A Dash of Insight

Misunderstanding the Fed Balance Sheet -- A Costly Mistake

At "A Dash" our principal mission is identifying the real experts on various topics.

There are so many sources of information and analysis.  The business models for financial media depend upon ratings, so popularity rules.  The easiest way to connect with readers or viewers is via the anecdote, the dramatic chart, and analysis that can be explained in "pop economics" terms.

The Fed balance sheet provides a good example.  The bearish element of the punditry has highlighted the dramatic increase in the monetary base and the various Fed programs as a sign of incipient disaster.  At first, many suggested that we were about to have another Great Depression.  Some still maintain this position despite the improving economic indicators.  Arguing in the alternative, these same people argue that we have merely delayed the real consequences.  In particular, we have already sowed the seeds for a new inflationary bubble

We have recommended a more compelling viewpoint.  It is not popularly accepted, partly because it is difficult to understand.  It is not Pop Economics.

Our Take

We highlighted the monetary stimulus in our Summer Quiz.  We followed up with an analysis using a better long-term take on the Fed balance sheet.

Briefly put, the Fed has stepped in to provide lending in markets where the private market has dried up.  This was necessary to limit the impact of the recession.  Fed Chair Bernanke has explained the plan for an exit strategy, to be implemented when normal and sensible lending resumes.

We see this as wise and sensible public policy.  We understand that many disagree, and that is what makes a market.  In particular, we have highlighted the thoughtful and market-oriented analysis of Bob McTeer, former Dallas Fed President and analyst at a free market think tank.  His credentials and expertise are impeccable.  We strongly urge readers to consider his analysis of Fed policy.  Here are some highlights.

McTeer criticizes those who use a compressed time horizon to show the increase in the monetary base.  He thinks this is deceptive, and points out that the analysts have no clear causal reasoning for the prediction of an inflationary explosion.  He is modest in his analysis, accepting that there is room for some inflation protection.

His key point is that the Fed is filling in for a failure of private markets to do normal lending.  This is a process that started with the failure of Lehman and the temporary cessation in commercial paper.  There will be an end and an exit strategy.  He notes that the monetary base expansion occurred eight months ago and has leveled off.  He writes as follows:

Meanwhile, the time to shrink is not close. The velocity of money obviously declined dramatically as money growth accelerated months ago. Under those conditions, rapid money growth is needed to prevent deflation. Anticipating velocity changes may be hard, but seeing them after the fact is rather easy. Just divide GDP (P x Q in the equation of exchange) by M (whichever definition of money you fancy) and you get the income velocity of that measure of money. Having GDP growing slower (negative lately) than M is growing tells you that V is declining.

Put another way: Money doesn't cause inflation; spending money may cause inflation. Money is not being spent at a sufficient rate lately to cause inflation.

and further..

The decline of nonbank credit leaves a large hole to be filled by bank credit until things return to normal. That's what Chairman Bernanke is doing as he purchases debt (assets) other than treasury debt-commercial paper, mortgage-backed securities, packaged student loans, auto credit, etc. Focusing on these purchases and not realizing the hole he is trying to fill would lead you to believe, falsely in my opinion, that seeds of future inflation are being sowed.

and finally...

...(T)he inflationary impact of fiscal deficits depend almost entirely on how they are financed, i.e., whether new money is created in the process. Growing deficits without comparable monetary expansion will push interest rates up sufficiently to get the debt purchased. Higher interest rates are likely to crowd out private investment as the government commands more and more of the financial resources. This is not a good outcome, but it's not inflation.

Conclusion

There is a time and place for various policies.  An ideological perspective that nothing will work is a losing investment strategy, as we have seen in the last several months.  Readers would be well advised to read the entire McTeer analysis.

There is a lot of buzz about what will be the "New Normal."  We expect this to be a return to sensible lending practices, relying on private markets.  The Fed will withdraw as this takes place.

Individual Investors and the Information Barrier

Here at "A Dash" we see the Summer of 2009 as a key time for investors.  Doug Kass is calling the summer a "snoozefest" but there has been plenty of action within a broad trading range.  Some themes have been working.  How shall we find new ones?

We started our summer research by identifying and highlighting the most important issues in a quiz format.  (While official entries have closed, you can still benefit from recording your own answers first.   As we take up each topic, we will reveal the "official" answers.

Background

Finding the right information is always a big challenge for investors, but the current circumstances have created a perfect storm .

Consider these sources:

• Political pundits.  Some want to find any possible basis for criticizing the President.  Here at "A Dash" we separate the citizen role from the investor role.  We hope to continue our long-term results -- making money regardless of which party is in power.  Consider the current dilemma.
  
