November 10, 2010
Regulatory Implications of Arbitrariness
Posted by Jeff Schwartz

As I noted in my last post, the arbitrariness of the stock market poses both fairness and efficiency concerns.  Out of concern for fairness, there may be a role for government in protecting investors from arbitrary and disparate market outcomes.  Efficiency concerns point to policies that would dampen the appeal of actively managed mutual funds.

Disparate market returns stem from market volatility.  If the market just went up by the same amount every year, everyone would earn the same thing.  To bring about greater equality of returns, therefore, regulation could seek to dampen the market’s swings.  Indeed, our current disclosure regime has been shown to reduce market volatility, and I have argued that this provides some justification for the regulatory structure. 

Government could also enact measures directly targeted at protecting retirement savers from market turbulence.  A range of proposals could be envisioned along these lines:  from the least intrusive—better education about market risk and risk management—to the most—replacing the 401(k) retirement paradigm with a funded government system.  What I think is most interesting is the prospect of government insurance of stock-market returns.  A study done by the Center for Retirement Research at Boston College showed that in retrospect the government could have guaranteed investor returns of 6% (investors in this case would have forfeited any returns above 6% in exchange for a guarantee of at least that amount).  Looking prospectively, the study concludes that under certain assumptions, the government could offer a 4% return guarantee with a 6% cap.  I have my concerns about the feasibility of this structure, which I’ll discuss in my next post, but at least in the abstract, it looks like a promising way to make saving more equitable.  

A range of policy options is also available for addressing the inefficiency of actively managed funds.  The least interventionist measures would involve better disclosure.  My suspicion is that part of the popularity of actively managed funds stems from their branding.  A 401(k) investor may not realize that a “growth” fund is actively managed, and charges a high fee for its services.  Therefore, better disclosure of both fund strategy and fees may be justified.  In a step in the right direction, the Department of Labor recently adopted new and improved fee disclosure regulations for 401(k)s. 

More interventionist steps are also imaginable.  For instance, 401(k) defaults could be set to index funds.  Because 401(k) investors tend to stick to default choices, this would likely have a material effect in channeling fund flows away from these instruments.  More thought is necessary about the type of regulation, and, indeed, whether any is advisable.  But a variety of alternatives seem to be available to make the allocation of investor resources more efficient.

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November 09, 2010
Arbitrariness and the Social Contract
Posted by Jeff Schwartz

In my last post, I talked about the arbitrariness that pervades both passive and active investing.  Today, I’ll talk about why we might care about this as a policy matter.

For one, the arbitrary nature of investing potentially poses fairness concerns.  Intuitively, it seems unjust that some should be rewarded by chance market moves while others are victims. 

This intuition can be fleshed out by appealing to Rawls’s notion of the veil of ignorance.  Behind this veil, those drafting the social contract do not know whether those whom they represent will be fortunate or unfortunate.  As such, he posits that these individuals would design society so that those who benefit from morally arbitrary good fortune, such as being born with high intelligence or to a wealthy family, share with those who are less lucky. 

This notion of egalitarianism can be applied to stock-market investing.  As discussed last time, to a great extent, stock-market gains and losses similarly represent morally arbitrary good and ill fortune.  Therefore, it seems that society would benefit to the extent that the chance gains and losses the market conveys are equitably distributed.  This line of thinking seems to have particular merit in the retirement context, where an intuitive conception of what is just tells us that the amount of one’s contributions rather than arbitrary market swings should determine the balance of one’s retirement account. 

Government intervention to effectuate the sharing of chance market returns, particularly in connection with retirement savings, may, therefore, be justified based on fairness grounds.

The arbitrariness also seems to suggest that the allocation of resources to actively managed mutual funds is inefficient.  Welfare economics tells us that we want resources to flow to their best use.  If returns that result from stock-picking are largely the result of chance, then expending resources in this pursuit may not be justified.  Why would we expend resources to arbitrarily distribute wealth?  This concern seems particularly poignant when one considers that market trading is zero sum in the sense that for every trader who bets correctly there is a counterparty who is not so fortunate.  Thus, chance gains and losses are simply reshuffled among investors without any moral claim to them, while fund managers extract fees for their efforts.

