econoclasm

Blockbuster/Netflix

2009-03-04T05:59:00.000-08:00

Rumors arise that Blockbuster might file for bankruptcy, and Netflix stock goes up 6%. Does that make any sense? Blockbuster freed of all that debt and interest expense becomes a less threatening rival?

Predictions for 2008

2008-01-04T07:03:00.000-08:00

1. The Fed funds rate will be flat or down in the first half of the year.

2. Inflation will pick up steadily through the year.

3. The 10-year Treasury will be flat for the first half but reach 5.75% by year-end, incorporating an increasingly discussed “inflation premium”.

4. Earnings on the S&P 500 decline 10%, to around $81.

5. The stock market, after a rocky start, will pick up a little through the middle of Q2 but then dip drastically in the second half. The S&P will end 2008 at 1,160, down 21% for the year.

6. The dollar will continue weak through Q2 and stabilize with the increase in the 10-yr Treasury rate in Q3.

7. China will host the Olympics, having first made sure to get all the dissidents out of the way. Inflation in China will begin to run rampant, but the currency will be flat or rise very modestly. China’s food imports will rise but there will still be shortages and high prices. There will be continued unrest in the countryside. By Q4, China will be on the verge of a steep recession and the stock market bubble will have burst.

9. Russia will become increasingly aggressive. Putin will be Prime Minister, and the constitution will be changed to radically increase the power of the Prime Minister. The Russian internet will be more tightly censored and controlled. Azerbaizhan, Kazakhstan, Ukraine and Georgia will be de-stabilized, and there will be Russian troops on, or even over, the border of one or more of these. The rouble will continue to rise.

10. Africa will continue to be a battleground. Darfur, Congo will continue in civil war. There will be a military coup in Nigeria and trouble will begin again in Angola. Robert Mugabe will finally be toppled in Zimbabwe and civil war will erupt between the Matabele and the Shona. Tensions will be running high in South Africa. In Kenya, Kibaki will resign and it will finally be the turn of non-Kikuyus to start lining their pockets.

11. The Middle East – who the hell knows? but it will be further de-stabilized in 2008. There will be civil war in Iraq, Al-Maliki will leave the country or be assassinated, and Turkey will make incursions into the North, possibly with surreptitious support from the US. Secular youth will make political gains in Iran and possibly in Saudi Arabia, Kuwait, Qatar and/or other more developed Arab countries.

12. Socialism will take hold increasingly in Latin America.

13. Partly as a result of all the foreign turmoil, John McCain will be elected President of the US.

14. Nike’s sneakers will be back in style, and the Patriots will win the Superbowl.

How to treat currency schizophrenia?

2007-10-30T09:10:00.000-07:00

I can never figure out currencies, because they're really complicated. The trouble is, the same stuff (money) is used for both spending and saving (or, if you like, investing). Based on money for spending, the dollar looks unreasonably weak. My daughter is spending a semester over in Paris, and it's costing a lot because you don't get so many Euros for your dollar anymore. You'd think that would correct itself: Americans stop buying European stuff, Europeans start buying American stuff, supply and demand shifts, dollar gets stronger. Trouble is, stuff is only a small part of the picture. Last time I looked, which was a while ago, the forex market turnover was about $2 trillion per day -- much more than you could explain just on people wanting to exchange stuff. For the rest of it, I guess, you have to look at the investing side: savers. And they don't care about how much stuff costs in one country or the other, they just go to the currencies with the highest interest rates, which is not the US right now, which is why the dollar is weak. Because of the hyperactivity of the securities markets, the saving/investing aspect of money overwhelms the stuff-buying aspect. It's almost like you need two different forms of money.

I always think there must be an arbitrage here, to take advantage of the different dynamics of stuff-buying dollar and the investment-buying dollar. If there were, then I suppose it would be: buy stuff in the US and sell it overseas. Or look for companies that do this.

Not so strange

2007-10-26T07:51:00.000-07:00

I think I get it now: bad economic news increases the danger of a recession, which hits the cyclical semiconductor stocks; it also increases the likelihood of an interest-rate cut, which lifts the more diversified S&P 500.

Strange divergence

2007-10-23T07:24:00.000-07:00

It seems almost every time I look at my watchlist these days that the S&P 500 and the SOX (semiconductor) index move in opposite directions. Weird.

Shell Game Continued

2007-10-16T05:59:00.000-07:00

So the banks are supplying money to back their SIVs. How is this supposed to help? Where are the banks getting the cash to do this, other than off their own balance sheets, which were exposed to the SIVs in the first place?

Well, the big three behind the deal are going to pull in other banks to help fund the backup pool. Banks that aren't worried about SIVs won't do it -- why should they? Only banks with problem SIVs will participate.

Maybe it's just a back door government bailout. The Treasury helped put the deal together. No doubt they will persuade the Fed to back it -- which is to say, the taxpayer.

Hiding the risk doesn't get rid of it.

Why care about the Fed funds rate?

2007-09-17T13:14:00.000-07:00

Everyone's busy wondering whether there'll be a cut in the target Fed Funds rate tomorrow, and if so whether it will be 25 or 50 basis points.

The real question should be: will a cut have any effect on the root problem? If banks are bothered about lending to each other on asset-backed commercial paper and the like because they're afraid of huge markdowns when values become clear, does it really matter whether they're lending at 5% or 6%?

Yahoo's end run on click fraud

2006-11-11T11:34:00.000-08:00

I've discovered an excellent site for followers of the markets: http://seekingalpha.com/ There's a ton of stuff there. The latest conference call transcripts are one of my favorites. It's one of the millions of great things that have happened to our world as a result of the web.

There's an interesting article in the digest I got this morning about Yahoo's settlement of a class action fraud complaining about click fraud. Click fraud is a major pain and drain for advertisers. Whenever someone clicks on their paid search links, the advertiser pays. So nasty minded competitors set up robots to click on their links, draining their marketing budgets. The search engines themselves, of course, have a big conflict of interest in the whole thing, because from their point of view the more clicks there are the richer they get, and they're the ones who count the clicks, so they don't have a big incentive, at least in the short term, to curb the abuse. (In fact, with some search engines of lesser repute, there have been allegations that the search engine companies themselves perpetrated the clicks). There's some number out there that around 14% of clicks are fraudulent (who knows where these numbers come from or how reliable they are, but I throw it out there as the now accepted number someone made up).

In any case, apparently there's been a class action suit on behalf of past advertisers, which is now being settled. The upshot of it is:

(a) The lawyers for the class get $5mm.
(b) If you've paid for advertising on Yahoo between January 1998 and July 31, 2006, you're automatically in the class (unless you opted out).
(c) If you didn't opt out (for example, if you never heard of the suit), it's too late to do it now.

Anyway, if you're interested, read the article:

http://internet.seekingalpha.com/article/20242

And if you follow the markets, register with this site, it's really good.

Starbucks as the canary in the coalmine?

2006-08-05T19:32:00.000-07:00

Starbucks reported a June quarter that was apparently disappointing to the street, with same-store sales only up 4%. They blamed it on an unexpectedly high demand for frappacino as opposed to higher-margin espresso, or something. Apparently it's more complicated to make the frappacino and their baristas just weren't up to it.

Isn't it likely, though, that Starbucks will be a great coincident indicator, or maybe slighly leading indicator, for a recession? I mean, what's the first thing you're going to give up when you need to tighten the belt a little? Rent or mortgage payment? Electricity? Speaking for myself, I wouldn't want to cut back on the roughly $600 a year I spend at Starbucks (that's $1.50 for the small -- "tall", which I refuse to say -- coffee and a $0.25 tip pretty much every day, on the turn of our 3-mile walk). But I guess that would have to be one of the first things to go if the wolf showed up in the neighborhood.

Can't say the past gives great evidence of this (see chart). Sure, there was a good blip down after the dotcom bust in 2000-1, but there've been quite a few of those over the years, none of them really correlated with recession. I even remember people saying back in the bust years that Starbucks was boosted by hosts of the unemployed dotcommers toting their laptops to the local when on their job searches.

In case you're wondering, Yahoo Finance says this stock is trading at a P/E of 44x and a forward P/E of 35x. Amazingly, the company is worth $23.5bn.

Oh, and how much did same store sales go up again? 4%, you say? Does this sound like a growth stock to you, deserving of a multiple like that? With a Starbucks about every three blocks in most of the town in the US?

The only thing against it being a screaming short is that only around 17% of its revenues are in the US. Will the rest of the world follow suit, do you think, and have one on every corner? Well, somehow total revenues for the quarter were up 20%, and that's the target they've set themselves for the rest of the year. 2,000 new store openings, 4% - 7% same-store growth and 20% overall.

How to fix the pension underfunding problem

2006-04-02T10:29:00.000-07:00

OK, how's this for an idea? The pay of company executives must be capped at a moderate level until the company's pension and health benefit plans are fully funded. No bonuses until the lower level employees are taken care of. The actuarial assumptions behind the plan obligations must be standardized.

So, management has a personal incentive to honor its contracts with the company's employees: they don't get paid until the employees rights have been protected.

I know, I know what you're going to say: the most talented managers will avoid working for companies with underfunded pension plans; so the companies in the worst condition will also be the worst managed, being unable to attract top talent.

I say: go ahead, throw down the gauntlet. Let's find out if the most highly paid executives really are the most talented or not. Maybe you skeptics will be surprised.

So, how about it, Congress? Stick it in your bill.

Video games revisited

2006-03-26T14:23:00.000-08:00

A year or so ago I mused on Kids these days and the numbers behind the video game industry. There's this company Gamestop (NYSE - GME). They have stores around the country selling videogames. Back then, in March 2005 it was trading around $20. Now it's up to almost $47. Just out of curiosity, I went to have a look at what has changed in between, other than the stock price...

Cash then: $205mm Now: $171mm
Book value then: $594mm Now: $543mm
LTM Revs then: $1.6bn Now: $1.8bn
Op Inc then: $$104mm Now: $99mm

So they've got less cash, less book value, revenues a little higher but less income... and the stock has more than doubled. Hmmmm.

There's about 73mm shares out, LTM earnings per share are $1.61, and analysts seem to be estimating around $1.90 a share in 2006.

