Friday, April 27, 2007

Hedging against the market

A question about hedge funds came up at the first Democratic presidential debate last night from moderator and NBC News anchor Brian Williams: Do hedge funds make America better in any way? It was directed to former senator John Edwards.

Earlier in the week, the news was about Edwards’ lawyering for a major hedge fund in New York, which some political observers believe could hurt Edwards’ presidential bid. During the senator’s first shot at the White House he has devoted some time talking about the Two Americas, one of the rich, the other of the poor. Now, he’s been talking again on the same tenor, the wage divide.

I’m not sure if what hedge fund managers make is market dictated. I am however certain of one thing: it is obscene. Last year’s earnings of the top bettor, James Simons, were $1.7 billion. Two others, Kenneth C. Griffin and Edward S. Lampert, took the cake of more than $1 billion each last year.

Here’s how James Cramer* of CNBC’s “Mad Money” has recounted his heyday as hedge fund manager as summarized by TheStreet.com:
It doesn't take much money to sway the stock market, Jim Cramer said on TheStreet.com TV's Wall Street Confidential video Webcast Friday.

In fact, when Cramer was short stock during his hedge fund days, meaning he was betting the stocks would fall, he would look to create a level of activity beforehand that could drive the futures lower, he told Aaron Task, the host of Wall Street Confidential.

Conversely, when he was long and wanted to make things "rosy," he would commit $5 million in capital to a handful of stocks and make sure they were higher, Cramer said. However, as the market is bigger now, an investor would need $10 million to knock stocks down or drive them up.

And sometimes, hedge fund investors boost the futures to create a false sense of excitement that can quickly turn negative when the sellers come in, Cramer said. He encouraged anyone in the hedge fund game to follow this strategy, as it's legal and a "very quick way to make money."

When Task asked if the fact that there are so many more hedge funds intensifies market moves, Cramer said hedge funds are positioned long and short, not just long like mutual funds.

It's "vital" for the next six days [trading days], after which it's "pay day," to control the market and not let it lift if your fund is short and/or badly trailing the S&P 500 year to date, he continued. Therefore, when market players are presented with a stock like Research In Motion (RIMM), "it's really important to knock it down because it's the fulcrum of the market today."

"A hedge fund that's not up a lot really has to do a lot to save itself now," Cramer said. "When you have six days and your company is in doubt because you're down, it's important to foment an impression that RIM is down, because RIM is the key today."

Although he estimated it would take between $15 million to $20 million to knock the stock down, he said it would be "fabulous" to do so because it would beleaguer all the longs who are keying on it. This is what we're seeing now, Cramer said. "When your company is in survival mode, it's important to defeat RIM."

RIM reported a really good quarter, it's a "terrific story" and the stock probably should be up. But being five days away "from making your quarter, you can't risk having RIM up this much," he said. (After trading as high as $140.11 intraday, RIM shares were recently down nearly 3% at $129.79.)

Similarly, it's important for market players who are short Apple (AAPL) to spread rumors that Verizon (VZ) and AT&T (T) don't like Apple's new phone.

Cramer said Apple is an "ideal short," and said if he were short the stock, he would call six trading desks and say he just got off with his contact at Verizon, who said that the company has no room for Apple.

"It's a very effective way to keep a stock down," he said. "What's important when you're in the hedge fund mode is to not do anything remotely truthful, because the truth is so against your view."

Maybe two weeks from now the buyers will come to their senses and realize everything they heard was a lie, but then again Fannie Mae (FNM) lied about its earnings, Cramer went on to say.
"It's just fiction and fiction and fiction," he said.

It's important for people to recognize that the way the market really works is that it has that nexus of hitting the brokerage houses with a series of orders that can push a stock down, after which rumors get leaked to the press and get on TV, Cramer explained. Then there is a "vicious cycle down."

On another note, Cramer said the Fed will have to cut rates and is "desperate" to figure out how quickly it has to cut them.
No wonder, presidential candidate John Edwards was taken aback.

The same question may be asked about private equity: Is it good for the public? This piece by Washington Post op-ed columnist Robert J. Samuelson makes for another interesting read. Samuelson describes private equity according to its critics as “sophisticated swindle that often cheats ordinary shareholders.”

