Felix Salmon

The civil and criminal investigations of Evil Financial Products Which Destroyed The World have now officially reached the stage of farce, with “federal regulators and state officials” reportedly investigating the fact that banks traded municipal CDS at the same time as underwriting municipal bonds.

The case here is so weak that I can only imagine that the ultimate goal lies in the shadow of the law, in the realm of a global settlement caused by the sheer weight of investigations. The banks can’t afford to laugh this kind of thing off, no matter how ridiculous it is on its face:

The probe is exploring potential conflicts of interest by banks that sell municipal bonds and then poise themselves to profit if those bonds fail, these people said.

A main thrust of their investigation is whether firms use their own money to bet against the bonds they sell and, if so, whether that activity is properly disclosed to bond buyers…

“It seems that when they are trying to sell CDS’s, they have to talk about the riskiness of the bonds, and that has some psychological impact on the investor’s view,” Mr. Lockyer said in an interview. “We might then pay a higher price to sell the bond. This isn’t right.”

That’s Bill Lockyer, of course, California’s treasurer, who started the ball rolling back in November 2008 when he was the prime source for a very silly ProPublica investigation along similar lines. But now he’s moved on from non-profit journalism shops to federal prosecutors, which means that his conspiracy theories are growing real teeth.

The crazy thing here, of course, is that the banks are damned if they do and damned if they don’t. The investigators are apparently trying to nail the banks for not disclosing that they had a short CDS position — but if they did disclose that, then the “psychological impact on the investor’s view” would be even greater, and California might need to pay even more to sell the bond.

What’s more, the WSJ seems happy to jump on the bandwagon, with editorial interjections like this:

Municipal credit-default swaps are still thinly traded, but their existence has the potential to spook investors in the same way investors have feared Greece defaulting on its bonds.

I’m not sure what this is supposed to mean. Is Ianthe Dugan implying that the mere existence of CDS on a certain bond can spook investors into thinking that the underlying credit is the next Greece? Is she saying that the CDS market was somehow responsible for Greece’s fiscal woes? Whatever she’s saying, she’s not making a lot of sense.

Blanche Lincoln would like to force banks to sell their swap desks, in a move which is opposed by a lot of regulators within Treasury, the Fed, and elsewhere. If that piece of legislation gets signed into law, then yes this kind of activity — trading in municipal CDS — would become illegal. But right now it’s perfectly legal, and investigating it is pure politics.

The important thing to remember here is that the effect of the CDS market on municipal borrowing costs, even if it’s non-zero, is exactly the same no matter who is doing the trading in CDS. If Goldman and BofA and JPM and the other banks caught up in this probe stopped making markets in municipal CDS, someone else would step in and take over from them. And if the trading moved onto an exchange, as it should, then that would only serve to make the CDS prices even more public, thereby spooking potential investors in municipal bonds even more.

But this investigation is political, it’s not based on coherent jurisprudence or financial logic. And as such, the banks’ responses are going to have to be political too. That global settlement is getting closer by the week.

Alex Tabarrok on the fragility of CDO models. Excellent — MR

The key to happiness: Hate your ex — Atlantic Wire

The Google Job Experiment. Clever. — YouTube

Justin Gillis has a great story about how no one with the ability to do anything about it seems remotely interested in measuring the severity of the oil spill in the Gulf of Mexico. The ubiquitous 5,000-barrels-a-day number seems to be a massive underestimate, and the stated reason for not getting a better figure is weak indeed:

A spokesman, David H. Nicholas, said in an e-mail message that “the estimated rate of flow would not affect either the direction or scale of our response, which is the largest in history.” …

“I think the estimate at the time was, and remains, a reasonable estimate,” said Dr. Lubchenco, the NOAA administrator. “Having greater precision about the flow rate would not really help in any way. We would be doing the same things.”

Why is the NOAA backing BP up on this? Knowing the size of the problem may or may not help in terms of being able to fix this particular problem. But it’s certainly going to be important going forwards.

