My only clue that they might have treated us nicer than some other gatherings, was that some staffers not at the meeting came in after the meeting to raid some cookies.  Now, maybe that is normal regardless there.  I’ve seen the same things in corporate settings.  The e-mail announcement, “Open season in room 406!”  That said, the chocolate chip cookies were all gone.   I had one, as did Tyler, I think.  Maybe the Treasury officials had the rest.

Personally, I am comfortable with the restrictions on reporting from the meeting.  The Treasury’s high-level staff sound the same tune.  It doesn’t matter if we identify them or not, they reflect the policies of the Obama Treasury.  With restrictions on not identifying who said what, to me it does not matter, because they were senior Treasury officials.  We can quote, or approximately quote.  We can’t tie it to a single person.  That doesn’t affect us much.  We know what they think, and we can write about it.  We just can’t say exactly who said it, or whether they were there.

Making Money or Not

Few areas of the US government are designed to make money.  One of the main points that Treasury made to us was that the TARP would cost little, or might make money.  TARP is a piece of a larger puzzle.  My question is this, counting in all of the bailouts, including all stimulus programs, what is the cost to the taxpayer?  Now, I ask my readers what they know here. E-mail me with any comprehensive pieces that you have seen, or put it in the comments, so that all can see.

When I look at the bailouts, AIG, Fannie, and Freddie have sucked up /are sucking up resources.  With respect to the GSEs, I appreciate the view that the Administration views Fannie and Freddie as a hole in the system that they can use to funnel money to housing without asking Congress for approval.  Certainly their financial result show it.  Fannie lost a lot of money last quarter and is begging for help.  Freddie lost less, but is not asking for money now, but they likely will in the future.  As for the Treasury, they have opted to not maximize the value of Fannie by allowing her to sell of tax credits to others, notably Goldman and Berky.  They are not interested in maximizing the value of the GSEs, only of using them for their policy goals.

One slide the Treasury showed us was that they thought they were making money across all of the TARP bailouts that they did.  Also, that their guarantee programs had made money as well.

True, so far the guarantee programs have made money.  That does not mean that the government should be in that business, as it may encourage greater risk taking later, because they think the government will rescue them in times of trouble.  In England, at least some think it is a bad precedent.

TARP may be doing okay, but the same moral hazard argument applies.  Also, bailouts may come after shareholders have lost a lot, but management teams may (and seem to be now) benefit disproportionately from the bailout.  Away from that, the losses from the GSEs, Auto companies, and AIG swamp other gains.  That’s what it seems to me.  Does anyone else know better?  Please put it in the comments, for all to see.

Away from that, consider how the FDIC is basically broke, and that the FHA is not far behind.  This crisis is not over.

A Place of Agreement

One place where I can agree with the Treasury is that there should be only one regulator of depositary institutions.  The insurance industry can choose among states, but for the most part there are states for big companies,and states for small companies.  The states willing to regulate the big insurance companies have done a great job relative to the banking regulators.  There are few failures.  AIG died for non-insurance reasons.  Penn Treaty was a basket case long before the crisis.  Who else died?

Having one regulator for banks will remove the ability of the banks to choose the weak regulator.  It raises the risk that the one regulator will be corrupted.  That’s a lesser risk, because with many regulators, the odds that one will be corrupt are high, and corrupt institutions will go to them to be regulated.  With one regulator, politicians can more easily watch the troubles, and can more easily assign blame.

I have no objection to one national insurance regulator either.  That said, many states will object, because they have differing standards.  But does Congress really want to do insurance law?  It takes up a lot of time and is complex.

The Final Note for Now

Things always look best for a borrower immediately after his most recent loan.  So it is for most programs in our economy that favor giving loans in this crisis to stimulate demand.  So it was in the 70s and 80s with lesser developed countries.  The finances looked great after the loans, but after they had spent it away on consumption, things looked much, much, worse.

So it is with government programs that interfere with the free market through offering cheap lending terms.  They give a temporary lift that leads to greater problems once the subsidy is spent away.  So it is now with government subsidies and loans.

