Volker, Greenspan and Donner, Too

[mikew]

Never trust an amateur economist.

Didn't know there was a distinction between professional and amateur economists? 

Greg
I couldn't get all the way through your post. I got out of breath climbing up to the third story and couldn't make any higher.

BTW did you see the ny times article on hedge funds?
http://www.nytimes.com/2005/09/04/business/04view.html

Traditionally, economists have thought that big up-and-down fluctuations in returns indicated risky investments, so many hedge fund investors have hoped to see a pattern of smooth and even returns. But Mr. Lo quickly saw that lots of hedge funds were posting returns that were just too smooth to be realistic. Digging deeper, he found that funds with hard-to-appraise, illiquid investments - like real estate or esoteric interest rate swaps - showed returns that were particularly even. In those cases, he concluded, managers had no way to measure their fluctuations, and simply assumed that their value was going up steadily. The problem, unfortunately, is that those are exactly the kinds of investments that can be subject to big losses in a crisis. In 1998, investors retreated en masse from such investments.

In his paper, he shows that the catastrophic losses of 1998 were preceded by a noticeable series of months of mediocre performance. Mr. Lo argues that while a hedge fund crisis appears to be sudden and to be caused by unforeseen events, the breakdown is only the late stage of the problem. As more hedge funds compete for the same slice of the pie, he says, their managers feel that they have no choice but to "leverage up," juicing their returns by borrowing more money to make bigger investments.

That, in turn, makes the investments more prone to a sudden credit crisis. Hedge funds that are highly leveraged are vulnerable to having their lenders - banks and big brokerage firms - cut off credit when they think that their money may be at risk. And Mr. Lo thinks that lenders would do exactly that in an industrywide downturn. That would force hedge funds to close out their positions at the worst possible time - the kind of cycle that brought down Long Term Capital Management.

The nightmare script for Mr. Lo would be a series of collapses of highly leveraged hedge funds that bring down the major banks or brokerage firms that lend to them. That's a possibility that the entire hedge fund industry - secretive and fractious though it is - has a huge interest in avoiding.



Mike

 

[greg]

Mike: This more than anything is my definition of a brittle economy--too much leverage in the system. The scary part for me personally is that those who aren't heavily leveraged face the same consequences as those who are, a falling stock market. Thanks for the article.

--Greg

 

[greg]

I agree that REITs are overvalued now.

I prefer a single level house in which each room is allocated for each asset class.

Make sure your bathroom doesn't explode and wipe out your bedroom too.

--Greg

 

[greg]

Greg, are you bored tonight? There must be something you can do to ease the pain.

Ha

I tried HGTV. Didn't work. Maybe I should have found my pistol, gone down the basement, and rubbed it with oil. Too late now.

Maybe we could start a commune in Missouri, near St. Joe? I read an article in the WSJ that goat meat is becoming more popular. We could raise goats for income. Advertize for a retired doctor to live with us who is willing to write perscriptions for goat milk. Sent a runner to Mexico once every three months for wholesale perscription drugs. Etc. We would only need one computer with internet connection because we would have the kitchen to talk in whenever we got bored. The economies of scale could be huge. JG could be kept walking the fence line for our protection-- the bait--so to speak. We could draw straws to see who brings him food and meds? Of course, Uncle Mick would be there to keep the women in line and for commentary on the septic. Life could be very good for us all, well most of us.

--Greg

 

[greg]

--Greg,

Just read War and Peace your "house" post, and my head hurts. What on earth do you do with all your spare tome time when you aren't thinking up all this....uhh..., stuff?

Please don't misterpret this question, but in your house, does your elevator go all the way to the top?

REW

No! That would be too dangerous, better to just have a hole in the roof that. . . . . . . . . .

--Greg

 

[greg]

I hope the markets drop so Greg can rest easy

Can you change your name to GloomandDoom?

No! If I did I wouldn't have anyplace to go.

 

[uncledrz]

Mike:  This more than anything is my definition of a brittle economy--too much leverage in the system.  The scary part for me personally is that those who aren't heavily leveraged face the same consequences as those who are, a falling stock market.  Thanks for the article.

