Sunday, April 17, 2016

The Big Short

I haven't posted in this space for more than 4 years.  I watched the movie, The Big Short, weekend before last, and I was reminded of much of the good work/research that I had done in this space. There was a point where I didn't think that I would want to view the movie, as so much of it seemed to be a "been there, done that."  Due to some DNA quirk, much of the 'subprime is not a problem' fell false to my ears.  Accordingly, I spent an inordinate amount of time doing amateur research; but I did it, doggedly.  And what I concluded was that there was no way that subprime would not be an issue.

There were several things that led me to that conclusion--not just based on general ramblings of others. You can see some of what I wrote here on subprime, and what I wrote here on hedge funds and systemic risk.

  1. First and foremost, the average income (for people who had income) to loan balance ratio for issued mortgages lowered considerably. Naturally this was a requirement to be able to sell over valued homes.  Runaway home-prices + easy money.  This statistic has NOTHING to do with subprime, but everything to do with stupid underwriting.  And I dug through the information published by the government to find this statistic. one reported on this salient fact.
  2. The risk curve on the mortgage insurers underwriting reports had shifted to the left.  Meaning that defaults were happening more quickly and in greater number.  None were reporting on this published fact (but there was lots of conjecture--correct conjecture).  The supportable facts were there.   I found these reports on line after a bit of rabbit holing on line, and once the fan blades were flinging dung they were soon yanked and not available later.
  3. All of the banks were still basing their loan loss reserves based on passed delinquencies, per my review of the financial statements of both mortgage lenders and the mortgage insurers.  I didn't understand that in relation to number 1 above.  I also don't understand why none were reporting on this--it was one of the easiest things in the world to discover and it was something that was worthy of being reported.
  4. The amount of synthetic instruments (credit default swaps) were not reported on any exchange. Accordingly, after reading some information about what happened in 1929 and the role of off-exchange instruments in the collapse, I believed that there would be a problem.
  5. That insurance companies who heavily invested in bonds had balance sheet risk was not anticipated in the news outlets.  My research (and I wrote about it in this space) told me that it would.
One of the things that I identified with in the movie is the "early is wrong."  Most palpable to me was the emotional wringing that these guys went through--to be 'right', but not seeing evidential matter in the market prices to support their positions.  I though the movie did a great job of conveying that angst and inner turmoil.

Finally, the tongue in cheek nature of several of the asides to explain some of the technicals was inspired.  The complexity of all of it is snooze worthy--but having the likes of Selena Gomez, Anthony Bordain explain it made these concepts accessible.

I may spend a little more time looking at a few market 'things' and posting here.

Friday, February 03, 2012

Permanent Hiatus

The Perplexed Investor is busy with real life stuff.  With that said, I'm on permanent hiatus from observing/writing about the market.  Given that I have much hard work and some fairly good observations in this space, I'm not yanking the blog just yet.

Thanks to those who have been patient and gracious readers over these last 6 years.

Wednesday, November 02, 2011

SPY Chart | 11/02/11

Above is a 60 minute SPY chart with a volume@price overlay.  As I've never shaken my belief that charts tell us nothing so fully accurate as price history, I do look at where the market has voted with its collective wallet. It is these places where the inextricable psychological and economic investment shows up--and where breaches of these areas (to the upside or the downside) are likely to elicit a reaction (buy to catch up or  Neither pundits nor technical analysis have any dibs on future certitude of market direction.   Since my last post, the market seems to be reacting to its current (in)digestion of news out of Europe. 

Euphoric, despondent and incredulous are all apt emotions that the market has experienced.  Who knows what it will bring today?  We are entering a area of important price support (to my eye anyway).  Likely to be more chopping as market participants try to digest the Euro stuff and the MF Global debacle.  And the MF Global evaporation is a reminder that the so-called smart money, is not so smart (said with schadenfreudic sarcasm).

