Bohring into the Future?

“Prediction is very difficult, especially if it’s about the future.” – Niels Bohr

The quote by the Nobel Laureate went through my mind as I read about the various economic forecasts by Fed governors and Regional Bank Presidents over the years. A couple Wall Street Journal reporters tabulated 700 predictions between 2009 and 2012, scoring them on how accurate they’ve been.

The officials most cautious on the economic outlook were the most accurate. But what’s interesting isn’t so much who was right, but what people do when their predictions are proven wrong. Some, like James Bullard, question their economic models. But it takes real integrity to question your very premises—like Minneapolis Fed President Kocherlakota, who said, “You have to learn from the data.” It’s more typical that people question the data, or the timing, or whether an accurate forecast was even possible–anything but their foundational assumptions.

Economic forecasts are important because they imply policies and investments that can help us all meet our goals. The future isn’t a random walk. If we want to do better, we need to learn from our mistakes.

Douglas R. Tengdin, CFA

Chief Investment Officer

Summers’ Day?

Why are folks so worked up over Ben Bernanke’s successor?

We’ve seen extensive stories in every major news publication over the past week. First, Yellen is a shoe-in. Then she’s favored due to her gender. No, it’s the other way. Then Summers is the front-runner. Then he isn’t. It’s enough to make you cry “Volker!”

The Federal Reserve Board Chair is a very powerful person. Monetary policy matters. Getting it wrong arguably led to the Great Depression in the ‘30s and the Great Inflation of the ‘70s. Managing the transition from super-low to normal interest rates is really, really important.

It’s not about the issues. Summers’ stances on the stimulus, deregulation, and Dodd-Frank aren’t out of the mainstream. But he has a reputation as an imperious egoist, the smartest person in the room who’s not interested in debate. Even his supporters admit this.

The Fed is a collegial, consensual body charged with multiple, conflicting goals. Alan Greenspan extinguished dissent over three decades and it didn’t end well. Bernanke’s successor needs to work well with others.

Douglas R. Tengdin, CFA

Chief Investment Officer

Cash over a Barrel

Why do we have payday lenders?

Payday lenders provide short-term, unsecured loans, sometimes linked to a paycheck, sometimes not. The amounts are usually fairly small–$100 to $300—although they can go higher. The service is popular: over 10 million people used payday loans last year.

The fees, though nominally small, can add up. For a $100 two-week advance, a payday lender might charge $15 up front. A borrower that does this 26 times over the course of a year will pay $390—almost four times the amount of the loan!

For this reason, payday lenders come in for a lot of criticism: they extract money from low-income communities, they lend to less-educated people, their ads emphasize convenience over cost, etc. But that’s where payday lenders compete—on convenience. If someone is short of cash and is facing a missed car payment or a bounced check, those costs are a lot higher. And a 20% APR for a $100 two-week loan would only allow a payday lender to charge 75 cents–less than processing costs, much less potential losses.

Payday loans exist because people need cash—and those needs don’t show up on schedule at convenient hours. “Price” isn’t the only way to compete.

Douglas R. Tengdin, CFA

Chief Investment Officer


Is the hedge fund industry doomed?

The indictment of SAC Capital and administrative action against its founder, Steven Cohen sure could make you think that. Cohen’s company is accused of systematically using inside information to defraud the markets, and Cohen is charged with failing to supervise them. If the charges are proven, SAC is out of business, most of Cohen’s wealth is confiscated, and he will never manage money again.

But Cohen’s firm was unique. It isn’t really an investment firm, it’s a trading firm. It employs some 400 traders who make thousands of short-term bets, both long and short, on how large, liquid stocks will do. For the privilege of putting money with SAC, investors pay 3% of their assets and 50% of their profits. Cohen himself invests money with his most profitable traders.

The structure of Cohen’s firm encouraged traders to set up expert networks of well-connected individuals who could tip them off to pending news. It rewarded them for getting as close to the line as possible without crossing it. Most hedge funds don’t do this. They arbitrage announced mergers, or convertible bonds, or speculate on corporate turnarounds (or not), or go long one company and go short a competitor. Some strategies have worked, while others have failed.

Hedge funds exist because hope of massive outperformance springs eternal, and some funds have been massively successful. (Although their massive fees make such outperformance unlikely.) As long as that hope remains, the industry will as well.

Douglas R. Tengdin, CFA

Chief Investment Officer


Can Detroit turn around?

Amid all the hoopla and controversy over whether the city inflated its pension obligations as a negotiating tactic and who actually has jurisdiction over their bankruptcy filing, the substantive question remains: what can they do to revive the city?

At the heart of Detroit’s problem is its population decline. The number of residents peaked in 1950 at 1.8 million. In the 2010 census, it was 700 thousand. And where did they go? For the most part, they moved to the suburbs. In 1950 there were 3 million residents of the larger metropolitan region, which now has 4.3 million—and has been fairly stable for 40 years.

Lack of jobs, crime, and corruption are cited as reasons why the city is hollowing out. But just as success can sow the seeds of future failure, present failure can create the conditions for future achievement. Low real estate prices in the city are attracting urban homesteaders. Leadership changes and increased financial scrutiny reduce the potential for corruption. And a leadership may finally give police and firefighters the resources they need.

But it starts with finances. Getting through bankruptcy and rationalizing their debts is critical to creating a strong city. And a growing, competitive Detroit would be good for everyone.