The above may overstate the case against active mutual fund management.  Some benefits do accrue to investors in the form of more accurate stock prices and a more liquid market.  Nevertheless, it seems probable that society is spending too much on the search for market-beating returns.  Thus, some type of regulatory intervention may be justified.

In my next post, I’ll talk about some potential responses to the fairness and efficiency concerns raised by the arbitrariness of the stock market.

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November 08, 2010
Arbitrariness in Markets
Posted by Jeff Schwartz

One issue I’ve been thinking about recently is the arbitrary nature of investing and how that relates to securities regulation and retirement savings.

Investors owe much of their stock-market returns to chance.  This is particularly true for retirement savers who contribute to passively managed index funds each month.  These investors have no control over what will happen in the market; they essentially take it as a matter of faith that their money will grow.  Due to chance alone, however, different investors will have different results.  And over time disparities can become dramatic.  A striking study by the Brookings Institution, which assumed steady contributions to a pure equity portfolio over forty years, found that different investors had vastly different savings as a result purely of the market’s performance during their investing lifetimes.  The luckiest investors had 7x more savings than the unluckiest.

Returns from active investing are also greatly influenced by chance market moves.  For example, a long-only equities mutual fund will usually do well when the market is on an upswing irrespective of the manager’s stock-picking skill.  Moreover, many of those managers who earn market-beating returns in any particular year will owe their excess returns to chance.  With so many mutual funds searching for diamonds in the rough, some will succeed merely as a result of luck. 

Indeed, both theory and empiricism suggest that luck accounts for a great deal of excess returns.  Both EMH advocates and critics agree that market volatility follows a highly unpredictable walk.  If this is the case, scant few will be able to skillfully outmaneuver the crowd.  This conclusion is backed up by a recent study by Eugene Fama and Kenneth French, which searched directly for the presence of skill in actively managed mutual funds.  They found little. 

Thus, retail investors who happen to be in successful actively managed funds likely owe their returns to chance.  Moreover, if retail investors find themselves among the fortunate few who participate in funds run by managers with true skill, it’s likely their fund choice was a lucky guess.  Fama and French used complex statistics to separate the wheat from the chaff, whereas ordinary investors must rely mainly on past returns, which are a dubious measure of skill owing to their problematic entanglement with luck.

Thus, we have chance, layered on top of chance, layered on top of chance.  I think that recognizing this aspect of investing has policy implications, which I’ll turn to in my next posts.

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October 06, 2010
Regime Uncertainty
Posted by Gordon Smith

In Dubai:

[A German investor who has lost money in Dubai] is now trying to bring suit in a court run by the Dubai International Financial Center, a government body set up to attract investors, which operates largely on British-based law and is independent of the opaque Dubai court system, where cases are conducted in Arabic and plaintiffs must go through local Emirati representatives.

Dubai’s real estate regulators have issued a flurry of rules since 2008 to clarify the situation and to comfort potential investors. But new rules sometimes contradict others issued just months earlier, often in ways that leave developers with the advantage and property buyers in a legal limbo, making many wary of ever investing in Dubai again.

Nightmare in the desert.

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August 14, 2010
The Hindenburg Omen
Posted by Gordon Smith

This is the stock market ...


Some say this is the stock market in September ...

The "Hindenburg Omen" is forecasting a market collapse in September. You can read the Omen's requirements at the WSJ. This is the sort of forecasting used by people who believe that past prices provide crucial insights into future stock prices. 

You don't have to be Eugene Fama to think that these people are selling snake oil. The W$J: "The Omen was behind every market crash since 1987, but also has occurred many other times without an ensuing significant downturn. Market analysts said only about 25% of Omen appearances have led to stock-market declines that can be considered crashes."

The appearance of dire predictions like this are the flip side of Dow 100,000 and other crazy predictions of endless economic prosperity. The economy is rarely as good or as bad as the extremists among us imagine.

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June 14, 2010
Are you a stock or a bond?
Posted by Usha Rodrigues

Having blogged about a certain risky personal investment, I thought I'd follow up with reassurance for those of you concerned about my financial welfare.  Worried about how much risk you're taking on?  Today's WSJ advises you to assess the market's affect on your human capital: your current paycheck and your career.

