Ali’s blog

Mostly quant stuff with occasional digressions

Archive for January, 2008

Reviews of quant books

Posted by alifinmath on January 31, 2008

As the mood strikes me, I’ll be writing reviews for quant books at this blog; this one’s becoming too cluttered with all sorts of extraneous posts. Expect less activity on that blog as writing reviews is more exacting than what I do here.


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Corporate America braced for recession

Posted by alifinmath on January 30, 2008

In the FT today:


Leading US companies are shifting into recession mode and preparing to cut costs, freeze hiring and reduce capital spending as they brace for an economic slowdown, senior executives and industry experts said.

Business leaders say rising oil prices, sagging consumer confidence and the on-going credit crunch are prompting them to put in place contingency plans to protect against the expected economic downturn.


And from Robert Reich (Secretary of Labor in the Clinton administration), also in the FT:


America’s middle classes are no longer coping

Ben Bernanke and the Federal Reserve have reduced interest rates another three-quarters of a point. But none of these fixes will help much because they do not deal with the underlying anxieties now gripping American voters. The problem lies deeper than the current slowdown and transcends the business cycle.

The fact is, middle-class families have exhausted the coping mechanisms they have used for more than three decades to get by on median wages that are barely higher than they were in 1970, adjusted for inflation. Male wages today are in fact lower than they were then: the income of a young man in his 30s is now 12 per cent below that of a man his age three decades ago. Yet for years now, America’s middle class has lived beyond its pay cheque. Middle-class lifestyles have flourished even though median wages have barely budged. That is ending and Americans are beginning to feel the consequences.

The first coping mechanism was moving more women into paid work. The percentage of American working mothers with school-age children has almost doubled since 1970 – from 38 per cent to close to 70 per cent. Some parents are now even doing 24-hour shifts, one on child duty while the other works. These families are known as Dins: double income, no sex.

But we reached the limit to how many mothers could maintain paying jobs. What to do? We turned to a second coping mechanism. When families could not paddle any harder, they started paddling longer. The typical American now works two weeks more each year than 30 years ago. Compared with any other advanced nation we are veritable workaholics, putting in 350 more hours a year than the average European, more even than the notoriously industrious Japanese.

But there is also a limit to how long we can work. As the tide of economic necessity continued to rise, we turned to the third coping mechanism. We began to borrow, big time. With housing prices rising briskly through the 1990s and even faster between 2002 and 2006, we turned our homes into piggy banks through home equity loans. Americans got nearly $250bn worth of home equity every quarter in second mortgages and refinancings. That is nearly 10 per cent of disposable income. With credit cards raining down like manna, we bought plasma tele­vision sets, new appliances, vacations.

With dollars artificially high because foreigners continued to hold them even as the nation sank deeper into debt, we summoned inexpensive goods and services from the rest of the world.

But this final coping mechanism can no longer keep us going, either. The era of easy money is over. With the bursting of the housing bubble, home equity is drying up. As Moody’s reported recently, defaults on home equity loans have surged to the highest level this decade. Car and credit card debt is next. Personal bankruptcies rose 48 per cent in first half of 2007, probably even more in the second half, which means a wave of defaults on consumer loans. Meanwhile, as foreigners begin shifting out of dollars, we will no longer have access to cheap foreign goods and services.

In short, the anxiety gripping the middle class is not simply a product of the current economic slowdown. The underlying problem began around 1970. Any presidential candidate seeking to address it will have to think bigger than bailing out lenders and borrowers, or stimulating the economy with tax cuts and spending increases.

Most Americans are still not prospering in the high-technology, global economy that emerged three decades ago. Almost all the benefits of economic growth since then have gone to a small number of people at the very top.


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More on Bush’s fiscal stimulus

Posted by alifinmath on January 29, 2008

An FT column by Clive Crook:


The president’s haste to design a fiscal-stimulus plan in co-operation with Congressional Democrats was almost as disconcerting. The deal, still tentative until the Senate has had its say, underscores the pessimism. In its own right (even assuming that it moves briskly and intact back to the president for his signature) the proposal is a puny initiative. Its mere existence, though, is a weighty political fact.

