Game theory is generally regarded as a science that seeks to understand how intelligent, rational humans cooperate and compete with each other during the decision making process. One of the more well known game theory models is called "The Prisoner's Dilemma". What makes this particular game theory model noteworthy is that under the construct of the prisoner's dilemma, the rational actors are compelled to behave irrationally and therefore end up making decisions that are not in their own best interests. This odd outcome given the specific framework of the prisoner's dilemma results in the model being looked upon as a paradox.
I believe that the Great Financial Crisis created some very problematic situations that have forced the Federal Reserve (and all other Central Banks) to create their own version of a "Prisoner's Dilemma" within the stock market. One primary issue that I feel required the Fed to use this unorthodox approach (as it continues to hold back a full scale economic recovery) is that most of the developed world is mired in a "Balance Sheet Recession". While not a mainstream and widely accepted economic view, Nomura economist Richard Koo has been talking about this phenomenon for decades. Initially he used the term to describe the economic conditions in Japan starting in 1990, but expanded his view to include the United States in 2008.
Wikipedia describes a balance sheet recession this way,
"A balance sheet recession is a particular type of recession driven by the high levels of private sector debt (i.e., the credit cycle) rather than fluctuations in the business cycle. It is characterized by a change in private sector behavior towards saving (i.e., paying down debt) rather than spending, which slows the economy through a reduction in consumption by households or investment by business. The term balance sheet derives from an accounting equation that holds that assets must always equal the sum of liabilities plus equity. If asset prices fall below the value of the debt incurred to purchase them, then the equity must be negative, meaning the consumer or business is insolvent. Until it regains solvency, the entity will focus on debt repayment".
Unfortunately many people (including most economists, analysts and Central Bankers) still do not appreciate that the United States (and indeed ALL of the advanced economies) are mired in a balance sheet recession.
One key difference between a balance sheet recession and a 'normal' recession is that when a central bank lowers interest rates in response to an economic slowdown, the increase in borrowing that normally occurs (in a regular recession) is not forthcoming. This is because as the definition above states, in a balance sheet recession the consumer is focused on deleveraging their balance sheet, not expanding their debt loads. .
It is this unique phenomenon that occurs only within the parameters of a balance sheet recession that I believe required the Federal Reserve to create their own "prisoner's dilemma" within the stock market. I believe they are attempting to fight one economic paradox (consumer deleveraging in the face of low interest rates) with a paradox of their own. In the Fed's prisoner's dilemma model, they are forcing rational, normally risk averse actors to behave "irrationally" and against their own best interests by forcing them to embrace higher and higher levels of risk. This decreases risk premiums which in turn raises equity prices (and high yield bonds as well).
I believe the Fed hopes that as asset prices increase, a significant wealth effect will be created that will work to counteract the economic contraction created via on going consumer deleveraging.
Unfortunately, I think the Federal Reserve has slowly realized that their grand experiment is rife with flaws and they now have no idea how to reverse the process without a) significantly damaging the stock market and b) throwing the economy into an even deeper and more painful recession than we saw in 2008.
I have attempted (as best as I can) to discuss a few of the larger and more glaring flaws that are holding back the recovery within the pages of this blog - specifically:
1. While Wall Street is acting in its own self interest (which should expected) it is achieving much of this success through increasingly abusive, predatory and illegal actions. Contrary to popular belief, Wall Street has not 'learned it's lesson' after the Great Financial Crisis, and the fines that were subsequently imposed have done nothing to resolve the problem. They will not stop because they can't help themselves. As such, these abuses continue to come at a very large cost to the rest of the economy.
2. The wealth effect is a myth, which is why income inequality gets worse even as the economy sputters.
3. Moral Hazard - Since the Great Financial Crisis "ended" in 2009, the Federal reserve and other Central banks have created an environment that has gradually become very complacent with regards to risk. In an economy (and market) where there is no real threat of downside risk, malinvestment persists - unfettered and unappreciated. It is only when risk is normalized and reintroduced back into the system will these issues begin to surface and be better understood.
4. The Great Financial Crisis of 2008-09 was a symptom of a bigger, more complicated problem - I laid out these bigger trends in my "The View from 30,000 feet" thesis.
Obviously there are many more flaws that could be holding back the economy from a full recovery - but these are the ones I've chosen to write about over the years.
What concerns me the most is that by creating this kind of extended prisoner's dilemma, the Fed is creating a dangerous environment where distortions are slowly becoming embedded into the system. It is important to remember that in the original Prisoner's dilemma scenario, the rational actors were only put in a position where they had to made an irrational decision ONCE. Once the decision was made, the consequences were immediate. The Fed model has been running non-stop for 7 years (and counting), which means rational players in this environment have been compelled to make irrational decisions against their best interests every single day. It's hard to imagine how that environment will work out without any unintended consequences.
A good example of a dangerous semi-permanent distortion that the Central Banks created via their prisoner's dilemma model is the phenomenon of people paying huge premiums on homes purchased in Vancouver (I discussed the issue in a post here). While paying a premium for a property may not be an unheard of event, it is slowly becoming the norm in the Vancouver area.
Unfortunately, since people are unaware that they are making decisions within a prisoner's dilemma it follows that they do not know many of the decisions they've made are "irrational" and not in their best interests.
What I find interesting is that when the Fed is tried to communicate their desire to normalize and END the prisoner's dilemma - the market responded quite negatively. It was as if people were starting to realize that irrational behavior was once again going to be subject to risk.
The market only started to improve when the economic data was so poor that it became glaringly obvious that the Fed would NOT be able to normalize rates and stop their prisoner's dilemma. This highlights yet another possible problem created via an excessive duration of a prisoner's dilemma within the financial markets: addiction.
There are four accepted states of addiction
1. Experimentation
2. Social use, regular use
3. Problem Use, Risky Use
4. Substance Abuse
If you look at where we are now, I think it's safe to say (after 7 years of on going Fed intervention into the markets via a prisoner's dilemma construct) that we are well on our way to stage 4 where we
"use a psychoactive drug (or in our case financial intervention) to such an extent that its effects seriously interfere with health or occupational and social functioning"
I have no idea how we normalize from where we are now without having a negative impact on the market AND the economy, but think we need to make those moves now before the addiction to our irrational behavior gets even worse.
