Dickson G. Watts - Speculation As a Fine Art and Thoughts on Life

1. Never over trade
2. Never reverse a position and go the other way.
3. Run Quickly or not at all.
4. Reduce your position when doubtful.
5. It is better to average up than down in a position (I completely agree)
6. Do not ignore public opinion.
7. Sell in weak markets.
8. Always factor in chance in your trading.

link

Quotable quotes

 (1) sex is kind of a nuisance, so why not find something else to do with the energy instead; and (2) all human relationships are to some degree transactional or parasitical, so don't take it personally  - Roger Ebert
link

绝句漫兴九首

年代：唐
作者：杜甫
作品：绝句漫兴九首
内容：

眼见客愁愁不醒，无赖春色到江亭。
即遣花开深造次，便觉莺语太丁宁。

手种桃李非无主，野老墙低还似家。
恰似春风相欺得，夜来吹折数枝花。

熟知茅斋绝低小，江上燕子故来频。
衔泥点污琴书内，更接飞虫打著人。

二月已破三月来，渐老逢春能几回。
莫思身外无穷事，且尽生前有限杯。

肠断春江欲尽头，杖藜徐步立芳洲。
颠狂柳絮随风去，轻薄桃花逐水流。

懒慢无堪不出村，呼儿日在掩柴门。
苍苔浊酒林中静，碧水春风野外昏。

糁径杨花铺白毡，点溪荷叶叠青钱。
笋根稚子无人见，沙上凫雏傍母眠。

舍西柔桑叶可拈，江畔细麦复纤纤。
人生几何春已夏，不放香醪如蜜甜。

隔户杨柳弱袅袅，恰似十五女儿腰。
谁谓朝来不作意，狂风挽断最长条。

百度

first post

this is a test post! is it working?

HDR settings

ISO 80,AV set at F/3.5. Auto bracketing,0,-2,+2 shot in RAW. Three RAW exposures straight into Photomatix and then the fun begins! I tend to use low strength tonemapping around 40ish and work with the other settings to try and get some realism. save as 16bit Tiff and then finish off with some curves maybe selective colours and USM in CS3.

 

From here

转贴 ：師大夜市好店不私藏

转贴 ：師大夜市好店不私藏

04/09/10 – 在这间店买了格子上衣

Taiwan 10

Thursday 02 Sept – 12pm touchdown. 2pm Railway station. Jiufen in the afternoon, Shilin at night

Friday 03 Sept - 6.45am ziqiang to Chiayi. 10.30am bus to Alishan. 12.30pm arrived.

Saturday 04 Sept - 3.30am sunrise train. 10am bus to Chiayi. 12pm HSR to Taipei. 2pm Raohe, Wufenpu. 101 area in evening. Shida at night

Sunday 05 Sept - Dong Qu in late morning. Museum in afternoon. Ximending at night, Shida at night

Monday 06 Sept - Railway station cakes in morning. Beitou Spa at noon. Ximending for lunch and gifts. 2.30pm at railway to pickup cakes. 3pm on bus and goodbye to Taiwan

The non blues

What goes well with grey jeans?

The Lehman Report

Beancounters in a bind

Mar 18th 2010 | NEW YORK
From The Economist print edition

Banks’ professional advisers come under scrutiny

IF SUNSHINE really is the best disinfectant, the 2,200-page report into Lehman Brothers’ downfall by its court-appointed bankruptcy examiner may do more to clean up finance than any number of new regulations. It paints a remarkably detailed, and damning, picture of Dick Fuld, Lehman’s ex-boss, and the executives around him. Their spectacularly ill-advised strategy was to take on oodles more risk in property just as everyone else was running the other way. Risk management was risible, with risk limits raised whenever they were breached and dodgy investments excluded from stress tests.

Lehman’s former leaders are not the only ones squirming in the glare. Some of its counterparty banks get a slap on the wrist for changing the terms of their collateral demands, for instance. But the strongest criticism of those who interacted with the flailing firm is reserved for Lehman’s auditor, Ernst & Young (E&Y), for failing to “question and challenge improper or inadequate disclosures”. The main “accounting gimmick” hidden from investors, but apparently known to the auditor, was called Repo 105. This technique helped the firm flatter its numbers by temporarily moving assets off its balance-sheet at the end of each quarter. Lawyers are also in the spotlight: unable to find an American law firm to approve the transaction as a “true sale” of assets, Lehman got the nod from Linklaters in London. Both E&Y and Linklaters deny any wrongdoing.

Although Repo 105 appears to have been in line with American accounting standards, its effect was to deceive. The technique allowed Lehman to reduce its reported leverage substantially and thus avoid ruinous ratings downgrades as it fought for survival. Investors would like to think that auditors consider not just the letter of the rules but their spirit, too. The examiner concluded that there was enough evidence to support a case for malpractice against E&Y.

The report identifies two other aspects to E&Y’s involvement. Lehman used subjective, inconsistent methods to value its illiquid assets. The examiner raises numerous questions about the auditor’s scrutiny of those “marks”, though he finds no evidence of deliberate misvaluation. Secondly, he accuses E&Y of failing properly to investigate claims about Repo 105 by a whistleblower, or to report these to the company’s audit committee (a claim which E&Y disputes).

All of which threatens to dent E&Y’s credibility and, perhaps, lighten its pockets. Class-action suits may follow. Lehman’s trustee could sue to recover losses suffered by creditors, who are seeking more than $800 billion in (at the last count) 64,000 separate claims. Nobody expects E&Y to suffer the same fate as Andersen, whose work for Enron led to its break-up in 2002, reducing the Big Five global accounting firms to four. But the industry, which had to swallow a raft of reforms, including Sarbanes-Oxley, after that scandal, could face calls for further tightening if similar tactics are exposed elsewhere.

Lehman is unlikely to be an isolated case, argues Prem Sikka, an accounting professor at the University of Essex, because “the guards are in bed with the prisoners.” Like rating agencies, auditors suffer from a potential conflict of interest because they are paid by those they judge (and can still tout for other work from them, despite post-Enron restrictions). E&Y’s annual bill for Lehman was $31m. With such big fees on the line, there may be a temptation to wave through practices that meet the rules but present a misleading picture of a client’s financial health.