The plan’s fiscal punch will be weaker than it should have been. The fastest-acting parts of the Democrats’ proposal – more spending on food stamps and unemployment benefits – were removed at the White House’s insistence. Some $50bn (€34bn, £25.2bn) out of the plan’s net outlay of $150bn is tax relief for business, which is slow to disburse and will do little to support demand even in the medium term. The administration did compromise on tax “rebates”, agreeing that cheques for $300 should go to people with incomes so low that they pay little or no tax, not just to middle-income households. That is fine, because the poor will spend more of what they get and the only good reason for this exercise is to spur demand. But money delivered through the tax system will not get to taxpayers until June at the earliest.


On a sidenote, what does it say about a country which elects and re-elects to its highest office a man whose natural station in life would be as a building janitor? A man who, in a time of economic crisis, takes measures that will hardly mitigate the impending storm? A man who, in this time of national need, still serves vested interests with unswerving dedication? A man who doesn’t feel the least bit of remorse or responsibility at the mess he’s helped create? A country gets what it deserves. 

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The worst and the best US presidents

Posted by alifinmath on January 29, 2008

A Norwegian professor’s judgement in a Norwegian newspaper:


Two members of the Republican party landed as both the worst and the best presidents. Bush, in Moen’s opinion, is the worst.

“His administration stands for a dangerous blend of arrogance and ignorance,” Moen told A-magasinet, claiming that Bush has lacked an ability to listen to and cooperate with other heads of state, and with the US Congress.

Moen cited the invasion of Iraq, the resulting chaos that has erupted in the country and the intelligence reports that Bush’s basis for the invasion (alleged weapons of mass destruction) didn’t exist. Bush also defied international opinion on a host of other issues, from the Kyoto agreement to rules for an international court, and his tax measures have widened the gap between rich and poor.

A federal budget surplus inherited from the Clinton administration has turned into a huge deficit and now the US is widely believed to be heading into a recession. Bush’s approval ratings are currently at a low point in the US, but Bush himself has indicated that he doesn’t care about his legacy.


Quite right. Bush doesn’t give a tinker’s cuss about his legacy. This is a man who could order the detonation of a nuclear device among a civilian population and not feel  even a twinge of compunction or responsibility. It would be interesting to know whether he’s taken a single policy decision on his own or whether he’s been following instructions at each and every step. Still, as I always maintain, a country gets the “leaders” and government it deserves.

I understand there’s an ongoing debate among presidential scholars on whether Bush is the worst the US has ever had. I suppose a consensus will be reached once he slinks back to Texas. But one must bear in mind that he was re-elected: it speaks volumes about the USA today.


Moen’s choice for the “next-worst” US president is James Buchanan, a Democrat, whose term ran from 1857-1861 and who is often called the father of the American Civil War. Buchanan is followed by Warren G Harding, a Republican who was president in the early 1920s and whose isolationist policies destabilized the world economy and helped fuel Germany’s desire for military revenge.

Moen chose Calvin Coolidge, president from 1923-27) who continued an isolationist strategy, as the fourth-worst president, and Andrew Johnson (1865-1869) as the fifth worst, because he allowed defeated southern states into the union without insisting that they reform themselves.

The Norwegian professor’s favorite president is Abraham Lincoln, also a Republican, who insisted on a government “of the people, by the people and for the people,” and who rose from a poor background to save a nation that had descended into civil war.

Franklin D Roosevelt is Moen’s choice as second-best president, for bringing the US out of the Depression, launching social reforms and leading the nation to victory in World War II. George Washington, the country’s first president, was ranked third-best, Thomas Jefferson fourth and Woodrow Wilson fifth.