  • The opposing pundits see no hope for any success.
  • The "supporting" pundits think that Obama has not gone far enough.
  • The impression for the individual investor is that nothing will work.
• Market pundits.  Some of these sources are selling a book, an idea, or a web site.  The information is not partisan, but it is biased.
• Economics pundits.  In the ongoing debate about policy, the reader can choose from among Keynesians, Monetarists, New Keynesians, or those from the Austrian School.  And we are just getting started!

Many of these ideas may seem tempting.  The results range from heart-felt opinions with an emphasis on one viewpoint, to mistaken information, to blatant misinformation.  It is a perfect storm for the average investor -- dubious information from all sides.

Pradeep Bonde, one of our featured sources, made this important point in a recent article:

There is always a bull market in conspiracies.Some of the popular investment blogs are active peddlers of conspiracy theories. In fact if you want to quickly become popular in trading blogosphere you should peddle conspiracies.

The article deserves a wide reading, so check out the whole piece to see if you can guess the leading conspiracies.

Let us illustrate with one example, the Fed's monetary policy.

The Critics

The many critics suggest that the Fed is making a big mistake.  They are  "debasing" the currency (this word is always present in the critical commentaries) and they have no exit strategy from their policy of monetizing the debt.

The most aggressive criticism illustrates a spike in the money supply.  This accusation comes from a noted political commentator who uses charts with no scales and no background.  Many investors watch this information on the original source or on youtube.  For those who have no money to invest and merely want reinforcement of their political views, this is good entertainment.  Anyone trying to get an investment return, is watching the wrong source.

Who would be better?  Try Bob McTeer, another of our featured sources.  He has the actual Fed credentials lacked by the wannabe commentators, and he is also a political conservative.  As we seek out good sources, we consistently find his observations to be the most sensible and most helpful.    Here is what he says about the money supply, a subject where he is an expert.....

The money supply spiked, and then flattened out. Pre-spike until now still gives us pretty big numbers, but they are getting smaller every day. Yet, commentators treat the money growth statistics as if the rapid rise is ongoing.

and later....

Turning to the different subject of how to lie with statistics, I've seen lots of graphs lately that have had the horizontal axis squeezed together to produce scary money-growth graphs. The most egregious is probably the graph of the monetary base growth dramatic enough to make You Tube. Shame!

As usual, the entire article is worth reading.  More people should read Bob McTeer.

The Data

To support the McTeer viewpoint, we need a simple chart.  Here it is, from the St. Louis Fed.

 

There are two obvious conclusions:

1. A log scale (showing the true percentage relationship over time) and a bit of history shows a very different picture from that of the critics.
2. The money supply spike came at the time of the Lehman failure, not during the Obama administration.  The Fed reacted to an emergency, and is now adjusting policy.

Investment Conclusion

There are plenty of things to worry about.  Fed policy is not one of them.

Many people need to rebuild their retirement accounts.  This means understanding how to interpret information.

Should You Own Junk Bonds?

At "A Dash" we think the time is right for high-yield bonds.  We hold profitable positions in these securities in personal and client accounts.  The yields offer an attractive alternative to most of the common shares, and have less chance of default or dilution.  Naturally, we are very attentive to comments on prospects for these securities.

Our attention focused on this item from Zero Hedge:

...everyone is ignoring that 20% of these names will be bankrupt by year end, unless Obama and TTT nationalize everything, in which case look for the first 5 year plenary session some time in December, complete with parades by the 91st and 341 Missile Wings showing off their Minuteman III arsenals (reduced to single warhead delivery to comply with START I).

Unlike most readers, we click through to the source, which reads as follows:

“Champagne might be a little premature,” Gregory Peters, head of credit strategy at Morgan Stanley in New York, said yesterday in a Bloomberg Television interview. “You’re still facing the biggest distressed default cycle that we’ve ever seen.”

Moody’s is forecasting the default rate among high-yield companies globally to soar to 14.8 percent by year-end from 8.3 percent in April as companies that financed a record amount of high-yield, high-risk debt leading up to the credit crisis struggle to refinance.

Our Take

A key skill for investors is to verify the accuracy of sources and their evidence.  We highlighted this problem, and noted the difficulty when readers uncritically accept the summaries provided by popular sources.  The summary from this author is not accurate when one looks at the source material.

The other key point in this case is the intermingling of a political viewpoint with investment advice.  There is plenty to analyze about the Obama Administration.  We work on this daily at our sister site, ElectionStocks.com, where we link policy proposals and decisions to stocks.  Our approach is strictly analytical.  We note successes and failures, and did the same for various candidates and the Bush Administration.  Our approach is not partisan -- strictly oriented to investment success.