If you're an investment banker or a stock broker, you're already exposed to the market by virtue of your job.  You are, in effect, a stock. Even if you think the market is going to soar, best not to put all your eggs in one basket by investing heavily in stocks.   If, like me or the article's author, you're a tenured professor, your exposure to the market is close to zero, and you can afford to take on more risks.  Your human capital is more bond-like than stock-like.  So the prescription is: if you're a stock, invest in bonds.  If you're a bond, you can invest more in stocks.

The author simplifies a bit, of course: whether you work for a private school or a state school, your salary is indirectly tied to the market, via the performance of the endowment or your state's budget .  But the basic point is sound: you have to look at the stability of your income before you can assess your risk tolerance. 

It seems to me that a lot the Main Street outrage over Wall Stgreet bonuses occurred because many NYC/London investment professionals didn't follow the above advice.  They viewed six figure bonuses as a guaranteed part of their compensation, something they were owed.  And they didn't adjust their lifestyle and investments to hedge against a market downturn that would hit their paychecks and their portfolios.  

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April 19, 2010
Defending Goldman
Posted by David Zaring

Eric's got some great posts up, and you can find much elsewhere on the Goldman prosecution, including from Larry.  I'll interrupt the very interesting masters forum to do what seems to be the unconventional: defend Goldman.  Sophisticated investors comprised every party to the transaction, for one thing.  The fraud seems to be the failure to disclose that John Paulson picked the assets for the investment vehicle - but someone had to, and anyone purchasing the assets knew someone was betting against them.  When this CDO was structured, moreover, John Paulson was a middling hedge fund manager, not the Wall Street titan of today.  For that reason and many, many others, the idea that dropping his name in the fine print would have changed a single investment decision strikes me as laughable.  I'm generally skeptical of the personification of financial crises, and I haven't followed this suit too closely, but this seems like making fraud allegations about Wall Street business as usual.  I could be persuaded to change my mind, and I may be missing something (securities enforcement isn't a specialty), but I'm not yet convinced.

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March 19, 2010
Global Settlement of Analyst ConflictsUpdate: The SEC Needs a Marketing Team
Posted by Christine Hurt

So the headline of a WSJ article today is "SEC Didn't Expand Upon Stock-Abuse Settlement," and the first sentence reads:  "The Securities and Exchange Commission has failed to turn key parts of a landmark stock-research settlement into industrywide rules, a move that threatens to gut pieces of the pact."

So, what's going on?  The 2003 "Global Settlement" among the ten biggest Wall Street firms (at the time), the NY AG's office (remember Spitzer?), the DOJ and the SEC required the banking parties to implement certain reforms with regard to conflicts between analysts employed by the banks, who were issuing research reports on current or prospective investment banking clients.  At the same time, Sarbanes-Oxley had been passed, requiring the SEC to promulgate rules addressing analyst conflicts of interests.  In response, the SEC passed Regulation AC and the NASD (now FINRA) passed several rules, including Rule 2711, to address the same issues.  As you might imagine, the SEC regulation addressed a tiny slice of the problem, requiring "clear and prominent certifications" by resarch analysts providing reports about any conflicts of interest.  Rule 2711 went further, addressing disclosure of conflicts, but also compensation, supervision, and communication between analysts and investment bankers at the same firm.  The Global Settlement admittedly went even further, requiring disclosures on the first page of research reports, physical separation of analyst and investment banking activities, and the presence of a compliance officer during communications between analysts and bankers.  So, seven years later, what's wrong?

Hard to discern from the article.  In August, the SEC went to U.S. District Judge Pauley, who approved the Global Settlement, to loosen some of the accords in that settlement.  Now, apparently the settlement was to be reviewed after five years, and the settlement was always intended to be stricter than industry-wide rules put in place at the same time.  However, the media has latched on to the fact that (1) the SEC wants to loosen its regulatory grip on some former wrong-doers and (2) the SEC never put in place regulation that would make these settlement terms permanent and industry-wide.

