Trader Pay Would Face Restrictions Under Draft Volcker Rule - BusinessWeek

Trader Pay Would Face Restrictions Under Draft Volcker Rule - BusinessWeek:

"U.S. banks would have to change the way they compensate traders involved in market-making activities under one of the proposed restrictions of the so-called Volcker rule, according to a draft circulating among regulators.

The rule, which aims to ban most proprietary trading by banks with federally insured deposits, would exempt trades related to market-making as long as the activity met at least seven standards, or principles. One principle would be that traders get paid from fees and the spread of the transactions rather than the appreciation or profit from their positions, according to a copy of the draft reviewed by Bloomberg News"

While no doubt this will be wildly unpopular, it seems it makes sense in a world where society (or at least Fed and Treasury) have concluded that some firms are too big to fail. With that decision, comes an inherent morale hazard problem. This MAY reduce it. (of course wouldn't the salary once makes be a function of profits? So while not directly tied to the actual trade, they are just one step removed and likely to still have traders take excessive risks. (Better not perfect ;) )

HT to MoneyScience on this!

Anonymous takes aim at the cozy world of investment analysis - QFINANCE

Chaoda | Anonymous takes aim at the cozy world of investment analysis - QFINANCE:

"Why does anyone rely on ‘sellside’ research? The investment analysts who produce it, for free, tend to work for investment banks that also have some very big ticket services to sell, such as the underwriting of IPOs, to the very companies whose performance they are supposed to be evaluating"

and now someone (uh who will remain nameless) is trying to do something about it (you can argue about their methods)

Q finance profiles one such report with Chaoda which can be downloaded here:

"Anonymous, the 'hacktivist' collective, has branched out into investment research with the launch of Anonymous Analytics. They have kicked off with a truly stunning research note on Chaoda Modern Agriculture.

Chaoda, which has been listed on the Hong Kong stock exchange since 2000, has a market capitalization of $460m and is one of dozens of Chinese companies that have been accused of fraud in recent months."

Pretty excited about this actually. Yes it has potential to be worthless (or worse) if people make things up, but also could help prevent problems of lack of transparency and misaligned incentives.

Elizabeth Warren - The Daily Show with Jon Stewart - 01/26/10 - Video Clip | Comedy Central

Elizabeth Warren - The Daily Show with Jon Stewart - 01/26/10 - Video Clip | Comedy Central:


Really really torn on including this one. It is clearly biased, but so are most things one way or the other. It is well done (maybe too well done since it makes one side look too bad.)

Elizabeth Warren stresses the urgency of Wall Street reform

The Daily Show with Jon Stewart
Get More: Daily Show Full Episodes,Political Humor & Satire Blog,The Daily Show on Facebook

The other side:


Issuing riskier mortgages allowed more home ownership. We can not have it both ways. Making stricter mortgages, will result in lower home ownership and less lending. So long as people understand the tradeoffs they are making, I am fine with whatever they decide, but Warren makes it appear that more stringent rules come at no cost. They do not.

She mentions how there were no serious market collapses from Depression to the 1980s, well, that is true, but the world suffered from lack of growth.  Opening up markets, increases risk, but also increases the benefits that markets bring.  Again, this is not reported.

Getting bailed out must come with a significant cost, else it leads to a horrible incentive structure where risks continue to increase (morale hazard).

Can the Federal Reserve get banks lending? - Sep. 23, 2011

Can the Federal Reserve get banks lending? - Sep. 23, 2011:

"Low rates can only do so much," said Greg McBride, senior financial analyst with Bankrate.com. "Operation Twist will not prompt banks to make loans they're not comfortable making. It won't prompt people to buy houses if they're worried about a job loss, and it won't help homeowners refinance mortgages if they're already unable to qualify."

Need some evidence?

Here are some annual numbers from 2010 from "Thetruthaboutmortgages.com

"... refinance volume fell about 14 percent as compared to 2009, while the 30-year fixed hit a record low 4.17 percent.

Of course, it wasn’t for a lack of interest; it had more to do with issues holding back homeowners.

A lack of home equity, more rigorous underwriting carried out by mortgage lenders, and the presence of second mortgages all hindered refinancing.

So what is the Fed so to? Increasing the money supply has not worked, lowering interest rates has not worked (or more correctly has not worked enough), they are out of tricks up their sleeve. The country needs job growth and until wages are more competitive internationally, hands are largely tied. My guess since they must appear relevant is to somehow create incentives to make loans to lower rated borrowers. Which alas history has shown to be a road to trouble.

Why Identifying a Bubble Is So Much Trouble: John H. Cochrane - Bloomberg

Why Identifying a Bubble Is So Much Trouble: John H. Cochrane - Bloomberg:

Perfect review of last week's behavioral finance class:

" High valuations are, on average, followed by many years of poor returns, and vice versa. High valuations are not, on average, followed by years of good cash-flow growth, or by ever-higher valuations.

This fact holds across markets:

-- High stock price/dividend, price/earnings, or market/book ratios are on average followed by years of poor returns, not years of higher dividend and earnings growth, or permanently higher prices, and vice versa for low prices.

-- High yield spreads (low prices) on long-term bonds are on average followed by good returns on long-term bonds, not by increases in short-term interest rates, and vice versa"

Class: read it! :)

Stanford researchers predict long-term personal finances in the lab

Stanford researchers predict long-term personal finances in the lab:

"New data suggests that different neurological systems are responsible for learning about gain and loss," Knutson said.

Psychology has traditionally held that learning is learning, but neuro-economics takes a different position. Positive emotions like excitement and negative emotions like anxiety, supported by separate brain circuits, seem to motivate gain and loss learning, respectively. Being good at winning money doesn't necessarily mean you're good at not losing it..."

and

"...individuals' test results corresponded tightly with their financial histories. Better performance during the gain-learning trials was closely related to more assets. Better performance during the loss-learning trials, however, was related to less debt."

