December 2008


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The stock market has been working its way higher since its late November lows. A somewhat positive ending to what was a very dismal year. The Dow was down 33.8% in 2008. To put this year’s performance in perspective, today’s chart illustrates the 15 worst calendar year performances of the Dow since its inception in 1896. As today’s chart illustrates, the Dow’s performance in 2008 ranks as the third worst on record. Only 1931 and 1907 endured greater declines. It is of interest that major banking crises occurred in 1931, 1907, 2008, and 1930 – the four worst calendar years on record in terms of stock market performance.

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Interest rates for countries running Current Account Deficits will be put at risk in this situation. Specifically New Zealand, who run one of the largest %/GDP CAD.

Record volumes of government bonds from the industrialised nations – intended to reverse what could be the worst recession since the Great Depression – threaten to curb access to credit markets by emerging economies.

Analysts warn that emerging market borrowers could be crowded out of the credit markets by $3,000bn of government bonds expected to be issued by the big developed economies in 2009 – three times more than in 2008. The US alone is expected to issue about $2,000bn next year.

Emerging market governments and corporates need to repay $6,865bn of debt in 2009, according to ING Wholesale Banking. This includes bonds, loans, interest payments and trade finance.

David Spegel, global head of emerging markets strategy at ING, said: “Refinancing risk is going to be one of the biggest problems for emerging market issuers in 2009.

“Sovereign defaults are unlikely, but many companies could face debt restructuring or default.”

Mr Chamie said: “Governments or companies that are highly rated will still be able to attract buyers, but the very large amount of issuance almost certainly means they will have to pay higher interest rates to get those investors.”

Brazil, Russia, India and China face external debt payments of $205bn, $605bn, $257bn and $2,437bn respectively, but can rely on large foreign exchange reserves to help meet bills.

Argentina has $64bn of external debt due in 2009; Turkey has $36bn falling due, ING says.

Countries such as Hungary and Ukraine have already been bailed out by the International Monetary Fund and the European Central Bank.

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How could I exit 2008 without the last word on flip-flop-fly and his stockpicking shenanigans. Therefore, from March 2007, we have the BWLD breakdown. I was a guest “weekend blogger” on the old site and wrote an analysis [bearish] on one of flip-flops dearly held long stocks, based on “the fat guy” will always eat at BWLD and “football season”

Atherosclerosis
Good morning chaps, I as previously advertised have been employed at the aforementioned historical minimum wage once reserved for galley slaves, that is, consider yourself lucky not to be fed to the sharks.

The title should alert you to the fact that we will start this weekend briefly examining the previously floated investment theme from Mr Fly; “Be long the adipose challenged consumer”

We are of course going to briefly discuss why this could in point of fact be a stroke of genius [no pun intended] and why it might save an otherwise go-go stock, I refer of course to BWLD

First, obesity is a disease, that is hallmarked by addiction, depression, poor self worth and esteem that finds solace in eating, thus chemically inducing the pleasure areas of the brain. [Limbic hippocampal region]

Thus, any product that provides the desired pleasure, will in all likelihood gain great loyalty from the consumer base. A second and as important factor is the cult of cool. Is this product a product that invokes the correct responses from your [the consumer] peer group.

Having never heard of BWLD, never mind eaten them these are questions that I cannot answer. It is important for any individual investor to have, or gain a viewpoint, as this could prove quite vital to the ultimate success of the investment.

Moving swiftly on to the Industry.
The Industry is Restaurants
P/E………………………………19.6
P/B………………………………4.8
Net Profit margin……………8.0
ROE……………………………..20.2
Debt/Equity…………………..11.8
Dividend Yield………………..1.8%

Some of these metrics are relevant to BWLD and some are not. Be warned in advance BWLD is a growth or go-go stock, it has very aggressive accounting. The success or failure in the accounting will have a large impact within the final outcome in market price.

The Debt/Equity ratio within the industry is high. Compared to BWLD it is massively high. In 2003 BWLD retired a tranche of debt via an equity placing. Why did this occur?