Economist link

Municipalities and derivatives

Cities in the casino

Mar 18th 2010 | BERLIN
From The Economist print edition

A derivatives farce makes its way to court in Milan. Others are sure to follow

ONE of the great advantages of financial innovation, it was often said, was that risk would end up going to those best qualified to hold it. In fact, much of it seems to have ended up in the hands of those least able to understand it. How some of it got there may soon be revealed in an Italian court. On March 17th four big banks, 11 bankers and two former city officials were charged with fraud in connection with the sale of interest-rate derivatives to the city of Milan. The trial is due to start in May.

The prosecution relates to a huge bet on interest rates that the four banks—UBS, JPMorgan Chase, Deutsche Bank and Hypo Real Estate’s DEPFA unit—helped the city authorities to take in 2005. The banks helped arrange the sale of €1.7 billion ($2.3 billion) of bonds for the city and then also helped it swap the fixed interest rate it was paying on the bonds for a lower, floating rate. Part of the contract is thought to have involved a “collar”, a way of limiting the range of outcomes on a bet, which protected Milan from rising rates but which also meant it would have to pay out if they fell.

The city claims that it was originally promised interest savings of about €60m on the deal but has now made big losses because interest rates have fallen, triggering payments to the banks. Bankers with knowledge of the transaction claim that, in fact, the city has benefited from offsetting gains as the interest rate it pays on the underlying debt has fallen too. The prosecution also claims that the banks charged more than €100m in fees that were built into the price of the swaps and were not properly disclosed to city officials. The banks all deny any wrongdoing.

The outcome of the case will be closely watched elsewhere. In Italy alone, local municipalities had derivatives exposures with a face value of €25 billion last year, according to the Bank of Italy. Some academics reckon that losses on these may go as high as €8 billion. In many of these cases local authorities swapped fixed rates for floating ones, only for collars incorporated into the deals to leave them with losses as interest rates fell. In other cases, losses may only start to show when rates move the other way. Had their bets paid off, however, it seems unlikely that any cities would be crying foul.

Other egregious examples of financial incompetence can be found in nearby Germany, where scores of public authorities also signed contracts that they seem not to have understood. In Leipzig the courts have been asked to rule in a dispute between the city and UBS. That case relates to a complex sale-and-leaseback agreement that the city signed for its local waterworks. Part of the deal reportedly entailed the city agreeing to insure a portfolio of loans against default through a collateralised-debt obligation (CDO). Making good on those loans may bankrupt the city.

In all, about 100 German local authorities are thought to have entered into sale-and-leaseback agreements with American investors over the past decade in a bid to take advantage of loopholes in tax laws. In many of these deals local municipalities unwittingly agreed to take on credit risks for various counterparties, exposing them to demands for collateral as the ratings of institutions such as AIG, an American insurer, fell.

Municipalities in America are also grappling with derivative contracts they barely understand. The city of Los Angeles is pressing Bank of New York Mellon to soften the terms of an interest-rate swap on $443m of bonds that is costing the city money because rates fell. And Jefferson County in Alabama is teetering on the edge of bankruptcy after it entered into swaps that were worth more than $5.4 billion at their peak.

Sorting out this mass of claims and counterclaims will keep lawyers busy for decades. In the meantime, cities can expect to have less room for financial manoeuvre. On March 11th Italy’s Senate Finance Committee endorsed proposals that will restrict the use of derivatives by municipalities. It will, for instance, force them to get an opinion on a proposed deal from the Economy Ministry and require them to prove that a transaction would leave them better off than simply repaying their current debt. To keep dancing, high finance and low-level bureaucrats may need a chaperone.

Economist link

Favourite Chopin

Nocturnes op.9. Nº2
Nocturne in C sharp minor op.posth.
Nocturne in C Minor, Op. 48 No. 1

Impromptus. Nº4 (Fantaisie-Impromptu) in C sharp minor op.posth.66.
Nocturne in E minor op.posth.72 Nº1.

A postmortem on Lehman Brothers

A postmortem on Lehman Brothers
Oh, brother

Mar 12th 2010
From Economist.com

Shining a harsh light on Lehman’s bankruptcy

IT SOUNDS distinctly unpromising. A nine-volume, 2,200-page report by a court-appointed examiner into the causes of Lehman Brothers’ bankruptcy, published on Thursday March 11th, has a table of contents that lasts for 38 pages. Its most exciting finding relates to an off-balance-sheet accounting gimmick. But the work of Anton Valukas, the chairman of Jenner & Block, a law firm, is crisp, clear and explosive.

Mr Valukas and his team took more than a year to research their report. They collected more than 5m documents and reviewed an estimated 34m pages of information. Looking at Lehman’s IT systems was a particular challenge. The firm had a rat’s nest of more than 2,600 systems and applications at the time it went bust; Mr Valukas boiled that down to the 96 most relevant ones, some of which are now operated by Barclays (the buyer of Lehman’s American arm after the holding company failed). He also conducted more than 250 informal interviews, many of them with Lehman’s directors and most senior executives.

The report’s juiciest finding relates to Lehman’s use of an accounting device called Repo 105, which allowed the bank to bring down its quarter-end leverage temporarily. Repurchase (“repo”) agreements, whereby borrowers swap collateral for cash and agree to buy the collateral back later at a small premium, are a very common form of short-term financing. They normally have no effect on a firm’s overall leverage: the borrowed cash and the obligation to repurchase the collateral balance each other out.

But Repo 105 took advantage of an accounting rule called SFAS 140, which enabled Lehman to reclassify such borrowing as a sale. Lehman would give collateral to its counterparty and receive cash in return. Because the deal was being recorded as a sale, the collateral disappeared from Lehman’s balance-sheet and the bank used the cash it generated to pay down debt. To outsiders, it looked as though Lehman had reduced its leverage. In fact, the obligation to buy back the collateral remained. Once the quarter-end had come and gone, Lehman borrowed money to repay the cash and buy back the collateral, and its leverage spiked back up again.

