Designing better futures

Texas ratios for 8,196 banks= 95 bank failures & $21.9 billion in bailouts?

A lot of noise is being heard about the Texas Ratio as a proxy for bank health.  Without knowing what is in a banks books and how those assets are going to perform who really knows.  I took the +8,000 US bank data set provided by http://www.lewrockwell.com/chris/banks/banks.html (Caveat emptor) and created a tool.

There has been a noted lull in the FDIC Friday night bankruptcy game as of late.  It may pick up after January 21st about the time the auto bailout is spent and the inauguration is winding down, coincidence?

If one assumes a Texas Ratio of 100 leads to trouble and that there is a 25% loss on assets in those 95 of troubled banks, then we are in for another $21.9 billion in net bailout fun.  Again all of this is pure speculation. I just thought I would organize the data and provide a tool for people to check out troubled banks and the potential impacts more easily. 

In a period of extreme uncertainty and volatility in the cost of money, the assumption of underlying asset values and the marked valuation of those assets banking can be considered an interesting sport these days.

So feel free to play around with the ole TexasBankorometer.  Happy 2009. Download Bankstexasratiov1.1

Anybody have an interesting data set to play with send me an e-mail.  I like to build models.

Ultracapacitors: is the energy revolution about to arrive?

EDITOR/Author's Note post publishing.  I didn't verify my source on energy density of Gasoline, my original online soruce indicated 19,500 BTUs/gallon.  The actual figure is closer to 115,000 a significant difference, here is a more reliable source  http://bioenergy.ornl.gov/papers/misc/energy_conv.html  My article is therefor not very useful.  I am leaving it up as an honest blogger. to remind me to check things a lot closer.  Apologies to my readers.  NG

Many technologies evolve along exponential curves. At some point an inflection point is reached and profound things happen.

Last week another patent from EEstor became public. This patent and earlier comments by the company could mean dramatic changes for energy if EEstor can finally deliver. Nothing has been proven at scale yet. Energy density is important but ignored.

People don’t necessarily want oil, they want reliable cheap energy in whatever form is convenient, reliable and cheap.We use gas and oil not because they are efficient or clean, but because they are wonderfully cheap, abundant and dense energy storage mechanisms. After 100 years of engineering the average internal combustion engine is only 18-20% efficient at converting the stored heat potential in gasoline to mechanical work. 

Many people thought hydrogen was the fuel of the future, but physics works against it, due to hydrogen’s low energy density.

Gasoline is a great store of energy at 19,500BTU’s per gallon.

1 kilowatt hour = 3,412 Btu

EEStor and Ultracapacitors: First across the finish line?

EEStor has stated that it intends to manufacture an ultra capacitor with amazing energy storage, cost and weight attributes. If EEstor or another firm can deliver on these claims it will be revolutionary.

An ultracapacitor is like a battery that charges and discharges rapidly, and has a near infinite life time.

Claimed EEstor details

EEstor's technology claims to have a total capacitance of 30.693 F and can hold 52.220 kWh of energy. The device is said to weigh 281.56 pounds. 

Details here at ultracapacitors.org

A gallon of gasoline provides the work equivelance in your car of  19,500BTU*.20% efficient= 1.14 Kwhrs of electricity. http://www.ecogeek.org/content/view/2405/80/

Assuming a 90% efficient electrical engine, the “battery” ultracapacitor mentioned above would hold the equivalent work potential of 52.2KWhr/1.14kwhr*.90=41.2 gallons of gasoline.

In earlier reports the information about the EEstor technology indicated the following attributes:

                                    Current    Future

Energy density, Wh/L      606        1513

Specific energy, Wh/kg    273       682
Price, $/kWh                 $ 61      $ 40

Cost: 

 At the price mention above the 281 pound battery could eventually cost (281/2.2*$40)=$5,109.

Your car might use $15,000 of fuel over it lifetime. Assuming your car is good for 150k miles @20mpg=7,500 gallons of gas will be used over the system life a car. At $2/gallon that equates to $15,000 in stored fuel energy cost.

The Kwhr electricity equivalent assuming 90% efficiency is 7,500*1.14=10,500Kwhrs.  At $.20/Kwhr retail that is $2,100 energy cost.  Combined with a $5,109 ultra-capacitor, total fuel and storage cost is $7,309 roughly half the cost of gas @$2/gallon.  The caveats are the ultra cap costs associated safety engineering and electric motors vs. ICE engines.

