause financial contagion. But when regulators ignored their growth, they became more opaque and more profitable, with credit ratings disconnected from reality. Like cracks in a building’s foundation, the risks seemed minor at first. But high ratings hid the instability of the entire structure. Until it was too late.

   Same script, different actors.   Hide junk bonds in a package with good bonds, and have the credit ratings agencies rate the whole package AAA, triple A, risk-free.

The credit rating agencies, particularly Moody’s Investors Service and S&P Global Ratings, are the central actors in this story, just as in the original. The computer programs they use to assign triple-A ratings remain flawed. Because loan defaults can come in waves, mathematical models should account for “correlation risk”, the chance that defaults might occur simultaneously. But the models for CLOs assume correlations are low. When defaults occur at the same time, these supposed triple-A investments will be wiped out. CLOs are just CDOs in new wrapping.

   Partnoy observes that keeping financial markets honest, clean and sane is really difficult!

It is hard to police the financial markets. New business school graduates are inevitably one step ahead of their regulator counterparts, and many of the least creditworthy businesses find it easy to borrow, because their loans can be quickly repackaged and sold. During the debates about Dodd-Frank repeal, legislators should keep their eyes on these complex investments and the agencies that facilitate them.

    Trump and his Treasury Secretary are actively working to repeal the key elements of Dodd-Frank, the legislation that keeps 2008 from recurring.

Fasten your seat belts!

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Warning: The Next Crash is Taking Shape

 By Shlomo Maital

     In the children’s fable, a boy cried “Wolf! Wolf!” in jest – until, when there really was a wolf, nobody came to help. Economists seem to be like that boy. We are always crying “wolf!”.   Problem is, sometimes, not always, the wolf does come.

     Writing in the New York Times, Ruchir Sharma, chief global strategist of Morgan Stanley Investment Management (a Wall Street insider for sure) sounds a thousand warning bells. When an insider cries Wolf!, we should listen.

       Here is why.

      “Central banks adopted zero to negative interest rates and provided huge amounts of cash” after the 2008 crisis. Result: “global financial assets are worth over $250 trillion, up from $12 trillion in 1980, or more than 3 times global GDP.” …”The ocean of money in financial markets is so large, it’s possible that ripples on its surface could trigger the next big downturn.”

       Suppose, just suppose, as North Korea and the US square off, global financial markets fall by 10%. That implies paper losses of $25 trillion, or half again as large as the United States’ annual GDP. That could trigger widespread panic.

         Why have asset prices risen so dramatically? Because when you get to borrow free money, you are tempted to do something, anything, with it —   even when returns are low. At long last, central banks are beginning to worry about what they’ve done – create a new bubble. As Sharma notes, “asset prices from stocks to real estate have never been this expensive simultaneously.” Clue that it’s a bubble? Of course.

         Since WWII, there have been 88 recessions – and 62 of them followed a stock or housing bubble or both. So a financial crash will inevitably bring an economic crisis.

       Does anyone else agree that the wolf is on the way?   Philip Inman, The Guardian, does. He notes that the US Federal Reserve is now starting to sell its $4 trillion in bonds, bought in order to pump money into the system. In other words – soak up some of the mountain of money it created. This will require the US Treasury to raise more in tax, Inman notes. Why? If the Treasury can’t sell bonds, it has to raise taxes.  But baby boomers everywhere, those who have grown wealthy, simply refuse to pay the taxes needed to keep their governments afloat. And the Trump administration is hell-bent on lowering taxes, not raising them.   The baby boomers are “offloading the problem to younger lower-income groups, who now must borrow excessively just to make ends meet”.  

     It’s a recipe for big trouble, which now includes a war between the generations – when once, we old fellows used to try to make things better for the younger kids, and now we seem to be working hard to make them worse. And I haven’t even mentioned climate change.  

     “There is growing evidence of a slide into outright deflation even ahead of the next recession…”, notes a financial analyst, Albert Edwards. He thinks the US will soon slide into recession. And Trump is about to appoint five new Fed governors, all of whom want less regulation and less government.  

       I know a fairly wealthy investor, highly savvy, who is pulling his investments out of the US and putting them into Europe, of all places. Problem is, in a global crisis, there is no safe haven.

       These are dangerous times.   Everyone should set aside a bit extra for rainy days, and prepare at least mentally for a new global crisis.

 

What Happened? Why Hillary Lost..My Take

 By Shlomo Maital

Hillary Clinton has now published her account of why she lost the presidential election: What Happened?   She admits to blame, but also blames many others, including the Russians and Comey.

     She also notes how she was unnerved at a crucial debate, when Trump lurked behind her, scowling. And a headline even praises her for ignoring Trump (see above).

   I disagree. Her is my take on an alternative scenario.

       Hillary:   turning and pointing at Trump.   “Is that the person the American people want to lead them?   Come out here, Mr. Trump, come out into the light where we can see you for what you are – a bully. You bully everyone, you bully women in particular – but Mr. Trump, you can’t bully me. I’m not afraid of you. A man who bullies, who hides in the shadows as you do in your shady business dealings, in your shady bankruptcies, in your hiding your income tax returns…   you are not worthy of the trust of the American people. We don’t like bullies. We don’t like liars. And we don’t like men who threaten women.   We are going to thump Trump on November 8! Thump Trump!”

     Hillary was the first female U.S. Presidential candidate. I recall that Israel had a woman Prime Minister, Golda Meir, who was widely believed to be a lot tougher than her male counterparts. Many criticized Hillary for her emails, her lack of human warmth, etc.   I think she would have won Ohio (and hence the election) if she had shown another quality – toughness. The irony is, Hillary is indeed tough. But the toughness was shown only in private, and rather hidden in public.   Alas!  

 

How to Help Creative People: Be (Or Support) Claude Shannon’s

 By Shlomo Maital

Claude Shannon

   Claude Elwood Shannon (1916- 2001) was an American mathematician, electrical engineer, and cryptographer. He invented what we today call known as “information theory” – the foundation of software, computers and cell phone technology.

   According to Wikipedia: “Shannon is noted for having founded information theory with a landmark paper, A Mathematical Theory of Communication, that he published in 1948. He is, perhaps, equally well known for founding digital circuit design theory in 1937, when—as a 21-year-old master’s degree student at the Massachusetts Institute of Technology (MIT)—he wrote his thesis demonstrating that electrical applications of Boolean algebra could construct any logical, numerical relationship.” In other words, you can do anything with 0,1.  

   NATURE magazine (July 13 2017, p. 159) has a review of a new book about Shannon, A Mind at Play: How Claude Shannon invented the Information Age. The review is written by Vint Cerf, who designed the architecture of the Internet.

     At the close of his review, Cerf notes:   “What emerges is a portrait of an exceptional free-spirited mind, nurtured by colleagues at MIT and Bell Labs….he was protected from some of the more mundane aspects of work, such as reporting progress, by colleagues and managers. They recognized his unique ability to wrestle insight from complexity, by peeling away details that obscured the kernel of problems and inviting creative solutions”.

     What I learn from this is:   Be like Shannon. Strip away the humdrum things you do, and focus on big problems, on the core of the problem. Peter Drucker taught “Innovation and Abandonment” and he began with ‘abandonment’. That is, what can you get rid of in your life that takes away time and energy from your creative powers? How can you be like Shannon?

     And, next best, if you cannot be like Shannon, can you identify and support other people around you who are like Shannon?   Supporting other creative people may be as important as being creative yourself.

Blog entries written by Prof. Shlomo Maital

Shlomo Maital
September 2017
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