The cost of capital in 2003 at the tailend of the recession was almost free money, the Fed discount rate was at circa 1.0% and corporate debt would have been around 3.0%, why in that environment deleverage and take expensive equity capital?

The answer is that the company holds an extraordinary level of cash, some $64.6million, while the working capital requirements are a fraction of that. We are talking say $5million in cash would just about squeeze by.

The reason is that there is an interest income that flows directly to the bottom line, boosting Net Profits. Further, the small amount of long term debt held by the company at $9.5million, the interest payments are capitalized. Not really for any other reason other than again boosting the bottom line. It is not illegal, but it is aggressive.

The industry pays a dividend, BWLD does not. Again, growth of Net Profits is key. They must continue to grow, and thus higher multiples will be awarded to the stock. Net Profits have grown, +40% annualised but this is a high hurdle to keep clearing

Depreciation is being accelerated for tax purposes, but not being disclosed in a forthright manner in the Income Statement, again aggressive.

A number of Operating costs are being capitalised, costs from Selling,General & Administration, again, aggressive, borderline legality issues with growth in Revenues [+24.5%] on an annulised basis far higher than SG&A [+17.1%]

The very high Capital Expenditures in relation to Depreciation charges will tend to overstate the cash generating ability of the business. [1.63]

Therefore we return to the necessity of loyal customers. In any economic downturn that might crimp Revenues, it is vital for a go-go stock to maintain earnings growth, without which the market might re-value the shares in short order.

Last point, the “Insiders” have been heavily selling stock, unloading circa $3million in stock, worth thinking about.

flip-flop-fly and the results;
Sector Spotlight: Machine Gunning
Wall Street can be a brutal place to make a living, especially during earnings season. To put it plainly, buying or selling stocks, ahead of earnings, is equal to river boat gambling. Furthermore, when one of your favorite companies misses estimates, not only does it hurt monetarily, it jars your very existence.

For me, this earnings season has been the worst of my career. I don’t think I’ve ever had two top ten holdings blow up like this, first NTRI, now BWLD. Thankfully, I had great success, early in the year, else I’d be in a deep hole.

The lesson to be learned: never go all in, or heavily overweight a stock, no matter how much you like it.

Sure, BWLD is a top ten holding, but comprises less than 7% of my holdings. Does that make me not want to punch the beards off of the bitches who are running BWLD into the ground? No.

However, I’ll survive this bombing and probably come out on top, eventually.

My plan is to buy here, for now. The stock is down way too much, on a small miss. Plus, the company is entering its best quarter, going into peak football season.

Nonetheless, I will not chase the stock lower. If it looks like support is weakening, I will wait for it to dip again, before adding.

In short, this is a machine gunning to the torso.

All in all, I’ll be fine, with nice gains and positions in HANS, MVIS, GME, RIMM, AAPL, VMI, iiG etc.

This hurts, but life goes on.

As for today’s trading:

With the Fed meeting on deck, I suspect the market will flat line, until “The Great Bearded One” makes his decision.

For now, I’ll make a few offerings to the stock God’s, while punching my fucking monitor– with the set of brass knuckles I have on my hands right now.

# posted by Broker A @ 9:41 AM 25 comments links to this post

Fly Buy: BWLD
I bought 10,000 BWLD @ $30.

Disclaimer: Don’t bother. This is a car accident with a bag of grenades in the trunk.

Tuesday, October 30, 2007

The Important Matter of Buffalo Wild Wings
So, “The Fly” was having a pre-earnings celebration, prior to the market close–waiting for BWLD to post spectacular numbers.

I was in the office, graciously handing out low end hamburgers, deli meatballs and good champagne, until I saw the BWLD miss.

Franticly, I started taking back the burgers, making the assholes in my office spit out the meatballs, while knocking over their champagne glasses. Needless to say, the party was over. Back to work.

I couldn’t believe my eyes; the fat bitches who run BWLD had done lost their chicken head minds, via not beating eps estimates.

