Congressional leaders say bailout deal is near - CNN.com

Congressional leaders say bailout deal is near - CNN.com:

"Under the tentative deal being finalized, the rescue program would be overseen by a board including the treasury secretary, secretary of commerce, head of the Securities and Exchange Commission and chairman of the Federal Reserve, said Sen. Kent Conrad, R-North Dakota, who heads the Senate Budget Committee.

According to Conrad, $700 billion would be disbursed in stages, with $250 billion made available immediately. In addition, the Treasury would establish an insurance program -- with premiums paid by the industry -- to mitigate taxpayer losses. The bill would also probably include some curbs on the compensation of executives at companies that participate."

In an earlier piece, the WSJ has a good description of what the government will be doing in any of the proposed plans(essentially buying and then trying to resell at a later date):

" -- a key goal is to remove much of those soured mortgage securities from banks' books, possibly through an auction system.

The government -- taxpayers, essentially -- would then hold those assets until they can be sold off in a more normal market once the economy and housing market recover.

and later

"So taxpayers face the risk of losing some part of the $700 billion -- but could also turn a profit if the U.S. ends up selling those holdings for more than the purchase price."

and as the WSJ points out, previous deals such as Bear and AIG are structureed similarly, which means that while taxpayers do have a great deal invested, the actual cost of the deals is not known. Indeed, they could make a profit (which is unlikely given government track record of selling securities, but possible).

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[Source: FinanceProfessor.com]

Waht do we know about Warren Buffett?

I am continually reminded in class how many college students know next to nothing about arguably the world's most famous investor. So when the WSJ's Wallet blog reported a few items on his personal finances, I jumped at the opportunity to send readers in that direction:

The Wallet:

"...what are Buffetts personal finances like? Our esteemed colleagues at Deal Journal have been tirelessly reporting on his deal-making psyche, so we thought we would round up some nuggets about his everyday spending.

-His net worth is around $62 billion (with a B), but he takes home a mere $100,000 as his annual salary as head of Berkshire Hathaway.
-He still lives in the Nebraska home he bought four decades ago for $31,500."

There are several other tidbits there as well, including the observation that his credit score is lower than you would thing due to identity theft.

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[Source: FinanceProfessor.com]

Thomas Friedman "Hot, Flat and Crowded" | Salon

We can argue how much pure finance this is, but Thomas Friedman has a new book out. I have not even seen it, but was profiled in Salon. In it he suggests the industries and fields in which we should be investing. Now I have trouble with anyone telling me where people should be investing (the market will usually get it), but the interview is interesting and I am fairly sure I will be buying the book.

Thomas Friedman "Hot, Flat and Crowded" | Salon:

"The shortest way I can explain it is that 'hot' stands for the increase in global warming, 'flat' is my metaphor for the rise of middle classes all over the world, from India to China to Brazil to Russia, who are now able to consume and produce like Americans, and 'crowded' is the fact that the population of the planet in my lifetime ...has almost tripled."

and later:

"...the engine of this whole change is the market. We're not going to regulate our way out of this problem. We can only innovate our way out of it. But that requires rules. It requires legislators, Congress, to write different rules. "

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[Source: FinanceProfessor.com]

Advantage of Youth: ignorance

Young people make better entrepreneurs because they're too inexperienced to know that their ideas are silly:

The mistakes novices make come from a lack of experience. They overestimate mere fads, seeing revolution everywhere, and they make this kind of mistake a thousand times before they learn better. But the experts make the opposite mistake, so that when a real once-in-a-lifetime change comes along, they regard it as a fad. As a result of this asymmetry, the novice makes their one good call during an actual revolution, at exactly the same time the expert makes their one big mistake, but at that moment, that’s all that is needed to give the newcomer a considerable edge.

» corante.com [ Contribute: submit link / submit article / submit company ]

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[Source: TradeBlog (TM) .net / Personal Finance Blog]

The end of investment banking as we know it?

Do you remember the old REM song "It's the end of the world as we know it"? Well they could have been singing about this past week in finance (except the feeling fine part maybe...). The latest manifestation is the news of yesterday that Morgan Stanley and Goldman Sachs begun the process to convert to a bank holding company. The move will bring them under the protection, but also the regulation, of the Fed.

Some of the coverage of this monumental switch:

Big payoffs off table for Morgan Stanley, Goldman:

"The move to convert to a commercial bank structure will help the two companies avoid the fates of Bear Stearns, Lehman Brothers and Merrill Lynch by giving them broader access to borrow federal money and the ability to build a stable base of deposits.

