Sunday, May 30, 2010
Wednesday, May 26, 2010
Tuesday, May 25, 2010
The case, Lewis v. Chicago, involved alleged discrimination against African American applicants for the Chicago Fire Department who took a test in 1995. The department set a passing score of 64 on the exam. Applicants who scored at least 64 but below 89 were informed that they passed the test, but would probably not be hired given the number of candidates who scored 89 or above. [26,000 applied and there were only a few hundred jobs, AT] Applicants scoring 89 and above were classified as "well qualified".
The majority of "well-qualified" applicants were white. Only 11 percent were black...
The trial court sided with the black applicants, and ordered the city to hire 132 randomly selected African American applicants who scored above 64. The court also ordered the city to divide backpay owed among the rest of the black applicants.
White, Asian and Hispanic applicants who also scored above 64 but below the 89 standard were not offered employment or backpay.
Perhaps you are wondering about the tests? You would be hard pressed to find any obvious racial bias. I haven't found the Chicago test online but you can find similar tests from New York (also the subject of lawsuits) here.
also, from the comments:
"In Sweden there are physical requirements for becoming a firefighter. These tests are fairly tough and selective, as the physical requirements on firefighters sometimes help save lives.
Needless to say, the requirements are lower for women, as it would be "discriminatory" otherwise. Sometimes you just have to wonder about the mental health of people deciding these things..."
Friday, May 21, 2010
Financial Reform Provisions: what concerns me, what I like, what I wish they'd add, and a general takeaway
"Would require the vast majority of all derivatives trading be executed on a public exchange as opposed to between banks and their customers as many contracts are currently."
This still seems to me like the impressive observation of one of the New York Times columnists a few weeks ago - "This bill seems to feel that since the establishment (banks, regulators and government) couldn't predict the last bubble, more power should be vested in them to predict the next one." Fundamentally, I don't know that we've reduced risk by that much. I see a number of unintended side effects, a few good things, and generally just a very blah bill. It's not downright economically destructive the way the healthcare bill is (though I am concerned about the Fed audit and not allowing commercial banks to hedge rates and defaults)... it just seems uninspiring.
Thursday, May 20, 2010
Now a Fortune piece offers evidence that a number of large employers are considering doing exactly that. "
"Of course that traditional employer-based architecture is a mess anyway, so there's a sense in which the more people who shift on to the exchanges the better. The problem is figuring out how to pay for it. In an ideal world, Washington would respond to a bigger-than-anticipated shift by slashing the subsidies and deregulating the exchanges, until you ended up with a system where the federal government was effectively paying for universal catastrophic coverage, rather than trying to subsidize comprehensive insurance. (The end result would be something that looked a bit like Wyden-Bennett, and a bit like Judd Gregg's stillborn compromise.)
But in a less-than-ideal world, the Fortune piece notes, the fiscal picture will get very ugly very quickly:
What does it mean for health care reform if the employer-sponsored regime collapses? By Fortune's reckoning, each person who's dropped would cost the government an average of around $2,100 after deducting the extra taxes collected on their additional pay. So if 50% of people covered by company plans get dumped, federal health care costs will rise by $160 billion a year in 2016, in addition to the $93 billion in subsidies already forecast by the CBO.
Tuesday, May 18, 2010
Below, we highlight the lessons that we believe could and should have been learned from the turmoil of 2008. Some of them are unique to the 2008 melt- down; others, which could have been drawn from general market observation over the past several decades, were certainly reinforced last year. Shockingly, virtually all of these lessons were either never learned or else were immediately forgotten by most market participants.
Twenty Investment Lessons of 2008
- Things that have never happened before are bound to occur with some regularity. You must always be prepared for the unexpected, including sudden, sharp downward swings in markets and the economy. Whatever adverse scenario you can contemplate, reality can be far worse.
- When excesses such as lax lending standards become widespread and persist for some time, people are lulled into a false sense of security, creating an even more dangerous situation. In some cases, excesses migrate beyond regional or national borders, raising the ante for investors and governments. These excesses will eventually end, triggering a crisis at least in proportion to the degree of the excesses. Correlations between asset classes may be surprisingly high when leverage rapidly unwinds.
- Nowhere does it say that investors should strive to make every last dollar of potential profit; consideration of risk must never take a backseat to return. Conservative positioning entering a crisis is crucial: it enables one to maintain long-term oriented, clear thinking, and to focus on new opportunities while others are distracted or even forced to sell. Portfolio hedges must be in place before a crisis hits. One cannot reliably or affordably increase or replace hedges that are rolling off during a financial crisis.