What’s more, the current estimate could hardly have been friendlier towards BP if it had tried:

The 5,000-barrel-a-day estimate was produced in Seattle by a NOAA unit that responds to oil spills. It was calculated with a protocol known as the Bonn convention that calls for measuring the extent of an oil spill, using its color to judge the thickness of oil atop the water, and then multiplying.

However, Alun Lewis, a British oil-spill consultant who is an authority on the Bonn convention, said the method was specifically not recommended for analyzing large spills like the one in the Gulf of Mexico, since the thickness was too difficult to judge in such a case.

Even when used for smaller spills, he said, correct application of the technique would never produce a single point estimate, like the government’s figure of 5,000 barrels a day, but rather a range that would likely be quite wide.

Why release a point estimate? Well, if the NOAA had released a range — say 3,000 to 30,000 barrels a day — then the press would have gravitated to the higher number, and talked about a spill of “as much as 30,000 barrels a day”, and that would be the main number people remembered. But it’s not the NOAA’s job to do PR for BP. And it is the NOAA’s job to get as much good information about this oil spill as possible.

So let’s get down there and measure this thing.

Nelson Schwartz and Eric Dash win the Cryptic Anonymous Quote award for the kicker to their story on a possible Wall Street settlement which would include, essentially, everyone:

Even some Wall Street executives concede that all the scrutiny makes proprietary trading a bit dubious. “The 20 guys in the room with the shades drawn are toast,” one senior executive of a major bank said.

There are three degrees of anonymity here: the 20 guys are anonymous, of course, if not downright apocryphal; the executive is anonymous too; and the executive’s employer is anonymous as well. And all this secrecy is in service of a quote which means pretty much whatever you want it to mean.

Still there’s substance in the rest of the story:

Legal experts are already starting to handicap potential outcomes, not only for Goldman but for the broader industry as well. Many suggest that Wall Street banks may seek a global settlement akin to the 2002 agreement related to stock research. Indeed, Wall Street executives are already discussing among themselves what the broad contours of such a settlement might look like…

As part of the 2002 settlement, 10 banks paid $1.4 billion total and pledged to change the way their analysts and investment bankers interacted to prevent conflicts of interests. This time, the price of any settlement would probably be higher and also come with a series of structural reforms.

I like the idea of structural reforms, since these reforms would presumably be over and above anything mandated by Congress. That’s one reason no settlement will come unless and until a financial regulation bill is signed into law: no regulator will agree to a deal in which banks agree to be bound by rules they’re going to end up bound by in any case.

On the other hand, if there are gaps and loopholes in the final legislation, a global settlement might well be the best way of closing them. Call it regulation by litigation: it can be quite effective, if practiced strategically. But is Mary Schapiro up to the task? I have to admit I have my doubts.

Mike Arrington has a classic Arrington rant today, directed at Fortune.com and entitled “You’re Welcome, You Bastards”. To cut a long story short, Fortune’s PR people got in touch with Arrington to flack a couple of excerpts they were running from David Kirkpatrick’s new book. Arrington agreed to all their preconditions (embargo, mentioning Fortune, linking to where the posts were excerpted on Fortune.com, etc) — and then got chewed out by both Fortune and Simon & Schuster, threatening to sue him for copyright infringement.

I can see this from both sides. From Fortune’s point of view, they gave Arrington a heads-up on their excerpts, and then instead of just linking to them and quoting them selectively, he ran the whole things, which is a violation of copyright. From Arrington’s point of view, however, it didn’t look like that at all. Since Arrington was barred from quoting anything at all until after the excerpts were openly and freely available online, the quid pro quo didn’t make any sense if, as Fortune asserts, he was only allowed to run excerpts of the excerpts. Here’s what Fortune’s flack wrote to Arrington:

The EMBARGO is until 8am, that’s when the stories will be live on FORTUNE.com. Below are the links, so you can include them in the story. Again, you’re set to post as soon as our story goes live and in the first line or two, note that the story stems from an exclusive excerpt in FORTUNE of David Kirkpatrick’s new book The Facebook Effect.

