Debunking the Narrative

I woke up at 4:30 this morning. The advantage of being retired is I can get up at 4:30 and if I get tired at 9:30, I just go back to bed for a while catch a few more hours and start the day again. This happens to me a lot. I sometimes wonder if man has this bifurcated sleep schedule built in, since ancient prayer traditions include a “night prayer”, which was something to do during early post midnight awakening, but long before sunrise. Pretty much you make babies or pray to God if you don’t have lights and internet.

I ran across this video this morning which is a critique of Ray Dalio’s predictions of the macro economy based on the financial engineering of the past 30 years. I have come to similar conclusions, which is why I’ve been bailing on the portfolios that tout passive investing into a financially engineered “reality”, what I call The Narrative. I read a lot of financial hocus pocus out there in FIREland, hocus pocus far more convoluted than the 4 x 25 narrative. Now it’s all about becoming a real estate tycoon. Real estate tycoonery is all tied up with levered cash flow. It’s a little like the Federal government. Why yes 23 trillion debt is just peachy until the economy crashy with an actual mean reversion kind of crash. You are basing your risk on a narrative of the past. A narrative when there was a free market. A narrative when companies borrowed money to increase productivity, not just buy back stocks in a maneuver to raise stock price.

This video describes Dallio’s perspective as well as this Vlogger’s perspective and largely my perspective. Depending on your perspective it might provide needed counter point to your narrative.

This guys presentation style drives me nuts. It’s very much like he’s selling timeshare. But what he’s selling I think is good to think about and it’s only 26 minutes long.

A friend of mine from High School is a professional photographer and graphic artist. He created the photo below. Imagine the scene of the displays against the pitch black of night. The displays would have immense majesty and would encompass your entire attention. Then consider the displays at dusk the day before Christmas Eve. It’s the trees and the sky who claim the true majesty, the trees and the sky that show the real majesty of God, not a bunch of lights on sticks

Roth to the Rescue!

We know the SECURE act decimated stretch IRA’s, so what’s a mother to do? In thinking about this problem once again the solution is to play growth against taxes. An IRA generates ordinary income tax as money is removed, and it is governed by RMD. So a typical RMD on a 2M IRA looks like this

At age 80 the 2M has grown to 2.4M and the RMD is $126K. If you’re pulling 50K from SS your taxable income is 176K. If you’re MFJ, 176K is in the 24% bracket. At 90 you’re RMD looks like this

193K plus SS growth at 2% inflation means you make 61K in SS or 254K total and your tax bill is 43K/yr. Your IRA is still worth 2.15M You and your spouse die at 91. So the 2.15M is transferred to your kids, who then have 10 years to clean that IRA out. Tis means your heir has to remove 290K/yr from the IRA to get the job done

Lets say your kid makes 200K/yr. That means for 10 years he/she will be making close to 500K/yr and paying 117K/yr in taxes almost triple the 43K you were paying. Bummer! Right?

This is where Roth conversion comes into play. If you can get the 2M in the IRA down to 500K the taxes are much more manageable. A 500K portfolio would play out like this.

With the same 50K SS your taxable would be 81K and your MFJ taxes would be 6,147 based on the standard deduction. Your portfolio would be worth nearly 600K. At age 90

If SS at 90 is still 61K your taxable income is 109K barely into 22% (you leave 12% at 104K MFJ standard deduction) and your taxes would be 10,000. The portfolio is worth 535K at age 90. You and the Mrs both die at 91. This means your heir needs to disperse about 73K/yr over 10 years to clean out the account

Same 200K/yr makes his/her income 273K/yr and the tax burden only 48K a substantial savings over the previous 117K.