Other Posts

Two more posts on the meeting, one from a blogger who was there:

A Sit Down With Senior Treasury Officials – Part II

and one who was not, somewhat critical, but constructively so:

Treasury and the Blogs

As for me, I’m glad I went.  I have a better zeitgeist of the US Treasury.  I am not more impressed, nor less impressed with them.  I do want the Federal Reserve to consider inviting us to meet with them.  They are far less accountable than the Treasury, and many of us would like to counsel them on their behavior that seemed smart at the time, but will likely prove destructive to the republic.  Dare you invite us, Ben, or do you have less courage than the Treasury?

One other blogger took his nameplate with him — I’m not sure who; the rest left theirs.  But this is what was in front of each one of us as we sat down to discuss matters at the US Treasury.  Treasury officials had similar nameplates.  It dictated where we would sit as well.  From the front of the room on the left, for bloggers it was Financial Armageddon, (Megan McArdle — not there), Accrued Interest, and Across the Curve.  On the right, Naked Capitalism, Kid Dynamite, Interfluidity, Me, and Marginal Revolution.  Aside from putting the two bloggers with the most traffic at the front, there did not seem to be any rhyme or reason to the seating.

The Treasury officials presenting generally sat in front, a few sat to the side and behind us.  It made for an interesting dynamic during the portion of the meeting where some bloggers disagreed over whether derivatives should be exchange traded or not.  The folks from the Treasury grinned.  See?  These aren’t easy questions to answer!  For me, with a middle view (bring interest rate swaps to exchanges first and see how they work, then try other instruments that are less liquid), I found the exchange to be a waste of precious time, but it was revealing of the attitudes of those in the Treasury.  I knew what the bloggers thought already.

The Biggest Financial Problem

I’ve written a number of pieces on why debt matters. (Or, where is the breaking point?)  I am in the process of reviewing This Time is Different: Eight Centuries of Financial Folly — a book that deals with the reality of sovereign defaults over the last 800 years.

Surprise! Over-indebted countries do default on their debt more often than less-indebted countries.  During the current crisis, we have two mechanisms running to blunt the troubles.  The government is running a large deficit, and the central bank is sucking in longer-dated bonds to lower interest rates.  I talked about why lower interest rates are not necessarily a blessing yesterday.  Today’s thoughts are on deficits.

After the meeting, I said to one Treasury staffer, “One of the quiet casualties of this crisis is that you lost your last bit of slack from the entitlement systems.”

“What do you mean?”

“Just this, prior to the crisis, Social Security and Medicare would produce cash flow surpluses for the Government until 2018.  Now the estimates are 2016, and my guess is more like 2014.  The existing higher deficit takes us out to the point where the entitlement systems go into permanent negative cash flow.  This means that the US budget is in a structural deficit for as far as the eye can see, fifty years or more, absent changes to entitlements.”

He looked at me and commented that it would be the job of a later administration.  No way to handle that now.  To me, the answer reminded me of what I say to myself when I go on a scary ride at Six Flags with my kids.  There is nothing we can do to change matters.  The only thing to adjust is attitude.  So, ignore the fact that you are afraid of heights, and enjoy the torture, okay?

Would that I could do that with the present situation.  The long term problems are too numerous, and the present crisis saps attention from what is arguably a larger problem.  Medicare, Social Security, unfunded Federal pensions and retiree healthcare, underfunded state pensions and unfunded retiree healthcare, and underfunded corporate pensions (flowing to the PBGC) are the crisis of the future.  We are talking underfunding and debts equivalent to 4x GDP in total.

The deficits may be helping out areas of our economy for which there is already too much capacity — autos, banks, housing, but isn’t aiding the parts of the economy that don’t have excess capacity.  The one advantage to Americans is that a decent amount of the debt is absorbed by the neomercantilists, who will get paid  back in cheaper dollars (if at all) than the goods that they provided originally.

This all feels like the Japan scenario.  Low interest rates, low growth if any in non-protected sectors, soggy debt-laden protected sectors, excess capacity in areas not salable to the rest of the world, high government debt, and a demographic crisis.  Also speculation using cheap leverage for carry trades.

I’ll try to tie this up in another post or two.  Sorry if this is verbose.