Sunday, October 18, 2015
Friday, August 28, 2015
Yet another unexplained 2 day rally in the S&P 500
Back in December of 2014 I took a bit of time to analyze the biggest 2 day rallies in the S&P 500 using daily prices from January 1940 to December 28th, 2014. I made a decision to ignore the 1929-1939 "Great Depression" period as the volatility experienced in the stock market at that time completely dominated the data set and I figured 75 years of daily prices was a sufficient sample size.
That blog post can be found here -
http://gubbmintcheese.blogspot.ca/2014/12/2-day-rallies-putting-dec-16-18th.html
After crunching through the data, I came up with the following summary:
That blog post can be found here -
http://gubbmintcheese.blogspot.ca/2014/12/2-day-rallies-putting-dec-16-18th.html
After crunching through the data, I came up with the following summary:
As you can see, the majority of the larger 2 day rallies had some form of catalyst or cause - be it a declaration of war, a currency crisis or the volatility during the popping of a bubble. I admitted that the "unknown" category was more a function of my lack of access to news, and (ahem, laziness) than it was these 14 days not having an explanation (I do these posts on my 'free time'... which is scarce).
Given the massive rally we just witnessed over the last few days of August - I thought I'd go back and revisit this data set to see how the August 25th to 27th rally measured up. It was impressive -
it ranked 21st out of 19,021 two day rallies - about a 4.6 sigma event. Wow.
This rally is even more impressive when you consider the other characteristics of large 2 day rallies:
It happened absent a typical mitigating factor such as a currency crisis, a popping stock market bubble, a recession or the outbreak of a large scale war. At best you 'could' suggest that the initial 1089 point drop (or 6.6%) in the Dow on the morning of August 24th was a Crash - something similar to the Crash of 1987, but I would remind readers that the Dow managed to recover 501 of those points and only closed down 588, or 3.57%. Even at its' worst this 1089, 6.6% intraday low can not compare to decline of 22.61% in a single day - it can't even break into the top 20 list of single day declines in Dow history (going back to 1899).
I pulled off a revised "Top 30" two day rallies of all time (going back to January 1940) - and listed the catalyst for each one (Crisis, bubble volatility, war, etc). All of the largest two day rallies rallies seem to have an explanation except for one (in red) - which I find very interesting.
So, the next time someone tells you that the rally from August 25th to 27th was a "no brainer" and should have been expected, mention that the rally was a 4.6 sigma event that ranked 21st out of a total of 19,021 two day rallies dating back to January 1940. It was also a rally environment completely void of any of your typical market chaos. In a nutshell it was hardly "business as usual".
Monday, August 10, 2015
Vancouver Real Estate: The Inconvenient Truth about Data Availability
I have read so many stories about Vancouver homes selling above their listing price over the years that I find myself completely numb to the phenomenon now. Of course every once and a while I’ll read a story of some house selling at an astronomical price, and I’ll try to comprehend the logic and fundamentals behind these moves. But after so many years of seeing these stories, I find the shock and confusion fades quickly and I get back to my day as if everything was normal. But I think it doesn’t take a real estate specialist or an international monetary watchdog to see that things in the Vancouver real estate market are far from 'normal'.
Some news articles have made an attempt to explain the drivers behind the market’s incredible jump. In this link, a real estate agent explains that the premium paid on the home he sold recently was simply the result of a very successful marketing strategy.
"I would call it strategically listed to garner the interest level that we wanted to get [and] the result that we got."
So, if we are to believe this agent's explanation at face value, the action of listing the home at an lower than market price generated an above average response of prospective buyers which in turn led to excess demand to buy, which ultimately led to a sale price that was fully 35% above the actual asking price.
While some agents do indeed list homes to garner more attention from prospective buyers, expecting this strategy to net an offer that is 35% over your asking price (in an already red hot market) seems to be a bit of a stretch (to this blogger at least).
Is it really true that you can lower the asking price on a home and wait for crowds of people to come in and offer an above ask price? Or, is this less a case of 'brilliant marketing' and more a case of a euphoric bull market that exists within a specific area of Canada.
While there is no denying that Vancouver has been growing steadily for decades (it really took off after the Expo in 1986 put them on the map), the last few years have been well beyond explanation -
As discussed above, it’s to the point now where it is commonplace for homes in the Greater Vancouver area to be selling for huge premiums over asking prices.
Here are a few recent examples of stories -
Developer pays 32% premium in hunt for Vancouver land
Shoppers willingness to pay premium for luxury homes
Vancouver buyer pays $1 million over asking price
What confuses me is why is no one is interested in digging down into the details of these transactions to find out exactly what is driving Vancouver real estate? Most of the stories provide guesses, theories or thoughts on where the demand ise coming from, but as of yet there have been no definitive reports provided. Some pundits suggest Vancouver prices are simply catching up to other great cities, while others suggest an influx of Mainland Chinese funds are driving prices.
Personally I think the theory of Chinese money flooding into the Vancouver market has a lot of merit and is absolutely worth looking into in more detail. Unfortunately apart from ‘ancedotal evidence’, any further information on the influx of Chinese buying hits a major roadblock. For example, MacDonald Realty recently suggested that over a third of all sales had mainland Chinese ties , but further down in the same article we are told that the 'data is unavailable to confirm' the thesis. Specifically it said,
Another story discusses calls by local residents to track the origins of sales to confirm (or deny) the Chinese buyers theory but once again mentions the same informational roadblock - "no data is kept on these transactions"
But don't take my word for it - just go to the Financial Transactions and Reports Analysis Centre of Canada website - and then look at the section on real estate..
There you will find these informative tidbits on the Federal requirements for all Real Estate agents and brokers -
Guideline 6B: Record Keeping and Client Identification for Real Estate
Some news articles have made an attempt to explain the drivers behind the market’s incredible jump. In this link, a real estate agent explains that the premium paid on the home he sold recently was simply the result of a very successful marketing strategy.