When the Roth is inherited there are no taxes to be paid and the Roth has the same 10 years to be cleaned out. Lets say you pulled just enough WR from the Roth to keep the 1.5M steady during your 20 years of RMD so 1.5M gets transferred. 10 years later that Roth would be worth 2.7M to your heirs tax free

That’s how you transfer wealth to your kids under the present SECURE tax regimen without annuities or Donor funds. The advantage is you get to use your money for you as cash flow during your life and your kids get a windfall when you pass. I estimate a tax free 4% WR on 1.5M will generate 60K/yr in income over the course of 20 years at 6% growth plus you will be taking the RMD on the IRA and SS. You pay minimized taxes during your life, since with Roth conversion all the taxes get paid sooner instead of later. Later costs more in taxes because of the progressiveness of the tax code and RMD percentages. You do pay all the taxes you owe, but you get to adjust those to your benefit not the governments benefit. If you want to convert even more you can take more out of the IRA over and above the RMD amount but just keep the total taxable income under 104K/yr. The excess money above the RMD amount pulled from the IRA can be put in the Roth to gather interest or you can just live on that extra money and have a smaller WR on the Roth.

The trick to this is efficient Roth conversion BEFORE RMD, and the trick to that is planning well in advance of actual retirement. Much of this blog has been devoted to understanding Roth conversion.

Secure Act Blues

On 1/1/2020 there is a new law in town. The stretch method of wealth transfer will be kaput. The government has devised a new schedule that will assure them a lions share of your wealth upon your death. They will do it by nailing your children to the cross.

There are typically 4 asset classes that transfer IRA, Roth, Brokerage, Real Estate. in 2019 you could dissolve the assets in the IRA and the Roth as an heir over a very long time, even into your next generation i.e. the grand kids. You could leave the kids an IRA say IRA 1, but you could also name grand kids as beneficiaries in a separate IRA called IRA 2 which could grow unmolested for decades. Kids get money, pay ordinary income tax, but had control over how much income is removed so they had some control over taxes. No more. Starting next year Roth and TIRA needs to be emptied within 10 years of inheritance. If you have a combined 2M IRA and it grows at 5% your kid has to pull out $260K/yr as ordinary income. Depending on his income this could easily put him in the top tax bracket for 10 years, accelerating his tax bill and allowing the government a larger slice of your money than they otherwise have enjoyed.

This maneuver isolates the politicians. By the time you’re dead and your kids take over the money, the law is seasoned and “no one” is to blame. As a voting block the kids don’t even know they’ve been fleeced, and the grand kids don’t have the first clue. What’s a mother to do?

I’ve been playing with using the power of compounding, mixed with the power of lower tax rates to come up with an inter-generational solution using the gift tax. Each parent can gift 15K/yr per kid tax free, so if you have 2 parents and 3 kids you can gift up to 90K/yr. If you have 3 kids and 3 grand kids that becomes 180K/yr. What you want to do is set up a schedule of disbursement that eats into the principal of the IRA over the projected course of your life span. So if you start with 2M at 5% interest and have 20 years to live you need to pull out 160K/yr to empty the account in 20 years. 100K /yr keeps the account steady state at 2M. This gives you good control over disbursement. If you want to keep some money in those accounts till you die simply take out an amount somewhere in the middle. Lets say you pull out 130K/yr at the end of 20 years you would have $1M left in the accounts and would have transferred $4.3M in net value to your kids if they just put that money away and let it dollar cost average and compound for 20 years. This uses the tax law and compounding as a means of transferring a ton of wealth. In addition There will still be 1M in the accounts which will be disbursed over 10 years @ 130K/yr. By varying the disbursement vs the residual you can figure what disbursement is optimal for a given progressive tax code.

Your eyes may pop out at this and ask how can this be true? The answer is your money compounds no matter who owns it. If you start with 2M at 5% and never remove a dime after 20 years you will have 5.3M, the same 5.3 M you wound up with except you transferred 4.3M of that at a low tax rate and then had the additional 1M still in your account at the time of death. More money stays in your family less money goes to Uncle Sam. The particulars matter however. You can’t do this rule of thumb. You have to mathematically optimize and minimize taxes across 2 or more generations. Certainly a gamble but a gamble with a highly likely outcome since no one else is going to do the work involved in the optimization. The governments rules are designed to slaughter most of the people and it’s hard to write a law that covers 100% if there is some wiggle room and there is wiggle room.

A second strategy would be to take money in excess of RMD from the accounts and stick that in a brokerage. You would have to pay ordinary income taxes but if you optimized into a Roth you can pull Roth money into a brokerage tax free. Upon death the brokerage receives a step up in basis to the heir, and a brokerage has no expiration and a different taxation regimen. In addition, as the heir you may be able to tax loss harvest the brokerage over a long time, turning at least part of that account into a Roth like asset or a partial Roth like asset. You also have control over how much you take out depending on other income sources further optimizing your tax bill.