Mr Valukas marshals plenty of evidence to back up his claim that “Lehman painted a misleading picture of its financial condition”. The effect of Repo 105 was material: the firm temporarily removed around $50 billion-worth of assets at the end of the first and second quarters of 2008, a time when market jitters about its leverage were pervasive (see table below). Mr Valukas can see no legitimate business reason to undertake the transaction, which was more expensive than a normal repo financing and had to be done through its London-based arm because Lehman was unable to get an American lawyer to agree that Repo 105 involved a true sale of assets.

He also uncovers all sorts of unguarded e-mail traffic about the practice, which employees variously described as “window-dressing” and an “accounting gimmick”. Bart McDade, who became president of Lehman in June 2008 and tried to stop the bank from being so aggressive in its use of Repo 105, described it in April of that year as “another drug we r [sic] on”. Mr Valukas believes that “colourable claims”—meaning a plausible legal claim for damages—could be brought against Dick Fuld, the firm’s boss, and three of Lehman’s chief financial officers for filing “materially misleading” quarterly reports. He also thinks that Ernst & Young, Lehman’s auditor, has a case to answer for allowing these reports to go unchallenged.

Whether the report will actually lead to lawsuits remains to be seen. Mr Fuld says he did not know about the Repo 105 transactions; Ernst & Young says that Lehman’s reporting was in line with accounting principles. But even if executives were not breaching their fiduciary duties, the examiner’s report gives Lehman’s creditors and shareholders an awful lot of other reasons to feel aggrieved.

 
Lehman's liquidity pool was not that liquid, after all 
As well as his findings on Repo 105, Mr Valukas describes how Lehman’s liquidity pool, which was designed to allow the bank to survive in stressed financial conditions for 12 months, contained cash and securities that had been assigned as collateral to its clearing banks, which grew increasingly nervous about doing business with Lehman. On September 10th 2008, just five days before it filed for bankruptcy, Ian Lowitt, the bank’s chief financial officer at the time, told investors that its liquidity pool remained strong at $42 billion. Yet an internal document from September 9th showed that it had a “low ability to monetise” almost 40% of the assets involved. The liquidity pool was not that liquid, after all.

Mr Valukas also draws back the curtain on the decisions that led Lehman into trouble in the first place. Lehman’s chiefs signally failed to see the potential contagion from the subprime implosion. In its pursuit of growth, the firm’s overall risk appetite was repeatedly increased and limits on the size of single leveraged-loan transactions were routinely ignored. Incredibly, stress tests failed to include many of Lehman’s most illiquid assets. Even when executives began to understand the scale of the risks they were taking, they kept taking on business rather than walk away from deals. Board directors were unaware for several months in 2007 that Lehman had breached its risk-appetite limit. They also did not know that executives had used a new methodology, based on aggressive revenue projections, to increase that risk-appetite threshold again in January 2008. And so on, for page after damning page.

Mr Valukas’s conclusion is that Lehman’s aggressive growth strategy and its approach to risk reflected “serious but non-culpable errors of business judgment” rather than any breach of fiduciary duties. But the stain on the reputation of the bank’s executives and directors has grown even larger.

Economist link

Repo 105

Posted by Tracy Alloway on Mar 12 08:05.

Think window-dressing on a massive, and possibly misleading, scale.

Much of the 2,200-page Examiner’s report into the Lehman Brothers bankruptcy centres around an “accounting gimmick” used by the bank, and signed off by auditors Ernst & Young, to reduce leverage.

That would be Repo 105 and Repo 108 — or Repo 105 for short.

And it/they worked like this, according to Volume III of the report:

Lehman employed off‐balance sheet devices, known within Lehman as “Repo 105” and “Repo 108” transactions, to temporarily remove securities inventory from its balance sheet, usually for a period of seven to ten days, and to create a materially misleading picture of the firm’s financial condition in late 2007 and 2008.

Repo 105 transactions were nearly identical to standard repurchase and resale (“repo”) transactions that Lehman (and other investment banks) used to secure short‐term financing, with a critical difference: Lehman accounted for Repo 105 transactions as “sales” as opposed to financing transactions based upon the overcollateralization or higher than normal haircut in a Repo 105 transaction. By recharacterizing the Repo 105 transaction as a “sale,” Lehman removed the inventory from its balance sheet.

Lehman regularly increased its use of Repo 105 transactions in the days prior to reporting periods to reduce its publicly reported net leverage and balance sheet. Lehman’s periodic reports did not disclose the cash borrowing from the Repo 105 transaction – i.e., although Lehman had in effect borrowed tens of billions of dollars in these transactions, Lehman did not disclose the known obligation to repay the debt.2851 Lehman used the cash from the Repo 105 transaction to pay down other liabilities, thereby reducing both the total liabilities and the total assets reported on its balance sheet and lowering its leverage ratios. Thus, Lehman’s Repo 105 practice consisted of a two‐step process: (1) undertaking Repo 105 transactions followed by (2) the use of Repo 105 cash borrowings to pay down liabilities, thereby reducing leverage. A few days after the new quarter began, Lehman would borrow the necessary funds to repay the cash borrowing plus interest, repurchase the securities, and restore the assets to its balance sheet.

Lehman never publicly disclosed its use of Repo 105 transactions, its accounting treatment for these transactions . . .

You can see why Repo 105 would be a tempting thing in the midst of a brewing financial crisis.

Leverage had become a focus of the ratings agencies and was widely thought to be an indicator of bank risk, which meant Lehman would have been hell-bent on reducing its leverage — at least publicly.

At the same time prices for things like CMBS and subprime loans were falling and/or illiquid — Lehman could not have reduced its balance sheet simply by selling things off without incurring large losses.

Hence the Repo, which the bank increasingly used between 2007 and 2008 — even breaching its own internal cap on the Repo’s use (about $22bn as of summer 2006).

