Opinion

Felix Salmon

ETFs jump the shark, FactorShares edition

Felix Salmon
Feb 24, 2011 21:29 UTC

Sometimes, financial innovations seem like a good idea at the time, and it’s only later, after everything has gone pear-shaped, that it becomes clear we would have been much better off without them. Other times, financial innovations are clearly a bad idea from the get-go:

Factor Advisors, a New York-based asset management firm, announced today the launch of FactorShares, the first family of spread exchange traded funds (ETFs) that allow sophisticated investors to simultaneously hold both a bull and a bear position in one leveraged ETF…

FactorShares ETFs are capital efficient, targeting a daily leverage ratio of 4:1… FactorShares ETFs seek investment results for a single day only, not for longer periods.

Some investments, in things like hedge funds or private-equity funds, are considered so risky that you need to be qualified to buy them. Other investments — public stocks listed on the NYSE are a good example — can be bought by just about anybody. FactorShares, incredibly, are in the second category.

Needless to say, no one with an ounce of common sense should go anywhere near these things. Even if you’re convinced that bonds are going to outperform stocks, you should never touch FSA, the fund which gives you a 2x leveraged long position in Treasury bonds combined with a 2x leveraged short position in the S&P 500.

Just look at the official FactorShares FAQ if you want some of the reasons: the funds certainly should never be held overnight, and “may experience tracking error intra-day”; there’s “a compounding effect and tracking error”; the leverage fluctuates and “could be higher or lower than an approximately 4:1 leverage ratio”; there’s the inevitable Management Fee, of 0.75%; “other fees apply including brokerage commissions”; the shares “are not mutual funds or any other type of investment company within the meaning of the Investment Company Act of 1940, as amended, and are not subject to regulation thereunder”; the Managing Owner has been a member of the National Futures Association only since December 2009; the shares “may be adversely or favorably impacted by contango or backwardated markets”; you have to deal with a K-1 form for tax purposes at year-end; and I’m sure there’s lots of other stuff in the various prospectuses.

What confuses me is why the SEC, the NYSE, and other institutions who consider themselves to be protecting individual investors would ever allow these things to trade openly on the stock exchange in this manner. This isn’t a company raising equity capital so that it can invest in the real economy and grow and thrive. Instead, it’s a pointless, parasitical, negative-sum financial monstrosity which will probably make a modest sum for its sponsor and lose money, on average, for anybody who invests in it. It doesn’t even serve any legitimate hedging purpose.

ETFs looked like a good idea when they started replacing index funds. But the more that this kind of thing happens, the more of a bad name they’ll have. Let’s hope regulators wake up and shut this scheme down, and lots of similar ones too. People who buy these things aren’t “sophisticated investors”; they’re really not investors at all. If they want to gamble, there’s always Vegas.

COMMENT

“Some investments, in things like hedge funds or private-equity funds, are considered so risky that you need to be qualified to buy them..”
——————-
While at the same time states are vigorously pushing lotteries, which are designed to separate the lower class from their money.

Posted by Loebner | Report as abusive

How Goldman Sachs is still running New Jersey

Felix Salmon
Feb 24, 2011 18:32 UTC

Who is responsible for turning New Jersey governor Chris Christie from an uninspiring and inchoate peddler of conservative platitudes into the major anti-union force that he is today? Step up, Mr Squid:

Christie won by about four points on Election Night in 2009, with little notion of what he was going to do next. When I asked him if there was any one moment of clarity that put him on the path from cautious candidate to union-bashing conservative hero, Christie pointed to a meeting about a month into the transition, when his aides came to him brandishing an analysis of the state’s cash flow produced by Goldman Sachs.

Goldman Sachs, of course, is the company where the CEO recently said of his employees that “If we could do it, we would have their bonus be 100 percent of their comp” — in other words, no salary whatsoever, no job security, give all the power to management and give the workers no rights at all.