- Risk is not inherent in an investment; it is always relative to the price paid. Uncertainty is not the same as risk. Indeed, when great uncertainty – such as in the fall of 2008 – drives securities prices to especially low levels, they often become less risky investments.
- Do not trust financial market risk models. Reality is always too complex to be accurately modeled. Attention to risk must be a 24/7/365 obsession, with people – not computers – assessing and reassessing the risk environment in real time. Despite the predilection of some analysts to model the financial markets using sophisticated mathematics, the markets are governed by behavioral science, not physical science.
- Do not accept principal risk while investing short-term cash: the greedy effort to earn a few extra basis points of yield inevitably leads to the incurrence of greater risk, which increases the likelihood of losses and severe illiquidity at precisely the moment when cash is needed to cover expenses, to meet commitments, or to make compelling long-term investments.
- The latest trade of a security creates a dangerous illusion that its market price approximates its true value. This mirage is especially dangerous during periods of market exuberance. The concept of "private market value" as an anchor to the proper valuation of a business can also be greatly skewed during ebullient times and should always be considered with a healthy degree of skepticism.
- A broad and flexible investment approach is essential during a crisis. Opportunities can be vast, ephemeral, and dispersed through various sectors and markets. Rigid silos can be an enormous disadvantage at such times.
- You must buy on the way down. There is far more volume on the way down than on the way back up, and far less competition among buyers. It is almost always better to be too early than too late, but you must be prepared for price markdowns on what you buy.
- Financial innovation can be highly dangerous, though almost no one will tell you this. New financial products are typically created for sunny days and are almost never stress-tested for stormy weather. Securitization is an area that almost perfectly fits this description; markets for securitized assets such as subprime mortgages completely collapsed in 2008 and have not fully recovered. Ironically, the government is eager to restore the securitization markets back to their pre-collapse stature.
- Ratings agencies are highly conflicted, unimaginative dupes. They are blissfully unaware of adverse selection and moral hazard. Investors should never trust them.
- Be sure that you are well compensated for illiquidity – especially illiquidity without control – because it can create particularly high opportunity costs.
- At equal returns, public investments are generally superior to private investments not only because they are more liquid but also because amidst distress, public markets are more likely than private ones to offer attractive opportunities to average down.
- Beware leverage in all its forms. Borrowers – individual, corporate, or government – should always match fund their liabilities against the duration of their assets. Borrowers must always remember that capital markets can be extremely fickle, and that it is never safe to assume a maturing loan can be rolled over. Even if you are unleveraged, the leverage employed by others can drive dramatic price and valuation swings; sudden unavailability of leverage in the economy may trigger an economic downturn.
- Many LBOs are man-made disasters. When the price paid is excessive, the equity portion of an LBO is really an out-of-the-money call option. Many fiduciaries placed large amounts of the capital under their stewardship into such options in 2006 and 2007.
- Financial stocks are particularly risky. Banking, in particular, is a highly leveraged, extremely competitive, and challenging business. A major European bank recently announced the goal of achieving a 20% return on equity (ROE) within several years. Unfortunately, ROE is highly dependent on absolute yields, yield spreads, maintaining adequate loan loss reserves, and the amount of leverage used. What is the bank's management to do if it cannot readily get to 20%? Leverage up? Hold riskier assets? Ignore the risk of loss? In some ways, for a major financial institution even to have a ROE goal is to court disaster.
- Having clients with a long-term orientation is crucial. Nothing else is as important to the success of an investment firm.
- When a government official says a problem has been "contained," pay no attention.
- The government – the ultimate short-term-oriented player – cannot withstand much pain in the economy or the financial markets. Bailouts and rescues are likely to occur, though not with sufficient predictability for investors to comfortably take advantage. The government will take enormous risks in such interventions, especially if the expenses can be conveniently deferred to the future. Some of the price-tag is in the form of back- stops and guarantees, whose cost is almost impossible to determine.
- Almost no one will accept responsibility for his or her role in precipitating a crisis: not leveraged speculators, not willfully blind leaders of financial institutions, and certainly not regulators, government officials, ratings agencies or politicians.
- There are no long-term lessons – ever.
- Bad things happen, but really bad things do not. Do buy the dips, especially the lowest quality securities when they come under pressure, because declines will quickly be reversed.
- There is no amount of bad news that the markets cannot see past.