No wonder people have trouble understanding the stock market.

It reminds me a bit of the video rental stores, like Blockbuster, Hollywood Entertainment and Movie Gallery. They have basically one product. And in the long run, everybody is going to get that product over the wire (downloading from the web).

Plus it's a Texan company.

Short! Short!

Jam Today

2006-03-24T18:23:00.000-08:00

Front page story in the Financial Times about pension reform. With the Pension Benefit Guarantee Corp piling up liabilities as companies went bankrupt, our Fearless Leader called for legislation to make it harder for companies to avoid making contributions to their pension plans, intending thereby to avert an impending bail-out of the PBGC. So guess what happened? The Senate and House have come up with legislation that makes it easier for companies to avoid making contributions to their pension plans. In exchange, the companies swear they'll make bigger contributions later.

Social security is about $4 trillion short. Medicare is about $28 trillion short. And now private pension plans. What is the US going to look like 20 years from now, I wonder?

How many paper bags does a commissary use?

2006-03-21T17:35:00.000-08:00

Robert Reich's book, Locked In The Cabinet, is full of amusing anecdotes -- he's a very funny man. He touches more than once on the Defense Department and the immense power in the government of the Pentagon.

Anyway, Prof Reich is not a big fan of the "Defense" budget. It puzzled him, apparently, that we wasted so much money on this useless pursuit and why somebody didn't do something about it. Then one day it dawned on him: The defense budget is actually a massive jobs program. It's America's answer to European socialism. Obvious, really, isn't it?

It's actually fun to subscribe to the DoD mailing list so you can see the money flowing. Every day you get an e-mail with the latest awards (or, more likely, the ones that aren't considered Top Secret). You can do it here:

http://www.defenselink.mil/news/e-mail.html

Here's a gem from a couple of days ago:

Duro Bag Manufacturing Co., Florence, Ky., was awarded an indefinite delivery requirements type contract with an estimated value of $5,603,930 for delivery of paper grocery bags to commissaries located in the Western Region. Work will be performed at the contractor's facility and delivery made to the commissary locations in the Defense Commissary Agency, Western Region. The contract is for a base period starting on May 1, 2006 with a contract completion date of April 30, 2009. Three offers were received, two awards were made. An award was also made to Ross and Wallace Paper Products Inc., Hammond, La., a small business for the Eastern Region
commissaries in an estimated amount of $4,183,340.

If I understand it correctly, this means that these two companies will get $9.8 million for supplying paper grocery bags to commissaries for three years. That's a little over $3 million a year. For paper grocery bags.

As it happens, I looked up the price of Duro grocery bags on the web. Their most expensive bag is offered at $92.28 for 3,000 bags. That's about 3 cents a bag. So the western and eastern commissary regions are buying, at that price, about 318 million paper grocery bags, or 106 million a year. That's assuming they're paying the full price you see on the web and not getting a volume discount. (I think they should get a volume discount, don't you?) That means they're going to be using 290,976 bags every day.

How much do these damn soldiers eat, anyway? And shouldn't they be in Iraq rather than hanging about our eastern and western commissaries?

What new system, though?

2006-03-19T12:58:00.000-08:00

Everyone has a great confidence in the so-called "market system". Prices are set by the balance between supply and demand. Stock prices fluctuate in such a way as to attract new capital to places where it is needed most. This creates an efficient economic machine which benefits everyone except the lazy and the handicapped. The apparently unparallelled workability of this system has created a political landscape in which almost everyone is in favor, even formerly skeptical peoples like the Europeans. There's plenty of flaws, and plenty of lies told about this market system, but nobody is really disposed to consider them significant, in the whole scheme of things.

We're heading in a direction where it might no longer work, though. And I mean "work" in the utilitarian sense of bringing the greatest benefit to the greatest number. If you extrapolate current trends, you can see the emergence of a small class of Neobarons together with a large global mass of Neopeasants. The robot thingy I talked about a couple of posts ago. Here's where I'm going to start sounding like a Marxist: eventually, the Neopeasantry will decide that this is not a fair way of allocating income, and they'll rise up and tell the Neolords to get stuffed. There's plenty of good stuff to read on this subject, my favorites being Paul Craig Roberts and the Princeton economist, Robert Frank (Winner Take All, and Luxury Fever).

Following Marx, Socialism was supposed to be the answer to the inequitable distribution of income. It just hasn't worked, though. In Russia, redistributing the "means of production" to the people just meant replacing the landowning/capitalist shit-heads with an elite of so-called "communist" shit-heads who, like their forebears, just went ahead and grabbed everything for themselves. With slightly less dire forms of socialism, involving fewer executions and less overt property theft, as we had in Britain in the 1960s and 1970s, it just resulted in economic chaos.

The question of what went wrong is complicated, but a good part of the problem was the removal of incentives. If you could make a living by doing nothing, then you probably would. The state would take care of you whether you worked or not. So a lot of people chose not to work, which, really, was just like the previous system except that the people who didn't bother to work were from the so-called "working classes" rather than the chinless wonders with inherited wealth.

In the days when labor was more important to production, that certainly mattered more than it would now. If we eventually reach the Robotic State, I suppose it wouldn't matter as much, and maybe socialism would begin to work. After all, if robots do all the work, then people could chooose not to work with no negative economic consequences. But maybe not.

Let's just say that our guiding principle is utilitarian: we want to create a system which brings the greatest benefit (= income, in our somewhat warped view of life) to the greatest number. How do we do it? Self-evidently, the market system won't do this. We badly need something to replace it.

Strange Goings on in Semiconductor Markets

2006-03-04T11:04:00.000-08:00

Nice week for me on Patriot Scientific. My friend Cal recommended this to me a little while ago at around 20 cents. I watched it double, triple on heavy volume and finally took the plunge when it got to 96 cents only to see it drop back to around 72 the following day. Ended the week at $1.55. The company owns some patents on microprocessors. It got $25mm from licensing to Intel, AMD and HP, then announced a license to Casio and, this last week, to Fujitsu. Classic story stock: there's a lot of microprocessors around these days; if they can get a tiny piece of each one sold... There's probably a hole in the story somewhere, though. The total revenues from INTC, AMD and HWP were $25mm, and that apparently covers sales going back to 1997 or something. When you consider that INTC and AMD between them own pretty much the entire x86 market, $25mm is pretty small potatoes. So how am I going to know when to get out? Have to think about that a bit. Unfortunately, they don't ring a bell at the top.

Meanwhile, a shock to the system when Intel announced yet another revenue shortfall vs previous estimates for Q1. I've been following the OSAT (outsourced chip assembly & test) market a bit after writing up Amkor back last year. Amkor has shot up recently (pat self on back here for calling it after they announced a $30mm buyback of their 9 1/4s). I own the #1 company in the industry, Advanced Semiconductor Engineering. I bought it because I thought the market was underestimating the strength of the chip market going into 2006: both Amkor and ASX had pretty bullish conference calls, each reiterating that it wasn't going to continue cutting the other's throat on pricing. ASX has a much better balance sheet, so I figured they would survive better if I turned out to be wrong. AMKR stock has been much stronger, though, because now nobody thinks they're on the brink of bankruptcy.

But what is going on with the chip market? The OSAT guys rely heavily on the handset (cellphone) market. Also on PCs. Driving also this year, apparently, the videogame console and portable music markets. It looks to me, though, as if the handset market is running out of steam. And PCs aren't that strong, either. Durable goods generally don't look so great. Intel's weakness might be explained by AMD gaining share, but considering AMD has only 20%, roughly, of unit shipments, it would have to be a pretty big shift of market. One analyst (a Mark Edelstone at Morgan Stanley) is upping his estimates on AMD and NSM, and Goldman is apparently expecting TXN to raise its guidance on Monday.

It's often a red flag when one company in an industry appears to be growing while the rest of the industry is having a tough time. I got burned once in disk drives believing that Miniscribe could be doing well while Seagate, Maxtor, Western Digital et al were all hurting: it turned out Miniscribe was shipping bricks. But that's another story.

The point is: who is right about the chip market for 2006? Can other companies really be doing well when Intel is pulling in its horns? Are the OSAT guys shaping up for another horrible plunge of the kind these companies are prone to? Maybe long ASX short AMKR would be a good pair trade? Not for me, because I don't short, but in principle.

Back to the Middle Ages

2006-02-05T07:15:00.000-08:00

Imagine a world in which almost everything is done by a machine. Machines make cars, TVs, MP3 players. Machines harvest crops, process and package food and send it to supermarkets. Machines diagnose and treat illnesses, and service customers over the phone (or web, whatever). The only things left for people to do are things that either can't be done by machine or that, for some reason, people prefer to have done by other people. Prostitution, for example. Waitering. (They can make robot prostitutes and waiters, but somehow it just isn't the same). Gardening.

What kind of an economy do we have when this is all achieved? It's what they call a feudal economy. There are a few barons of industry who own all the machines, and a lot of very low-paid workers slaving away in the service of the barons. The old feudal economy was based on land ownership. The new one would be based on ownership of machinery.

How are we going to avoid ending up like this? We're going to need a new system.

Back to the USSR

2006-01-28T11:02:00.000-08:00

Back in the day, the Soviet Union was what Al Quaeda is today. The Orwellian bugbear. Then came glasnost and perestroika (I can't remember the difference, something to do with being all open and human, in sharp contrast to the secretive apparatchik predecessors), the falling of the wall, devolution of the former soviet union countries, the re-unification of Germany, and the give-away of public assets to Friends of Yeltsin. Suddenly the Russians didn't look 7-feet tall anymore, they were just cute and friendly, everyone waited for the so-called "peace dividend" (money to be saved from the defense budgets -- yes, I'm not kidding) and pundits heralded a New World Order.

