Wednesday, December 24, 2014

What is going on at Citi Bank?

Conspiracy theory at Citi Bank 

The character played by Mel Gibson in the movie conspiracy creates his blogs by connecting pairs of articles in the newspaper.  The president is in Turkey and NASA is sending up a space shuttle so there is likely to be an earthquake near Turkey when and where the president is visiting.  

Well I found these two recent articles in the paper.

My Comments:

Citi expended considerable political capital and public image because of their role in getting this change to Dodd frank done.    Why did Citi lead this charge?  Why now?   Are activities like the Chinese commodity fiasco more prevalent than realized?    Are losses larger than what has been acknowledged? 

Second article states Citibank has failed two recent Federal Reserve stress tests.   How bad are the problems at Citi?   Did Citi have an urgent need for this legislation?    

The second article points out that the bank has slimmed down by axing a life insurance unit and a brokerage unit.  The bank is still number 3 in assets and is still too large to fail or jail.   The article does not have any discussion of the size of the bank's off-balance sheet activities that can now be transferred on balance sheet.

Most major banks gain from change to Dodd-Frank.   However,  each bank has an incentive to not lobby for the change with hopes that some other bank will push and get blamed for pushing too hard.    This is a variant of the prisoner's dilemma problem.   Why did Citi push so hared for this change at this time?   Does Citi need the change more than the other actors in the industry?

Concluding thought:   Two failed stress tests and a manic high-profile push for changes in Dodd Frank.   What's happening at Citi?   

Thursday, December 11, 2014

Thoughts on the Partial Repeal of Dodd-Frank

Personal Anecdote:  In 1991, the Treasury Department was pushing legislation to move the regulator for Freddie Mac and Fannie Mae out of HUD and into an independent agency.  I was a young analyst loaned from Economic Policy to Domestic Finance to study HUD’s models

HUD had written a report claiming that Fannie Mae could survive an interest rate shock up to 24 percent or so.   I went through the model line by line and found a problem with the assumption about Fannie Mae’s portfolio.   HUD assumed that the adjustable rate mortgages in Fannie Mae’s portfolio were pure ARMS with no annual or lifetime caps.   Most ARMS limit annual changes in interest rates to 2 to 3 points and lifetime changes in interest rate to 6 percentage points.

The HUD model substantially overstated the ability of Fannie Mae to survive a large increase in interest rates.   I was allowed to present this result to a Deputy Assistant Secretary in Domestic Finance.  This DAS was a smart man who left his Wall Street firm to spend a couple of years serving in Washington.   The DAS praised me for my findings and said that he was not concerned because he believed the long-term trend for interest rates was down.  

An independent regulator was created.   The DAS was correct.   The failure of Fannie Mae and the subsequent bailout was the result of credit risk not high interest rates.

 The Current Situation:  Our government is a joke.   After the bailout the Chairman of the Federal Reserve Board went before Congress and said he did not understand how derivatives and mortgage backed securities worked.

The issue today appears to be oil and whether bank supervisors are going to understand and evaluate and if necessary limit the way banks hedge risks against oil price changes.  The issue today also remains too big to fail.   Banks are bigger now than in 2008.   Banks have made scant progress describing how they would unravel their business in the next crisis.

 One of the major achievements of the Obama Administration was the passage of legislation mandating tighter supervision in order to restore confidence to the financial system.  The Obama Treasury populated by Clinton-era officials has not aggressively implemented the new law.

President Obama is pressuring Democrats in Congress to vote for the spending bill that removes restrictions the Dodd-Frank restrictions that he fought so hard for.   He should have issued a veto threat.

The sad truth is that the Administration of George H. W. Bush was more concerned about financial regulation than the current Administration.   In 2010, the Tea Party not the Democratic Party, was the major force opposing the excesses of Wall Street.

The issue of the next Wall Street bailout is becoming a question of “when” not “if.”

Concluding Thoughts and Anecdotes: Elizabeth Warren appears to be one of the few Senators aware of the magnitude of this problem.   The Clinton-era officials who dominate the Treasury are blithely unconcerned.     

I am concluding this post with a child’s math problem.  If Elizabeth Warren gave one of her balls to President Obama and another of her balls to Hillary Clinton, how many balls would President Obama have and how many balls would Hillary Clinton have?   Please show your work!

Monday, December 8, 2014

Resource allocation problems in the Democratic Party

Resource Allocation by the Democratic Party In Texas

Question:   How much did the Wendy Davis and Greg Abbott spend in the 2014 Governors race in Texas?

How much money did all Democratic and all Republican House candidates spend in their 2014 House races?

Did the Democrats wisely allocate resources in 2014 political races in Texas?  Comment on what these numbers imply about the viability of the Democratic Party in Texas?

Numbers:    I got the campaign expenditure numbers for the Texas Governor’s race from the web.

Texas Governors Race Expenditures
$ Millions

Abbot was able to spend around $11 million more than Davis.  The difference is non trivial but Davis had a decent amount of resources.    (These numbers do not include expenditures from outside independent groups.)