So what parts of the settlement were amended, and how does it change analyst practice now, with Regulation AC and Rule 2711 still in place?  Pauley may have kept in place the strictest reforms.  In fact, the WSJ Blog describes the incident as Pauley rejecting the SEC's request.  But, the article tells us "[t]hough it keeps a firewall that forbids stock analysts and investment bankers from talking without a rules-compliance officer present, the decision essentially eased other restrictions involving the dealings between investment bankers and analysts, including a clear separation between analysts and the firms' investment-banking operations."  However, it doesn't tell us what that restriction was or how it was eased.  So, let's take a look at Pauley's Monday, March 15, 2010 order, which amends "Addendum A" of the Global Settlement, here.  To find out what parts of the Global Settlement stay in place, we need to compare it to the original Addendum A, here.  The changes are actually substantial.  Here are the changes the banks agreed to in 2003 that now go away: 

2. Legal Compliance. Research will have its own dedicated legal and compliance staff, who may be a part of the firm's overall compliance/legal infrastructure

5. Compensation. Compensation of professional Research personnel will be determined exclusively by Research management and the firm's senior management (but not including Investment Banking personnel) using the following principles:

a. Investment Banking will have no input into compensation decisions.

b. Compensation may not be based directly or indirectly on Investment Banking revenues or results; provided, however, that compensation may relate to the revenues or results of the firm as a whole.

c. A significant portion of the compensation of anyone principally engaged in the preparation of research reports (as defined in this Addendum) that he or she is required to certify pursuant to Regulation AC (such person hereinafter a "lead analyst") must be based on quantifiable measures of the quality and accuracy of the lead analyst's research and analysis, including his or her ratings and price targets, if any. In assessing quality, the firm may rely on, among other things, evaluations by the firm's investing customers, evaluations by the firm's sales personnel and rankings in independent surveys. In assessing accuracy, the firm may use the actual performance of a company or its equity securities to rank its own lead analysts' ratings and price targets, if any, and forecasts, if any, against those of other firms, as well as against benchmarks such as market or sector indices.

d. Other factors that may be taken into consideration in determining lead analyst compensation include: (i) market capitalization of, and the potential interest of the firm's investing clients in research with respect to, the industry covered by the analyst; (ii) Research management's assessment of the analyst's overall performance of job duties, abilities and leadership; (iii) the analyst's seniority and experience; (iv) the analyst's productivity; and (v) the market for the hiring and retention of analysts.

e. The criteria to be used for compensation decisions will be determined by Research management and the firm's senior management (not including Investment Banking) and set forth in writing in advance. Research management will document the basis for each compensation decision made with respect to (i) anyone who, in the last 12 months, has been required to certify a research report (as defined in this Addendum) pursuant to Regulation AC; and (ii) anyone who is a member of Research management (except in the case of senior-most Research management, in which case the basis for each compensation decision will be documented by the firm's senior management).

On an annual basis, the Compensation Committee of the firm's holdinglparent company (or comparable independent personslgroup without management responsibilities) will review the compensation process for Research personnel. Such review will be reasonably designed to ensure that compensation decisions have been made in a manner that is consistent with these requirements.

6. Evaluations. Evaluations of Research personnel will not be done by, nor will there be input fiom, Investment Banking personnel.

8. Termination of Coverage. When a decision is made to terminate coverage of a particular company in the firm's research reports (whether as a result of a company-specific or category-by-category decision), the firm will make available a final research report on the company using the means of dissemination equivalent to those it ordinarily uses; provided, however, that no final report is required for any company as to which the firm's prior coverage has been limited to quantitative or technical research reports. Such report will be comparable to prior reports, unless it is impracticable for the firm to produce a comparable report (e.g., if the analyst covering the company andor sector has left the firm). In any event, the final research report must disclose: the firm's termination of coverage; and the rationale for the decision to terminate coverage.

9. Prohibition on Soliciting Investment Banking -Business. Research is prohibited from participating in efforts to solicit investment banking business. Accordingly, Research may not, among other things, participate in any "pitches7' for investment banking business to prospective investment banking clients, or have other communications with companies for the purpose of soliciting investment banking business. a. Research personnel are prohibited from participating in company- or Investment Banking-sponsored road shows related to a public offering or other investment banking transaction. b. Investment Banking personnel are prohibited from directing Research personnel to engage in marketing or selling efforts to investors with respect to an investment banking transaction.

