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Author Archives: Susanna Gibbons, CFA

Too Big To Fail

3rd June, 2016 · Susanna Gibbons, CFA · Leave a comment
Susanna Gibbons, CFA

On May 16th, The Heller Hurwicz Economic Institute at the University of Minnesota hosted Neel Kashkari, President of the Minneapolis Federal Reserve, in a conversation on his Too-big-to-fail initiative. During the financial crisis, Mr. Kashkari ran the much-maligned TARP program, in which all banks in the US were infused with cash in an effort to “un-clog” the financial plumbing and allow markets to return to normal functioning. Mr. Kashkari was very clear that he felt the TARP program was necessary, that the Fed’s primary mistake in the crisis was that they were always reacting late, but that they were nonetheless very uncomfortable with the interventions which they felt were required. He was also very clear that the conversation he has started is intended to explore a wide range of transformational options with respect to the banking system, including breaking up the largest banks, or regulating them as public utilities, and that the Minneapolis Fed  is in the process of gathering information and opinions on this topic.

Mr. Kashkari was, however, resolute in his opinion that some action needed to be taken, and that the perhaps-majority opinion at the Fed that Dodd-Frank should be allowed to work before they shake things up was not an acceptable outcome. Something needs to be done, he believes, to put an end to too-big-to-fail forever. The basic philosophy, which on its face sounds quite reasonable, is that the public should not have to risk anything to support banks, that it is inherently unfair to use public funds to protect banks’ equity holders during a crisis since banks are private, for-profit institutions.

But does this philosophy actually makes sense? What we are really concerned about is having a banking system that is able to withstand a crisis, but we do not want to be forced to rely on systemically-focused tools like providing crisis-based market support. Instead, we are determined to identify a banking structure – whether through a better mix of businesses or a higher capital requirement – that has no negative impact on the public wallet.

The underlying philosophy, in my opinion, is illogical. Let’s just focus on the capital requirement. Many theoreticians would like us to believe that higher capital requirements are costless (or even beneficial), since they result in lower debt costs and greater capacity for risk-taking by banks. This is essentially a souped-up version of Miller-Modigliani, an application of that frictionless world of firm capital structure to the entire economy.  Most bankers are on the other side of this argument – they believe that higher capital requirements result in a higher overall cost of capital, which constrain a bank’s ability to lend, thereby limiting economic growth overall. A recent review of academic literature in a DNB Working paper titled Effect of bank capital requirements on economic growth: a survey, found that most empirical evidence suggests that an increase in capital costs of 100 basis points reduces lending by anywhere from 1.2 – 4.5%. While the paper was careful not to extrapolate from this to an expected impact on GDP overall, I would argue that a lending reduction of this amount spread across an entire economy would have a measurable impact on GDP. If the growth impact on our $18 trillion economy was just 10 basis points annually, over a ten year period this lower growth would cost the US Economy about $1 trillion in GDP – more than the 2008 bailout. And let us not forget that the entire amount lent under TARP was repaid, so the cost to the taxpayer is probably best summed up as the interest paid on funds borrowed.

I fully realize that in that last paragraph I am just making numbers up. My point is to simply place what seems like a modest growth impact in context with respect to the perceived unfairness of providing stability to the banking system during a crisis. There is no solution to this problem that is costless to the public, and it is entirely possible that the cost of building an unassailable fortress around the banking system is significantly greater than the cost of supporting the system in crisis.

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Posted in Hot Topic Commentary, Local Charterholders | Tags: Federal Reserve Bank of Minneapolis, Mr. Kashkari, Neel Kashkari, The Heller Hurwicz Economic Institute, Too Big To Fail, University of Minnesota |

How I Became a Quant

19th April, 2016 · Susanna Gibbons, CFA · Leave a comment
Susanna Gibbons, CFA

The International Association of Quantitative Finance (“IAQF”) has been participating in a series of panels around the country titled “How I Became a Quant”, one of which was hosted locally by the University of Minnesota’s MCFAM (Minnesota Center for Financial and Actuarial Mathematics in the School of Math) on Friday, April 15 2016.  The discussions are focused on providing students and practitioners a personal view into the careers of a range of quantitative finance professionals. I had the good fortune to be asked to participate on the panel which presented in the Twin Cities, along with Anna Kincannon, Capital Planning Manager at Bremer Bank; Dharini Loknath, Petroleum Products Analyst at Cargill, and Michael Szwejbka, SVP Risk Analyst at US Bank. The panel was moderated by Chris Prouty, an instructor with the Master of Financial Mathematics (MFM) within MCFAM and exotics trader at Cargill.