The problem is that once the stories were live on Fortune.com, anybody could link to them and quote from them selectively, with or without Fortune’s permission or advance knowledge. Fortune has neither the right nor the ability to dictate how a blogger links to and quotes from a story on its website, if all he’s doing is quoting small excerpts of the excerpt.

So it was reasonable for Arrington to assume that he was being offered something that wasn’t available to any other blogger: the flack talked about Arrington’s “exclusive post” and said that s/he would “love to offer” the excerpt to Techcrunch. But after Arrington ran the whole thing, it became clear that there was really no exclusive offer at all, as far as Fortune was concerned: they just wanted Arrington to blog their story in the same way that any other blogger would, and they thought that if they showed him the excerpts in advance under embargo, that might increase their chances of getting that blog entry.

Obviously, there was a miscommunication, and in the wake of the miscommunication I think that Fortune’s behavior stands up much better than Arrington’s. (I should mention here that Fortune.com now comprises three former colleagues of mine from my Portfolio days: Dan Roth, Paul Smalera, and Megan Barnett.) Fortune, sensibly deciding that there was no upside in getting into a public fight with Arrington, let the matter drop. But Arrington, even after he was informed that he was in violation of copyright, kept the full excerpts up on his site, and then decided to go public with an aggressive blog entry when the inevitable c&d came from Simon & Schuster.

The fact is that misunderstanding a flack’s communications is no defense against continued copyright violation — not when the details of the violation have been spelled out to you in no uncertain terms. Arrington can legally no more continue to publish the Fortune excerpts in full than I can publish Arrington’s blog entry in full. And given that the excerpts are freely available at Fortune.com, it’s no disservice to the readers of Techcrunch for Arrington to just point them to Fortune.com and let them read the excerpts there.

But equally an important part of the whole story is the way in which Fortune’s PR people fundamentally messed things up. If they’d just waited for the excerpts to go live and then told Arrington about them, none of this would have happened. But instead they decided to make lots of extra work for both themselves and Arrington, all of which ended up creating nothing but ill-will, ranting phone calls, and legal threats. They should never have offered Arrington an “exclusive” anything — because that isn’t what they wanted to do. But they over-reached, and ultimately bear the blame for what happened.

I get flacked quite a lot, and whenever people offer me exclusive stuff, my general response is that once something’s up online, anybody can link to it. So just let me know when it’s up, and I’ll link to it then if I think it worthwhile. And I think Arrington’s coming around to the same conclusion: “the next time someone asks us for a favor,” he writes, “we’re less likely to do it given how this turned out.” Good. If only because level playing fields ultimately benefit everybody.

This morning I worried that a set-it-and-forget-it buy-and-hold investment strategy of any description is prone to failure — but at the same time it’s fair to say that the track record of people trying to do anything more active is unimpressive. So, in a world where stocks look far too risky to invest in, what should people do with their money?

For any given asset class, there are good reasons to stay away. Emerging markets have a long history of disastrous sovereign crises, complete with markets going to zero. Stocks are volatile, and bonds don’t yield remotely enough to justify the risks of (a) rising interest rates; (b) default; and (c) inflation. Inflation-linked government bonds are often quite illiquid, and if you want to keep them in a constant-duration portfolio, that can damage you a lot, since you’re constantly buying and selling in order to keep the duration constant. Besides, they’re asymmetrical: the downside is always much greater than the upside, and in general debt is denial.

On the other hand, as Matt Ridley explains at length in his new book (which I review here), pretty much the entire history of humanity is a history of economic growth coming as ever-increasing numbers of people connect and trade with each other. Real Gross World Product is going to rise over the long term, especially now that the world’s population is more interconnected than ever before, and therefore it’s reasonable to assume that investments, in aggregate, globally, are likely to go up too.