Douglas R. Tengdin, CFA

Chief Investment Officer

Rights and Responsibilities

Are public pensions a contract or a right?

That’s what we’re soon going to find out. Detroit’s bankruptcy filing puts the city’s retirement obligations front-and-center. Among the $20 billion in debt cited in their petition was $9 billion in retiree obligations–$3 billion in pensions and $6 billion in health care coverage.

Leave aside for the moment how these numbers were calculated; they were likely inflated to make the bankruptcy filing more tenable. What can be done with these liabilities?

In most states and with private companies, pensions are contractual obligations that can be adjusted in bankruptcy. But other states—including Michigan–cite public pensions in their constitutions, and the 10th Amendment of the Federal Constitution constrains Federal priority over the States. So are they more like personal savings accounts?

All this will be adjudicated over the next several years. It will be messy and vicious. But it’s necessary if Motown is ever to get its mojo back.

Douglas R. Tengdin, CFA

Chief Investment Officer

Euro / Dollars

Why is the Euro so strong?

A couple years ago there were widespread expectations of a Euro-zone breakup. Greece was facing ejection, and when small nations like Estonia joined the Euro, the biggest question was, “Why?” Many observers expected the Euro exchange rate to go to parity with the Dollar, or lower.

But that never happened. In spite of Europe’s entering a second recession a year ago or so, the currency has been remarkably stable. At its weakest, it was about $1.20. Now it’s $1.32, and has been near that level most of the year.

Some credit the ECB’s bank support—providing long-term financing for banks throughout the system. Others look to the Euro-zone’s current-account surplus, a fruit of the zone’s fiscal austerity. But it seems to me that the answer is much simpler: interest rates. Rates in the US are near zero, overnight rates in Europe are 0.50%. Investors can earn more, risk-free, sitting in Euros. It costs them money to bet against the currency.

So the Euro has been stable, in spite of all the negative expectations. While the common currency may have issues, reports of its death were greatly exaggerated.

Douglas R. Tengdin, CFA

Chief Investment Officer

Ben Bernanke, Jedi Knight

Do or do not. There is no try.

That’s what I thought as I listened to Ben Bernanke discuss reducing the Fed’s asset purchases, then “clarify” his remarks, then testify before Congress that the Fed will remain accommodative. Prior to the Fed’s competing mandates—stable inflation, full employment, financial stability—comes one operational priority: clear communication. In the face of Fed uncertainty, investors have been known to panic.

But Bernanke’s mind trick seems to have worked. After falling 10%, the US equity market has rallied to new highs. After rising ¾ of a percent, 10-year bond yields have stabilized at 2 ½ percent. The markets seem to understand that while higher rates are inevitable, they aren’t imminent. The Chairman may not have levitated the markets, but he’s at least kept them from going over to the dark side.

Still, it’s going to continue to be a monumental task: weaning the economy off the gobs of easy money it has become accustomed to. The Fed now has a $3.5 trillion balance sheet—four times its size prior to the Financial Crisis. Those reserves represent a significant risk.

Because the Fed itself is significant: the cost of money surrounds and penetrates everything; it binds the markets together. It’s what gives the Fed its power. If Ben’s getting too old for this sort of thing, his successor needs to be a true Master as well.

Douglas R. Tengdin, CFA

Chief Investment Officer

Motown Going Down?

Detroit just filed for bankruptcy. Who knew?

When I’m looking into a new credit, the first place I look in the financial statements is the auditor’s opinion. Auditing is an under-appreciated art. You have to be detective and diplomat. It can be incredibly tedious until it’s not. And sometimes the audit reveals some real gems.

Like the school district in Maine that couldn’t find $230 thousand in cash. Or the New Jersey law that requires their cities and towns to report their finances contrary to generally accepted principles. And then there’s Detroit.

Their audit was audacious: 72 operational comments; 23 repeat comments, including a physical asset control system that didn’t record when something was sold. So any sale—a car, a computer—was double-counted in the books: as cash, and as an asset. The auditors found at least $3 million in double-counting.

So, yes, Detroit has economic problems and pension problems and crime problems and other issues. But at the end of the day, if you don’t have clean financials—if you don’t know where your money is—you may not have enough to pay your bills.

Douglas R. Tengdin, CFA

Chief Investment Officer

Organization, Smorganization?

Organization matters.

That was my thought when I read about investor Eddie Lambert and Sears. In 2002 Kmart went through bankruptcy. In 2003 Lambert recapitalized the firm and took it over. In 2005 they bought Sears and began to consolidate the two retailers.

Some org charts look like hierarchies, some like bicycle wheels. Sears’ now looks like China’s Warring States Period: 40 autonomous businesses competing for attention and marketing. The theory is that competition brings out the best in us, and that markets in everything allow important information to emerge and drive better decisions.

The practical effect is that this works, sometimes. I personally experienced the culture shock of moving from a clubby New England banking culture to a scrappy no-holds-barred New York model back in 1989. Sometimes the struggle to survive makes everyone more productive, but sometimes it’s like a feeding frenzy among sharks: only the biggest and meanest—not the talented, innovative, or efficient—survive.

Firms exist when people work better together than apart. If Sear’s people can’t cooperate, there’s no reason not to break it up.

Douglas R. Tengdin, CFA

Chief Investment Officer