To be clear – I am not a quant, nor did they expect me to be one. I introduced myself as a “Quant-a-be” (rhymes with “wannabe”), which basically means that my career in fundamental analysis, portfolio management, and asset management has repeatedly crossed paths with our more quantitative brethren, while my actual skills remain mired in prose and poetry rather than mathematics. In spite of my deficiencies, the discussion was excellent, and focused on a few key themes.

First, all of the panelists were in agreement over the importance of communication skills, and the need to work closely with business units on the development and implementation of models, whether they are risk management, decision making, or business analysis tools.  Without clear understanding of the business need, it is very difficult to develop successful tools, and yet much of our industry remains sharply divided along quantitative / not-quantitative lines. There is great opportunity for students who are successful in developing their skills in both areas.

Second, the panel dwelled on history for some time, and the importance of knowing exactly how we have gotten to where we’ve gotten. There is a lot to be learned from understanding market failures of the past, and the role that quantitative finance may (or may not) have played in those episodes. While the development of quantitative models seeks to guide forward-looking decision making, they are based to a large degree on history, and having a solid understanding of that history can help to identify key assumptions and potential weaknesses.

Third, there was a fair amount of conversation around the role that quantitative finance currently plays in the banking world, particularly around the implementation of the capital planning process and stress testing required by the Federal Reserve under CCAR. While there is not necessarily strong agreement around the ultimate effectiveness of CCAR, it is clear that this has become, and will continue to be a driving force around the employment of students with strong quantitative skills.

Finally, there were many topics covered of a significantly more technical nature, during which time I felt rather like Winnie the Pooh roaming the Hundred Acre Wood, humming a little hum to myself until something came ‘round which I recognized. And perhaps, in the end, that is all that we can ever do as Investment Professionals. By I really do believe that the continued evolution of quantitative finance provides those of us who wander with the best of hope of charting a course through the woods.

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Posted in Hot Topic Commentary, Local Charterholders | Tags: communication skills, how I became a quant, International Association of Quantitative Finance, investment professionals, quant, Quantitative Analysis, quantitative finance, Susanna Gibbons, University of MN |

Trap Queen

30th November, 2015 · Susanna Gibbons, CFA · 1 Comment
Susanna Gibbons, CFA

A couple of days ago, shoppers at the Westfield Mall in Paramus, NJ got treated to an unexpected shower of cash from Fetty Wap. While out with his daughter, the rapper of the year tossed more than $2,000 in cash over a balcony, and shoppers screamed in delight as they scooped up the bills. How ironic that as Fetty Wap is showering us with cash, Janet Yellen and her Posse are preparing to raise short term interest rates, bringing an end to 7 years of extraordinarily easy monetary policy. A sort of Feddy Wrap, if you will.

The market appears to be well prepared at this point for that first rate hike, and it will probably pass with very little fanfare. But over time, as the Fed slowly turns off the spigot, there will surely be an impact. The problem is, even in the best of times, both the magnitude and timing of the impact from changes in monetary policy are very difficult to predict. We have never had such an extended period of zero interest rates, so assessing how changes in policy will play out seems a like a crap shoot. While we have seen significant recovery in asset prices, growth in the real economy has remained fairly anemic. Seven years of zero interest rates and $3.7 trillion of asset purchases have failed to have a significant impact on growth. The money multiplier has not exactly been boomin’, and Yellen is in real danger of becoming the liquidity trap queen.

Not everyone agrees that we’re in a liquidity trap, of course, but it seems pretty clear that the monetary transmission mechanism is not as effective as it has been in the past, or as we would have liked. We’ve been poised for “lift-off” several times now, and both inflation and growth expectations have continued to surprise on the downside. So when Yellen talks about moving slowly with interest rate hikes, I think we had better take her at her word. This will not be a Greenspan / Bernanke cycle, with regular 25 basis point moves. The minutes from the last FOMC meeting began with the committee’s discussion on equilibrium real interest rates, which likely fell to negative levels during the 2008-9 recession, and are even now close to zero. Equilibrium short-term rates should rise, but only gradually. The falling unemployment rate suggests that what feels like anemic growth probably actually exceeded potential GDP.

That is a heck of a message. Real GDP growth at 2.5% is running ahead of the growth in potential GDP. Equilibrium rates are close to zero. Inflation expectations have declined significantly (as measured by TIPs Breakevens), and this in what looks like the later stages of the expansion – just when we should be worrying about higher inflation. Forget the dot plot, I would focus on the gradual. It feels to me like we aren’t going anywhere, and we better settle in for some liquidity trap luv. Rate hike potential of about 50 basis points over the next year might be all we get, not the 125 or so that futures are pricing in.

