The usual caveats apply. Everyone’s financial situation differs. Consult your own advisor or do your own research. We have been wrong before.

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We apologize for the barage of emails but we’ve experienced a decade’s worth of financial events in a week. We will give a quick rundown of the government’s actions in the last 24 hours and then discuss what “safe” means.

FDIC-ish Protection for Money Market Funds
The US government will seed a guaranty program to provide insurance for money market funds, similar to the way FDIC provides protection for bank deposits. Details are scant. One key difference will be that the insurance is optional but available to any fund that agrees to follow rules about portfolio investments and pays an insurance premium. Another is that there does not appear to be any cap on the value of insured holdings. A fun trivia fact for you: the money for this initiative is from the same fund Bill Clinton and Robert Rubin used to bailout Mexico during the Peso crisis in 1994.

Troubled Asset Relief Program (“TARP”)
Don’t you love the cute acronym – “TARP”? The US government has announced a huge fund to buy up dodgy mortgage-backed paper. They are pitching this as a similar program to the Resolution Trust Corporation (RTC). The RTC was established to slowly liquidate all the illiquid assets the US government got stuck with when it took over bankrupt savings and loan associations (“S&Ls”) during the 1980s. It was considered a big success because the RTC eventually recovered a lot of money for the US taxpayer by patiently selling off investments over time. The new program is different in that they will buy assets from investment funds and financial institutions that are still in business. This could be a stealth bailout if the government pays more than market value for the investments or a great deal for taxpayers if they buy decent but illiquid assets at bargain basement prices from desperate sellers.

Short-sale ban on all US financial stocks
Holy catfish. In a blatant attempt to prop up stocks (temporarily) and put the blame for recent events on those evil no-good short sellers, the SEC banned short-sales on over 800 different stocks. This looks like a deferral of pain rather than an avoidance of pain and poses a severe disruption in the normal trading of stocks. It is hard to find a metaphor that can express how unprecedented this action is. We actually sent an email to our congressman complaining about it.

What does “safe” mean?
That is a great question and gets to the heart of risk management. There are many types of risk and putting together portfolios of risk that have the highest expected returns given the maximum amount of loss our clients are willing to accept is our business.

Today, we want to talk about two specific kinds of risks. The first kind of risk is that you don’t get the cashflows you were expecting. The second risk is what we will call opportunity risk. You will still get back the cashflow you were expecting but, after you agree to the terms of an investment, a better one becomes available.

An example. You lend someone $100 and they promise to pay you 10% interest in a year plus pay the loan. Tomorrow, they are willing to pay 11% interest. Even though your investment is “safe” in the sense you will still get $110 in 364 days, your investment has lost value because of opportunity risk. If you were to pawn off this loan to someone else, they would only pay $99 for it.

Almost all investments on the planet have opportunity risk. Treasury bills have opportunity risk. Your two year cell contract with AT&T has opportunity risk.

Sometimes we are aware of it, sometimes not. When we buy a bank CD, there is opportunity risk. The banks, however, are allowed to tell us that our $100 CD is still worth $100, even when higher CD rates are now available and you would have to pay massive penalties to get your money out early. This makes them feel good and us feel good.

The money market funds were created to give everyone this same feeling of serenity. Even when things move a little bit (up and down) they always cost $1. We can get out the exact same amount of money we put in, any day. The reality is that the investments that a typical money market fund own still have some opportunity risk and move a little. Not a lot, but some.

In the old days, while the investments in money market funds had a little bit of opportunity risk, they had minimal cashflow risk. We got concerned earlier this year when we saw all sorts of strange asset-backed securities and heavy weightings towards financial institutions appearing in portfolios. We were especially concerned that if one fund had losses from cashflow risk, there would be a panic, mass liquidations and increased opportunity cost losses across the board. Fast forward to Monday and this fear became reality.

When we said that not all money market funds were safe, we meant “safe” in the way money market funds have been sold – as never varying in value. They are safe in the sense that there is no chance you lose all your money or even most of it.

Maybe it is time we all started recognizing that risk is an inherent part of our lives and that our focus should be on understanding the risk and making active decisions about how much and what kind of risk to take.

Elizabeth and Jessica

It turns out that the decision to do so was more Citibank’s than theirs.

Citibank unilaterally reduced their $190,000 line down to $10,000 (less than their Citibank credit card) yet kept all the same annual fees in place.

Most agreements allow an issuer to reduce a line of credit if your credit goes south or if your house goes substantially down in value. In our client’s case, neither of these applied.

