Dr. John Rutledge Blog

• dinner with Saudi Ambassador to China tonight. Talked about earthquake relief efforts and lots of other stuff. Charming man. #
• Colder than heck in Beijing tonight. Forgot to bring a coat. Brrrrrr. #

• @danibabb This piece you have posted is wonderful. I would like all young children to read it. #

• Off to meet with Mitubishi. will be interesting to learmmore about the carry trade isue here. #
• Initial claims was 516,000, an increase of 32,000 from the previous week’s revised figure of 484,000. Jobs/GDP damage just starting to show. #
• Foreclosure rates up 25 percent year-over-year. this is actually a good sign. We have to burn through these before a market is established. #
• Cessna cuts 665 jobs in Kansas, Oregon. Maybe this is not the best economic environment for selling luxury aircraft? #
• Congress examines $700 billion rescue program. Glad SOMEBODY is watching! #
• Paulson says troubled assets will not be purchased. What an idiot. #
• Congress panel eyes $25 billion automaker loan bill. Bad idea. #
• Governor: Connecticut faces huge budget deficits. There is going to be a lot more of this as property and sales tax receipts fall. #
• Brazil: $400B needed for offshore oil development. Forget falling oil prices today. There is going to be a ton of energy investment ahead. #
• Federal grant to help laid off Maine paper workers. Assistance should be helping train the workers for new jobs, not just providing incomes. #
• Moody’s downgrades YRC Worldwide ratings. The ratings agencies are always the last to know what the hell is going on. #
• Cleveland newspaper increases job cuts to 50. Stories like these are not only recession; the also show damage of online advertising. #
• Va. Tech, OSU to help Africa boost food production. Science can alleviate the food problems in poor countries. Very important investments. #
• NJ governor: Property tax rebates not guaranteed. Ah, the truth is finally breaking through the clouds. #
• Energy agency warns of supply crunch. This is still the REAL story in energy. D o’t be faked out by current price declines. #
• German Economy Enters Recession - Spiegel Online. Welcome to the club. #
• French consumer prices fall in October. Britain likely in recession, risks deflation: Bank of England. Deflation, not inflation is the risk. #
• SEminar topic–Missed Capital Calls: How GPs Can Prepare For & Deal With LP Short Falls. This is happening in the current crunch. #
• Halt in consumer spending hurts retailers. Consumer fear, cash hoarding has shut off purchases. Stand by for lousy Xmas season, markdowns. #
• Office holiday parties are getting downsized. Am interested in the 1001 ways people are adjusting their lives to survive the credit crunch. #
• Facing tough times, Chevy, Ford sticks with NASCAR. This is NOT a boondoggle; it is a good marketing spend to keep sales flowing. #
• an. to delay $209M worth of highway projects. UN-priming the pump? #
• NFL playoff ticket prices go down. Lot more prices going down in months ahead. That’s why it was so DUMB for Fed to worry about inflation. #
• Mayors, governors prod Congress for financial help. Everybody wants money. #
• Tired in Tokyo–going to sleep for few hours before 8AM plane to Beijing. Oh the merry life of a road warrior. #

• “Too bad that all the people who know how to run the country are busy driving taxicabs and cutting hair.” George Burns (George was right) #
• IEA says world energy demand will rise 1.6% a year 2006-2030, calls for investment in energy infrastructure to prevent supply squeeze. #
• NYC gathering to address climate policy under Dems. Lord save us now. #
• Lawmakers press White House to help auto industry. Detroit needs a fresh start under new leadership. It will take bankruptcy to do it. #
• What Unions Really Want: A Stimulus Bill. I bet they do. Unions will be crunched up in bankruptcy process. Will leave stronger companies. #
• Regulators urge banks to fight crisis by lending. A banker taking loan risk in this market would be violating his fiduciary duty. #
• AIG hosts seminar while seeking additional Fed aid. A company in trouble must do the things to keep the revenues flowing in, even seminars. #
• American Express registering as a bank holding company another mouth to feed out of bank reserves. #

• Hawaii’s Lingle, Aiona make Asia trips next week. Stay home Linda; use the money to educate the kids. #

• North Dakota trade officials headed to Turkey. 2 words for this. Boon Doggle. #

Interesting NBER working paper by Khandani and Lo, What Happened to the Quants in August 2007?: Evidence from Factors and Transactions Data, in which the authors attempt to trace the capital market blackout to its source.

As you know from the blog and my recent book, Lessons from a Road Warrior, I believe that the academic finance community (including all those guys with Nobel Prizes for inventing so-called modern portfolio theory and the dreaded Black Scholes theorem) deserve a certain amount of the credit for the capital market meltdown. We have trained an entire generation of finance students that correlation coefficients are facts of nature, like Boltzmann’s constant, are gifts from God; they are not. Based on this presumption, they crafted elaborate securities based on the assumed stability of historical statistical relationships, like houses built on sand. Moral of the story–correlations are always temporary.

I presented an alternative framework for looking at risk and return at several business schools in recent weeks. The students liked it; the professors not so much. For more on this, read Keynes’s warning against the misuse of probability theory in the last chapter of A Treatise on Probability or Prigogine’s elegant collision operators in The End of Certainty.

JR

Abstract:
During the week of August 6, 2007, a number of quantitative long/short equity hedge funds experienced unprecedented losses. It has been hypothesized that a coordinated deleveraging of similarly constructed portfolios caused this temporary dislocation in the market. Using the simulated returns of long/short equity portfolios based on five specific valuation factors, we find evidence that the unwinding of these portfolios began in July 2007 and continued until the end of 2007. Using transactions data, we find that the simulated returns of a simple marketmaking strategy were significantly negative during the week of August 6, 2007, but positive before and after, suggesting that the Quant Meltdown of August 2007 was the combined effects of portfolio deleveraging throughout July and the first week of August, and a temporary withdrawal of marketmaking risk capital starting August 8th. Our simulations point to two unwinds - a mini-unwind on August 1st starting at 10:45am and ending at 11:30am, and a more sustained unwind starting at the open on August 6th and ending at 1:00pm - that began with stocks in the financial sector and long Book-to-Market and short Earnings Momentum. These conjectures have significant implications for the systemic risks posed by the hedge-fund industry.

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• Loved the combat of a week in New York. Now I get to see granddaughter Bella who just learned to walk. Yay. #
• Next week Tokyo & Beijing to see what they are doing to mange the fallout from financial meltdown. Recent china economy news not good. #

• Headline: Illinois hopes ‘Obama buzz’ will boost tourism. In your dreams. #
• Chinese official talks to striking taxi drivers. This is an interesting example of the political morphing taking place in China. #
• Pricey paintings fail to make splash at NY auction. The cash hoarding is taking place at all levels. Deflation is painful and disruptive. #
• Auto parts maker to lay off 186 in Indiana. Collapse of the auto companies is working its way down the supply chain. Very tough for midwest #
• Retailers report steep sales declines in October. Retailers are feeling the effects crunch big time. Consumers are sitting on their cash. #
• Toy maker Mattel to cut 1,000 jobs worldwide. Slowing retail sales = Christmas worries = cut overhead, slow or cancel orders, markdowns. #

• SBA loans drying up. No working capital, no jobs. http://tinyurl.com/599ayy #
• Detroit automakers, UAW to meet with Pelosi. That is going to be an expensive meeting for all of us. #