A lot of people like investing in stocks because the stock market has, in the US, and over the past couple of generations, managed to outperform GDP growth. But that’s not sustainable over the long term. Stocks can grow to account for an ever-greater share of the economy, at the expense of privately-owned companies; and they can become increasingly leveraged. But both trends must come to an end, and indeed it looks as though we reached that point a while back. From there on in, the main way for stock-market growth to exceed GDP growth is if you have a bubble, and investing in bubbles is in general contraindicated.

Like most of the sensible people invested in index funds, I’d love to see a fund predicated on the idea that “I know that I don’t know”. I don’t want to be responsible for making asset-allocation decisions, because I’m not qualified to do so, and I’m likely to end up allocating assets to underperforming sectors of the global economy. So what I’m looking for is an everything bagel: an index fund or ETF which allocates its money to all the public asset classes in the world, apportioned according to market capitalization. It would include a lot of government bonds, of course, and a smattering of index-linked ones; it would have corporate debt and subordinated debt and convertibles; it would have MBSs and CDOs and securitized credit-card receivables; it would have local-currency bonds and stocks from BRICs and from frontier markets and from all the other emerging markets too; and of course it would have a large amount of money in developed-world equities too. Add the whole thing together, and you’ll have a single investment which is as diversified as you can get: a simple, unleveraged, all-in bet on the global economy.

Now the management fees on this kind of thing would probably be prohibitive if it tried to invest in hundreds of different jurisdictions and asset classes at the same time. And it would still be subject to expropriation risk as well: countries are more than capable of confiscating foreign investments, or defaulting selectively on their foreign debts. Just because you’re invested in a country, doesn’t mean your real returns will match that country’s GDP growth.

But maybe this is one of those cases where a bit of financial innovation might not go amiss: can someone invent a Gross World Product swap, a financial instrument which simply pays out (or reinvests back into itself) that year’s increase in global economic activity, as denominated in say SDRs? No one’s going to get rich investing in such things. But it would do a pretty a good job of preserving global purchasing power, and would surely serve as a useful benchmark for more active global fund managers. Although I fear to think how the people on the short side of the swap would delta-hedge their exposure.

Joe Weisenthal points out that we’ve diverged in unusual directions when it comes to the story about Andrew Cuomo investigating the banks over providing misleading information to the ratings agencies. He’s normally the libertarian caveat-emptor guy, but thinks this could be a big deal:

This issue isn’t nothing, because if there’s a clear pattern of providing improper data to the raters — and again, this is just an early-stage investigation — then the banks begin to look like they were specifically trying to deceive customers on behalf of their own trading desks or special clients (like John Paulson).

I, on the other hand, suspect that this is more of a fishing expedition, thanks in part to a line in the NYT story about how the banks in question were “contacted after subpoenas were issued by Mr. Cuomo’s office late Wednesday night notifying the banks of his investigation”. (Weirdly, that line has now disappeared from the story.) I concluded from that that the investigation was just beginning, and that the NYT had been told about it even before the banks were.

That said, I’m no expert on the internal workings of the NY AG’s office. It’s entirely possible that Cuomo has already put together a colorable case against the banks, and is now issuing his subpoenas just to fill in the gaps, as it were. On the other hand, reading Story’s rather vague story, I get the feeling that there’s relatively little in the way of solid evidence as yet, and that, as Weisenthal notes, this investigation really is in its very early stages.

So, can someone help me out on this? When the subpoenas start flying, is that a sign that the AG has already got the goods, or that he’s only just beginning to look for them?

Mohamed El-Erian has released his 8-page summary of the medium- and long-term outlook for the global economy, and while there are few surprises, it makes for a most worthwhile read.

The big picture is of a world which (a) can’t afford to make more mistakes, and (b) is certain to make more mistakes, thanks in part to the increasingly important role of politics in national economies. The world seems to be converging on a model of “state capitalism”, but no one really knows what that model looks like, and with national and international politics becoming increasingly fractious, tail risks are increasing even as the base-case outlook remains underwhelming.

