Today there is a horrific derivatives bubble that threatens to destroy not only the U.S. economy but the entire world financial system as well, but unfortunately the vast majority of people do not understand it. When you say the word "derivatives" to most Americans, they have no idea what you are talking about. In fact, even most members of the U.S. Congress don’t really seem to understand them. But you don’t have to get into all the technicalities to understand the bigger picture.
Basically, derivatives are financial instruments whose value depends upon or is derived from the price of something else. A derivative has no underlying value of its own. It is essentially a side bet. Originally, derivatives were mostly used to hedge risk and to offset the possibility of taking losses. But today it has gone way, way beyond that. Today the world financial system has become a gigantic casino where insanely large bets are made on anything and everything that you can possibly imagine.
The derivatives market is almost entirely unregulated and in recent years it has ballooned to such enormous proportions that it is almost hard to believe. Today, the worldwide derivatives market is approximately 20 times the size of the entire global economy.
Because derivatives are so unregulated, nobody knows for certain exactly what the total value of all the derivatives worldwide is, but low estimates put it around 600 trillion dollars and high estimates put it at around 1.5 quadrillion dollars.
Do you know how large one quadrillion is?
Counting at one dollar per second, it would take 32 million years to count to one quadrillion.…
After a Massachusetts wake-up call Obama has decided to pay more attention to Paul Volcker. Is it too little, too late to quell public anger? What will the effects be if new Glass-Steagall legislation is enacted?
President Barack Obama tomorrow will offer proposals to limit the size and complexity of financial institutions’ proprietary trading as a way to reduce risk- taking, an administration official said.
“We’ve got a financial regulatory system that is completely inadequate to control the excessive risks and irresponsible behavior of financial players all around the world,” Obama said in an interview with ABC News broadcast tonight.
“People are angry and they’re frustrated,” Obama said in the ABC interview. “From their perspective, the only thing that happens is that we bail out the banks.”
The proposed rules could limit activities of banks like Goldman Sachs Group Inc., the most profitable investment bank in Wall Street history. Goldman reaped more than 90 percent of its pretax earnings last year from trading and so-called principal investments, which include market bets on securities and stakes in companies.
President Obama on Thursday will publicly propose giving bank regulators the power to limit the size of the nation’s largest banks and the scope of their risk-taking activities, an administration official said late Wednesday.
He also would prohibit proprietary trading of financial securities by commercial banks, including mortgage-backed securities. Big losses in the trading of those securities precipitated the credit crisis in 2008 and the federal bailout.
Last week he proposed a new tax on some 50 of the largest banks to raise enough money to recover the losses from the financial bailout, which ultimately could cost up $117 billion.
Now, in perhaps his most daring move, he is calling for a modern-day version of the Glass-Steagall Act, which in 1933 separated commercial and investment banking. The new separation would prohibit standard commercial banks from engaging in proprietary trading using funds from their commercial division.
Only a handful of large banks would be the targets of this legislation, among
You can learn a lot about gambling if you’re willing to analyze 27 million hands of online poker. Don’t have time for that? No worries; sociology doctoral student Kyle Siler of Cornell University has done it for you. His counterintuitive message: the more hands you win, the more money you’re likely to lose — and this has implications that go well beyond a hand of cards.
Siler, whose work was published in December in the online edition of the Journal of Gambling Studies and will appear later this year in the print edition, was not interested in poker alone but in the larger idea of how humans handle risk, reward and variable payoffs. Few things offer a better way of quantifying that than gambling — and few gambling dens offer a richer pool of data than the Internet, where millions of people can play at once and transactions are easy to observe and record.
To gather his data, Siler used a software system called PokerTracker and directed it to collect and collate information on small- medium- and large-stakes games. He limited the games to no-limit Texas Hold ‘Em with six players in order to eliminate at least some extraneous variables. It was in the course of crunching all that information that he found the strangely inverse relationship between the number of hands won and the amount of money lost. He also noticed that it was novice players who lost the most.
The reason for the paradoxical results was straightforward enough: the majority of the wins the players tallied were for relatively small stakes. But the longer they played — and the more confident they got — the likelier they were to get blown out on one or a few very big hands. Win a dozen $50 pots and you’re still going to wind up far behind if you lose a single $1,000 one. "People overweigh their frequent small gains vis-à-vis occasional large losses," Siler says.
