One Banker Whom I Respect

The Texas Monthly runs a profile of Dick Fisher, the CEO of the Dallas Federal Reserve bank. Known for his hawkishness on interest rates, he may be taken for a dyed-in-the-wool Republican, but in 1994 he ran as the Democratic candidate for the U.S. Senate against Kay Bailey Hutchinson.

By all accounts, including his own, Fisher didn’t make much of an impression on the people of Texas. Hutchison was reelected in a twenty-point landslide

Dick Fisher has surprises sprinkled throughout his resume. His father struggled to make ends meet, moving the family to China, California, Mexico and Florida during Richard's childhood. As a child, Richard spoke Spanish better than he did English. He worked summers at a greasy spoon, got a scholarship to prep school, and ended up in the Ivy League.

By the time I met him in the 1970's--we were in the same study group--the transformation was complete. Always preppily dressed, he didn't have to tell anyone that he went to Harvard, he looked it. He was more "Ivy" than the other Ivy graduates in our class and was a straight arrow in appearance, attitude, and behavior when, frankly, most of us weren't.

His classmates are honing their golf swings, but Richard appears to be working harder than ever.

A Crisis That Isn't

Sooner or later one of these governance "crises" will have dire consequences, but your humble observer doubts that the impending October 1st shutdown of the Federal government will have different results from the sequester, the 2012 debt limit kerfuffle, or the 2012 U.S. Treasury downgrade. Some people, such as government employees, will be affected, but the rest of the country will probably just shake its collective head and hope that the stalemate does not go on too long.

While there has been no government shutdown since 1996, there were 17 separate events in the previous 20 years so clearly the markets would not be too inconvenienced by a brief hiatus. Analysis by Rabobank found that the previous events had very little impact on bond yields. The famous 1995 shutdown did not make a dent in a roaring equity bull market.

Undoubtedly the House Republicans will take most of the blame for the shutdown, but I can't fault them too much for their desperate and seemingly futile attempt to stem the tide of big government. Increased government control over medical care, education, and banking seems to have made the problems in those areas worse; the proposed solutions always involve more spending, prosecuting the "crimes" of the people working in those sectors, and more regulation and more laws.

Someday lenders will stop lending, taxpayers will stop paying taxes, and government services will be shut down in earnest, but the good news is that it won't be this October 1st. © 2013 Stephen Yuen

An American Success Story

Charlene Chu (Bloomberg photo)

Denver-born Charlene Chu, 42, is the "rock star" of Chinese debt analysis:

When top officials at the U.S. Federal Reserve want to understand the Chinese financial system, they meet Charlene Chu. Goldman Sachs, which isn't short of China experts, interviewed her and sent the transcript to its clients. And one of the world's most influential investment firms calls her a rock star

Ms. Chu's ascent to the top of the Chinese--therefore, the global--bond world is what used to be called an American success story.  After working at the New York Fed and studying at Yale, she moved to China without a job in 2005 "to dig deeper into China's banks and to learn more about her father's family." (Her late father was a general in the army of Chiang Kai-shek and worked as a dishwasher during his life in America.)

After the Fitch credit rating agency hired her, she unearthed hundreds of billions of dollars of previously unaccounted-for Chinese bank obligations, and the rest is history.

In the 1980's quiet, self-effacing Henry Kaufman moved world bond markets when he made his interest-rate forecasts for Salomon Brothers. Charlene Chu may not be the "mega-" bond rock star that Henry Kaufman was, but just give her time.

Still Going Strong

Eugene Fama on too-big-to-fail (H/T Tyler Cowen) [bold added]:

Basically, the institutions that are considered to be too big to fail have their debt priced as if it’s riskless, which gives them a low cost of capital and makes it very easy for them to expand and become an even bigger problem. Plus, everybody now accepts the assertion that they are too big to fail, which creates a terrible moral hazard for the management of these financial institutions. Business leaders won’t consciously tank their companies, but too big to fail will push them toward taking more risk, whether they realize it or not.

I don’t think Dodd–Frank (the Dodd–Frank Wall Street Reform and Consumer Protection Act) cures that moral hazard problem. Even if lawmakers could devise the perfect regulation for such a cure, the chance that it will be implemented by the regulators in the way designed is pretty close to zero.

The simplest solution would be to raise the capital requirements of banks. A nice place to start would be a 25% equity capital ratio, and if that doesn’t work, raise it more. The equity capital ratio needs to be high enough that a too-big-to-fail financial institution’s debt is riskless, not because of what is essentially a government guarantee but because the equity ratio is very high.

In 1969 Fama, Fisher, Jensen and Roll wrote the seminal article on the efficient-market hypothesis. Lesser lights have won the prize; as Tyler Cowen says, give the man his Nobel.

Barron's: Making Another Call, But We'll Pass

In last week's cover story Barron's proclaimed that Facebook shares, which had closed that Friday at $22.86, were worth "perhaps only $15". FB shares promptly fell on Monday. (They did recover nearly all their losses later in the week when Facebook announced a new Gifts-to-friends product, which was not part of the Barron's piece.)

On 9/28 Facebook closed at $21.66, down 5.25% from the previous Friday.

Emboldened by last week's success, Barron's makes another call--this time bullish--on another widely followed company [bold added]:

Based on the likely outlook for capital-markets activity and Goldman [Sach]'s ability to continue growing its book value, it is easy to conclude that the shares could rise at least 25% within a year.

From Friday's close of $113.68, Barron's foresees GS popping to about $142. That target doesn't seem particularly aggressive in that it is well short of Goldman Sachs' peak in 2011:

Barron's does make a persuasive argument. Goldman's conservative market cap (90% of tangible book value), its deleveraging since the 2008 financial crisis, and the 1.6% dividend yield indicate a stock with little downside and much upside, given its leadership position in currently moribund global capital markets.

Goldman Sachs has long been on our watch list but we have never pulled the trigger. The financial sector is one of politics' favorite whipping boys, and Goldman is its most prominent player.

Barron's is probably right about the 25%, but we're just as likely to get that return in tech, commodities, and hard assets without as much headline risk. Pass, for now. © 2012 Stephen Yuen