Monday, September 19, 2011

Deja vu

The market these days is reminiscent of the pre-Lehman/Bear Stearns market.  The markets were hyper-reactive---with maniacal swings up and down. As I had done so much research and understood the factual underpinnings of the events (before they unfolded so dramatically), I was able to evaluate statements made by various talking heads.   I was not assured by assurances.

Rather, I understood clearly the systemic risk potential before anyone was talking about it. I had invested hundreds of hours of personal research to understand the unfolding risks.  I read financial statements (of mortgage insurers, insurance companies, mortgage companies and the investment banks) and saw the loan loss reserve and derivative language which told me that using historical methodologies in the sans-sane underwriting environment was going to lead to sharp losses.  I read the S&P, Fitch and Moody's reports which FGIC published on their site.  They no longer do. Most importantly, I understood that systemic risk would collapse all asset classes--there is no basket of diversification that would be safe.   And as we soon found out, even some safe classes--money markets--were not safe.

This research made my head hurt.  The only industry I had a passing acquaintance with was the mortgage industry and that was from audit experience very long ago.  I found the investment bank financial footnotes overwhelming.  But I read them. I thought the insurance companies would be at risk because of the amount of fixed income securities they bought.  Turns out that I was right.  I saw no analyst or talking head suggest that this was a sector that would suffer.
Sure, many were talking about the dangers of derivatives and agressive lending, but all of the doom and gloom centered on a symptom of the problem, subprime.  Rather the entire housing industry that was in a bubble due to easy money for all--just not subprimers.  A few hours at the OFEO site and reviewing their statistical reports for average earnings of households to average home prices and a 2 minute calculation  indicated to me that the problem was sorely underestimated.

The new designer mortgages were not to get undocumented folks into homes, but to get "normal" households into homes where the home values as a multiple of household income had increased markedly (39%).    From 2000 to 2006 housing values increased 76% while household income increased 27%.  It is worth noting that home values increased even more post 2006--but my research was in 2007, and there is no need to update it.

Now, fast forward.  We are awaiting another clown-sized shoe to drop in the form of the European 'stuff' and in the form of no new jobs creation for the US and the threat of a a continuing (or new) recession.    Hard to know if it has dropped already or if we are just cowering in its shadow as it hovers above. My only surprise is that it has taken this long for the giant festering pustule of the Euro-centric economic mess to finally pop.  Similar to our own issues in 2007.  The demise of the banking industry was long foretold in 2006 and so. It takes a while for these whispered, muted fears to take on gut grabbing terror. However, today, I do not feel buoyed by the certainty of my research.  I do not profess to understand the intricacies of what is going on in Europe. 

There is a great paper called Irrational Optimism (Dimson, Elroy, Marsh, Paul and Staunton, Mike, Irrational Optimism (December 2003). LBS Institute of Finance and Accounting Working Paper No. IFA397. Available at SSRN: or doi:10.2139/ssrn.476981).  It is worth your taking time to read.  Here is the first paragraph from the abstract:

We address the tendency of many investors to overestimate the rewards and underestimate the risks of investing in stocks over the long term - that is, investors' irrational optimism. In particular, we examine the widely held belief that stocks are a "safe" investment for the long run. The probability of experiencing a real loss on equities depends on the expected real return and standard deviation of stocks. Judgments about the future magnitude of these two parameters typically involve extrapolating from history. We use a global database of real equity returns from 16 countries during the 103-year period from 1900 through 2002 to confront the optimism of investors with the reality of history
While I feel somewhat ill-equipped to know with any certainty of what is down the road,  I do know that ultimately we have to rely on our own judgments of the risks. Dimson etal's paper is one that helps illuminate perceptions, and I try to keep the valuable perspectives in that paper at hand.   If we could learn anything from the last bout of certitudes where the eventualities of the collapse of the dollar and treasuries were 'no-brainers', we should learn this:  conventional wisdom in unconventional times is not worth much.