It’s complicated but it’s a puzzle that can be solved, and is worth being solved. I don’t have the details worked out yet, just the general framework, but my preliminary massage of the data shows this should work quite nicely.

Secure Act Update

The Secure Act was attached to the continuing resolution to keep the government funded and therefore will be signed into law and take effect 1/1/2020

For me this changes my Roth conversion schedule. Originally I was converting about $250K/yr. This year I converted $214K to keep my Medicare costs under better control. Medicare is an ongoing nightmare of arcane rules. My $250K MFJ conversions doubled my Medicare cost. For 2020 my Medicare cost will drop to 1.28 x the basic cost or $185/mo. Next year with the Secure act in effect I should be able to drop that back to a basic rate of $144/mo since my conversions are going to be less. I will also save on taxes. My regularly scheduled conversion bill was about $41K/yr on my AGI but will drop to about $17K/yr. This allo ws me to convert the same total amount in smaller aliquots over a longer period of time which improves the cash flow in any given year. The savings over 5 years pays for 1 free year of retirement and my net projected Roth account will be 1.5M over the 5 year to age 72 conversion vs just under 1M in the account using the larger 2 year to age 70 conversion.

Secure hoses up wealth transfer. All those articles you’ve recently read about creating “generational wealth” are now crap. You won’t be funding your grand-kids but the national debt. It is what it is, so take advantage where of the code as it will exist in 2020 instead of kvetching. You never step in the same river twice and we are stepping into a new river.

I funded my conversions for the next 4 years by selling stocks high this year and not waiting for the necessity to sell in a down market. Locking in 90 – 100% of the gains gives me a 100% war chest to use while converting as opposed to playing the odds of making an extra 5% by not selling, in the face of a possible 50% loss. Life is about the analysis of probabilities and then ordering the probabilities from most likely to least likely. Since they are probabilities there is no guarantee, but given my druthers I’d rather own the most likely scenario rather than the long shot.

The Secure Act will likely force wealth transfer to funnel through insurance products. Elsewise you could start funding your progeny over the course of your life. Instead of RMD take out RMD + 10% and slip the kiddo the 10%. You could slip the 10%/yr into BRK.B in a taxable account and it would have no tax consequence for owning it, but step up in basis when you croak. Better than paying some damn insurance company.

Wanna See Me Pull a Rabbit…

I was watching a video today. It wasn’t about what I’m going to write but it lead me to this conclusion once I saw the stats. The government changed 401K’s. It used to be you had to opt in to 401K’s now you have to opt out. It used to be when you opted in your money went into a money market, now it goes into a target dated fund AUTOMATICALLY. I found out 60% of 401K’s, now automatically funded, hold a single asset, a target dated fund. The amount held in this class is 2.4 trillion. You might say, well that’s good! People are being looked after! But who is really being looked after and at what cost? Fore every dollar put in a target dated 401K the government owns a percentage and that percentage has little to do with the fund. The government has effectively turned your retirement into their annuity which you will pay to them on their schedule for the rest of your life. The target fund is pretty much proprietary as well what you see is what you get. The fund gets to collect fees, forever, and even at 10 bp that’s a hell of a lot of fees on 2.4 trillion dollars. In addition your money is locked up in risky assets not of your choosing. You can’t buy gold or commodities or hedge in anyway. You can’t reallocated and put risk on or take risk off. Your money is entirely managed and not necessarily for your benefit.