Economists View http://economistsview.typepad.com/
Cafe Americain http://jessescrossroadscafe.blogspot.com/
Market-Ticker http://market-ticker.denninger.net/
Econbrowser http://www.econbrowser.com/
Greg Mankiw’s Blog http://gregmankiw.blogspot.com/
Carpe Diem http://mjperry.blogspot.com/
Credit Writedowns http://www.creditwritedowns.com/
Gregor Macdonald http://gregor.us/
Jeff Miller http://oldprof.typepad.com/
Floyd Norris — NYT http://norris.blogs.nytimes.com/
Market Beat — WSJ and their real time economics blog, deals, and real estate blog… http://blogs.wsj.com/marketbeat/
FT Alphaville — http://ftalphaville.ft.com/
James Pethokoukis — Reuters http://blogs.reuters.com/james-pethokoukis/ (also Matt Goldstein and Rolfe Winkler at Reuters)
Curious Capitalist — Time http://curiouscapitalist.blogs.time.com/
Matt Taibbi — http://trueslant.com/matttaibbi/ (And others at the same site)
Trader Mark http://www.fundmymutualfund.com/
Dealbreaker http://www.dealbreaker.com/
The Epicurean Dealmaker http://epicureandealmaker.blogspot.com/
Ultimi Barbarorum http://ultimibarbarorum.com/
Zero Hedge http://www.zerohedge.com/ (ask for Tyler Durden or Marla Singer)
The Reformed Broker http://thereformedbroker.com/
Crossing Wall Street http://www.crossingwallstreet.com/index.html
Cody Willard http://cody.blogs.foxbusiness.com/

Add to that good ideas from my readers:

Warren Mosler
Bill Cara

Now, Treasury responded to me, thanking me for the list, but said that the mainstream media bloggers already have access.  Fine with me — I was just gauging talent and reach.

The Nature of a Liquidity Trap

Go back in history over the last 25 years.  How did the Fed manufacture recoveries?  They lowered interest rates enough so that borrowers would be willing to borrow and refinance assets that had cash flow streams that were not financable in the higher interest rate environment, but financable in the lower interest rate environment.

With each successive rescue, interest rates at the trough were lower than before, inviting borrowers that were increasingly marginal to buy assets, borrowing money at cheap rates to pay them off over time.  We thought we saw the bottom, 2002-2004, but no.  The Fed Funds rate can go to zero, and what’s more the Fed can buy longer dated Treasuries, Agencies, and Mortgage Bonds, lowering interest rates on the longer end of the yield curve.  This allows even more marginal borrowers to buy assets. If they face some hiccup in their cash flow, they will default, and quickly.  If you doubt this, consider the high currently expected rate of default on FHA loans originated over the last two years.

Yes, low rates can get them to buy, but it cannot get them to hold on.  But wait, these are criticisms of the Fed, not the Treasury.  Mostly so, but what of the expensive housing tax credit  and cash for clunkers.  Those belog to the Treasury.  They are not economic programs — the costs far outweigh the benefits.  But wait.  Those shouldn’t be pinned on the Treasury; Congress, bought and paid for, are pushing these programs on behalf of their lobbyists.

If so, where is the administration to shame Congress over such behavior?  Where is the President who should press for a line-item veto?  (I like Wisconsin’s version. )  Let the Treasury, backed by Obama, ascend to the bully pulpit, and say that such programs are a waste of taxpayer dollars.

The Fed and Treasury have been able to touch of a speculative rally in financial assets, which benefits financials, but with weakness in  end-user demand, the lower rates do nothing to stimulate investment in plant and equipment.

All that said, there are three things that could go wrong here:

1. Contrary to the expectations of the Fed, inflation could rise, and cause the Fed to tighten.
2. All of the excess dollar claims could lead to greater depreciation of the dollar.
3. Defaults could cause credit spreads to widen.

Those have not gone wrong yet, but they are all threats.  More tomorrow, when I discuss difficulties with entitlement programs.

As a multi-purpose quant, I have learned over the years that it is impossible to estimate an option curve/function when the variable in question has only been “in the money” or “out of the money.”  (As an example, one can’t estimate the withdrawal function on deferred annuities because haven’t had a large sustained rise in interest rates since the product was created.)  With mortgage debt, over the last 70 years, real estate values  have never fallen enough to make default a reasonable choice until now. Thus in the past, when unemployment hit, one could sell, rather than default.  As I have said before, foreclosure typically occurs when someone is inverted on their mortgage, and a life event happens: death, divorce, disability, disaster, disemployment, change in financing terms, or deciding that it is worthless (and doing a strategic default).