All of which makes Christie’s improbable victory over former Goldman chairman Jon Corzine so much more ironic. Only someone who has beaten a squid himself, it seems, is capable of taking Goldman’s advice to its logical conclusions.

COMMENT

Danny_black – my point still seems to be wizzing by peoples’ heads in this thread. I know that hswkitty et all hate GS – I don’t really care. What is hypocritical, ironic, absurd, , is that Felix was demonizing GS in this post for being unfair to their own employees! irony alert… ding ding ding.

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Vikram Pandit’s deceptive reporting

Felix Salmon
Feb 24, 2011 18:15 UTC

On February 14, 2008, John Lyons, the examiner in charge of large bank supervision at the OCC, sent Citigroup and its auditors a scorcher of a valentine. In a nutshell, it said that Citigroup had no idea what it owned and had no idea how to value it. “Risk management had insufficient authority,” it said, the board “had no effective oversight role,” and “matters requiring attention” ranged from corporate governance and risk management in general and CDO valuation in particular.

Eight days later, on February 22, Citi unveiled its annual report to shareholders. In that report, Vikram Pandit personally attested that Citi had full control over its finances and that its valuations were reliable; the auditor, KPMG, said exactly the same thing.

The FCIC should have asked questions about this — after all, the OCC letter comes from its own archives. But it doesn’t seem to have done so, which means that it has fallen to Jonathan Weil to do the digging and to construct a timeline and to ask awkward questions. The problem is that Weil, as excellent as he is, doesn’t have nearly the power that the FCIC had. So he can get stonewalled easily:

Pandit, Crittenden and O’Mara didn’t return phone calls. A KPMG spokesman, George Ledwith, declined to comment, as did an OCC spokesman, Kevin Mukri. A Citigroup spokeswoman, Shannon Bell, declined to discuss the OCC’s findings.

It’s now certain that Citi and its auditors were well aware of the problems the bank had in valuing its assets — those problems were clearly spelled out to the bank in a formal letter from its regulator. And yet, as Weil writes:

Somehow KPMG and Citigroup’s management decided they didn’t need to mention any of those weaknesses or deficiencies. Maybe in their minds it was all just a difference of opinion. Whatever their rationale, nine months later Citigroup had taken a $45 billion taxpayer bailout, still sporting a balance sheet that made it seem healthy.

Both Pandit and KPMG are still in place; their la-la-la-la-we-can’t-hear-you approach to disclosure seems to have worked perfectly. But the SEC should look into this. It’s the formal disclosures in the 10K which now look deceptive at best and downright fraudulent at worst. I know it’s fun to chase hedge funds for insider trading. But we’re still waiting for the crisis-related prosecutions to begin, and this would seem to be a fruitful place to start — especially given Pandit’s newfound hero status.

Update: Shannon Bell emails with the full official statement from Citi:

“Citi maintains rigorous disclosure controls and procedures to support its CEO and CFO certifications.  These controls and procedures were followed in connection with the filing of the 10k in February 2008, and Citi’s certifications were entirely appropriate.”

(Cross-posted at CJR)

COMMENT

We must not blame Citigroup only. What is described in the article is the failure of the Basel II framework, not Citigroup. Fortunately, Basel III is way better, although we cannot expect that it will solve all the problems.

The article covers what happened in February 2008. In July 2009 we had the enhancements to the Basel II framework that try to mitigate these risks.

According to the Basel Committee:

“The supplemental Pillar 2 (supervisory review process) guidance addresses several notable weaknesses that have been revealed in banks’ risk management processes during the financial turmoil that began in 2007.

The areas addressed include:

– Firm-wide governance and risk management;
– Capturing the risk of off-balance sheet exposures and securitisation activities;
– Managing risk concentrations;
– Providing incentives for banks to better manage risk and returns over the long term; and
– Sound compensation practices.