Now, as you already know, “The Fly” came back to the internets and declared tomfoolery. I sugar coated the reaction and made believe the STOCK WASN’T DOWN 5 FUCKING BUCKS.

Believe me when I say, I am fully aware that the stock “de-banked” me.

In other words, the homosexual commenter, named “Knob Polisher,” is right! I’m just throwing money away, owning this dog bone of a stock. Not only did I lose buckets of money; I bought 3,000 shares at the bell.

Ha! Who’s better than me?

Here’s the kicker:

Those disgusting, filthy, slobs, who run BWLD, let the company miss. That’s right, it’s entirely managements fault. They showered themselves with stock grants, while watching the drunken idiots, who eat at their filthy restaurants, eat cheap wings. This is America, ain’t shit cheap, with the exception of heavy lead laden toys–made in China.

Fuck that.

If “The Fly” were CEO of BWLD, he’d jack prices continuously, especially on over inebriated patrons.

I mean, why should I, as CEO of BWLD, have to absorb the high cost of freakishly big chicken wings? Again, fuck that; I’m passing that cost, and much more, along to you (the drunken, football fool).

In short, the BWLD quarter was devastatingly bad. Atrocious. I’d spit on the CEO, if given the chance and proper escape route.

What “The Fly” needs to do is get done with his 2005-2007 plays, and prepare, via hard nosed research, for 2008-2010.

Fly Buy: BWLD
I bought 3,000 BWLD @ $38.95.

Disclaimer: If you buy BWLD because of this post, filthy restaurants will spring up all over your neighborhood. And, you may lose money.

Today is the day, ladies.

After the close, we find out if those fat fucks from Ohio were redoubling their chicken wing eating efforts or not, at BWLD. The current eps estimate is .26; I’m hoping for .31.

Either way, I’m a buyer of the stock, going into peak football season. Remember, BWLD makes more money off alcohol consumption, than wings.

Hey, guess what?

Bernanke is going to skin the shorts alive today. And, iiG is up, again. Anyone surprised?

Which reminds me, “The Fly” bet ‘both of his eyes,’ that VMI would print $100, this week.

Finally, seeing the low end restaurant chain TXRH post good numbers gives “The Fly” confidence that BWLD will do the same. Also, I’d like to beat the devil out of the fuckers who keep selling LFT.

Off to my local Panera Bread.

Going forward, I have unbreakable confidence in BWLD. Aside from queer corn prices, BWLD should be clicking on all cylinders, going into peak football season. Should the stock dip, post earnings, I’ll be cracking open the family safe, in order to get a piece of the burgeoning chicken wing business.

Finally, “Don Dollar Danks,” CEO of iiG, is settling lawsuits I never knew existed. Funny, yet profitable shit. In my opinion, Danks is the best CEO in America. However, it’s also worth noting, if he were a guest in my house, I wouldn’t leave him alone for a second–for fear he would steal the silverware or a few DVD’s.

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Name..Date………..Price……….#shares…………Cash……Current Price…..%Return
FXY..8/8/07…….$84.78…………83…………$2963.26……..$109.72……+29%
NHI..3/3/08……..$29.95……….170………..$4908.50…….$27.15…….-9%
PIV..3/4/08……..$14.81……….586………..$1318.50…….$10.01…….-32%
BWP.15/4/08…….$24.03……….290………..$3031.30…….$18.00……-25%
PCF…21/4/08……..$7.76………..2100………$3704.00……..$5.18……-33%
CST.28/4/08……..$2.35………..2100……….$5065.00…….$1.75…….-25%
FNM.8/9/08……..$0.01………..820………..…$3089.8……..$0.72…….+19%
COP.7/11/08….$51.03……….50……………$3448………….$51.78……..+1%
MOO..18/11/08…$25.03…..100………..$2497……..$27.87………….+11.3%
BRK.b.19/11/08….$2684……….1……..$3316.0…….$3013……………+12%
UNG…06/08/09…$13.35…..374……$5000.0……$13.35………….0.00

Capital……………………………………………………………………….……-5.17%
Dividends…………………………………………………………………………+3.42%

Total……………………………………………………………………………….-1.75%

Comments
Dividends have gone a long way to mitigating the “total return” or current loss of the portfolio. Maintaining a cash position, and buying only gradually partial positions has also mitigated the losses on total positions.