I don't know about you, but Putin (as in "Put in the boot") scares me. Granted, it was getting a little anarchic over there before he took over, what with former KGB guys going around private-enterprising like crazy. And it's true that the sale of assets to the oligarchs under Yeltsin was extremely sleazy. Still, he really seems to be returning the country pretty rapidly to central state control. He got back most of the oil and gas assets by trumping up some ridiculous charges against Khordorkovsky and Yukos, and sent packing any other of the so-called oligarchs who didn't toe his line. All very KGB, which isn't really surprising considering his origins. You'd have thought there'd have been an outcry in the west. State appropriation of assets? That's capitalizmu? There were a few murmurs here and there, but the main reaction of the western investors was to pile in and start trying to get a piece of the action, like buying Gazprom bonds. They still can't wait to invest more, even under the new rules whereby foreigners can't own more than 49% of Russian oil & gas assets. So P has the best of both worlds: he gets the dollars and still keeps control of the assets. Just as for small shareholders under US-style capitalism, the question springs to mind: what is ownership without control?

Amazingly, Putin did put up with some dissent, notably from his outspoken economic advisor, Andrei Illaryonov, who called the Yukos appropriation the "swindle of the year" and, as a pro-free market economist, has been very critical of the return to central control. Illiaryonov lasted a surprisingly long time. He's gone now, though, I need hardly add.

Lately, Putin's been busy trying to squeeze the strategically important FSU countries back into the old Bearhug. Ukraine and Moldova and so on. And in the past week, he's been turning his beady eye (you know, the one our esteemed leader looked into and found a soulmate in) on the human rights organizations. No wonder, considering how much flak he's taken over his methods in Chechnya. Meanwhile, he's taken over the presidency of the G8. And still nobody really seems to care.

Russia is the world's second-largest producer of oil, after Saudi Arabia, and is rapidly becoming Europe's sole source of natural gas. See http://www.csmonitor.com/2005/1228/p01s01-woeu.html for a map of Russia's gas pipeline network in Europe (which excludes proposed pipelines to the Far East). Russia has about 25% of the world's reserves of gas, about equivalent, I'm told, to Saudi Arabia's oil reserves. And that's before they start on the Barents Sea reserves.

I suppose you can't blame him. After all, it's his job to advance his country's interests. But why are we going along with this and pretending it's all fine?

Water will run downhill

2005-12-10T15:31:00.000-08:00

Interesting article in the FT today titled "How the City of London defeated the prophets of doom". London, once feared obsolete as a financial centre because of the rise of the Euro and the might of Manhattan, has had a booming resurgence, for three reasons:

(a) Sarbanes Oxley. It's become so expensive and onerous to list in New York that everyone is flocking to London instead. In 1999, the dollar value of IPOs in New York (around $80bn) was around 10x the value in London. Last year, London raised $10.3bn and the US only $6bn.
(b) The Bush war on terror. Arabs, flush with cash, don't want to put their money in the US where what they regard as a capricious and high-handed administration might decide to seize it. Instead, they're reinvesting in their own countries, starting a Middle East capital centre and leaving the rest with London.
(c) Over-regulation on the Continent, which makes it easier to fire people when things slow down.

Money is like water -- it's very hard to prevent it sinking to the lowest levels. You just have to leave one little crack.

The beginnings are there for the end of the American era, and our leaders are doing everything they can to speed it along.

Jewel in the crown

2005-12-07T16:37:00.000-08:00

Lot of stories about India this week. Intel is planning to invest $1bn there in the next five years. So, too, Microsoft. AMD is thinking of building its next chip plant there. And on top of this, Mac the Knife at Morgan Stanley is offshoring 2,000 back-office jobs there. Suddenly it seems to be the place to go, sort of reminiscent of China a couple of years ago.

It was perhaps inevitable. There's something very enterprising about the Indian culture. I remember back in Africa, on a beach, sharing barbecued goat with some local Indians who came over to our island for a Sunday afternoon outing.

"We are the Jews of Africa", said one of them, and there are, indeed, similarities. Africa is full of Indians, or was, many of them small-time entrepreneurs running little shops selling to the natives (not, generally, to the so-called Europeans). They have in common, also, a dedication to education and a bent for math.

Another characteristic they share is a high propensity for saving. I was having dinner a while ago with some money managers in Philadelphia (in a Japanese restaurant owned and run by Morimoto, or whatever his name is, from Iron Chef). One of the analysts, an Indian, told me this, that all the Indians he knew saved far more than they spent.

Thrift, education and enterprise, a good recipe for eventual economic dominance.

We in America are fairly good at enterprise. But thrift and education are not conspicuously ours. There's not all that much we can do about becoming more thrifty, but we could be doing a lot more for education. If we took cut the defense budget by just 1% we'd have an extra $4.5bn a year to spend on education. Even the blundering old defense hawks ought to realize that it's actually a far better investment than building more planes and bombs. Education leads to prosperity, and, as history shows, prosperity is the best defense.

The new bankruptcy law

2005-08-19T11:47:00.000-07:00

We've become used to seeing the shadow of George Orwell, shaking his head ruefully, behind the names of new laws. The Clear Skies Act that allows more pollution. The Patriot Act that suggests anyone who doesn't support it is a traitor, and so on. Now we have the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005. Not quite as bad, perhaps, but still the "consumer protection" is a bit ironic in view of the new provisions giving major new status to credit card issuers in consumer bankruptcies.

There's an interesting article, though, on the consequences for business bankruptcies:

http://www.cfo.com/printable/article.cfm/3936429?f=options

You can see the Wall St lobby behind this legislation, salivating. It used to be that an investment bank that issued bonds for a company that subsequently went bankrupt couldn't then become the advisor to the deadbeats. So the big banks were shut out of a lot of lucrative advisory work, much of which was handled by smaller banks and by specialist advisors like Chanin & Co and Houlihan Lokey. The numbers are pretty decent. These boutiques can easily take $150K a month for a couple of years working on a Chapter 11. (Take a look at Eagle Picher, for instance, which filed back in April. Houlihan Lokey just submitted their first bill: over $530,000 in fees and over $80,000 in expenses). Under the new law, that "conflict" has been waived. If you work for Houlihan Lokey or Chanin, you might consider getting a headhunter and seeing if you can get yourself heading up a reorg department at one of the big banks.

The hedge funds are probably pretty happy, too. Management's "exclusivity period" has been shortened. Previously, the existing management could pretty much delay as long as it wanted putting together a reorganization plan. Interested parties (like the creditors) couldn't do very much about it. Now any interested party can come in a file a competing plan after 18 months.

On the other hand, it's probably going to have a negative effect on distressed bonds. New rules on trade claims (guys who did business with the bankrupt company) will put vendors and suppliers in a better position, shoving the "general unsecured" creditors, which usually includes unsecured bondholders, down the ladder a bit.

As for small businesses, well, what do you expect from this administration? Although they get some breaks, they now have much more onerous reporting requirements and -- nice boon for law firms -- have to have an attestation that they have complied with the bk laws. That'll make it a lot more expensive to survive the whole process.

Down And Out In The USA?

CAFTA NAFTA SCHMAFTA

2005-07-01T09:03:00.000-07:00

I was brought up believing in free trade. The logic is pretty clear: if you let the markets sort it out, then each country will produce what it's best at producing. They call it the law of comparative advantage. So, if Brazilian farms can produce soybeans cheaper than US farms, then let Brazil do the soybeans and we'll concentrate on something we do better, like making new software or something. If we do this, both countries benefit: Brazil's GDP goes up, because it's growing more soybeans, and our GDP goes up, because we're producing more software. Everyone gains. Win-win.

That's the orthodox economic thinking on the subject, at least as it was taught when I was in school.

I've just been reading this book I found in a thrift shop, Locked In The Cabinet, by Robert Reich, who was Labor Secretary under Clinton in 1992 and for a few years thereafter. (It is a fantastic and hugely entertaining book, by the way -- read it!). He has an interesting view on this:

Just because both countries' GDP goes up doesn't mean that it's a win-win-win-win for everybody. The trouble is this: US farmworkers don't know how to design new software.

In other words, it's fine for the US in the macro sense that its GDP goes up. But if you think of GDP as being composed of Profits + Wages (just to simplify it), GDP is going up because profits go up more than wages go down. From the point of view of the US farmworker, it's a lousy deal. From the point of view of the guy who owns the software company, it's a great deal.

So, fine for NAFTA and CAFTA, but to make it fair on everyone and genuinely a good thing, you need to take a substantial portion of the extra profits and plow them into improving the lot of the disadvantaged (in this case, the US farmworker). How? Well, you could use the money to train him in software engineering.

So before this CAFTA thing goes through the House, let's all call our congressman and make them redress the balance. They can have CAFTA, but only if they increase funds for education of the jobless. GDP gains are all very well, but only if everyone benefits.

Hooray for TRACE - Bonds for the little guy

2005-06-11T11:07:00.000-07:00

Pros in the bond world have been griping and moaning for quite a while now about the NASD TRACE requirements, because now they can't rip people off nearly so easily. TRACE is the Trade Reporting And Compliance Engine. It requires broker-dealers to report all their bond trades (on the list of eligible bonds), and the trades get displayed to the public on a 4-hour time delay.

Back in the "good old days" (depends a lot on your perspective), we bond trading desks could just rip the sh*t out of our accounts because, unlike in stocks, nobody can see the trades. So you could buy a million bonds (ie $1mm face amount) at, say, 88 and sell them at 91 and nobody would know they'd been ripped for 3 points ($30,000 on a $1mm trade). Once in a while, of course, the word would somehow get out and the customer would maybe stop trading with that particular desk or put them into the penalty box for a month. Then, of course, there's the NASD 5% rule, which discourages trades where the desk makes 5% or more. But by and large it made for a pretty profitable business. Now, though, everyone looks at TRACE. And even though the broker names aren't shown on the trade, trades, at least in most high-yield issues, are relatively infrequent, hence pretty visible, and it doesn't take rocket science to see when you've been ripped. Widespread wailing and gnashing of teeth among bond traders and their salesmen.

Of course, retail guys get ripped off way more than institutions. It doesn't necessarily mean all that much for a trading desk -- after all, a $10,000 trade is more like a spread than a trade for a desk that trades in $1mm pieces. Still, it's all gravy. Here's an example: take a look at the Sea Containers 8 7/8s of 2008. On Thursday at 13:25:33, a $15,000 piece traded at 98.25. At 14:38:58, another $15,000 trade was reported at 100.375. That's a spread of 2 1/8. The range for the whole day was 96.5 to that trade of 100.375 -- damn near 4 points for a bond that only yields a bit more than twice that for the whole year. Someone got ripped.