I obtained numbers on spending on all House races in Texas from the Federal Election web site.   Go to the portal below specify race=House, state=TX and Party= DEM or REP.

The database covers money spent in primaries by all candidates in both parties.  It is a measure of total political activity in all House races in 2014.

Statistics on House Candidates In Texas
# Of House Candidates
$ Spent Million


The Republicans had almost twice the number of candidates and spent over three times the Democrats on House seats in Texas.

Even with 56 candidates spending money the Republicans chose to not enter a couple of overwhelmingly Hispanic Districts in Texas.   This was smart because a lack of opposition in Democratic strongholds reduced turnout for Davis

Political Remarks:  The last Democrat to win statewide in Texas was Ann Richards.   However, the statewide election drought is less important than the lack of energy in local and District races.

The Democrats whine that they are losing because of gerrymandering and voter-id  laws.   The real problem is that the Democrats aren’t thinking clearly.   They’re not fielding a full team. 

Wendy Davis would have gotten more votes if she had given her money to Democratic House candidates.   These candidates would have gotten Democrats to the polls who would have voted for Davis. 

Outside groups and the DNC would also have gotten more bang for their buck by giving to Democrats running for the House than to Davis.

The money spent on Grimes in Kentucky would have been much better off spent in Texas.   (Seriously, why should the Democrats spend a nickel on a candidate who won’t say whether she voted for President Obama?)

The Democrats complain they have less money than Republicans but they don’t allocate their funds properly. 

November is past and a critic of this piece could claim that hindsight is 20/20.   But we are less than two years away from 2016.  

People interested in this post may also want to read the post about Hillary Clinton’s road map for 2016.

Sunday, December 7, 2014

Review of some literature on life cycle funds.

This post was originally published at my   Life cycle funds are intuitive but the empirical work finding that the sacrifice in return is larger than reduction in risk is compelling.

I believe the alternative may involve a relatively stable equity/debt allocation but an equity basket that does not include highly leveraged or risky firms.

Question: A friend suggests that I put my retirement savings in a life-cycle fund. What is a life-cycle fund? Should I follow his advice?


What are life-cycle funds?

A life-cycle fund (also called a targeted fund or an age-based fund) is a fund where asset allocations are automatically changed over the saver’s holding period. A young entrant to the workforce would place a large portion of his 401(k) savings in stocks during his twenties or thirties. Over time, the fund manager reallocates assets by selling stocks and by purchasing less risky assets – bonds and T-bills.

This investment strategy was recommended by Burton Malkiel in his famous book “A Random Walk down Wall Street.”

Malkiel, B., A Random Walk Down Wall Street, New York, N.Y., Norton & Company, 1996.
  • In the 1996, version of his book, Burton Malkiel recommends that a person in his twenties have 5% of assets in cash, 25% of assets in bonds, and 70% of assets in stocks. Burton Malkiel’s recommended asset allocation formula for an investor in her fifties is 10% of assets in cash, 60% of assets in bonds, and 30% of assets in stocks.
Also, the type of stocks selected might change over time. In early years, the fund manager will likely select growth stocks. In later years, the fund manager will likely invest in low p-e stocks.

Prevalence of Life-cycle funds:
According to a survey by Tower Watson around 72% of firms offer target funds as the default option in the firm’s defined contribution plan. Most major investment firms, (Fidelity, Vanguard, TIAA-CREF, T. Rowe Price) offer life-cycle funds. A good list of firms offering Life-cycle funds can be found in this article in the Street.

Here are some links to some institutions offering life-cycle funds

Age-based funds have also been used to assist individuals who are savings for college with a 529 plans. One article that I read stated that over 70% of 529 plans offered a target-age fund as an option. Here are two articles on life-cycle funds in 529 plans.

Should you purchase life-cycle funds?
Intuitively, it seems desirable to sell high-risk assets when one nears retirement.
However, a theoretical analysis presented by Kritzman (2000) suggests that maintaining a balanced portfolio can provide superior results compared to a strategy of drastically changing the mix of assets in a portfolio.

Kritzman, M.P., Puzzles of Finance: Six Practical Problems and Their Remarkable Solutions, John Wiley and Sons, Inc., New York, 2000.
  • Kritzman specifically asks whether it is better to invest 100% of funds in stocks half the time or 50% of funds in stocks all the time, a question that has implications for both market-timing strategies and life-cycle strategies. Kritzman shows that placing half of the portfolio in stock all the time provides the same expected return and less risk than a strategy of owning all stocks half the time.
Evidence from the finance literature indicates that life-cycle funds do not increase return and reduce risk compared to funds employing other investment strategies.