Being a longer term strategy, time will tell whether “ultimately” this strategy turns into a winning proposition.

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From “The Economist”

TWENTY years ago The Economist wrote about eight young economists who were making a big splash in their discipline and beyond. One of them, Paul Krugman, recently won the Nobel prize for his models of international trade and economic geography. Ten years later we tried to repeat the trick, identifying another eight young stars, many of whom were taking their discipline far off-piste. One has since achieved even greater fame than anticipated. Steven Levitt of the University of Chicago became a household name as co-author of “Freakonomics”, a bestselling book published in 2005.

“Freakonomics” owed its origins to a profile of Mr Levitt in the New York Times magazine in 2003. Its success has won a new readership for economists, beyond the business section and the opinion columns, in the glossier pages of the weekend supplements. The best young economists, as a consequence, have already attracted plenty of attention. That leaves us in a bit of a quandary. We feel like lonely prospectors, who, returning to a favourite stream, find it overtaken by a gold rush.

Undeterred, we have given the prospecting pan another shake. We asked leading authorities in the discipline to name the best young economists in the world. Between them, they proposed over 50 researchers, but several names recurred on many lists. We have sifted the 50 down to eight, all of whom received their PhDs in the past ten years.

The family tree
Several of the scholars in this year’s batch trace their intellectual ancestry back to those we picked ten years ago. For example, Jesse Shapiro of the University of Chicago and Roland Fryer of Harvard are recognisably the intellectual heirs of Mr Levitt. They share the same knack for finding ingenious ways to answer unlikely questions, often by plundering forgotten troves of data.

At just 29, Mr Shapiro can already boast a collection of eye-catching findings worthy of a sequel to “Freakonomics”. He has shown that some judgments are best made without too much information: people are better at predicting the winner of American gubernatorial elections when they watch the candidates with the sound turned off. Harsher jail conditions do nothing to deter prisoners from reoffending. If anything they encourage recidivism. Preschoolers who watch television do better academically than children who don’t, especially if their parents have little education or poor English.

Mr Fryer’s ambition is to unravel the causes of black underachievement in America, especially in education. His search for explanations extends beyond racism and poverty to contemplate the role of a self-defeating culture. He calculates that a black student who earns straight A grades will have 1.5 fewer friends from his ethnic group than an equally swotty white student.

Michael Kremer, another of those we cited ten years ago, can also claim an intellectual relative in this year’s cohort. Esther Duflo of the Massachusetts Institute of Technology (MIT) received more recommendations than any other economist. Some who didn’t nominate her thought she was too established to count as “new”.

With her colleague, Abhijit Banerjee, Ms Duflo and Mr Kremer have remade development economics, nudging it away from its concern with policies, towards a preoccupation with projects. They study economic development as seen from the field, clinic or school, rather than the finance ministry. They might be called the “peace corps” of economists, bringing the blessing of their investigative technique to the neglected villages of India or the denuded farms of western Kenya.

Ms Duflo has made her name carrying out randomised trials of development projects, such as fertiliser subsidies and school recruitment. In these trials, people are randomly assigned to a “treatment” group, which benefits from the project, and a “control” group, which does not. By comparing the average outcome of each group, she can establish whether the project worked and precisely how well.

In one study, Ms Duflo and her colleagues showed that mothers in the Indian state of Rajasthan are three times as likely to have their children vaccinated if they are rewarded with a kilogram of daal (lentils) at the immunisation camp. The result is useful to aid workers, but puzzling to economists: why should such a modest incentive (worth less than 50 cents) make such a big difference? Immunisation can save a child’s life; a bag of lentils should not sway the mother’s decision either way.