But now residential real estate values have fallen.  When someone loses their job, the option to default becomes real.  Do a short sale, and give the bank a hit.

With stress-testing, the devil is in the details.  How do you turn unemployment, housing prices, etc., into losses tailored for each individual company?  Different underwriting standards can make quite a difference in the results.  I would have been more than happy to dig through detailed stress testing models.  That was my job once.

When the Treasury announced the stress-testing results, it was at  a time when the gloom was thick.  It was a positive to the market that the government would not require huge amounts of extra capital, and in most cases, no extra capital.  Thus the market rallied.

With many simple asset classes that were under stress, the Fed and Treasury offered guarantees that would enable them to easily survive the panic.  Absent the guarantees, most short assets would have been “money good,” but there would have been significant doubt for a brief time.

As I commented to a Treasury staffer after the meeting, with financing rates so cheap to buy financial debts, regardless of what kind, it is no surprise that corporate bond spreads have tightened, while there is still little lending to finance growth in the real economy.  That is why there is such a gap between Wall Street and Main Street.

Main Street sees unemployment and low capacity utilization.  Wall Street looks at bond spreads and P/Es.  Those are not the same things.  The current stimulus has emphasized healing the financial sector in an effort to avoid contagion and depression.  It does not directly address slack in the real economy.  The real economy funds the bailout of financials, but does not directly benefit.  Thus the disconnect between Main Street and Wall Street.

Many financial  measures and companies have rebounded, but little expansion has occurred in the real economy.  Even with companies that have done bond offerings, they have often used the proceeds to bolster the balance sheet, rather than expand capacity.  Safety first is the watchword.

Perhaps a change happens when companies with a lot of cash appear as takeover targets in a sluggish market.  Easier to grow market share through acquisition rather than organically, and what’s better, their cash helps pay for the deal.

Housing Initiatives

It seems that the low end of the housing market has bottomed.  Government programs have something to do with it.  The tax credit has made a difference in the short run, as has the efforts of the Fed to support the mortgage markets through the purchase of RMBS.

Mortgage modifications are advertised by the Treasury, but the results are small.  Away from that, I will say that successful modifications occur more likely when there is some degree of principal forgiveness.

Tonight, I will pick up on the risks of low interest rates in part 4.

Who was Invited?

I’ve been in touch with staffers at the Treasury.  One of them gave me a list of the invitees.  Here is the list of those invited that did not come:
Abnormal Returns
Alea
Barry Ritholtz
Clusterstock
Free Exchange at The Economist
Paul Kedrosky
Andrew Leonard
Calculated Risk
Yglesias
Megan McArdle
Mike Konczal
Baseline Scenario
Mish
The Audit at Columbia Journalism Review
Credit Slips
Prudent Investor
Brad Delong
Felix Salmon

If you were in the Treasury’s shoes, who else would you have invited?  E-mail me, or put it in the comments.  Tomorrow I will mention who I thought would have been good additional guests.

Continuing Coverage

Here is a list of posts to date on the meeting:

Friday in Vegas (Kid Dynamite):
“A Sit Down With Senior Treasury Officials – Part I”

Naked Capitalism:
“Curious Meeting at Treasury Department”

The Aleph Blog:
“My Visit to the US Treasury, Part 1″
“My Visit to the US Treasury, Part 2″

Across the Curve:
“Bond Market Open November 04 2009″

Accrued Interest:
“Financial Regulation: How Would You Have It Work?”

Michael Panzner
Treasury Officials Meet With Financial Bloggers

A Few Observations of My Own

Interfluidity
Sympathy for the Treasury

That’s all for now.  Until this evening and part 4.

Comments

1) No big deal on fewer Agencies being bought. But what if they decide to do the same to mortgage bonds? They see the bloat building up on the Fed’s balance sheet, and they are beginning to wonder how they will unwind it. The first part is easy, but it gets hard fast.

·
2) Gives us a clue as to when they will change policy. Look at:

o Labor unemployment

o Capacity utilization

o Current inflation readings

o Future inflation implied by TIPS

·
3) The FOMC appears to only look at the stock market when reading financial  conditions. Bond spreads have rallied.