I’m not so sure about this list of best presidents. I can’t stand the sanctimonious Wilson. And one of my favorites — Richard Nixon — isn’t on the list at all (I’m not joking). Nixon was arguably the most intellectual president of the 20th century — a man who slept with Spengler’s Decline of the West under his pillow. The president who increased arts and science funding, who created the Environmental Protection Agency, and who established diplomatic relations with Communist China.

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Estimating exposures in credit derivatives

Posted by alifinmath on January 29, 2008

Some points Chris Prouty was making yesterday being echoed by Robert Pickel (chief executive of the International Swaps and Derivatives Association) in a piece in the FT:


In recent weeks, otherwise sophisticated commentators have made some basic yet potentially damaging errors about the amount of risk exposure held via credit derivatives. These assumptions, including those made by William Gross, Pimco’s chief executive, significantly overstate net settlement flows that would result on default of “underlying” entities. There is a danger this might create a climate of fear in financial markets in which companies, including Pimco, operate and which are already dealing with severe market volatility.

Critically, these errors ignore conventional market use of economically offsetting positions, which reduces the amounts at stake sharply. We seek here to illustrate some more down-to-earth assumptions; not to forecast the future. This is how the numbers really work:

First, the $50,000bn “notional” or nominal amount is just that; a nominal figure that references the “underlying” bonds and loans being protected by use of credit derivatives.

Focus on the net exposure of these transactions, many of which hedge or offset one another. A recent Fitch Ratings survey estimates net exposure at less than $1,000bn.

Factor in a probability of default of 2 per cent and a 25 per cent recovery rate and protection sellers would have to settle an aggregate $15bn of losses.

None of these amounts would be “lost” to the system; a credit derivative simply transfers a potential gain/loss from one party to another. Clearly, while $15bn is not trivial, it is a small fraction of aggregate write-offs to date on loans and securities; and less than a 10th of Mr Gross’s suggestion.

And our figures are conservative: we use a slightly higher ($50,000bn) figure for the total reference amounts; we round up the net exposure figure; we use a higher default rate than the 1.25 per cent used elsewhere; and our projected recovery rate is much lower than the 50 per cent used by Mr Gross.


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Interview technique I

Posted by alifinmath on January 28, 2008

This is one of my less serious posts. To even discuss interview technique, I make the assumption that your resume was chockful of the usual buzzwords and acronyms and hence managed to get past the software sentinels that are used to reduce the mountain of resumes to a more tractable hill. Truth to tell, I don’t believe in the process of applying for a job, getting interviewed, and then being made a job offer: this might work if the number of applicants is relatively small and one’s credentials are outstanding. Since this is unlikely, people prefer to use their contacts or suck up to potential employers at conferences and conventions. The way the world turns. But I’m digressing (incipient senility). I don’t care how, but you’ve managed to snag an interview. Now forget the usual rubbish of fair and impartial assessments: the interviewer will decide within a few seconds — usually on a subconscious basis — whether he likes you or not. If he does, you have a chance. Let’s examine an interview described by my favorite American novelist, James Ellroy in American Tabloid to see how an interviewer assesses strengths and weaknesses: one of the protagonists, Pete Bondurant, is trying to recruit a Klansman for an anti-Castro campaign:


Lockhart dropped down the hatch. He wore a soot-flecked sheet, cinched by a gunbelt and two revolvers.

He had bright red hair and freckles. His drawl was deep Mississippi.

“The money I like and the move to Florida don’t bother me. But that no-lynching rule has gotta go.”

Pete backhanded him. Dougie Frank (Lockhart) stayed upright — give him an A-plus for balance.

“Man, I have killed oversized white trash for less than what you just did.”

Punk bravura: Give him a C-minus.

Pete slapped him again. Lockhart pulled his right piece — but didn’t aim it.

Nerves: A-plus. Sense of caution: B-minus.

Lockhart wiped blood off his chin. “I like Cubans. I might stretch my racial-exclusion policy and let your guys into my klavern.”

Sense of humor: A-plus.