Those who start with the conclusion -- an attack on government policy -- and then look for evidence, may be in for a long four years of bad investment decisions.

Long  PGF

Does Blogging Enable Market Manipulation?

The greatest strength of financial blogs is also a potential weakness.  There is so much information that readers frequently rely upon the interpretation of the writer.  Most people do not click through to the supporting links.  They go to their favorite sources for information, and generally rely upon the interpretation of the writer.

We know this is true from our own stats, even when we strongly encourage readers to check out an entire article.  Readers rely upon us to make accurate representations of source material.  We are expected to provide a fair summary and accurate illustrative quotations.

Fair enough.  No one has time to check out all of the sources, no matter how carefully we try to document.

This is in sharp contrast with mainstream print sources, where editorial procedures review material before it is published.  Not so in the blogosphere.

The issue can be simply stated:

Blogs with a wide following have a special responsibility to check and re-check accuracy before posting.  If the authors do not do so, there is an easy means of manipulation.

Step one:  Get a dubious story out there somewhere -- anywhere.

Step two:  Get a noted blogger or pundit to mention the story.

Step three:  Mainstream media sources race each other to be first with this news.

Trust in link sources is vital.

Strong Sources

We feature several blogs where the authors provide plenty of links and summaries.  Some of the sources are anonymous bloggers.  We believe this conveys a special responsibility, since the reader does not know the background or skill of the writer.  It takes more evidence to be convinced of these sources, but the proof is evident in the work.  If one checks out the links, the accuracy proves out.

Here are examples of sources where the links are fairly interpreted with very high reliability:

• Abnormal Returns.  The summary tells you what you will see.  You can choose whether to read it.
• Charles Kirk.  Always interesting, always accurate.  Many interesting links.
• Alea.  Anonymous, but with special insight on credit markets.
• Calculated Risk.  Respected by everyone -- earned through accuracy.
• Paul Kedrosky.  Especially useful in finding interesting academic papers.
• The Big Picture.  Barry has a viewpoint, but his sources are always carefully documented and accurate.
• Muckdog.  We like the "everyman" viewpoint, which often captures the spirit of the market.  The links support his statements.
• Dr. Brett.  Unchallenged authenticity, with widely varying interests.
• David Merkel.  What you see is what you get in links at The Aleph Blog.
• Adam Warner.  The quotes are always representative.

We are leaving out many, of course, but this is designed to illustrate.  The WSJ blogs, for example, are carefully sourced.

The Jury is Out for Some

Like many others we follow the work of the anonymous blogger "Tyler Durden."  Seeking Alpha assures us that this person is an authority. He has rocketed to a high level in the new Seeking Alpha rankings -- a position of influence and responsibility.   Many of the articles display interesting and informative insight concerning the inner workings of big firms and hedge funds.

Since there does seem to be a viewpoint in the Durden work, we have great interest in the sourcing and evidence.  Let us look at an example of links from the prolific Durden.

Must read on CNBC propaganda: "Immelt and NBC Uni CEO Jeff Zucker supposedly told top CNBC executives and talent to be less critical of President Obama and his policies" This explains why nobody with half a brain watches CNBC anymore (THR hat tip Guest)

Since we have opined on CNBC politics, this was of great interest.  Our viewpoint is that opinion shows like Kudlow's in the evening are interesting and informative.  Viewers know what they are getting, and it is a lively debate.  We do not like the intermingling of politics and journalism during the business day, when CNBC anchors get to interview authoritative guests.  We are not very interested in the opinions of the journalists, and viewers should not be either.

If one reads the link, one can readily see that the quoted section does not accurately represent the article.

First up was a woman asking about a reported meeting in which Immelt and NBC Uni CEO Jeff Zucker supposedly told top CNBC executives and talent to be less critical of President Obama and his policies.

Immelt acknowledged a meeting took place but said no one at CNBC was told what to say or not say about politics.

During the woman's follow-up question, her microphone was cut off.

The key point is that Immelt denied the charge in the Durden quote.  Perhaps he suggested that journalists should be journalists in non-opinion shows.  We do not know, of course, but that would be a good thing.  Helping investors to separate political decisions from their finances is good advice, as we have frequently suggested.

Even more telling is this section from the rest of the article:

Later, during the umpteenth question about MSNBC, another shareholder's microphone was cut, according to multiple attendees.

"The crowd was very upset with MSNBC because of its leftward tilt," one attendee said. "Some former employees said they were embarrassed by it."