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*Jim Cramer is also author of “Real Money: Sane Investing in an Insane World,” “You Got Screwed!” and “Confessions of a Street Addict.”

Tuesday, April 24, 2007

State vs market continues with Kerala Experience

Placeholder has brought up the “Kerala experience” in that Indian state with a population a third of the Philippines that has attained a high degree of human development such as 94 percent literacy and high life expectancy while compromising economic progress.

Juxtaposing the Kerala phenomenon with the Philippine dilemma, Placeholder writes thus:
There is also the very real possibility that our present deadbeat Philippine elite won't be up to the historic task unlike their counterparts in East Asia and India. We may have to bide our time while we let the process of replacing the current elite with a more functional one (from the ranks of the poor and middle class) take place. In the meantime, the welfare of the rest has to be looked after.
So, why not emulate Kerala, he then posits.

If the goal of the good society, to borrow Noam Chomsky’s paraphrase of Bertrand Russell and John Dewey, is to “produce free human beings whose values were not accumulation and domination but rather free association on terms of equality and sharing and cooperation, participating on equal terms to achieve common goals which were democratically conceived” then the Kerala experiment could be a close approximation. But without such unique experience being integrated into the dominant economic order would it be sustainable?

As explained by Nobel Prize economist Amartya Sen, “the concept of cutting yourself out from the world of advanced technology, increasing productivity, and the opportunities that globalisation offers to the world will be a retrograde step.”

Where the Kerala educational and literacy expansion appears to be faltering as pointed out by Sen is “when it comes to developing higher educational potentials in tune with the opportunities offered by its wider network of school education” as well as “when compared to other States, in making the content of education suit the demands of the contemporary age, including in providing a focus on the technical facilities related to the rapidly expanding information economy in the world.”

So after a successful capacity expansion, Kerala, I believe, must take the next sequence - which is opportunity expansion. This is where Kerala, Inc. as in my proposed Philippine, Inc., must be pursued. Without opportunity expansion, the human capital they have produced, just as Philippines’ best and brightest, will emigrate to where there are opportunities.

Fortunately for Kerala, having moved forward already to genuine pluralism and democratic consensus, it is far ahead of the Philippines. The remaining challenge for Kerala it seems is how to transform its decentralized and consensual bureaucracy into “collective entrepreneurship,” which is here also deemed as the marriage of the state concept and the market construct, to compete in the world market. On the other hand, national governments of developing economies must be given enough maneuvering room by the forces of globalization (and therefore must not be hamstrung by Washington Consensus’ structural adjustments and rules of good behavior) to deliver the programs for those they are supposed to serve in the first place, and in order to thrive in the global economy.

(Entrepreneurship in this regard is considered as a social function, a network of conjoint relationships and accumulated knowledge of the community that hosts the individual entrepreneurs; hence, the government, or the bureaucracy in particular, is in a better position to take the initiative. The “entrepreneur” becomes thus as close as Harold Laswell’s political animal deciding “who gets what, when and how”.)

I agree with Placeholder that in the Philippines the deeper problem remains the perpetuation of the lackadaisical and rent preserving economic elites whose core constituencies are the traditional politicians (the trapos), and the “let’s move on” middle class who are themselves conserving their rents in a society of limited opportunities against those occupying the lower rung.

There are indeed no easy paths to growth with equity but the sooner this is discerned, especially by the reformist constituency of the middle class and heterodox politicians, the less are the chances of being entrapped in a pitfall of passing fancy.

Thursday, April 19, 2007

The fiction of American free market model

(This is my share in an ongoing state vs market exchange first started in Inquirer Current but I'm not sure where to post my piece, whether in Current, Placeholder or Newsstand; hence, I've decided to make it an entry here)

Before Adam’s Smith’s postulation of the market theory, providing for the welfare of the governed had traditionally devolved upon enlightened princes, the governors. Their governments vied in the promotion of commerce and industry in their respective kingdoms. To create wealth for the realm, one of the preferred methods employed was to encourage exports and discourage imports through a system of using the powers of the sovereign to amass a surplus of gold and other international monetary assets. Arguing against mercantilism, the system he attacked in the Wealth of Nations, Smith wrote that what mattered was not the possession of gold or silver but the quantity and quality of goods and services at the disposal of individuals and societies alike.