The Pillar 3 (market discipline) requirements have been strengthened in several key areas, including:

– Securitization exposures in the trading book;
– Sponsorship of off-balance sheet vehicles;
– Resecuritization exposures; and
– Pipeline and warehousing risks with regard to securitization” exposures

George Lekatis
http://www.basel-iii-association.com

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Why it pays to ignore the market

Felix Salmon
Feb 24, 2011 16:56 UTC

At the end of 2008, the loan market was in stunningly bad shape. There was almost no bid for loans in general, and cov-lite leveraged loans in particular were treated like they were radioactive. If you looked at the prices they were trading at, the market was clearly expecting a huge wave of defaults in the very near future, along with very low recoveries.

Two years later, the picture could hardly be any different. High-yield bonds are being issued within 40bp of the state of Illinois. Cov-lite loans are being churned out at bubble-era pace: the $8.8 billion so far this year is 25% of all loans year-to-date, already tops the 2010 total, and works out to an annualized pace of something in the region of $65 billion. The defaults that everybody was expecting generally failed to occur, and the few defaults that did happen had surprisingly high recoveries.

The WSJ‘s Mike Spector is at pains to point out that “creditors aren’t guaranteed to lock in these better recoveries. Distressed-debt exchanges, while giving good recoveries in the short-term, could later prove a mirage should firms falter again.” This is true broadly, but false narrowly: if creditors want to lock in their recoveries they can do so very easily by selling their shiny new bonds and loans in this frothy market at very high prices.

When I started blogging full-time in 2006, I formulated a principle — that the market is the best pundit. Sometimes the market is wrong and some specific pundit is right, as I’m sure my boss at the time, Nouriel Roubini, would love to remind you. But the expectations priced in to the market are a more reliable base case than any other forecast you might use.

That principle didn’t work out well for me in the case of mortgage bonds. Or just about anything else: the market took it upon itself to go completely bonkers, with a level of volatility bespeaking zero reliability whatsoever when it came to priced-in expectations. Even so, in the midst of a massive recession it did seem reasonable that crazy cov-lite loans would start defaulting en masse — no matter what the Fed did in terms of monetary policy.

But something interesting happened: it turned out that these bonds and loans were big enough to concentrate the minds of the creditors. Banks and investors worked hard to avoid realizing losses, in a manner which has most emphatically never happened in the mortgage market or with small business loans. You can call it “extend and pretend” or “delay and pray” if you like, but it seems to have worked, with a lot of help from the Fed. That was unexpected, and because it was unexpected it had a huge effect on prices, which outperformed massively in 2009 and 2010.

So when the market seemed unreasonably sanguine, in early 2007, it was wrong. And when the market seemed reasonable in its pessimism, in late 2008, it was also wrong. Right now we’re back to unreasonably sanguine again — Bethany McLean says, sensibly enough, that the recent uptick in cov-lite issuance is “a sign that some kind of reckoning is in store.” But the one thing I’ve learned over the past three years is that the market just isn’t a sensible or rational place.

If you’re being logical about such things, stocks look incredibly frothy right now, just as bonds do, both in terms of valuation and in terms of psychology. But this market has a way of making everybody look foolish, no matter how logical they are. Which is ultimately just another reason to spend as little time as possible paying any attention at all to the market. It’ll just drive you mad.

COMMENT

Good insight, najdorf. One of the fictions promoted by index investing is that there are only two distinct securities in the world: “stocks” and “bonds”. People forget that different segments of the stock market have very different characteristics.

Note that this isn’t necessarily an attempt to “beat the market”. Some stocks are at risk of losing 90% of their value in a recession. Some are not. Pretty easy to tell the difference between the two classes. The riskier stocks will almost certainly produce better returns as long as things go well, but individual investors have to decide whether or not that additional return is worth the additional risk TO THEM.

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Will the government’s mortgage settlement work?

Felix Salmon
Feb 24, 2011 15:44 UTC

Back in November, Michael Barr told me that by the end of the first quarter this year, the government should be in serious discussions with banks about how they’re going to fix their broken mortgage operations. Those discussions seem to have started up, on an informal basis, as the government has cobbled together a not-quite-ready-for-prime-time settlement proposal which it will at some point formally present to the banks.