Lockhart spit a tooth out. “Give me something. Let me know that I’m more than just some punching bag.”

Pete winked. “Mr. Boyd and I might put you on a bonus plan. And the Agency (CIA) just might give you your own Ku Klux Klan.”

Lockhart did a Stepin Fetchit shuffle. “Thank you, massah! If you was pro-Klan like a real white man, I’d kiss the hem of your sheet!”

Pete kicked him in the b*lls.

He went down — but didn’t yell or whimper. He cocked his gun — but didn’t fire.

The man got passing marks overall.


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How the rich work for their wealth

Posted by alifinmath on January 28, 2008

As we all know, the rich sweat blood for their wealth — that’s what CNN and Fox tell us (or suggest), so by golly it must be true. But perhaps sometimes they get a helping hand. Bill Moyers is one of my favorite investigative journalists and here he interviews the author of Free Lunch — David Cay Johnston — who indicates that this is indeed the case.

That the American rich have achieved their status through government largesse and/or through corrupt American politicians and officials is nothing new. Most of the large US fortunes from the 19th century onwards have probably been on this basis. Forget all that nonsense about making a better widget in a competitive marketplace: that’s not the way to riches. The way to real wealth is through government contracts, government protection of one’s markets, and government grants and subsidies. Ask General Dynamics or Bechtel. Government, monoply power, and vast wealth are inextricably tied together.

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The black box economy

Posted by alifinmath on January 27, 2008

An article in today’s Boston Globe that’s in line with what I’ve been saying and suggesting on this blog for a while: no-one really understands the economy today because no-one understands the web of financial instruments that interact with our real world. There are no conceptual tools around to get a bird’s eye perspective of the financial world, if indeed it’s even possible. Anyway, an excerpt from the article:

A handful of financial theorists and thinkers are now saying we shouldn’t (be so confident this time that the downturn will correct itself). The drumbeat of bad news over the past year, they say, is only a symptom of something new and unsettling – a deeper change in the financial system that may leave regulators, and even Congress, powerless when they try to wield their usual tools.

That something is the immense shadow economy of novel and poorly understood financial instruments created by hedge funds and investment banks over the past decade – a web of extraordinarily complex securities and wagers that has made the world’s financial system so opaque and entangled that even many experts confess that they no longer understand how it works.

The scale and complexity of these new investments means that they don’t just defy traditional economic rules, they may change the rules. So much of the world’s capital is now tied up in this shadow economy that the traditional tools for fixing an economic downturn – moves that have averted serious disasters in the recent past – may not work as expected.

In tell-all books, financial blogs, and small-circulation newsletters, a handful of insiders have begun to sound the alarm, warning that governments and top bankers may simply no longer understand the financial system well enough to do anything about it.

“Central banks have only two tools,” says Satyajit Das, author of “Traders, Guns and Money: Knowns and Unknowns in the Dazzling World of Derivatives,” who has emerged as a voice of concern. “They can cut interest rates or they can regulate banks. But these are very old-fashioned tools, and are completely inadequate to the problems now confronting them.”

“A lot of financial innovation is designed to get around regulation,” says Richard Sylla, professor of economics and financial history at NYU’s Stern School of Business. “The goal is to make more money, and you can make more money if you don’t have to keep capital to back up your investments.”

(By the way, Sylla has coauthored a book, “A History Of Interest Rates,” that’s well worth looking at for background knowledge.)

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Getting out of the USA II

Posted by alifinmath on January 27, 2008

Mark Ehrman — author of “Getting Out” — has written a comment to my earlier post (Getting out of the USA). I think he makes some valid points and indirectly provides a response to Chris Prouty’s question on how to emigrate.

Oh, by the way, I see Mark has his own site

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Posted by alifinmath on January 26, 2008

The high and the mighty have been congregated at Davos for the last week or so. The movers and shakers; the big money makers; the global ruling class. Expensive wine. Single-malt whiskies. Long, sonorous speeches. Wild parties. The pox on them all.

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