Hickman, K., Hunter, H., Byrd, J., Beck, J. and Terpening W., “Life-Cycle Investing, Holding Periods and Risk,” Journal of Portfolio Management, v 27, No 2, pp. 101-11, Winter 2001.
  • Hickman, Hunter, Byrd, Beck, and Terpening (2001) compare simulated returns from three different types of life-cycle investing techniques to an allocation that invests all assets in the S&P 500 regardless of the holding period. The S&P allocation strategy dominates the three life-cycle models for the 40-year holding period. The mean ending wealth balance for the S&P allocation strategy was 2.3 time higher than the best performing life-cycle strategy and 6.9 times as high for the worse performing life-cycle strategy. The median ending wealth balance for the S&P only strategy was 1.3 times higher than the best life-cycle strategy and 2.2 times higher than the worse life-cycle strategy.
  •  The S&P strategy had a substantially higher standard deviation in returns than the three life-cycle strategies. However, returns were highly positively skewed. The higher standard deviation of stock returns can be primarily attributed to upside return potential rather than downside risk.
  • The authors also show that the cost of investing in life-cycle funds is smaller over shorter time horizons. Median ending wealth balance is only 10.5% higher for the S&P 500 strategy compared to the most effective of the three life-cycle models. (Does this suggest that life-cycle investing is better suited for saving for college in 529 plans than for saving for retirement?)
Some financial analysts maintain that life-cycle techniques would reduce financial risk associated with adding private accounts to Social Security? This possibility was considered by Robert Shiller.

Shiller, R.J., “The Life-Cycle Accounts Proposal for Social Security: A Review,” National Bureau Working Paper No. 11300, May 2005.
  •  Shiller finds that based on historical returns for the U.S. market, a basic life-cycle investment approach for personal accounts would leave investors worse off than the current Social Security system 32% of the time. By contrast, investors remained invested 100% in stocks would only be worse off than the current Social Security system 2% of the time. Under a more pessimistic stock return assumption, life-cycle private accounts left workers worse off than the current Social Security system 71% of the time.
Investors considering life-cycle funds should also consider the following two articles prior to investing.

Cramer points out that many target-date funds did not perform well in 2008 and have high fees.

Final thoughts:

Investors interested in life-cycle funds need to consider whether investment in a life-cycle fund would have helped insulate an investor a decade or so away from retirement from the impacts of the tech crash or the financial crisis crash. I believe the answer to this question is NO! An investor in his or her 50s with assets in a target fund in 1999 or in 2008 would still have had most of his savings in stocks at the time of these crashes. One could argue that after experiencing a huge loss he should double down after a crash rather than switch based on an age-based allocation formula.

Life-cycle funds will not effectively insulate a cohort from a sudden market collapse in the last decade of their career.

Saturday, November 29, 2014

Implications of 1992 and 2008 for 2016

Implications of 1992 and 2008 for 2016


1992 and 2008 were both great years for Democrats but a comparison of these two elections reveals that Bill Clinton and Barack Obama took very different paths to the White House. 

Compare 1992 and 2008 electoral outcomes by state and discuss possible avenues for a Clinton victory/defeat in 2016.


Below I categorize the nation into four types of states – (1) states won by Clinton in 1992 and Obama in 2008, (2) states won by Clinton in 1992 and McCain in 2008, (3) states won by Bush in 1992 and Obama in 2008, and (4) states won by Bush in 1992 and McCain in 2008.

Four Types of States
Democrat in 1992 and Democrat in 2008
Democrat in 1992 and Republican in 2008
Republican in 1992 and Democrat in 2008
Republican in 1992 and Republican in 2008
North Carolina
D. C.
South Carolina
North Dakota
West Virginia
South Dakota
New Hampshire
New Jersey
New Mexico
New York
Rhode Island


Republicans will put forward strong challenges in at least six Clinton/Obama states – (1) Colorado, (2) Iowa, (3) Maine, (4) Nevada, (5) Ohio, and (6) Wisconsin.    Also, New Hampshire is always tight.   Republicans did well in statewide races in all of these states in 2014. 

 Opinion:  It is almost certain Iowa will flip to Republicans if Hillary is anointed and Republicans actively court Iowan voters.  (Obama is much more popular in Iowa than Hillary ever was or will be.    I also believe Obama is much more popular than Clinton in Colorado.

 Democrats are likely to lose all states won by Clinton in 1992 and lost by Obama in 2008 including the state where Hillary Clinton was first lady.

See chart below on how hostile this territory is for Democrats:

% of House Delegation
that is Republican
South Carolina
West Virginia

Al of these states had statewide Senate races in 2014.   Hillary campaigned for the Democrat.    All Democrats lost. (Am waiting on runoff result in LA.)

Hillary is less popular than Obama in Virginia and North Carolina two states where Obama turned blue in 2008.  Hillary is popular in Florida though.

2008 Primary Results
North Carolina

The only possible state where Democrats have a shot in 2016 despite Republican victories in 1992 and 2008 is Arizona.   This shot requires a huge Hispanic turnout is a long one. 

Concluding Comments:  The one thing I learned in 2008 is that Barack Obama is a much more gifted politician than Hillary Clinton.    Hillary will not be able to reassemble the political map that put her husband in the White House.    In order to win in 2016 Hillary Clinton is going to have to take the states that Obama turned blue.   I don’t believe she can do this while simultaneously distancing herself from the President and his record.