In academic circles Hyman Minsky is now regarded as the great exalted savant of economics, but it wasn't always this way. "Many of Minsky's colleagues regarded his 'financial-instability hypothesis' which he first developed in the nineteen-sixties, as radical, if not crackpot.", writes John Cassidy in a February 4th, 2008 article in The New Yorker entitled 'The Minsky Moment'. You can find a lot of information about Minsky's "financial-instability hypothesis" on the Internet and specifically at Wikipedia, but Robert Barbera sums it up best in his book The Cost of Capitalism: "Minsky's thesis can be explained in two sentences. A long period of healthy growth convinces people to take bigger and bigger risks. When a great many people have made risky bets, small disappointment can have devastating consequences." Barbera also explains the culmination of these consequences: "When you own risky assets that are falling in value you need cash, you have to start selling your good risky assets. If everyone does this at the same time, the price of good risky assets begins to fall, and soon it looks like all risky assets are bad assets. That is the Minsky moment.".
If we delve further into Minsky's 'financial-instability hypothesis' Wikipedia states: "Minsky argued that a key mechanism that pushes an economy towards crisis is the accumulation of debt. He identified 3 types of borrowers that contribute the the accumulation of insolvent debt: Hedge Borrowers; Speculative Borrowers; and Ponzi Borrowers. The 'hedge borrower' can make debt payments from current cash flows from investments. For the 'speculative borrower', the cash flow from investments can service the debt, i.e., cover the interest due, but the borrower must regularly rollover or re-borrow the principal. The 'Ponzi borrower' borrows based on the belief that the appreciation of the value of the asset will be sufficient to refinance the debt but could not make sufficient payments on interest or principal with cash flows from investments; only the appreciating value can keep the Ponzi borrower afloat.". We were inundated with Ponzi borrowers at the height of the real estate bubble, both on the individual and institutional level, and this cut the legs out from under the stock market.
There is currently a paradigm shift in academic economic cliques because of the success of the TARP program which not only raises doubts about the conservative free-market economic theories, but also brings back Keynesian postulates. As I wrote in the last posting of this blog, Minsky amalgamates supply-side and demand-side schools of thought and brings economic thinking to a new level. There is a sea change going on and we on Main Street may not be aware of it yet, but those within the inner circles of Wall Street are surely conscious of the influence this has on our portfolios. As is, the smart money piled into the market right at the bottom in March and the little guy, or individual investor, stayed in cash or invested in bonds and in effect, was left holding the bag, although this was a good year for bonds, but nothing like the action in the market. Now that the market has rallied over 60%, individual investors will probably begin buying stocks only to have the market implode again once the government stimulus money runs out. And this is a big part of Minsky's hypothesis, that market collapses are inevitable and part of a healthy economic scenario only to be propped up by a big dose of government intervention.
To gather the material that enabled me to put together this posting I read The Cost of Capitalism by Robert Barbera and thought the book wasn't quite up to snuff. I expected more from Mr. Barbera because he is a good economist and I thought the book took a roundabout way of making his points, plus, some of the interior chapters were laborious when discussing the history of free-market economics since the late 1970's. There is an awful lot about Hyman Minsky in The Cost of Capitalism, but it doesn't warrant the outlay of almost $30 for the price of admission when a simple trip to Wikipedia or a search for Minsky on Google should do the trick. However, it should be noted that although Minsky is not currently part of the mainstream nomenclature or will he ever be, as an investor, you should be aware of his theories because they do effect your profits.
Sunday, December 27, 2009
Sunday, December 20, 2009
How Markets Fail
Two weeks ago The Economist published a list of their four best finance books of 2009 and two of them piqued my interest, Too Big To Fail by Andrew Ross Sorkin and How Markets Fail by John Cassidy. Both books have been getting rave reviews in the financial press so I ordered them on Amazon and finished How Markets Fail early this morning. Boy was I disappointed. I hope Too Big To Fail is better because I just slogged through 350 pages of some of the most tedious writing I've come across this year. At the outset of the book Mr. Cassidy states he didn't want it to read like a text book, but I'm afraid this is exactly what he's done. This is not to say the book has no value because I did learn a lot from it, but it would appeal to a much broader audience if it didn't drag on for so long.