We seem to be leaving the era of independent central banks behind us, as they are now the only institutions capable of taking on the debt which moved during the most recent crisis from banks to now-overburdened sovereigns. The last major holdout, Jean-Claude Trichet, threw in the towel last weekend, and we’re now in a world where the only real guarantee of central bank independence is a small government debt. (Think Australia, which, alongside Canada, is one of the few relatively bright spots in the non-EM Pimco universe.) El-Erian is not happy about this development:

I am inclined [to warn] against the long-term implications of additional steps to turn monetary authorities (with revolving balance sheets) into fiscal agencies (with more permanent exposure to dubious assets). An even larger-scale use of central bank balance sheets, if it were to materialize, would provide only a temporary respite, and the collateral damage and unintended consequences would be serious, including the impact on inflationary expectations.

But in an overleveraged world, inflation is maybe preferable to default as a means of getting rid of the massive debt burden which Pimco sees weighing down all of the G3 economies for the foreseeable future. In any case, Pimco is looking at what it thinks will happen, rather than what it thinks should happen, and it sees inflation coming back first in some emerging economies, and then, looking out a few years, in the U.S., then Europe, and finally in Japan.

As far as the U.S. is concerned, El-Erian sees a vicious cycle playing out in the high unemployment figures:

Unemployment is high and will likely remain so for the foreseeable future, accentuating concerns about skill erosion and loss of labor market flexibility.

I’m hopeful this isn’t the case. It’s true that most important skills are learned and honed on the job rather than at schools and colleges, and it’s also true that a labor market where professionals are jumping from one great opportunity to the next has more inherent flexibility than one where they care mostly about holding on to their present position. But on the other hand, I suspect that geographical labor-market flexibility is increasing, as the unemployed become more willing to move to where the jobs are, and also to simply walk away from their underwater mortgages. Meanwhile, all those people going back to school while they wait for the labor market to pick back up have to be learning something useful.

There’s not a lot of what you might call investment advice in this paper, beyond a general idea that it’s important to stay alert and that a set-it-and-forget-it buy-and-hold strategy of any description is prone to failure. But there are two interesting long-term ideas at the end of the piece:

- It is a world where the currencies of the emerging (as opposed to submerging) economies will continue to warrant a greater allocation over time; and

- It is a world where the safest of carry will come from duration and curve in sovereigns that, due to their economic and financial fundamentals, are truly core countries in the midst of this global paradigm shift.

If a retail investor was interested in playing these trends, the first one is relatively easy: you buy a emerging-market local-currency bond fund. The second one, however, is harder: how do you put on a trade where you basically borrow short and lend long in the biggest global economies, without inadvertently becoming a bank and taking on all the credit risk that entails, especially in a world where it’s becoming increasingly difficult to differentiate credit and rates?  I daresay that El-Erian is right when he implies that the U.S. yield curve is going to remain pretty steep for the next few years. But I suspect you need to be a big company like Pimco to make money from that trade.

Jamie Galbraith explains that govt debt and deficits are a good thing, not a bad thing — Wapo

Lean hogs in gold: the only financial indicator that matters — TBI

My first official Reuters wine column — Reuters

Philips Unveils World’s First LED Replacement for Most Common Bulb — Inhabitat

As the Tories take over from Labour, the UK gets a bit more aggressive on financial reform — FT

Carney to CNBC — NBCU

Joey Kincer might have a net worth of $200k. But he’s still a 32-year-old who lives with his parents — NYT

Amendment banning mortgage steering payments passes 63-36 — Senate

I review new books from Richard Florida and Matt Ridley — BN Review

John Taylor says that a Greek restructuring is “inevitable”, says ECB has lost credibility — CNBC

Louise Story says that Andrew Cuomo, NY attorney general and would-be governor, is piling onto the CDO bandwagon, sending subpoenas to eight (count ‘em) banks, asking if they misled the ratings agencies when they were putting together their structured products. It’s a long article, and notably the substance of Cuomo’s investigation is left until the very last paragraph:

A central concern of investors in these securities was the diversification of the deals’ loans. If a C.D.O. was based on mostly similar bonds — like those holding mortgages from one region — investors would view it as riskier than an instrument made up of more diversified assets. Mr. Cuomo’s office plans to investigate whether the bankers accurately portrayed the diversification of the mortgage loans to the rating agencies.