Randomised trials “give you the chance to be surprised”, Ms Duflo says. Had they arrived at this result using some other method, she and her colleagues would have assumed they had made a mistake. But randomisation removes such doubts, showing that it was indeed the lentils that made the difference. The result cannot be dismissed; it must be explained.

The approach has its critics. A randomised trial can prove that a remedy works, without necessarily showing why. It may not do much to illuminate the mechanism between the lever the experimenters pull and the results they measure. This makes it harder to predict how other people would respond to the remedy or how the same people would respond to an alternative. And even if the trial works on average, that does not mean it will work for any particular individual.

The randomistas, as Ms Duflo and her comrades are called, liken their studies to the clinical trials that prove the efficacy of new drugs. But the ultimate ambition of economics is for something more akin to anatomy. Researchers hope to dissect the underlying physiology of an economic problem, revealing how the leg bone is connected to the thigh bone. With a full anatomy of behaviour—what economists call a structural model—they can determine if a policy or project will work even before it has been attempted.

The early anatomists of the human body suffered from a shortage of fresh cadavers to work on. Medical students would trek long distances to watch a dissection performed. Economists often find themselves in a similar predicament. Short of good empirical meat, they have to rely on elaborate theory and guesswork to fill in what they cannot observe.

Amy Finkelstein, also of MIT, the fourth of our young stars, has anatomised the market for annuities in Britain. The industry suffers from “asymmetric information”: customers may know more than the provider about their chances of dying. Unfortunately, this private information is as hidden from economists as it is from the annuity company. Ms Finkelstein and a colleague, James Poterba, have shown how to infer the cost of this unseen problem from what can be observed, namely the kind of annuities people choose and the length of their life after retirement.

Like Ms Finkelstein, Raj Chetty, recently hired by Harvard from the University of California, Berkeley, is a promising young “public economist”: a student of tax and spend. He has great respect for structural models. But in a recent paper he makes the case for judicious short cuts. Often you don’t need to dissect a whole body; a few choice incisions are enough.

For example, he wanted to know whether policymakers should raise unemployment benefits. To answer this question, a structural model would need to specify how much a dollar is worth to a person on the dole, as compared with someone in work. It would also need to quantify the burden a job hunt imposes. This isn’t easy to find out. But Mr Chetty argues it is unnecessary.

He gleans all the information he needs by looking at the time it takes unemployed people to find a new job. Unsurprisingly, they take longer when their benefits are more generous. This is usually attributed to “moral hazard”—people take less care to escape a danger, such as joblessness, if they are insured against it. But Mr Chetty shows that skewed incentives account for only 40% of the delay.

The rest is due to what he calls a “liquidity effect”. The unemployed typically have few liquid assets to fall back on and little chance of a loan from the bank. This forces them to rush their job search. If they had savings to dip into or credit to tap, they might search with greater deliberation. This kind of dallying is, in a sense, optimal. The unemployed decide that an unhurried job search is worth the extra cost of depleted savings or heavier loan repayments.

Higher benefits ease this liquidity problem. Raising benefits by $1 a week would do as much social good as raising American GDP by $290m, Mr Chetty calculates, although government loans to the unemployed might do better still.

Twenty years ago macroeconomists dominated our list of the best young thinkers, but they are under-represented in this year’s batch. We found plenty of agreement about the three or four young macro thinkers most likely to succeed, but surprisingly little confidence that they would. One leader in the field suspected their work represented a moment of beauty, not truth. Another complained that the youngsters lacked the “vision thing” that distinguished the greats of the past.

Ramsey revisited
If so, perhaps they can blame the times that produced them. They came of age during the Great Moderation, a period of macroeconomic tranquillity and intellectual consensus. They are in thrall not to John Maynard Keynes, sage of the Depression, but to his Cambridge contemporary, Frank Ramsey, a precocious polymath who made his contributions in the prelapsarian 1920s. Ramsey was interested in how much of its income a nation should save so as to maximise its prosperity now and in the future. His work underpins much of modern macroeconomics, in which agents act today with an eye on tomorrow. But the framework is best suited to analysing steady accumulation, not violent cycles of speculation and liquidation. So it is not the obvious place to start to explain the world economy’s present predicament.