Small-stakes players also tend to do better with small-denomination cards. A pair of jacks may…
Upon reading various hedge fund investor letters and conversing with colleagues in the industry, one thing has become quite clear: hedge funds got their asses kicked on the short side of the portfolio in 2009. This is by no means a shocking revelation given that the stock market itself has risen over 70% from the lows back in March 2009. After all, a rising tide seems to lift all boats. While the negative performance of short positions over the past year is a common trend, we want to focus on a theme found in many of their portfolios.
Here’s the common link: many hedge funds have shorted businesses with high operating leverage. Amidst the crisis of the past two years, operating and financial leverage became quite a detriment to various companies. Hedge funds quickly recognized this and shorted shares of companies who would struggle with this burden in an uncertain economic climate. At the time, it was a poignant move. However, markets are often driven by perception (versus reality).
What are we talking about here?
We’re simply pointing out that the high operating leverage that was once seen as a detriment to the companies that hedge funds were/are shorting can now be construed as an attribute. According to the market, the economy is recovering and things are slowly but surely getting better. (More appropriately, the markets have been the beneficiary of massive capital inflows). Regardless, this market rebound re-instills confidence and shifts investor sentiment. And, most importantly, it reverses risk tolerance.
The very companies investors avoided like the plague during the crisis are now catching a bid because investors’ risk tolerance has returned. Many hedge funds missed this swing in perception and bore the brunt of the blow. It doesn’t matter right now if the company could potentially have problems due to their operating leverage. Right now, all that matters is that risk tolerance has returned and risk is ‘in’. This goes back to the age old market debate of perception versus reality.
We can’t tell you how many times we’ve seen hedge funds comment on the ‘mistakes’ they made in 2009. Almost all of their mistakes are on the short side of the portfolio. And while they don’t name specific stocks,
As we enter the new year investors will be wise to focus on the risks of 2009. Although the crisis appears long behind us it’s important to keep an eye on the bigger picture. Little has changed in terms of the structure of our global economy therefore the risks remain largely the same. Let’s take a moment to highlight some of these risks as we begin to prepare for a new year:
1) Those darned analysts
It would be comforting to think that Wall Street’s analysts were in fact doing us all a great big favor with their expert analysis, but the truth is, more often than not, they aren’t. As we have seen with my proprietary expectation ratio, the analysts have been behind the curve at every twist and turn of the crisis. They remained too bullish heading into 2007 & 2008 and then were behind the curve as operating earnings tanked and they turned very bearish in Q408 and Q109. Like clockwork, the ER bottomed and the market soon followed. The greatest risk heading into 2010 is an analyst community that becomes wildly bullish and sets the expectation bar too high for corporate America to hurdle itself over. Early readings show this is not a great risk at this point, but it continues to tick higher.
By guest author Terry Doherty and Ilene, your editor
Terry Doherty is the Research Program Coordinator in the Depts of Biomedical Sciences and Academic Affairs at Cedar Sinai in Los Angeles, California.
Double-Edged Sword: Swine Flu and Vaccines
There’s plenty that is unknown about the swine flu and the swine flu vaccine. If searches on the internet are any indication, deciding whether or not to be vaccinated may be a tough, emotionally charged decision for many people. So how – without having the background to write a swine flu grant proposal, conduct the research, and get the thing published in the New England Journal of Medicine – do we decide whether or not to get a swine flu shot?
One way is to attempt to evaluate and weigh the risks of the vaccine against the risks of the flu. That is how I approach the subject, but it’s easier said than done. As is often the case with medical interventions, the risks are not fully known. And even if we could carefully assess the risks, our underlying assumptions may be wrong. Percent risks are averages collected by studying large populations. We may not be one of the statistical average. Then there are the gaps in the available data, and own biases and belief systems. Our view of the world affects our analysis and often we are not even aware of how large of an effect those biases may play.
Just in time for the national roll-out of the new H1N1 flu vaccine, Wired Magazine and the Atlantic have weighed in on the ongoing vaccine war: Wired has a profile of Paul Offit, a vaccine researcher and pediatrician who has consistently spoken out in favor of vaccination and pointed to the lack of evidence linking vaccines and autism; the Atlantic checks in with a piece questioning the science suggesting that flu vaccines and antiviral drugs prevent people from dying.
