Bernie and A-Rod

by Jeff Feldman.

Bernie and A-Rod have a lot in common. First of all, they both cheated. Second, several people suspected they were cheating. Third, both were at the top of their profession, seen as virtually peerless. Now there is no question that they are responsible for their actions and should face the consequences. But aren’t Bernie’s investors and A-Rod’s employers and fans equally culpable? Didn’t they see what they wanted to see? Bernie provided what were ostensibly above-market, low risk, returns. A-Rod hit home runs at an unprecedented rate. They both gave the market exactly what it wanted.

So let the market be warned. We have to be vigilant and when, as the saying goes, it looks too good to be true, there is a very good chance it is to good to be true. As an investor, I have a simple rule. If someone is offering consistent returns and constantly taking in new money, I assume it’s a Ponzi scheme. One can never be sure, and I may miss a great opportunity one day, but I’ve been in the business 42 years and it hasn’t happened yet.

Plus, Bernie would not explain his trading strategy and that is always a red flag.

Ironically, regarding strategy, baseball used to be a game of strategy and statistics. The home run was not the centerpiece of the game. A true baseball fan enjoyed a 1-0 game decided by a suicide squeeze just as much as a 10-9 game with 7 home runs. But over the past 20 years, as with other sports , baseball became a power game. We got caught up in the home run onslaught of what steroid enhanced players like Mark McGwire and Sammy Sosa. The video game generation does not have the attention span required for the traditional slow-moving baseball game.


Baseball has been around for more than 100 years; ballpark dimensions provide fairly consistent numbers of home runs. The game didn’t need home runs to attract fans, until recently. As the home run became more important, and since baseball could not move in the fences without destroying the integrity of the game, the incentives for hitters to take steroids blossomed. And with the hitters juiced, some pitchers felt the need to keep up. Team owners, and management, understood the value of the home run and so had an incentive to look the other way. The point is, it would be virtually impossible to change the nature of baseball from a strategy based game, to a power based game, without changing the dimensions, or the equipment. So, you had to change the players.

There is an analogy in investing. It has been extremely difficult for fund managers to produce consistent, above market, returns over a long period of time. Three quarters of
of fund managers do not outperform their chosen benchmark in any given year. Bill Miller at Legg Mason beat the S&P 500 15 years in a row (making him a Superman) then lost almost 45% in 2008. And if one invested with Miller in 1998, currently that position is underwater by 10%. So now comes Bernie Madoff to a game of strategy and statistics and he says he will not be a home run hitter but rather will consistently hit doubles and triples (and he will never strike out). Investing has been around longer than baseball and nobody has been able to overcome the odds without cheating. So with Bernie, as with A-Rod, we should have known.

The more troubling aspect of the Madoff business is the sense of entitlement expressed by his investors. They believed that the wealthy play on a different playing field with different rules. They could have their cake (higher returns) and eat it, too (no risk). I don’t know if the $50 billion number is an accurate measure of the money Bernie took, but assume for the moment it is. If that money had been invested in a basket of opportunities in medical technologies and environmentally friendly innovations, the potential returns would have been a multiple of the $50 billion and the downside would unlikely not be as bad as the total loss his investors are facing.

Madoff Style Investments Don't Cure Diseases

In addition, the successful technologies would improve standard of living for the rest of us. It is very dangerous for the wealthy to believe that they can strategically avoid risk and make money with an options trading strategy that benefits nobody but them. Even if it were possible, the eventual consequences of such a strategy could be dire. We need to invest in a sustainable, and growing, economy.

Back to Basics


Our nation, and particularly the wealthy, has to get back to basics.

Investment analysis is about balancing risk and reward -- not eliminating risk.

Trekkie Alert: Medical Tricorders May Come Soon

Peter Pitts at Drugwonks shows that soon Star Trek medicine may come to all of us in the form of a medical tricorder.

In a post entitled 510(k) for a Tricorder, he writes:

Doctors could soon be using a Star Trek-style device the size of a BlackBerry to check patients' genetic suitability to different medicines. A prototype of the hand-held device is already being tested by British scientists, who say it could be on the market in two years. The SNP (pronounced snip) Doctor is the kind of gadget that might by have used by Dr Leonard McCoy in the original Star Trek TV series.
From a drop of saliva or cheek swab it can analyse DNA to tell if a patient has the right genetic fit for a particular drug.

