Thursday, June 30, 2005


Light posting ahead . . .

Be patient . . . We've got a one of the little Hypotheticals getting hitched!


Operation Yellow Elephant revisited

We've been startled to learn there is actually some dissenting voices out there on the left of center side regarding Operation Yellow Elephant.

For those who haven't clicked on the logo to the left, OYE appears to have been started by good folks over at Jesus' General and Crooks & Liars. Satire aside, OYE exists to make the serious point that helluva lot a chickenhawks (Vietnam and Iraqi eras) among the Iraq war supporters. Among other things, OYE helps to underline how the demographics of those in combat don't exactly match those of the GOP (especially the Young Republicans).

Kevin Drum, a well-known blogger we have linked to for nearly a year, however, came stumbling out the blocks a few days ago with this opinioned defense of bloat-tard Christopher Hitchens:
[Hitchens] argues that it's absurd to think you've scored some kind of withering putdown of war supporters by pointing out that most of them (and their sons) haven't volunteered for duty. Since I support police, fire, and social welfare programs despite the fact that I'm not a police officer, a firefighter, or a social worker, I think he's right on this.
Ross at the Talent Show and Digby have both slapped Drum's arguments around, as have Drum's own commentators.

But since Kevin seems so keen on keeping his left-moderate reputation, we think maybe it's worth noting that even the Washington Post's Richard Cohen can see through the Drum/Hitchens' crapola:
The late John Gregory Dunne -- novelist, essayist, screenwriter -- was my friend. For a year or two around 1990, though, he wouldn't have anything to do with me. I found this out the hard way by inviting him to dinner. He wouldn't come, he said, and when he asked if I wanted to know why, he told me flat out: I was a hypocrite.

The proof of my hypocrisy was my support of the looming Gulf War. I wanted Iraq out of Kuwait, and I wanted Saddam Hussein dealt with. But when Dunne asked me if I wanted these things badly enough that I would want my own son to fight in the upcoming war, I said no -- I would leave that to others. If this be hypocrisy, then I am a hypocrite.

In the end, Dunne and I resumed our relationship, but I never really knew what to make of his criticism. I thought that he had something of a point. But I also saw limited war the way I see a fire or a bank holdup or some such thing. We call on cops or firefighters to risk their lives to do what we are not willing or able to do ourselves. This is their task, and sometimes it costs them their lives.

As far as I was concerned, my firefighter-police officer analogy held for the Iraq war also -- at least until I concluded that the war itself was a mistake. Until that moment, I had thought that getting rid of Hussein was a dandy idea, especially since he was purportedly armed with hideous weapons of mass destruction. We now know they did not exist -- although they once did -- and neither did his alleged ties to al Qaeda. Still, Hussein is gone. "Was it not worth at least some sacrifice to remove such a man from power?"

The quote is from a June 19 Post op-ed by Robert Kagan, one of the most thoughtful and influential of the pro-war foreign policy intellectuals. I read that sentence with the eyes of my late friend. I know Dunne would have pounced on it, clipped it from the paper and called someone to ask precisely who or what Kagan was willing to "sacrifice." It is not likely to be anyone Kagan knows, since middle-aged Yale graduates are not likely to have friends in the National Guard or children hankering to join the Marines. Even the Vietnam War, with a draft that initially managed to catch mostly the poor, cast a more egalitarian net than this one.

[. . .]

Dunne's rebuke hectors me, and I simply have been unable to reconcile his position with what I think are the realities of power politics. But I nonetheless find myself studying the mini-profiles of the dead and noting those who were young and those who were not so young -- the enlistees and the reservists, the career guys (and gals) and the short-timers. Many in every category were seeking some vocational training or some spending money or the chance to go to college. (No recruiter emphasizes the chance of getting killed.) The hard truth is that for a lot of enlistees, if they had had more cash in their pockets, they would now be doing something else.

Dunne liked to refer to "sunshine patriots" -- those of us who called for others to fight a war we or our children would never fight. This war was conceived by sunshine patriots and directed by them -- and fought for reasons that some in the administration knew were exaggerations or, in some cases (Dick Cheney's nuclear scare-mongering), sheer fabrications. It has become the sorriest of wars, conceived for one reason, fought for another, good enough for others to fight, not good enough for ourselves and, maybe, an awful quagmire in the making. It's time the sunshine patriots looked outside.