So why did Citibank do this?

All the banks are feeling pain from losses they are experiencing from home equity loans. In the olden days (i.e. a couple of years ago), hardly anyone defaulted on a home equity loan. If they got in trouble, most people just sold their house at a profit and paid off all the loans. Home equity lines also weren’t given out like candy. Most people who got them actually used them for fixing up their homes. It turns out that the clientale you attract by pitching the virtues of debt consolidation are not the most likely to pay you back if the going gets even slightly rough.

The banks with big portfolios of home equity loans are getting hit two ways. First, they are losing money. Second, the market is hammering them because of concerns about future losses (exhibit A: E*TRADE, exhibit B: Citibank) . It shouldn’t really be a surprise then to see the banks aggressively trying to get rid of any outstanding lines. Batten down the hatches!

From what we have seen, the banks seem to be yanking even lines that they have no right to yank- kinda like the insurance companies that reject all claims the first time they are submitted.

What should you do?

First of all, you make sure that your financial plan does not presume the availability of a line of credit. Everybody needs some cash.

If you know you will need money from your line of credit soon (an imminently approaching house remodel), you should consider drawing down the money NOW.

Finally, if you are in a fighting mood, you probably can challenge some of these credit line reductions. If you successfully do so, drop us a line (info@alexis-palmer.com) – this applies even to people who are not our clients. We will raise a fuss if we see a pattern of banks systematically stepping over the line.

So what did our client do? They are busy so they just closed the line completely. Citibank then had the gall to try and charge them a fee for doing so!

As always, everyone’s situation differs and you should do your own homework or consult your own advisor.

If you search for “financial advisor Palo Alto”, you won’t find us unless you use Yahoo search, in which case we are the top  search result.

We have taken some more steps to help people who are trying to find us like implementing an Adwords campaign where we pay to advertise our own name as well as a few more generic terms like DFA advisor, investment advisor, and financial planner Palo Alto. This is helping a little bit but the whole thing is very frustrating.

This whole experience has led to some interesting conversations. People fall into two camps – “Google is evil” and “You can’t complain about a free service being taken away.”  I am personally in the middle. There is a highly symbiotic relationship between Google, the content providers (i.e. us) and readers. We all contribute something and we all get something. Creating content and webhosting are not free. High speed internet access is not free. Running a giant search engine is not free. It is in all our interest to keep the web spam free and to help legitimate businesses reach customers and vice versa on a consistent basis.

Elizabeth Alexis/ Jessica Palmer

The first suspicious thing happened a couple of weeks ago when we reviewed the list of search terms people had used to find our website and one phrase turned up that we knew did not appear on our site. I will not repeat it but let’s just say it is not appropriate in family or professional settings.

I chalked it up as a “mistake” on Google’s part.

Then the number of visitors finding us through web searches dwindled and I started to get worried.

It turns out that there is a nefarious “black hat” spammer who has found a way to sneak in a file that looks like harmless (but is encoded) and puts links to all sorts of adult sites in the footer of certain web pages, invisible to the naked eye but glaringly obvious to the search engines. This boosts the ratings of those sites in the search engines because they have more links.

Unfortunately, it totally destroys the ratings of the host website (i.e. us). There are people who purposely hide certain words in their website that are unrelated to their actual business in order to get more traffic and Google does not take kindly to attempts to trick its search engine. Google stopped checking our site on January 30 and has dropped all but a couple of pages from its search results (our disclaimer and one particular article). At this point, a search for our names won’t get you to the site.

We’ve cleaned up everything on our end and upgraded the software we use to run the site to the latest version. We have begged for mercy from the great Google gods in the sky requested reconsideration.

Now we are just waiting, waiting, waiting for Google to give us the green light again.

We are not primarily a web-based business but it is still disruptive. Many potential clients (even existing clients) find it easier to just search on our name than to remember our exact web address.

Lessons learned?

1) Google does not make mistakes.

2) Monitor, monitor, monitor.

3) Stay on top of upgrades.

4) Live by the sword, die by the sword. We are all increasingly dependent on the web which can give as well as take. I would not be surprised to see some attempt to regulate Google and its ability to blacklist – just wait until some Congressman’s side business gets kicked out. Personally, I withhold judgment until I see how long it takes us to get back in.

This whole thing feels a lot like having your identity stolen and your credit rating hammered. Think of Google as one of the credit agencies, the black hat spammers as the identity thieves and us as the mostly innocent victims who might or might not have been okay if we had taken additional precautions.