I’d love more detail on this because it seems a little weird to me. The ratings agencies knew exactly which bonds were being put into in the CDOs and it really should have been up to them to check on things like geographical diversification. In the case of a CDO-squared, I can imagine that tracking down the true underlying assets might have been difficult and that the ratings agencies might have relied on the investment banks to help them with that. But there’s no mention in the story of CDO-squareds, or synthetic CDOs, or anything else which might have increased complexity and therefore the opportunity for deliberate befuddlement. Instead, there’s lots of talk about banks hiring former ratings-agency employees, which might be distasteful but which is hardly illegal.

That said, I think we’ve probably moved beyond the point at which it’s important how strong these cases are. All that Cuomo needs to do is tell Story about his investigation and most of the damage is already done: he never needs to bring an actual case, and in fact, given the amount of time it takes to put such cases together, he’ll probably have moved on to grander elected office by then anyway.

The theater of all this, then, is what really matters. The banks in question are going to be on the back foot; I’d advise them simply to say that they’re cooperating fully etc, etc and leave it at that. At least unless and until some substantive accusations start emanating from Cuomo’s office. But as Cuomo’s predecessor Eliot Spitzer knows, the attorney general of New York has a lot of power when it comes to bullying banks, and right now the harder Cuomo bullies the banks, the more popular he’ll be. The bankers, in turn, have little choice but to take their lumps and remind themselves how much money they’re making while doing so.

Ultimately, it’s entirely possible that the banks are going to wind up having to make some kind of settlement with the AG. Everybody knew that the job of the CDO origination desks at the investment banks was to put together the riskiest and highest-yielding instruments possible while still retaining a triple-A rating. Similarly, everybody knew that investment bankers during the dot-com boom would carefully put together “friends and family” lists of people getting access to hot IPOs, so as to butter up potential clients. And then, when the party was over, suddenly prosecutors declared themselves shocked — shocked! — that such activity had been going on.

The fact is that the investment banks exacerbated and profited from the incompetence of the ratings agencies by hiring away anybody smart, by gaming the models (which the agencies made public) and by funneling so much cash to the agencies in the form of fees that the agencies had no incentive to crack down on them. That’s shameful, and I for one would love to see the banks get their comeuppance for that behavior. Even if the forensic justification for it is dubious at best.

Meanwhile, the WSJ has a bit more information on the case against Morgan Stanley, adding that it’s not only Dead Presidents but also deals named ABSpoke and Baldwin being looked at:

Some CDO offering documents indicated that mortgage assets selected for the deals may have factored in the interests of market players whose interests were “adverse” to other investors. But none went as far as to state that hedge funds or banks’ trading desks were making bets against the deals for their own accounts, according to documents reviewed by the Journal.

This is essentially a slightly weaker version of the case against Goldman in the Abacus deal. In that case, the SEC is saying that Goldman implied to investors that the person structuring the deal was long when in fact he was massively short. In these cases, the banks did make a disclosure about adverse interests, but didn’t go as far as they should have done in terms of revealing that they themselves intended to hold on to the short position.

Again, the same political calculus applies: it’s incredibly dangerous to take the Goldman route of fighting the accusations aggressively. Better, I think, to just cooperate fully with the SEC and see what happens. And, of course, if and when the relevant Wells notice arrives, to disclose that fact to investors immediately.

Calculated Risk has the latest First American CoreLogic negative-equity numbers, and a scary chart to boot:

The share of borrowers whose mortgage debt exceeds the property value by 25% or more fell slightly to 10.4% or 4.9 million borrowers, down from 10.6% or 5 million borrowers. The aggregate dollar value of negative equity for these deeply underwater borrowers was $656 billion.