--Greg

ok Greg, you and Donner are both very concerned about the high debt our nation is carrying, as are Greenspan and Volker. If it implodes, recession likely to follow, thus cash assets should be held.
OTOH, our recent history shows that cash will not hold up to inflation over an extended period and thus one needs assets such as stocks and real estate. Sure, the little guy is going to take the hit if the hedge fund type investments cause financial distress in the markets, but does the little guy do anything other than mantain a balance portfolio (stock, bonds, real estate, cash)?

 

[flipstress]

So my investments are in a house, a five story house, a five story house with structural problems that I think I can judge fairly well as an amateur financial engineer. 

I like your analogy.  Is the structure more like a pyramid, though, in that you put your safest floor on the bottom and that it is the biggest floor, and you keep adding on and building up with less safe investments toward the top but in smaller allocations?  So if the top topples, your strong base will remain?

It could also be still boxy, like a block-like house but with lower ceilings with each succeeding upper floor so that the toppling of the top would not be so heavy to crush your base floors.

Edit to add:  Of course, what one considers "safe", "safer", "safest" (determining what to put in each of the floors or what materials to use for each floor's construction) depends on the type of risk with which one is most concerned.  The problem is how to correctly read the environment, including the "weather", when you are building your "house".  One might have to remodel periodically or "re-arrange/re-locate furniture" as you do or propose to do.

 

[Donner]

No , I am not really Alan Greenspan, or Paul Volker or even Bill Gross.  (see link below)
I guess I just think like them.    Or maybe they think like me.  Don't suppose they are lurking around this Board to get their inspiration do you?  Hope not.  How come Bill Gross gets the big bucks and all I get is grief by ER Board cognescenti?  Oh well, its more fun here than appearing on CNBC anyway!   


http://www.pimco.com/LeftNav/Late+Breaking+Commentary/IO/2005/IO+September+2005.htm

Greg--  I think Bill would agree with your house building strategy except that he apparently feels
that a one floor bungalow with four walls and a roof built of cash is the way to go right now.   Wonder what his asset allocation looks like?  Let's change the title of this thread to Volker, Greenspan, Gross and Donner, Too.  Wonder whose next? :

Donner

 

[Marshac]

Never trust an amateur economist.

An amateur is only an amateur until they get paid

 

[greg]

Greg-- I think Bill would agree with your house building strategy except that he apparently feels
that a one floor bungalow with four walls and a roof built of cash is the way to go right now. Wonder what his asset allocation looks like? Let's change the title of this thread to Volker, Greenspan, Gross and Donner, Too. Wonder whose next? :

Donner

Thanks for the Bill Gross article. You caught it before me. My five story house analogy is useful only to me. I was just hoping that others might take a look at their portfolios and slice them up into the natural risk and behavior components. Ten parts are too many--you get goofy looking at moving parts; two or three doesn't give you a good feel for the dynamics of your portfolio. See each part separately and identify the possible behaviors--especially if they get volitile. I think everyone needs to look at each segment of their portfolio and sort of see the behaviors so that they can easily identify problems--and pre-measure their own emotions and tactics if bad things happen to one or all parts. It's just a slightly different take on the same old risk management stuff. Many people have already made their decisions, and that's good. But I'm always worried about those who go along complacently and then panic near the bottom and sell. It happens during every single up-down cycle. A majority piles out near a bottom. I wish I didn't have to time. But I always remember that if you lose 50% of the pile, you have to make 100% to get it back to 'go.' I see ten years--optimistically--to make that happen if all goes very well.. It's worth it to me not to reach too hard in the first place. If I had $100K right now and had to put it in the market I'd probably split it up in Hussman Funds. The man seems to know his stuff.

--Greg

 

[HFWR]

Oh well, its more fun here than appearing on CNBC anyway!

Unless I'm being interviewed by Becky Quick...

 

[Helen]

Mike:  This more than anything is my definition of a brittle economy--too much leverage in the system.  The scary part for me personally is that those who aren't heavily leveraged face the same consequences as those who are, a falling stock market.  Thanks for the article.