·
4) The FOMC assumes that stagflation will not happen again, or that their quantitative easing does not put us in a Japan-style liquidity trap.

• If you were invited, send me an e-mail.
• Tell me why you decided not to come, if you would.

If present trends continue, I can tell you that bloggers are not pushovers for the US Treasury, but neither are they deaf or heartless.  Since my last post, here are the responses to the gathering:

• Curious Meeting at Treasury Department
• A Few Observations of My Own
• Financial Regulation: How would you have it work?
• Bond Market Opening November 03 2009 (John Jansen)

As all bloggers there will note, those from the Treasury were kind, intelligent, funny… they were real people, unlike the common tendency to demonize those in DC.  As for me, I live near DC, and I am an economic libertarian, but I have many friends at many levels inside our bloated government.

They have to do their jobs.  If there is a conspiracy, it is well-hidden.  There are simpler ways to understand the mess that comes out of national politics.  We get the result that is least offensive to the most, and pleasing to few.

We had a good discussion, but I am not the one to put myself forward.  I made some comments, but did not get to ask my questions.  My personality was not the dominant one.

What I propose to do in this series of articles is go through the main arguments of the US Treasury from the handouts that they gave us (sorry, I can’t scan them and put them out for view), and try to give a fair rendering of what they have done.  My audience is dual: I am addressing those who read me in the blogosphere, and those at the Treasury.

-=-=-=-=-==–=-==–==-=–=-==-=-=-=-=-=-

Treasury officials said that they were trying to reduce the footprint of the rescues/bailouts as much as possible, doing it at a rate that would not jeopardize the recovery.  Their goal is to put in place  regulations that will prevent future disasters once the current disaster is past.

David: Well, yeah, that’s what to do if you can.  The question is what will happen to the markets when you start to remove significant stimulus from critical areas, as I said to my pal Cody a year ago.  Much of that is not in the domain of the Treasury, but the Fed.

The Treasury understands that the troubles of 2008 came from poor credit regulation and tight coupling in the financial system.

David: we over-encouraged single family housing as a goal for Americans.  When debt was too high for cash flows from average American households to afford residential housing, the prices of housing began to fall, and the foreclosure process began, as foreclosures happen once someone is inverted on their mortgage.  Residential real estate prices overshot by a lot.  We should be surprised that there are problems now?

I would not only eliminate the tax credit for new buyers, but I would phase out the interest deduction for mortgage interest.  Get people financing with equity, not debt, even if it means the economy is sluggish for a few years.  It will bring a longer-lasting self-sustaining recovery.  Debt-based systems are inherently fragile because fixed commitments remove flexibility from the system.

To the Treasury I would say, “Markets are inherently unstable, and that is a good thing.”  They often have to adjust to severe changes in the human condition, and governmental attempts to tame markets may result in calm for a time, and a tsunami thereafter.

Those that understand chaos theory (nonlinear dynamics) were less surprised by the difficult markets that we have faced.  We saw it coming, but could not predict exactly when the system would face crisis.  Bears are often right, but with significant delays.

The government is not the majority player in the system, but is the biggest player.  At critical points their willingness to offer support helped lead to a market rebound.

Now in the actions of the government, there is some “making virtue out of necessity.”  In supporting Fannie & Freddie in February 2009, they did not have much choice, unless they were to let them fail, which might have been a good thing.  As it is, F&F seem to be black holes where the government is unlikely to recoup their investments.

As for the bank stress-testing, one can look at it two ways: 1) the way I looked at it at the time — short on details, many generalities, not trusting the results.  (Remember, I have done many such analyses myself for insurers.) or, 2) something that gave confidence to the markets when they were in an oversold state.  Duh, but I was dumb — the oversold market rallied when it learned that the Treasury had its back.

I’m tired, and that’s enough for the evening.  I’ll pick this up tomorrow.

You might have seen my fanciful post, Fallowhaven, Part 1.  I wrote that because I thought I could reveal almost nothing of my visit to the US Treasury today.  As it is, I can talk about it, but not quote any officials there, nor say who was there from the Treasury.