Very interesting!

Front-running Goldman Sachs From A TD Ameritrade Account | Wall Street | Marketplace from American Public Media

Front-running Goldman Sachs From A TD Ameritrade Account | Wall Street | Marketplace from American Public Media:

"After the rogue trader brought down UBS’s credit rating and perhaps even its CEO, there’s another example of a bold rogue trader - except, in this case, the allegedly rogue was trading against his own bank, not taking big bets on its behalf.

The Securities and Exchange Commission accuses former Goldman Sachs trader Spencer Mindlin of figuring out some of the bank’s trading strategies and then beating his own bosses to the punch. The full complaint is here.

On Wall Street, there’s a name for what Mindlin is accused of doing: “front-running.” You can picture the image: a guy sees a trade, and runs in front of it to get to it first."

From Money Science.

What Investors Really Want: A blog by Meir Statman

What Investors Really Want: A blog by Meir Statman:

I was looking for material for class the other day and found this. (we never got to it in class but will soon!)

Amidst a very informative discussion on the reason for a reluctance to "break the buck" in money market accounts and the resulting flawed accounting system, Statman brings the discussion to behavioral biases:

"Losses make us feel stupid. Hindsight error misleads us into thinking that what is clear in hindsight was equally clear in foresight. We bought the stock at $100 because, in foresight, it seemed destined to go to $150. But now, in hindsight, we remember all the warning signs displayed in plain sight on the day we bought our stock. Interest rates were about to increase. The CEO was about to resign. A competitor was ready to introduce a better product.

The cognitive error of hindsight is accompanied by the emotion of regret. We kick ourselves for being so stupid and contemplate how much happier we would have been if only we had kept our $100 in our savings account or invested it in another stock that zoomed as our stock plummeted."

Meir Statman is a true expert on behavioral finance. If you have not read his book, I HIGHLY recommend it.

Timothy Geithner and Jim Cramer

Interesting video interview in which Geithner and Cramer discuss Europe as well as the US.

Video - The founder of The Vanguard Group talks with The Wall Street Journal about life and investing. - WSJ.com

Video - The founder of The Vanguard Group talks with The Wall Street Journal about life and investing. - WSJ.com:

"Buying and holding stocks and bonds for the long term and maintaining a diversified portfolio are still the smartest strategies for the average investor, says Vanguard founder Jack Bogle in answer to Mark Cuban and other critics of these traditional approaches. In the Big Interview with Journal columnist Jason Zweig, Bogle takes aim at the culture of market speculation. Betting on long odds, he says, "doesn't pay off very often.""

Here is the interview with Mark Cuban:

Bankers Hooked on Gambling Need a Capital Intervention: View - Bloomberg

Bankers Hooked on Gambling Need a Capital Intervention: View - Bloomberg: "
Short version: bailouts and asymmetric payoffs add to the incentive to take risks. Managers learned this faster than other stakeholders (shareholders, auditors, and regulators) could adapt their monitoring. We have created an incentive to take risks.


From a Bloomberg editorial:

"...to fully grasp their position, it helps to understand why they find leverage so attractive. Consider two banks, both with $100,000 in assets. The first got the entire $100,000 from its shareholders, giving it a 100 percent capital ratio. The second raised only $1,000 in equity and borrowed the rest, giving it a 1 percent capital ratio. In the first case, a $1,000 profit on the assets will generate a meager 1 percent return on the shareholders’ $100,000 investment. In the second case, the same $1,000 gain will produce a 100 percent return on equity. The second option also has a steep downside: A loss of only $1,000 can wipe out the shareholders.
No Fear

At a big, systemically important bank, high leverage allows executives to play a heads-I-win-tails-you-lose game with taxpayers. In good times, the leverage makes the bank extremely profitable to shareholders, allowing executives to collect juicy bonuses. In bad times, as the European experience yet again demonstrates, governments have no choice but to step in and bail out the banks, and executives have nothing to fear but a highly remunerative exile."

Class: be able to talk about this today! For instance: with bailout promises (explicit or implicit) do shareholders have an incentive to allow managers to take large risks.

The World's Greatest Money Maker: Warren Buffett - BBC Documentary - 1 of 6 - YouTube

The World's Greatest Money Maker: Warren Buffett - BBC Documentary - 1 of 6 - YouTube
One more video? Why not?

Modern Portfolio Theory video

How can people watch TV when this is on???  :)

The Impact of Asymmetry on Expected Stock Returns: An Investigation of Alternative Risk Measures by Stephen Huffman, Cliff Moll :: SSRN

The Impact of Asymmetry on Expected Stock Returns: An Investigation of Alternative Risk Measures by Stephen Huffman, Cliff Moll :: SSRN:
"

Previous research indicates that returns are not normally distributed and that investors seem to care more about downside risk than total risk. Motivated by these findings and the lack of research on upside risk, we model the relation between future returns and risk measures and investigate the following questions: Are investors compensated for total risk? Is the compensation for downside risk different than the compensation for upside risk? and which measure of risk (i.e., upside, downside, or total) is most important to investors? We find that, although investors seem to be compensated for total risk, measures of downside risk, such as the lower partial moment, better explain future returns. Further, when downside and upside risk are modeled simultaneously, investors seem to care only about downside risk. Our findings are robust to the addition of control variables, including prior returns, size, book-to-market ratio of equity (B/M), and leverage. We also find evidence of short-run mean reversals in daily returns. Our findings are important because we document a positive risk-return relationship, using both total and downside risk measures; however, we find that investors are concerned more with downside risk than total risk.