One specific complaint about MSNBC concerned Keith Olbermann's interview of actress Janeane Garofalo, who likened conservatives to racists and spoke of "the limbic brain inside a right-winger."

We spend very little time on MSNBC, but from what we have seen, we can understand the criticism.  Once again, the key is whether the program purports to be journalism or opinion.  This part of the article is exactly the opposite of the theme of the Durden quote.

Briefly put, we do not think that the Durden summary of the link is a fair and accurate representation of the article.

Another recent  example is the unsourced claim that SPY is hard to borrow.  This was challenged by Doug Kass (full disclosure -- Kass is a valued colleague at TheStreet.com).  Kass checked this out and found no problem with a borrow.  Here is the Durden response:

Update 4: Doug Kass disagrees:

I have received emails from several trading sources, stating that the market is rising because the SPDRs (SPY) are hard to borrow now and arbs are being squeezed.

This story is hogwash, as I just tried to borrow 500,000 SPDRs and had no problem doing so!

Position: Long SPY; short SPY puts and short SPY calls

Maybe Doug can disclose at what term and rate he got the borrow. Doug - I am dead serious - can I borrow 5 million SPY right now at 0% from you? Hell, will give you 1%

We expect to hear more about this dispute.  Meanwhile, anyone wanting to short the market can do so through a futures account.  There is no problem in "borrowing" e-mini's to go short, the method favored by those of us in Chicago.  There is an arbitrage opportunity with SPY.  The claim of a problem in shorting does not have face validity, so we look forward to some evidence.

Our Take

It is easy for investment readers to be swept up by apparent authenticity, especially from a source that everyone seems to follow.

We hope that "Tyler Durden" will balance frequency of posting with accuracy in representing links.

We have a continuing concern about the "leaked stress test" story, where he is a supporter of a dubious source.  That is a question for another day.

A Problem: Business Journalists and Political Opinions

At "A Dash" we take the investor perspective.  Put very simply ---

We seek credible news sources where astute journalists draw out the expert opinions from leading experts.

We frequently express dismay when business journalists substitute their opinions for a presentation of facts, when columns have a clear slant, when bloggers start with a conclusion, and when anchors intermingle opinion with questions.

A New Voice

It is important to identify these errors.  They are not obvious to the average listener.  This intersection of political comment and business news has stimulated a reaction.  There is now a new fact-checking source, Financial Media Matters.  Readers following politics may already be familiar with Media Matters, which describes its mission as follows:

Media Matters for America is a Web-based, not-for-profit, 501(c)(3) progressive research and information center dedicated to comprehensively monitoring, analyzing, and correcting conservative misinformation in the U.S. media.

We should all understand the approach and possible bias.  Having said this, the reports are factual and worthy of evaluation.

We do not engage in political advocacy, but the intersection of political discussion and the economy is crucial right now.  Investors need to understand what is factual and be willing to consider fact-checking in an open-minded fashion.  This is a new source, and a valuable one.

The First Impact

Media Matters challenged CNBC, suggestion that Larry Kudlow was using his platform as the basis for a possible Senate race.  CNBC responded with a clear denial of a Kudlow Senate run.  This is positive and important.

We have been long-time fans of the Kudlow show, which brings together many experts and draws out opinions.  We have also been concerned about political commentary in Kudlow's anchor segments on CNBC.

The clarification of this point is a good positive step.  We followed these developments via the excellent blog from the University of North Carolina, Talking Biz News, now added to our featured sources.  We commend the work of Chris Roush, the distinguished journalism prof at North Carolina.  This is a good time for investors to monitor his work, and that of his team.

Conclusion

Successful investing means putting aside personal political viewpoints.  The election is over.  It is time to consider the investment implications of the policies in place.  This is not a discussion over cocktails -- it is about your money and your investments.

The overwhelming trend in market commentary is that no government program will work.  The criticism of each announcement is immediate and pervasive.

The critics often disagree based upon personal values or politics.  They are not engaging in a dispassionate analysis of the programs.  Government efforts are not perfect, but they will have an impact.  Mainstream economic forecasts recognize this, and diverge widely from those of the punditry, mostly non-economists.  Check out this disparity in a  nice pickup of some key observations by SF Fed President Janet Yellen at Calculated Risk, another of our featured sources.

Getting this right is the most important challenge for investors.

Think You can Predict GDP Revisions? Think Again!

The focus group here at "A Dash" rejected the original title for this piece, the more professorial "Understanding and Predicting Revisions in Government Data."