And the effect is pretty clear. From the report:

Hence the Examiner’s conclusion:

The Examiner concludes that there is sufficient evidence to support a colorable claim that: (1) certain of Lehman’s officers breached their fiduciary duties by exposing Lehman to potential liability for filing materially misleading periodic reports and (2) Ernst & Young, the firm’s outside auditor, was professionally negligent in allowing those reports to go unchallenged. The Examiner concludes that colorable claims of breach of fiduciary duty exist against [former CEO/CFOs] Richard Fuld, Chris O’Meara, Erin Callan, and Ian Lowitt, and that a colorable claim of professional malpractice exists against Ernst & Young.

And the response, as reported by the FT:

In a statement, Mr Fuld’s lawyer wrote: “Mr Fuld did not know what those transactions were – he didn’t structure or negotiate them, nor was he aware of their accounting treatment,” his attorney wrote in a statement.

“Furthermore, the evidence available to the examiner shows that the Repo 105 transactions were done in accordance with an internal accounting policy, supported the legal opinions and approved by Ernst & Young, Lehman’s independent outside auditor.”

E&Y said in a statement: “Our opinion indicated that Lehman’s financial statements for that year were fairly presented in accordance with Generally Accepted Accounting Principles (GAAP), and we remain of that view.”

Mr Lowitt’s attorney said in a statement: “In the three months during which he held the job, Mr Lowitt worked diligently and faithfully to discharge all of his duties as Lehman’s CFO, Any suggestion that Mr Lowitt breached his fiduciary duties is baseless.”

Mr O’Meara could not be reached for comment. A lawyer representing Ms Callan declined comment . . .

via FT

First impressions of Jetbook Lite

Arrived today with my other books loot from Amazon.

The JBL is my first ebook reader, initial impressions are good.

- Roughly the size of a paper back, much thinner of course. Handy, the portruding battery compartment serving as a grip

- The text show well on the screen, easier to look at than text on a computer LCD screen. I prefer the LED screen to an e-ink display, the former doesn’t suffer from the blackout screen and refresh lag in between page scrolls. However the battery life is said to be much shorter, waiting to see how the eneloop lite batteries hold up.

- Controls feel simple and intuitive so far. The scroll bar is nicely placed on the left, allows one hand operation. I can grip the unit and

- The unit powers off automatically after a period of inactivity. The time is customizable, default being 5 mins. Just nice.  The unit resumes after 2-3 secs on the last viewed page of the novel after powerup, nice! This is the beauty of a dedicated ereader, i can treat it like a paperbook. Put it down when i am done reading and pick it up later to resume reading. No waiting for system startup and launching programs as i would be doing with a convergeance device such as netbooks or PCs.

- Supports multiple bookmarking for every novels. This would come handy for mystery novels especially. Adobe reader needs this feature badly.

- There is no backlight, which reduces eye fratigue when reading but is also may be a tad inconvenient on dark cast afternoon when i don’t to turn the lights on. I need to check out what clip on reading lights are there on the web stores.

- Unit comes with a selection of classics novels on the 100mb internal memory.

- First book - A Study in Scarlet :)

- No SD card bundled :(

- I bought it for 115usd at a Newegg special. This is a great price, but considering i need to pay borderlinx($10?), the eneloop lites($15), buy a pouch plus a SD card, the cost adds up.  Last i check, the Jetbook with build-in lithium-ion batteries and a pouch was selling $279.44 locally..hmm.  This is a close one. If i knew of this offer i could have bought it without waiting for shipment. It would probably has some form of local warranty too. Ah well. The ability to swap batteries will be handy on a trip, i already have cellphone and camera charging to deal with. I can share AA batteries between my iriver mp3 and the JBL too. Now thats a plus.

To do

- What size of SD card to buy?

- Where to get a nice pouch for the JBL?

- Check out reading lights

- No more excuses! This is why i bought this, time to catch up on my PDF documents reading list. Reading PDF on computers was a pain and most of the time i turned to surfing net anyway. Get off the pc and start reading!

Cab home from Changi

After midnight.

Meter = $14.40

Late night +50% = $7.20

Airport surcharge = $3.00

Total = $24.60

Symbols in batch files

'>' and '<' are special characters in command prompt. They means input and output redirect. So they can't be directly echoed in command prompt. You need to escape them with '^'. 

C:\>echo <
The syntax of the command is incorrect.

C:\>echo ^<
<

This is mentioned in http://www.microsoft.com/windowsxp/home/using/productdoc/en/default.asp?url=/windowsxp/home/using/productdoc/en/ntcmds_shelloverview.asp

The following characters are special and have to be escaped:
<, >, |, &, or ^,

via MSDN blog

Fighting sore throats and cough

• Tussil Five – good for suppressing cough. Tried and tested by me!
• Avoid all fruits except papaya which is good. Orange,apples and other fruits have citrus acid which aggravate the condition.
• One Eye Ah Peh Liang Teh sachets

Simple text logging with a batch file

@echo off
Cls
set /p m=Task:
echo %DATE%^|%TIME%^|%m% >> log.txt

via enrri.blog

Lifehacker - xls quicklogger

When the river runs dry

A special report on financial risk  
When the river runs dry
The perils of a sudden evaporation of liquidity

Feb 11th 2010 | From The Economist print edition

STAMPEDING crowds can generate pressures of up to 4,500 Newtons per square metre, enough to bend steel barriers. Rushes for the exit in financial markets can be just as damaging. Investors crowd into trades to get the highest risk-adjusted return in the same way that everyone wants tickets for the best concert. When someone shouts “fire”, their flight creates an “endogenous” risk of being trampled by falling prices, margin calls and vanishing capital—a “negative externality” that adds to overall risk, says Lasse Heje Pedersen of New York University.

This played out dramatically in 2008. Liquidity instantly drained from securities firms as clients abandoned anything with a whiff of risk. In three days in March Bear Stearns saw its pool of cash and liquid assets shrink by nearly 90%. After the collapse of Lehman Brothers, Morgan Stanley had $43 billion of withdrawals in a single day, mostly from hedge funds.