The most interesting part of the proposal, as it’s described in the WSJ, is that it looks as though the banks are going to be encouraged to do principal reductions on mortgages in lieu of paying fines:

If a unified settlement can be reached, some state attorneys general and federal agencies are pushing for banks to pay more than $20 billion in civil fines or to fund a comparable amount of loan modifications for distressed borrowers.

I’m cautiously optimistic about this. There are risks of the banks ultimately getting off very lightly: a fine is a punishment for doing something wrong, while principal reduction, by contrast, can actually benefit banks if they do it right. But in this case it seems that most of the benefit might go to homeowners and bondholders rather than banks.

The one thing I’m sure about is that the final settlement, if and when it arrives, is going to be extremely complicated, and will be presented with great fanfare and a huge headline dollar amount. But the settlement will in reality mark the beginning, not the end, of the process, and the proof of the pudding will be in the execution.

“You should hold us to whether things get better or worse,” said Barr in November. “If a year from now nothing has changed, that would be a reasonable criticism.” There’s still a lot of time to go, on that front. But amid all the noise surrounding the settlement, let’s keep our eyes on the ultimate prize, which is meaningful help for homeowners. Both government and the banks have made lots of promises on that front in the past, none of which have turned out to be worth very much. The settlement will constitute yet another high-profile promise. And we won’t know until much later this year whether it’s done any good at all.

COMMENT

i really dont see why the government is on a witch hunt to punish these banks. Barney Frank was the one 10 years ago saying we ahd to offer more loan products to people with less than perfect credit. Rather than taking the blame the government keeps trying to blmae and punish everyone else. Forums like http://www.mortgages.com discuss this mroe in detail.

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The secrecy of the FDIC, FOIA edition

Felix Salmon
Feb 24, 2011 15:22 UTC

Russell Carollo, of Mark Cuban’s JunketSleuth, has a great post up today about the way in which the FDIC aggressively rebuffs FOIA requests that other government agencies are happy to comply with. The FDIC has long been a hugely powerful and unaccountable arm of the government, and its letters to Carollo stink of arrogance and entitlement.

The FDIC repeatedly refused to provide any information on travel by its employees, claiming, among other things, that it has no central database, that Junketsleuth’s requests were too broad and that even if they had the information, the public wouldn’t have a right to see it…

Although the FDIC has rejected all of JunketSleuth’s Freedom of Information Act requests, more than 20 other agencies that got identically worded letters turned over their travel databases, which contain hundreds of thousands of records…

In addition, more than 30 agencies have provided JunketSleuth with other types of records. Those include hotel bills, airline receipts and other documents related to travel by top agency officials and other government employees, or to travel to specific destinations that we asked about.

But the FDIC provided nothing.

In response to JunketSleuth’s initial request for data, the FDIC claimed that our request – again, worded identically to those that yielded voluminous records from many other agencies – did not “reasonably describe” the information being sought.

The FDIC also said that we did not specify a time frame for the records we sought, suggesting that our request for data could be interpreted to mean all travel-related information compiled since the agency was created in 1933.

The FDIC seems perfectly happy to send responses to FOIA requests saying that it will provide no information at all on the grounds that the FOIA “could be construed to include” some impractically massive amount of information. It’s a textbook example of bad faith: what’s clearly happening here is that the FDIC has first decided that it’s not going to provide anything at all, and then instructed its lawyers to find some colorable reason why the request is being denied.

Why is it that the FDIC is being so willfully obstructive even as other agencies, including the Department of Defense and the FDA, are much more cooperative? The answer is surely the culture of secrecy and of we-know-best that pervades the financial sector generally, including the areas where it seeps into government. The Fed, of course, is just as bad, if not worse — it has a habit of dismissing FOIA requests out of hand, on the grounds that it’s not a government agency. (Technically, it’s a privately-owned corporation.)