So next time you want to buy bonds, go to http://www.nasdbondinfo.com/asp/bond_search.asp first, type in the name of the bond you're interested in, and follow your nose to see where it's been trading. Let your broker know before you do the trade that you've checked out the prices on TRACE. Don't let them take you for more than a point, including commission.

And, way to go, guys at NASD! It's nice when once in a while the regulating body isn't too cozy in bed with the regulatees.

Euro Trash? Non!!

2005-05-27T07:06:00.000-07:00

Everyone is Europe is apparently wondering what’s going to happen on Sunday when La Populace in France votes “No” in a referendum on whether to accept the proposed new European constitution. Some of them are worried that a Huge No (as opposed to, say, a 52% No) will cause the Euro to plummet.

What is this new European constitution? Well, nobody has really been reporting much on that, but as far as I can tell it’s mostly about having a common foreign policy (with a European Foreign Minister, like a sort of Secretary of State), a sort of Grand Fromage Presidential type character, and some kind of common defense policy. Theory is that a French No would scupper the whole thing, because, after all, France was the No 1 country responsible for the united Europe in the first place (back in the 50s).

The FT has an interesting little speech on why the Frogs should be croaking “Non!”:

“There is a sentiment that we are entering a new world where the rules of the market prevail and where the state plays a less important role” [says a local expert]. “And there is a feeling that part of society is benefiting from this globalisation, the people who travel abroad, have money, work in businesss and are the company bosses, the journalists, the experts. But we the people are threatened by globalisation”.

Sounds sort of how people feel in the US.

Anyway, why the hell should this cause the Euro to plummet? Even if they don’t get their precious constitution – and they probably will find a way to do it in the end – it won’t make Europe disappear. The common currency will still be there. In fact, with US bond rates back down to around 4% (amazing!!! Jeez, it’s enough to make any forecaster humble), and the Euro down at a six month low or something against the dollar – reflecting huge anxiety already – not to mention that they would be saying “No” to yet another fat layer of bureaucracy -- I think the Euro will actually go up. Anyone wanna bet?

Hedge funds nab another $25bn

2005-05-25T05:57:00.000-07:00

Yes, another $25bn into hedge funds in Q1, according to the FT. I've seen different estimates of total hedge fund assets in the last couple of days. Well, two estimtes. It's either $1 trillion or $1.5 trillion.

The long-awaited dampening of hedge fund returns happened at last. They said it was the GM downgrade that did it all, but really that's not the whole story. Convertible arbitrage was already over-arbed, to the point where it wasn't surprising returns became negative. Take a look at the Red Hat convert, says this old friend of mine. Came with some minimal coupon, like 0.5% or something and a huge premium, like 40%. How could the arbs make any money with those numbers? Well, apparently they couldn't, and the thing is now down in the 80s somewhere with a relatively reasonable premium.

Anyway, point is, the more assets go into hedge funds, the more difficult it is to beat the market, because the more you are the market. Here's the part that appeals to the cynic in me, though: fees. Hedge funds take 2% or 2.5% in fees (usually plus 20% of the "carry", ie upside -- but not of the downside, nts). That's a lot higher than for mutual funds. So now you've got (a) less than market returns (b) higher fees and (c) less transparency. Sounds like a great deal for all those guys taking money out of mutual funds and putting it with the savvy hedge fund managers, what?

Executive Perks

2005-05-20T07:13:00.000-07:00

So two top bankers leaving Morgan Stanley have been paid not to join the camp trying to get rid of the MS CEO. Apparently Joe Perella (famous from old times as one half of the dynamic duo that propelled First Boston into an M&A powerhouse) and some guy called Terry Meguid, evidently another superstar, got paid $6.4mm apiece for leaving as long as they agreed not to join the eight former Morgan Stanley execs who are trying to get CEO Purcell ousted. In other words, the CEO is using the company's money to protect his own position. Oh well, just another example among many, I suppose...

If you've got it, flaunt it

2005-05-06T05:57:00.000-07:00

That was the motto in the 1980s, when greed officially became good. Here's the latest retail numbers, for April:

Neiman Marcus sales up 12.5%
Nordstrom up 6.9%
Federated (including Macy's and Bloomingdale's) up 2.8%
Target up 1.3%
Walmart up 0.9% (mostly in food)

Translation: not really necessary. Let's just say two words: tax cut.

Mind you, the kids are still spending pretty rapidly:

American Eagle up 20%
Abercrombie & Fitch up 16% (these last two being same-store numbers).

Where do they get the money, these kids?

Cracks in the edifice?

2005-04-28T17:06:00.000-07:00

The FT reports today that the private-equity groups behind the biggest deal of recent times -- the $11bn SunGard Data deal -- are having trouble getting the financing. The bank group trying to put together a $3bn bridge loan for the deal are getting a "lukewarm" reception, and nobody seems to want the high-yield piece(s). The banks are supposedly very nervous -- that old joke about the so-called "bridge" turning into a "pier".

Meanwhile, a subprime lender from Southern California somewhere, name of Triad Financial Group, trying to do a buyout, had to scale back their $200mm high-yield deal to $150mm and up the coupon to 11 1/4 (for a B3/B- deal) to get their paper sold. The original talk on this deal was 9%. The last time subprime lenders had coupons like that was Metris, best I can remember, which very nearly went bust last year.

Meanwhile again, Deustsche Bank had to withdraw a $825mm issue that was supposed to fund the $2.6bn buyout of Masonite by KKR. Apparently DB had to eat the whole deal -- they really can't be liking that. If you can't get a deal done with the KKR name behind it, it's a sign of real trouble, methinks. There's quite a few private equity buyouts in the pipeline, pretty much all depending on the high-yield market to get them done.

In another interesting development, another reinsurer, Swiss company Converium, is being supoena'ed in the ongoing probe into MBIA. (Converium got into some pretty big trouble last year, too, as I recall). MBIA is the biggest bond insurer around. I'd say a huge chunk of the securitization market is backed by MBIA: they are the backing that gives comfort to all the investors in the AAA-rated top pieces in god knows how many trillions of mortgage, bond, credit card, and finance receivable deals. Well, I guess Fannie Mae is behind a lot of the mortgage deals -- real solid company there, what?

Maybe I'm just in a scare-mongering mood today, but this all looks like the beginning of a big shift in the debt markets. Treasuries remain calm, but I can see spreads over treasuries widening all over the place. And most of us are borrowing on spreads, not on the so-called "risk-free" rate. Take cover, chaps. The rebar is leaving the building..

Questions of refinement

2005-04-25T17:02:00.000-07:00

Valero is taking over Premcor and in the process becoming the largest oil refiner in the country, with a capacity of 2.5 + 0.8 = 3.3mm barrels of oil a day. (The US consumes about 21mm barrels a day, so it's a pretty big chunk). Bigger even than Exxon. Pretty impressive. Not a good sign for us consumers, though, I would think: after the deal, there will only be 5 refining companies in the country, I hear -- a small enough group for price collusion to become very easy to do.

Right now, it's a very profitable business. "Crack spreads" -- the difference between the cost of a barrel and the price you can the resulting refined products at -- are apparently around $14 a barrel, which is surely about as high as it's ever been.

Here's a strange fact: no new refineries have been built in the US since 1976. This despite the fact that the industry is chronically close to 100% capacity (as you can imagine if you think about what our consumption has done since 1976). The environmental hurdles are, apparently, just too high. Makes you wonder, though, doesn't it? I mean, the oil industry is usually pretty good at getting what they want. Do you think it's possible they actually don't want any new refining capacity? They'd rather have $14 crack spreads perhaps. You'd think, too, they might make up the shortfall by building in Mexico, but that hasn't happened either... Odd.

I keep hearing, every time crude oil prices go up, that it's partly caused by "lack of refinery capacity". This is a proposition I don't understand. I mean, if refineries are too busy to accept more oil, wouldn't that have the opposite effect? Surely it would decrease the demand for oil, not increase it. If anybody out there knows why, I'd like to hear it.

Break up break up fees

2005-04-20T19:25:00.000-07:00

Bankrupt Adelphia cable made a deal to sell to Time Warner and Comcast. I forget the size, somewhere around $17bn. Then Cablevision comes along, also wanting to buy. But part of the deal is a 2.5% break-up fee. In other words, if Adelphia backs out, it owes TWC about $400mm.

These break-up fees have become pretty standard in merger agreements. Obviously, though, they're not in the best interests of shareholders (where these are public companies) or creditors (in the case of bankruptcies like Adelphia).

Private companies can make whatever deals they want. For public companies, though, these fees should be outlawed.

Scotland Going Back Into China

2005-04-11T20:36:00.000-07:00

The Royal Bank of Scotland is apparently contemplating an investment of up to $4bn for a 20% stake in Bank of China (which is the #2 or #3 bank in China), according to a story in today's FT. Under Chinese law, foreign investors can't own more than 20% of a Chinese bank, so they're ponying up for as much as they're allowed to.

The Chinese banking system is a bit of a mess. Under the strict central control of the Chinese Communist Party, the banks have apparently made loans to over 170,000 SOEs (State-Owned Enterprises, as opposed to the rather amusingly named SOBs or State-Owned Banks). Not surprisingly, that has resulted in enormous losses over the years, since the banks have been lending based on central policy (and, no doubt, bribery) rather than on economic merit. It's reckoned that non-performing loans in China's roughly $4 trillion portfolio of bank assets have been in the hundreds of billions.

On top of the bad loans, there's a very distinct smell of corruption. The Chairman of the China Construction Bank (CCB), another of the so-called "Big Four", recently resigned after being accused of taking a $1mm bribe. (This came to light when a Chinese company filed in California court against an American IT company, Alltell Information Services, which it accused of reneging on a deal to pay it a commission. Alltell is accused of paying the $1mm to the bank chief, as well as a trip to Pebble Beach and his son's school fees, to kill this deal -- the broker's lot is not always a happy one, to be sure). The previous chairman of the same bank is already in jail for taking bribes while head of the Bank of China. The corruption isn't only at the top, evidently: the manager of a sub-branch of BoC has gone missing along with $120mm; several senior staff of the same bank were found to have loaned $78mm to a property developer using fake documents; a group of staff at CCB is accused of making off with $14mm in 98 separate scams; a lone typist at the bank's Dalian branch is accused of embezzling $6mm over the years to feed his gambling habit. It looks pretty much as though baksheesh is endemic in the banking system -- and you can probably extrapolate that to the economy as a whole.