"I would call it strategically listed to garner the interest level that we wanted to get [and] the result that we got."
So, if we are to believe this agent's explanation at face value, the action of listing the home at an lower than market price generated an above average response of prospective buyers which in turn led to excess demand to buy, which ultimately led to a sale price that was fully 35% above the actual asking price.
While some agents do indeed list homes to garner more attention from prospective buyers, expecting this strategy to net an offer that is 35% over your asking price (in an already red hot market) seems to be a bit of a stretch (to this blogger at least).
Is it really true that you can lower the asking price on a home and wait for crowds of people to come in and offer an above ask price? Or, is this less a case of 'brilliant marketing' and more a case of a euphoric bull market that exists within a specific area of Canada.
While there is no denying that Vancouver has been growing steadily for decades (it really took off after the Expo in 1986 put them on the map), the last few years have been well beyond explanation -
As discussed above, it’s to the point now where it is commonplace for homes in the Greater Vancouver area to be selling for huge premiums over asking prices.
Here are a few recent examples of stories -
Developer pays 32% premium in hunt for Vancouver land
Shoppers willingness to pay premium for luxury homes
Vancouver buyer pays $1 million over asking price
What confuses me is why is no one is interested in digging down into the details of these transactions to find out exactly what is driving Vancouver real estate? Most of the stories provide guesses, theories or thoughts on where the demand ise coming from, but as of yet there have been no definitive reports provided. Some pundits suggest Vancouver prices are simply catching up to other great cities, while others suggest an influx of Mainland Chinese funds are driving prices.
Personally I think the theory of Chinese money flooding into the Vancouver market has a lot of merit and is absolutely worth looking into in more detail. Unfortunately apart from ‘ancedotal evidence’, any further information on the influx of Chinese buying hits a major roadblock. For example, MacDonald Realty recently suggested that over a third of all sales had mainland Chinese ties , but further down in the same article we are told that the 'data is unavailable to confirm' the thesis. Specifically it said,
Another story discusses calls by local residents to track the origins of sales to confirm (or deny) the Chinese buyers theory but once again mentions the same informational roadblock - "no data is kept on these transactions"
The most interesting thing about this “lack of data” excuse is that it’s false.
But don't take my word for it - just go to the Financial Transactions and Reports Analysis Centre of Canada website - and then look at the section on real estate..
There you will find these informative tidbits on the Federal requirements for all Real Estate agents and brokers -
Guideline 6B: Record Keeping and Client Identification for Real Estate
and client identities (including 3rd parties) -
So, based on the information taken directly from the Canadian Government's FINRAC website, real estate agents and brokers are required to record the identity of their clients (including 3rd parties) and the origins and amounts of money used for "ANY TRANSACTION OVER $10,000".
This means that contrary to the narrative, the data on who is buying what in Vancouver IS available and therefore we could determine how much money is coming in from Mainland China absolute certainty. Unforunately for some reason, we choose not to.
I have no idea why interested parties (Municipal, Provincial and Federal Governments, corporations, Real Estate Boards and financial firms) don't see the value in having a better understanding of exactly who is dabbling in their real estate markets, but my gut tells me that all related industries have taken a "don't ask, don't tell" approach.
Put simply - They just don't want to know the answer. And more importantly, I think they don’t want us to know either.
As with anything in life, ignoring or suppressing issues in the hopes that any “inconvenient truths” go away or resolve themselves on their own hardly ever works.
In my mind, the most important lesson to take away from what’s going on in the Vancouver real estate market today is this: “As with trees, real estate prices don’t grow to the sky”.
There is no denying the fact that Vancouver is a beautiful city, and that many people want to live here. But the phenomenon of paying 35% over the asking price of a home is not a typical occurrence, and instead reflects an overly euphoric market. While we don’t know when a particular market might experience a correction, we can review the fundamentals, look at past bull markets, and demographics to determine with reasonable comfort where prices “should” be. Back in the old days, before Central Banks controlled all aspects of asset prices and rendered this kind of information irrelevant, this was called “fundamental analysis”.
Two things I’d suggest people consider when looking at Vancouver real estate:
1) The concept of price insensitive buyer and sellers that was recently discussed by Ben Inker at GMO – In this piece Mr. Inker identifies a particular type of asset buyer where
“the expected returns of the assets they buy are not a primary consideration in their purchase decision”.
Inker goes further to state, “it is worth recognizing that investors prepared to buy assets without regards to the price of those assets may also find themselves in a position to sell those assets without regard to price as well”.
Inker’s views do a great job (I think) of foreshadowing future problems in the Vancouver market: “in order to see massive changes in the price of a security, you don’t need the price insensitive buyers to become a seller. You merely need him to cease being the marginal buyer”.
Students of history will recall Japan’s insatiable demand for exotic real estate in Hawaii during their economic boom of the early and mid 80s. At that time you had a country experiencing a massive economic boom that pushed domestic prices through the roof. In response many wealthy Japanese (like their Chinese counterparts today) started accumulating vast properties in a very small, concentrated area. In the case of Japan it was Hawaii, in the case of China, it is Vancouver. As such, it is worthwhile spending a bit of time finding out what happened when the Japanese economy slowed down in 1989. The Federal Reserve Bank of San Francisco wrote a paper on this issue entitled,“Fluctuating Fortunes and Hawaiian House Prices” that I would suggest is worth a review.
2) My second point would be to not allow yourself to become too complacent about the markets. Paying a 35% premium to the going market price is not a normal, sustainable phenomenon. Imagine all of your other major purchases following the same pattern. For example, you go to a coffee shop and order a Latte. The bill is $3.50, but you are told that if you really want your latte immediately, you will need to pay $4.73. You then go to the grocery store to get some food for dinner. When you get everything checked out, the bill comes to $85.75 – but again you are told “if you want it now” you will have to pay $115.76. You can see when the current real estate environment is removed from its’ market friendly narratives – that the process is a bit illogical. At the very least it should provide some caution towards our actions and attitudes – and the desire to get more information so we can better understand what’s driving this marketplace.