If the market goes up your account grows. If the market goes down your account crashes PERIOD. If you need some money you sell some fund whether it be low or high. Your sale has no flexibility. You can’t sell bonds if they happen to be high and you need some money and not sell stocks if they are low. The same is true with purchase. You buy a share of fund automatically no matter if the market is at all time highs, all time lows or in the middle. Shares are purchased robotic-ally, essentially by government mandate. This set up makes you entirely vulnerable to SORR. The only thing you have to sell is a share no matter the price and the only thing you have to buy is a share no matter the price. Price is not part of the equation. The algorithm is dirt simple. A buy order is placed and a share is bought a sell order is placed and a share is sold. No other optimization allowed when a share is sold Uncle collects the taxes on the entire amount as ordinary income, not on just the profit. If you bought a share at $100 and sell it at $50, you get taxed on 50 even though you have a $50 loss. If inflation has eroded your purchasing power by 50% so your $100 is now worth $50, you get taxed on the $100, now worth $50 and the government pays off it’s debt with your devalued retirement money. I checked an old 401K today I haven’t looked at for a few years it used to be in JP Morgan, now it’s in a Vanguard target dated fund. It changed all by itself with no input from me.

The real trick is to stuff the rabbit back in the hat.

Stocks For The Long Term

I made my money largely from 1990 to today, about a 30 year investment career. I started investing in 1975, trading commodities in Illinois and did some other business deals, but in 1981, I went to med school and later went into the Navy to pay back the cost of medical school so my investing at that time largely consisted in cheap living and trading my time to stay out of debt. I am the cohort discussed in this video.

I followed the markets since I was a kid. My first real term paper as a kid was on Jesse Livermore. My second was on the stock market. Both required reading a book or two and trips to the library since those papers were written about 1963 or so. Al Gore is 4 years older than me and had yet to invent the internet. When I was writing my papers he was trying to get laid in the back of daddy’s car, the one with the huge fins.

I lived through the recessions of the late 50’s the 60’s the 70’s and the 80’s. I went into the Navy because the inflation of the 80’s, ate all my medical school savings, so these periods weren’t historic to me, they are my history. My Dad started a business in the 60’s and went out of business because of the recession in ’66. I remember Japan in the 80’s. Japan equity investors couldn’t make enough money it was like opening a fire hydrant of money. All the smart boys were buying Japan. Japan was invincible. I didn’t own Japan, except in the 80’s when I was in med school, I ate a lot of Ramen, plus some fried eggs. Once in a while some sushi.

In the chart presented in the video he looks at several time frames. He looks at the first 60 years. The first 60 years were a time of pensions. Investing was NOTHING like today. To invest you needed a LOT of money. Every trade cost $200. A round trip cost $400. That was the invention of stocks for the long haul. If it cost 400$ to get into and out of a trade that made $1000 there was a huge psychological barrier to making that trade. It still exists today in the form of cap gains tax. People will hold onto doggie funds just because of the $20 of cap gains that have built up over decades. They typically don’t even know what the cap gains might be because “it’s complicated” but they know they are there and it’s a barrier to doing the right thing in the face of doing the cheap thing with the least hassle. Yet everybody is a tycoon.

Things changed in 1978 when Jimmy Carter signed a bill that divorced savings and loan interest from prime. Before ’78 S&L’s were highly regulated and could charge only 2 % above prime interest. After Carter’s swipe of the pen, S&L could charge any interest the market would bear. Of course to make the interest they need the money to lend so the peeps were part of the equation. The S&L charged 6%, the peeps got paid 3%. 9%, 6%. 18%, 12%. This is called inflation. Another thing that happened is the 60’s. Boomers came of age got woke and womens got libbed. Those libbed womans went to work in the 70’s which means house hold income (money supply) increased dramatically. First thing mama wanted with the new dough was a bigger crib so housing took off. Just what the S&L needed a ready source of new credit applicants for larger loans. The result? Inflation. Housing prices sky rocketed and that’s when the myth of the investment nature of home ownership was born. Many of the silent and GI generation bought houses after the war like brownstones in Boston and NYC and saw their property values explode with the increased productivity caused by the 2 hands that had previously supported the family turning into 4 hands. That ship has sailed. There aren’t anymore hands to put to work so that boot in productivity won’t happen again, but boomer parents and grandparents took advantage to sell at a 500% profit and move to FL.

In the north, garages were constructed out of concrete block because it was cheap. Houses were constructed out of limestone and brick and wood. When I moved to FL I was amazed everyone was living in a house that up north would have been considered a garage. in terms of construction quality.

Another thing happened. Corporations wanted out from pension liabilities so the government created tax deferred vehicles by which “investors” could plow their dough into “pretax” accounts, let the money compound tax free and the government would reap decades of compounding as ordinary income tax when the geezer started unloading the dough.