The authorities want to take its banks public. The reasoning behind the decision is good: with the discipline of public ownership, these banks will have to get their act together. And they need to get their act together by 2006, when, under an agreement with the WTO, foreign banks will be allowed in to compete. But it's not an easy proposition after this kind of publicity. It doesn't help, either, that other IPOs of state owned enterprises have performed very badly in the aftermarket -- mainly because managements have, effectively, walked off with the proceeds. The Chinese government has so far had to inject $45bn into the two big IPO candidates (CCB and BoC) to make their balance sheets acceptable to potential investors.

Who would want to invest in this mess? Well, just about every international bank, apparently. ING, the Dutch financial group that mopped up Barings after the Nicholas Leeson debacle 10 years ago, is buying up to 19.9% of Bank of Beijing (along with 5% to be taken up by IFC, the World Bank's private equity sub). And there are plenty of rivals lined up alongside RBS for a piece of BoC, or any other bank that comes up for grabs. Not hard to see why: those 1.3bn Chinese, and the (apparently, anyway) booming Chinese economy (now, at something like $1.5 trillion, overtaking France to be the 5th largest in the world after the US [$11], Japan [$4.5], Germany [$2.5] and the UK [$1.9] ).

On an apparently unrelated matter: Khordorkovsky made a defiant closing speech at his trial in Russia for embezzlement, fraud and tax evasion. K probably stole Yukos in the early 1990s when Russia's state assets were "privatized" -- sort of like China's are being now. It's reckoned "the oligarchs" got a lot of prime stuff very cheap under Yeltsin. Putin has been clawing the assets back -- first the media companies, then the oil and gas. K was very high profile in his opposition to Putin, so they're making an example of him. Meanwhile, they've pretty much grabbed back Yukos by burying it under tax claims (the amount of the claims, apparently, aren't far short of total revenues, so they look pretty bogus). Although some western investors have continued pouring money in despite this apparent disregard for property laws, it has scared, net net, about $9.5bn out of the country. An object lesson, I would think, for RBS.

When's The Recession?

2005-03-30T15:27:00.000-08:00

A couple of quarters ago I bet my friend and fellow analyst, B, that we'd have a recession by the second quarter of 2005. Fifty bucks on the line. A recession being defined as a quarter of negative real GDP growth. Right now it looks like I'm going to lose the fifty, which I can ill afford at present but never mind. Certainly B is not a guy to bet against lightly, and it is to his credit that he persuaded me down to fifty from a hundred.

You could see his point. There was no sign of a slowdown in GDP growth at that point, and with both short and longer term rates at historically very low levels it didn't look all that likely: usually it's high short term rates that's responsible for recessions. All the same, my reasoning went, the best time for a recession, from the viewpoint of a political incumbent, is right after the election. Get it out of the way before the mid-terms and try to get the economy roaring again at the four-year mark. Actually it's not as true as it used to be -- recessions have been remarkably scarce in the last 20 years compared to historically. Anyway, I'm pretty cynical, as you may have gathered, about the current incumbents. They'd be the type to play it safe.

It's surely coming at some point. Expectations are continually being revised downward in Europe: France is a little stronger than it has been, though confidence there is at a 15-month low; Italy is looking weak; growth in the UK is pretty minimal and expectations are going more in a southerly direction; and the latest confidence index from Germany, the largest economy in Europe, was unexpectedly low. Japan is flirting with recession once again, and in South Korea factory output recently suffered its worst decline in seven years. (Thanks to the FT's excellent Philip Coggan for some of this info). Latin America is going gangbusters, it's true, as you'd expect from resource-rich regions (ditto, for example, Australia and oil-rich Former Soviet Union countries). Then there's China. Lord knows what's going on in China. Can you really believe the numbers they publish? And, with all the recent news about graft and fraud in the banking industry, not to mention the incredible bad debt levels, can you really expect that economy not to crash at some point? When it comes, it'll be a big one, IMO.

Exports were only 10% of US GDP in 2004, so it's not critical that the rest of the world be thriving, but it certainly helps. Imports (-15% of GDP) are likely to go up, because the dollar is weak. Oil, for instance, is costing a lot more this year. Government spending (about 20% of GDP) is going to stay high, we can pretty much count on that. The biggest factor, of course, is the consumer -- about 70% of GDP in 2004. What will bring him crashing down is a rise in interest rates. That really puts the crimp on big-ticket durable goods spending (cars, large appliances, etc); and these days when so much spending is on the credit card, it's not just big-ticket spending that will get hurt.

Maybe I'm going to be out fifty bucks, but I'm still betting on a recession before the end of 2005. Any takers?

House For Sale

2005-03-28T21:30:00.000-08:00

Suddenly there's a flurry of articles on the housing boom. Friday in the NY Times, Saturday in the Washington Post and today in the Financial Times. All with stories of how people are trading houses like they used to trade dotcom stocks in the late 1990s. (See: Extraordinary Popular Delusions And The Madness Of Crowds. By Charles MacKay. 1841. You can get a copy here:

http://www.popula.com/items_fp/item_description.cfm?item_fp_ID=237616 )

There's a theory that goes something like this: LT Capital Management collapsed back around 1998. With that and the related Asian currency crisis, the Fed had to pump a lot of money into the system. The liquidity eventually found its way into dotcom stocks. When that bubble collapsed in 1999, the Fed had to do a whole lot more injecting of money to try and minimize the negative effects on the economy. That easy money policy has been in place pretty much ever since, and its effect has been to support the bond markets, the stock market and, as a kind of side effect, the house market. It's called Pass The Bubble. Where to next?

The thing about "market prices" is that they aren't necessarily representative of the whole market. Prices are made "on the margin" -- there's a whole lot of houses out there, but people determine the value of their houses by referring to a very small number of transactions. It's a very illiquid market, and you really can't value the whole housing stock based on a few trades. (I was reading somewhere the other day about the Japanese property market bubble in the 1990s, when, it was said, the land on the which the Imperial Palace and gardens sit in Tokyo was worth more than the entire state of California. That sort of makes the point. Apparently average prices in Japan have now fallen by about 80%).

Well, prices are certainly getting pretty crazy in my neighborhood. Supposedly my house is now worth over three times what I paid for it about five years ago. So, despite the fact that it would be a royal p.i.t.a. to find somewhere else to live and move all our crap over there, I called in the broker and signed up. If you are one of those speculators who is making such a finel living flipping houses, feel free to drop me a line.

Nationalize Microsoft

2005-03-24T21:46:00.000-08:00

No, I'm not a socialist. I wouldn't go around nationalizing everything. But I think exercising a little eminent domain over Microsoft is a great idea, not only for the massive economic benefits but also, as they said when they hanged Admiral Byng, "pour encourager les autres".

Microsoft is still wrangling with the EU as to how to implement the EU antitrust ruling, using the same stalling tactics they've always used to weasel their slimy way to the top.

They no longer serve any useful economic purpose. We don't need any more "upgrades" to our spreadsheet or wordprocessing programs or to our operating system, and it is certainly an economic negative for this company to force us to take them just in order to escape finding really useful ways to make a buck. Nationalizing the company might make others think twice before embarking on such rampant abuse of monopoly power. As for the worldwide economic benefits, just imagine what producticity might be unleashed if nobody had to pay for the operating system and the source code were made freely available. Write to your congressman!

Kids These Days

2005-03-23T15:56:00.000-08:00

Tiger Woods gets $50mm to advertise for Nike, or whoever it was. Howard Stern gets $500mm (OK, not all cash) to take his show over to Sirius satellite radio (which, by the way, also agreed to pay $200mm to carry broadcasts of NFL games). By now, we're used to seeing big numbers in sports and entertainment. So yesterday's news that the NBA signed 5-6 yr licensing deals for a reported $400mm sounds pretty ho hum. Wait a minute, though: the deals were with Electronic Arts and four other video game companies. Video games!

Electronic Arts, the world's largest video game company, already has a $500mm 5-yr exclusive deal with the NFL, and Take Two is reported to have signed a $300mm exclusive long-term deal with the baseball guys. By my reckoning, that's about $200mm a year for virtual basketball, football and baseball. Bear in mind, here, that these three are all pretty much North American sports, so we're really not talking about worldwide markets. To the videogame makers, sports games are worth, apparently, about $1.2 billion a year in revenues.

Here's a funny sidelight: part of the revenues are from advertising within the games. They can actually stick ads into the virtual game just like they do in the real ones.

I took a quick look at Electronic Arts's financials (ticker ERTS). They do about $3.2 billion a year in sales and bring $500mm - $600mm to the bottom line. They have a market cap of around $17 billion, no debt and $2.6 billion in cash at 12/31/2004. The stock is trading at about 30x last twelve months' earnings ($55 stock, $1.86 EPS) and, despite all the cash, doesn't pay a dividend. About half their sales are from overseas, mostly Europe.

One of the other companies participating in the (obviously non-exclusive) deal, by the way, is Atari. There was a time when Atari seemed the invincible king of the videogame business, back in the early 1980s when games like PacMan and Space Invaders were the very latest thing. Turned out kids suddenly got bored with videogames and Atari was caught with enormous inventories of unwanted cartridges.

Atari these days (if it's even the same company - ticker ATAR) has a market cap of about $400mm, a tiny fraction of Electronic Arts (which didn't even exist back then) and revenues of around $410mm. There's also Take-Two Interactive Software (TTWO, maker of the very successful and highly criminal Grand Theft Auto series), with a $1.9bn market cap and $1.25bn in revenues, and Midway Games (MWY) with a $900mm market cap and $160mm in revenues. The fifth player is Sony, obviously not a pure play. Other players not in this sports deal are Activision (ATVI) $2.4bn market cap, $1.4bn in sales, and THQ (THQI) $1.1bn market cap, $700mm in sales.