In the end, no one really knows if or when the Vancouver market will correct. “When the bubble pops in Vancouver” has been the subject of speculation for years. What I find interesting is that we do in fact have the data and ability to see exactly who and/or what has been driving the markets, but instead we choose to ignore this opportunity. Maybe it will be fine in Vancouver, or maybe decades from now we will read another research piece by the San Francisco Fed entitled, “Fluctuating Fortunes and Vancouver House Prices”.
Friday, April 24, 2015
When Fiduciaries go bad
From Wikipedia: "A fiduciary is a person who holds a legal or ethical relationship of trust between himself or herself and one or more other parties (person or group of persons).
Typically, a fiduciary prudently takes care of money for another person. One party, for example a corporate trust company or the trust department of a bank, acts in a fiduciary capacity to the other one, who for example has entrusted funds to the fiduciary for safekeeping or investment. Likewise, asset managers—including managers of pension plans, endowments and other tax-exempt assets—are considered fiduciaries under applicable statutes and laws. In a fiduciary relationship, one person, in a position of vulnerability, justifiably vests confidence, good faith, reliance, and trust in another whose aid, advice or protection is sought in some matter.
In such a relation good conscience requires the fiduciary to act at all times for the sole benefit and interest of the one who trusts."
So the Coles notes version of this suggests that a person who is deemed to be 'vulnerable' vests trust and good faith in another person (the fiduciary) for professional advice, guidance or help. Further, upon acceptance of the responsibility, the fiduciary has a legal and ethical responsibility to exhibit a very high standard of behavior (higher than a simple "duty of care") to ensure the vulnerable party is protected from exploitation from that particular relationship.
Obviously a lot of very bad things can happen to a person who establishes a fiduciary relationship with someone who has questionable ethics and bad motives.
So who in the financial industry is a fiduciary and who isn't?
Well - investopedia has a nice description of the difference between the two here:
here's an excerpt:
"In the investment field, there are two primary parties who are able to offer investment advice to individuals, as well as institutional clients such as pension funds, non-profit organizations and corporations. These parties are investment advisors and investment brokers who work for brokers-dealers. Many clients may consider the investment advice they receive from each party as similar, but there is a key difference that may not be completely understood by the investing public. The difference pertains to two competing standards that advisors and brokers must adhere to, and the distinction has important implications for individuals who hire outside financial assistance. Below is an overview of both parties, the standards each must follow and how the standards that brokers follow can create conflicts between themselves and their underlying customer base. "
So investment advisors, who are regulated by the Securities & Exchange Commission are considered fiduciaries, and as such are bound by the Investment Advisor's Act of 1940. It means all advisors need to put their client's interests above that of their own and insure that all advice fits the client's needs, objectives and risk tolerances.
Broker-dealers on the other hand are regulated via the Financial Industry Regulatory Authority (FINRA) and therefore only need to fulfill a "suitability obligation". This obligation suggests that the broker-dealer makes recommendations and undertakes actions that are "consistent with" the best interests of the client.
I will leave readers to go through all of the details of who is, and isn't a fiduciary, and what the rules and differences are between suitability & fiduciary obligations for themselves. And start getting more to the point of this post...
It is my humble view that ANYONE who provides investment/financial advice to a client of any nature should be considered a 'fiduciary' - and as such should be held to the accepted and much higher standards of a fiduciary.
I believe Wall Street, or more accurately (since I live in Canada) the "financial industry", has done a masterful job of muddying the waters with regards to who should be held under the lens of the fiduciary standard for selfish, profit seeking reasons. I'm sure that's not a shocking statement given all of the amazing abuses we've seen over the last 8 years - but it needs saying (again and again and again...)
I am also of the believe that the financial industry has changed its approach over the last 2 or 3 decades, and has now taken on what I've described in previous posts as a parasitoidal sort of relationship with clients. You can read more about this in my blog post entitled, "Symbiotic, Parasitic and Parasitoidal Cycles of Finance".
Former Goldman Sachs director Gus Levy was famous for suggesting that Goldman was "long term greedy". The insinuation here was that Goldman was pricing their services in a such a way that they were maximizing profits while still keeping clients happy and well represented. This model worked, and worked well. While you may assume that due to my bearish rants on the industry (via here, and twitter) that I'm very much 'anti-finance', but this is actually a model that I'd happily endorse because in the end - everyone wins - and the 'fees' can be negotiated and agreed upon ahead of time.
But, somewhere along the lines - somewhere in the mid 90s I'd argue, Wall Street's profit model changed. I'm not sure who started it, or how, but somewhere, somehow the tried and true, perfectly harmonious "long term greedy" model morphed into something I'd describe as "predatory finance".
Under this new model, it seemed that clients were no longer to be well represented, but instead exploited or sacrificed in the name of quarter over quarter profits or annual bonuses. Of course the biggest problem with this transition was that no one told the client. Meaning for the most part, clients were left believing that the financial industry was still working tirelessly with their best interests in mind.
Obviously there are a lot of fantastic advisors and firms out there who are 100% honest, and as such are busting their buns to do the right thing for their clients - but I think most of them would agree that they are not in the majority.
In fact, as Bill Black discusses (here and here), thanks to a combination of "Control Fraud" and Gresham's Dynamic, honest brokers are more than likely getting displaced by other, less ethical brokers who don't mind 'bending the rules' and working against their client's best interests to help increase corporate profitability.
Is that assertion a stretch?
Well look at the comments and career of Christian Bittar, who was allegedly "Trader Number 3" from the Deutsche Bank Libor Scandal -
From the article:
"he was Deutsche Bank’s most profitable derivatives trader, earning a bonus of almost 90 million pounds ($136 million) in 2008 alone"
"Bittar, who joined Deutsche Bank in 2001, took billion-euro positions on the direction of short-term interest rates with the firm’s own money and reaped hundreds of millions of euros in profit for the bank."
Bittar was named global head of money market derivatives trading, moving to Singapore, in the years that followed, according to the CFTC
and most importantly -
Bittar hasn’t been charged with any offense.