John Bogel came up with the idea of low cost passive index funds in 1975 which fit this time frame of creation of DIY investing. There were other mutual funds but they were offshoots of the rip off industry where you had to pay fees to get in, fees to get out and fees to stay in, but since the pensions were shutting down it was they only game in town for most working people. A round trip was $100 to the broker, 3% to 7.5% up front to the mutual fund company, and then 1.5%/yr to maintain the account. What little money you did make, you would get to pay compounded taxes on later when you were a geezer beside the 1.5%.

Competition worked in the late 90’s and prices at brokerages started coming way down. I was day trading for about $10 a round trip in the early 2000’s and fund cost hit the skids after the 2000 crash again due to competition. Trading became easy as the internet came to be, and brokerages realized they could make far more money by cutting out the private broker and letting the tycoons (rubes with the computers) generate millions of round trips with the press of a button. Now we have AI and everybody has to trade against a machine.

The point is there really is no history to history in terms of repetition. Housing is NOT going to go up 500%. There is no second spouse yet to be leveraged. I trade ETF’s all day every day, as many times as I want in a day FOR FREE. Boomers are done. They made their nut and will now spend far less on a relative basis causing a hit on GDP. Millennial’s can’t buy boomer houses because millennial’s had their house money ripped off by the colleges. Come to OUR school for 6 years get a degree in gender studies, get drunk, get laid, get woke, get $150K in bankruptcy proof debt and screw your parents because their “nest egg” house is unmarketable to someone with$150K debt and a job and future equal to a gender study degree, post 2008 housing crash. That’ll teach them damn boomers!

When you listen to this video consider the history behind the graph. Gundlach is 60, 7 years my junior but none the less a boomer. He’s lived my shared history. Dalio is 70, 3 years my senior and he too has lived my shared history. I came to believe what these guys believe through my own independent analysis before I found their videos.

In Japan they believed in stocks for the long run. same in EU. China is not going to break out, they are going to become Japan. Russia is too alcoholic and crooked to amount to anything. I’ll put the short synopsis video first, it’s only 12 minutes and covers the bullets. The actual Gundlach interview is second.

I have no idea what future is going to unfold, but I’m 100% sure (on a risk adjusted basis) it won’t look like the past 30 years. When you look at a narrative consider the context within which that narrative occurs.

The Illusion of Independence

I’ve recently pulled back on reading and posting on FIRE blogs, except for a few I consider close friends. The more I study the reality of the interdependence of the financial system the more the concept of financial independence becomes a joke. The financial independence “movement” is simply a loose collection of narratives, all claiming some basis in fact, but in fact the basis is just narrative. The interesting thing is people base their realities, and the security of their futures on narratives and folk lore. As an aside I grew up on the south side of Chicago and in the winter they would open the hydrants around the park and the park. The park had been graded to form a shall bowl, so H2O in a big bowl plus a Chicago winter = instant hockey rink! In the summer the park dried out and we played baseball. This will eventually get somewhere.

I read Doc G’s posts sometimes at Diversfi and his story is a case in point. He’s a smart guy, quite entrepreneurial and managed to turn primary care into a near 1M/yr producer being a provider to nursing home patients. He lived on half and soon enough had a pile. He branched into side gigs including Hospice medical director and started a blog and a pod cast and a career in speaking. I was reading how all of that has virtually vanished for him. The nursing home practice is gone, the Hospice gig is gone, his partner in the podcast has other plans. Doc G is a smart guy and will no doubt survive, but the point is just because you write a narrative, a reality does not materialize. His narrative was not independent. It was entirely dependent. Dependent on the continued Hospice employment, on the continued podcast. Furthermore his “independence” is dependent on the performance of the economy. Doc’s in his mid 40’s and has another 45 years of expenses to cover.

I wish Doc well in his endeavor but it occurs to me he has an opportunity. Suzie O published a podcast with Paula at “Afford Anything” about the danger of “financial independence” and the FI world lost their minds! The very idea their independence could be threatened was anathema. Yet in Doc G’s story we see exactly how dependent we are, how in no time the narrative of our tycoonery can be blown away. The illusion of independence is the core narrative being sold in FIRE land.