How Markets Fail is divided into three sections: the history of Utopian economics, the history of realistic economics and the inflation of the housing bubble and its implosion. In the history of Utopian economics, Mr. Cassidy gives a brief, but detailed chronology of free-market economic theory dating back to Adam Smith and culminating with the Chicago School led by Milton Friedman. The second part of the book is the history of realistic economics and how this branch of economic thinking refutes some, but not all of the doctrines of the supply-siders. John Maynard Keynes, behavioral finance and Hyman Minsky are all highlighted in this section and this is where Cassidy falls short. He devotes a chapter to Minsky when he should have extrapolated more about him because at the end of the book, Minsky turns out to to be dead on with his theory of meshing both the free-market and Keynesian schools of thought. The final 150 pages is devoted to the 2008-2009 real estate crash and this has been overdone by too many authors, so let's get back to Minsky.
As Cassidy writes: "Minsky advanced the view that free market capitalism is inherently unstable, and that the primary source of this instability is the irresponsible actions of bankers, traders, and other financial types. Should government fail to regulate the financial sector effectively, Minsky warned, it would be subject to periodic blowups, some of which could plunge the entire economy into lengthy recessions.". I first heard about Hyman Minsky in an interview on CNBC with Paul McCulley, the Chief Investment Officer at PIMCO, and had no idea about why he was so enthusiastic about him. This is partly to do to the fact that Minsky is not a very well know economist, but he is getting there. Like Mr. Cassidy summarizes: "Perhaps the biggest lesson we have learned is one Hyman Minsky taught us as far back as the 1980's: Wall Street needs taming. On an individual level, banks, investment banks and other financial companies provide essential services. Taken together, however, their self-interested actions have created and amplified economic disturbances, largely through the use of leverage and excessive accumulation of risk.".
In fact, Cassidy blames the Great Recession of 2008 on Alan Greenspan and his free market cronies because: "The notion of financial markets as rational and self-correcting mechanisms is an invention of the past forty years.". In the conclusion of How Markets Fail, Cassidy pontificates: "If Ronald Reagan, instead of appointing Greenspan to the Fed in 1987, had talked Paul Volker into staying another four or eight years, things would have turned out differently...When historians come to write about the 'Greenspan Bubbles,' they will do so with good cause: more than any other individual, the former Fed chairman is responsible for letting the hogs run wild." How Markets Fail hits the bullseye in citing Greenspan and the supply-siders for the Panic of 2008 and also whetted my appetite for more information about Minsky, but never really sated me, so next on the docket is something more substantial. There should be a place for a book like this, like in the hands of hardcore economics students, but for the average investor, you should really skip this one.
How Markets Fail is divided into three sections: the history of Utopian economics, the history of realistic economics and the inflation of the housing bubble and its implosion. In the history of Utopian economics, Mr. Cassidy gives a brief, but detailed chronology of free-market economic theory dating back to Adam Smith and culminating with the Chicago School led by Milton Friedman. The second part of the book is the history of realistic economics and how this branch of economic thinking refutes some, but not all of the doctrines of the supply-siders. John Maynard Keynes, behavioral finance and Hyman Minsky are all highlighted in this section and this is where Cassidy falls short. He devotes a chapter to Minsky when he should have extrapolated more about him because at the end of the book, Minsky turns out to to be dead on with his theory of meshing both the free-market and Keynesian schools of thought. The final 150 pages is devoted to the 2008-2009 real estate crash and this has been overdone by too many authors, so let's get back to Minsky.
As Cassidy writes: "Minsky advanced the view that free market capitalism is inherently unstable, and that the primary source of this instability is the irresponsible actions of bankers, traders, and other financial types. Should government fail to regulate the financial sector effectively, Minsky warned, it would be subject to periodic blowups, some of which could plunge the entire economy into lengthy recessions.". I first heard about Hyman Minsky in an interview on CNBC with Paul McCulley, the Chief Investment Officer at PIMCO, and had no idea about why he was so enthusiastic about him. This is partly to do to the fact that Minsky is not a very well know economist, but he is getting there. Like Mr. Cassidy summarizes: "Perhaps the biggest lesson we have learned is one Hyman Minsky taught us as far back as the 1980's: Wall Street needs taming. On an individual level, banks, investment banks and other financial companies provide essential services. Taken together, however, their self-interested actions have created and amplified economic disturbances, largely through the use of leverage and excessive accumulation of risk.".
In fact, Cassidy blames the Great Recession of 2008 on Alan Greenspan and his free market cronies because: "The notion of financial markets as rational and self-correcting mechanisms is an invention of the past forty years.". In the conclusion of How Markets Fail, Cassidy pontificates: "If Ronald Reagan, instead of appointing Greenspan to the Fed in 1987, had talked Paul Volker into staying another four or eight years, things would have turned out differently...When historians come to write about the 'Greenspan Bubbles,' they will do so with good cause: more than any other individual, the former Fed chairman is responsible for letting the hogs run wild." How Markets Fail hits the bullseye in citing Greenspan and the supply-siders for the Panic of 2008 and also whetted my appetite for more information about Minsky, but never really sated me, so next on the docket is something more substantial. There should be a place for a book like this, like in the hands of hardcore economics students, but for the average investor, you should really skip this one.