Whatever the title, it is the same topic.  It will be uninteresting to the many who have already made up their minds.  It continues our theme about those who disparage information from many sources.

There is a quiet battle going on.  It is more important than most realize.  On one side are those whose every article seeks to "dumb down" the discussion.  They find something wrong with every data release.  These commentators, who almost universally lack the traditional training or credentials, use some "common man" argument, appealing to what most readers already believe.  What do they have at stake?  If correct, then their opinions are just as good as the PhD economists!  And with no cost in time or money to get the education!

On the other side there are the regular economists.  While they have plenty of room for disagreement, they are all committed to finding and interpreting the best data.

A Case in Point:  The GDP Report

Last week we observed that the reaction to the GDP report seemed overdone.  Our own viewpoint is that economic activity peaked in Q407.  If the decline is sufficiently significant in the opinion of the NBER, we shall see an official recession beginning with that date.  We have written on these lines several times.

When the advance report for Q208 was announced as 1.9% real growth, that seemed like a pretty good rebound.  Perhaps it is time to think about what may generate the next turning point, and when the market may anticipate the turn, a subject intelligently raised by Tim Plaehn at Investing Thoughts.

"Oh, no!" said the punditry (and a few respected commenters here at "A Dash."  Their basic contention is that the "deflator" used is unrealistic.  The deflator is an inflation measure geared to the basket of good in question.  The amateur economists prefer to use their own inflation gauges (Big Mac index, Martini Index, Oil index, gut feel -- whatever) instead of the various official choices).

They do this despite careful warnings and explanations describing each measure of inflation.  The use of this complaint is now so pervasive that a wide variety of reports are called into question including retail sales, personal spending, and GDP as well as the regular PCE and CPI announcements.

Popular media citations included sources we admire and follow like Rich Karlgaard and Felix Salmon.  (We probably owe Barry Ritholtz a link here also, since he has been a leader on this theme.  Perhaps Barry or someone else will supply it.  His articulate and powerful statements always capture the attention of many readers and the media.)

By contrast, there is are excellent explanations from our favored economists at Econbrowser.  James Hamilton, showing off his teaching skills, writes a post that anyone can understand.  He explains why the price of  imported goods are not and should not be a part of the GDP measurement.  It only takes five minutes to read, and it is time well spent.  His conclusion is as follows:

But wait a minute, Islandia's pundits decry. How can your crummy accounting claim that inflation was only 1%? Last year we bought 500 coconuts and 1 barrel of oil for $600, but this year if we tried to buy the same thing it would cost us $630. The inflation rate, they tell you, is obviously 5%, not 1%. You must have intentionally cooked the books, they charge, just to make the economy appear better than it is!

You patiently try to explain that imports aren't included in GDP, and that's why the numbers came out the way they did.

But they're not going to believe you.

We know that this does not make complete sense out of context, but maybe readers will be sufficiently intrigued to follow the link!

His blogging colleague, Menzie Chinn, has a more complex viewpoint.  While he thinks that revisions are likely, he does not agree with the criticism of the deflator.  More ambitious readers should take a look at his analysis.  His conclusion is as follows:

Thus, it seems to me that we should anticipate that over time, we should continue to see a disjuncture between the GDP deflator, and what we think should be the price level.

This is not to deny the possibility that the GDP deflator might be revised upward. That could happen. But my view is that a lot of the puzzlement abounding can be resolved by recognizing the difference by the GDP deflator and the gross domestic purchases deflator.

Our Take

At "A Dash" we do not develop independent inflation forecasts nor GDP forecasts.  We are consumers of economic data.  We look for the best sources and recommend them to our readers.

Many traders and investors are also consumers of such data -- very poor consumers.  They do a poor job for two reasons:

1. They do not understand the technical aspects of the subject.
2. They believe that "gut feel" and popular perceptions are an adequate substitute for data.

Markets react to these perceptions.  It is a source of market inefficiency and an opportunity for those who take the time and trouble to understand.  This understanding does not require learning advanced economics.  It merely requires identifying the real experts on the subject. 

The New York Times Attacks Richard Syron

When does a good story get in the way of informing readers? Editors of all major publications face this decision each day. A recurring topic at "A Dash" is how many bloggers play fast and loose with facts. The Internet gatekeepers push along the stories placing the burden on readers. No matter how intelligent the reader, no one is going to check facts, sources, and analytical techniques for various stories.

With print media in competition with blogs, the distinction is starting to fade. Cyberspace is full of unedited and often unchallenged text. It lasts forever.

