Wednesday, October 28, 2009

EMH and intervention in bubbles

Martin Wolf in the FT looks at the latest book by equity strategist Andrew Smithers. This argues that the central bank should intervene in asset bubbles. Wolf says:

Yet, for those interested in economic policy, Mr Smithers’ arguments have wider significance. If markets can be valued, it is possible to tell whether they are entering bubble territory. Moreover, we also know that the bursting of a huge bubble can be economically devastating. This is particularly true if there was an associated surge in credit. This is also the conclusion of a significant chapter in the latest World Economic Outlook. In extreme circumstances, monetary policy loses its impact, as the financial system is decapitalised and borrowers become bankrupt. What we see then is what Keynes called “pushing on a string”.

It all makes great sense, but it omits the fact that contrarian action as practised by Buffett and Smithers is not so much a triumph of analysis but of nerve, obstinacy and an accumulation of political capital. The majority will argue that it is not a bubble, that the central bank is outmoded and 'does not get it'.

Saturday, October 24, 2009


Don't let people tell you that the government can fix economic data. If they could, Q3 GDP would have shown the increase that was expected. From the Guardian:

Gordon Brown's hopes of fighting the general election on the back of a clear economic recovery suffered a severe blow today when government figures showed that Britain is experiencing its worst recession since the mid-1950s.

To the disappointment of ministers, figures from the Office for National Statistics showed a shock 0.4% fall in gross domestic product in the third quarter of the year.

The figures, which stoked tensions between No 10 and the Treasury ahead of the pre-budget report later this year, were seized on by the Tories as evidence that Brown was wrong to claim that Britain was best placed to weather the recession.

If he had fixed that, no one would have suspected as it was totally anticipated that there would be a small rise in output (and still possible given the likely revisions to the provisional number).

Thursday, October 22, 2009


The FT takes a look at Goldmans with an assessment of the 'true proprietary trading' as being 10% and additional information about the bonus pool.

Nor is it merely a giant hedge fund. Its pure proprietary activities make up about 10 per cent of its revenues. Market-making in bonds and equities, now its main business, serves companies and investors, although it is a capital-intensive and sometimes risky activity.


The bonus problem in investment banking is not the absolute size of the rewards (although shareholders ought to ask themselves if the employees really are worth it) but the incentives they create.

Goldman probably has one of the most partner-like pay structures for its managing directors. About two-thirds of bonuses are in restricted stock that vests over four years and its most senior partners have to hold 75 or even 90 per cent of the stock until after they retire.

Monday, October 19, 2009

Valuing securities

The FT talks about the effect of a re-valuation of 'toxic assets' on on the profits of US banks in Q3.

“There were some assets that had lost too much value six months ago and investors are recognising that,” said Robert Smith, chief executive of Rangemark, which specialises in structured products. “Yet despite the rally, much of the collateral is broken and banks and investors are still holding a lot of securities that even now may not have been sufficiently marked down. Valuation methods are still oversimplified, which means risks may not be property assessed.”

It raises an important point about the valuation of assets. This is not just an issue for accounting (historic cost accounting against latest market price) but also one for valuation in general. Is it possible to fix one valuation on a financial asset. Even if we take a simple bond, the valuation will depend on the rate at which future cash flow is discounted and this rate is subject to uncertainty about inflation, liquidity and, particularly, risk. As the perception of risk changes, the value of the asset changes.

Wednesday, October 07, 2009


Has 'financialisation' encouraged boom and bust? John Authers and others says that it does:

The United Nations Commission on Trade and Development devoted a chapter in its trade and development report to “the financialisation of commodity markets”.

It wrote: “Commodity prices, stock prices and the exchange rates of currencies affected by carry trade speculation moved in parallel during much of the period of the commodity price hike in 2005-08, during the subsequent sharp correction in the second half of 2008 and again during the rebound phase in the second quarter of 2009.”

The “herd behaviour” of many participants reinforced impulses to sell positions in commodity futures when prices began to fall. Financial investors treated commodities “increasingly as an alternative asset class to optimise the risk-return profile of their portfolios” and paid “little attention to fundamental supply and demand relationships in the markets for specific commodities”.

I'm not so sure. If this were the case, there would be easy profits to make from contrarian views. Where are these profits?