11 (c)(3)-(5): [discussing when analysts may speak to prospective investors prior to an IPO]

3) All such oral communications to a group of ten or more investors must be made in the presence of internal legal or compliance personnel;

4) A written log of all oral communications described in (2) above must be maintained; and

5) All written logs must be retained for the period required by Rule 17a-4(b)(4). 2.

II.2 Transparency of Analysts' Performance. The firm will make publicly available (via its website, in a downloadable format), no later than 90 days after the conclusion of each quarter (beginning with the first full calendar quarter that commences at least 120 days following the entry of the Final Judgment), the following information, if such information is included in any research report (other than any quantitative or technical research report) prepared and furnished by the firm during the prior quarter: subject company, name(s) of analyst(s) responsible for certification of the report pursuant to Regulation AC, date of report, rating, price target, period within which the price target is to be achieved, earnings per share forecast(s) for the current quarter, the next quarter and the current full year, indicating the period(s) for which such forecast(s) are applicable (e.g., 3Q03, FY04, etc.), and definitiodexplanation of ratings used by the firm.

There's a lot there that is deleted. It may be that Rule 2711 covers these things now, so they are superfluous.  It may be that some of the accords turned out not to matter.  Or a combination.  (Do not have time to check word for word, but there are a lot of headings that seem to address the same topics -- compensation, communication, etc.)  Or it may be that the SEC is bowing to industry pressure to loosen its grip on analyst research. Either way, either the WSJ article is right and the SEC is being successful in going against public sentiment in loosening regulation right now or the WSJ Law Blog is right and the court rejected the SEC's attempt to loosen regulation right now.

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November 15, 2009
Bloomberg v. google
Posted by Erik Gerding

Now that the kids are asleep, I finished the Sunday Times.  A few questions based on the profile of Bloomberg's expansion:

1. When will Google take on Bloomberg?

2.  When will either take on Lexis and Westlaw?

There was a one sentence hint in the article that Bloomberg is beta testing some web-based product for law firms.  Anybody know what that product looks like?

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June 01, 2009
Are You Betting on Hyperinflation?
Posted by Gordon Smith

If you aren't at least a little worried about inflation, you aren't paying attention. If you are a lot worried about inflation, join the so-called Black Swan Fund (Universa Investments L.P.) in placing your bet:

Unlike last year's sudden market implosion, inflation isn't an unimaginable event that few currently anticipate. In fact, many fear inflation right now amid government efforts to goose the economy. Universa's bet, however, is that inflation will reach levels few expect.

By opening the inflation fund, Universa is trying to capitalize on a wave of investor demand for its products, which when they're right can protect investors from extreme market moves.

So let's get the story straight ... Nassim Nicholas Taleb writes The Black Swan, and we all love the book. His "long-time collaborator," Mark Spitznagel, makes some bets against the market and gains big in 2008. Money from new investors starts flowing, and Spitznagel's funds go from $300 million in January 2007 to about $6 billion today. He starts looking for places to put that much money, and he lands on hyperinflation.

Do you see anything wrong with this story? We had an endearing expression for this sort of thing when I was growing up in Wisconsin, but I don't use that crass expression anymore. Let's just say that the Black Swan Fund looks to be doing things exactly backwards. Rather than allowing a great idea to drive financing, the Black Swan Fund is allowing the financing to drive the creation of a new idea. But the new idea they are betting on is supposed to be a black swan, which is, by definition, rare and unpredictable!

UPDATE: Someone else is skeptical of the Black Swan Fund.

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January 15, 2009
Posted by Gordon Smith

On the eve of the closing for my refinancing, I notice this from the W$J:

Interest rates on fixed-rate mortgage loans for prime borrowers have fallen to below 5%, the lowest level since the 1950s, triggering a wave of mortgage-loan inquiries from borrowers eager to refinance. But lenders and mortgage companies say that as many as half of the people who want to refinance can't meet the credit hurdles and won't get approved.

