Archive for July, 2008


This is George Soros’ latest book. It draws upon a structure which he describes as “reflexivity”, which includes a “cognitive function” and a “manipulative function”. The best example I can think of to relate the two, is that it is a two part process; the cognitive function is the recognition of objective data, like “Oil is over $100”, and the manipulative function is our way of trying to come up for an explanation for this fact. the problem is that we use, what he describes as, an incorrect framework which allows us to predict and explain social phenomena, when we can’t accurately do so. In short, his thesis is really a counterpoint to all economic theory relating to equilibrium and the laws of supply and demand.

There is also a great 10 page synopsis/introduction describing the current financial condition (probably the most accurate articulation of the problem I’ve ever read). The book itself is around 100 pages, but its a surprisingly difficult read – I think It’s clear he didn’t have any help in writing it. For much of the book, however, he is pleading to make a mark in the philosophical world (this part can be skipped).

If you decide to read this book, It really heats up around p. 75, when he actually begins relating his strategy to this current financial crisis. Here are some memorable insights from that section:

Concerning Modeling:

“By endowing social science with the prestige of natural science it allows scientific theories to be used for manipulative rather than cognitive purposes.”

His New Paradigm:

“By applying the postulate of radical fallibility to financial markets, one can assert that, instead of being always right, financial markets are always wrong…they cannot predict economic downturns accurately, but they can cause them…Markets move away from a theoretical equilibrium almost as often as they move towards it, and they can get caught up in initially self-reinforcing but eventually self-defeating processes.”

This is my interpretation of his message: markets do not operate on a set of principles predicated on rationality, mainly because the participants within it are not rational. This stems from a number of problems, but mainly from a lack of true understanding of the market’s condition, especially during boom-bust scenarios. Since we as market participants, cannot obtain absolute knowledge, and because we base our decisions on our own perception of a situation, we “are obliged to act on the basis of beliefs which are not rooted in reality.”

Also of note: He thinks that his philosophies have not been accepted in academic circles because Economists would be forced to relinquish some of their stature as, the “all knowing”.

Definitely worth reading.


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So I thought I should post something relevant to my internship before I finish up this week…the two types of instruments which are dealt with on a most regular basis, are Interest-rate swaps and credit-default swaps:

An interest rate swap is a contractual agreement to exchange a stream of periodic payments with a counterparty. The traditional interest rate swap agreement is an exchange of fixed interest payments for floating rate payments:

(Click to enlarge)

A Credit default swap (CDS) is a swap designed to transfer the credit exposure of the reference obligation between parties.

It is an agreement between a protection buyer and a protection seller whereby the buyer pays a periodic fee in return for a contingent payment by the seller upon a credit event (such as a certain default) happening in the reference entity

§ A pension fund owns USD 10 million worth of a 5 year bond issued by Risky Corporation;

§ In order to manage their risk of losing money if Risky Corporation defaults on its debt, the pension fund buys a CDS from Derivative Bank in a notional amount of 10 million dollars which trades at 200 basis points;

§ In return for this credit protection, the pension fund pays 2% of 10 million (200,000 euro) in quarterly installments of 50,000 euro to Derivative Bank;

§ If Risky Corporation does not default on its bond payments, the pension fund makes quarterly payments to Derivative Bank for 5 years and receives its 10 millions loan back after 5 years from the Risky Corporation;

§ Though the protection payments reduce investment returns for the pension fund, its risk of loss in a default scenario is eliminated;

§ If Risky Corporation defaults on its debt 3 years into the CDS contract then the premium payments would stop and Derivative Bank would ensure that the pension fund is refunded for its loss of USD 10 million

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I already talked about the ambiguity surrounding the Chevy Volt, but I saw something interesting in CNN Money today, concerning T. Boon Pickens’ ideals of a wind powered nation. In case you’re unfamiliar with the framework of his plan, here is a very brief synopsis, via CNN’s summary:

T. Boone Pickens, the billionaire oilman, has been hitting the airwaves, pitching a plan to use wind to replace all the natural gas that’s used to produce electricity, then using that saved natural gas to fuel cars.

While that’s interesting, it isn’t what caught my eye:

While automakers are betting on electric cars as the vehicle of the future, those electric cars will still need backup engines to recharge the battery on long trips, at least for the foreseeable future.

Those backup engines could run on natural gas, said Julius Pretterebner, a vehicles and alternative-fuels expert at Cambridge Energy Research Associates.

Pretterebner also pointed to a host of other reasons why natural gas in cars is a good idea: It’s about half as expensive as gasoline and 30% cleaner; the infrastructure to get it to service stations already exists; it’s relatively cheap to convert existing cars ($500 to $2,000 per car, he said); and natural gas can be carbon neutral, if it’s made from plants, a process he said requires no new technology.

That sounds pretty cool to me…the only problem I have is one which stems from lack of understanding (I’m not exactly a bio-chemistry whiz, so I’ll have to leave the dynamics of this study to the engineers back at Lehigh to explain to me). His thoughts are clear, but I find it peculiar that we haven’t heard this concession before…Did this guy just figure out that the infrastructure for natural gas has been available for use to the general public throughout oil’s 70% ascent year to date?

