Even the Best Can Fall Victim To the 'Efficient Markets Hypothesis'

The preamble to this recent column by Ted Butler (subscription but worth it for his fine work in tracking the silver market) is a discussion of how 'gold loans' are not really proper loans, because the collateral gets reformatted and sold off.

What sparks the discussion is the recent talk and articles in Bloomberg about the Gold Forwards rates being negative, implying that it is difficult to obtain leased gold. Ted finds this kind of discussion frustrating apparently.   They disclose rates, but not the amount of ongoing transactions.

I should add that to me there is little substantial difference between leases and swaps in what these fellows are doing.  That seems to be largely a manner of terminology and choice of market venue when you boil the transaction down to the essentials.

Ted explains that when you loan a tool to your neighbor, you expect to get your tool back.  In the case of gold leasing, as Bloomberg points out, the gold gets reformatted and sold off to Asia.  So the gold leasing really does not make sense to Ted.

 

Now I would beg to differ at this point, because unlike your favorite power tool monetary objects are often considered to be 'fungible' and in a lease you may not expectto get the exact bars back necessarily.  You merely ask for the same quality, form and amount as I understand it.  If this is not the case, then Bloomberg has inadvertently disclosed a massive fraud.

You don't expect to get your bars back unless it is a custodial arrangement.  But as the German people have recently discovered, good luck with that.  You may get whatever the custodians at the Fed can find, because they have not merely stored the gold for you, but they have apparently utilized it.

Therefore, Ted's reasoning goes, because they do not make sense, gold leases do not exist in any appreciable size anymore. They were just a kind of fad perpetrated by JPM and some foolish miners some years ago.  That forward selling in the form of hedges blew up badly and miners like Barrick were forced to take sizable losses in a rising market.

At this point I would say the leases do not make sense, but not for the same reason Ted cites.  They do not make sense to me because they both misprice the counterparty risk AND the terms and other details of the leasing are not disclosed to all the interested parties.  The lenders who are central banks do not inform. the public who actually own their nation's gold.  Such leasing ought to be disclosed transparently and in real time.  

But this is not the case. The lengths to which the public must go to discover the extent of the leasing of their gold has been well documented by GATA for example.

The reason I find Ted's conclusion weak, and potentially harmful, is that it is obviously based on the 'efficient markets hypothesis.'   If something does not make economic sense, it ought not to exist in an efficient market, and therefore it does not exist except as some limited anomaly.  Gold leases don't make sense to me, so therefore they do not exist, or if they do, are not significant enough to be considered.

Economists used to joke that if you told an efficient markets guy that there was a ten dollar bill lying on the sidewalk, he would reply that 'there couldn't be, because if there was someone would pick it up.'

I have asked the fellows at GATA if they have any firm numbers on current gold loans out, primarily from central banks.  I know this is an ongoing quest because central banks are notoriously reticent to providing any such details of their activities. 

We know leasing exists, we know the rates, we just do not know the details of the size of the market and the extent of the deals.

I found this column to be of concern because Ted is a very well respected analyst.  I read his columns regularly and like him quite a bit.  So I do not wish this to seem to be overly critical.  And I realize that it might seem that I am trivializing his argument, but this is the heart of it. 

Ted has been quite vocal in asserting that JP Morgan et al. have been manipulating the silver market based on what he has seen at the Comex.

But I did want to take the time to point out that a) gold leasing is not like lending out a specific object and b) just because something does not make economic sense to you, does not mean it is not happening.   His argument is not based on any new data, but rather dismissive of something because there is no 'smoking gun' available, only circumstantial evidence. 

These markets and this financial system is all too often the story of all control frauds and bubbles, and misappropriation of others people's money and goods.  Lots of things don't make sense to the rational, honest mind anymore.   Many of the financial deals that cities, counties and nations engaged in that cost their people hundred of millions of dollars made no economic sense.  But there they are.

The efficient markets hypothesis has been used to justify an enormous amount of financial fraud and bad policy decisions over the past thirty years. It is the mother of frauds, from MF Global to Enron to Madoff to the Housing Bubble.

These are smart and important men.  They are far too rational and god-like, your betters, to do things that you would not even think of doing.  They are 'the System.'

Given the extent of the frauds and riggings, I am often tempted to think these days that if there is money to be made at it, if it is being conducted in secrecy, and if it involves other people's property, people who are relatively unheard and powerless, it probably does exist.  But I prefer to stick to the facts, even if it is a plodding and sometimes frustrating path.

 

GATA was kind enough to provide this link to more recent news below.  What do you think they mean by 'actively managing their gold reserves?'   Moving the bars around and dusting them off?

