A Close up of a Few VIPs

“VIP” is an American appellation. It stands for very important person – or people; I am not sure which. Very important people do not wait in line. They get the best tables at restaurants. And often, they get to set or influence policy – if not directly, then indirectly. A few of them were recently in news.

(i)

Not Understanding What I Hear, Not Knowing What I Write

The recently released minutes of the Federal Reserve Board shows that as late as August 2007, the Board members had no inkling about the approaching storm. The Financial Times reported the story under the heading Fed red-faced as notes reveal officials failed to grasp dangers of 2007 crisis.

The ever obsequious New York Times put a positive spin on the story and presented it as the problem of scarcity of data. We learned that one Board member had presented as evidence of weakening economic conditions his private conversation with a Wal-Mart executive who said that Mexican workers were sending less money back home. Blah, blah, blah.

Of course, no institution in the world has more facts and data about the U.S. economy than the Fed. So what blinded the Board Members was not the paucity of facts, but the inability to interpret them. The mind is an active, synthesizing and interpretive faculty. A deficiency in its interpretive dimension makes it less than whole. The interpretative deficiency we are discussing has its roots not so much in biological, but social factors: facts must be fitted into the Procrustean Bed of the official beliefs and ideologies. As these beliefs and ideologies are false, the interpretations they lead to are necessarily bunk.

Two years before the 2007 Federal Reserve Board meeting, and with the knowledge gleaned from the reading only the newspapers, this is what Nasser wrote in Vol. 3 of Speculative Capital:

The rise of credit derivatives is the latest evolution of finance capital where market and credit “dimensions” are brought together. We are currently witnessing the early stages of this development. But armed with the theory of speculative capital we can see what is happening, i.e., what is changing. We can also discern the cause, pattern and characteristics of the change. So whereas for others credit derivatives are the risk-diversifying, need-fulfilling products of an innovative Wall Street, for us they are the footprint of speculative capital on its march towards systemic crisis.

(ii)

Ditto

Speaking of inability to interpret, a couple of times in his blog Nasser mildly criticized Mohamad El-Erian’s understanding of finance. El-Erian, in case you do not know, is the CEO and co-chief investment officer (with Bill Gross) of Pimco, the largest fixed income fund in the world, with $1 trillion under management.

Both Gross and El-Erian are media darlings. Rarely a day goes by without one or both of them appearing on a TV program or penning a commentary piece in the Financial Times.

Yet, what is the quality of their comments? Here is what El-Erian, rumored to be the more intellectual of the two, wrote on January 8 in the FT:

The investment recommendations made by many financial commentators are dominated by cross-asset-class relative valuation rather than the fundamentals of the investment. A typical refrain runs something like this: buy X because it is cheaper than other things out there.

This is an understandable approach, as unusual central bank activism has artificially elevated certain asset prices. Yet the dominance of this increasingly popular advice comes with potential risks that need to be well understood and well managed.

In talking about the “domination” of “cross-asset-class relative valuation”, our man is describing the modus operandi of speculative capital. Nasser developed a theory and wrote a series of books on that. From his Vol. 1 (1999):

Speculative capital is massive in size. It grazes on the spreads and brings volatility to markets … Because speculative capital was hidden from the view, the cause of this volatility remained a mystery. Markets seemed increasingly irrational.

What can you really know about a stock when its value seesaws 10% or 15% in the space of a week or less for no apparent reason? Not much, say some perplexed investors. With the stock market embroiled in some of the most volatile moves in years, it is getting increasingly difficult for money managers to plan and execute their strategies. (Wall Street Journal, November 24, 1997, p. C1)

And:

Rising volatility is worrisome, if only because people who are paid to study such things have no clear answers as to why it is happening now. (New York Times, August 31, 1997, p. F4)

Nevertheless, fund managers must deliver results. Staying on the sidelines on account of volatility is not an option. What can they do if stocks are volatile and drop for no apparent reason? The answer is that they discover “relative value” trading. A news story in the Wall Street Journal captured this crucial shift in stock trading strategy:

[Mr. Schermerhorn who manages $4 billion] also scorns the growing emphasis on “relative” valuation, comparing a company’s P/E ratio with those of other companies in the sector, rather than absolute valuations or historical levels. But other investors concede they are reluctantly having to pay more attention to relative valuation. “Lately, if you’d used almost any kind of absolute-valuation guidelines, you’d have kept out of this market altogether, and missed a lot of the bull market,” sighs Mr. Jandrain [who manages a stock fund]. “The reality is that we’re still at record [valuation] levels historically by nearly every measure, and you have to look for pockets of relative value.” (Wall Street Journal, November 24, 1997, p. C1)

“Rrelative value” trading – comparing one stock against similar stocks – is arbitrage trading. Mr. Jandrain … is being forced to disregard forecasting, i.e., individual stock analysis with an eye to estimating its future growth, in favor of buying relatively undervalued or selling relatively overvalued stocks. He calls that “looking for pockets of relative value.” But arbitrage by any name is arbitrage. In his quest for pockets of relative value in the equities market, Jandrain has assigned his fund to the ranks of speculative capital, thus guaranteeing that relative value trading, and, with it, the volatility of the stock market, will increase.