Both articles have elicited heated debate all over the Web: Amy Wallace, who wrote Wired’s piece, excerpted below, has received vitriolic criticism and attacks from vaccine opponents, setting records for page views…
This debate over vaccination doesn’t seem likely to end any time soon. For critics, vaccines…
I still maintain that the rest of earnings season will be broadly positive, however, two negative trends have developed over the course of the last few days that have changed my market outlook from bullish to neutral.
The first change in trend has been the recent spat of “selling the news”. After the 6% run-up since the beginning of earnings season we are now seeing investors sell into strength. This is a clear sign that the buying power is waning. In essence, the owners of equities now have more incentive to sell than new buyers have to buy mainly because earnings were largely priced in over the course of the last few weeks. A new positive catalyst will need to develop from here for stocks to make a substantial move higher.
The second negative trend is the move in the dollar. Today’s nearly 1% decline in the dollar index is staggering. The negative trajectory of this move is simply unsustainable. I also believe the $1.50 mark in the Euro is one that will not be tolerated for long. Compounded by the move in the dollar is the surge in oil prices. It’s only a matter of time before analysts become increasingly concerned about the impact of high oil prices on consumers. Any move higher in the dollar (for whatever reason – short covering, politics, etc) will weigh on the market.
For these reasons I think it is prudent to take a step back from the poker table and take a break. Although I am not shifting to a short position I do view this market as one that is characterized by abnormally high risks. The strength could very well continue through the next 3 weeks of earnings season, but after the 6% surge over the last 4 weeks I think it is prudent to take profits here.
Sometimes when you’re sitting on a strong hand you need to realize that the risks outweigh the rewards and that perhaps your hand isn’t quite as strong as you think….
Will regulation hobble capitalism? I think the opposite is true. Properly done, government regulation of the financial industry will move the industry closer to the capitalist ideal. By capitalism, I mean where those who take the risks and put up the money get the fruits of their labor. And, importantly, where those who take the risks and put up the money actually do take the risks, bearing the full costs of failure as well as success.
Capitalism means bearing the costs
I sometimes miss the rugged beauty of Utah, where I spent some of my pre-Wall Street years. From my house on the foothills of the Wasatch mountains, I could see the cliffs of Mount Nebo to the south, nearly fifty miles away. Ten miles north, the western face of Mt. Timpanogas, capped with snow into early summer. To the west, the sun reflecting on Utah Lake. Oh, and on the eastern shore of the lake, the black smoke billowing out the stacks of Geneva Steel.
Geneva Steel was built to produce steel during the war effort, and kept in operation until seven years ago. It teetered at the edge – and at least two times over the edge – of bankruptcy, closing for good in 2002. Left behind were assorted furnaces, presses and scrap metal sold to a Chinese steel producer, and a giant pond of toxic sludge.
Fortunately, we’ve learned a thing or two about toxic sludge in steel production. The steel producer, in this case the original parent of the Geneva plant, U.S. Steel, has to set aside a fund to pay for the clean-up. The sludge is part of the production process, and the clean-up is a cost of production, even though it is a cost that is not realized until many years down the road. As a result, steel costs are a little higher and the shareholders fare a little worse than if this longer-term expense were not forced onto…
The rally off the March 8th lows has been nothing but spectacular. In hindsight, it’s clear that investors overreacted to the downside, but as stocks surge more than 50% it’s time to begin pondering whether the current rally is a bit ahead of itself. Contrary to my bottom call on March 8th when I said it was time to invest in risky assets (a full history of my 2008/9 calls can be found here including our 2008 crash call and March 8 buy call), now is the time to put on your risk management cap on as a number of various threats begin to pop up across the market. I recently turned near-term bearish on stocks due to 2 primary reasons: sentiment & seasonality.
1) Sentiment – As I often say, psychology drives markets. After months of skepticism regarding the rally we are finally beginning to see an overwhelming amount of bullishness. This is a screaming contrarian indicator. The latest consumer confidence readings showed a marked jump to 54.1 and bullish sentiment among fund managers has soared to its highest level since 2003:
The latest Merrill Lynch fund managers survey shows an extraordinary jump in optimistic sentiment. The survey makes up the current psychology of 204 portfolio managers running over $550B in assets. The report shows a 63% jump in sentiment since July and the highest reading since November of 2003.
After months of short squeezes and failed market declines this optimistic sentiment has begun to eat into one of the fuels of this rally: short sellers. Recent short sales data shows the lowest readings since the market tanked in early February. As we lose the short sellers we lose an important driver of higher prices.