Background: The New York Times Attack

Charles Duhigg studied history at Yale and got an MBA from Harvard on the way to becoming a reporter for The Los Angeles Times and then The New York Times. His feature article on Freddie Mac and Richard Syron attracted plenty of attention and comment today.

The main contention is that Syron got a memo in 2004 from his Chief Risk Officer, David A. Andrukonis, warning that the firm was financing questionable loans. The next year Mr. Andrukonis left "to become a teacher." Duhigg has plenty of anonymous sources who confirm that Syron had this information.

Since we accept the factual authority of The New York Times, we do not challenge that there was such a memo. We also do not doubt that sources were confirmed. This leaves room for plenty of other complaints.

Challenges from our Blogging Colleagues

The best job of analysis on this article came early in the day from Tanta at Calculated Risk, one of our featured sites. She was clearly on a mission. Among other points she noted the following:

• The Times short-changed Syron's resume;
• Too many anonymous sources;
• No recognition that this was one memo of many; and
• Faulty grasp of the role of the GSE's.

Nice work.

Matt Stichnoth, writing for Bankstocks.com, has some other good points. He draws our attention to the following:

• There was a big change from 2004 to 2005. These problems were not so obvious in 2004, and might not even have applied to loans at that time.
• Recognition of Congressional pressure for Fannie and Freddie to pursue social missions; and
• Recognition that the worst crisis in history might not have been totally foreseen.

Both of these articles deserve to be read in their entirety, as well as the original article.

Our Take

There is a common statistical problem involved here. In any large organization there are many people warning about many things. Sometimes the warnings are completely unnoticed. Sometimes they are evaluated but found to be unpersuasive.

If one starts with all of the situations where there is "a warning" the executive might have done very well. Who knows how many problems Syron correctly anticipated and solved or how many bogus concerns that he ignored.

If one begins with the conclusion, it is usually easy to spot something. Finding the warnings that should have alerted someone to the big mistakes is a classic revisiting of history. Some examples include the following:

• FDR did or should have known about the attack on Pearl Harbor.
• NASA should have known about the defective O-Rings before the Challenger disaster.
• President Bush should have known about 9/11 before the attacks.

We are surprised that these incidents were apparently not covered sufficiently in the Yale history program, nor the statistical problem in the Harvard MBA program.

There is also the policy perspective. The reason that GSE's had implicit government support is that they were following national policy, using prescribed rules (including degree of leverage), and overseen by appropriate authorities. It was a balancing act.

Whether these organizations, neither fish nor fowl, are appropriate mechanisms of policy is a question for another day. Second-guessing the executives confronted with difficult decisions is another matter altogether.

The Consequence of Journalistic Choices

We doubt that most readers, on their own, thought about the many points raised here or by Tanta and Matt. Since The New York Times has a much larger circulation than the bloggers, only a few will be alerted.

Our guess is that most will accept this as just another case of corporate greed. For every issue there is some simple heuristic, a lowest common denominator if you will, that resonates with those who have conclusions in mind when they read news. We are disappointed, therefore at the conclusion reached by another of our favorite sources. After noting that Syron has received $38 million in compensation since 2003 while the stock prices have declined, here is the conclusion offered:

This was simply greed on the part of an executive, a transference of wealth from Shareholders to himself . . .

Full Disclosure

While we have no position in Freddie Mac (FRE), we have a recent and very successful position in Fannie Mae (FNM) -- long stock and short the pumped August calls.

Choosing Sources for Data and Analysis

At "A Dash" we emphasize the need for objectivity in finding and analyzing data.  It is good for public understanding and it is good for your investments.

We disagree sharply with those who allow their own biases to guide their work.  One way to spot such pundits is to see how they treat sources.  Many have embraced the work of a conspiracy theory website that purports to show the "real" economic data, getting rid of the alleged biases and manipulation of government.

We have avoided linking to this site in the past, but our work on misleading data and the cost to the individual investor will lead us there at some point.

Meanwhile, mainstream economists simply ignore this source.  Mainstream media writers, with one prominent exception, have also ignored him.  There is a good reason.  Professional economists choose to deal with those who behave in a collegial fashion-- those who share data and who are open to discussion.  Professional journalists demand a good source for their material, and often some independent support.

Despite this general lack of official recognition, the "research findings" from this source are starting to appear in the comments of many others, often without attribution.

A Frontal Assault

In an excellent article, Menzie Chinn at Econbrowser, one of our featured sources, takes a look at some of the data criticisms of the conspiracy theorists.  Covering difficult topics like inflation and GDP measurement, he shows that apparent data inaccuracies result from many things, most frequently the lack of up-to-date inputs.  His conclusions on inflation measurement are similar to our own, (and he also gets a similar reader reaction).