Some interesting things happen with energy density at the EEstor claimed levels. New markets open up. The specific energy in the table above at 682Wh/kg is greater than gasoline 1.14kwhr/lb of gas/2.2 =518Wh/kg.Most small two cycle engines such as lawnmowers, leaf blowers, motorcycles, recreational vehicles etc would be replaced rapidly.

At high enough energy densities and electric price differentials it could makes sense to physically ship electricity the same way we ship oil (energy) today.  Say, Iceland or some other cheap geothermal resource produces at $.04/kwhr  

Shipping costs of $40/metric tonne 1,000kilos would add only $40/1000=$.04/kg at .628Kwhrs/kilo add up to $.064/kwhr for transport. 

You could have green energy delivered to a dock for say $.114/kwhr.  Add on capital costs and margin etc. you are still looking $.15/kwhr which is interesting for many world markets. 

In many countries the cost of power is much higher than $0.20kwhr, assuming it is even available.  Quality of energy is also a factor.  In many emerging countries one limiting factor to economic growth is stable cheap power.Cheap physical energy storage and delivery could change some markets and countries overnight.

The expensive generators that run in many cities in the developing world could be shut down as the monopolistic grid gets end run via physical delivery of electricity. Entrepreneurs north of Lagos could harvest solar energy at $0.10/KWhr and truck it wherever demand was in Nigeria for example. 

For those off the grid a solar panel with a built in ultracapacitor, makes energy available without the grid. It may be $1/kwhr but that is a good deal considering the alternative of no energy.

Power when you need it is worth a premium. We think of nothing paying $4 for a D cell flashlight battery which stores .020Kwhrs.  That equates to $4/.02Kwhr=$200/Kwhr.

Having spent a few weeks in the bush in Niger among Hausa living off the grid and understanding their energy and health needs. Cheap energy will be nothing short of revolutionary for economic and human development.

In the developed world being “off grid” is a lifestyle choice.In the emerging world, being off grid correlates to lost years of life expectancy, literacy and lost human capabilities and potentials in the Amarytya Sen sense.

Cheap energy storage will be more life changing for the 2.5billion living on less than $2/day than it will be for you picking up your new electric car in 2015.

Ships & trains

Some initial markets for high density electricity that will open up as the technology evolves will be fixed transport routes such as railroads and shipping where cost is everything and infrastructure upgrades are easy to price.If you have a fixed route transport infrastructure with a 20-30 year duty cycle ultra-capacitors may make sense when the energy density cost crosses the bunker and diesel fuel cost equivalence levels.

Grid disintermediation

The HVDC and other grid technology upgrades in some areas could shrink as most of the defined capacity for grids is designed for peak loads.  At $1-3m/mile for HVDC transmission assets, it may make sense to forward and store electricity to the edges of the grid off peak. We do the equivalent with pumped storage where convenient geographically today.

The electricity transmission companies will lose and gain from all of this. On one hand every gallon of gas, fuel oil etc. replaced by electricity is a new market, on the other hand, storage at the edges, mean a shrinkage of the required asset base as the “peak” demand infrastructure requirement shrinks.

Many don’t realize it but the US transmission companies have limited interest in efficiencies at lower cost due to their reward structure. Electric generating and distributing utilities have limited incentive in consumers purchasing less of their product.Shaving peaking capacity is nice, but utilities get scared when they think about every consumer being 10% more efficient.They have 20 year debt, plants and business plans based on steady demand escalation. It isn’t a co-incidence that we don’t have smart meters in our homes. Even something as simple as a visible electric use meter in the home have been shown to cause a behavior shift in people reducing consumption up to 10%.

Renewables

Renewable energy sources such as wind and solar have cost issues associated with transmission and the 20%-30% resource availability. Cheap energy storage, compressed air, batteries or ultra-caps at the right price can shift the price dynamics more in favor of these resources as the transmission needs required become less relative to delivering baseload equivalent energy.

If energy storage can approach EEstor’s claims, the world will be a different place for many. The biggest impact may be among the rural and urban poor who come onto micro or local grids without waiting for nationalized power generation to reach them. Some have been waiting for decades. There are now 4 billion cell phone users, let’s hope we have 4 billion renewable electricity users in the near future.

Heretics of Finance was my lump of Xmas Coal

  I ate a little too much on Christmas eve and couldn't sleep, so I thought I would read my fresh copy of the Heretics of Finance while I waited for the fat man to make his entrance through our chimney.  By 2:00 AM no Fatman, no gifts and a disappointing book was finished.