But it also likely means an end to the sky high profits that were topped by few other companies. The strict rules set by the Federal Reserve will limit opportunities for big payoffs from bets on the price of oil and other investments usually funded with borrowed money.

'The Fed is a much more intrusive regulator...experts expect smaller companies _ including private equity firms and hedge funds _ to take their place.

But even in the area of private equity this switch to a bank holding company may have large implications. For instance, investment bankers have been large players in Private Equity a practice that will likely end.

From the WSJ:

"Goldman has been a big investor in its own private-equity funds, and Morgan Stanley intended to be. Close to half of the capital in Goldmans most recent, $20 billion buyout fund, for instance, came from the parent company and its employees. Morgan Stanley is expected to contribute about one-third of the capital to its new fund. But changing into bank holding companies may limit how much capital these banks are able to commit to their PE funds...."

From the NY Times:

"The move alters one of the models of modern Wall Street, the independent investment bank, soon after the federal government unveiled the biggest market intervention since the New Deal. It heralds new regulations and supervision of previously lightly regulated investment banks, as well as an end to the outsize paychecks that helped shape the image of the chest-thumping Wall Street banker."

The new classification will also affect the amount of leverage the firms can use.
Again from the NY Times:

"The regulation by the Federal Reserve also brings a host of accounting rule changes that should benefit the two banks in the current environment. [ugh, I cringe when accounting rule changes are ever given as a reason for anything]

In return , they will submit themselves to greater regulation, including limits on the amount of debt they can take on. When it collapsed, Lehman had about a 30:1 debt-to-equity ratio, meaning it had borrowed $30 for every dollar in capital it held. Morgan Stanley currently has a debt-to-equity ratio of 30:1, while Goldman Sachs has one of about 22:1.

Bank of America, on the other hand, currently has about an 11:1 leverage ratio, while JPMorgan has about 13:1 and Citigroup about 15:1."

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[Source: FinanceProfessor.com]

From SSRN, The Financial Economics Network, and the American Finance Association

Free is too good of price to pass up!

In cooperation with the American Finance Association (AFA), the Financial Economics Network (FEN) is pleased to announce the American Finance Association 2009 Meetings Abstracting eJournal. This abstracting eJournal is available to all subscribers at no charge and contains abstracts of the meeting papers with links to the full text within the SSRN eLibrary.

The purpose of this abstracting eJournal is to provide a data warehouse for all abstracts and papers presented at the meetings and to facilitate their distribution to the finance profession as a whole. Abstracts of the papers will also be distributed in subject-specific eJournals within the FEN Network and, where appropriate, in the journals of our sister networks.

You can browse all American Finance Association 2009 Meetings Abstracts in the SSRN database using the following link. There are currently more than 100 such papers in the system. You may wish to bookmark it in your browser.

View papers: http://www.ssrn.com/link/AFA-2009-San-Francisco.html
Subscribe: http://hq.ssrn.com/jourInvite.cfm?link=AFA-2009-San-Francisco

Conference URL: http://www.afajof.org

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[Source: FinanceProfessor.com]

Top 3 fund managers earn over $1bn

The combined earnings of the world's top 25 hedge fund managers of almost $15bn exceeded the national income of Jordan last year and three individuals took home more than $1bn, according to an industry survey.

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[Source: TradeBlog (TM) .net / Personal Finance Blog]

Equities Swing With Harvard MBAs

Mr. Soifer tracks how many Harvard Business School graduates choose market-sensitive jobs each year. If 10% or less of that year's class take jobs in investment banking, investment management, sales & trading, venture capital, private equity, or...

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[Source: TradeBlog (TM) .net / Personal Finance Blog]

Steve Forbes says the American economy is stable, but anxiety remains.

There may be yet another villain at work: inflation. Many of us are familiar with John Maynard Keynes' quote, "There is no subtler, no surer means of overturning the existing basis of society than to debauch the currency. The process engages all...

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[Source: TradeBlog (TM) .net / Personal Finance Blog]

Mini-case on Cerberus from NY Times

Investments Are Faltering in Chrysler and GMAC - NYTimes.com:

"...for Cerberus, named after the mythological three-headed dog who guards the gates of hell, the news keeps getting worse.

On Wednesday, Chrysler, which owns the Jeep and Dodge brands, said its sales in the United States fell by a third in August ....The same day, GMAC, in which Cerberus holds a 51 percent stake, said it was trying to stanch the bleeding from a business that was supposed to be immune to the ups and downs of the car industry: home mortgage lending. GMAC and its home loan unit, Residential Capital, announced that they would dismiss 5,000 employees, or 60 percent of the units staff, and close all 200 of its retail mortgage branches....

