Saturday, June 27, 2009

The second derivative is bad

I have been firmly in the “second derivative is good” camp for some time. Green shoots were few and far between – but the economy no longer appeared to be in free-fall. When the free-fall stopped it was time to buy equities – and whilst it was not time to ease up on the looser monetary and fiscal policies – it may have been sensible to limit them somewhere near the levels that they now are.

The data I considered most persuasive was the delinquency data at Fannie and Freddie. It gets worse every month, but until the last data point it was getting worse at a decreasing rate (especially if you adjusted for the foreclosure moratoriums they implemented).

Today I am more worried. My favourite data point (rate of increase of Freddie Mac delinquency) has deteriorated – especially in their insured portfolio. Its not sharp deterioration – and it is possible – even likely – that Freddie Mac will have end credit losses considerably lower than the bears anticipate. But as a second derivative bull I am feeling just that little bit less certain.

Contra: the usually bearish calculated risk has a fairly good data point here.


John

For the real masochists – here is the monthly data from Freddie Mac. The brilliant interest rate management I identified recently has continued albeit not with the panache of the previous month.

Finally BondInvestor has not contacted me as requested. I really would appreciate it.

4 comments:

Problem Is said...

My fastball won't hurt you if it hits you in the head because it has negative acceleration...

It just slowed down from 96 mph to 95.

Velocity being the 1st derivative of position (where the ball is) acceleration being the 2nd (how fast is that fastball getting faster).

Thanks John for the correct analysis of the latest Government/ Wall Street love project:

"How to Lie with Statistics"

or

"How to Fleece the American Public Without Really Trying"

John Hempton said...

Ah - but if your fast ball is slowing down then at least someday it will stop - and if it slowing down at a predictable rate we can even plausibly model it.

But when it is speeding up at an unpredicable rate then hell - who knows where we are going. If you guess you are just making it up.

--

I have done quite extensive modelling of credit losses - enough to know when I have some basis for a prediction and when I am just making it up.

Unfortunately some data points give me the willies.

J

Mrs. Watanabe said...

...and when the ball hits you, you experience the 3rd derivative, aka jerk or jolt. That's the interesting one for physics.

For financial stuff, I'm a simpleton... first derivative for me.

Rich said...

One thing that could have an impact on default rate is that the portfolio isn't growing much. Loans typically don't default in year one, and then start to get worse. If the portfolio isn't growing, the book will have more of the older loans that are likely to have a higher default rate.

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