Other than that, the article highlights the short-term difficulty of converting to wind power, because the applicable tax credits expire every 2 years.

Regardless of the oil industry’s apologetic laws, like this tax credit policy, I think that with the right government, these issues get straightened out. Look at what was accomplished when our backs were against the wall under this regime of bad government? Hank Paulson pulled that bail out plan together pretty fast…

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Macro Man

I’m having trouble finding things to write about which don’t have a negative undertone, so pardon this post…it’s more like a review anyway.

Macro Man is truly one of the most unique blogs I’ve ever read…the content, while humorous, does not compromise the substance of the author’s thoughts of our economic condition. He has a post today which proposes that the US cash in on its investments of the Gadsden Purchase, Louisiana Purchase, and pretty much everything other than our original 13 colonies, in order to raise money to overcome the financial crisis, cover our budget deficit, and start over. The guy redefined cynicism and satire at the same time:

According to Macro man’s calculations, the asset sales would raise a total of $11.55 trillion (less investment banking fees, of course)….easily more than enough to retire the publicly held debt of the Federal, state, and local governments. The excess cash (comprising some $4 trillion or so) could be used to directly back most Fannie and Freddie mortgages on a dollar for dollar basis, thus getting rid of that nasty problem.

Looking ahead, the Macro Man Plan will make life a lot easier for the remaining United States. The worst housing markets (Florida, California, Las Vegas) will now be someone else’s problem. Ditching Florida and Arizona will significantly reduce the Social Security burden in years to come, while the secession of Texas should bring about a welcome reduction in future military spending. The environmental costs of California smog will now be borne by China, while Canada can pay for the benefits of Detroit autoworkers.”

There’s quite a bit more. He took the time to calculate what each region of the US is worth based on a pricing multiple of 8. As Barry Ritholtz often says, “This would be funny if it weren’t so sad…”

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There has been quite a bit of press lately about electric cars. The Personal Journal (yes, the same section of the WSJ I made fun of the other day) has an installment which features GM’s former CEO Robert Stempel, who had spent much of his career around this technology, and is coincidentally the same guy who approved GM’s famous EV1, the car which prompted the documentary “Who killed the electric car?”….he offers, as the article puts it, “some sobering words” which were not captured in this documentary.

“The business side of the case wasn’t there. The EV1 was too expensive…We were way off the cost target,”

Well that wasn’t clear to the users at the time, but in hindsight the cars were offered through a leasing program, where GM clearly didn’t recoup the cost of the car through the monthly lease payments. Honda is doing something very similar with their fuel cell vehicle.

Stempel also discusses how the commodity boom has negatively affected the pricing of the raw materials needed to make these contraptions work. Unfortunately, it looks like he is on the mark…

The GM Volt plug-in hybrid was supposed to hit showrooms in 2010 for $30,000. Well, apparently it’s not that easy to redesign wipers, stereos and other electrical accessories so they drain as little juice as possible from the battery. GM has announced that the first generation Volt will be “closer to $35,000”. The good news is that the late 2010 deadline hasn’t been officially pushed back, though GM says that if it can’t make it, the car might be delayed until the Spring of 2011.


Well, that kind of sucks. I hope $35,000 is still cost effective for a plug-in hybrid. I am, however, curious to see what GM’s estimates are for the actual fuel economy of the Volt (once you use the 40 miles worth of electricity).

Luckily for us, GM is one of the worst run companies ever. They haven’t been profitable since 2004, and if it weren’t for continual government support, they’d be gone by now. That should offer a sigh of relief, since Honda and Toyota haven’t rushed their electric cars into production, and have enough of a life line to get this thing right…with time.

In last week’s edition of The Economist, they had an article about the future of SUVs. I saw a staggering statistic about how both the car dealer and manufacturer make better margins on the sale of 1 SUV than they do on the sale of nearly 10 compact cars (this was by no means a scientific study, it was coming from a car salesman). Still, if that number resembles anything close to reality, I think that is a pretty good reason why we see so many SUVs on the road; the sales people have monetary incentive (the best kind) to sell SUVs. Predatory salesmanship, anyone?

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Via TheBigPicture:


Seeing as I haven’t posted anything about actual equity ideas in a while, there are a couple of good ETF’s out there if you believe in this trend, or in the idea that this is just a pull back in oil.

The XLE SPDR would normally be a little boring for my taste, (because Chevron and Exxon make up 28% of the fund) , but big oil companies have been beaten up for the sake of recession, lately.


I think the better play is OIH, which includes only Oil Service stocks – the guys who find the oil, and the guys who drill for it. Here’s the ETF’s top 10 holdings:



You pick up a lot of good exposure, while diversifying your risk. This sector hasn’t been as nicked up as the XLE, probably because they’re not involved in buying/refining crude oil. That makes me a little less comfortable taking on a short term position, because I’m not sure any sector is “recession proof”. As the old adage goes: “all  boats fall with the tide”

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Courtesy of Bespoke Investment Group:


That’s a pretty diverse list of important companies. I sure hope Bank of America doesn’t miss their earnings tomorrow…that could put an end to this rally pretty fast.

Also, there’s word of a storm which could develop into a hurricane off of the Gulf of Mexico in the coming days…Oil didn’t react too badly, as it was up $1.25 in Singapore.

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