My surprise was that only bloggers were there.  I expected reporters from major papers, but that was not the target audience.  The closest to mainstream media would have been Megan McArdle, who presumably said she would be there (there was a placard for her), but did not show.  The rest of us were independents:

• Marginal Revolution — Tyler Cowen
• Interfluidity — Steven Randy Waldman
• Kid Dynamite’s World
• Naked Capitalism –Yves Smith
• Financial Armageddon — Michael Panzner
• Accrued Interest
• Across the Curve — John Jansen

As I write now, only John Jansen has commented on the meeting, and only briefly.  I have a lot to say about the meeting, but I can’t get it into one post.  I will spread it out over several posts, and try to explain the  views of the Treasury, are where they make sense, or not.

I appreciated being able to meet my fellow bloggers.  Putting faces to the names is special.  Would that I could bring all of the major investment/finance/economics bloggers together for a gathering.  There would be many disagreements, but it would sharpen us all.

More tomorrow –  I want to talk about the successes and failures of the current rescue, and how the Treasury views them.

Oh, there were Fannie and Freddie, also.  They each represented 1/3rd of the investment base, leaving 1/3rd to everyone else.  So at the conferences, there would be a lot of them around.  Throw a rock, hit someone from a GSE.

The tax credits made a lot of sense for Fannie and Freddie back when they were profitable.  The credits/deductions minimized their taxes.  (They had numerous tax reduction schemes, but this was a big one.)  But now Fannie and Freddie are unprofitable, and it is less than certain as to when they will ever be profitable again. It would make a lot of sense for Fannie and Freddie to sell their Affordable Housing deals to some profitable entity that can use the reduction in taxes.

I have gone through a deal like this for a former client back in 2000.  It’s complex but not impossible to do.  The problem for Fannie Mae in this case is that they are now controlled by the US Treasury, and the prospective purchaser is Goldman Sachs.  Very bad optics.  The US Treasury does not want to look like it is favoring Goldman by approving the deal, and it is conflicted in its decision, because allowing the transaction will cause the Treasury to take in less taxes, though it might increase the value of Fannie.

This is what you get for having the Government take stakes in businesses that they regulate, rather than doing a simple liquidation of a very large failed enterprise.  (Stories from NYT, WSJ)  Both business and politics end up worse off when they are not kept as separate as possible, so that the ordinary conflicts between the two stay at the level of business pushing back over regulations and the government attempting to correct business abuses.

I don’t know where this one goes.  Goldman buying the tax credits should have been a moderately complex deal, but the complex interests of the US Treasury make the matter much more difficult.  My intuition says this won’t be the last time we see a conflicted situation like this in the near term.

Fallow had the challenge with Fallowhaven’s smallness of making ends meet for the realm.  The agriculture was marginal; they could grow some crops, enough to feed all for now, but what if the realm grew?  Farming might not be enough.  Fallow encouraged two things to try to meet the challenge.  He encouraged craftsmen to take up their crafts there, taxing them lightly, but encouraging them to train others, and export their goods where possible.

His departed father encouraged learning.  He continued his father’s ways, and set up schools for the children to learn during the months they were not needed for farming.  He encouraged promising scholars to attend schools in the capital, Greyhaven, asking them to return to build Fallowhaven into a better place.

He was a happy man.  A good wife, five healthy children, with three in adulthood already.  The oldest daughter was spoken for, and he looked forward to the wedding.  The crops had been good this year, and as Fall fell, he mused saying, “God has been good.  We are ready for Winter.”

His reverie was broken by his second son Peter. “Father, a royal courier!”  Fallow arose and went to meet the courier.  Royal couriers were rare this far out from Greyhaven, and Fallow wondered what could be so big as to justify the visit.  Was the King dead?

Clad in yellow and red, the courier dismounted and said, “Where is Lord Fallow?”  Fallow waved and and said, “I am.”  The courier said, “I must speak to you privately.”  Fallow looked around, and realized that a large part of his family and servants had flooded into the area.  Who could blame them?  This didn’t happen every day.

“Come into the study in my house,” Fallow said.  The courier followed, as did Peter.  Fallow said to Peter, “Wait outside, and tell others not to bother us.”  Peter nodded as the two men entered the study.