My friend and mortgage broker told me that he has been swamped with inquiries, and he seemed surprisingly grateful to get our credit scores (both around 820) and the appraisal (down only about 3% from our purchase price less than two years ago). Now I understand why:

Only about a third of U.S. mortgage debt outstanding is likely to qualify for refinancing, said Doug Duncan, chief economist of Fannie Mae. Nearly 70% of borrowers don't make the cut, he said, most often because their credit isn't good enough or they don't have sufficient home equity. A significant number of homeowners owe more than the current value of their homes, a situation sometimes known as being "under water." Others can't profitably refinance, often because they hold jumbo mortgages, those above the $625,000 limit for loans that can be bought or guaranteed by Fannie Mae or Freddie Mac in the highest-cost areas.

I reiterate that I am not an expert in mortgages, but I suspect a lot of people are frustrated by the incongruity of being unable to lower their monthly mortgage payments on account of the fact that they have bad credit. Wouldn't their creditworthiness improve if they got the new loan?

Yeah, I know it's not that simple, but still ...

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January 07, 2009
Deal or No Deal?
Posted by Gordon Smith

If you have been following my mortgage rates saga, you know that I was hoping for rates in the high 4s before I close on my refinancing. As of this morning, I was locked into 5.125%, but rates went down this week again, and I can re-lock today at 4.875%. The mortgage brokerage that I am using, which happens to be owned by my neighbor, has a policy of re-locking only once. The broker wanted me to wait for the job news on Friday. If it's bad news -- "and we expect it to be bad," he said -- rates could go down again. He was hoping for 4.75%. Aside from the fact that this one-time re-locking policy does not appear to be set in stone, this was a no-brainer: lock me in at 4.875%!

Now, I am clearly no expert in mortgage rates, but I am also not in the habit of taking financial advice from people who are rolling the dice with my money. If everyone is expecting bad job numbers on Friday, I assume that expectation is reflected in the current rates. Thus, the rates will decline as a result of the jobs report only if that report is worse than expected. What are the odds of that? I have no idea, but something far south of 100%.

What if the jobs report is surprisingly good? "Then rates could go up again," he conceded. What are the odds of that? Again, no idea, but way less than 100%.

Is it more likely that the jobs report would be surprisingly bad or surprisingly good? Hmm. I have no way of evaluating that. Let's say these two results are equally likely (each has a 15% probability), but that the most likely result (70% probability) is that the jobs report will be unsurprising.

One last question: is it more likely that we would see big movements down  in mortgage rates following a surprisingly bad report or big movements up  in mortgage rates following a surprisingly good report? On this one, we know that the upward movement is capped by my current lock rate, so even without more concrete information, it seems somewhat more likely that mortgage rates will move down substantially in my favor.

So, roughly speaking, there is a 70% chance that I can get the same rate as today's if I wait until Friday, a 15% chance that I will get a worse rate than today's (as high as 5.125%), and a 15% chance that I could get a better rate than today's (with some chance that the report will be very disappointing, thus giving me a much better rate). The bottom line is that my expected rate from waiting is slightly better than my expected rate from locking in. But my risk aversion -- coupled with the possibility of bending the single-lock policy -- caused me to pull the trigger today.

Besides, can you really complain about a mortgage at less than five percent?

UPDATE: The jobs report came out, and our unemployment rate is at a 16-year high ... just as everyone expected. So mortgage rates didn't change a whit. So we are closing next week at 4.875%.

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December 31, 2008
Mortgage Rates
Posted by Gordon Smith

Mortgage rates just keep falling, but we could see bigger drops in the very near future. Here is the theory about why even the current low rates are higher than they could be in a few months:

When the equity markets are performing well, they create competition against mortgage backed securities and funds. Investors are always looking for the highest yield (return) possible, so when other options are available, they tell mortgage buyers Fannie and Freddie that unless they offer some higher-yield options, they are moving to bonds or stocks. So those mortgage buyers then require higher yield loans from the issuing banks and lenders (those who originally sold you the loan) and rates rise.

Conversely, when the market expects the Fed to lower rates, they start snatching up bonds quickly while higher interest rates are still available. That drives up demand and allows banks to lower rates. And if the stock market is performing poorly, investors look for mortgage backed investments as an alternative, again, pushing mortgage rates down.

What's happening now?