For those of you who don't live and breathe the FDA approval process, 510(k) refers to the process of approving medical devices for use in the USA. According to the FDA in its Premarket Notification 510(k) webpage:

A 510(k) is a premarket submission made to FDA to demonstrate that the device to
be marketed is at least as safe and effective, that is, substantially equivalent, to a legally marketed device (21 CFR 807.92(a)(3)) that is not subject to PMA. Submitters must compare their device to one or more similar legally marketed devices and make and support their substantial equivalency claims. A legally marketed device, as described in 21 CFR 807.92(a)(3), is a device that was legally marketed prior to May 28, 1976 (preamendments device), for which a PMA is not required, or a device which has been reclassified from Class III to Class II or I, or a device which has been found SE through the 510(k) process. The legally marketed device(s) to which equivalence is drawn is commonly known as the "predicate." Although devices recently cleared under 510(k) are often selected as the predicate to which equivalence is claimed, any legally marketed device may be used as a predicate. Legally marketed also means that the predicate cannot be one that is in violation of the Act.

"Don't leave him in the hands of 20th Century Medicine." Dr. McCoy, Star Trek IV: The Voyage Home.

Grandfathering Permits in Emissions Trading Schemes

Why is it that items are "grandfathered" and not "grandmothered?" Has anyone thought of that? Especially since grandfathers can't give birth to anything?

Well, now that we're past etymology,

Rich Sweeney at Common Tragedies wrote an interesting post on 18 February 2009, entitled, The Problem with Grandfathering Permits which highlights a major challenge related to running cap and trade systems -- notably the issuance of permits based on past emissions. He notes that:

... one of the problems with output based permit allocation is that it creates an incentive for actors to alter their behavior in the period(s) prior to setting the allocation. For example, if carbon permits were simply given out proportionally based on firms’ share of total carbon emissions in the previous year, there would be a huge incentive to be as dirty as possible.

Knowing that their allowances could be based on their emissions the year before the scheme was implemented, polluters might ramp up their emissions so they could have the largest allowance possible.

Windpower Employs More than Coal Mining in US

I originally saw this in The Coffee House , which in turn referenced a post from the Green Wombat.
It seems that the windpower industry employs more people than the coal mining industry.

Here’s a talking point in the green jobs debate: The wind industry now employs more people than coal mining in the United States.

Wind industry jobs jumped to 85,000 in 2008, a 70% increase from the previous year, according to a report released Tuesday from the American Wind Energy Association. In contrast, the coal industry mining employs about 81,000 workers. (Those figures are from a 2007 U.S. Department of Energy report but coal employment has remained steady in recent years though it’s down by nearly 50% since 1986.) Wind industry employment includes 13,000 manufacturing jobs concentrated in regions of the country hard hit by the deindustrialization of the past two decades.

Madoff + Mortgages = One Economic Mess

by Jeff Feldman

The past few weeks have been full of Bernard Madoff news and mortgage disasters. What is important, however, is what these twin tales paradoxically reveal -- trying to avoid risk in investing may lead us to the riskiest investments.

Madoff is a crook; lock him up and throw away the key. What about his “victims?” Are they blameless? They were seeking above average returns from an investment they perceived to have, little or no, risk. But most of them could not explain what they had invested in and knew little about the Madoff operation. All that mattered was there was no risk. And look what happened to Zsa Zsa Gabor .

Perhaps if they had been investing in something real, like Volkswagen beetles, this wouldn't have happened -- and they would have produced something that people could use.

And let's face it, derivatives based on mortgages are pretty vaporous, too.

The buyers of securitized mortgages thought the pools they were buying were rated AAA. That of course meant that they were taking no risk and thus could leverage those investments in order to get an above average rate of return.

Then there were the buyers of credit default swaps who were buying the credit risk of entities that they perceived had little or no chance of failing, thus allowing them to earn an above average return from the premiums earned. Yet, would these people have bought into the argument that decaffeinated coffee crystals are equivalent to a high quality brew (apologies to Lauren Bacall)?

So we invested trillions of dollars, all of which were going to earn above market returns for no risk, violating every principle of finance.

Then there are the folks who have engaged in 130/30 strategies and “portable alpha” strategies under the assumption that they reduced risk without giving up any return. These investors built models based upon asset allocations, algorithms and the efficient frontier without ever giving any consideration to what was actually going on inside the companies that made up their portfolios.