 

If the world 'leasing' troubles you, think about OTC swaps.

 

Related:  Central Banks More Actively Managing Their Gold Reserves

Ted Butler's column of Nov 19 - Popular Misconceptions

"Gold loans are fraudulent through and through, because the real owners don’t get the proceeds when the sale is made and the collateral ends up with an unrelated third party who has no obligation to return the metal. But because they appeared to work for a while, otherwise intelligent people overlooked the obvious fraud and collected the benefits while they were available. Today, those tracking gold loans report the amounts of these loans outstanding are down 95% from levels at the peak around the year 2000. For me, I can’t figure out how even 5% of these loans could still be in existence.

That’s why I’m skeptical about all the talk of GOFO and gold lending as who in their right mind would ever loan or borrow metal under the circumstances I’ve described? There are few, if any, documented instances of specific loans and the parties involved or to the purpose of these loans. I suppose it might make sense to be a borrower if one intends to default on the loan, but that’s hardly legitimate. Likewise, I suppose a central bank might lease metal if there was an illegitimate intent to depress prices, but that couldn’t be discerned from GOFO rates.

Therefore, I think all the articles and commentary about GOFO are still goofy and unproductive. It seems akin to some deep debate by religious philosophers during medieval times about how many angels can dance on the head of a pin. I’m not trying to be insulting, because I believe there is a negative side to the current discussion about gold loans and lending rates that would be eliminated if the discussion ended once and for all. There is somewhat of a common denominator in the debate over gold lending in that most reporting on GOFO appear to be staunch believers in the ongoing gold and silver price manipulation. It is also well-known that those who insist that there is an ongoing manipulation in silver and gold (like me), are considered to be fringe conspiracy theorists. I think that is somewhat earned because so many who believe in manipulation tend to espouse other conspiracy theories (definitely not me). "

Weekend Reading - Ode to Financial and Political Narcissists and Sociopaths

The expense of spirit in a waste of shame (Sonnet 129)
by William Shakespeare

The expense of spirit in a waste of shame
Is lust in action; and till action, lust
Is perjured, murderous, bloody, full of blame,
Savage, extreme, rude, cruel, not to trust;
Enjoyed no sooner but despisèd straight:
Past reason hunted; and no sooner had,
Past reason hated, as a swallowed bait,
On purpose laid to make the taker mad:
Mad in pursuit, and in possession so;
Had, having, and in quest to have, extreme;
A bliss in proof, and proved, a very woe;
Before, a joy proposed; behind, a dream.
     All this the world well knows; yet none knows well
     To shun the heaven that leads men to this hell.

This video below illustrates why the rational expectations model of efficient markets is a dangerously misinformed theory, and perhaps a deadly rationalization for plunder. The theory, like so many flawed economic models, discards the outliers of the norm, who in the real world are in sufficient number to have a statistically significant effect on the outcome and the shape of the market.

And this is why self-regulation without objective oversight, the rule of law, and justice for all in equal measures is a path to self-destruction.

Power attracts certain personality types, and organizations that value power, or ruthless determination to achieve results at any cost, often end up being run by people with the mentality of predators. And the predatory environment can become self-reinforcing and self-sustaining given time.

“A nation can survive its fools, and even the ambitious. But it cannot survive treason from within. An enemy at the gates is less formidable, for he is known and carries his banner openly. But the traitor moves amongst those within the gate freely, his sly whispers rustling through all the alleys, heard in the very halls of government itself.

For the traitor appears not a traitor; he speaks in accents familiar to his victims, and he wears their face and their arguments, he appeals to the baseness that lies deep in the hearts of all men. He rots the soul of a nation, he works secretly and unknown in the night to undermine the pillars of the city, he infects the body politic so that it can no longer resist.

A murderer is less to fear.”

Marcus Tullius Cicero

Wealth Dispersion and General Thoughts on the Future of Economics on a Saturday Afternoon

Here is an interesting graph of wealth distribution, or dispersion, as I call it from Cherchez La Verite.

I am not sure I agree with his conclusions or even his premise, not because I disagree but because it requires some thinking and leisure to digest it. But the data is most interesting.

I wonder if any of the quant economists have performed simulations on virtual populations, and then examined the results of varying different tax rates, and concentrations of wealth because of fiscal policy and regulatory structure, among other things.

I have an hypothesis that great concentrations of wealth lead to economic stagnation, but I am afraid that I have not the means or the talent anymore to conduct that type of research.

The difficulty in a study like this is that the assumptions are greatly magnified into the results. If you assume certain buying, spending, and savings behaviours, the downstream impact can greatly alter, and even distort, the outcomes.