A Cerberus spokesman said in a statement on Wednesday that it remained confident in its management of Chrysler and GMAC. No one is pleased with current market conditions, he said. However, Cerberus is a patient investor and not a market timer, and we take a long-term view of our investments. Our funds are structured accordingly.

Class discussion questions: Some ideas for a class discussion.

1. What does this say about the limitations of diversification? Notice how even though Cerberus seemed diversified, bets that were at first glance uncorrelated (mortgages and car sales) both turned against them at the same time.

2. What does it say about long term vs short-term investment strategies. For instance the article states :

"Over the years, Cerberus excelled by gaining control of companies in bankruptcy and nursing them back to financial health....Top executives at Cerberus have said they are determined to fix the company and that their $7.4 billion investment will pay off.

What risks does a firm incur when holding onto an investment that turns bad? What is the risk of selling now? (i.e. losing out on return if they turn it around). Can you think of anything from own life that was like that?

3. Upper level class? try this. What does this type of strategy suggest about returns to private equity funds? How is this related to the "survivorship" bias problem?


SBU note: the on campus fitness center is in large part the result of a multi-million dollar donation by Bill Richter who is a founding partner of Cerberus, so there is a higher degree of interest in Cerberus on campus.

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[Source: FinanceProfessor.com]

A Cool August for I.P.O.s - Mergers, Acquisitions, Venture Capital, Hedge Funds -- DealBook - New York Times

The number and size of Initial Public Offerings (IPOs) vary a great deal from month to month. Last month was not a good one for IPOs across the globe.

A Cool August for I.P.O.s - Mergers, Acquisitions, Venture Capital, Hedge Funds -- DealBook - New York Times:

"The Wall Street Journal noted that the global I.P.O market saw the lowest number of deals in August since Dealogic began compiling the data.

Last month 25 firms came to market, raising $1.25 billion, compared last August, when 88 companies raised $8.18 billion around the world according to Dealogic, The Journal noted."

For a data on US IPOs by month see this spreadsheet that Jay Ritter maintains from January 1960 to December 2005.

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[Source: FinanceProfessor.com]

Fed Official Says Institutions Must Be Allowed to Fail - Mergers, Acquisitions, Venture Capital, Hedge Funds -- DealBook - New York Times

Fed Official Says Institutions Must Be Allowed to Fail - Mergers, Acquisitions, Venture Capital, Hedge Funds -- DealBook - New York Times: "

The president of the Federal Reserve Bank of Kansas City, Thomas M. Hoenig, said on Monday that for economies to work best, institutions must be allowed to fail.

Economies must find a balance between financial stability and a stable price environment and in doing so must be able to allow individual institutions to fail...."

Which is what anyone would say, but then do we let the institution actually fail when it does get into trouble? If the prospect of such failure is missing, there is an increased moral hazard problem where institutions take on larger and larger risks while allowing the government to hold the cards of a losing hand.

Hoeing's speech is available here.

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[Source: FinanceProfessor.com]

Big commodities hedge fund shuts down - Daily Briefing

Big commodities hedge fund shuts down - Daily Briefing:

"Tumbling commodities prices have claimed a big victim. Ospraie Management is shuttering its biggest hedge fund after a 27% plunge last month, The Wall Street Journal reports, following a series of wrong-way bets on oil and natural gas, among others. The fund, run by Julian Robertson disciple Dwight Anderson has been selling off its holdings over the past three weeks, the paper reports. At its height last year, the fund had $3.8 billion in assets."

Given it is the start of the school year, a concentration on basics may be called for so if you are not totally sure what a hedge fund is, and even if you just want to have another look, here is the Wikipedia entry that is interesting and has some details (if true, hey it is Wikipedia) that even so-called experts may benefit from a read. For instance it has a nice description of the various forms of funds, on the size and flow of funds, and on their pay plans.

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[Source: FinanceProfessor.com]

U.S. Moves Toward International Accounting Rules - NYTimes.com

It will be interesting to see how fastthis actually happens, but moving towards a single standard is great news as it will eventually result in lower transactions costs.

