In keeping with our items-are-three motif: The Peter Principle in action, the collapse of A.I.G., and the nascent breaking of the dollar. See Vanity Fair, “The Man Who Crashed the World.” ♦

Even we are surprised by CNBC’s see-no-evil defense of the Federal Reserve ahead of the House Oversight hearings. Don’t know how we’re going to be able to watch Becky Quick again.

Here are some of the Fed’s e-mails. Our favorite line: “Just had a long talk with Ben…. [I]ntends to make it even more clear that if they play [the MAC] card and then need assistance, management is gone. (Forgot to tell him KL [Ken Lewis] is near retirement.)”

That’s an e-mail from the President of the Federal Reserve Bank of Richmond, Jeffrey Lacker. He’s writing that Ben Bernanke “intends to make it even more clear” to Ken Lewis and/or the Bank of America board (both or either may be implied) that if BofA pulls out of the Merrill acquisition, and then needs further assistance navigating the financial crisis, BofA’s management will lose its jobs. Lacker laments that such threatening tactics may not carry much weight with Mr. Lewis, who is near retirement.

This is the glue that keeps the U.S. markets together? Got it.

Whether or not any strong-arming went on here is what the investigation is about. Ken Lewis has already testified twice, under oath, that he was threatened by the Fed and the Treasury Secretary with losing his job (and the rest of the directors theirs) if BofA didn’t go through with the deal. One may surmise — and Chairman Issa’s committee hearings will hopefully reveal — whether this pressure included BofA keeping the extent of Merrill’s losses a secret from the company’s own shareholders. We’ll know more when you do.

At issue is whether or not the Federal Reserve conspired to violate securities laws, hid pertinent information about the merger from other federal regulators, pressured Merrill to delay the timing of announcements regarding its losses, and on and on. Arguing that “anything goes” in a crisis, as CNBC would have it, implies that our markets are no longer sufficiently robust to withstand their own cyclical pressures. They’re probably right.

But it’s craven, as is accepting that laws don’t apply to those in government, just to the rest of us; or that the ends justify the means; or that Congress has no real authority over the Fed. ♦

An article in hedgeweek asserts that funds of funds are “defying predictions of extinction” (link to article). Sounds like good news.

If anyone can provide a citation of such a prediction — that every fund of fund (FoF) would someday cease to exist — we’d like to see it. Who made that prediction? We think a strawman.

Swensen at Yale and others certainly think that FoFs add no value, and would probably like to see them join the fossil record. But whose prediction is the industry defying? Googling some relevant search terms just turns up more Internet articles in the same vein — articles discussing how this invisible “prediction” that the industry would cease to exist was so, so wrong. So a citation would help.

In any case, the degree of upheaval and change in the funds-of-funds industry has probably not been exaggerated at all. Or if so, by what measure? The article doesn’t say. Funds of funds clearly have “become one of the principal casualties of last year’s” market upheaval…

To measure the degree of change here, look at the steps these shops are taking to define new business models for themselves. Many FoFs are redefining the range of services they perform for both investors and managers. Also look at the sheer number of funds that have already closed down. (Wish we had fresher data on this but last time we checked — about two months ago — it was a significant percentage of the total — north of 15%. And that was only the second chorus of the redemption song.)

Here’s an idea for an article worth writing: Call ten FoF managers and ask them how they’re redefining their business models. Probe, question, discern any real trends, and write about it. Now that would be interesting. There’s a story there because the business model is undergoing radical change at many shops, and the people pushing for that change are generally product and market experts, and worth paying attention to.

That’s the good news: Not that the industry is defying some nonexistent prediction of its extinction, but that many in the FoFs crowd are real pro’s — they’ve seen it all, end to end, and they know how to pick up the pieces and play a pivotal role connecting managers and investors. Many will survive, many have already become part of the fossil record.

It doesn’t take a strawman to make this interesting. ♦

Portmeiron

Back in January, we asked if anyone could help us think of the name of an alternative-investment site we used to visit years ago (see the bottom of our Resources for Job Hunters post).

We found it!… Albourne Village, an eight-year-old hedge-fund and alternative-investing community targeted at accredited investors and institutions.

We remembered the site as using the metaphor for “a café or an island or something like that.” Not quite. Despite the fact that we’re enjoying 1967’s Prisoner TV series on DVD, the village metaphor somehow slipped our minds. It even has its own mayor. If you’re accredited, check it out. ♦

Unable to see the appeal of MyFace (is that what it’s called?), we decided to create a more professional networking profile.

If you are interested in global asset allocation or portfolio modeling, be the first to connect with us on LinkedIn. Our profile is at: http://www.linkedin.com/in/stracia.

It’s where all the cool kids hang out. ♦

Ow, stop hitting me.

Have you ever had an idea that was kicking around in your head… for two years?

On New Year’s Eve 2007 we announced our global asset-allocation model, which by that time had been in development for months. We searched high and low for a global-macro allocation index, finally determining that there was no such thing (see our rant here). So we did what MSCI, Dow Jones, FTSE and all the other global index providers failed to: We created our own global asset-class index by solving the unique set of data-collection and manipulation issues that a global portfolio presents. And we took it one step further with “smart” indexing technology.

How Many Trials Can You Do in a Millisecond?

Based in Excel/VBA, the model rips more horsepower out of that software than any Microsoft engineer ever intended. Somewhere in the world, someone is using VBA to perform one thousand Monte Carlo simulations per second on a deep data set, and then delivering the results to a graphic-rich spreadsheet that auto-formats an analytical dashboard on the fly.