Mercantilism, which also means state involvement in, or control of, the economy was a dominant economic attitude when the European economy was “developing.” What thereafter came into being as laissez-faire proceeded to oversimplify an economic ideology: If men are barred from pursuing their natural disposition driven by self-interest, initiative will be stultified, but liberated, progress is bound to take place as a matter of course.

The spirit of liberalism in Great Britain hit town in the American colonies already resentful of serving as suppliers of raw materials and as captured market for the manufactures of the mother country. The new idea rebelled against coercion and the pervasiveness of governments. But even as the American Revolution triumphed, men of wealth and power in the colonies began to look askance at the supposed spontaneity and wisdom of liberal populism. So that when it was America’s turn to develop its economy, the founding fathers led by Alexander Hamilton, instead of pursuing laissez-faire free trade capitalism reverted to mercantilism, or neo-mercantilism. Although opposed by Jefferson who believed that which governs least governs best, Hamilton succeeded in calling for an active (federal) government in infrastructure development and industrialization fortified by tariff protection against British manufactured goods. Hamiltonian economics later became known as the “National System” of the USA, Inc., the key postulates of which were:

1) Protecting industry (new factories or infant industries) through selective high tariffs and later via government subsidies;

2) Government expenditures in infrastructure development targeting internal improvements such as road building and other public works;

3) Creation of big banking such as national banks along with policies promoting productive enterprises.

Despite the professed reverence to the market’s invisible hand, the United States did not after all develop on the basis of laissez-faire economics. On the contrary, there is historical indication it was in America that modern economic protectionism was born. At best, American free market was an afterthought.

Little wonder the first Miracle of Asia, Japan, Inc., was built by its own founding fathers, the Meiji leaders, according to Hamiltonian economics under the guiding hand of the state. And the roaring “Tiger, Inc.” and now the awakened Dragon, Inc. simply followed suit in adopting the American way.

To build the Philippine, Inc., I have also argued that
even the market construct could become fair if struggling but willing and ready nations are given a decent chance to build and accumulate just as exactly as the leading economic powers of today did during their own growing pains and struggles; and enabled to be on similar footing, then and only then should these latecomers be made to face up to the challenge of competition. On an individual level, they call this “affirmative action” in America. I believe even nations are entitled to equal opportunity. This axiom, possibly more legitimating than “economic liberalism,” requires that adjustments to transformation of this sort relative to the prevailing international economic order should demand more of the stronger states than the weaker ones, not the other way around.

Thursday, April 12, 2007

Investment common sense

Reacting to the criticism that I had quoted from Philippine Senator Manny Villar to the effect that Philippine banks would rather acquire Treasury bills and other sovereign debt instruments than lend to businessmen because aside from the rates being so attractive, the “investments are risk-free and protected from depreciation,” commenter UPn at mlq3’s blogsite was quick to riposte: Wouldn’t you want your own retirement funds (along with funds from the GSIS or SSS) to be in such instruments (attractive rates, risk-free, protected from depreciation) as opposed to being lent to businessmen-cronies of whoever is sitting in Malacanang?

Our exchange was part of a broader discourse wherein I have proposed, among others, that the Philippines should look at the best practices of successful economies in the region that have attained “late-industrialization” such as South Korea and Taiwan. I have cited that the high investment rate of the Koreans has kept the debt/GNP ratio unchanged despite heavy foreign borrowing.

The analogy between individuals and nations in terms of investment goals is not farfetched. For example, building one’s nest egg through investment in “growth” equities involves higher risk than, say, in the “stable” bond market. For younger investors with a longer time horizon, growth stocks (of companies that reinvest earnings back into the firm for business expansion) can provide protection against escalating cost of living due to inflation. But individuals nearing retirement would be wise to put their money in safer portfolios such as sovereign instruments that provide current income and protection of principal.

Just as individuals ought to be guided by sheer common sense in investment, so must nations.