In hockey to win, you have to learn to skate to where the puck is going to be, not to where the puck isn’t or was. You have to be where the puck is going to be and then put the puck in the net in a spot where the goalie isn’t, using velocity, acceleration, rates of change, probability, finesse, and brute force.

I have a friend who went to Chautauqua and heard JL Collins. He was all about buy my book! He was also all about “don’t review my book unless you’re going to give me and it 5 stars!”. He was prominently featured in this stupid documentary Playing with FIRE along with Vicki Robbin and half a dozen other FIRE movers and shakers as THE GURU’s. As I study real finance Guru’s these “luminaries” aren’t even smoke on the water.

Buffet says: “USE PASSIVE!!” Buffet is sitting on 100B dollars. If USE PASSIVE is the way to go why isn’t that 100B in VTSMX? I own BRK by the way. Munger has a few B. Munger owns 3 stocks. Not 3 funds, 3 stocks. Buffet made his dough by buying low and selling high. Buffet tells you to buy VTSMX. Why would he tell you to buy VTSMX and not own VTSMX himself? Why does Munger not own VTSMX? What is the present day value of VTSMX that would be all time high. Buffet doesn’t own VTSMX because he’s waiting for it go go low before he buys it (this is called timing). Buffet knows how to skate to where the puck will be. He’ll be there to buy you out when you will be forced to sell low. I own BRK for this exact reason Buffet knows where to skate and when to pounce. Munger knows to put his money in 3 winners not 2997 losers. One of those winners is BRK. Munger skates with Buffet. If you’re not predator, you’re prey. JL Collins knows this. He’s not a great guru he sells books to prey. Vicki Robbin is the same. She’s not a guru she’s a promoter. She’s the fisherman you are the fish.

Doc G with his recent reversal of fortune can become the voice of reason based on experience in this space. The voice of the reality of how dependent your “independence” really is. In surgery we have a saying: whip it out and someone is going to come along and cut it off for you.

Investing is not all gloom and doom nor is it all happy days are here again. Investing is about learning to skate to where the puck is going to be, against a very predatory competition who’s desire is to buy low when you are forced to sell low. Investing is dynamic and nuanced and success is hidden from view behind the narratives. Do not be complacent Buffet is waiting to eat your lunch.

More Good News

I’ve relied on the efficiency of non correlated assets especially stocks v bonds to buoy up my risk profile. What that means is I buy a certain amount of return and pay for it with a certain amount of optimized risk. Over decades the correlation between stocks and bonds has been zero. What happens if that correlation becomes positive? The answer is nothing good. There are portfolios out there that better capture non correlated diversity for example the Ray Dalio All Weather, or the Golden Butterfly, or the Harry Browne Permanent Portfolio. I’ve written about these, most recently here .

This morning I ran across this video, which describes the possible changing risk involved in owning a 60/40 if correlations change from non correlated to moderately or very correlated. It’s something to think about. I’m not saying it will happen, but we see central banks vigorously fiddling with the knobs, in a time were this amount of debt has never existed, and pretending to have “control” of the rudder. I’m not sure they control the rudder. I’m not sure they even control the narrative.

Is It Busted?

We spend our lives living in a narrative, actually multiple narratives. We live in the narrative of a constitutional republic, while at the same time the process has become anything but constitutional. We trade in markets which are built on scaffolds we don’t even begin to understand, because we substitute a narrative in place of actual knowledge.

Narratives are easy morsalized bites which may or may not have any basis in reality. Recently the FED has started to expand it’s balance sheet yet again, through the Repo market. In September liquidity froze, ballooning overnight lending rates from the FED’s preferred 2% to 10%. In order to stay solvent companies need to have their liabilities covered, i.e. they need to be able to point to some cash in the bank when the regulator and the market comes calling. If corporations, like insurance or brokerage houses are short on cash they borrow some over night from banks. Banks charge interest for the privileged and the interest they charge is independent. Banks accept collateral for the use of their money. So I may own 1M in US treasuries and I may need 1M to look solvent so I can borrow 1M in cash and put up my 1M in treasuries as collateral. The next day I expect some money to come in say 1,020,000. So I pay back the 1M plus the 2% interest and get my treasuries back. It’s a market.