There are a million examples of pre-crisis abuses but the one that I always think of as the ultimate poster child of abuse pre-financial crisis is the Goldman Sachs' "Abacus" deal with Paulson.
Or, if you don't like me picking on Goldman, how about that time Bear Stearns tried to play "hot potato" by bundling up all of their problems into one IPO called "Everquest"? They pooled all of their most toxic assets and tried to pitch it out into the muppetsphere (the term Muppet was coined by the industry and refers to naive investors who act as cannon fodder for crappy, problematic deals)
Of course the industry will try to spin a PR friendly narrative that "we had some bad actors", or that "there were holes in our compliance management" or that it's really "not that big a deal", but the "gee whiz, we don't know what happened there" excuses sort of fall short when you consider that as of December 2014, the largest US banks have paid out a collective $180 BILLLION in fines and settlements.
The problem is an epidemic, and the incentives to exploit fiduciary relationships are alive and well.
Bill Black, who was in charge of investigating the Savings and Loans scandal in the 80s presented a very harsh assessment of the Great financial crisis -
To me - the key statement in this video piece was when Black said this,
"When people cheat, you can not as a regulator continue "business as usual". They go into a different category, and you must act completely differently as a regulator"
Let's do a quick acid test - are firms cheating? Answer: Yes
which was mentioned in another great article, by William D. Cohan -
"Can Bankers Behave"
(My answer would be for the most part: No, they can't.. unless things change dramatically)
So, when getting financial advice, use Ronald Reagan's advice: "trust but verify" -
Especially when you are being sold stocks are "cheap", or that we are at the start of a recovery, or that you should take out a 109 month car loan (from 2008 & today), or are told to use the equity in your house to buy stocks or use a 7 year car loan to buy stocks or (alledgedly) get talked into taking out a loan at a 42% annual interest rate...
This behavior and abuse will continue to build until something blows up - which is a large part of the reason why I continue to be so defensive with regards to the market. It's NOT better, it's just that the people who blew it up the first (and second and third) time are TELLING you it's better. they are telling you that they've learned their lesson, that the risks are far lower than they were in 2007 and that there are backstops and protection measures now in place.
No.
We need a present day Ferdinand Pecora to get us back on track. We need to regain control of our financial industry, we need to demand change, and we need to make sure regulators and politicians start representing the best interests of the voters, and not simply that the of monied interests.
It sounds naive, but it's the truth.
We can change things now, or we can wait for another crisis.. it's entirely up to us.
caveat emptor..
Typically, a fiduciary prudently takes care of money for another person. One party, for example a corporate trust company or the trust department of a bank, acts in a fiduciary capacity to the other one, who for example has entrusted funds to the fiduciary for safekeeping or investment. Likewise, asset managers—including managers of pension plans, endowments and other tax-exempt assets—are considered fiduciaries under applicable statutes and laws. In a fiduciary relationship, one person, in a position of vulnerability, justifiably vests confidence, good faith, reliance, and trust in another whose aid, advice or protection is sought in some matter.
In such a relation good conscience requires the fiduciary to act at all times for the sole benefit and interest of the one who trusts."
So the Coles notes version of this suggests that a person who is deemed to be 'vulnerable' vests trust and good faith in another person (the fiduciary) for professional advice, guidance or help. Further, upon acceptance of the responsibility, the fiduciary has a legal and ethical responsibility to exhibit a very high standard of behavior (higher than a simple "duty of care") to ensure the vulnerable party is protected from exploitation from that particular relationship.
Obviously a lot of very bad things can happen to a person who establishes a fiduciary relationship with someone who has questionable ethics and bad motives.
So who in the financial industry is a fiduciary and who isn't?
Well - investopedia has a nice description of the difference between the two here:
here's an excerpt:
"In the investment field, there are two primary parties who are able to offer investment advice to individuals, as well as institutional clients such as pension funds, non-profit organizations and corporations. These parties are investment advisors and investment brokers who work for brokers-dealers. Many clients may consider the investment advice they receive from each party as similar, but there is a key difference that may not be completely understood by the investing public. The difference pertains to two competing standards that advisors and brokers must adhere to, and the distinction has important implications for individuals who hire outside financial assistance. Below is an overview of both parties, the standards each must follow and how the standards that brokers follow can create conflicts between themselves and their underlying customer base. "
So investment advisors, who are regulated by the Securities & Exchange Commission are considered fiduciaries, and as such are bound by the Investment Advisor's Act of 1940. It means all advisors need to put their client's interests above that of their own and insure that all advice fits the client's needs, objectives and risk tolerances.
Broker-dealers on the other hand are regulated via the Financial Industry Regulatory Authority (FINRA) and therefore only need to fulfill a "suitability obligation". This obligation suggests that the broker-dealer makes recommendations and undertakes actions that are "consistent with" the best interests of the client.
I will leave readers to go through all of the details of who is, and isn't a fiduciary, and what the rules and differences are between suitability & fiduciary obligations for themselves. And start getting more to the point of this post...
It is my humble view that ANYONE who provides investment/financial advice to a client of any nature should be considered a 'fiduciary' - and as such should be held to the accepted and much higher standards of a fiduciary.
I believe Wall Street, or more accurately (since I live in Canada) the "financial industry", has done a masterful job of muddying the waters with regards to who should be held under the lens of the fiduciary standard for selfish, profit seeking reasons. I'm sure that's not a shocking statement given all of the amazing abuses we've seen over the last 8 years - but it needs saying (again and again and again...)
I am also of the believe that the financial industry has changed its approach over the last 2 or 3 decades, and has now taken on what I've described in previous posts as a parasitoidal sort of relationship with clients. You can read more about this in my blog post entitled, "Symbiotic, Parasitic and Parasitoidal Cycles of Finance".
Former Goldman Sachs director Gus Levy was famous for suggesting that Goldman was "long term greedy". The insinuation here was that Goldman was pricing their services in a such a way that they were maximizing profits while still keeping clients happy and well represented. This model worked, and worked well. While you may assume that due to my bearish rants on the industry (via here, and twitter) that I'm very much 'anti-finance', but this is actually a model that I'd happily endorse because in the end - everyone wins - and the 'fees' can be negotiated and agreed upon ahead of time.