--Greg

I have to agree that there is too much leverage. That's why it feels like too much money chasing too few investments. But, I think it will be worse for those who are heavily leveraged.

I rode out the tech bubble until last November when I moved most of my investments into short term securities. Only time will tell, but I really believe the bubble moved from high tech to the housing market and perhaps beyond. I think Greenie should have let the tech bubble burst and recover on it's own. It seems like he merely moved a fairly small problem to a bigger one. After he retires it will pop big time, it's like a zit coming to a head. I have to wonder if his looming retirement caused him to strategize differently.

The government and private citizens are living like there is no tomorrow. There is very little elasticity left. If the economy continues to do well then there is no problem, but that is not reality. People, and the Government are leveraged to the hilt and interest rates are rising. The yield curve is damn close to flat and will probably invert with the continued rise in the short term interest rates; and they will rise because inflation is a real threat. When a recession hits and workers start losing their jobs the lack of elasticity is going to have a spiral effect, due to the lack of personal savings and new fangled (careless lending practices) mortgages. What will the ratios of deficit to GDP look like if the GDP drops, what will it look like if interest rates continue to rise ? How can government spending (a huge factor in GDP) continue to rise ?

On a national level we have a high trade deficit, a high budget deficit, a pension bail out program that is in trouble, and social security and medicare programs which are in trouble. This can only mean higher taxes and fewer payouts. We also have our auto and airline industry in deep doo-doo. Plus we have a ton of money in risky hedge funds which apparently no one can make sense of (think Orange County).

On a micro level we have a negative or low (at best) personal savings rate and an aging workforce. Many of these problems are on a global scale.

So, I guess I can change my name to doom and gloom but I see trouble ahead. To me, the real question is how to handle it.

I'm ducking for cover in short term securities and I-bonds. Like I've said before, if I can make a few percent above inflation I can bail out of the workforce in 7.5 years.

I watched the high tech bubble explode and kicked myself in the ass for not paying attention to reality. I'm now thinking that I might get a second chance and if I'm right the high tech bubble was cheap tution.

May we live in interesting times (as long as I'm learning I'm OK with that),

-helen

 

[moghopper]

I think Greenie should have let the tech bubble burst and recover on it's own.

That is easy to say, but he had to adjust to what he was given...

Loosened policy due to the Asian crisis, then because of Y2K fears... Then tightened afterward, combined with the equity bubble let to recession, combined with Terror attacks led to a loosening, now back to tightening.

I think it has been whipsawing pretty good through no fault of Greenspan, Clinton, Bush.

Could things have been handled differently? Can't they always when you're looking backward??

 

[Helen]

That is easy to say, but he had to adjust to what he was given...
Could things have been handled differently?  Can't they always when you're looking backward??

Well, I don't know how much looking backwards I am doing. Most of my post is projecting - we are still holding steady at the moment.

Greenspan said it's never an easy ride after interest rates have been historically low. He knew that before he lowered the rates.

Katrina snuck up on us within a matter of days. The aging population, increased deficits and low personal savings rates/high consumer debt did not.

We created the problem of little elasticity via a lack of planning for the future. We've painted ourselves into a corner. Now we are just waiting for a catalyst.

-helen

 

[Helen]

That is easy to say, but he had to adjust to what he was given...

Loosened policy due to the Asian crisis, then because of Y2K fears...  Then tightened afterward, combined with the equity bubble let to recession, combined with Terror attacks led to a loosening, now back to tightening.

Warning, I do not have a Ph.D in Economics ...

The asian crisis impact on the US economy was well over before interest rates dropped. The Y2K fears did call for a moderate loosening. The equity bubble was a result of the loosening.

The terroist attack was tragic emotionally, but economically was just a blip on the screen, much like three mile island.

The major problems we have now were a long time in the making. I agree with what I think you are saying, it is a bi-partisan problem. It seems to be an escalating mind set problem within the American culture, government and citizens alike. The mindset seems to be, as long as things are good today, let's not worry or prepare for the future.

-helen

 

[moghopper]

Well, I don't know how much looking backwards I am doing.

I was speaking only in regard to Fiscal policy moves in the last 10 years. Obviously I should have spelled that out.