“What is it then?” Fallow asked the courier.  The courier said, “Lord Fallow, I have an unusual request from the King.  Things are not well in the Royal Treasury.  This may surprise you, but the King has taken notice of you, and thinks you run your realm well.  He has asked that you would travel to meet the Royal Treasurer in Greyhaven, talk with him, and offer advice.”

Fallow was shocked.  “Me?  What could I do for the kingdom?  We are the least of the King’s realms.”

The courier said, “Do you despise the opinion of the King?  Come to Greyhaven and help as best you can.”

Fallow swallowed and said,  “I will order the affairs of my realm and come as quickly as I can.  When am I expected?”

The courier replied, “It took me seven days on fast horses to get here.  The Royal Treasurer expects you in two weeks.”

“I will be there.  Depend on it.” said Fallow.

“We expect nothing less,” said the courier, and he left to bring word back to Greyhaven.

As the courier left, Peter came in.  Fallow said, “Peter, get Timothy.  We are going on a journey, and he must care for the realm in my absence.”  Peter left, and brought Timothy back.  After he charged his oldest son with the care of the realm, he told Peter to get ready for a long journey — the two of them were heading for Greyhaven.

Fallow’s mind was swimming, but he knew that he needed to talk to his two closest advisors — his wife, and his chaplain/pastor.  With his wife she told him to be careful, that he was her hero, and to do everything to come back safely with Peter.

The chaplain/pastor was more direct, telling him to be careful of what he said in Greyhaven.  “We are a small realm.  Be wary of any plots they might have against us.  Remember your duty toward us, your people.”

“Old friend,” Fallow said,”Did we not grow up together as boys?  Yet we now together have charge of the realm.  Watch out for Timothy while I am gone.  I will do my best for the realm and kingdom, as God gives me strength.”

Peter came in saying, “The horses are ready, Father, and provisions laid in.”

The chaplain said, “Go with the blessing of God.”  Fallow hugged his friend, then called to his family and servants to say that he was leaving.  They poured out to say their goodbyes.  Timothy said, “I will make sure that everything is done to your standards, Father.”

Fallow said, “You will do well.  I expect nothing less.  If you have questions, listen to our pastor.”

With that, Fallow and Peter mounted their horses, and waving, set out for Greyhaven.

After my last book review, a reader asked how I was able to read so many books, given my other responsibilities.  My answer is this: I keep a book near me at all times.  When I get a break, I read a few pages.  Over a week, that means a book gets read.  That’s how I read so many books.

Onto tonight’s book: I had a number of friends that liked Nerds on Wall Street, and I liked it as well.  The book has a number of strengths.  The author explains complex financial instruments in relatively simple terms.  The same for complex trading techniques.

The author gives history and background as one that was sucked into computerized finance from a technical background that might have had him in a purer technological role.  As I read what he went through, I said to myself, “He was seven years ahead of me.”  I had my own share of innovative things that I did, but the things done in his era were bigger.

He gives reasonable explanations of how computerized trading works, and what factors they look for in designing trading systems.  He talks about the common factors that dominate trading systems, and a few that he knows of but has not published.  (He gives a taste, but does not serve up the full dish.)

Like me, he serves up a full plate of data mining disasters.  There are a lot of losses to be taken by those who think they have discovered a statistical regularity in the financial markets.  The few significant regularities make sense to seasoned observers, and are not consistent.  They pay off 70% of the time, and kill you 15% of the time.

On Wall Street, if you are really, really smart, they will hand over to you exceptionally advanced tools that you can use to destroy yourself in a unique and memorable way.  So it was for LTCM.

Quibbles

The book is badly edited.  Many elements appear multiple times with little modification.  It sometimes reads like a bunch of articles that was strung together into a book.  The editors should have tried to create something more cohesive.

The last several chapters feel like an afterthought, though many of the ideas presented there are ideas that I have suggested.  I have talked about splitting mortgages into smaller mortgages plus equity appreciation rights.  I have also suggested creating mutual banks, rather than what was done with the TARP.

All that said, the average reader will learn a lot here.  I recommend the book to those that want to dig into how the equity markets became more computerized.  For those that want to understand the same for the debt markets, that book remains to be written.

If you want to buy it, you can find it here: Nerds on Wall Street: Math, Machines and Wired Markets

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