Over the last 15 years, with the advent of electronic trading platforms and the rapid expansion of proprietary trading desks, the investment community has labored ,and hard, to eliminate risk from investing. Of course, it turns out that that instead of eliminating risk, the engineers have made it pervasive and now we are suffering the consequences. But why did risk become such an anathema in the first place? There is no such thing as a low-risk, high-reward investment, certainly not for long. But after the tech bubble burst in 2000, institutional investors developed an aversion to risk. Hedge funds sprung up to offer the solution. But investors were not satisfied with the returns provided by the market because they were seeking to recover the losses from the tech bubble. They maintained their aversion to risk but required above market returns. Wall Street is always willing to oblige investors. So we got what we asked for. This is similar to what happened with Enron. Through the 80’s and 90’s it became common for analysts to predict quarterly earnings down to the penny and growth companies that missed estimates were severely punished by investors. So Enron created, out of whole cloth, the stable growing earnings pattern that we hungered for.

I have been on Wall Street for 40 years. I have accumulated a good deal of knowledge and I have seen a lot. My experience told me we would wind up exactly where we are and I spent two years on a public speaking tour trying to point out the problems. Many of you will recall my rants which did little good. It is dangerous to wave a flag in the face of a charging bull.

Now greed has been overwhelmed by fear but that will pass. When it does, investors will come out of their bunkers.

Those investors will be assuming risk. Some will make money; many will lose money but we will all be better off. The investors who backed Bell took a risk that other inventors would get to the market first. Other investors backed losing systems or thought the invention would go nowhere, notably Mark Twain.

Capital formation is the basis of economic growth. Financial engineering leads to the destruction of capital and we now all know where that leads.

We must now get back to basics and make our capital markets the engine of growth they have always been and to restore prosperity for all.

Hopefully, we will return to the fundamentals of investing; looking for companies that will offer tomorrow’s innovations which will improve life for all, like the telephone

Bernard Madoff Talks About His Relationship with Regulators

Bernard Madoff talks about his relation with regulators and how violations can't remain under the radar for long on Wall Street. Just tell that to Harry Markopolos.

The short version:


The long version (over 30 minutes).

Safe Passage

by Jeff Feldman.

It was quite remarkable to watch the market trade down on Tuesday, while the Secretary of the Treasury was testifying before Congress. Just ten years ago, that testimony would not have broadcast live and 20 years ago it wouldn’t even have made the news. Now the market is analyzing testimony in real time. This morning I saw a self-promoting ad on CNBC, better known as bubblevision calling its reporting “Fast, accurate, and actionable.” Actionable is what we are all about today. Instant gratification is a requirement.

When Jim Cramer does his “Lightning Round” on Mad Money, he prefaces by vowing that he has no prior knowledge of the callers or the stocks about which they will inquire. He wants us to know that absolutely no preparation or analysis has been done to support his pronouncements. This is, of course, to demonstrate his prodigious knowledge about the stock market. But is this offering really preferable to his getting advance notice to prepare well researched opinions? What about the callers? Wouldn’t they be better off if his responses took into account their portfolios and financial situation? Can you imagine a doctor conducting a “Lightening Round” on live television? “Let’s go to Joan in Indiana. What ails you Joan?” Would anyone act on such advice? Is your money any less important than your health?

It seems we have moved beyond the old joke of “ready fire aim” to simply, “fire at will,” with predictable results. Perhaps recognizing this mentality, Secretary Geithner did not give us actionable information. The absence of same caused the Dow to decline 400 points.

Consider what would have happened if he had given the market what it was looking for? Imagine, if it became apparent from his testimony, that the bank stocks are under valued. How much money would have piled into that trade?

After the testimony, the pundits paraded onto the screen to proclaim they want certainty from the government on the value of bank assets before they will consider investing in them. This is the equivalent of the 19^th century American pioneers proclaiming, “we will not settle the west until the Government takes care of the Indian problem,” or the astronauts demanding a Government guarantee of their safety before taking off for the moon. We must be willing to take some risks without being backstopped by the Government. Note that Intel announced yesterday the intent to spend $7 billion on new plant and equipment. No guarantees. No assurance it will work out. Businesses need to start looking forward without regard for government action. If we start investing in the industries that will solve societies greatest needs: healthcare, clean tech, education, and efficient transportation to name a few, we can begin the road to recovry. Some businesses will succeed, many will fail and we will all be better off. There are no quick fixes to the hole we are in. There is nothing that is fast and actionable. This is a slow difficult grind. Those that say it is too risky or too difficult miss the point. Our country and our way of life are at stake. Those with excess capital can’t hoard their way out of this.

Their capital is worthless without a sustainable economy. And that sustainable economy is achievable. Lets turn off CNBC (making us immediately smarter) and go to work.