But if so, chances are they’re using the wrong software; and so are we.

It’s Always a Good Time to Get Serious

So we are in early discussions with a custom software-development company to see about porting the solution from Excel to an interactive, Web-based application environment. We are looking either to outsource the development or to manage it internally, and merely outsource the programming. We’ll let you know how it goes.

At the Risk of Gushing Vinaigrette…

In the meantime, we want to give some credit where it’s due. The good people at Balsamiq Studios let us try out their software-whiteboarding program, Balsamiq Mockups. We promised them we would let our readers know about our experience with the program, good or bad.

One of our mockup screensIt was good. In fact, Balsamiq Mockups is one of the most intuitive and useful applications we’ve used in 25 years. (Coincidently, 25 years is how long balsamic vinegar is aged for. It’s what the mystics call coincidence.)

Never having even heard of the program before yesterday, much less used it, we were able to completely map out a fairly complex user interface in one day. With zero training and zero headaches, we created thirteen mockup screens for discussion with a software engineer.

If Bill Gates could provide software like this, we might have finished that textbook on financial modeling by now. But Balsamiq has an advantage on Microsoft: It’s got two full-time employees. (Judging by Vista, Microsoft has at least twice as many.)

Lots of people are leaving the financial-services industry these days. Even those leaving involuntarily seem to be doing so with relief; we note John Thain as an exception.

Some of these emigres are starting their own businesses, including new software ventures — recognizing that applications used in finance are too often clunky and out-of-date, two or three technology generations behind in terms of user-friendliness and operability. Such applications are not only difficult to use, but difficult to train on — and that means expensive to maintain. Especially when your turnover is high and shrinking margins mean embracing “younger” (ageism for cheaper) “talent” (euphemism for automaton).

The world doesn’t need more software. It needs more good software. And it needs more entrepreneurs. Got a software concept? Take a look at Balsamiq Mockups. After two years (and 25), it feels good to get our idea down on “paper.” ♦

Being surrounded on all sides by fallacy, we are interested in it. So an article in today’s Journal caught our eye: “How Group Decisions End Up Wrong-Footed.”

The author ponders how so many educated, well-organized investment professionals have managed to lose so many billions of dollars in a relatively short time. He arrives at a starting point for portfolio allocation which is exactly the same as Stracia’s:

Define the default position. Max Bazerman, an expert on decision-making at Harvard Business School, suggests that investors start with the assumption that the ideal portfolio is a diversified basket of low-cost index funds. Any deviation from that strategy should require extraordinarily compelling evidence.

We couldn’t agree more. For paying subscribers, we provide an optimal allocation among asset classes, updated during the first week of each month. The allocation through March was as follows:

GOCMX: March 2009

We provide this and much else to paying subscribers; read about our subscription services or our bespoke analysis.

The “default position”… An “instantaneously optimized” portfolio… A “starting point” for your own analysis. It’s all the same, and unless you are using our GOCMX, you’re missing the easiest way to lower risk and increase returns of which we are aware. ♦

Today’s Journal reports that Bank of America CEO Ken Lewis was urged to withhold information regarding Merrill Lynch’s financial position from the public. (Link to article; related story.) He complied, because of who was doing the urging: Federal Reserve Chairman Bernanke and Treasury Secretary Paulson.

The testimony was taken by the New York Attorney General in February.

It’s not difficult to put oneself in these regulators’ shoes. Bernanke and Paulson were trying to engineer some kind of economic recovery — or at least not make the widespread problems even worse. In broad strokes, that is their charge.

They looked at the steaming pile of nuclear risk that was Merrill Lynch and said, “Geez, let’s just keep this information to ourselves. Investors will panic if they knew what we know about the size of these positions, their risks, the likelihood of default, etc.”

It’s an obvious and logical progression of thought to any market participant — from an investor to a CEO to a regulator. But it’s simply illegal to withhold material information from the public. We understand that the issues surrounding disclosure law can be hairy and nuanced; this is not one of those cases. Disclosure should, by law, have been swift and full.

You don’t need to be a legal eagle to understand that if the allegations are true, then by pressuring Lewis to withhold material information from the investing public — which includes BofA shareholders, prospective buyers and short sellers — Messrs. Bernanke and Paulson appear to have violated securities law. Ken Lewis, too.

We are not aware of any rule, regulation, clause, or law that gives Federal Reserve Chairmen or Treasury Secretaries “override” powers. Maybe there needs to be one, maybe not; that is a valid discussion. Until which time, rules are rules. A law’s a law. And criminals are criminals.

Neither are we aware of any rule that says a CEO has to violate securities law because Bernanke or Paulson tells him to. The “override” appears ad hoc and illegal.

If regulators don’t trust markets, why should anybody else? How small investors are expected ever again to trust U.S. securities markets is beyond us. BofA shareholders appear to have a compelling class-action suit against two of the most powerful men in global finance, and the system they represent.

The Catch-22 is that Bernanke and Paulson were probably acting responsibly, and in what they believed — rightly or wrongly — to be in the best interests of all of us. Ken Lewis, too.

It had to be a difficult choice and it had to take guts to encourage the CEO of America’s largest financial institution to break the law. It also took guts for Lewis to fess up under oath.

Did they all three do the right thing, the law be damned? Does the system need to have emergency override powers built-in? Would the exercise of such power really protect markets, or would it be ineffective?

These are policy questions that need to be resolved. In any case, a crime without a bad guy is still a crime, and we believe that the broad market probably does not benefit from a perception that criminals are in charge. ♦