And when people reason through this verbally, rather than perform a structured simulation based on transactions, the distortions increase by an order of magnitude or more based on their own biases.

I used to create simulations like this all the time, for industrial and commercial purposes, and also did a decent amount of econometric modeling. So I am sure someone is doing it somewhere. But I suspect they are doing it in think tanks and places where the outcome is predetermined by the basis of their grant.

Concentrated wealth magnifies the needs and predispositions of the holder. Since the amount they require for basic necessities can only consume so much, one would think that the amount spend on the aggregate of necessities will eventually be reduced. And what they do with their excess of necessity wealth is going to be greatly influenced by their character. Are they a gambler, who inherited the wealth? Are they productive and beneficent? Are they dissolute and venal?

And what about government? Taxation can concentrate enormous wealth in the government. What sort of government does one have, or does one assume? Are they warlike, productive, redistributive, and how corrupt? What about corporations? They can be like small governments, and levy taxes through monopoly and persistent frauds. How are they managed? Corporations are not rational machines, as the efficient market hypothesis would probably presume. Indeed, corporations are often much worse than governments in terms of sheer blockheadedness, greed, and short-termism.

Hard to say. But there is a related field of study in decision making theory, which looks not at wealth but the distribution of decision making power in organizations. It is concerned with the validity and effectiveness of decisions made across a range of broader consensus to a narrow oligopoly and even a great man dictatorship.

The general observation I came to in this study was that decisions tend to be more valid depending on the quality of the information, the facility of the evaluation of it, or intelligence/learning/experience, less the biases and distortions.

A decision becomes a little better if the information is more widely dispersed and a variety of actors can exchange freely in increasing and refining it. There is a point of decision dispersion where the returns not only diminish, but become counterproductive because of the noise and inability of new actors to add value, and actually detract from the process. But finally what I found interesting is that in the aggregate personal error, bias and distortions tends to diminish quickly as a detractor from the result, assuming a non-homogeneous population with some independence of thought.

So too this same sort of study can be applied to the concentration of wealth, since wealth is power. But it is even more interesting because spending habits will vary since the percentage of spending on essentials changes much more slowly than wealth can increase.

And how one assesses the outcomes is also essential. What is thought to be a 'good outcome?' Not necessarily in a rough measure like aggregate GDP, but perhaps GDP with modifiers like the median wage, and a poverty level of essential spending. This is important because so often economic policy arguments are presented with the goal of optimizing short term GDP.

Alas, I have little hope that this will be done now, for the US has had a leadership role in quantitative economic studies, and their work has been twisted generally into the service of whores, robber barons, and gamblers as the speculative society reaches a crescendo. But some day this too will change.

"Build America Bonds" Paying a Shocking Premium to Corporates

The “Build America Bonds” were created by Bill S.238 called "The Build America Bonds Act of 2009 which provides $50 billion of federal taxpayer funds to subsidize state and local government tax free bonds in support of 'shovel ready' infrastructure projects.

The U.S. Government gives the issuing municipality or state a 35% rebate on the interest that the issuer pays to the bond holders. This is a huge benefit for local governments.

We have not yet found out why, but it is apparently giving a big benefit to the buyers of the bonds who are getting an income stream at well below market prices for comparable issues. In some cases the BAB bonds are pricing at 149 basis points over comparably rated corporate bonds.

Where is the inefficiency coming from in this bond offering? Who is taking the differential, the vigorish, being granted to the state and cities? Who are the underwriters and the market makers? Who are the big market makers besides Pimco? What are the fee structures being charged compared to the overall bond market?

Meredith Whitney, star analyst that she is, was the closest with her $4.65 prediction. She thinks the stock has lots of room to run, notes Fortune. Goldman, in her mind, will surf the economic woes now roiling the country. Goldman is a top underwriter of municipal bonds and the No. 1 underwriter of Build America Bonds. "These are a new type of municipal bond, part of the Obama administration's $787 billion stimulus plan. Cities, states, universities and government entities use BABs, as they're known, to finance infrastructure projects. This is a potential $50 billion annual market, Whitney says, and Goldman currently holds a 25 percent share," reports a Fortune article.

Oh now it all makes sense. Droit de Seigneur.

Bloomberg
Taxpayers Inferior to Shareholders With Obama Bonds
By Michael McDonald and Bryan Keogh

July 22 (Bloomberg) -- State and local governments, forced to close budget gaps by firing workers and shutting schools, may pay at least $4.2 billion more in interest than companies with similar credit ratings on Barack Obama’s Build America Bonds.

