We still have not fixed the dangers presented by derivatives. I would repeal the Commodity Futures Modernization Act as soon as possible.
What would you say was the best outcome of the disastrous financial events of 2008?
We learned who was full of crap and who was not. Other than that, it was a total catastrophe.
What do you feel has been the most disappointing legacy of the 2008 crash?
1) Lack of prosecutions for fraud; 2) Rewarding the bad actors.
After the S&L crisis, thousands of bankers were prosecuted. Many went to jail. We failed to do that this time, and that is a slow-growing cancer.
As to the bad actors: When a surgery goes awry, you don’t send in the same surgeons to repair the damage—you want a fresh pair of hands and eyes, cutters who have no vested interest other than saving the patient.
We failed to do that as a nation. We put the people who helped to create the problem—Tim Geithner! Larry Summers!—in charge of the solution. That is a recipe for failure.
It often seems like economic forecasting these days boils down to, what’s Ben Bernanke going to do today? Many people think all this quantitative easing will end very badly. What do you think?
The Fed can always hold the paper to maturity. They then return this back to the Treasury, who gives them cash for it. No muss, no fuss.
This may be a bit contrarian, but I believe that once the decision was made to bail out Citi, BofA, Morgan Stanley, AIG, etc., the Fed had its hands tied. There is too much junk on the books (Thanks to FASB 157) for the Fed to normalize rates.
People do not understand the counter-factual—what the world would have been likely to look like if the banks went through reorgs like GM and Chrysler.
You’ve said behavioral finance plays a large role in your investment strategy. That being the case, which investor “biases and cognitive errors,” as you call them, are you paying close attention to these days?
Well, my answer to the first question certainly goes into that. I also find that the kinds of calls we take from clients and prospective clients are almost a chess game of behavioral economics. It is astounding to observe once you learn what to look for.
What advice would you give financial advisors charged with the task of securing their clients’ retirements?
Learn to think in terms of years and decades, not days or weeks. Use a good asset allocation model to own a broad and diverse (low fee) asset classes. Rebalance regularly. Give up the stock picking (leave that to the idiots on TV). Oh, and shut the TV altogether.
You are an outspoken critic of hedge funds, particularly when it comes to the outsized compensation of hedge fund managers. Why do you think most people should pass on hedge funds? Which investors might benefit from hedge funds?
As a group, they are overpriced and underperforming. There is a very non-gaussian distribution of alpha generation among various funds, meaning a handful of managers are creating the vast majority of the alpha. Yet people throw money at alt investments like hedge funds, VCs and PE like they are specific asset classes with mean reversion qualities. (They aren’t.) If most people cannot even pick a mutual fund manager, why do they think they can pick VCs and emerging hedge fund mangers?
Which kinds of alternative investments or strategies look promising to you and why?
Managers CAN create alpha, but the rub is, they only seem to do so when they are small—when their AUM is relatively tiny. Once they become big, they morph into wealth transfer machines, moving cash from investors to themselves. The data on this is overwhelming —hedge funds as an industry have captured over 90% of the investment gains for themselves, leaving less than 10% for the risk investors!
Which thought leaders do you respect the most and have had the most influence on your view of the financial world?
I like Ray Dalio’s view of critical self-reflection—analyzing what you did wrong in order to learn from it. Jeremy Grantham’s ability to ignore short term and focus long term is pretty amazing. I like what Jeff Gundlach has done in terms of what drives his fixed-income thinking.
Bob Shiller is one of my favorite professors in the world. He is simply a delightful, humble person—and incredibly insightful. I really like what Michael Mauboussin has been writing about, separating luck from skill.
Ultimately, it is the quants like Cliff Asness, James O’Shaughnessy and Paul Wilmott who are driving some very interesting thinking.
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