This is what should be happening now, right? The equities markets are uncertain and volatile, and the Fed continues to lower rates, driving up present demand for bonds and mortgage backed investments, thus pushing mortgage rates lower.

But it isn't happening the way it should. Investors are avoiding mortgage-backed investments and while are low, they certainly aren't as low as they should be considering the factors in the market and history.

There are many factors at play, but two are most obvious. The first is that there is a major black mark on mortgage investments right now. Even with equities sliding and fear of more Fed cuts, investors are putting a high risk premium on mortgage backed investments and won't invest unless the rates are higher. The banks won't lower the rates because their investors are basically saying they won't buy them. So rates stay higher to try to attract investors.

And the second factor only compounds the first, and that's that the lenders aren't opening the coffers. They got burned big-time on risky loans, and now they are being more selective, and are likely hoarding liquid assets, namely cash.

The Fed announced in November that it would buy up to $100 billion in debt issued by Fannie Mae, Freddie Mac and the Federal Home Loan Banks, but yesterday it said that it will attempt to buy $500 billion in mortgage-backed securities by the middle of 2009.


The aggressiveness of the Fed's action has some people thinking that rates in the middle of next year could be down in the 4.0-4.5 range. So here I sit, having started the process of refinancing my 6.25% mortgage two weeks ago and wondering if it's asking too much to hope for rates to dip down to the high 4s in the next two weeks ...

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April 08, 2008
Say Cheese
Posted by Fred Tung

I grew up eating at The Cheesecake Factory, so I was somewhat disappointed when I heard that the Calabasas, California company had attained the dubious honor of making CalPERS' 2008 Focus List of underperforming companies.  They sell great cheesecake, but according to CalPERS, the company has underperformed its peers by 140.5 percent over the last 5 years.  CalPERS objects to the company's staggered board and supermajority voting requirements for certain bylaw amendments, and the pension fund has a pending shareholder proposal to eliminate its staggered boards.  The four other companies that made the list--all with staggered boards that CalPERS opposes--are:

Hilb Rogal & Hobbs, an insurance brokerage based in Glen Allen, VA;

Invacare, a healthcare equipment supplier from Elyria, OH; 

La-Z-Boy (remember The Price is Right?) of Monroe, Michigan; and

Standard Pacific, which sells household durables and homebuilding supplies, from Irvine, CA.

Interestingly, according to a 2007 report by Wilshire Associates, Focus List companies have annual excess returns of -13.3% below their respective benchmarks for the five years before CalPERS involvement, but enjoy positive annual excess returns averaging 12.2% in the five years following.  Perhaps there is an investment strategy here?  See Riskmetrics for additional commentary.

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October 18, 2007
To infinity and beyond?
Posted by Fred Tung

We generally take as an article of faith that stock prices will rise in the long run.  And the evidence so far tends to bear this out.  Over any 20-year period, US markets have produced positive real returns.  A recent Economist piece suggests caution, however.  It notes the dismal long-term performance of the Nikkei, bellwether for the world's second largest economy.  The Nikkei is still at less than half its peak, which it hit in the late 1980s.  Recounting the conclusions of a 2004 study by London Business School professors, the article notes that only 3 of the 16 stock markets in continuous operation in the 20th century can match US markets' any-20-year-period positive returns.  In Japan, France, Germany, and Spain, 50 or 60 years could elapse before positive returns came; in Italy or Belgium, it could be 70 years.

The possibility of not-always-rising markets strikes fear in the heart of anyone with a 401(k) or an IRA, including me.  The privatizing of retirement in the US means that all of our futures ride on the stock market.  Social security may be a pipe dream for those of us not too close to retirement.  Imagine the turmoil if an entire generation's retirement savings were wiped out--or even significantly curtailed--by
a prolonged market downturn. 

Hey, maybe that's cause for optimism.  The government couldn't possibly allow the markets to languish over the long term.  The political backlash would be severe.  Perhaps the recent mortgage-crisis rate cut and Treasury-led bank bailout fund are signs of the times.  The federal government is in effect trying to stem a run on the bank.  Perhaps if investor confidence can be buoyed for the short term, the market can correct itself without too much long-term damage.  More generally, with the government standing behind the market, we can't lose in the long run.  Right?

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