U.S. Moves Toward International Accounting Rules - NYTimes.com:

"The Securities and Exchange Commission moved Wednesday to allow some large American companies to begin using international accounting standards as early as next year, and to require all American companies to do so by 2016....The adoption of international accounting standards by the United States would move the world toward one set of standards, which should make it easier for investors to compare companies operating in differing regions, and make it easier for companies to raise capital in whatever market seems most attractive"

From the Economist:

"GAAP was the beancounters gold standard for decades, but it is now widely seen as cumbersome....For several years, the SEC and the London-based International Accounting Standards Board (IASB), which oversees the international rules, focused on steadily bringing the two sets of standards together. But it has been a struggle, largely thanks to the Byzantine nature of the American system. Mr Cox embraced the more radical approach approved this week in the belief that it would boost the competitiveness of American firms."

People will no doubt argue whether the right standard was chosen, but those things can be sorted out later if the need arises.

From Forbes:

"To ensure that the international rules meet the SEC's standards, the agency set 2011 as a date to evaluate critical milestones and decide on mandating IFRS.

The SEC's milestones include steps to ensure that international accounting rule maker London-based International Accounting Standards Board (IASB) and its trustees are accountable and independent."

What are some of the differences?

From the WSJ:

"The IFRS system is generally considered more flexible, and giving companies the choice could spell the end of GAAP, experts believe. The international standards are deemed especially desirable for large U.S. companies with foreign subsidiaries, which now must maintain two different sets of books...."Tax considerations are another potential hurdle....international accounting has no equivalent to U.S. accounting for inventory on a last-in, first-out basis, for instance. So-called "LIFO" accounting shields companies from heftier taxes when inventory costs increase due to inflation...."

From Yahoo (the AP):

"The IFRS system is generally considered more flexible, and giving companies the choice could spell the end of GAAP, experts believe."

From the Economist:

"IFRS allows fewer securitised assets to be kept off the books than GAAP does, for instancea matter of import for banks."

Uh, wait, that horse just left...oh well.


Stay tuned, this one will be playing out for many years.

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[Source: FinanceProfessor.com]

Why It's Wrong to Hold Too Much of One Stock - WSJ.com

Why It's Wrong to Hold Too Much of One Stock - WSJ.com: "hey think they're reducing risk and optimizing gains by following the adage, 'Invest in what you know.' Yet too much concentration in one stock actually increases risk...

David Hirshleifer, a finance professor at the Paul Merage School of Business at the University of California, Irvine, says people have a natural tendency to like things with which they're familiar.

"We treat things we're used to as friends.""

Later:

"..a report released earlier this year by Citi found that a portfolio should have 25 to 30 stocks to minimize stock-specific risk. It found that only one in 10 stocks consistently outperformed the Standard & Poor's 500-stock Index over the past 20 years in any three-year period. Additionally, a third of the stocks in the index underperformed the overall market by at least 15% or more at any given year. Mr. Munshower says it isn't unusual for high net-worth and ultrahigh net-worth clients to have high concentrations of one stock in their portfolios. "It's very hard for people to sell a concentrated position...""

If there is one thing finance can teach us it is to diversify our investments. While diversification will not eliminate risk (systematic risk is still going to be a problem in most cases), diversification will reduce risk.

How important is diversification? It is the the second most important piece of investment advice I give my family and friends. The list?

1. Invest early and often to let compounding work in your favor.
2. Diversify! Across asset classes and across different investments. (remember not all investments are made in financial instruments-education is also an investment, so too is your health).
3. Transaction Costs matter: keep them low!
4. Make full use of any tax-advantaged plan.
5. Automate your savings so you do not need to worry about them. (also what you never had you will not miss).
   
6. Do not panic. Think long term. Ups and downs happen.
7. Live below your means.
   

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[Source: FinanceProfessor.com]

2002's News, Yesterday's Sell-Off - washingtonpost.com

2002's News, Yesterday's Sell-Off - washingtonpost.com:

"A six-year-old article mistakenly seen by Bloomberg financial news users ....reported the bankruptcy of United Airlines and triggered a massive sell-off that nearly obliterated the company's stock in a matter of minutes.

The light-speed wipeout is a powerful reminder of how quickly bad information can spread via the Internet to a trigger-happy Wall Street that is willing to dump millions in stock before checking the facts.

It exposed the vulnerability of Bloomberg's influential brand name to bogus content."

This is a few days old, but we were talking about it in class and thought others might like it as well.

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[Source: FinanceProfessor.com]

Is it rational to give to charity? Yes!

Giving can be its own reward? Yes!

Being leader of BonaResponds (coolest volunteer group in the world! Ok, maybe I am slightly biased) has led me into some interesting discussions on charitable giving. Some strict classic economists have argued that charity and other selfless acts do not make economic sense. To that argument I always remind them that people (and I guess monkeys too!) maximize utility and not money. Here are some recent articles that give further credence to the charitable giving can be economically justified and what at first glance appears irrational may be just the would-be economist looking at the wrong metric.