I used to own one called Acclaim Entertainment, which was a fairly decent name in that business in the 1990s. I see they filed bankruptcy back in September. The stock is in the pink sheets at .39 cents a share.

Electronic Arts stock took a pummelling on Monday after it lowered its expectations for sales and earnings for 2005 ($1.62 - $1.64 expected in EPS). Granted it has a very strong balance sheet and can stand, no doubt, several tough years. But, especially give the history of the videogame industry (see above), does it really deserve a forward P/E of over 30x? Not that I really know a lot about this business, but I can't see where the growth is supposed to come from.

For a quick look at the retailing of electronic games, and some light on the hardware side, see this story on GameStop (GME):

http://yahoo.smartmoney.com/onedaywonder/index.cfm?story=20050323&afl=yahoo

This Texas-based (uh oh! red flag!) company has over 1,800 stores around the country and plans to open another 370 - 400 this year, expanding its base by over 20%. Among their competitors are WalMart, Best Buy and, presumably at some point, web-based downloading.

It's a world of bread and circuses. Just seems to me the circus/bread ratio is at an all-time high. If your average joe doesn't have enough bread to pay for a circus ticket, how long can this go on?

Nobel Economist: No Bullshit On Social Security

2005-03-21T19:26:00.000-08:00

An editorial in the FT today by Joseph Stiglitz on social security. With the White House Used Car Sales team out there flashing the usual smoke and mirrors it's nice to see some straight talk. It's not really a very complicated subject. Because of a change in the age structure of society (ie a higher ratio of retirees to active workers), the current "pay as you go" system is set to go bust. Not today. Not tomorrow. But, according to the pundits, around 2040. That's 35 years from now, when people who are not even born yet will have been in the workforce for 10 years.

I don't know why the Used Car Sales team is deciding to make a big issue of it now. I suppose they've always been opposed to it, and now they're thinking they better get it done before the Sales Director leaves office in 2008, because the chance may not come again. No doubt they have the full backing of Wall St., which stands to make a lot of money in fees and commissions on those pointless private accounts.

"If there is a remarkable achievement of the Bush proposals", Stiglitz concludes, it is that, "they simultaneously undermine the solvency of the Social Security system, worsen the fiscal deficit, diminish the security of the elderly and increase the incidence of poverty". The Bush proposals do nothing to attack the root problem, and it's hard to see how anyone could believe otherwise. Worth a read.

Meanwhile in a related story on the front page, Standard & Poor's has declared that the US, Germany, France and the UK will be junk credits within the next 30 years, for the same basic reasons -- pension and healthcare costs for the growing retiree base swamping the ability of the active workforce to pay.

A lot can happen in 35 years, friends, take it from one who has been around for a while. To assume that society will not find ways to adapt to the changing circumstances is extremely naive. The world population will be around 8.7 billion by 2040 (from around 6 billion now), of which a good 3 billion haven't been born yet. Technology will continue to evolve, and productivity will continue to grow as a result. I'm not saying we shouldn't do something about the theoretical future imbalance in Social Security. But for heaven's sake don't swallow the bullshit being shovelled out of Washington.

Fund Managers Bullish. Ding Ding!

2005-03-19T19:53:00.000-08:00

There's an old Wall Street saying: "They don't ring a bell at the top".

Here's a hint, though. Last week Merrill Lynch released its latest survey of fund managers. Merrill has apparently been doing this survey since 1999. It covers 302 managers with almost $1 trillion under management. A record 59% of them are over-weighted in equities. Ding Ding!

Some further points from the survey (http://www.ml.com/?id=7695_7696_8149_46028_46688_47167) : These professionals (often a good contrary indicator because they are the market) are relatively bearish on the US stock markets (and the dollar), which prolly (as my kids say) means they'll outperform the preferred locales, viz. Japan and the so-called "emerging markets". Energy and industrials are the most popular sectors among these cognoscenti.

They're bearish on bonds, though, apparently, with 57% underweighted in fixed-income. I'm pretty bearish myself on this sector, and have been, wrongly, for the last year at least, so maybe I'm going to be wrong again.

I read an interesting paper a couple of days ago about the whole US currency problem. The author is one Nouriel Roubini, of NYU's business school (my alma mater, as it happens). See: www.stern.nyu.edu/globalmacro/ BW2-Unraveling-Roubini-Setser.pdf . This would certainly tend to make you pretty bearish on the US bond market. An interesting sidelight, though, on the Chinese currency peg: one way for the tectonic pressures to be relieved, theoretically, would be for US prices to rise more slowly than Chinese prices. What are the consequences of that for the nominal interest rate differential?

Nerd vs Nerd (vs Us)

2005-03-18T17:07:00.000-08:00

The Philadelphia Stock Exchange announced yesterday it will start making a book on "events". Yes, we ordinary citizens will be able to buy/sell the over/under on a number of so-far unspecified events. OK, it's not quite as racy as it sounds -- there are no plans (so far, anyway) to give spreads on football or basketball games. More likely will be bets on economic numbers like non-farm payrolls, crop numbers or individual company earnings reports, or even on events like outbreaks of mad cow disease. Coincidentally, an outfit called HedgeStreet Inc from San Mateo, California, will be offering a similar wagering venue in Q3. This is already done in some places -- notably in the UK where companies like Ladbrokes will make a book on just about anything. The difference is, Ladbrokes is explicitly in the gambling business, with High Street betting shops where people can go and bet on horse races and stuff.

Are we getting too far away from Useful Economic Purpose? Believe it or not, the original futures exchanges did serve a useful economic purpose. A farmer, for instance, who wanted to be sure how much he would make on his wheat, could fix the price today for delivery in three months, hence know that he had enough money to shell out on the new harvester. On the other side of the trade, the flour company would know exactly how much it was going to have to pay for the wheat. In other words, it was all about risk: both sides could reduce their risk.

Maybe not. You can see how the Philadelphia Betting Shop might serve the same function. A hedge fund that was short treasuries, for example, (expecting interest rates to go up, perhaps because it thinks the economy will overheat) might be hurt if the non-farm payroll number came out too low (implying weak economic activity, hence lower interest rates and higher treasury prices). At the right price, it might be worth it to hedge a little just in case they were wrong. Who would take the other side of the trade? I suppose maybe a company that was preparing to issue bonds next month might want to protect itself against rates going up. All sounds pretty reasonable.

But do we really need it? We pretty much already have as many derivatives as we need to do the job of spreading risk in an economically rational way. (See our post from a couple of days ago: $1.9 trillion a day in FX contracts!). Let's not forget that even when the risk-spreading is economically efficient, it's still a zero sum game. You can't help thinking that this is just another way for one set of nerds to pit their computers against another set of nerds. Each side takes its "management fee". Guess who's the loser?

How Many Americans Collect Dividends?

2005-03-17T18:40:00.000-08:00

There's been a flurry of stories lately about how government departments have been turning news releases into propaganda for the incumbent administration. It seems to me that they've always done that, though probably not to the extent we've seen in the last couple of years. Particularly since Goebbels, I suppose, governments have been particularly conscious of the value of propaganda.

Today the US Treasury issued a release (http://www.treas.gov/press/releases/js2326.htm) detailing the numbers of taxpayers benefitting from the two rounds of tax cuts we've seen since the UCS took over the White House. According to this release, over 105mm Americans benefitted in one way or another from the tax cuts. The release didn't break out dollar amounts (ie the extent of the benefit for each group), so there's no direct insight into which income groups benefitted by how much. We can probably assume from this omission that the data aren't particularly favorable to those who voted these cuts in.

Almost 94mm benefitted from the new 10% tax bracket. A little over 25mm benefitted from a reduction in the top tax rates. The number of filers benefitting from the elimination of taxes on dividends and reduction in taxes for capital gains amounted to 22m (or about 10% of the adult population).

These tax cuts, of course, are the major reason for our current humongous budget deficit. The treasury press release ended with an exhortation to make the cuts permanent. Coupled with the explosion of pork barrel spending that's been allowed to pass unvetoed, it's hard to avoid the conclusion that they actually want the government to go bankrupt -- this being the best way, presumably, to force a dismantling of the New Deal state. Remember "Rosy Scenario" and "Deficits as far as the eye can see" ? It feels like Reaganomics all over again.

Metabusiness Is King: But For How Long?

2005-03-16T14:53:00.000-08:00

Two very different press releases in the past couple of days. Yesterday, the financial services firm of Lehman Brothers posted very strong results for its first quarter (ending February), way ahead of expectations. It gave the market a bit of a boost early in the day. Today, General Motors, icon of the American manufacturing economy, announced that it would fall below expectations in the first quarter, posting a loss instead of early forecasts of breakeven and reversing its operating cash flow forecast from plus $2 billion to minus $2 billion. GM has been in the news a bit lately because of the possibility that some of its debt will fall below investment grade and into the so-called Junk category -- a development that might well be accelerated by this little piece of news. That, among other things, put Mr Market into a bit of a funk today.

It really puts the US economy into perspective. Lehman made $875mm in the quarter to February on revenues of $3.8 bn, an annualized return on equity of 24.5%. Bond trading generated $2bn in revenues. Investment banking had a record quarter (Lehman advised on four of the top 10 M&A transactions in the quarter; Asia and Europe broke records on the back of strong mortgage and other asset backed securities transactions). Three other publicly traded brokers, or as you might call them, "metabusinesses", Goldman, Morgan and Bear Stearns are all due to report later in the week.

Will someone please explain? I admit I've always had some trouble understanding how Wall St can continue to flourish while Main St seems to spend most of its time under floodwater. I mean, granted there are some relative bright spots in the "real" economy -- we're pretty strong in, for instance, "aerospace" (a bit of a euphemism?), semiconductors, software, and movies to name just three real industries. But Wall Street essentially depends on all these other "real" areas doing well. I mean, they don't actually make anything, do they? They just shift money about. At bottom, they depend for their profits on the profitability of "real" companies. You would think that this situation would be untenable in the long-term. Yet it's been this way for as long as I can remember.