Bob McDowall of Tower Group, a consultancy, explains that liquidity poses “the most emotional of risks”. Its loss can prove just as fatal as insolvency. Many of those clobbered in the crisis—including Bear Stearns, Northern Rock and AIG—were struck down by a sudden lack of cash or funding sources, not because they ran out of capital.

Yet liquidity risk has been neglected. Over the past decade international regulators have paid more attention to capital. Banks ran liquidity stress tests and drew up contingency funding plans, but often half-heartedly. With markets awash with cash and hedge funds, private-equity firms and sovereign-wealth funds all keen to invest in assets, there seemed little prospect of a liquidity crisis. Academics such as Mr Pedersen, Lubos Pastor at Chicago’s Booth School of Business and others were doing solid work on liquidity shocks, but practitioners barely noticed.

What makes liquidity so important is its binary quality: one moment it is there in abundance, the next it is gone. This time its evaporation was particularly abrupt because markets had become so joined up. The panic to get out of levered mortgage investments spilled quickly into interbank loan markets, commercial paper, prime brokerage, securities lending (lending shares to short-sellers) and so on.

As confidence ebbed, mortgage-backed securities could no longer be used so easily as collateral in repurchase or “repo” agreements, in which financial firms borrow short-term from investors with excess cash, such as money-market funds. This was a big problem because securities firms had become heavily reliant on this market, tripling their repo borrowing in the five years to 2008. Bear Stearns had $98 billion on its books, compared with $72 billion of long-term debt.

Even the most liquid markets were affected. In August 2007 a wave of selling of blue-chip shares, forced by the need to cover losses on debt securities elsewhere, caused sudden drops of up to 30% for some computer-driven strategies popular with hedge funds.

Liquidity comes in two closely connected forms: asset liquidity, or the ability to sell holdings easily at a decent price; and funding liquidity, or the capacity to raise finance and roll over old debts when needed, without facing punitive “haircuts” on collateral posted to back this borrowing.

The years of excess saw a vast increase in the funding of long-term assets with short-term (and thus cheaper) debt. Short-term borrowing has a good side: the threat of lenders refusing to roll over can be a source of discipline. Once they expect losses, though, a run becomes inevitable: they rush for repayment to beat the crowd, setting off a panic that might hurt them even more. “Financial crises are almost always and everywhere about short-term debt,” says Douglas Diamond of the Booth School of Business.

Banks are founded on this “maturity mismatch” of long- and short-term debt, but they have deposit insurance which reduces the likelihood of runs. However, this time much of the mismatched borrowing took place in the uninsured “shadow” banking network of investment banks, structured off-balance-sheet vehicles and the like. It was supported by seemingly ingenious structures. Auction-rate securities, for instance, allowed the funding of stodgy municipal bonds to be rolled over monthly, with the interest rate reset each time.

The past two years are littered with stories of schools and hospitals that came a cropper after dramatically shortening the tenure of their funding, assuming that the savings in interest costs, small as they were, far outweighed the risk of market seizure. Securities firms became equally complacent as they watched asset values rise, boosting the value of their holdings as collateral for repos. Commercial banks increased their reliance on wholesale funding and on fickle “non-core” deposits, such as those bought from brokers.

Regulation did nothing to discourage this, treating banks that funded themselves with deposits and those borrowing overnight in wholesale markets exactly the same. Markets viewed the second category as more efficient. Northern Rock, which funded its mortgages largely in capital markets, had a higher stockmarket rating than HSBC, which relied more on conventional deposits. The prevailing view was that risk was inherent in the asset, not the manner in which it was financed.

At the same time financial firms built up a host of liquidity obligations, not all of which they fully understood. Banks were expected to support off-balance-sheet entities if clients wanted out; Citigroup had to take back $58 billion of short-term securities from structured vehicles it sponsored. AIG did not allow for the risk that the insurer would have to post more collateral against credit-default swaps if these fell in value or its rating was cut.

Now that the horse has bolted, financial firms are rushing to close the door, for instance by adding to liquidity buffers (see chart 4). British banks’ holdings of sterling liquid assets are at their highest for a decade. Capital-markets firms are courting deposits and shunning flighty wholesale funding. Deposits, equity and long-term debt now make up almost two-thirds of Morgan Stanley’s balance-sheet liabilities, compared with around 40% at the end of 2007. Spending on liquidity-management systems is rising sharply, with specialists “almost able to name their price”, says one banker. “Collateral management” has become a buzzword.
Message from Basel

Regulators, too, are trying to make up for lost time. In a first attempt to put numbers on a nebulous concept, in December the Basel Committee of central banks and supervisors from 27 countries proposed a global liquidity standard for internationally active banks. Tougher requirements would reverse a decades-long decline in banks’ liquidity cushions.

The new regime, which could be adopted as early as 2012, has two components: a “coverage” ratio, designed to ensure that banks have a big enough pool of high-quality, liquid assets to weather an “acute stress scenario” lasting for one month (including such inconveniences as a sharp ratings downgrade and a wave of collateral calls); and a “net stable funding” ratio, aimed at promoting longer-term financing of assets and thus limiting maturity mismatches. This will require a certain level of funding to be for a year or more.

It remains to be seen how closely national authorities follow the script. Some seem intent on going even further. In Switzerland, UBS and Credit Suisse face a tripling of the amount of cash and equivalents they need to hold, to 45% of deposits. Britain will require all domestic entities to have enough liquidity to stand alone, unsupported by their parent or other parts of the group. Also controversial is the composition of the proposed liquidity cushions. Some countries want to restrict these to government debt, deposits with central banks and the like. The Basel proposals allow high-grade corporate bonds too.

Banks have counter-attacked, arguing that “trapping” liquidity in subsidiaries would reduce their room for manoeuvre in a crisis and that the buffer rules are too restrictive; some, unsurprisingly, have called for bank debt to be eligible. Under the British rules, up to 8% of banks’ assets could be tied up in cash and gilts (British government bonds) that they are forced to hold, reckons Simon Hills of the British Bankers Association, which could have “a huge impact on business models”. That, some argue, is precisely the point of reform.