Perhaps most important has been the enormous shift in analyst estimates. After turning bearish in early June, I reversed the position in early July for one reason – earnings. My analysis led me to believe that estimates were far too low primarily due to the fact that analysts were not accounting for cost cuts. The estimates have been outrageously low, but now as the consensus begins to believe in a full blown recovery the
First, welcome to Michael Pettis. Michael is a professor at Peking University’s Guanghua School of Management, where he specializes in Chinese financial markets. He is also Senior Associate at the Carnegie Endowment for International Peace. Second, this is an excellent article that provides insight into the thoughts of the Chinese people. – Ilene
Three weeks ago China Daily published a pretty funny article about a recent survey on credibility that had taken place in China. According to the article,
At a time when shamelessness is pervasive, we are often at loss as to who can be trusted. The five most trustworthy groups, according to a survey by the Research Center of the Xiaokang Magazine, are farmers, religious workers, sex workers, soldiers and students.
A list like this is at the same time surprising and embarrassing. The sex business is illegal and thus underground in this country. The sex workers’ unexpected prominence on this list of honor, based on an online poll of more than 3,000 people, is indeed unusual.
It took the pollsters aback that people like scientists and teachers were ranked way below, and government functionaries, too, scored hardly better. Yet given the constant feed of scandals involving the country’s elite, this is not bad at all. At least they have not slid into the least credible category, which consists of real estate developers, secretaries, agents, entertainers and directors.
I am not sure what secretaries have done to get themselves such poor rankings (could they mean party secretaries?), and I am not sure what kind of directors they mean (movie directors? managing directors?) but not everyone found this survey funny. Last week a columnist in the People’s Daily had this to say about the same survey:
In recent years, China has already paid a high price for the prevailing credibility crisis. The annual losses caused by bad debts have reportedly amounted to about 180 billion yuan, and the direct economic losses induced by contract fraud each year is also up to 5.5 billion yuan. Besides, shoddy and fake products contribute to another great loss involving at least 200 billion yuan. Generally, credibility crisis would cost China as much as 600 billion…
Chinese home prices in August rose the most in more than six years, indicating local government efforts to avert a housing bubble have failed. Average new-home prices in the 70 cities rose 1.2% in August from July, the biggest increase since January 2010, while the value of home sales jumped 33% last month from a year earlier. At the same time, prices in Tier 1 cities, soared 3.5%, the ...
By Knowledge Wharton. Originally published at ValueWalk.
While most of people have already decided whom to vote for in the presidential election, there are still quite a few undecideds. A new app, called ‘Voter,’ promises to help bring more clarity about candidates based on their stances on issues and one’s own beliefs. The app developers say it also automates what could otherwise be a laborious process of determining candidates’ credentials and positions, and reduces human bias in the selection process.
Hunter Scarborough, the creator of the Voter app, says plans call for extending the app beyond the November presidential elections to candidates in races for Senate, House of Representatives and governors’ seats. Next, he plans to take it further to local elections such as for city councils, and may also go international. He discusses th...
China has stanched a string of defaults and speculation authorities will continue to stave off failures is leaving investors the most bullish on local junk bonds in five years, despite record maturities.
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"When you let the free market take over, the little people get screwed and bankers get rich. Chile tried privatizing retirement plans and surprise, surprise, fund manager ate the profits… Pretty sure the results would be the same here..." ~ Jean-Luc
I was so pleased yesterday by the announcement that I have joined the Research team at GoldCore as it meant that I could finally start talking about it and was back in a role that lets me indulge in my passion by researching and geeking out on all things gold, silver and money.
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Epizyme was founded in 2007, and trying to create drugs to treat patient's cancer by focusing on genetically-linked differences between normal and cancer cells. Cancer areas of focus include leukemia, Non-Hodgkin's lymphoma and breast cancer. One of the Epizme cofounders, H. Robert Horvitz, won the Nobel Prize in Medicine in 2002 for "discoveries concerning genetic regulation of organ development and programmed cell death."
Before discussing the drug targets of Epizyme, understanding epigenetics is crucial to comprehend the company's goals.
Genetic components are the DNA sequences that are 'inherited.' Some of these genes are stronger than others in their expression (e.g., eye color). Yet, some genes turn on or off due to external factors (environmental), and it is und...
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