There would appear to be a great business opportunity monitoring search results to see if websites have been hacked. I will note that Google, unlike the credit agencies, does not appear to be trying to capitalize on weaknesses in its own procedures by offering such services themselves.

So why do we bother analyzing companies?

We will sometimes offer commentary on an individual company because understanding the individual players within the economy offers insights into broader trends. Most of our clients have equity based compensation and sometimes we think that what we learn from studying their employer is worth sharing. It also is fun, if you like making financial diagnoses from incomplete financial information like a company’s 10-Q filings. Kinda like House, but a company’s health instead of a real person’s.

Here is an old essay on stock-picking:

On stock-picking

Over the years, I’ve become more and more convinced that stock-picking is an exciting but expensive hobby– both for “amateurs” and so-called professionals. This is backed by more or less all academic research and my personal experience. The best book designed for general consumption that explains why is A Random Walk Down Wall Street. If you have the urge to invest in stocks but haven’t read it and you spot it in a used book store or at a library book sale, definitely pick it up. There are about a zillion editions, any one will do.

I personally subscribe to a camp which academics call the “weak-form of market efficiency”. While I definitely believe stock market, and individual stock, valuations are subject to whims and fancies of investors, I don’t believe they vary in a way that is consistent enough to make money over time using a “system”. There was a whole group of guys I used to work with who were always trying to fine-tune their model but every time they thought they’d figured out how to print money, real life got in the way. And while I don’t believe most stocks at anyone time represent their “true” worth, the mechanisms to correct valuation are crude. If stocks get way too cheap, there are LBO firms to scavenge around and when valuations get too high the venture capitalists get to work, just like they did in the late 1990s. But in between, it’s more or less anyone’s guess as to if and when sentiment will change. And for individual stocks, idiosyncratic risk (eg brilliant CEO gets brain cancer) is high enough to make investing in any one surefire winner extremely risky.

There is one strategy, however, that has historically done well over time — but when I say time, I mean decades. Eugene Fama and Kenneth French were the researchers who first made “value investing” famous. If you look at almost all the famous investors through time, more or less they all fall into the value or contrarian camp (Buffett, Graham, Templeton, Lynch, Neff, Price).

Value investing means buying companies that look cheap, really cheap. There are any number of plausible reasons why value investing makes sense.

Fama and French hypothesize that a company selling for a low valuation relative to its assets is probably a distressed company and that investors demand a really big discount to invest in a company with known problems.

Burton Malkiel (author of a Random Walk) would argue that “growth” companies sell at a price which incorporates the best case so they have little room for appreciation and a lot of room to fall if they lose their luster with investors and value stocks, conversely, can’t fall much further and if redeemed have room to go up. Structurally, Wall Street moves mostly as a herd and prefers winners which gives support to both these ideas.

Value investing is hard for Wall Street to do though. As its alternate name, contrarian, suggests, it means doing something that most other people are not. Your stocks go up when everyone else’s go down but can go down when everyone else’s portfolio is skyrocketing. For nascent portfolio managers benchmarked to the S&P 500, this out-of-stepness can end careers. And buying and loving the dogs can turn even the toughest investor’s stomach.

So what to do? Easy. Buy a passively managed portfolio of value stocks as part of diversified portfolio with more normal looking things. Passive? Yes, passive. Passive, in my mind, means any strategy that is dictated by quantitative inputs.

Here are the arguments against active mutual fund management:

1) Over time, more or less no one outperforms the market. Even most of the success of the “famous investors” can almost all be explained by a value tilt. And then there are the less famous managers…

2) Active managers feel compelled to trade to earn their outrageous fees. This costs investors in so many ways I can’t even talk about it without starting to choke.

3) Their outrageous fees.

So why can’t most mutual fund managers outperform? I could write and write and write on this topic, but I have children to raise and financial plans to write. I think it is partly a function of the mutual fund structure itself, partly the way fund managers are rewarded, partly the incestuous nature of Wall Street and partly that it is more or less impossible to outperform the market and have a truly diversified portfolio.

And even if someone could outperform the market — how would you know? Random chance dictates that certain managers will always do better than the average. By the time you figure out some guy or gal is for real, they decide to retire or they have a baby or the market changes so whatever advantage they had fades.

What do you do though if you are hopelessly addicted to stock-picking?

1) Put the vast majority of your money into that ideal passive diversified portfolio. Then, compare your performance(including taxes paid) to decide whether you’d rather take up golf or hot air ballooning and pick stocks in a fantasy league.