Much can be done to reduce market stresses without waiting for these reforms. In repo lending—a decades-old practice critical to the smooth functioning of markets—the Federal Reserve may soon toughen collateral requirements and force borrowers to draw up contingency plans in case of a sudden freeze. Banks that clear repos will be expected to monitor the size and quality of big borrowers’ positions more closely. The banks could live with that, but they worry about proposals to force secured short-term creditors to take an automatic loss if a bank fails.

Another concern is prime brokerage, banks’ financing of trading by hedge funds. When the market unravelled, hedge funds were unable to retrieve collateral that their brokers had “rehypothecated”, or used to fund transactions of their own; billions of such unsegregated money is still trapped in Lehman’s estate, reducing dozens of its former clients to the status of unsecured general creditors. Brokers suffered in turn as clients pulled whatever funds they could from those they viewed as vulnerable. Temporary bans on short-selling made things even worse, playing havoc with some hedge funds’ strategies and leaving them scrambling for cash. Regulators are moving towards imposing limits on rehypothecation.

Early reform could also come to the securities-lending market, in which institutional investors lend shares from their portfolios to short-sellers for a fee. Some lenders—including, notoriously, AIG—found they were unable to repay cash collateral posted by borrowers because they had invested it in instruments that had turned illiquid, such as asset-backed commercial paper. Some have doubled the share of their portfolios that they know they can sell overnight, to as much as 50%.

Regulators might consider asking them to go further. Bond markets, unlike stockmarkets, revolve around quotes from dealers. This creates a structural impediment to the free flow of liquidity in strained times, argues Ken Froot of Harvard Business School, because when dealers pull in their horns they are unable to function properly as market-makers. He suggests opening up access to trade data and competition to quote prices. Some senior figures at the Fed like the idea, as do money managers, though predictably dealers are resisting.
Twin realities

The other brutal lesson of the crisis concerns the way liquidity can affect solvency. In a world of mark-to-market accounting, a small price movement on a large, illiquid portfolio can quickly turn into crippling paper losses that eat into capital. Highly rated but hard-to-shift debt instruments can finish you off before losses on the underlying loans have even begun to hurt your cash flows. If markets expect fire sales, potential buyers will hold off for a better price, exacerbating fair-value losses.

In future banks will be more alert to these dangers. “We were looking at the bonds we held, focusing on the credit fundamentals. We lost sight of the capital hit from illiquidity and marking to market that can seriously hurt you in the meantime,” says Koos Timmermans, chief risk officer at ING, a large Dutch banking and insurance group. “We now know that you have to treat the accounting reality as economic reality.”

Another lesson is the “opportunity value” of staying liquid in good times, says Aaron Brown, a risk manager with AQR, a hedge fund. In an efficient market dollar bills are not left lying around. But in the dislocated markets of late 2008 there were lots of bargains to be had for the small minority of investors with dry powder.

For some, though, bigger liquidity problems may yet lie ahead. Some $5.1 trillion of bank debt rated by Moody’s is due to mature by 2012. This will have to be refinanced at higher rates. The rates could also be pushed up by an erosion of sovereign credit quality, given implicit state guarantees of bank liabilities. And, at some point, banks face a reduction of cut-price liquidity support from central banks—offered in return for often dodgy collateral—which has buoyed their profit margins. Mortgage borrowers on teaser rates are vulnerable to payment shock. So too are their lenders.

Economist article

Number-crunchers crunched

A special report on financial risk
Number-crunchers crunched
The uses and abuses of mathematical models

Feb 11th 2010 | From The Economist print edition

IT PUT noses out of joint, but it changed markets for good. In the mid-1970s a few progressive occupants of Chicago’s options pits started trading with the aid of sheets of theoretical prices derived from a model and sold by an economist called Fisher Black. Rivals, used to relying on their wits, were unimpressed. One model-based trader complained of having his papers snatched away and being told to “trade like a man”. But the strings of numbers caught on, and soon derivatives exchanges hailed the Black-Scholes model, which used share and bond prices to calculate the value of derivatives, for helping to legitimise a market that had been derided as a gambling den.

Thanks to Black-Scholes, options pricing no longer had to rely on educated guesses. Derivatives trading got a huge boost and quants poured into the industry. By 2005 they accounted for 5% of all finance jobs, against 1.2% in 1980, says Thomas Philippon of New York University—and probably a much higher proportion of pay. By 2007 finance was attracting a quarter of all graduates from the California Institute of Technology.

These eggheads are now in the dock, along with their probabilistic models. In America a congressional panel is investigating the models’ role in the crash. Wired, a publication that can hardly be accused of technophobia, has described default-probability models as “the formula that killed Wall Street”. Long-standing critics of risk-modelling, such as Nassim Nicholas Taleb, author of “The Black Swan”, and Paul Wilmott, a mathematician turned financial educator, are now hailed as seers. Models “increased risk exposure instead of limiting it”, says Mr Taleb. “They can be worse than nothing, the equivalent of a dangerous operation on a patient who would stand a better chance if left untreated.”

Not all models were useless. Those for interest rates and foreign exchange performed roughly as they were meant to. However, in debt markets they failed abjectly to take account of low-probability but high-impact events such as the gut-wrenching fall in house prices.

The models went particularly awry when clusters of mortgage-backed securities were further packaged into collateralised debt obligations (CDOs). In traditional products such as corporate debt, rating agencies employ basic credit analysis and judgment. CDOs were so complex that they had to be assessed using specially designed models, which had various faults. Each CDO is a unique mix of assets, but the assumptions about future defaults and mortgage rates were not closely tailored to that mix, nor did they factor in the tendency of assets to move together in a crisis.

The problem was exacerbated by the credit raters’ incentive to accommodate the issuers who paid them. Most financial firms happily relied on the models, even though the expected return on AAA-rated tranches was suspiciously high for such apparently safe securities. At some banks, risk managers who questioned the rating agencies’ models were given short shrift. Moody’s and Standard & Poor’s were assumed to know best. For people paid according to that year’s revenue, this was understandable. “A lifetime of wealth was only one model away,” sneers an American regulator.

