[Rhodes22-list] A bit of light at the end of the tunnel?

[Brad Haslett]

David,

That is good news!  Buffet didn't get wealthy by making stupid bets.
Attached is an article about people who did make stupid bets.  I was
encouraged by the author's praise for Vanguard since a huge chunk of
my savings is in various Vanguard funds.  Time to hunker down and ride
out the storm.

Brad

--------------------------

September 23, 2008
Keep It Simple
Posted by Karl Okamoto

When I meet someone who claims to live by just a few "tried and true"
simple rules, I tend to wrinkle my nose. How unsophisticated!
Un-nuanced! Anti-intellectual, even! After all, the world is a
complicated place. Life by platitude must, therefore, oversimplify,
over-generalize and exclude the gray areas that matter.

Oddly, though, many of the most successful people I know – successful
in all kinds of ways – from making fortunes to finding inner
peace—share a certain certainty about things. They have a few simple
rules, and they live by them.

So, for example, over the last few days I am quite certain the boring
certainty of a John Bogle (of Vanguard Group fame) is looking pretty
sophisticated. While not completely unscathed, if you followed the
standard asset diversification advice given by such unsophisticated,
old-fashioned guys like Mr. Bogle, your volatility these last few days
would have been quite tolerable. More importantly, you would be in a
position to hold on, play another day (or decade for that matter) and
see your portfolio recover and indeed prosper as good times return. In
fact, counter-intuitive as it may feel, assuming you didn't "lose your
seat" last week, you should be looking at your nest egg with an even
greater sense of ease. Last summer your nest egg was much less likely
to grow as a source of wealth for your needs than it is from here.
While I now have less of it, I am much more confident that the money I
do have will be adequate for the job I expect it to perform.

Of course, this is precisely why the Fannie Mae's, Lehman's and AIGs
of the world have gone to heck. Instead of making certain that they
would always "keep their seats" and "live to play another day," they
piled the chips on double zero and rolled the dice. They did that
because along the way they forgot to "keep it simple." Higher returns
require higher risk. "Absolute return strategies" that offer returns
above that of government bonds do not offer "absolute" returns by
definition. A simple rule tells us that. No risk, no reward. Ask any
hedge fund manager how he makes money after the world quickly
discovered the easy money one could make in the early days of
arbitrage or currency trading. He'll tell you, he takes risk.

So let me offer one more anti-intellectual suggestion. As we ponder
the regulatory solutions to the current mess, my suggestion is we keep
it simple. The reason why financial institutions blow up is the same
reason houses go into foreclosure. People take risks they cannot fully
insure. Normally people are pretty good about avoiding such extreme
positions because they understand the downside and wisely avoid it. So
if I am going to lose my 20% down payment on this condo if I can't
support next year's mortgage payments, I'll buy a cheaper one where I
am certain I can "keep my seat" in a down-turn. By appealing to
human's natural optimism and avarice while at the same time masking or
often eliminating the downside cost, the home lending market created a
"heads I win, tails who cares" environment for home buyers that
eliminated the "old fashioned" calculus that defined prudent home
buying and finance.

Similarly, both a hedge fund manager and the CEO of an investment bank
or multi-line insurer (both being not much more than a hedge fund in
some other drag), face a similar temptation. If I take cheap and
plentiful financing (put simply, borrowed money), put it into
so-called "absolute return" investments (put simply, those complicated
deals that some Math PhD can demonstrate will not lose money in any
scenario within a standard deviation of x and certainty level of y,
blah, blah, blah), I get to keep 20% of the upside (which the model
and my own natural optimism tell me is very likely to be big) or take
early retirement (or hit the beach until the next cycle of mania
comes) if it all blows up (which it probably won't). Well, hindsight
bias tells us that it was obvious this was a bad choice for Fannie,
Freddie, Lehman, Bear, etc. But put yourself into their position ex
ante if you can. It's a "no brainer." I for one, would swing and swing
hard, just like they did. Black Scholes tells me that the option value
alone of the proposition means a rational person would put as many
chips as possible on the most volatile positions he can get away with.
And that is exactly what they did.

So how do we keep it simple if we are going to "regulate" this
problem? We change this equation. Make people play with their own
money, and lose it if they are wrong. That means, for one, no bail
outs. It also means that the new transparency the world needs through
regulation is the means to better understand whether the people on the
other side of a trade have any skin in the game. It turns out, as a
simple rule has told us all along, it makes a big difference when we
deal with people with something to lose.

On Wed, Sep 24, 2008 at 12:31 AM, David Bradley <dwbrad at gmail.com> wrote:
> This may be the best news in a couple of weeks - smart money with a
> long view.  How long did it take to get over the late-80s banking/real
> estate meltdown?  (I think about 7 years before things took off again
> after Gulf War I?)  What do you think the half life will be this time
> around?
>
> Dave
>
>
>
> NEWS ALERT
> from The Wall Street Journal
>
>
> Sept. 23, 2008
>
> Goldman Sachs said it has reached an agreement to sell $5 billion of
> perpetual preferred stock to Berkshire Hathaway in a private offering.
> In addition, Goldman Sachs is raising at least $2.5 billion in common
> equity in a public offering.
>
> Berkshire Hathaway will have warrants to buy another $5 billion in
> common stock. The perpetual preferred stock will have a dividend of
> 10%.
> __________________________________________________
> To subscribe/unsubscribe or for help with using the mailing list go to http://www.rhodes22.org/list
> __________________________________________________
>