There is no way to do justice to his article in a brief summary, so we encourage everyone to read it.  You will get a link to the Twilight Zone if you want to go there, and some very specific refutation of key points.  The analysis of GDP inputs is especially enlightening and relevant.

Our Take

On the one hand, we have official government data.  This is detailed information on every aspect of methodology, on the components of various data series, and including the ability to examine alternate measures.  Thousands of economists and pundits pore over the data, sharing and exchanging opinions.

On the other hand we have a single source.  Menzie could not do a complete comparison because he did not have access to the data.  In the absence of checking and peer review, mistakes are frequently made.

Here is the irony.  Many of the prominent pundits who are the loudest complainers about the official government data, often using quite colorful language, drink deeply from the waters of the conspiracy theorist.

It is something to think about.

A Lesson from Dad

The "Dad" I am talking about is Bill Miller.  No, not the one you already know, although we admire the Legg Mason fund manager.  I lost my Bill Miller last year, but the lessons are still there.  Some of them are quite relevant for investors.  (We did a little father/son bonding at Chez Dash this weekend.  Missions accomplished with only one circuit breaker kicked and a couple of buckets of water.  Dad was smiling.)

A Famous Miller Family Story

Here is a signature moment from the young Bill Miller.  I am quoting the key elements, but the tale is told in more detail in this article, Respect versus Arrogance.

The passing of my father, William H. Miller, last week, and some hours of thought on the road have sparked some introspection.  What we try to do at "A Dash" bears his mark.  In a way, that is strange.  Dad went to war instead of to college.  Growing up in the Detroit area, he understood engines.  The principles are simple:  Fuel, Oxygen, Ignition.  It is amazing how people can get this wrong.

As a sailor on his first ship he found himself in an interesting situation.  The engines had been overhauled, but would not start.  Experienced machinists could not figure out the problem.  Officers were hovering and complaining.  The young sailor asked if he could try something.  There was a lot of skepticism, but he was given his chance.  He knew that the fuel and air were OK, so he removed the spark plug and tapped it on the deck, narrowing the gap.  When the plug was replaced, the engines started!

If you could see a picture of the young sailor, cap tilted at a jaunty angle, you might guess the mixed reaction.  The officers were delighted at a problem solved.  Those in charge of the engines were less enthusiastic.

This story was repeated many times over in his Navy career.  While he never got all of the promotions he deserved, he was a fixture on the boats deployed by his Captains.

No Substitute for Knowledge

A crucial lesson from this is that there is no substitute for actual knowledge about a subject.  It does not matter what your rank is.  It does not matter how many years you have served.  It does not matter how many other people call you "Sir."

If you do not have the knowledge, you cannot make the engine start.

The Investment World

There is an interesting difference between social science and engines.  When a theory about an engine is incorrect, the results show up right away.  When a theory about social science is incorrect, the idea may persist for many months -- even years.

This makes it much more difficult for the consumer of information. How do you know when the engine is not going to start?

Here are some red flags.

Misuse of the word "rigor."  A long causal chain with a lot of unsupported assumptions may seem powerful, but it does not meet the definition of rigorous.  A strong argument begins with an assumption that everyone would share, and then provides evidence at each point.  The longer the chain, the more evidence that is needed.  Whenever someone makes a big argument about "rigor", make sure that he has some credentials for each step in the chain.  Big hint:  Rigor usually means peer review.  Those with thin skins about criticism of their work are usually not rigorous.

Selection Bias.  This happens when one starts with a pre-conceived notion of the world and distorts evidence to fit the conclusion.  It is a characteristic of many of the leading investment blogs.  Ironically, many of the same bloggers talk frequently about behavioral economics and the dangers.

The "Slick" Factor.  Many of the top-ranking pundits are there because -- well -- because they are top ranking pundits.  They are cited as "friend/buddy/pals" of someone, or called "doctor" or "professor" to amplify credentials.  Most of them are good with sound bites on TV.  None of them could actually start the engine.  Most of these guys have never created a quantitative model, and would have no idea how to begin.  They do not know SPSS from American Idol.  Their charts come from others -- those with a world view they want to sell.  Many become famous by making a prediction that works--eventually.  There is no real accounting of the investment impacts.

The "Big Money" Managers. Statements from the "big-time" fund managers carry a special warning.  Does it really need to be stated that these people always have an agenda?  If a manager has a fiduciary responsibility to clients and a fund, and then gets a spot on TV, what do you expect him to say?  It would be irresponsible and deceptive to talk against his own book.