Whenever information has emerged which Treasury or the Fed initially wanted to keep secret, the deleterious effects have been invisible — once again, the risk of something bad happening as a result of disclosure is an excuse used to justify a blanket decision not to disclose anything, rather than the reason for that decision. It’s worth remembering here that immediately before he was Treasury secretary, Tim Geithner ran the hugely secretive New York Fed, and did nothing to improve its transparency.

Government is, by its nature, a massive bureaucracy, and it’s very hard if not impossible to change an ingrained culture in such places. But a bit of top-down pressure could only help. Perhaps the White House could appoint an “openness czar” or similar to whom anybody getting serially rebuffed could appeal. Because this secrecy is ultimately self-defeating, not to mention politically damaging.

(Cross-posted at CJR)

COMMENT

Felix S. asks: “Why is it that the FDIC is being so willfully obstructive even as other agencies, including the Department of Defense and the FDA, are much more cooperative?”

As a general comment, bank regulatory agencies have very wide internal discretion on expenses, and they would prefer not to be scrutinized, thank you very much.

More important, bank regulatory agencies generally have limited external oversight. They are funded by bank fees (OCC, OTS) or bank premiums (FDIC) not by the Congressional budget process. Once those bank fees/premiums are paid, the contributors (banks) have absolutely no audit or review power over how the funds are spent. And Congress can do little about this except excoriate the agencies publicly for a day or two. The Inspector General/GAO does perform audits but not often enough.

And the current FDIC reaction to FOIA has two other specific causes: first, the FDIC Fund is running a deficit (it is in the 2nd year of a 3-year prepaid premium that provides the Fund cash but not income).

When the crisis hit, the FDIC began hiring consultants and outside legal experts not permanent staff and internal counsel. These external contractors are paid by the hour making the FDIC hugely inefficient for managing bank failures. Whenever you pay an investigator or lawyer by the hour to analyze a problem (a bank failure or near failure), the incentive for them is to keep digging deeper/wider/more far afield in order to keep the billable hours up. The FDIC has responded to this ballooning expense by lagging their payables to extraordinary terms–200+ days in some cases–in order to reduce apparent expense and to minimize the fund deficit until they can buy time to accrue additional income from the prepaid premiums.

Practical result: this small-bank failure crisis will be stretched out over 3-7 years so the FDIC doesn’t have to borrow from the Treasury for the clean up. So don’t expect a reasonable FOIA release anytime soon.

Second, Chairman Bair has announced that she is leaving in June 2011. While she has done a good job during a tough time–certainly standing up to Paulson, Geithner et. al. who were trying to raid the FDIC fund wasn’t easy–she is now very surely protecting her legacy. Why would she want to release records on a FOIA request?

So the FDIC FOIA stonewall seems to be a case of “apres moi, le deluge.” But, the coming flood will be more like drops of water akin to economic Chinese water torture.

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Counterparties

Felix Salmon
Feb 24, 2011 06:18 UTC

Deutsche Bank’s algos go rogue in Korea — Bloomberg

In which Robert Macmillan agrees with me on market reporting — Reuters

Wall Street profits totaled $27.6 billion in 2010, second only to 2009 — NYS

Which “senior Obama Administration officials” will be visiting SXSW on Mar 12? And who’s invited? — SBA

Bethany McLean on the resurgence in cov-lite loans — Slate

Love this project from Conrad Bakker — eBay

Nairobi bike rap! — Prolly is not Probably

You know what’s wrong with young people today? They’re just not disciplined enough to become pickpockets — Slate

50% of iPad owners read newspapers, compared to 15% of other e-reader users — GigaOm

Cyclist Contemplates the 46 Traffic Lights in Central Park — Gothamist

COMMENT

With all the stressful news in the world and markets, I think it is no wonder people turn to American idol. (I seldom watch TV, but I started watching it) I may even watch the oscars, but I doubt it. I might if people made speeches using this template:

http://www.washingtonpost.com/wp-srv/int eractivity/oscar-generator.html?tid=wp_f eaturedstories

On biking…One thing to do with crosswalks is to get off the bike and become a pedestrian, walk safely over the intersection and then resume being a vehicle. 46 times would be a lot, but if it prevents accidents, then why not?