2) Have an investment thesis. Understand what you are buying and why so if things change you can reevaluate.

3) Buy value.

4) Sell when it stops being value or your assumptions in your investment thesis turn out to be wrong (hard to do if you didn’t note your assumptions to begin with).

Easy, right?

Yesterday I finally had the chance to meet Paul Farmer of Partners in Health (PIH).

If you haven’t heard of him, just think Mother Teresa with a Harvard MD/ Ph.D, a comfort in articulately dressing down the powers that be using Powerpoint slides, a few uncomfortable data points and a relentless rhetoric. He alternates his time between selling the world on the fundamental human right of the poor to the same standard medical treatments that the wealthy (or, in Paul Speak, “well resourced”) enjoy and delivering said care to impoverished communities in the world’s “resource poor” areas like Haiti, Peru, and Siberian prisons.

This is a man whose constituency are the poorest of the poor. In his world, South Africa and Brazil represent the well-to-do.

I’d heard a lot about Paul over the years from my friend Becca who is embarking on a similar career of living mostly in “underresourced” settings so it was nice to see this figure who has been so influential in her life and many others.

If you want to learn more about the specifics of his incredible life to date, Tracy Kidder has just written a book about him or you can listen to an archived NPR interview with Farmer.

I come from a background of mathematical equations, theoretical constructs, and economic models. You start with a set of assumptions and then derive logical results. If the real world does not look like your model, then you have to go back and study your assumptions since the results are mathematically derived and must follow.

This has been a very useful paradigm for me. You take a simple model that is easy to understand and then you focus on the assumptions – everything is about the assumptions. What exactly are you assuming? Are they correct? Are they static (do they look different under different scenarios)? Does it matter if they are not entirely correct? In what cases does it matter if they are not right?

For me, the model is simply a tool and becomes a means to understanding, not an end in itself. That is true for the Black-Scholes option model, software code, supply and demand models and portfolio theory. I have found myself a lonely figure in believing that a model is simply a starting point rather than the goal.

*Perhaps* I view everything through a certain set of glasses, but I saw Paul’s talk yesterday to the Stanford community as a scathing critique of people’s ability to appropriately use models, particularly in the context of the world’s poor.

His first point was simple. If (anytime you see an “if” you know it’s assumption time) we really do believe in certain human rights as espoused in documents like the Universal Declaration of Human Rights, our laws and spending should reflect those rights. If they do not, we should fix them.

What he implied, but did not say outright, is that if we don’t make changes, it must mean that we believe that the poor do not have the right to proven and widely available life saving interventions like TB drugs or AIDS anti-retroviral drugs since we have the money required to save the millions who now die unnecessarily from infectious disease.

The money is there, if not allocated. In the context of a world economy of more than $30 trillion, the discussion of whether it costs $5 or $10 billion a year to keep alive the millions afflicted with a treatable communicable disease is an example of a discussion where the assumption being off by a factor of 2 or 3 doesn’t matter—for many reasons. We can afford to reallocate 0.002% or 0.005% of our income with those who did not have the good fortune to be born in an OECD country. In dollars and cents, this means contributing $50 for every $100,000 we earn.

Paul’s second point was how much time his group spends overcoming inertia supported by a misuse of assumptions. An example: in the 1990s a common refrain was that patients with drug resistant TB in the third world generally die because it is too hard and expensive to treat them. As Farmer puts it, ”Is this the end of a conversation or the beginning of an interesting one?”

His group did a small scale study using local health care workers to treat patients in the slums of Lima, Peru in which most of the sick were quickly cured – disproving the “too hard” assumption – it simply wasn’t true.

Evaluating the “it’s too expensive” assumption was more complicated. The drugs used to treat people infected with a strain of TB resistant to the drugs commonly and cheaply used to cure patients were very expensive. But why? They were cheap to produce in quantity and off patent, meaning that anyone had the right to make them. It turns out that because there wasn’t demand for them (because the world had determined that the only people who needed them couldn’t afford them) no one other than the original manufacturer was doing so.

Always go back to your assumptions. You will learn a lot about the problem by studying them. And if your starting assumption is that basic health care service is a human right you will spend a long time looking at the assumptions when they lead to conclusions that deny those rights.

I think we can all learn from the experiences of Paul and his group Partners in Health. These are some thoughts I had following the talk, reinforced by my own personal experiences.

1. If we read the declaration of human rights and believe them to be true – we need to ask hard questions of ourselves and our communities.