It's raining.
'Nuff said.

Tuesday, June 28, 2005


Reaction to Bush's spewing?



Another year, another Comfest

Central Ohio is still trying to recover from the 3-day party/blur that is Comfest. Our 10-second review is that the bands were on par with previous years (that is, very good), but seemed more diverse (also good).

Knowing the effects of drinking beer and laying for hours in the sun, none of us wanted to be lugging a camera around, but one of our correspondents has provided some pixs of their own from Sunday at the Comfest.


The above documents what had been rumored all week - that the Dixie Chicks would be there incognito. (Actually, this is long-time Comfest volunteer Cyndi Woods who received the Volunteer of the Year Award for her work on the Street Fair portion of Comfest. She's flanked by Queen Candy Watkins and fellow Princess of the Pavement Joan Couden.


Here, the Hoo Doo Soul Band is tuning up before testing whether the French-leaning crowd has learned anything about rhythm in the last year.


Finally, we have another French-o-phile, state representative Dan Stewart, who shocked the Comfest crowd by showing them a document that he claimed would allow anyone to become Chief Investment Officer at BWC for a day. Apparently, BWC is auctioning the rights to be CIO as a fund-raiser for the agency. (Sorry, cash or money orders only. Just send to Ohio GOP c/o Bob Bennett, 211 S. Fifth St., Columbus).

Stewart also told the crowd that under his leadership the Ohio General Assembly just passed a resolution making body painting the State of Ohio's official "Art." As all good Comfest activists do, Stewart also admonished the crowd to remember that, "They are just boobs. Get over it!"

Monday, June 27, 2005


Additional flaws in MDL reporting: Liability and exposure

This is the second of a two-part post to address what we see as some significant recent flaws in the reporting on MDL - signficant in the sense that they serve to downplay how risky, stupid and irresponsible those around the MDL debacle were.

This one will be shorter than part one.

BWC's exposure to MDL losses:
We had a good laugh when we saw this reported comment:
Barry Slotnick, the attorney for MDL Chairman Mark D. Lay, said the direction of the economy was to blame for the losses, not his client.

“This is an example of trying to get the public excited,” said Mr. Slotnick, who is defending MDL against a lawsuit filed by the state. “Had interest rates gone up as expected, Ohio would be a very rich state and would have acclaimed Mark’s brilliance.”
That's like saying the roulette wheel is entirely to blame for losing a thousand bucks because the ball landed on red instead of black.

Uh, Barry . . . no fidiciary authorized Mark Lay to create his short-selling pyramid.

And, as one acquaintence of ours said, "even if I had won enough gambling to buy a new car, my wife would have divorced me for taking the chance."

C'mon. Is Lay's best defense really going to be that, "heck, he might have won that bet"?

Lay's and Terry Gasper's transgressions (aside from Gasper being an investment hack who got his job at BWC under murky circumstances having mainly to do with his political connections)
are that they engaged in unauthorized and highly-risky short selling amplified by their strategy to manipulate investment durations.

After laughing at Slotnick, we also laughed when we read this:
Financial speculation with state funds hit $5.6 billion last year in an investment strategy far exceeding a company's contract with Ohio's fund for injured workers, according to a report released Friday.

The state says it was never at risk for losing that much money because of the contract. . . [BWC] spokesman Jeremy Jackson said Friday. Jackson said a clause in the bureau's contract with MDL prohibited it from being held liable for more than the sum of its investment.
Give us an f'ing break. That's damn easy for BWC to assert now, but if the amount of the loss had exceeded the initial investment, we have no doubt that the state of Ohio - one way or another - would have been liable.

Let's parse the statement, "The state says it was never at risk for losing that much money because of the contract".

We'll start with the "never at risk" part. How likely MDL could have at least a billion dollars (as compared to hundreds of millions)? The answer is that it would have been relatively easy although most likely improbable. That's a far cry, however, from never.

Again, anytime someone engages in short selling of securities, the exposure to losses is unlimited. As we have noted before, there is more safety in shorting bond-related securities because the prices tend to move in smaller increments than equities. Nonetheless, all it would have taken for MDL to lose a billion or two is a major "shock" to the financial world such as another 9/11 event or an earthquake or international currency scandal. These would trigger huge jumps in the bond markets. Smaller events can also have the same effect.