Moreover, heavy use of models may have changed the markets they were supposed to map, thus undermining the validity of their own predictions, says Donald MacKenzie, an economic sociologist at the University of Edinburgh. This feedback process is known as counter-performativity and had been noted before, for instance with Black-Scholes. With CDOs the models’ popularity boosted demand, which lowered the quality of the asset-backed securities that formed the pools’ raw material and widened the gap between expected and actual defaults (see chart 3).

A related problem was the similarity of risk models. Banks thought they were diversified, only to find that many others held comparable positions, based on similar models that had been built to comply with the Basel 2 standards, and everyone was trying to unwind the same positions at the same time. The breakdown of the models, which had been the only basis for pricing the more exotic types of security, turned risk into full-blown uncertainty (and thus extreme volatility).

For some, the crisis has shattered faith in the precision of models and their inputs. They failed Keynes’s test that it is better to be roughly right than exactly wrong. One number coming under renewed scrutiny is “value-at-risk” (VAR), used by banks to measure the risk of loss in a portfolio of financial assets, and by regulators to calculate banks’ capital buffers. Invented by eggheads at JPMorgan in the late 1980s, VAR has grown steadily in popularity. It is the subject of more than 200 books. What makes it so appealing is that its complex formulae distil the range of potential daily profits or losses into a single dollar figure.
Only so far with VAR

Frustratingly, banks introduce their own quirks into VAR calculations, making comparison difficult. For example, Morgan Stanley’s VAR for the first quarter of 2009 by its own reckoning was $115m, but using Goldman Sachs’s method it would have been $158m. The bigger problem, though, is that VAR works only for liquid securities over short periods in “normal” markets, and it does not cover catastrophic outcomes. If you have $30m of two-week 1% VAR, for instance, that means there is a 99% chance that you will not lose more than that amount over the next fortnight. But there may be a huge and unacknowledged threat lurking in that 1% tail.

So chief executives would be foolish to rely solely, or even primarily, on VAR to manage risk. Yet many managers and boards continue to pay close attention to it without fully understanding the caveats—the equivalent of someone who cannot swim feeling confident of crossing a river having been told that it is, on average, four feet deep, says Jaidev Iyer of the Global Association of Risk Professionals.

Regulators are encouraging banks to look beyond VAR. One way is to use CoVAR (Conditional VAR), a measure that aims to capture spillover effects in troubled markets, such as losses due to the distress of others. This greatly increases some banks’ value at risk. Banks are developing their own enhancements. Morgan Stanley, for instance, uses “stress” VAR, which factors in very tight liquidity constraints.

Like its peers, Morgan Stanley is also reviewing its stress testing, which is used to consider extreme situations. The worst scenario envisaged by the firm turned out to be less than half as bad as what actually happened in the markets. JPMorgan Chase’s debt-market stress tests foresaw a 40% increase in corporate spreads, but high-yield spreads in 2007-09 increased many times over. Others fell similarly short. Most banks’ tests were based on historical crises, but this assumes that the future will be similar to the past. “A repeat of any specific market event, such as 1987 or 1998, is unlikely to be the way that a future crisis will unfold,” says Ken deRegt, Morgan Stanley’s chief risk officer.

Faced with either random (and therefore not very believable) scenarios or simplistic models that neglect fat-tail risks, many find themselves in a “no-man’s-land” between the two, says Andrew Freeman of Deloitte (and formerly a journalist at The Economist). Nevertheless, he views scenario planning as a useful tool. A firm that had thought about, say, the mutation of default risk into liquidity risk would have had a head start over its competitors in 2008, even if it had not predicted precisely how this would happen.

To some, stress testing will always seem maddeningly fuzzy. “It has so far been seen as the acupuncture-and-herbal-remedies corner of risk management, though perceptions are changing,” says Riccardo Rebonato of Royal Bank of Scotland, who is writing a book on the subject. It is not meant to be a predictive tool but a means of considering possible outcomes to allow firms to react more nimbly to unexpected developments, he argues. Hedge funds are better at this than banks. Some had thought about the possibility of a large broker-dealer going bust. At least one, AQR, had asked its lawyers to grill the fund’s prime brokers about the fate of its assets in the event of their demise.

Some of the blame lies with bank regulators, who were just as blind to the dangers ahead as the firms they oversaw. Sometimes even more so: after the rescue of Bear Stearns in March 2008 but before Lehman’s collapse, Morgan Stanley was reportedly told by supervisors at the Federal Reserve that its doomsday scenario was too bearish.

The regulators have since become tougher. In America, for instance, banks have been told to run stress tests with scenarios that include a huge leap in interest rates. A supervisors’ report last October fingered some banks for “window-dressing” their tests. Officials are now asking for “reverse” stress testing, in which a firm imagines it has failed and works backwards to determine which vulnerabilities caused the hypothetical collapse. Britain has made this mandatory. Bankers are divided over its usefulness.
Slicing the Emmental

These changes point towards greater use of judgment and less reliance on numbers in future. But it would be unfair to tar all models with the same brush. The CDO fiasco was an egregious and relatively rare case of an instrument getting way ahead of the ability to map it mathematically. Models were “an accessory to the crime, not the perpetrator”, says Michael Mauboussin of Legg Mason, a money manager.

As for VAR, it may be hopeless at signalling rare severe losses, but the process by which it is produced adds enormously to the understanding of everyday risk, which can be just as deadly as tail risk, says Aaron Brown, a risk manager at AQR. Craig Broderick, chief risk officer at Goldman Sachs, sees it as one of several measures which, although of limited use individually, together can provide a helpful picture. Like a slice of Swiss cheese, each number has holes, but put several of them together and you get something solid.

Modelling is not going away; indeed, number-crunchers who are devising new ways to protect investors from outlying fat-tail risks are gaining influence. Pimco, for instance, offers fat-tail hedging programmes for mutual-fund clients, using cocktails of options and other instruments. These are built on specific risk factors rather than on the broader and increasingly fluid division of assets between equities, currencies, commodities and so on. The relationships between asset classes “have become less stable”, says Mohamed El-Erian, Pimco’s chief executive. “Asset-class diversification remains desirable but is not sufficient.”