The macroeconomist nominated most often for our list was Iván Werning of MIT. Mr Werning is an economist’s economist; an elegant theorist, whose early contributions provided streamlined proofs that other thinkers could make use of. One of Mr Werning’s ambitions is to unite Ramsey’s work with that of another elegant theorist, Sir James Mirrlees. Sir James won the Nobel prize in 1996 for exploring how best to set taxes when people can disguise their true worth from the revenue collector. Mr Werning asks the same question, but in the forward-looking, macroeconomic setting provided by Ramsey.

Mr Werning and his co-authors have so far derived at least two theoretical results of note. The first is to show that the unemployed have sufficient incentive to find work, even if they receive unemployment benefits indefinitely. The second is that bequests from one generation to the next should be subsidised by the government, with smaller inheritances receiving higher rates of subsidy. Mr Werning and his co-author, Emmanuel Farhi (a young Harvard macroeconomist), point out that the biggest roll of the dice in life is the family you are born into. Their system of subsidies would take the edge off this uncertainty.

Two of the economists we highlighted ten years ago—David Laibson of Harvard and Matthew Rabin of Berkeley—were exponents of “behavioural economics”, incorporating the insights of psychology into the dismal science. The sub-discipline has continued to flourish in the decade since, seeping so far into the mainstream that its disciples no longer constitute a self-contained school. The randomistas, for example, often invoke behavioural explanations for their experimental results.

Xavier Gabaix of New York University, our seventh pick, is another example of someone who is au fait with behavioural economics but not defined by it. He has written papers with Mr Laibson, including one that explains why hotels can get away with overpricing the mini-bar. But his interests extend beyond the behavioural.

He has, for example, shown a fascination with “power laws”: tantalising statistical patterns that seem to crop up wherever you look hard enough. The size of cities, the pay of executives and the performance of the stockmarket all seem to follow such laws. For cities, the law can be crudely expressed as the “rank-size rule”. The second-biggest city will have roughly half the population of the biggest; the population of the third-ranked city will be one-third of the first’s, and so on. The relationship between executive pay and company size also obeys a power law: companies twice the size tend to pay their chief executives roughly 25% more.

These curious regularities have more than numerological appeal. They give clues about what can and cannot explain the size and growth of the things they describe. For example, the rank-size rule could not hold if small cities grew systematically faster than big ones, or vice versa. The power law of executive pay also requires a particular kind of economics to explain it. Mr Gabaix thinks the “economics of superstars”, invented by Sherwin Rosen, fits the bill.

Top executives may differ only slightly in their talents, just as sports champions differ only slightly from runners-up. But the better managers nonetheless get hired by the bigger firms, just as the best entertainers sing to the largest audience. This means an executive’s small edge in managerial skill is amplified, because his talents go to work on a bigger canvas. Mr Gabaix made a splash in 2006 when he concluded that the “excessive” pay of chief executives was not necessarily excessive. Compensation may have grown sixfold from 1980 to 2003 not because managers were six times greedier, but because the firms they ran were six times bigger.

If the size of firms obeys a power law, economies will comprise some very big firms and a long tail of small ones. The fortunes of the biggest companies might then stir the whole economy, Mr Gabaix conjectures. The $24 billion dividend paid by Microsoft in December 2004, for example, added 3% to America’s personal income that month. Mr Gabaix calls for a more “granular” approach to macroeconomics, which would weigh the contribution of big firms to national aggregates.

This granular view is already taking hold in studies of international trade. Countries, after all, do not trade with each other; companies do. A few firms usually account for the lion’s share of a country’s exports: in America, the top 10% of exporters account for 96% of the country’s foreign sales, and only 4% of firms export at all.