Once your negative equity reaches 25%, chances are you’re going to default even if you don’t have to: walking away is becoming both more common and more socially acceptable.

I’d love to know whether any banks at all mark their mortgage holdings to market if the mortgages are performing. My guess is that they don’t — which means that there’s likely to be a lot more in the way of write-downs hitting banks over the next few years. Especially in the sand states.

Tadas Viskanta reckons that we might be entering a “golden age of stock picking”. Why?

This volatility seems all the more meddlesome in light of the growing belief that the equity risk premium is likely to be lower in the future than it has been in the past. Whether you attribute this to risk-seeking behavior on the part of individuals or simply an artifact of history, in either case it makes the potential rewards of the stock market seem not worth the risk to many.

One could argue that we have already seen a retreat by investors from picking individual stocks into collective, diversified vehicles like mutual funds and exchange-traded funds. Furthermore post-Internet bubble it seems that speculative activity on the part of individuals has been funneled into trading ETFs and more recently foreign exchange. Individual stocks seem to be the artifact of a long gone era of investing.

Therein lies the opportunity. With everyone focused on the global macroeconomic situation it seems as if good old fashioned stock picking is being forgotten. Rather than fixating on the downside of volatility maybe investors should be focused on the opportunities created by said volatility.

Who wouldn’t have wanted to buy Accenture or Procter & Gamble at $0.01 on Thursday? These are clear anomalies but the broader point still stands. If the market is going to go through periodic episodes of volatility that bring down the prices of all stocks (good and bad) doesn’t it behoove investors to take advantage of these opportunities?

I’m not convinced, and not only because active investors, in aggregate, never outperform the stock market.

Firstly, volatility is good for traders, not investors: just check out the spectacular trading results at the money-center banks last quarter. Those profits come from trading desks which are structurally flat(ish), rather than from investors who are structurally long. The advantage that investors have over traders is that they have time and patience, but if stocks in general are going nowhere over the long term, then that advantage dissipates, and playing the stock market becomes a zero-sum game in which the big banks are winning and therefore everybody else is losing.

More generally, there’s no real evidence that I know of which suggests that stock pickers in general, and value investors in particular, outperform during periods of volatility. To the contrary, my feeling is that they do best when stocks in general are cheap and rising, in the earlier stages of bull markets. It’s true that a small subgroup of opportunistic value investors — Bill Ackman comes to mind — has a real ability to identify securities which have overshot in periods of volatility and are therefore mispriced. But as Ackman’s own Target trade proves, this is a high-risk strategy which shouldn’t be entered into by anybody who can’t afford to lose the money they’re betting.

Conceptually, I think that what Tadas is talking about here is a strategy of sitting patiently at the side of a turbulent river, and waiting until a juicy fish just jumps out and lands in your lap. But it’s not as easy as that. Buying low is also known as the catch-a-falling-knife trade, which has left many a smart investor extremely bloodied. And once a stock has fallen far and you’ve missed the opportunity to buy it at its lows, it can be psychologically pretty hard to buy it at significantly higher levels.

Most importantly, however, in a choppy sideways market, investors have to be able to sell high as well as buy low. Which basically means that they have to have trading skills on top of those analysis and investment skills. It’s a rare combination.

Finally, I think it’s pretty clear that we’re now living in a highly interconnected world where confining yourself to a single asset class, like U.S. equities, is placing yourself at a massive disadvantage. And individual investors don’t remotely have the resources to be able to position themselves strategically across the incredibly diverse range of instruments which are now available globally.

There are surely opportunities out there, but I doubt that the best ones involve the old-fashioned method of paying cash dollars for U.S. stocks; in fact, my guess is that the big value-investor returns will come from buying elsewhere in the capital structure, and especially from restructuring trades where debt turns into equity with real long-term value. And for those, you need to be not only a good analyst and a good trader, but also a qualified institutional buyer and have access to excellent lawyers. And your minimum investment, especially in the loan market, is going to be enormous.