The Koreans, to break from the confines of a traditional society, have defied the bitter “stabilization” prescription of the Washington Consensus and adopted expansionary policies to achieve productivity and growth. It would have been nonsensical if aiming for industrial expansion, the community’s surplus were left in the hands of hoarders or lackadaisical entrepreneurs who would rather conserve their rents. The Korean economy has taken off because profit-maximizing entrepreneurs in targeted businesses or sectors in conjunction with state intervention ploughed back a substantial portion of their earnings in further productive investments. As a result, the manufacturing sector rapidly shot up even as it imparted its growth impulses to the economy in general to attain industrialization.

Young and emerging economies could not afford to aspire merely for stability, unless the goal is nothing more than the preservation of the wealth of existing economic power and/or guarantee the repayments of foreign debts at the expense of national development.

In an economy like the Philippines where there is a high concentration of interlocking ownership among the manufacturing sector and banking institutions, the supply of working capital for industrial expansion could be much easier to assemble if the internal will is there to grow, and compete with other economies. Unfortunately, the will to develop, as suggested by Trade and Industry Secretary Cesar V. Purisima in 2004, is wanting. Purisima stressed: “(P)rivate domestic sources alone could finance a critical mass of projects that will be necessary to jumpstart and sustain the country’s economic development.”

Do you still remember the UP 11 report of August 2004, which has raised for the Philippines the specter of “rapid growth”? Here’s what I have written then:
One of the notable assertions the UP economists made almost axiomatically was: the “growing size of the debt and the deficit are undoubtedly the biggest reasons that investment and growth in this country have remained sluggish.” Is the issue really too “esoteric,” as the distinguished economists would want others think, to be comprehended by non-economist like many of us, specially when their paper also claimed that “rapid growth” is one of those “external shocks” that could make the country “vulnerable”?

It seems that when the problem is premised on being supposedly “arcane,” it becomes easier for intellectuals to ascribe the blame to the already severely battered public sector, the bureaucracy specifically, or even the poor tax structure, perpetuating even more popular disenchantment with the government. It had also the effect, unintended or not, of skirting “constructive public discussion” of other relevant important questions and actual economic experiences despite pretenses to welcome them.

First off, bear in mind the position paper affirmed that the Filipinos—or logically the economic elites for that matter—hold most of the government’s peso-denominated debt and “a good chunk” of the dollarized domestic debt (and the further fact that the national debt at 3.36 trillion pesos as of the end of 2003 is “split almost equally between foreign and domestic liabilities”). This is indicative of the overriding interest particularly on the part of the domestic wealth holders in renting their money at guaranteed earnings relative to otherwise risking such wealth in rational productive investments, conceivably fearful likewise that too fast a growth rate and inflationary pressures could threaten the value of their money. With the debt service (the income to the lenders) calculated at about 30 percent of the national budget, the money involved going to only some individuals is obscenely mind-boggling, or, to put it differently, enough to lull the rentier persona of the entrenched economic elites into an ongoing passive investment spree at the expense of the real economy of the nation. . . .

As Filipinos should by now have learned . . . restrained economic growth propels governments into ballooning indebtedness given that low productivity in the real economy undercuts tax revenues while the resultant unemployment or declining wages generally impact disposable income and the direly needed newer capital formation. This more or less calculated scenario—or imposed “structural adjustments” as others put it—leaves the “model borrower” (that the Philippines as a sovereign debtor has been programmed to always aspire to be) the unfortunate choices of either more belt-tightening, or more borrowing with higher risk premiums, or both, often as we all know, in wanton disregard for the plight of the voiceless citizens.

If then the paramount goal were to stop the escalating government debt as a proportion of GDP, won’t it be possible to attain it should the growth of GDP outpace the ever-rising debt? This would only mean that past the crisis and beyond some short-run government bureaucratic measures (such as new tax schemes and pork barrel curtailments), the wealth creators at the firm level must lead the march toward competitiveness and productivity growth, the intuition of the now famous “UP 11” that it would be “no more than whistling in the dark” notwithstanding. Therefore, rather than despair, perish or self-destruct, Filipinos must take the course that remains wide open for them—build and produce to earn enough to pay debts, provide basic needs, keep an efficient bureaucracy and build even more. When government capital expenditures are at a minimum, the private sector must take up the slack in investment to boost employment and enable the citizens to pull through a sense of confidence in the future.