The $17.4 billion of Build America Bonds sold since April pay an average yield that’s 0.96 percentage point more than corporate securities with the same ratings, according to data compiled by Bloomberg and based on the 25 largest deals.

“Taxpayers are taking it on the chin,” said G. Joseph McLiney, president of Kansas City, Missouri-based McLiney & Co., a firm that specializes in selling municipal bonds that qualify for federal tax credits. “There should be no spread.”

While Build America Bonds opened credit markets to municipalities after the collapse of Lehman Brothers Holdings Inc., states and cities are being penalized compared with corporations, which are 90 times more likely to default than local governments, according to Moody’s Investors Service....

‘Disserving Their Constituents’

The difference in borrowing costs shows elected and appointed officials are failing taxpayers, said Stanley Langbein, a banking and tax law professor at the University of Miami and former counsel at the U.S. Treasury in Washington.

Issuers are “supposed to get the best rate available,” Langbein said. “To me they’re disserving their constituents. Their responsibility is to get the lowest rate available, which is the corporate rate.”

Congress included the Build America Bonds program in the $787 billion stimulus President Obama signed into law in February, after sales of fixed-rate municipal bonds fell 17 percent last year to $281.1 billion, according to Bloomberg data. Most of the drop followed Lehman’s bankruptcy in September.

The initiative, which expires at the end of next year, provides a federal subsidy for 35 percent of the interest costs on taxable bonds sold by states, local governments and universities to finance capital projects that create jobs. Borrowers say they save money compared with tax-exempt debt because the interest after the federal payments is lower than tax-exempt benchmarks.

‘Priced it Right’

“We feel like we priced it right,” Jennifer Alvey, Indiana’s public finance director, said of the June bond sale. Indiana is paying a rate of 4.28 percent after the subsidy, lower than on tax-exempt bonds, she said. “That’s the difference I care about.”

Investors demand higher rates from municipal borrowers because Build America Bonds are 91 percent smaller than company offerings on average, according to data compiled by Bloomberg.

While California sold $5.23 billion in April, the largest issue so far, Avondale, Arizona, offered $29.8 million on July 6 for sewer and other public improvements. The average par amount for Build America Bonds is $102.5 million, compared with $1.16 billion for the 611 U.S. investment-grade corporate bond offerings this year, according to Bloomberg data.

‘Pricing Power’

Investors also require higher yields because they say the securities may become difficult to trade if the program isn’t extended past 2010, said Natalie Trevithick, a senior vice president at Pacific Investment Management Co. The Newport Beach, California-based firm runs the world’s biggest bond fund, the $161 billion Total Return Fund.

“We do have much more pricing power in these deals,” Trevithick said.

Endowments, foundations and pension funds are overlooking the securities because unlike Pimco, they don’t have expertise to analyze municipalities, said Peter Coffin, president of Boston-based Breckinridge Capital Advisors, which oversees $10 billion in bonds.

“You have a lot of big buyers so there’s less price competitiveness,” said Scott Minerd, the chief investment officer at Santa Monica, California-based Guggenheim Partners, which manages $100 billion.

Alan Krueger, the Treasury’s chief economist in Washington, said Build America Bonds succeeded in reviving the municipal market by lowering debt costs. He said municipal and corporate securities are different, so they are difficult to compare.

‘Good Start’

“Build America Bonds are doing what they were designed to do, which is lower the cost of capital for municipalities and increase access to capital markets,” Krueger said in a July 15 telephone interview. “That’s what Build America Bonds are intended to do, and they’re off to a good start doing that.”

State tax collections fell 11.7 percent to $160 billion in the first quarter compared with the same period in 2008, the largest drop in at least 46 years, the Rockefeller Institute of Government in Albany, said in a July 17 report.

Congress’s Joint Tax Committee estimated in February that the Treasury would spend $9.8 billion through 2019 subsidizing the bonds. Matt Fabian, a managing director at Municipal Market Advisors in Westport, Connecticut, said in a June 22 report that the program’s price tag may reach $27.3 billion by the time all such securities mature in 2044...

The spread is even wider when considering more of the smaller Build America Bond deals, according to Philip Fischer, a strategist in New York at Merrill Lynch & Co., a unit of Charlotte, North Carolina-based Bank of America. He found that on July 15 the average yield on bonds of more than $100 million compared with an index of AA corporate rates was 1.49 percentage point.

“Munis and corporates are apples and oranges in terms of the credit, but does that justify that kind of spread? Not for me,” said Ben Watkins, the director of Florida’s state bond division. Investors in the corporate bond market are “taking advantage of an opportunity.”