Friday, December 18, 2009
A Wing and a Prayer
As the markets have moved sideways and consolidated the past month, my portfolio has limped along with them losing roughly 35% since mid July, but treading water since October. I try to remain objective about my leveraged short positions, but sometimes I get lost in the current euphoria of a 60% run-up since early March and doubt my myself, but that's only to be expected. For every Meredith Whitney or Bill Gross in their bearish predictions, there are plenty of bulls to take the opposite side of the trade. Where this market will go is anybody's guess.
This morning I read the Carnegie Management Group Hotline which is free to anybody with an Internet connection. They do have stock and ETF recommendations, but you must be a premium subscriber to access that. For my purposes, just reading what they had to say today was good enough for me. The hotline said: "The media and the market 'experts' would like for us to believe that the economy has bottomed and the next bull market is underway. That is simply not possible. Dividend yields are near all-time lows. The S&P 500 P/E ratio for reported earnings is an astronomical 140--the highest level in recorded history according to Standard & Poor's.". I have read on some blogs that the P/E for the S&P 500 is near 140, but I've never seen it in writing from an accredited source. I checked the S&P Web site and they have the 2009 P/E at 88 which is sky high. Where they got the 140 from, I don't know, but it was probably in the way that they read the data and calculated it. In any event, the P/E ratio is well above it's historical norm and things tend to revert to the mean. This doesn't imply that it can't go higher, just that it's going to go lower at some point.
The Carnegie Management Group Hotline also had some more interesting data: "Every decade, the markets face a grave three-year cycle....do you remember:
The recession and bear market of 1920, 1921, and 1922?
The recession and bear market of 1930, 1931, and 1932?
The recession and bear market of 1940 and 1941?
The recession and bear market of 1950, 1951, and 1952?
The recession and bear market of 1960, 1961, and 1962?
The recession and bear market of 1970, 1971, and 1972?
The recession and bear market of 1980, 1981, and 1982?
The recession and bear market of 1990, 1991, and 1992?
The recession and bear market of 2000, 2001, and 2002?"
Just because there is a pattern here, does not mean that the pattern will repeat itself, but there is a precedent. If this piece of information is worth anything, 2010 and 2011 could mean tough times ahead which would be great for my ETF allocations. However, I remind myself of what Warren Buffett said: "Beware of past-performance 'proofs' in finance: If history books were the key to riches, the Forbes 400 would consist of librarians.". For some reason, Warren Buffett always sobers me up.
This morning I read the Carnegie Management Group Hotline which is free to anybody with an Internet connection. They do have stock and ETF recommendations, but you must be a premium subscriber to access that. For my purposes, just reading what they had to say today was good enough for me. The hotline said: "The media and the market 'experts' would like for us to believe that the economy has bottomed and the next bull market is underway. That is simply not possible. Dividend yields are near all-time lows. The S&P 500 P/E ratio for reported earnings is an astronomical 140--the highest level in recorded history according to Standard & Poor's.". I have read on some blogs that the P/E for the S&P 500 is near 140, but I've never seen it in writing from an accredited source. I checked the S&P Web site and they have the 2009 P/E at 88 which is sky high. Where they got the 140 from, I don't know, but it was probably in the way that they read the data and calculated it. In any event, the P/E ratio is well above it's historical norm and things tend to revert to the mean. This doesn't imply that it can't go higher, just that it's going to go lower at some point.
The Carnegie Management Group Hotline also had some more interesting data: "Every decade, the markets face a grave three-year cycle....do you remember:
The recession and bear market of 1920, 1921, and 1922?
The recession and bear market of 1930, 1931, and 1932?
The recession and bear market of 1940 and 1941?
The recession and bear market of 1950, 1951, and 1952?
The recession and bear market of 1960, 1961, and 1962?
The recession and bear market of 1970, 1971, and 1972?
The recession and bear market of 1980, 1981, and 1982?
The recession and bear market of 1990, 1991, and 1992?
The recession and bear market of 2000, 2001, and 2002?"
Just because there is a pattern here, does not mean that the pattern will repeat itself, but there is a precedent. If this piece of information is worth anything, 2010 and 2011 could mean tough times ahead which would be great for my ETF allocations. However, I remind myself of what Warren Buffett said: "Beware of past-performance 'proofs' in finance: If history books were the key to riches, the Forbes 400 would consist of librarians.". For some reason, Warren Buffett always sobers me up.
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