These observations (drawn from work by Andrew Bernard of Dartmouth College among others) demand a theory to explain them. That gap has been filled by Marc Melitz, a trade economist at Princeton University and our final new star.

Mr Melitz is a pioneer of the “new, new trade theory”, which succeeds the “new” trade theory propounded by Mr Krugman almost 30 years ago. The source of its novelty is its recognition that firms differ, and only the best firms export. In America, for example, exporting factories are more than twice as big as plants that do not sell beyond their shores, and they squeeze 14% more out of their workers.

In Mr Melitz’s theory firms first prove themselves at home, discovering their own limits and abilities. Only the best then venture overseas. Entering a foreign market is an expensive endeavour, he points out, even before firms encounter the tariffs or transport costs that preoccupy most trade models. An exporter must find and introduce itself to distant customers, comply with alien regulations and set up distribution channels abroad. One study found that it cost Colombian chemical factories over $1m to enter a foreign market.

The gains from trade also differ in Mr Melitz’s model. In the new trade theory that preceded it, international commerce raises the productivity of firms by enlarging their market, allowing them to reap economies of scale. In Mr Melitz’s model, trade raises the productivity of industries, not by allowing firms to grow bigger, but by giving the better firms a bigger share of the market. Foreign competition sifts and sorts firms, winnowing out the weakest firms and leaving a greater share of the market to their stronger rivals.

Just as Mr Krugman found a clean way to account for economies of scale, Mr Melitz handles the heterogeneity of firms without spoiling the lines of his model. It now serves as a pliant workhorse for lots of “granular” thinking in the field.

Bodice rippers
Over 60 years ago Paul Samuelson laid down “the foundations of economic analysis” in his seminal work of that name. In the introduction, he describes his dawning realisation of the underlying unity of the subject. As he laboured in each field—consumer behaviour, public finance, international trade, business cycles—he encountered similar problems, which yielded to the same set of mathematical techniques. Mr Samuelson’s book squeezed a shapeless body of economic knowledge into a tight corset.

In the decades since, the laces have been unpicked. It is not just that economists are nosing into new fields of social behaviour. They have been doing that at least since Gary Becker of the University of Chicago wrote about crime and the family in the 1960s and 1970s. But today’s economists show no great attachment to the rational model of behaviour that guided Mr Becker. Economic theory has become so eclectic that ingenious researchers can usually cook up a plausible model to explain whatever empirical results they find interesting. Economics is now defined neither by its subject matter nor by its method.

What, then, unites these eight young stars and the discipline they may come to dominate? Economists still share a taste for the Greek alphabet: they like to provide formal, algebraic accounts of the behaviour they explain. And they pride themselves on the sophistication of their investigative methods. They are usually better at teasing confessions out of data than their rivals in other social sciences. What defines economics? Economics is what economists do—the best of them, anyway.

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Sometime in 2007, at the very tailend of the credit expansion, or the worst possible moment, banks entered the “Constant Debt Proportional Obligation” [CPDO] derivative market. This “Structured Bond” pays variable interest at 200+ basis points over LIBOR.

*Bank sets up a Special Purpose Vehicle [SPV] off Balance Sheet
*The SPV sells the Bonds [CPDO]
*The cash proceeds are invested cash equivalents
*The bank enters the derivative markets to “Sell” CDS

The proceeds from CDS sales + interest from cash equivalents go to pay the CPDO holders their interest. Thus to pay the holders of the CPDO’s that they sold, due to the increasing fluctuations within the LIBOR rate, banks found it necessary to “Sell” rather alot of CDS in order to meet interest obligations.

At maximum leverage, CDS exposure could reach slightly in excess of 15X. Thus the sale of $1 Billion in CPDO obligations would trigger the sale of $15+ Billion of CDS contracts. The banks models indicated mathematically, based on historical data the worst case scenario would result in a 10% loss.

Well, the rest of course is history, the LIBOR market went to hell, the banks and their Balance Sheets went to hell, the markets went to hell and the economy looks well on it’s way to hell.

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