Neural Responses to Taxation and Voluntary Giving Reveal Motives for Charitable Donations

" consistent with warm glow, neural activity further increases when people make transfers voluntarily. Both pure altruism and warm-glow motives appear to determine the hedonic consequences of financial transfers"

Monkeys Enjoy Giving To Others, Study Finds:

"Researchers at the Yerkes National Primate Research Center, Emory University, have shown capuchin monkeys, just like humans, find giving to be a satisfying experience. This finding comes on the coattails of a recent imaging study in humans that documented activity in reward centers of the brain after humans gave to charity."

NowWeAreTalking offers still more evidence of the benefits of giving.

"...researchers at the University of British Columbia and the Harvard Business School found that individuals report significantly greater happiness if they make charitable donations or give gifts to others rather than spending on themselves (March 21 edition, Science)."

Which is really just to say that some of the things that appear irrational, are actually rational when utility and not just risk and return are considered. Need other examples? Excess trading, buying high flying stocks to be able to brack about them, even lottery tickets if they allow you to dream of winning big.

BTW if all of this talk about giving makes you want to be happier, BonaResponds is always ready to accept any and all donations of money, food, tools, just about anything. As the leader, I will guarantee it gets put to good use!

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[Source: FinanceProfessor.com]

Finance Crossword Puzzle

Custom Crossword Puzzle---

I thought a crossword puzzle would be a unique way to review for class, so I made this one up. Sort of fun. It is probably too easy but really have no experience, so figured easy is preferred to hard.

The answers are here.

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[Source: FinanceProfessor.com]

Does Social Security Increase Poverty?

One of the real dangers of writing a blog is becoming political. I do not want to at all. In fact I have purposely not said anything about Social Security for that reason. It is the proverbial third rail. That said, it came up in class yesterday when we were talking about the importance of compounding on future values, plus it has been a hot issue for years with friends and is covered in quite a bit of detail in Real Change (one of the books I am ristening (risten= Read and listen).), so I will at least point this article out that deals with some of the issues you generally do not hear from politicians who are trying to scare up every vote possible.

Social Security Increases Poverty: Newsroom: The Independent Institute:

"Social Security affects poverty among the elderly in two offsetting ways. While it reduces poverty by providing income to retired persons, it discourages private saving during the working years....The net effect of this is increased poverty among the retired population.

To understand this conclusion, it is important to compare the rate of return on taxes paid that is generated by Social Security to the rate of return people could receive on their private saving. For those retiring in 2008, the average implicit real (inflation-adjusted) rate of return on Social Security taxes paid was slightly below 3 percentand it is scheduled to decline to under 2 percent in the next forty years. In contrast, if people retiring in 2008 had invested the taxes they paid into Social Security in a balanced portfolio (60 percent stocks and 40 percent bonds), they would have received a return of 5.5 percent."

One problem with this of course is that the past is not likely to repeat itself and market returns may be much lower (see for instance Paul Krugman's piece from NY Times in 2005). That said, returns that are less than two percent and in many cases negative (even before being concerned with the solvency of the Social Security System) makes it likely (although not certain), that you could earn more elsewhere than through social security.

While I can not vouch for its accuracy, here is an interesting calculator that estimates how much you will earn on your "investment".

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[Source: FinanceProfessor.com]

SSRN-A Generalized Rank Test for Testing Cumulative Abnormal Returns In Event Studies by James Kolari, Seppo Pynnonen

This one may not be of wide general interest but it definitely will be for those who do academic financial research. From the abstract:

SSRN-A Generalized Rank Test for Testing Cumulative Abnormal Returns In Event Studies by James Kolari, Seppo Pynnonen:

"This paper proposes a generalized rank test that can be used both for testing cumulative abnormal returns as well as single abnormal returns. Empirical properties of the test statistics are studied with simulations using CRSP returns. The results show that the popular test statistics, like Patell, BMP, Corrado, as well as the adjusted Corrado-Zivney test tend to under-reject the null hypothesis as the CAR period increases. The suggested generalized rank test seems to avoid this bias. Furthermore, it is robust against the event imposed volatility and cross-correlation due to the event day clustering, and foremost it is more powerful than the standard parametric tests of Patell and BMP."

Cite: Kolari, James W. and Pynnonen, Seppo,A Generalized Rank Test for Testing Cumulative Abnormal Returns In Event Studies(August 25, 2008).
Available at SSRN: http://ssrn.com/abstract=1254022

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[Source: FinanceProfessor.com]