Posted by hsvkitty | Report as abusive

Vulture funds in distress

Felix Salmon
Feb 24, 2011 01:25 UTC

Playboy has long mixed its girlie pics with serious journalism, but it’s not always obvious why. Take the December 2010 issue, for instance. It includes a fantastic investigative piece on vulture funds by Aram Roston, which isn’t advertised on the cover and which wasn’t placed online either until I found out about it a few days ago and started nudging them.

In any case, all’s well that ends well: the story’s up now. It suffers from the same problem that bedevils all investigative features on vulture funds: for all that such people will talk to trade journalists and vulture-fund apologists like myself (although even I have difficulty talking to them), they’ll very rarely talk to anyone doing this kind of piece. Roston talked to one vulture on the record — Hans Humes — and includes a number of anonymous quotes as well, although some of the anonymous quotes are certainly from Humes as well. The result is necessarily one-sided, although not remotely as bad as other articles I might mention, and the real fault here lies with the vultures, rather than with the reporter.

What Roston has done is look into the early history of vulture funds — Ken Dart vs Brazil, Jay Newman vs Panama — in a way I haven’t seen elsewhere. This history is hard to dig up: he clearly knows what he’s talking about. I have quibbles — I always thought that Elliott Associates successfully lobbied in Albany to change the law about calculating compound interest, rather than unsuccessfully lobbying to change the law about champerty. But these things are minor. What’s impressive is some of the color that Roston has dug up around the way that Elliott works:

Newman tried to freeze, attach or seize anything belonging to the government of the Congo. The government tried to keep a step ahead of him, allegedly resorting to fraud or straw owners to keep its oil revenue out of the vultures’ talons.

The vultures set up an intelligence operation to gather information and pursue allegations of corruption against the Congo. Newman supposedly set up an operation in London to conduct private investigations.

One vulture fund investor described the cloak-and-dagger operations. “Think Casablanca,” he said. He told me an “information bazaar” tried to dig up dirt on the leaders of Congo-Brazzaville, and former CIA station chiefs cooperated. “They’re all former spooks,” he told me. “Senior guys, station chiefs.”

Their operator was proud of what he’d accomplished in gathering information about Congolese corruption, but he marveled at the cost of digging up the dirt. “This piece of information, $50,000.” He held out one hand as he said it. “This piece of information, $100,000.” He held out the other hand…

The country settled with most of the aggressive vulture funds at 55 cents on the dollar, but Newman and his financier at Elliott scored better than the others. Apparently by agreeing to stop providing reporters with negative information about the ruling family, Newman is said to have collected about $90 million from the Congo. He had paid less than $20 million for the old debt. His biggest cost may have been for lawyers, private eyes and lobbyists.

You can see how Elliott’s investors love this: it’s the very definition of uncorrelated returns.

Roston quotes one anonymous vulture as defending his work on the grounds that vultures expose corruption. That’s pretty weak, as even Humes admits. The reasons to admire vultures are a bit more subtle than that: their existence reassures big institutional bond investors that their will always be a bid for their paper, and thereby reduces sovereigns’ borrowing costs. Or to put it more generally, someone has to be willing able to enforce a legally-binding contract in a court of law. Otherwise, no one will buy any bonds at all, given that they’re nothing but legal contracts. (For a much longer defense of vulture funds, check out my 2007 post here.)