Not surprisingly, more investors are now willing to give up some upside for the promise of protection against catastrophic losses. Pimco’s clients are paying up to 1% of the value of managed assets for the hedging—even though, as the recent crisis showed, there is a risk that insurers will not be able to pay out. Lisa Goldberg of MSCI Barra reports keen interest in the analytics firm’s extreme-risk model from hedge funds, investment banks and pension plans.

In some areas the need may be for more computing power, not less. Financial firms already spend more than any other industry on information technology (IT): some $500 billion in 2009, according to Gartner, a consultancy. Yet the quality of information filtering through to senior managers is often inadequate.

A report by bank supervisors last October pointed to poor risk “aggregation”: many large banks simply do not have the systems to present an up-to-date picture of their firm-wide links to borrowers and trading partners. Two-thirds of the banks surveyed said they were only “partially” able (in other words, unable) to aggregate their credit risks. The Federal Reserve, leading stress tests on American banks last spring, was shocked to find that some of them needed days to calculate their exposure to derivatives counterparties.

To be fair, totting up counterparty risk is not easy. For each trading partner the calculations can involve many different types of contract and hundreds of legal entities. But banks will have to learn fast: under new international proposals, they will for the first time face capital charges on the creditworthiness of swap counterparties.

The banks with the most dysfunctional systems are generally those, such as Citigroup, that have been through multiple marriages and ended up with dozens of “legacy” systems that cannot easily communicate with each other. That may explain why some Citi units continued to pile into subprime mortgages even as others pulled back.

In the depths of the crisis some banks were unaware that different business units were marking the same assets at different prices. The industry is working to sort this out. Banks are coming under pressure to appoint chief data officers who can police the integrity of the numbers, separate from chief information officers who concentrate on system design and output.

Some worry that the good work will be cast aside. As markets recover, the biggest temptation will be to abandon or scale back IT projects, allowing product development to get ahead of the supporting technology infrastructure, just as it did in the last boom.

The way forward is not to reject high-tech finance but to be honest about its limitations, says Emanuel Derman, a professor at New York’s Columbia University and a former quant at Goldman Sachs. Models should be seen as metaphors that can enlighten but do not describe the world perfectly. Messrs Derman and Wilmott have drawn up a modeller’s Hippocratic oath which pledges, among other things: “I will remember that I didn’t make the world, and it doesn’t satisfy my equations,” and “I will never sacrifice reality for elegance without explaining why I have done so.” Often the problem is not complex finance but the people who practise it, says Mr Wilmott. Because of their love of puzzles, quants lean towards technically brilliant rather than sensible solutions and tend to over-engineer: “You may need a plumber but you get a professor of fluid dynamics.”

One way to deal with that problem is to self-insure. JPMorgan Chase holds $3 billion of “model-uncertainty reserves” to cover mishaps caused by quants who have been too clever by half. If you can make provisions for bad loans, why not bad maths too?

Economist article

Debt sustainability - Not so risk-free

Debt sustainability

Not so risk-free
Feb 11th 2010
From The Economist print edition

Which countries have the biggest problems?

MARKETS have suddenly woken up to the idea that not all government debt is risk-free. There is a long and not very honourable history of sovereign default, either explicitly or implicitly via inflation and currency depreciation.

So which countries are in the biggest trouble? The ability of a government to honour its debt depends on a number of factors, in particular the size of the debt burden relative to GDP, the interest rate paid on that debt relative to the economy’s growth rate and the size of the government’s primary budget balance—the surplus, or deficit, before interest costs.

If the interest rate paid on public debt is higher than the economy’s growth rate, the stock of government debt will rise as a share of GDP unless governments run a primary budget surplus. The bigger the stock of debt, the bigger that surplus needs to be. This arithmetic suggests that countries with big primary deficits, big debt stocks and a big gap between interest rates and growth are most vulnerable.

This can be a self-fulfilling process. Investors will worry about governments’ ability to service their debt and will push up yields, making debt servicing even harder. The shorter the maturity of the debt, the quicker this problem will arise. And if the debt is denominated in a foreign currency or held largely by foreign creditors, then a debt crisis can be compounded by a currency crisis.

The table shows the main sources of vulnerability for a range of OECD countries. The first column shows each country’s primary deficit or surplus adjusted for the economic cycle. The second column shows the OECD’s forecast for each country’s net debt-to-GDP ratio in 2010. The third column measures the gap between bond yields on debt of average maturity for each country and the OECD’s forecasts for growth in 2010 and 2011. The bigger the negative number, the bigger the problem (although longer-dated debt tends to pay higher yields, so this measure may disadvantage countries which have less refinancing risk). The countries are ranked by adding together their relative league-table positions on these three measures, a rough gauge of the scale of their debt problems.

The fourth column adds another source of risk—the average time to maturity of outstanding government debt. Countries with shorter maturities are more likely to face refinancing problems than those with longer ones. Two big borrowers stand out on this measure: America, for its short debt maturities, and Britain, which can draw some comfort from the lengthy duration of its debt.

Countries that come out badly from the tables may not default, of course. Japan looks worrying on many measures, for example, but has long been able to fund itself by issuing government debt to domestic investors. America’s debt remains the sanctuary of choice when risk aversion rises. Some, like Ireland, have already taken tough decisions to get their finances under control. But as Greece and others are finding out, they will all face severe pressure from the markets to bring their deficits under control. And that may cause a political as well as a fiscal crisis.

Economist article

Appending a date to files

7z.exe a "c:\temp\onenote_%date:/=%.zip" "C:\Users\\AppData\Local\Microsoft\OneNote\12.0\Backup\Personal Notebook"

A simple way of appending a date to a backup file. It works by stripping out the '/' symbol from the date, which may not seem seem like much but always had me stumped. I found a few date scripts on the web but those were just too complicated for me.  This will be very useful for backups of Onenote, great program it might be but could really use an export data function. The program backup data automatically by default to the hidden application data folder. How difficult would it be to add that option and let folks backup their data easily? 

Another way would be to use Namedate , a program that appends dates to a specified program.