There are those who will likely never part with their Fetty Wap cash. There are also some who will save it, and others who went straight to Shake Shack. The choices are always the same. Save it, spend it, hoard it. Whether we realize potential growth may be a function of the latter. And how many hoarders are out there? I wonder….

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Posted in Hot Topic Commentary | Tags: #FedWatchinRappers, Feddy Wrap, Fetty Wap, Janet Yellen, liquidity trap, Short term interest rates |

Watch Me Whip

16th October, 2015 · Susanna Gibbons, CFA · 1 Comment
Susanna Gibbons, CFA

As I was doing The Whip last night in my living room, my son covered his eyes with his hand and walked out with a disgusted “that’s just wrong.” I yelled after him “I don’t need your permission to do The Whip…hey, are you listening to me…? Anybody can do The Whip if they want to. Anybody!”

So much has been written over the past couple of years about the lack of diversity in the investment business. We’ve tried the mentoring programs, we’ve highlighted the performance benefits, we’ve taken the negotiation courses, but for all of the hand-wringing, it feels like we have gotten nowhere. According to the CFA society, we have in fact gotten nowhere. Focusing just on women, there are currently a lower percentage of women applying to take the CFA exam than there were 20 years ago. Most of the people I know in the business say they can’t find the diverse applicants they want to hire. And women in particular seem to be avoiding the business because of the lack of visible, viable career paths – there’s no one who “looks like us,” so how can we possibly imagine an investment career?

Last night, as my progeny turned his back on my dancing, I had a moment of clarity around this problem. We are all, always, seeking to affiliate. We have fairly rigid ideas about who can do what. In the investment business, we have collectively allowed this urge to overwhelm our rational judgment. We have become increasingly balkanized in our own affiliation groups, somehow unable to step beyond these boundaries to make the choices we know will result in better businesses and better careers.

For those in charge of the hiring, that means you have to stop thinking about diversity as simply a willingness to accept those who show up. You actually have to go out and build the pipeline, develop the networks, and find a way to reach the people who currently are not reaching you. Stop thinking about this as an altruistic burden; it will be a profitable investment in your business.

And for those among us trying to break in or move up – they ain’t going to give it to us, you gotta take it. Stop waiting for permission, stop expecting to find affiliation. Move outside your comfort zone and pursue the investment business because it is exciting, intellectually challenging, ever changing and rewarding. Even if you don’t end up where you initially intend, the journey will be amazing.

Take that, my little teenager. Watch me whip.

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Posted in Hot Topic Commentary, Local Charterholders | Tags: Diversity, Watch Me Whip, women in finance |

Grinched

15th December, 2014 · Susanna Gibbons, CFA · Leave a comment
Susanna Gibbons, CFA

For the past several Decembers, Investment grade corporate bonds showered investors with positive excess returns. Strong demand met reduced new issue supply, and the resulting yield grab left us all feasting on performance. This year, though, it looks like credit spreads have been climbing the slopes of Mount Crumpit.  Over the past six months, they have gone from around 100 basis points, to about 135, and it’s hard to say whether we’re anywhere near the peak.

Supply has not helped the situation. The market stands at a record $1.2 trillion year-to-date, and Mega deals have hit the market throughout the fourth quarter – Medtronic with $17 billion, Alibaba with $8 billion, Kinder Morgan over $7.5 billion, Becton Dickinson over $6 billion….the list goes on. Most of these performed well (at least initially, on growing concessions) but they have also put a lot of pressure on the market overall as investors try to raise liquidity to participate in increasingly attractively priced new issue. These transactions have, by and large, funded significant re-leveraging activity – whether for M&A, share buybacks, or other capital structure engineering.

KMI and BABA have been notable laggards, particularly over the last couple of weeks. They are most exposed to two of the market’s biggest fears: oil and China. Oil prices below $60 seems finally to have grabbed the attention of the equity markets, which have been shrugging off the mixed-message-indicator since October’s sell-off.  How equities feel about China is harder to say, but the Chinese have not been at all concerned, at least judging by the CSI 300, up about 35% for the year.

We in the credit markets are not so sanguine. While little Cindy-Lou Who of the equity world lies a-snooze in her bed, we know perfectly well that the Grinch is slinking around the Christmas tree snatching up a year’s worth of presents. As excess returns slip away, we just hope that we’re left with a can of who-hash.

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Posted in Weekly Credit Wrap | Tags: BABA, corporate bonds, Grinched, KMI, Weekly Credit Wrap |
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