Andrew Lo faces a challenge with any book he writes or co-authors. That challenge is the quality of the body of work he has produced before.  He is one of my favorite academics in quant finance as he usually has a healthy skepticism of the efficient market hypothesis and is willing to entertain differing opinions and properly treat the EMH hypothesis correctly as hypothetical.  This is good science and good judgment, he is robust quantitatively and uses good tools and judgement.

The book Heretics of finance is a series of questions posed to some of the ancien regime of technicians.  I anticipated an intriguing insight into robust results of various technical approaches.  What was delivered was a series of interviews rife with confirmation bias, subjective review and sorely misplaced self congratulatory praise for "beating" the academics. 

The practitioners barely seem to articulate what they do or how they do it, much less present a convincing case "it" has been done.  The title Voo-doo market technician may stand tall after reading this book, if it is held up as the heretics defense.

Most technicians use variations on the theme of a filter (low or high) pass from a signals perspective and seek to transform a price signal into a secondary signal with lower variance and a mean that is shifted to the right with lower kurtosis than the original signal. 

Moving averages, RSI etc. and the usual cast of characters make their appearance here.  I have a lot of patience for the tools they use if they provide results, but little sympathies with the depth with which these practitioners seek to understand either how the tools work or why. 

Studying ancient Greek oracles reading chicken entrails teaches one a bit about Greek culture and the standing of the priestly caste, but woefully little about the drivers of history or fortune telling's ability.  The Heretics of finance, serves up the priests, hands covered in entrails, but with little else to speak of other than a knowing pride that technicians aren't academics.

Andrew Lo has written some good things on quant approaches such his work on statistical arbitrage failure and the dispersion failures in august 2007.  This book is disappointing as it neither entertains nor illuminates.  I should have picked a classic for Christmas eve as I scored an own goal with this one and got a big lump of coal for the effort.

P.S. I'm not anti-technician. I created a quant forex index based on a series of filters seperated by E to reduce harmonics years ago.  The approach works, becuase of serial correlation in central bank rate moves. No magic just extracting serial auto-correlation using a series of filters. The document is here. If you are interested in quant approaches or have a qaunt fund looking to work with someone.  Lets talk. I'm up double digits for 2008 with a 1.10 sharpe ratio using L/S equities.

Introducing Oscar Option, Mr. Market’s cousin

Mr. Market is a helpful tool value investors use to rationalize price swings away from what they believe to be intrinsic value.  Mr. Market is presumed to be an erratic character and serves as a useful anthropic metaphor for value investors to explain share price variance away from intrinsic company value.

Inherent in the value thinking framework is the assumption of value or intrinsic worth at a share price point.  My own opinion is that 80% of firms don’t operate in value markets or industries as they lack moats and other Value attributes. We will leave that aside for now. 

To introduce Oscar Option, we will assume you have found Mark’s Moat Maker inc., a nice company spewing free cash flow and earnings in such a manner that our appetite says intrinsic value rests at $30 per share.  Like good value investors we base this on 5 years worth of historical figures and believe it to be sustainable into the future.

One of the problems investors have with Mr. Market is that he talks a good game.  For months at a time Mr. Market may whisper into the ear $20,$25,$19,$45 or any such number for Mark’s Moat Maker inc. 

After a while it is easy to anchor our new price point to whatever we recently “heard” Mr. Market say.  This is standard behavioral anchoring bias and a response to social expectations, a confirmational bias.  The over “heard” Mr. Market mentality can become the “herd” reality.

To paraphrase Ben Graham, just because people agree or disagree with you doesn’t make you right or wrong.  Being right early or in the middle of you position doesn’t count, investing is an end game, although a smooth comfortable ride constantly up would be nice, it is probably the exception rather than the rule.

The problem is the noise in the middle.  All that price chatter from Mr. Market while you hold your position can be disturbing.  Picking an entry or exit point for an idea is difficult. 

Many people ask, “Should I get out of X?”  Answering this is a fool's errand as standard attributional bias means that unless you help pick the “best” exit you are either a genius or fool and typically the latter. 

The most helpful thing one can do is aid someone’s mental framework.  For a position holder considering selling, I put forward the following question.  “Would you like to own more of X today?”  If they aren’t willing to buy more then they are probably better off exiting as they believe there is negative intrinsic value relative to the current price.

An interesting way to get around the chatterbox stress of Mr. Market is to preplan a strategy.  You can even get paid to do so.  If you believe that you understand a firm’s long term intrinsic value then why not preset your entries and exits and get paid to do so.  The noise of day to day events and vapid CNBC/FoxBusiness commentary shouldn’t affect intrinsic value.