Such is the impact of speculative capital on financial markets: fund managers reluctantly joining a trend which they abhor and whose dynamics they do not understand. In the process, they push stock market even higher. Those traders who position themselves to profit from a decrease in P/E ratios get clobbered.

Relative value trading, rise in the market volatility, rise in high-frequency trading, synchronization of the markets across countries, correlation of assets classes (bonds, stock, commodities) as a result of which they all move up and down at the same time (and render diversification for the purpose of hedging pointless) and finally, globalization have but one common cause: speculative capital. El-Erian sees every one of those causes and can dispense expert advice about the best trading strategies under each condition. What he cannot do is see the larger force that links them all together. That is why he could never see what is about to come not matter how hard he looks – or thinks.

(iii)

The Chief of the Naval Operations of Afghanistan

What would you say, and how would you react, if the man sitting next to you on a plane introduced himself as the chief of naval operations of Afghanistan?

Why, you would laugh. You might not actually say anything in consideration of etiquette, but you would involuntarily chortle. Afghanistan, after all, is a land locked country; I am not sure it even has a lake. So the idea of it having a chief of naval operations is prime facie absurd. How could the position even exist and what kind of an ass would accept it if he were offered?

Now, what would you say, and how would you react, if someone introduced himself as the Ireland pension ombudsman?

If you are not sure, see the above. The catch is that this position, unbelievably, does exist and is currently occupied by one Paul Kenny.

Why unbelievably? Because conceptually, an Ireland pension ombudsman is as absurd as an Afghanistan chief of naval operations. What makes the two comparable is that there is exactly the same number of protections for workers’ pensions in Ireland that there is access to open seas in Afghanistan.

From the Financial Times of January 3, under the heading Aer Lingus pension move sheds light on Ireland’s woes:

Under Irish law there is little oversight of the pensions sector and no safety net for workers. Solvent employers with underfunded schemes can wind them up and walk away.

Solvent employers with underfunded schemes – underfunded because they, the employers, have chosen not to put money into the fund – can wind them up and walk away. Just like that.

Note also the word “scheme”. There was a time pension plans were called plans. Now the FT, with its editors’ British sensitivity to words, calls them schemes. Here is the difference between plans and schemes:

“We know from what the Pensions Board has said that 80 per cent of defined benefit pensions schemes in Ireland are technically insolvent,” says Paul Kenny, Ireland pension ombudsman.... But the real issue, analysts say, is whether Irish politicians are prepared to force already hard-pressed businesses to top up the underfunded pensions.

Jim Kelly, regional secretary with the Unite trade union, said companies were using the economic crisis in Ireland as an excuse to close their defined benefit schemes and in some cases to try to get out of providing any pension to workers.

“In the current difficult economic climate businesses are putting more emphasis on their own viability than on their employees’ entitlements,” Mr Kelly said. “This will end up being a disaster for the future. It is only when we get out of this crisis that we will see the real tragedy that has occurred for workers.

(iv)

A Sad, Sad Woman

I am talking about Ruth Porat who is being considered for the No. 2 spot at the Treasury.

Ruth is quite a go-getter: Stanford, Wharton, what have you. A 2010 New York Times laudatory profile quoted he colleagues who said that she was “a tireless worker”. That turned out to be an understatement:

In 1992, during the birth of her first son, she was on the phone in the delivery room making client calls. And in her spare time she, along with her husband, a lawyer, renovate and sell New York City apartments.

Ms. Meeker, the godmother to each of Ms. Porat’s three sons, remembers one meeting with management at the media company Ziff Davis where Ms. Porat threw her back out. “Instead of leaving she laid on the boardroom table and continued on with the presentation,” Ms. Meeker said.

Ruth Porat reminds me of the Ugly – of The Good, The Bad, The Ugly fame – who, trying to entice his fellow thieves, asked them: If you work to live, then why kill yourself working?

The Ugly knew a thing or two about work-life balance.

Yet, there is another angle here beyond obsession with work and money that the Porats, renovating and selling fixed-it-uppers in their “spare time”, cannot hide.

Imagine – visualize – a woman lying in pain on her back on a table in a boardroom full of people and giving a PowerPoint presentation. Can you imagine a man doing it? A George Soros? A Tim Geithner?

Imagine making client calls when you are about to deliver a baby.

Can you top these scenes in obscenity?

There are different ways for the underdogs to put up a defense. Jean Genet gave us one in Our Lady of the Flowers: “If I declare that I am an old whore, no one can better that, I discourage insult.”

Ruth Porat is playing a variation of the same theme. She discourages criticism by being obscene herself. But the whole thing stinks: her behavior and the conditions that make her to behave the way she does. That she acts on her own “free will” only adds insult to the injury. There is an Exhibit A of “internalizing the external conditions” if there ever was one.