Roston also fails to note that while the profits in vulture investing can be enormous when it works, the losses can be even bigger when it doesn’t work. What he describes as “the vultures’ biggest play of all” — Argentina — has been an unmitigated disaster for the vultures, who are happily racking up legal fees and court judgments in New York, none of which make them any money at all, even as the bondholders who accepted Argentina’s exchange offer have seen their new bonds soar in value. At this point, it’s pretty much unthinkable that the holdout vultures will ever end up making more money off Argentina than they would have done if they’d just accepted Argentina’s initial offer. And to date, of course, they’ve received nothing. More generally, the total profits of all vulture funds ever remain a rounding error in the history of sovereign debt flows — it’s important to keep these things in perspective, and to remember that profits in some countries have to be offset by losses in other countries which never paid out.

Roston’s conclusion — that vultures will be with us always — is less hopeful than my view that a consensus is forming between people who used to be very far apart, and that the vulture-fund debate is slowly fading into irrelevance and anachronism. Certainly the Argentine elephant is going to remain in the room for the foreseeable future — and now, of course, there’s a very real risk that we’ll see the whole thing kicked up a few orders of magnitude if eurozone sovereigns get into the sovereign-default game. But for the time being the European Central Bank is doing a great job of keeping distressed sovereign debt out of the hands of potential litigants.

One vulture investor recently moaned to me that there was nothing to invest in, these days, what with all asset prices going through the roof. Maybe the thing which really kills vultures isn’t legislation from the likes of Maxine Waters, but rather ultra-loose monetary policy and quantitative easing. Vultures profit from distress; they tend to drown, rather, in liquidity.

Why do we want stocks to go up?

Felix Salmon
Feb 23, 2011 21:28 UTC

Comment of the day comes from TFF:

When asset prices go up, you are poorer.

When asset prices go down, you are richer.

That equation holds true as long as you are in the accumulation phase of your life. It reverses in retirement, and is perhaps ambiguous for somebody nearing retirement, but for somebody in their 20s, 30s, and 40s, it is undeniably true.

As someone who’s saving for retirement, this is clearly true. My preference is for assets in general, and stocks in particular, to be as low as possible for as long as possible, so that I can accumulate as many of them as I can before they go up and as few as necessary after they’ve become expensive.

But here’s the weird thing: most of the people cheering for the stock market to go up are in the accumulation phase of their careers, not the spending phase. They’re still putting money into retirement funds, and they aren’t intending on spending it for decades. So why are they so happy when stocks go up, and sad when stocks go down? Shouldn’t it be the other way around?

One good reason is that if you require a certain annualized rate of return over the years that you save for retirement, then every year that return is low only serves to push the necessary future return further and further out of reach.

A less good reason is the internalization of the false promise of compound interest — the idea that you want your money to be compounding from day one. In reality, yields go up when prices go down, and you still want to be able to compound at high yields, when prices are low, rather than at low yields, when prices have risen. If you can save for decades at a steady real yield of 5% with prices going nowhere, you’ll accumulate much more money than if you start saving at 5% and then rates quickly drop to 1%. Even after accounting for the capital gain on the first bonds you bought.

The main reason, however, is simply psychological. If asset prices go up, that means people with assets are richer, and have made money in the markets. If you’re rich and you’ve made money, that makes you happy. Even if over the long term you’d be better off if you were able to continue buying bargains.

COMMENT

Good morning, y2kurtus. Want to see something uncanny? Pull up the chart for the S&P500 between 1/1/1969 and 2/24/1973. (Yahoo’s financial charts go back this far.) Now pull up a chart for the past four years, 1/1/2007 through 2/24/2011. Near-perfect match? Maybe one of the charts whizzes can put together an overlay?

Now look ahead at the ~8 years following that. The S&P500 didn’t set a new high until mid-1980, with massive inflation for the intervening years.

The scariest thing IMHO is that we are more vulnerable today than we were then. Massive budget deficits, spiraling national debt, high unemployment… And asset prices (while they’ve followed a similar pattern) are well above where they were in 1973 according to the graham-shiller index.

Very hard to see how that works out to peace or prosperity.

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