But, somewhere along the lines - somewhere in the mid 90s I'd argue, Wall Street's profit model changed. I'm not sure who started it, or how, but somewhere, somehow the tried and true, perfectly harmonious "long term greedy" model morphed into something I'd describe as "predatory finance".
Under this new model, it seemed that clients were no longer to be well represented, but instead exploited or sacrificed in the name of quarter over quarter profits or annual bonuses. Of course the biggest problem with this transition was that no one told the client. Meaning for the most part, clients were left believing that the financial industry was still working tirelessly with their best interests in mind.
Obviously there are a lot of fantastic advisors and firms out there who are 100% honest, and as such are busting their buns to do the right thing for their clients - but I think most of them would agree that they are not in the majority.
In fact, as Bill Black discusses (here and here), thanks to a combination of "Control Fraud" and Gresham's Dynamic, honest brokers are more than likely getting displaced by other, less ethical brokers who don't mind 'bending the rules' and working against their client's best interests to help increase corporate profitability.
Is that assertion a stretch?
Well look at the comments and career of Christian Bittar, who was allegedly "Trader Number 3" from the Deutsche Bank Libor Scandal -
From the article:
"he was Deutsche Bank’s most profitable derivatives trader, earning a bonus of almost 90 million pounds ($136 million) in 2008 alone"
"Bittar, who joined Deutsche Bank in 2001, took billion-euro positions on the direction of short-term interest rates with the firm’s own money and reaped hundreds of millions of euros in profit for the bank."
Bittar was named global head of money market derivatives trading, moving to Singapore, in the years that followed, according to the CFTC
and most importantly -
Bittar hasn’t been charged with any offense.
There are a million examples of pre-crisis abuses but the one that I always think of as the ultimate poster child of abuse pre-financial crisis is the Goldman Sachs' "Abacus" deal with Paulson.
Or, if you don't like me picking on Goldman, how about that time Bear Stearns tried to play "hot potato" by bundling up all of their problems into one IPO called "Everquest"? They pooled all of their most toxic assets and tried to pitch it out into the muppetsphere (the term Muppet was coined by the industry and refers to naive investors who act as cannon fodder for crappy, problematic deals)
Of course the industry will try to spin a PR friendly narrative that "we had some bad actors", or that "there were holes in our compliance management" or that it's really "not that big a deal", but the "gee whiz, we don't know what happened there" excuses sort of fall short when you consider that as of December 2014, the largest US banks have paid out a collective $180 BILLLION in fines and settlements.
The problem is an epidemic, and the incentives to exploit fiduciary relationships are alive and well.
Bill Black, who was in charge of investigating the Savings and Loans scandal in the 80s presented a very harsh assessment of the Great financial crisis -
To me - the key statement in this video piece was when Black said this,
"When people cheat, you can not as a regulator continue "business as usual". They go into a different category, and you must act completely differently as a regulator"
Let's do a quick acid test - are firms cheating? Answer: Yes
from:
Second question - are regulators 'acting completely different' in the face of cheating?
Not so much - 'deferred prosecutions' and charging fines continue to be favored plays by the regulators, as we continue to wait for ONE arrest and conviction of an executive who is 'personally' responsible for abuse.
and Wall Street knows it -
Elizabeth Warren to JP Morgan CEO (in 2013), "I think you guys are breaking the law...."
So what is the point of this post?
It's to point out that the financial industry is NOT your buddy. For the most part the incentives are out of whack and need to be corrected. Yes, there are still 'great people' working in the industry who are honest and who do a great job - but I think they would agree that they are being heavily out gunned by the predators and exploiters of the system who are busy making as much money for themselves at any cost.
Remember - the financial industry attracts a tremendously high number of sociopaths..
and as I discussed in my post, "The Farmer & The Viper" - sociopaths are wired to pursue a reward "at any cost"
I'm happy to see more research is being done in this area (it's finally not just me going on and on about this stuff).
Consider this fantastic paper by Alain Cohn, Ernst Fehr1 & Michel Andre Mare entitled,
which was mentioned in another great article, by William D. Cohan -
"Can Bankers Behave"
(My answer would be for the most part: No, they can't.. unless things change dramatically)
So, when getting financial advice, use Ronald Reagan's advice: "trust but verify" -
Especially when you are being sold stocks are "cheap", or that we are at the start of a recovery, or that you should take out a 109 month car loan (from 2008 & today), or are told to use the equity in your house to buy stocks or use a 7 year car loan to buy stocks or (alledgedly) get talked into taking out a loan at a 42% annual interest rate...
This behavior and abuse will continue to build until something blows up - which is a large part of the reason why I continue to be so defensive with regards to the market. It's NOT better, it's just that the people who blew it up the first (and second and third) time are TELLING you it's better. they are telling you that they've learned their lesson, that the risks are far lower than they were in 2007 and that there are backstops and protection measures now in place.
No.
We need a present day Ferdinand Pecora to get us back on track. We need to regain control of our financial industry, we need to demand change, and we need to make sure regulators and politicians start representing the best interests of the voters, and not simply that the of monied interests.
It sounds naive, but it's the truth.
We can change things now, or we can wait for another crisis.. it's entirely up to us.
caveat emptor..
Saturday, March 21, 2015
Paul Tudor Jones & Ray Dalio channel James Goldsmith
This week both Paul Tudo Jones and Ray Dalio had comments that took the twittersphere by storm. Tudor Jones presented a thought about "Just Capital" at the Ted2015 talks while Dalio warned about the Fed raising rates too early and repeating a 1937 styled correction. The latest 1937 warning from Dalio was interesting given his other rather dark worry relating to the possibility of the rise of a 2nd Hitler.
I know what you are saying, "Geez Gubb.. nice light topic for a Saturday afternoon" - but hear me out.