- If you've just stared into the abyss, quickly forget it: the lessons of history can only hold you back.
- Excess capacity in people, machines, or property will be quickly absorbed.
- Markets need not be in sync with one another. Simultaneously, the bond market can be priced for sustained tough times, the equity market for a strong recovery, and gold for high inflation. Such an apparent disconnect is indefinitely sustainable.
- In a crisis, stocks of financial companies are great investments, because the tide is bound to turn. Massive losses on bad loans and soured investments are irrelevant to value; improving trends and future prospects are what matter, regardless of whether profits will have to be used to cover loan losses and equity shortfalls for years to come.
- The government can reasonably rely on debt ratings when it forms programs to lend money to buyers of otherwise unattractive debt instruments.
- The government can indefinitely control both short-term and long-term interest rates.
- The government can always rescue the markets or interfere with contract law whenever it deems convenient with little or no apparent cost. (Investors believe this now and, worse still, the government believes it as well. We are probably doomed to a lasting legacy of government tampering with financial markets and the economy, which is likely to create the mother of all moral hazards. The government is blissfully unaware of the wisdom of Friedrich Hayek: "The curious task of economics is to demonstrate to men how little they really know about what they imagine they can design."
Monday, May 17, 2010
Friday, May 14, 2010
and people have been building on that for years. Certainly, there's risk that can be diversified away, but I'd bet that if you can find 15 securities that are not identical in most respects, adding a 16th doesn't cut as much risk as it saps return.
Monday, May 10, 2010
adjust for something like Thursday's Wall Street panic attack?"
So I suppose my response to that would be that we shouldn't adjust
anything- people who are really affected (day traders, people who use
margin) know the risks. The necessary adjustments on Wall Street (and
there are many) regard fairness foremost (I'll address this in a
second) and risk-taking (less obvious), neither of which are reflected
in a one day panic.
That said, defusing volatility without harming the regular functions
of markets or raising the cost of capital is (obviously) a good thing.
Thus, like financial reform, procedures for halting, slowing or
defusing intraday crises would be valuable. I was wondering if they'd
close the exchange for a bit but A) it didnt hit the built in
circuitbreaker for the whole market, though some stocks did, and B)
that wouldn't necessarily have stopped the plunge on other networks
like ECNs. In fact, stopping primary trading could have even worsened
things bc of less buying liquidity but continued selling panic.
Thus, a number of big improvements come to mind. Firstly, make the
circuit breaker time dependent, as well as magnitude dependent.
Clearly, a 10% drop in ten minutes is more serious than a 10% drop in
a day. Circuit breakers that factored in speed of drop would be good.
Secondly, coordinate the networks such that when the primary exchange
closes down, the secondary ones do, too. Incidentally, this should
also apply to market opens and closes - currently, the NYSE opens 30
seconds later than a lot of the secondary NASDAQ or ECN networks, so
anyone who submits trades before the open can get cheated out of a
portion of the spread. The secondary networks should not be permitted
to trade when the primary listing exchange is closed. This has both
fairness and anti-panic benefits. There are also decent reasons to
implement the circuit breaker on an upward basis, as well.
Additionally, improving liquidity makes it harder to have a panic.
High-frequency trading can exacerbate panics and drives liquidity from
the market by functionally stealing a piece of every spread (for more
information, see my prior comments at number 7 here:
Flash trading (basically, where some people see trades a fraction of a
second before others) is blatantly unethical and drives liquidity from
the market because large block sellers or buyers don't want to be
jumped by hundredths of a penny by people who see their trades before
the market does. Dark pools make liquidity invisible and getting rid
of them would make the market deeper and less prone to panics (though
it's difficult to eliminate dark pools without getting rid of flash
trading first). To the Obama administration's credit, it has been
working to illegalize flash trading, and is looking at dark pools.
Some more ideas I've heard or had to combat UHFT and flash trading
(they're related but not the same) are to tax cancelled transactions
(instead of a turnover tax), or re-widening spreads away from pennies
to nickels (the market functioned perfectly fine in eighths until
1999). Even more radically, partially ECN-ing the market, where
matching and execution are not continuous but instead execution
happens at certain predetermined points (perhaps every 5 minutes, or
something like that) and only matching can happen in the interim,
would help to reduce a lot of the egregious HFT and flash trading
Finally, relaxing mark-to-market rules somewhat can, in some
instances, reduce liquidity crunches and, depending on the assets,
margin calls for some more sophisticated securities.