So we can't talk about the idea of billions of dollars of losses in terms of whether it can or can't happen. We can only talk about it in terms of what the probabilities are that it can or can't happen.

Our point is that such a loss could happen, and it is those kinds of probabilities that good portfolio managers are supposed to spend a lot of time thinking about it. Anyone that claims that a billion dollar loss by MDL could never have happened has no idea what he or she is talking about.

The second part to parse is the clause, "because of the contract." We are willing to grant the the contract may have initially indemnified BWC from certain losses, but the fact is that a loss in the range of a billion or more dollars would have tested the contract protections in the furnace of real-world finances, politics and courts - and we believe that the contract would have been reduced to ashes.

There is just no conceivable way that BWC or the State of Ohio would have been able to walk away from some bank, investment house or other financial entity that is demanding that someone pay the $1 billion (or whatever) that they are owed. Mark Lay's pockets aren't that deep. He may have been insured, but it's doubtful that he had coverage for short-selling.

Inevitably, the State of Ohio would have been forced to eat all or part of the entire loss.

The bottom line is this: There, indeed, was the potential for the MDL to spiral out of control to the extent that billions of dollars had been lost, and BWC/State of Ohio would have had to make good on the loss. They might have been able to settle for pennies on the dollar, but, they would have to had to make good one way or another.


Additional flaws in MDL reporting: Duration

This is the first of a two-part post to address what we see as some significant recent flaws in the reporting on MDL - signficant in the sense that they serve to downplay how risky, stupid and irresponsible those around the MDL debacle were.

Duration Redux:
We know that some of these concepts are difficult to grasp, so what we have to say below isn't really a slam at reporters covering the MDL scandal - it's more of a warning that they still don't understand what the MLD "strategy" was.

Case in point is a story that appeared this weekend in the Blade, the AP, the Dispatch, the B-J and elsewhere. The jist of the story is that consulting firm, Callan Associates, has documented the leveraging the MDL did, and confirmed that Mark Lay ran the leveraging up to about $5.6 billion (previous guesstimates had put the number at $3 billion - $7 billion). That's billion - with a "b" as compared to $225 million originally allocated to MDL.

But the newspapers' explanation falls short of explaining the massive risk behind Lay's scheme. For example, the Blade says this:
MDL’s primary investment strategy was to short U.S. Treasury bonds that would mature in almost 30 years. The strategy was based on the continued rise in short-term interest rates by the Federal Reserve.

When an investor shorts a bond or stock, he is speculating that the price is too high and will eventually drop. He sells borrowed securities to other investors and agrees to buy those securities back at a later time, when he presumes their price will be lower.

The practice of shorting depends on financial leverage, investing with borrowed money to amplify potential gains.

[. . . ]

[B]y the end of September, 2004 . . . MDL had leveraged 26 times the amount of money the bureau had committed to the fund.
This is a huge muddle with several faulty leaps in logic. Let's see if we can sort this mess out.

First, shorting, indeed, does require borrowing a security, but it does not require multiple leverage. If you have a good credit rating and accessible collateral, any Tom, Dick and Mary can engage in short selling. Working through a stock broker, if you want to gamble that a share of GM is going to drop in price in the near future, you borrow a share of GM for a fee or interest payment, sell it and stick the proceeds in an interest paying account.

If you gamble wrong, you may be screwed in a big, big way. As we have noted before, shorting exposes you to unlimited losses if the security price rises instead of falls.

But, if you've gambled right, the stock soon drops in price, you buy it at the new lower price and give the share back to the loaning entity. You keep the difference in price plus whatever bank interest you earned. If that total is more than whatever shorting fee or interest you had to pay to borrow the stock in the first place - you made money. More on this last point later.

But - listen up reporters - that is only Phase I of the MDL strategy.

Phase II was to synthetically alter the effective "duration" of the investments. (Remember, Mark Lay described the strategy as being and Active Duration Fund. This is no accident.) We have struggled to come up with a simple description of "duration" in previous posts and still feel less than satisfied. Here's another try. Duration is an indicator of how the relative return a bond-related investment.