While I am certainly encouraged by these two recent gentlemen sounding these warnings, I will say I'm not the least bit shocked. This was something I called at the very beginning of the Great Financial Crisis when it became clear to me that the politicians weren't going to make any meaningful reforms to try and regain control of Wall Street.
To me it was clear: Wall Street was calling the shots.
Remember this from Brad Sherman?
Sherman made some excellent forecasts as to what would happen if the US carried out the bailout..
I know what you are saying, "Geez Gubb.. nice light topic for a Saturday afternoon" - but hear me out.
While I am certainly encouraged by these two recent gentlemen sounding these warnings, I will say I'm not the least bit shocked. This was something I called at the very beginning of the Great Financial Crisis when it became clear to me that the politicians weren't going to make any meaningful reforms to try and regain control of Wall Street.
To me it was clear: Wall Street was calling the shots.
Remember this from Brad Sherman?
Martial law if they didn't bailout Wall Street? Seriously?
But, the person I credit the most with calling the financial crisis, the abuse by Wall Street and generation of Corporatism is Sir James Goldsmith - who laid all of this out in an interview he did with Charlie Rose back in 1994.
If you haven't taken the time to watch this interview in its entirety, you are doing yourself a great disservice.
I'm not going to provide a link to all 6 sections of this interview as I figure if you find it interesting, you will seek the rest of it out on your own.
But - even in the first portion, what does Goldsmith say?
He calls global wage deflation, increasing profit margins, a hollowing out of the middle class, a "destruction of one's society" and the rise of corporatism.
All the same things that Dalio and Tudor Jones are warning about now, 21 years later.
It was this interview that really helped me gel all of the ideas I had buzzing around in my head and inspired me to write "The View from 30,000 feet"
and now Tudor Jones and Dalio are warning about the growing risks of unrest and market corrections.
As you know, Ray Dalio produced a fantastic discussion on "How the Economic Machine Works"
and I agree with everything Dalio says - but have made the contention that at the 23:10 mark, Dalio's simplified machine video misses the mark.
In the video - Dalio talks about how a government increases taxes on the rich to promote a 'redistribution of wealth from the haves to the have nots" and if this doesn't happen we start to see tension rise between the wealthy and the poor. Dalio then introduces the Central Bank as the hero and suggests by printing money, it helps drive up asset prices which in turn allows more people to become credit worthy.
Unfortunately as Amir Sufi and Atif Mian have already shown, asset price increases are NOT flowing to all components of the US economy.
moreover, politicians and regulators seem to continuing their long standing tradition of siding with Wall street at the expense of main street.
So, when you consider Goldsmith's commentary about the unappreciated trends in the global economy, and add in Wall Street's incredible influence and on going self interests, along with the knowledge that not ALL people are benefiting from the increase in the stock market and the US's economic "recovery".. you will get a better understanding of why I've been voicing the same dark warnings as Tudor Jones and Dalio over the last 7 years. .
Very few people have put all of these things together - and while some (like Dalio and Tudor Jones) are doing so now, only a handful made this call back in 2008.
I am thankful for Jimmy Goldsmith's warnings - as they truly opened my eyes to the direction we were heading down.
It's also helped me formulate my views on the sociopathology that exists on Wall street, and the various parasitic phases of Wall Street.
I really do hope that I am wrong on these calls - but they seem to be confirmed more and more with each passing week.. which as I'm sure you can imagine is not great.
It is my sincere hope that at some point we get a present day Ferdinand Pecora to come in, regain control and reform the system.. but it seems that we are still a long way away from this critical step.
Thursday, March 12, 2015
Symbiotic, Parasitic and Parasitoidal Cycles of Finance
Part of my big macro economic piece (posted here) planted blame for the 2008 Financial crisis squarely at the feet of the financial industry. The is the very same industry that I've worked in every day since I graduated from University in 1993 with a degree in Economics (hey, don't laugh..).
I started working as an investment advisor at a bank owned brokerage firm, one of the big four, and as crazy and stressful as it was, I wouldn't change the experience for anything in the world as it really helped open my eyes to how the system worked and where the REAL incentives lay.
From my perspective, seeing first hand how the bank culture took over the brokerage side was a fantastic experience and the lessons I learned there helped me refine my instincts and skills as a money manager.
Now - if you've been reading this blog at all you will know that I am absolutely NOT an economist nor an analyst. As such, most of the comments and observations I make here are usually rough, unscientific and lack the polish and eloquence provided by many of the other people who take time to share their thoughts on the markets and the economy. But I think what I lack in written eloquence, I make up for by having a keenly observant eye and an obsessive passion for figuring out what's going on.
So - with all of that stated, let me start my "point".
I have long used the analogy that the financial industry is much akin to a tape worm that is attached to the stomach of the global economy. As the economy grows, so does the tape worm and the tape worm's associated appetite. This mostly clumsy analogy suggests that there is a parasitic relationship shared between the financial industry and the global economy.
I would suggest that over history, finance and the global economy have experienced parasitic cycles that ebb and flow from one extreme to another. Those cycles could be broken down into three distinct classifications:
i) symbiotic
ii) classic parasitic
iii) parasitoidal
In a symbiotic relationship (which is not 'officially' parasitic, but bear with me) both the financial industry and the global economy benefit from the relationship. A simple but effective example from my own little retail investment world would be the creation and mass distribution (by the financial industry) of zero coupon, or "stripped" bonds. These things are fantastic for client accounts (RRSPs and RRIFs) as well as being a huge source of revenue for the financial industry.
In a classic parasitic relationship - only one party (the parasite) benefits, and at the expense of the "host". You can take your pick here from a multitude of brutal parasitic financial plays, but to keep things simple let's just refer to the Goldman/Paulson/Abacus deal - Boo!
In this situation Goldman and Paulson did very well, while the buyers of Abacus (the hosts) got blasted.
Finally in a parasitoidal relationship - the parasite draws so much in the form of resources that it ends up either sterilizing or ultimately KILLING the host.
Again - take your pick, but for me the biggest (but as of yet 'unproven') example would be the plethora of debt instruments that have been made available to consumers. Each of these debt instruments draws a charge in the form of interest - that depletes the financial health of the host.