$1.9 Trillion A Day

2005-03-14T14:57:00.000-08:00

That's how much is traded, apparently, in foreign exchange markets. Of that, the spot market (ie foreign currencies) account for about $620 billion while the other $1.3 trillion is, presumably, in "derivatives" -- meaning options, futures contracts and whatever other "derived" products there are out there.

Compare that number with the volume of world trade. According to the OECD (www.oecd.org), total world trade amounts to about $2.3 trillion per quarter (close to $10 trillion per year). Or, let's say, $25 billion per day. To put it another way, of the $1.9 trillion in foreign exchange trading that goes on every day, only around 1.3% is necessitated by trade between countries in goods and services.

What the hell is the other 98.7%????

Well, here's a clue: the FT (yes, my main source of news) reports that hedge funds are moving in as market makers. Hedge funds have traded FX for years, of course. (One of the most notorious trades in hedge fund history was in FX, when George Soros made $1.1 billion betting on a fall in sterling back in the early 1990s). But the actual market making has been left mostly to large international banks, which make money on a "spread" (ie they buy at a lower price than they sell, just like a stockbroker) rather than by taking large positions. In recent years, a lot more trading has gone on line, to places like FXAll (you can see them at fxall.com), which sees about $35bn a day in trading (a tiny percentage of the total market, but it's growing pretty fast). I guess the hedge funds have become so comfortable in this market that they're going to have a go at market making (through EBS, a centralized currency trading platform catering directly to banks). So why are they in the market, again? Oh, yeah, not because they need to buy Polish vodka or anything, but because they have a feeling zlotys are headed up.

Maybe I'm missing something here, but... doesn't the other 98.7% sound pretty much like, well, a casino?

US Consumes 22% of World's Food?

2005-03-13T17:31:00.000-08:00

In retail value, at least, yes, apparently.

According to a recently released report from IGD, the global retail market for food in 2003 was $3.5 trillion (out of a total global retail market of $8.8 trillion). The US accounted for roughly 22% of this, which would be around $770 bn. (which comes out to about $2,600 per person per year).

So, let's see. Our (US) population is roughly 296mm (see http://www.census.gov/population/www/ ), out of a world population of about 6.4 bn. That's 4.6%. And we're responsible for 22% of the world's retail food purchases. Either we're eating too much, or we get charged too much for food.

BTW, the same report predicts that this world food retail market will grow at 4.8% a year until 2020. You may be relieved to hear that most of the extra calories (OK, dollars, anyway) will be consumed by non-Americans (Indians, Russians and Chinese), so that the US share will decline to "only" 19%.

The 1970s were hellish. Are they coming back?

2005-03-11T14:47:00.000-08:00

Markets worrying about inflation again. I suppose there must still be enough of us old timers around for this to scare the living shit out of anyone with an investment portfolio. Back in the late 70s and early 80s it really seemed as if we would never again be able to wring inflation out of the system. It took the enormous resolve of Paul Volcker, plus a deep and abiding recession, to get rid of it. A prime rate that reached, I think, 21%, and the long treasury at 15% in early 1982. You could get a 17% - 18% return just by staying in (the newly invented) money market funds. Milton Friedman was king of economists, and it really looked like controlling money supply was the answer. Thursday after the close the newest money numbers were released, and Friday's market pretty much came or went according to whether people thought they were regaining control.

There were also a lot of commodity shocks -- particularly oil (in 1973 and again with the fall of the Shah in 1979), but also all kinds of other commodities, like sugar, coffee, gold, silver and base metals. There would be periodic consumer scares: suddenly, everyone would be lining up to buy toilet paper because it was rumored to be running out, like gasoline. Once everybody began to expect inflation as a matter of course (and it seemed pretty likely, given that we'd gone for several years without being able to get rid of it), it got sort of built into the system. You expected your pay to go up just so you could stay even with rising prices. They began to put cost of living adjustments into everything, including social security. You'd stay the hell out of bonds, because you were getting paid back with fixed dollars that bought less every month. But even stocks just diddled around, never really going anywhere: most companies had trouble maintaining profit margins, because price increases wouldn't necessarily stick in a stagnating economy even though costs were rising because of wages and raw material prices. It was so bad that you were afraid to invest in companies that didn't use the more conservative LIFO (last in first out) method of accounting for inventories and COGS. Oil and other natural resource stocks did OK, but everything else got left behind. So even though many portfolio managers are too young to remember this horrible time, it's a relief to see they're not totally blind to the threat.

Apparently we're not as vulnerable to raw material costs as we used to be. Apparently, we use about half as much energy per unit of GDP as we used to in 1973 -- a response, obviously, to the 1970s price shocks, but one that took a very long time to come about. (Still, we do import around 10 - 11 million barrels a day of oil, which comes to around $16bn a month with oil at $55. Put that in the context of a trade deficit of $55 - $60bn a month and you can see it's a decent percentage of our total tab. The IEA has just adjusted upward again its estimate of world oil consumption for 1985, to 84.3mm barrels a day.) I suppose we do a lot less manufacturing than we used to; services aren't as badly affected. Still, the Fed noted in their latest beige book out this last week that companies aren't having any difficulty passing along cost increases; so inflation at the wholesale level will, most likely, start finding its way into our pocketbooks.

Speaking of services, a footnote to yesterday's post on hedge funds. CSFB just came out with a study. They say hedge funds now control around $1 trillion of assets. Last year they contributed about $25bn in revenues to broker-dealers worldwide, which would be, therefore, about 0.25% of their asset base. Total revenues to these banks were in the range of $200bn. That's $200bn charged, essentially, for investors to swap assets with one another; $200bn deducted from total returns to savers whose money is being moved around. Some day soon I'll write more about the great savings skim and the economic puzzle of bond salesmen's pay.

A toxic name for Clinton's hedge fund

2005-03-10T18:41:00.000-08:00

News today that Bill Clinton will be speaker at the opening for a new hedge fund in New York. It's an Austrian company to be known as Superfund Asset Management, and it aims to put hedge fund investing within the reach of your average investor (minimum holding only $5,000). Apparently the track record is pretty good: two funds started in November 2002 have returned 52% and 82%, and that's after deduction of fees. Superfund, you may remember, was the name given to a large pile of money set aside for cleanup of toxic waste dumps in the 1980s. We're hoping these hedge funds don't become too toxic for their investors.

Hedge funds, unlike mutual funds, are pretty thinly regulated. That can be good for the participants as long as the management is honest and knows what the hell it's doing. But it also gives them more room for recklessness (they may be called hedge funds, but that no longer means they've hedged their bets) and for fraud. The SEC, which is hampered by a lack of authority over hedge funds, has brought 51 cases in the past 5 years, according to the FT, with investor losses of around $1.1bn. Just last week, a new fraud came to light: some fund in Florida by the name of KL Financial apparently lost $70mm (and maybe as much as $300mm). While they were losing money hand over fist, apparently, they were boasting to their investors of annual returns in the area of 150%.

Hedge funds can put their money pretty much wherever they want, so, unlike mutual funds, they're not bound by particular markets. So their pitch is that they can make money no matter what the stock and bond markets are doing. If stocks look overpriced, they'll do commodities, or currencies, or distressed bank debt, or convertible arbitrage or whatever. I don't know what the numbers are, but they've grown tremendously in the last few years.

I'm certainly not the first one to point out that once everybody's doing it the returns are bound to go down. Worse, the management fees are much higher than you'd generally pay in a mutual fund, so you (as an investor) are starting off at an immediate disadvantage. There are even, now, "Funds of funds", which are hedge funds that invest in other hedge funds -- so the whammy is multiplied. (The last time Funds of Funds were popular, by the way, was in the go-go years of the 1960s, and the most famous Fund of Funds was IOS, the one run by Robert Vesco and Bernie Cornfeld. Bernie went to jail in Switzerland and died a few years ago. Vesco went on the lam, taking a couple hundred million dollars with him (but not before giving $200K to Richard Nixon's reelection campaign). He's in jail in Cuba now, for another fraud he perpetrated there, and due out in 2009 when he'll be almost 80. (You'd think you'd be able to stop once you had the $200 mill, wouldn't you? Check out a short bio at http://slate.msn.com/id/1007117/ ).

The SEC has a paper on hedge funds. If you're thinking about putting money in, you might want to take a quick look: http://www.sec.gov/news/studies/hedgefunds0903.pdf. The old warhorse in charge of the SEC, Bill Donaldson (yes, founder of Donaldson, Lufkin & Jenrette), is trying to get authority to regulate them more, but it's an uphill battle. A goodly portion of brokerage house fees these days apparently come from hedge funds.

Here's a quote of the day, from Anais Faraj of Nomura Securities: "We appear to be repeating the benign 'golden age' cycle that spanned 1955-74". It echoes vaguely that famous quote of Nobel prizewinning economist Irrving Fischer in 1929: "Stock prices have reached what looks like a permanent high plateau..."

Mr Market feeling glum today

2005-03-09T14:32:00.000-08:00

Keynes talked about "animal spirits" and Ben Graham apparently liked to talk about a manic-depressive called Mr Market. Some days Mr Market focuses on good news, some days on bad. Today, for instance, he focused on the bad. Today he was worried about an increase in inflation and its corollary, interest rates. He's also concerned that corporate profit growth is slowing down. So he bid the 10-yr Treasury rate up to 4.5%, the highest level it's been for a while, and took the Dow down 100 points or so.

Worry about inflation isn't new. The money supply has been growing at a solid clip (check out the Federal Reserve Board website for the numbers). Interest rates, both short and long, have been on the floor for a long time. Then there's that ever-growing budget deficit. By the old wisdom, these are all likely ultimately to cause inflation. The mystery, really, is why it hasn't reared its ugly head sooner. You can see it in commodity prices all right: oil into the mid 50s, copper at a 16-year high, aluminum at a 10-year high, steel through the roof for quite a while now, just for a couple of examples; but it hasn't really been evident in retail prices. (Not officially, anyway, though you've got to wonder whether they aren't cooking the numbers.)

As for corporate profits, you would certainly expect growth to start slowing there. They're at a pretty high level relative to GDP historically, you wouldn't expect them to continue growing forever. (You can check this out at the Bureau of Economic Analysis website, http://www.bea.gov/). This goes along with the rapid growth of productivity we've seen since the latest recovery: GDP may be up, but job growth lagged way behind, with increased productivity making up the difference.

