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Tax Arbitrage Opportunity March 30, 2008

Posted by federalist in Finance, Taxation.

Market dislocations have resulted in a very unusual circumstance: Tax-exempt securities are presently yielding more in nominal terms than comparable taxable securities. Therefore, if you have any investments in money markets or fixed income outside of a tax-exempt account (i.e., not in an IRA or 401k), now is a good time to move it to tax-exempt investments!

Normally this situation doesn’t occur: In an efficient market investors should bid up the cost of tax-exempt securities until their after-tax yield has fallen close to the level of comparable taxable securities. However, there is no tight coupling between the supply of tax-exempt securities and the demand for them by individuals with taxable capital. I suspect that under normal circumstances speculators help to maintain the expected equilibrium between taxable and tax-exempt securities using leveraged arbitrage. But right now all of the leveraged speculators are either in distress or else chasing even better opportunities, so this arbitrage pressure seems to have evaporated.

This week I transferred all of my money-market savings to USEXX, which with a nominal yield of 2.7% gives an after-tax yield (assuming you’re in the 35% tax bracket) of 4.15%! This is at a time when the best taxable savings and money-market accounts are yielding no more than 3.2%.


Plausible Basis for Regulating Wall Street March 24, 2008

Posted by federalist in Finance, Government Regulation.

Government seems to follow any crisis with excessive attempts to regulate.  I am wary of any government interference in markets — especially in an industry like finance which has good incentives to self-regulate.  Either way, Asher Meir suggests a good analogy to guide Wall Street regulation:

There is a good reason that insurance and banks are heavily regulated. Whenever you are betting against infrequent events like floods, there is always the danger that insurers will take the money and run, and have nothing left to give customers come high water. So insurers have strict capital requirements. Some derivative strategies have similar dangers. Portfolio insurance works to insure any given investor against a market crash, but when it was adopted by huge numbers of market participants there was obviously not enough cash anywhere to indemnify the hundreds of billions of dollars of losses in the 1987 crash. We rely on banks to mediate virtually all of our financial transactions, so it is proper for regulators to ensure their soundness. Today, hedge funds supply much of the liquidity in the markets and have become in many ways bank-like entities.

Of course, hedge funds rarely trade derivatives in isolation.  Almost every transaction involves a bank-like counterparty or broker.  Brokers and exchanges are supposed to ensure that all of the contracts they trade can be fulfilled.  The last year has shown us that they don’t always do that as well as they should, so maybe more industry regulation is appropriate at the broker level.

Moral Hazards in Hedge Fund Management March 16, 2008

Posted by federalist in Finance.
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Via MarginalRevolution, Foster & Young give a poignant example of the perils of hedge funds: Essentially, derivatives allow funds to take highly skewed bets, and the industry’s opacity and complexity can conceal these tail risks (unless they actually hit). Foster & Young point out that a malicious manager could easily exploit this situation to make a fortune with a high probability. I touched on some countermeasures that investors should use to control for this, although even the smartest and best-intentioned investors can be ambushed and ruined by unforeseen “tail events.”

Academic Journal Cartel Begins to Crack March 8, 2008

Posted by federalist in Markets.
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WSJ reports that the cartel for academic journal publishing (led by Elsevier) seems to have pushed its market too far:

In 2006, the editorial board of the venerable mathematics journal Topology resigned en masse over the high subscription price charged by publisher Elsevier, a dominant player in the industry.

Congress has mandated that by April 7 papers arising from NIH-sponsored research — roughly 80,000 of them a year — be made freely available in the federal PubMed database, which can be read by anyone with an Internet connection.

Another blow for open access to scholarly research was struck recently by Harvard’s arts and sciences faculty, whose members voted to publish on the Internet for all to see — gratis. These professors will give Harvard world-wide nonexclusive license to their work, and the university will exercise it by posting their papers. The journals won’t have much choice if they want the work of Harvard professors. The faculty members will still publish in expensive journals, but the move to put the same materials on the Internet is a stake poised at the heart of a vampire that has been sucking dollars out of academic institutions for years through the ever-sharper bite of subscription prices.

It’s about time: It was a strange market that allowed a private company to control and profit from the copyright for academic research that is almost always funded with public money. A non-profit has stepped in to meet the need for refereed papers:

The nonprofit Public Library of Science has been in the vanguard, petitioning for change and launching scholarly publications of its own. Its journals in such fields as biology, genetics and tropical diseases are published electronically after peer review, and the contents are promptly made available at PubMed for all to see. Instead of charging subscribers, PLoS covers its costs by charging authors from $1,250 to $2,750 per article (usually paid by their institutions and reduced or waived for authors who can’t pay). One virtue of this business model is that it might discourage, however slightly, the résumé-padding practice of slicing and dicing the same findings for publication in different journals.

U.S. Continues to Stand Alone Against Nuclear Recycling March 2, 2008

Posted by federalist in Energy.

Environmentalists are a mercurial lot.  They support laws to compel people to recycle even when it is wasteful to do so, but raise no complaint about the other law that prohibits recycling of our most dangerous and useful recyclables: nuclear waste.  William Tucker describes this bizarre holdover from the blinkered Carter administration:

[F]ederal regulations require all radioactive byproducts of nuclear power plants to be disposed of in a nuclear waste repository. As a result, more than 98 percent of what will go into Yucca Mountain is either natural uranium or useful material. Why are we wasting so much effort on such a needless task? Because in 1977, President Carter decided to outlaw nuclear recycling. The fear then was that other countries would steal our plutonium to make nuclear bombs. (India had just purloined plutonium from a Canadian-built reactor to make its bomb.) This has turned out to be a false alarm. Countries that have built bombs have either drawn plutonium from their own reactors or—as Iran is trying to do now—enriched their own uranium. Canada, Britain, France and Russia are all recycling their nuclear fuel. France has produced 80 percent of its electricity with nuclear power for the last 25 years. It stores all its high-level “nuclear waste” in a single room at Le Havre.

Instead of profitable recycling, the U.S. government has spent $4 billion over 25 years studying and preparing a long-term waste storage site at Yucca Mountain.  Costs to actually store nuclear waste there would run into tens of billions of dollars.

[20090127 Addendum: Starting 2015 the global uranium market is expected to face large deficits.  I asked one market analyst how much fuel the United States could harvest from our existing “waste” if it were recycled, and he responded, “The materials potentially available for recycling (but locked up in stored used fuel) could conceivably run the US reactor fleet of about 100 GWe for almost 30 years with no new uranium input.”]