For the sake of this, let's say duration is the measure of relative return of an investment. If you look at bank ads for CDs, you'd see that a 3-month CD might be paying 3.5% interest, a 6-month CD is paying 3.75% and a 1-year CD is paying 3.9%. So, interest rates are sort of a proxy for duration.

Now, if you think you are a clever investor, you might look at these CDs and ask yourself, "Wouldn't it be nice to be able to get a 3-month CD with something close to a 1-year return!"

Well - believe it or not - that is what clever leveraging can do. (You'll have to trust us on this part of it because the math is too hairy to present here.) By actively manipulating the leverage, you can manipulate the effective duration of the investments. You synthetically create a 3-month CD paying 3.8%, close enough to the 1-year rate to make it worth while. You have manipulated the duration to amplify potential gains."

In the real world, things aren't really this simple. If you manipulate durations, you also amplify potential losses. It's amazing how much symmetry there is in finance.

Back to MDL, the point of all this is that playing with the duration of Mark Lay's investments was the strategy. Leveraging was not the strategy, only the means to get there.

Now, we have been asked, "Could have leveraging, by itself, been a valid strategy?" The answer is, probably not. The field that MDL and Mark Lay (unlike Tom Noe) operated in is considered to be very "efficient". Efficient markets have a strong tendency to quickly level themselves out. If a player in the market has some tip or insight that allows he or she to make an unexpected profit, the market quickly shifts to make make additional moves like that less likely.

Roughly speaking, a pure leveraging strategy wouldn't work for the same reason that a person can't borrow money from his or her bank, and then turn around and buy a CD from the bank. This would be the financial equivalent of a Perpetual Motion Machine - a "free money" machine.

In the real world, the bank sets its lending rates higher than it's interest rates, so you never earn enough to cover your costs. The bank's executives and financial staff exist for the nearly the sole purpose of making sure that "spread" between lending rates and interest rates.

Thus, according to financial theory, if Lay had guessed right about the direction of the bond market, and had just stuck to a simple borrow-and-buy shorting scheme, it is doubtful that he would have made much more of a return that if he had put the money in the bank.

To sum up, Mark Lay and Terry Gasper knew that the only way the investment made sense is if they could amplify the returns from short-selling, not by expanding the investment which, by itself, would have accomplished nothing, but by structuring the leverage to manipulate the duration. This is where the big, irresponsible, calculated risk came.

As we have noted several times, the whole MDL affair parallels the infamous Orange Co. (CA) bankruptcy case. More precisely, MDL is the photographic negative of what happened back then. The investor in Orange Co. leveraged millions on a long-stock bet and lost billions. MDL leveraged millions on a short-stock bet and got lucky when it only lost hundreds of millions. But they are the two sides of the coined minted from ignorance, hubris and the arrogance that comes from playing with other peoples money.

Now, we have to admit that we haven't seen the Callan report, so we have to go on what others said about how it places blame and criticizes the bureau and MDL. Again, from the Blade:
At that point, MDL had leveraged 26 times the amount of money the bureau had committed to the fund. The bureau maintains that MDL was only permitted to leverage 1.5 times the fund’s principal and broke its contract.

The Callan report concluded that $100 million could have been chopped off the bureau’s losses if MDL had only leveraged between 10 and 20 times the fund’s capital.
The notion that the mistake with MDL is that it leveraged the fund 26 times instead of 10-12 is just wrong. We can't say that strong enough. Wrong, wrong wrong. It is too hard to tell at this point if this is bad reporting or bad analysis on Callan's part, or both.

You simply cannot accept the MDL leveraging strategy, and then criticize them because they did it few times too many times. In fact, going to the extreme with the number of times the investment was leverage was perfectly consistent with the overall strategy. At least give Lay and Gasper credit for that.

The problem with MDL wasn't the number of times they leveraged. The problem was that the package of shorting and manipulating the durations was an irresponsible high-risk strategy to begin with, being played by amateurs, without even the crudest financial risk-management systems in place to sound warnings when the bets started going south.

So, Ohio reporters, our advice is this (with apologies to Deep Throat): Follow the duration!

Someone needs to nail down where Callan is on this issue because this is really the crux of what- if anything - the government investment funds will learn from the MDL scandal.


Weekends over . . .

. . . and we're back.

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