Conclusion:  Strong Voices are Leading You Astray

Here is Bill Miller's lesson, some great principles applied to investing.

• Don't take some long-winded analysis to be "rigorous."  Check whether the author has the relevant expertise -- research methods, economics, government, etc.
• Check your sources.  It is pretty easy.  If your favorite source dishes up a constant stream of one-sided commentary, you should already know the answer.  You can enjoy reading your source for entertainment, but not for investing.
• Look beyond the "talkers" and check the actual predictions.
• Do not conclude that someone in a uniform with braids really knows how to start the engine.

And finally,  realize that everyone is an expert on something.  Learn to listen instead of pretending that you already have all of the answers.  Be willing to challenge, but do not be arrogant.

Thanks, Dad.

Government Conspiracies and Your Money

At "A Dash" we are amazed almost daily by the haughty and high-handed disrespect from Wall Street when it comes to the everyday workings of government.  So many powerful voices are so confident, and simultaneously so wrong.  This is typical when an expert switches subjects from something he really knows about-- stocks, trading, technical analysis, etc.-- to something he knows nothing about.

CNBC stimulates this with their "guest hosts" who are encouraged to offer an opinion on whatever topic comes up that hour.  Of course, some of their journalists are already participating in that way.  Looking to the frequently-cited wise men, Jonathan Berr runs down a short list, but there are many more good candidates.

When we see the errors, it is a "kid in a candy store" feeling.  Start with a bunch of traders, fund managers, and lawyers.  None has ever developed a quantitative model, and many cannot construct or interpret simple tables or regressions with statistical controls.  They have not taken (or do not remember) the beginning classes in government, economics, statistics, or research methods.

These pseudo-experts cite actual data, developed with great care by the strongest experts, as "a work of fiction."  As if they knew the difference!  Why?  Two reasons.

First, they do not like the result they see.  It does not agree with their own daily experience.  They confuse their own compartmentalized view of the world with reality.  It is also a message they can sell to their audience, often a niche group who share their world view.

Second, diminishing the real experts increases the influence of the pretenders.  If these powerful voices can convince most to ignore data, then anecdotal evidence rules.  It is an alternate data universe.

And the pseudo-expert is also the master of the anecdote.

The most prominent media voices support them.  Why?  It is a good story.   There are very few who choose to educate readers rather than to play to their existing biases.  It is a good business model.  Readers can understand anecdotes, but not statistical methods.

There is a symbiotic relationship between media and the pseudo-expert community.

Conspiracy Theory

Taken to the extreme, the pseudo-expert actually suggests that "government" is acting in a conspiratorial fashion.  It is pretty easy to recognize such superficial analysis.  It is the work of people who have seen too many movies and read too few books.

The biggest red flag?  Look for those who discuss the U.S. "government" as if it were a  unitary actor.  This is seen only in a ruthless dictatorship with a small inner circle.  Those who conclude, for example, that the President is "cooking the books" on inflation or employment data make this mistake.  They do not understand that the actual work is being done by a non-partisan senior executive service.  (Those interested in how government decisions are actually made should consult our summary article.)

A Failed Conspiracy

Actually, conspiratorial moves are rare and for good reason.  Even closely held secrets, like the original Watergate plan, have a way of leaking out.  The recent suppression of the global warming report provides a nice example.  Menzie Chinn at Econbrowser, one of our featured sites, discusses the report that the Bush Administration thought was too dangerous to release, now available after four years.

This Washington Post article shows what happens when the echelon of political appointees tries to tamper with the work of those who serve government regardless of the party in power.

This is an important example to remember the next time someone is selling a conspiracy theory that you should not be buying.

Investment Effect

One of the strongest things an investor can do is to discover information that is poorly understood or appreciated by everyone else.  It is especially ironic that the commonplace viewpoint is offered as "contrarian" by those taking it!

Briefly put, one can gain an investment advantage simply by identifying and believing information from the real experts on various economic topics.  How simple!

Where to start?  Here's a hint.  The "government" as represented by the diverse Congressional and bureaucratic interests has no unified position about the measurement of inflation.  Many members of Congress, for example, would like to increase Social Security benefits and labor cost-of-living increases.  They would be happy to see inflation measurements that would aid these constituent groups. The BLS employees have tenure and are not subject to political pressure.

Meanwhile.....

Big-name fund managers like Bill Gross have a strong financial interest in public perception of inflation and the economy.  Like any smart manager, he talks his book.  Should you be listening?

More later on Bill Gross versus the BLS, now in its fifth year, but still playing on a blog or TV station near you.