Monday, December 23, 2019

Stress Test

It’s widely believed that the U.S. government bailed out the bankers who caused the financial crisis just over a decade ago and left the American people to suffer. President Obama’s secretary of the Treasury, Timothy F. Geithner, defends his team’s actions in his book Stress Test: Reflections on Financial Crises. What makes the book so believable are his admissions of mistakes and how uncertain they were about the correct actions to take throughout the crisis. However, he is very clear that protecting banks was a necessary evil to avoid cascading failures that would have led to meltdown in the greater economy. There was a very real possibility of a depression and massive unemployment. “Our only priority was limiting damage to ordinary Americans and people around the world.”

We’re familiar with the anger over bailing out the bankers who caused the problems in the first place, but less well known is the anger banks had for the government. “Conventional wisdom holds that we abandoned Main Street to protect Wall Street—except on Wall Street, where conventional wisdom holds that President Obama is a radical socialist consumed with hatred for moneymakers. The financial reform law that he wrote and pushed through a bitterly divided Congress after the crisis, the most sweeping overhaul of financial rules since the Depression, is widely viewed as too weak, except in the financial world, where it is described as an existential threat.”

Given the perception that bank bailouts cost taxpayers trillions of dollars, the truth is surprising. “In early 2009, the IMF estimated the U.S. government would end up spending nearly $2 trillion rescuing the financial system. In fact, the U.S. government’s crisis response not only prevented the collapse of the financial system and helped revive the broader economy, but as of the end of 2013 it was projected to generate about $166 billion in positive returns for taxpayers.”

The ratings agencies played an important role in creating the financial mess. “The AAA label ended up being very misleading. The ratings agencies were not exceedingly competent. Their ratings typically lagged cycles in finance, staying too optimistic too long. Since the issuers rather than the purchasers of securities paid them, they had some incentive to give generous ratings that kept issuers happy.”

The government was often criticized for not being tougher on the banks. However, being too tough on one bank would have caused more runs on other banks. By signaling that the government would back the banks, investors would be in less of a panic to get their money out. “A lot of firms that didn’t deserve saving still needed to be saved.”

“We provided extraordinary support to the financial system in general and some very poorly managed financial firms in particular. We didn’t do it to help their executives buy fancier mansions and sleeker jets. We did it because there was no other way to prevent a financial calamity from crushing the broader economy. When financial systems stop working, credit freezes, savings evaporate, and demand for goods and services disappears, which leads to layoffs and poverty and pain.”

As someone who spent much of his time in government trying to get out of politics, Geithner has little incentive to play politics with his account of the financial crisis. This is an important factor in making this book a good read. Warren Buffett says “Tim’s book will forever be the definitive work on what causes financial panics and what must be done to stem them when they occur.”

Friday, December 20, 2019

Short Takes: Bank Profits Edition

It’s gift-buying season. Each year, more of my Christmas shopping shifts online. It’s still tough to come up with good ideas for presents, but at least I don’t wander aimlessly in malls much anymore.

Here are some short takes and some weekend reading:

Tom Bradley at Steadyhand says that the profits Canadian banks earn from their individual customers (all of us) is the highest in the world. This reminds me of a scene from Wolf of Wall Street where Canadians are on the phone and DiCaprio plays the banks.

Ryan Krueger explains how we lose huge amounts of money in everyday banking.

Robb Engen at Boomer and Echo gives an overview of his financial life for the past decade. He definitely worked harder than I did during the 2010s. After quitting his day job, that’s going to change.

Preet Banerjee explains new research showing that people tend to pay down debts by “balance matching,” which has none of the benefits of the debt avalanche method (pay highest interest first) or the debt snowball method (pay smallest debt first).

Friday, December 6, 2019

Short Takes: Illusory Wealth, Tax-Loss Selling, and more

Here are my posts for the past two weeks:

Useless Activity

The Most Important Thing

Am I Fixing a Mistake or Making an Active Decision?

Here are some short takes and some weekend reading:

Tom Bradley at Steadyhand gives three potential sources of illusory wealth in the markets today. Along with his thoughtful commentary, he uses the great terms “bezzle” and “psychic wealth.”

Justin Bender goes into detail about tax-loss selling strategies. This stuff can get tricky. Fortunately, it’s only relevant in taxable accounts. Even people with million-dollar portfolios often don’t have enough in their taxable accounts to bother with tax-loss selling.

Dan Hallett says Bitcoin is for speculating, not investing. I agree (

Ellen Roseman says phone scams are on the rise.

Tuesday, December 3, 2019

Am I Fixing a Mistake or Making an Active Decision?

I recently discovered a mistake in my spreadsheet related to my fixed-income allocation during retirement. Fixing it will involve selling off a sizable chunk of stocks. But I think this may be more of an active portfolio decision than just fixing a mistake.

For years I’ve been striving to come up with mechanical decisions about how to handle my portfolio rather than making active decisions that amount to a form of market timing. One of my rules now that I’m retired is to maintain 5 years of after-tax spending money in fixed-incomes investments, including short-term government bonds, GICs, and savings accounts.

Poking through the spreadsheet that holds my mechanical rules, I noticed a problem with the 5 years of fixed income calculation. I didn’t factor in CPP and OAS pensions properly. I treated these pensions as though I’m receiving them spread out over my whole retirement instead of just getting them later in life. So, my 5 years figure is too low now and will be too high once I get into my 70s.

Fixing this on my spreadsheet immediately triggered a rule demanding that I sell off a big chunk of my stocks to boost my fixed income. So far, it just seems like simply correcting a mistake.

However, the reason I was looking at this part of my spreadsheet at all is because very high stock prices are starting to make me nervous. Because my fixed-income allocation amounts to a percentage of my portfolio size, the growth of my overall portfolio this year has triggered some shifts from stocks to fixed income, but I’ve been feeling like I want to shift even more out of stocks to protect against a possible stock market crash.

Ordinarily, I have these feelings and just ignore them with the help of my mechanical rules. But this time I have the perfect excuse to give in to my fears: an apparent spreadsheet error. However, it would be easy enough to defend the original calculation as sensible enough. I’m probably viewing this as an error because I really want to sell off some stocks.

In the end, I’ve decided to make the spreadsheet change and sell some stocks. But if I’m being honest with myself, I’m mainly doing it because of my possibly mistaken belief that the probability of a stock market crash has been increasing.

Monday, December 2, 2019

The Most Important Thing

It’s a compelling recommendation when Warren Buffett says “This is that rarity, a useful book.” He said this about The Most Important Thing: Uncommon Sense for the Thoughtful Investor, by cofounder of Oaktree Capital Management, Howard Marks. It turns out that “investor” in this book means active investor. The lessons on risk management and other topics are top-notch for those trying to beat the market, but passive investors won’t get much out of it.

One lesson for active investors is to seek out inefficient markets and be better than others at assessing value. This makes the S&P 500 a poor place to look for undervalued stocks.

Another lesson is that risk is the possibility of losing money, which is different from volatility. Risk comes mainly from high prices. Markets always seem riskier after they decline, but in reality, stocks are riskiest when their prices are highest.

To be a successful investor, it’s necessary to be skeptical. This means being skeptical of both too much optimism and too much pessimism.

While I don’t recommend active investing to anyone because very few investors have sufficient skill to expect to beat the market, anyone planning to pursue this path should learn the lessons taught by Marks in this book.