Tadas says that “the rise of the self-directed 401(k), the emergence of discount brokers and the proliferation of news/data sources via the Internet all played a role in making investing both cheaper and simpler.” That’s true. But it’s a narrow slice of the global investing universe. And it’s not necessarily the most attractive one right now.

The Dead Presidents CDOs now reportedly being investigated by the Justice Department were not your garden-variety synthetics:

One feature of the Morgan Stanley deals was a structure that could increase the magnitude of the bullish investors’ exposures to the underlying mortgage bonds. This feature, which was disclosed in some offering documents, made it more likely that such investors could lose money if the underlying bonds performed poorly.

This bears a family resemblance to what the NYT reported back in December (h/t Alphaville):

Morgan Stanley established a series of CDOs named after United States presidents (Buchanan and Jackson) with an unusual feature: short-sellers could lock in very cheap bets against mortgages, even beyond the life of the mortgage bonds. It was akin to allowing someone paying a low insurance premium for coverage on one automobile to pay the same on another one even if premiums over all had increased because of high accident rates.

I’d love to know more about this feature. I’m not looking for a quick one-sentence summary which can be dropped into a newspaper article, but a detailed explanation of exactly what it was and how it worked. Does anybody have offering documents from Citi or UBS for these deals which might include such a thing?

I think this shows the limitations of print-based journalism, and the long way we have yet to go before newspapers fully embrace the web. Both the WSJ and the NYT give the impression that they have seen and understood the structures in question, and that they’re simply summarizing them in order to make their stories easier to read for a broad audience. That’s fine — but once you’ve done that, do please give the full details online to finance geeks who want to understand the deals on a finer-grained level.

There were lots of synthetic CDOs structured and sold at the end of the subprime boom, but the ones being singled out by regulators and prosecutors seem to be the unusual ones — first the Goldman deal which was created at the behest of John Paulson, and now the Morgan Stanley deal with this mysterious embedded structure. It would be a great service if the news media, rather than just trying to report the news, also published primary documents and full details of what they’re writing about, so the rest of us can come to our own conclusions.

Update: ProPublica has found a bunch of Jackson prospectuses, if somebody fancies reading them.

John Powers is a genius. Watch the 6 min intro to his film here, or live — Star Wars Modern

Photo set from massive sinkhole near St Jude, Quebec. Power of nature in an awful story — Montreal Gazette

How have I not until now come across RockPaperScissorsLizardSpock? — Deviantart

Michelle Vaughan’s wonderful oyster prints are now on 20×200, buy the pair — Salty, Slurp

Poster Boy jailed for 11 months, 3 weeks before his book comes out — WSJ

Congratulations, You’re Paying the Least Amount Of Taxes In Sixty Years — TBI

“It is a catastrophic mistake to increase the scale of complex systems without examining the possible implications for failure” — Index Universe

Apple’s no-nipples policy means fashion mags are censoring their iPad editions — ShinyShiny

The hedonic treadmill over the course of 39 minutes, courtesy of Jacob Weisberg — Twitter, ibid  

Advanced search in Gmail — Google

Full disclosure: John Powers is a friend. And Michelle Vaughan is my wife.

Is it a coincidence that the price of gold hit an all-time high just as David Cameron was becoming the prime minister of Britain? Yes. But it’s also indicative of the enormous amount of uncertainty that continues to pervade the market. If you’re just looking at the stock market, you’re not looking at the most sensitive barometer of fears about the global economy in general and the eurozone in particular. As Paul Krugman notes, the euro/dollar exchange rate is probably a better place to look, and that’s now back down below 1.27, after trading at 1.50 as recently as December. For what it’s worth, here’s the price of gold in euros:

It’s entirely conceivable that we could see gold at €1,000 an ounce pretty soon. Which, just as much as recent stock market volatility, is a pretty clear indication that there’s still a lot of worry out there, trillion-dollar eurozone bailout plans notwithstanding.