What happened in Sept was interest to lend 1M ballooned to 10%, meaning suddenly banks saw a much bigger risk in the system and wanted 5 x the interest to lend the 1M for the same collateral that had been used as collateral the week before. The spike in interest also called a lack of liquidity was blamed on “quarterly income tax payments”. The narrative raises it’s ugly head. Taxes are more regular than sunrises. There is no business that is not aware of its quarterly obligation. It’s like numero uno on the calendar of up coming events in the life of a business. The idea that businesses somehow forgot to budget enough to pay taxes to the extent that it caused interest to balloon to 10% is simply ridiculous. I ran a business for 30 years and somehow always managed to remember to pay my taxes.

So what happened? A change in risk happened. No longer was the collateral adequate. In fact the collateral had been discounted 5X. Suddenly my 1M in treasuries or whatever was actually viewed as 200K when it came to getting a loan. Guess what happened in 2008 to Bear Sterns and later Lehman. “Sorry boys no more money for your crappy collateralize debt obligations (CDO’s) because they aren’t worth the paper they are printed on. We no longer believe the cabby who bought a 1M McMansion and then took out a 500K line of credit to buy a 2 new cars and a boat will be able to pay his obligation and so your paper that contains his loan is pretty worthless. We’ll loan you 3 cents on the dollar, take it or leave it. From our perspective It’s more likely the cabby will just plop the keys in the mailbox and walk away”

I ran across this video and it’s worth watching. It explains the FED funds market and how the government is having to inject money into the process to paper over the obvious excessive risk in the system. Guard your children and your wives, the narrative will not protect you. Only a clear understanding of reality will.

This Is What Your Up Against

I listened today to a video talking about market vol. The range of the VIX for the year is 11 to 36 and today it’s 13. In the video he spoke about AI’s effects. AI is a Bayesian like engine that reprices risk according to constant real time data streams and then trades on the picture the data paints based on likelihood. What does that statement mean?

Imagine you’re on a boat several miles off shore from your little island. You go out fishing every day to catch your family some supper and to have some fish to trade for other goods say maybe a bottle of white. You bases your life on the day in day out probabilities that today will be not unlike yesterday. Today however there was an under sea earthquake 2000 miles away which generated a tsunami headed to your island. While you’re out fishing the wave passes under you. Monstrous energy passes you but only a couple feet of vertical translation is all that you perceive. You just keep fishing since today is just like yesterday, maybe stay out an extra hour to get a few more fish to sell so the kids can have Christmas. Soon enough the wave hits the bottle neck and the energy dispersed across a huge area is all concentrated on your islands shore line and your island is destroyed. Your day was just like yesterday. Your boat is still intact, you have a load of fish, but you no longer have a home or a family, you just don’t know it yet.

This is how AI works. It creates a most likely picture and trades into that picture without the ability to understand reality. It relies on the presumption that the picture it creates is an accurate representation of reality, and the more days that picture goes unchallenged the more the AI scales it’s investment into the picture being actual reality. Since it has a huge presence in the market it’s picture of reality carries a lot of weight, in the pricing of risk based on it’s rules. The AI doesn’t care, it doesn’t understand beauty, it doesn’t understand families or islands or tsunami’s. It has some know ledge of tsunami’s but has no sensitivity to that risk to the picture given the preponderance of days and days of the same ol’ same ol’.

The data it is fed suffers under the same delusion as the passive investor. The passive investor doesn’t have an understanding nor a sensitivity for tsunami’s either. The crash hits and he’s plowing yet more money into a train wreck based on the picture a blog narrative painted for him. Why the future is like the past! But wait, no island exists.

In 1989 on Christmas Eve at 3:39 in the morning my house burned down. My picture I used to judge my normalcy burned up. It gives you great pause when in 5 minutes you go from having a complete life to having no toothbrush or underwear or shoes and it 25 degrees outside. But you are grateful you didn’t get burned up and your wife didn’t get burned up. You attend midnight Mass wearing smokey stuff you manage to find in a box under some rubble. YEP 4 x 25… I heard it in a love song.. heard it in a love song… can’t be wrong