Sub prime mortgages, credit cards, lines of credit, 9 year car loans, car equity loans, Home equity loans, etc etc etc..
Again - if you read my larger macro piece, you know that I believe we hit 'peak debt' in 2007 and are now mired in a balance sheet recession of biblical proportions.
But, what I think the financial industry hasn't figured out is that all of these debts, all of the resources that they've drawn from their host (the consumer) has ended up KILLING them, or pushed them past the point of no return as we were motivated by profits and bonuses rather than fulfilling our fiduciary duties to provide SUITABLE financial advice to our clients.
This is why economists are always so flummoxed why the economy isn't bouncing back after 6 years of zero rates and unprecedented intervention and stimulus.
At best the host is now on life support in the ICU and is in a coma, and that's hardly a good thing.
Unfortunately for us, the financial parasite will never learn their lesson as they have sociopathic tendencies (as discussed here: http://www.gubbmintcheese.blogspot.ca/2014/05/the-farmer-and-viper.html) and as such will never change or ease off in their thirst for more resources.
NB: Another great discussion of the status-quo parasitic/parasitoidal relationship between finance and the rest of the world can be found in Jesse Eisinger's outstanding piece here: http://mobile.nytimes.com/2015/03/05/business/dealbook/despite-changes-an-overhaul-of-wall-street-falls-short.html?referrer&_r=0
THIS is why I think the economy continues to struggle.
Now I know these points may sound a bit far off given my rambling, choppy writing style - but please, don't kill the messenger. For those who prefer glossy, professional, researched views look at what the BIS just wrote:
Call me crazy but I think this just confirmed by parasitic tie in.. (See what I mean? I can see it and write about it, but will leave it to other people to do a more thorough and eloquent job or researching and writing about it. )
So what to make of all this information?
Well first and foremost, I would take EVERYTHING that Wall Street says with a large grain of salt. Don't get me wrong, there are some very honest and amazing people who work in this industry.. not everyone is a bad guy or girl.
Unfortunately though, the incentives are hugely misaligned.. which means the little people who still believe in the fiduciary relationship with their investment people, are probably getting taken advantage of.
As Stephen King said, "Trust of the innocent is the Liar's most useful tool".
Keep that in mind when you are told that 'stocks are cheap' by people on the Street - even as the Shiller CAPE sits just below 28, a level only surpassed in 1929 and 2000...
Plainly put - we desperately need another Ferdinand Pecora, and we need him asap.
Great read here: http://en.wikipedia.org/wiki/Pecora_Commission
Unfortunately it appears as though government and regulators are still far too cozy with the financial industry to make any changes - which suggest we are (as of now) simply doomed to repeat yet another crisis.
I hope we can get this sorted out before another break comes, but it's certainly not looking great at this point.
Maybe tomorrow.
Cheers all.
Gubb
Wednesday, March 11, 2015
An observation from the front lines - commentary from a real estate agent in Vancouver
As I discussed on twitter - I received this email response from a client of mine after sending him a story about the Vancouver market. This was his reply.
(names removed for obvious reasons)
Hi Gubb,
Good article, I see it up close and personal every day.. I've been struggling to get a hold of business and it's becoming more difficult every month. The overall influence of the Asian buyer has become overwhelming. Home sellers almost universally believe it's necessary to hire an Asian realtor to get top dollar selling a home. Buyers are constantly having to go into multiple offer situations and are being out bid by Asian buyers willng to pay well over asking and assessed value. I've written offers on 4 properties in the last month - ALL were outbid, some by as much as 30% over asking
70% of the for sale signs hopping up are with Asian realtors. The older, more well established realtors who dominated this market a few years ago are now fighting for listings and the back stabbing has begun. Up the street from my office the new home British Pacific Properties are selling new MODEST homes that start between $4m and $5m, and ALL of the buyers so far are from Mainland China who expect to come here once a year for a couple of weeks of holiday.
People are starting to speak out but no one is doing anything. In Australia they have the same problem but their government's foreign investment review board has implemented new rules to stem the surge in home sales to foreigners. We need to do the same.
GUBB Comments below:
My client then provided an example of a big recent home sale for $51,800,000
http://www.vancouversun.com/business/Priciest+Metro+Vancouver+homes+draw+buyers+from+China+with+video/10875651/story.html
Pretty amazing stuff. I do honestly think that the percentage of Vancouver sales with Mainland Chinese ties is FAR higher than 30%.. I'd be willing to suggest it's closer to 60%.. but of course no one really cares... yet.
Cheers!
Gubb
(names removed for obvious reasons)
Hi Gubb,
Good article, I see it up close and personal every day.. I've been struggling to get a hold of business and it's becoming more difficult every month. The overall influence of the Asian buyer has become overwhelming. Home sellers almost universally believe it's necessary to hire an Asian realtor to get top dollar selling a home. Buyers are constantly having to go into multiple offer situations and are being out bid by Asian buyers willng to pay well over asking and assessed value. I've written offers on 4 properties in the last month - ALL were outbid, some by as much as 30% over asking
70% of the for sale signs hopping up are with Asian realtors. The older, more well established realtors who dominated this market a few years ago are now fighting for listings and the back stabbing has begun. Up the street from my office the new home British Pacific Properties are selling new MODEST homes that start between $4m and $5m, and ALL of the buyers so far are from Mainland China who expect to come here once a year for a couple of weeks of holiday.
People are starting to speak out but no one is doing anything. In Australia they have the same problem but their government's foreign investment review board has implemented new rules to stem the surge in home sales to foreigners. We need to do the same.
GUBB Comments below:
My client then provided an example of a big recent home sale for $51,800,000
http://www.vancouversun.com/business/Priciest+Metro+Vancouver+homes+draw+buyers+from+China+with+video/10875651/story.html
Pretty amazing stuff. I do honestly think that the percentage of Vancouver sales with Mainland Chinese ties is FAR higher than 30%.. I'd be willing to suggest it's closer to 60%.. but of course no one really cares... yet.
Cheers!
Gubb
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