Tuesday, August 30, 2011

On Forecasting Economies, Markets and Hurricanes and the Democratization of Blather

I am seeing many critics now stepping out with their perennial second guessing (at best) and ridiculing (at worst) Irene's denouement landfall.  Though only a schadenfreudically disappointing CAT 1 hurricane, I'm here to tell you that being in the purple wind bands for a sustained period of time is no fun.  Having your entire county's power grid knocked out is even less fun.  A 150 year old red oak or beech tree is a powerful force when it comes crashing down on your home, car, or body.

Waiting until there was certitude about the storm's intensity and the when/where it would make landfall means that you are too late if you've underestimated. When dealing with catastrophic losses of life/property, the error that should be made is on the side of overestimating, not underestimating, the magnitude of the event.  With time comes certainty, but time also erodes options (such as evacuations) in the event that you underestimate the outcomes of a particularly event. 

What you want to avoid is being on the other side of an event of some consequence (weather, economy, market, or some trick you've decided to try with your car/boat/motorcycle/skateboard/mountain bike) and hanging your head, kicking the dirt and dazedly muttering, "coulda, woulda, shoulda" in some refrain.  Katrina, 'subprime' (which was so much more than that), lead paint, asbestos, DDT among many other events, bear witness to the costs of underestimating (or ignoring) consequences. 

Weather events, like economic and market events, (and our personal stunts that end badly) can only be evaluated with full clarity in hindsight.  These critics suffer from the need to second guess decisions that needed days of consideration and many hours of execution on limited information from the vantage point of hindsight.   I surely do not want my health and welfare in their hands.  From where I sit still recovering from being in the purple wind bands in a county whose electrical grid was entirely (not partially) decimated by many hundreds of fallen trees (of the 150-200 year old age), the din of the sideline carpers at least is drowned out a bit by the hum of the generator and buzz of the chainsaws.

Such writings also make me question if the internet's democratization of opinions is such a good thing.  Freedom of speech and having something worthwhile to say do not go hand in hand--and sometimes the internet and the many forums of 'expression' feel like the democratization of blather.  I'm sure that I've made my own deposits to the blather bank, but I try not to.

All the better to overestimate Irene and have her disappoint, than to have her juiced up and/or wobbling outside the bell curve of underestimation.  I can point to several hundred old oak trees more than 150 years old that have weathered many a hurricane...but not this one.  And many a person decided to ride out Katrina because 'in their experience' such storms, despite warnings, could be endured.  Right.

The art of assessing risks and making considered judgments based on a possible range of consequences is just art.  When we have to act is not always at the time that we have full information.  And having full information generally makes it too late to act.  Too many last breaths are preceded by "If only..."


Monday, August 29, 2011

Return from Hiatus

I am returning from a much needed vacation away from the markets.  I found myself zigging when the market was zagging and then zagging when it was zigging.  Guess what got zinged?

I have a page on this blogged tagged "wisdom".  It serves as a place for me to write down things that I find important and want to both reference and share.  I would like to highlight a couple that are very meaningful to me.

The first is from Musashi:

Harmony and disharmony in rhythm occur in every walk of life. It is imperative to distinguish carefully between the rhythms of flourishing and the rhythms of decline in every single thing.

And the second is from Munenori (a nice corollary to the one above):
When fighting with enemies, if you get to feeling snarled up and are making no progress, you toss your mood away and think in your heart that you are starting everything anew. As you get the rhythm, you discern how to win. This is "becoming new."

Sun Tzu reminds that choosing not to fight can be a successful strategy.  So with the zig and the zag and the zing, I elected to put my pencil down and rest my head a bit.  I am feeling more clear eyed and refreshed from the break.

Sunday, July 10, 2011

Parsing out Leisa-land "Stuff" from The Perplexed Investor

I shouldn't let my state of peplexion (This is a word that I freely made up when naming this blog in 2006) fill this space with other "stuff" that I want to write about that has no bearing on the market.  But I like to write, and I like to share the other stuff, so I elected to create a blog called Notes from Leisa Land.  It is a bit cleaner, and is likely to help eliminate some confusion about why the heck am I writing about wine, snakes or countertops.

I hope you'll visit me there.