 Mr. Market’s cousin Oscar Option pays you to plan around your intrinsic value price estimate.  Assuming you have done your homework on Mark’s Moat Maker inc. and believe its long term intrinsic worth is $30 a share which is north of the $20 it trades for today .  You are interested in partnering up with this firm as a shareholder for the long haul.  Before purchasing a share you come up with a game plan involving Oscar Option.

You plan on buying a share of Mark’s Moat Maker today at $20 a 33% discount to your intrinsic value estimate.  You determine that $45 per share is a bit steep for Mark’s Moat Maker inc. so you tell Oscar to CALL you when it hits $45 and sell the position.

You also decide that $10 per share is cheap for Mark’s Moat Maker inc. as it is 66% below your $30 intrinsic value estimate and quite a deal. You would like Oscar Option to PUT a share of Mark’s Moat Maker in your account at $10 per share.

Think about that for a moment.  Value investing is psychologically uncomfortable and counter intuitive which is why so few do it well.  You are selling options to your friend Oscar Option.  If the price goes up 125% you are asking him to CALL you to exit the position.  If the price goes down you are asking Oscar to PUT another share in your account.  This might feel strange, but it could be considered a value investing strategy. 

In this situation you are an option seller which is something usually considered risky.  If you believe you understand the underlying companies intrinsic value and are willing to own it, then you are already bearing risk. Oscar Option pays you for the favor of exercising your orders, which is a better bargain than you get with a standing stop order.

The nice thing about Oscar Option is that he pays you for the privilege of executing your game plan.  If you own the underlying share and you truly believe that $30 is the fair intrinsic price, it makes sense that you would want more at a 66% discount and that you would want out at a 50% premium.  What you are doing is selling options to your friend Oscar Option who has some of the manic depressive attributes of his cousin Mr. Market. 

On the long side you get CALLed to unwind your top heavy shares and on the short side you get to PUT a little more in your account.  As an option seller you collect premium which means you get paid for both of these orders whether executed or not. 

You can sell these options 3-6 or months in advance.  If you truly believe intrinsic value moves slowly then this should comfortable not only in bolstering you income, but in managing your position.

Please don’t undertake options positions unless you fully understand the, mechanics, tax issues and other risks inherent.  If it isn’t in your circle of competence avoid it.  Better a simple plan failed that you can learn from, than a complicated one that works which you don’t understand and may lead to bigger trouble down the road.

Regardless of working with Oscar Option, do consider the psychology of pre-planning your exits and entries.  The daily News to Noise ratio is probably 1:99, most of it is there to sell ads, not teach or inform.  Mr. Market’s chatter is intoxicating, entertaining, time consuming and potentially dangerous. 

Once you own a share of a company, every grain of information illicits an emotional response over time it will affect you.  If you get quotes on your blackberry you may be stimulated and stressed, but are you winning?  Thin slicing your time ever more doesn’t make it more productive, quite the opposite actually.

For the experienced options trader, Oscar Option may be more interesting as an exercise in psychology and equity position management.  As a risk fan, former runner in a bond futures options pit and quant there is lots to be said for Gamma risk, black swans and Black Schole’s myriad flaws so Oscar Option can be characterized as a naïve strategy, but may serve as a useful thought exercise for many. 

With current volatility high and a lot firms trading near cash, selling puts and collecting premium while potentially getting a company at a bargain may not be such a bad deal.  The caveat of course is to correctly identify intrinsic value. 

No, I am not an armchair theoretician, I work with a small hedge fund, and yes I am up double digits for the year with a 1.10 Sharpe ratio. Maybe it’s luck, maybe it’s not.  If you work for a fund and would like to talk strategy or collaboration send me a message.

On a side note, Charlie Munger (Warren Buffet's partner) is in my opinion the most financially successful anthropologist alive today. Read his book, it is easily worth more than 5% of what you are currently investing in educational payback.

 

The current paradox of disappearing money...

  For those of you considering the credit crunch storm, head winds, uncharted waters, typhoon, CDO hurricane over,  I offer the following two thoughts.

Paraphrased from James Grant. 

"It is time to stop worrying about what the risk free rate of return is and start worrying about the risk associated with free returns." 

Those of you familiar with a 1bp T-bill will understand this.

For others who think of the financial world as the Dow or equities, please have a look at the current A2P2 spread.  These are dark days indeed. 

The money is disappearing faster than we can bail it back into the system.  No money is almost as bad as poorly distributed money.  I assume most of you are finding your inner bankishness a la Goldman and filling out your TARP forms.  Trickle down economics 2.0 in action.

image source: the entertaining XKCD