We can go to the extreme and like Paul, work in countries like Haiti, or we can find ways to help the poor closer to home.

Most of us can certainly write checks to support the efforts of those who are working to remedy the current situation of extreme inequity.

Whether we can or cannot make a difference remains a philosophical discussion until we actually start doing something.

What steps, even baby steps, can we take to respect these rights?

Contributions can be in time, money or even made by supporting political leaders who will do more to address our responsibilities as members of the human race to each other (Paul’s group definitely accepts cash contributions ).

2. Start. Just start.

When you have a problem that you are told is really big and hard but needs solving, you need to dig in. It is only in the course of doing that you can begin to understand the true challenges and true solutions. This is equally true of development projects and developing software. Starting small, reassessing and then getting bigger is a good general model to follow when other efforts are not getting you anywhere.

3. Anytime you hear a statement or result that’s designed to “end a conversation” is the beginning of an interesting conversation.

These are the conversations that lead to breakthroughs – in medicine, in business and in life.

4. Beware of the tendency for scientists (social and otherwise) to lose the forest for the trees.

This usually manifests in obsessive attention to the details of the model that don’t matter. In economics, this means a confusion between economic and statistical relevance (which has become a datapoint of its own).

In public health, there are many who have become so obsessed with precisely measuring the gruesome impact of bad water on health that they have lost sight of the real question which is what can be done to clean up the water. In this case, the model will spit out a result that you want to get pathogens out of the water regardless of whether someone gets diarrhea 4 or 5 times a day. My friend Becca had to write an editorial this year in the leading British medical journal to shake her colleagues out of their analysis paralysis. Again it’s about the assumptions. Are they right? Which ones matter– and which ones don’t.

5. Number crunchers need to take some responsibility for the numbers they produce.

While none of us can be held accountable for all ramifications of the work we do, data people need to adhere to a similar standard that doctors espouse, “do no harm”.

Someone did a study showing that it was more cost-effective to spend a dollar on the prevention of AIDS than the treatment of patients with the disease and pronounced that all donations should go towards prevention.

This was almost a death sentence for millions and millions of people.

Let’s look at some assumptions in this analysis. The high cost of the drugs regime was taken as a gien. Thankfully some people did not take this assumption as fixed and worked to change it. The last thing I’ve heard is that the Clinton Foundation has just negotiated prices down to $140 a year — a significant improvement from the more than $15,000 the same drugs cost in 2000.

Farmer would probably say that the unspoken assumption in such a study is that as a society we have a choice not to treat third world patients with the same standard of care anyone with AIDS in the US receives and hence violate their human rights. The same researchers could have framed their study in an entirely different light — look world, given that we have to treat sick patients and that’s expensive, pony up some more cash that can be used to prevent infection – instead of their plea to stop treating AIDS patients.

Another implied assumption is that a hypothetical person who does not have the disease should be interchangeable on a one-for-one basis with an actual victim with a name and family. We as a society do not generally make choices that reflect this assumption (in economic parlance, we “discount” future uncertain outcomes). As they say, an ounce of prevention is worth a pound of cure (the 16:1 ratio of cure to prevention in the proverb is coincidentally very close to the estimate the authors of the paper get, using current drug prices).

Furthermore, what right do we have to make that difficult choice for the affected societies?

As Executive Director of the Global Fund to fight AIDS, TB and Malaria, Dr. Richard Feachem puts it:

“Cost-effectiveness analyses can be well used and it can be stupidly used… I was driving across Uganda with an economist… and we came upon a horrendous traffic accident. A school bus had collided with a truck. Children were lying all over the road. Some were dead. Some were dying. Others were seriously injured. I said, ‘hurry, hurry let us call ambulances and get these children to hospital quickly. Many of them maybe saved.’ The economist said, ‘No! Let us drive on to Kampala, to discuss seatbelt legislation with the government. It’s more cost- effective.’ The Global Fund will not be calling on that economist.”

6. It is important for policymakers and policy influencers to stay close to their subject.

Despite his status as one of the leading figures in global public health, Farmer still spends a good portion of the year in clinic treating patients. Only Farmer can say why exactly he does so but I would imagine the rewards are more tangible than the slow grind of wearing away at prevalent attitudes about the impossibility of delivering basic human rights to all the world’s citizens.

I think many people would be better at what they do if they did the same.

This means principals teaching a class, people expounding on privatizing social security offering financial planning services to the low and middle income, and CEOs spending a day or two in their employee’s shoes.

The end.