Trying to Cure the Wrong Disease

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Trying to Cure the Wrong Disease

Regulators don’t think it is the place of Congress to second guess how they size up securities. Fed Chairwoman Janet Yellen said recently that legislation would “interfere with our supervisory judgments.”

Regulators are not required by the Constitution, but Congress, perverse as it is, is the body closest to the people, getting put up for election regularly. Of course Congress should oversee financial regulation and monetary policy from an unelected Federal Reserve. That’s their job.

I’m not saying that the Congressmen themselves understand these things well enough to do anything — but that’s true of most laws, etc. If the Federal Reserve says they are experts on these matters, past bad results notwithstanding, Congress can get people who are experts as well to aid them in their decisions on laws and regulations.

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Blue MountainBlue Mountain Credit Alternatives Fund was up 0.36% for November, although the fund remains well into the red for the year. For the first 11 months, the fund was down 24.85% gross. Q3 2020 hedge fund letters, conferences and more Blue Mountain's fundamental credit strategy was up 0.63% for November, including a 1.09% gain for Read More


The above is not my main point, though. I have a specific example to draw on: municipal bonds. As the Wall Street Journal headline says, are they “Safe or Hard to Sell?” For financial regulation, that’s the wrong question, because this should be an asset-liability management problem. Banks should be buying assets and making loans that fit the structure of their liabilities. How long are the CDs? How sticky are the deposits and the savings accounts?

If the maturities of the munis match the liabilities of the bank, they will pay out at the time that the bank needs liquidity to pay those who place money with them. This is the same as it would be for any bond or loan.

If a bank, insurance company, or any financial institution relies on secondary market liquidity in order to protect its solvency, it has a flawed strategy. That means any market panic can ruin them. They need table stability, not bicycle stability. A table will stand, while a bicycle has to keep moving to stay upright.

What’s that you say? We need banks to do maturity transformation so that long dated projects can be cheaply funded by short-term savers. Sorry, that’s what leads to financial crises, and creates the run on liquidity when the value of long dated assets falls, and savers want their money back. Let long dated assets that want debt financing be financed by REITs, pension plans, endowments, long-tail casualty insurers, and life insurers. Banks should invest short, and use the swap market t aid their asset liability needs.

Thus, there is no need for the Fed to be worrying about muni market liquidity. The problem is one of asset-liability matching. Once that is settled, banks can make intelligent decisions about what credit risk to take versus their liabilities.

In many ways, our regulators learned the wrong lessons in the recent crisis, and as such, they meddle where they don’t need to, while neglecting the real problems.

But given the strength of the banking lobby, is that any surprise?

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David J. Merkel, CFA, FSA — 2010-present, I am working on setting up my own equity asset management shop, tentatively called Aleph Investments. It is possible that I might do a joint venture with someone else if we can do more together than separately. From 2008-2010, I was the Chief Economist and Director of Research of Finacorp Securities. I did a many things for Finacorp, mainly research and analysis on a wide variety of fixed income and equity securities, and trading strategies. Until 2007, I was a senior investment analyst at Hovde Capital, responsible for analysis and valuation of investment opportunities for the FIP funds, particularly of companies in the insurance industry. I also managed the internal profit sharing and charitable endowment monies of the firm. From 2003-2007, I was a leading commentator at the investment website RealMoney.com. Back in 2003, after several years of correspondence, James Cramer invited me to write for the site, and I wrote for RealMoney on equity and bond portfolio management, macroeconomics, derivatives, quantitative strategies, insurance issues, corporate governance, etc. My specialty is looking at the interlinkages in the markets in order to understand individual markets better. I no longer contribute to RealMoney; I scaled it back because my work duties have gotten larger, and I began this blog to develop a distinct voice with a wider distribution. After three-plus year of operation, I believe I have achieved that. Prior to joining Hovde in 2003, I managed corporate bonds for Dwight Asset Management. In 1998, I joined the Mount Washington Investment Group as the Mortgage Bond and Asset Liability manager after working with Provident Mutual, AIG and Pacific Standard Life. My background as a life actuary has given me a different perspective on investing. How do you earn money without taking undue risk? How do you convey ideas about investing while showing a proper level of uncertainty on the likelihood of success? How do the various markets fit together, telling us us a broader story than any single piece? These are the themes that I will deal with in this blog. I hold bachelor’s and master’s degrees from Johns Hopkins University. In my spare time, I take care of our eight children with my wonderful wife Ruth.

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