It all makes a certain amount of sense. A lot of the tax cuts since the UCS took office have gone to the rich. When you give a tax cut to some poor wage slave, he pretty much spends it all, but if you give it to someone who's already consuming everything he wants then it goes into investments. Not surprisingly, you see asset price inflation first -- increased house prices and stock and bond markets. Commodity prices? Well, they've been saying for a while that hedge funds have been wagging the dog at least in the oil markets, why not in other natural resources too? Hedge funds is where, increasingly, these rich guys put their money. On top of that, of course, is the rapid growth of manufacturing in China, whose economic ebullience (so far, anyway) has been widely credited with strength in raw materials markets (China is now the second largest importer of oil, for example, after the US). The asset inflation goes along with a recovery that doesn't make a lot of new jobs: if the tax cuts go to people who don't spend it, you don't get a lot of "demand pull". Ultimately, unfortunately, if the economy doesn't catch up with the markets, asset prices will suffer, at least in real (inflation-adjusted) terms.

2005-03-08T17:32:00.000-08:00

That 50-year French bond is being quickly followed by a 50-year Italian job. This time, though, it's a corporate, from Telecom Italia, a 500mm Euro issue rated at the low end of investment grade (BBB average of the three agencies). According to the FT, demand for these really long-dated issues is due to "ageing populations, asset-liability mismatches at pension funds and insurance companies, and regulatory changes in several EU countries". Sounds a bit thin to me. (50-year liabilities? Are there suddenly many more 20-year olds buying life insurance policies?).

Venezuela came with a 1bn-Euro deal maturing in 10-years priced at 350 over the US treasury (ie 7.1%). It's rated an average of B by the three rating agencies. The spread is roughly comparable to that of single-B US junk bonds. Venezuela. Isn't that where that guy Chavez is in charge?

In Europe they issued a CDO called Leopard III. Yes. The spread on the AAA piece was 25 over Euribor (I suppose that's roughly like LIBOR) -- the tightest ever for a CDO and, for the first time, below the spread on a US CDO. I like name. Hope it doesn't come back to bite them.

What is a CDO, anyway? Well, it's just another form of the securitized loan I talked about a couple of days ago, where they essentially borrow at a low rate to buy loans that pay a higher rate. They're getting pretty damned complicated these days. They now have what are called CDO-squared (CDOs whose assets are CDOs) and even CDO-cubed. What does it all mean? As our friend Warren B noted, probably nobody really knows. But the essential point, as far as I can see, is leverage: using small amounts of equity to control large amounts of assets. Works great when the asset goes up, not so great on the way down. It's the same thing that caused the great market crash of 1929 and the 10-year depression that followed.

The new McKinsey quarterly is out. There's an interesting piece purporting to debunk the idea that the weak job growth of the last few years (actually they're talking about 2000-3) was due to foreign competition. Rather, they say, it's because of high productivity growth (you need less labor to get the same output), weak domestic demand and the strength of the dollar. Sounds about right to me, though I think you do have to be skeptical of these ivory-tower studies, which rely heavily on assumptions and reasoning that is not necessarily made clear in the published report. ("We estimate that... " "Our research shows that..." and so on). They conclude that protectionism isn't the answer. Rather, focus on stimulating domestic demand and encouraging exchange rates (especially the dollar-pegged Chinese rate, I'm guessing) to reach their natural level.

Warren Buffett's annual letter

2005-03-07T15:00:00.000-08:00

Can a nice guy get rich? It's hard to read Warren Buffett's annual letter to shareholders without thinking that, yeah, against all reason, it really is possible for a nice guy to get rich. (You can download the letter at berkshirehathaway.com. There's always a few good one-liners in there and it's generally very educational besides. And I don't mean educational like your math teacher's lectures on calculus: he actually has a talent for making economics and accounting comprehensible, even to people like us.) Of course, he may just have really good PR, and there are, no doubt, one or two skeletons lurking somewhere in his apparently pristine closet, but this is a man you can't help liking. (Of course, his friend Bill Gates is an entirely different kettle of fish; and they do say you can tell a man by the company he keeps...)

This year, Father Warren's lecture is on the trade deficit. No doubt you've seen the headlines about America becoming a "sharecropper society" as we struggle to pay the interest on all the money we've borrowed from foreigners to finance our spending. He's forecasting a decline in the dollar as a result. No big surprise there. Every day, we spend $1.8 billion more on foreign goods than they buy from us. That's basically how much our debt to them goes up every day. Mounts up after a while.

A couple of years ago, he sounded the alarm on "derivatives" as a financial weapon of mass destruction that was liable to blow up at some point. We still haven't seen that prediction come true, but then he does tend to be early on these things -- remember how everyone thought he'd lost his touch when he refused to join in on the dotcom frenzy? The derivatives market has done nothing but grow ever since. (See, eg, the post on securitizations. There's also been pretty impressive growth in so-called Credit Default Swaps, of which more, perhaps, anon). Meanwhile, the General Re subsidiary is still, after three years, busy unwinding its derivative positions in what is supposed to be a highly liquid market. If this is liquid, Buffett implies, what kind of a meltdown can we expect when everyone wants to unwind at once? Scary thought. An interesting question to ponder: how would you play this one if you thought it was coming tomorrow?

BTW, M. Buffett puts in a plug for The Financial Times as good reading material for those who are interested in these things. Me too. And it's not just financial news. There are a couple of very entertaining columnists, among them Lucy Kellaway and Peter Apsden. The weekend section is great. The crossword, for those who like the English-style cryptic, is a relatively easy one and fun to do (we especially enjoy compiler Cinephile, an 80+ year old retired vicar). Best of all, perhaps, is the Martin Lukes column on Thursdays (it's kind of a Dilbert thing, only told in e-mails rather than pictures, and makes you squirm almost as much as watching that other Brit feature, The Office TV series).

ESPN has launched a free online poker game, and got more than 30,000 people to sign up in the first couple of days. Course, it's not a real-money game. For that you have to go to partypoker.com. Which, incidentally, is rumored to be getting ready for an IPO, most likely in Europe. (Best thing about this one are its founders' names: Ruth Parasol and Anurag Dikshit. I kid you not). What is it with the sudden reawakening of poker? I thought it had gone out of style in the 50s. (By the way, as I recall, Warren Buffett boasts of having put himself through school partly on poker proceeds. "In every poker game", he says, "there's a patsy. And if you can't figure out who the patsy is, then you're the patsy").

Yield crazy

2005-03-05T14:03:00.000-08:00

The bond market is still red hot, pretty much in all sectors and practically around the world. The French government just sold a 50-year bond to yield 4.21%. The deal was so hot it had to be upsized to 6bn Euros ($7.9bn). For those of us who remember the 15% treasury (with inflation running well into double digits), it seems a bit weird. Why would anyone go for a deal like that?

Meanwhile another record was broken in the securitized market, where homebuilder Centex sold a $1bn deal at 7bps over 1-month LIBOR for the top tier (1-yr paper). The 3-yr tranche was at 17bps. In other words, the market is looking at them as being just about as safe as treasuries. Asset-backed securitization deals in 2004 amounted to a record level of almost $900bn (vs $585bn in 2003), and so far this year is ahead of last. The assets in "asset-backed" are mostly houses, cars and other unspecified loans. (Some of them were a little more unusual -- like, for example, the David Bowie, James Brown and Isley Brothers music-royalty deals -- shades of Hollywood Stock Exchange here).

What are securitized loans? OK, say you want to buy $100mm of mortgages yielding $6mm a year in interest. You issue $90mm of 1-year "asset backed" paper yielding LIBOR + 20 or 3.1% right now. The rate is nice and low because the paper is "overcollateralized" ($100mm of assets covering $90mm of paper) and there's a lot of buyers. Then you put in $10mm of your own cash to fund the rest. So you pay out roughly $2.8mm in interest to the asset-backed guys and get to keep the $3.2mm balance. So you're earning 32% on your $10mm of equity. Pretty nice, ey?

But what happens, I hear you asking, when you have to refinance the 1-year paper, short-term rates have shot up and house prices have collapsed? Yeah, well, that's leverage for you, gotta take the rough with the smooth.

It's the same story all over the fixed income market. Spreads are way down in emerging market (3rd world) debt and in junk corporates (which had a record year for issuance, at $140bn, last year and is still pretty hot, even though, according to the rating agencies, the proportion of "triple-hook" (CCC) debt has been steadily rising). Everyone's looking for yield.

What's driving all this? Our friend the Span, of course, and his liquidity-crazed cronies at other central banks around the world. They've been pumping money into the system with what you might call "irrational exuberance". If you can get money so cheap, why wouldn't you go out looking to play the spread (between what the money costs you and what you can lend it out at)? No wonder there's a new hedge fund every two minutes.

March 4th, 2005

2005-03-04T13:03:00.000-08:00

Greenspan voices support for consumption tax (in testimony to a Bush tax panel yesterday). The Span has really turned into a sandwich-board for the Used Car Salesmen in the White House. I don't know why. He never seemed so far-right ideologically. I guess he just doesn't have the balls of his plutonium-orbed predecessor, Paul Volcker.

The consumption tax is another step in the UCS dismantling of our democracy. It's non-progressive, of course -- ie hits lower-income people hardest and, like the two tax-cuts-for-the-rich, doesn't foster demand, hence is pretty non-stimulative. I guess they must want to live in the third world.

Speaking of which...

HSBC will be hiring analysts in Bangalore. They changing the way they do research, to long-term, big-picture. (Actually, there's a carve out for "trading ideas", which sounds pretty much like research-as-usual to my mind). They're doubling their analyst staff in Hong Kong, New York and wherever the hell else they have offices, and also intending, apparently, to hire about 100 "junior analysts" in Bangalore. First it was call centers, then accountants and draughtsmen. Get the trend here? As education improves in countries like India, so outsourcing will more higher up the scale. Production = Capital + Labor. Capital is global, and in time so will be labor, I suppose.

Productivity numbers for Q4 2004 were revised upward, to a growth rate of 2.1%. If it gets high enough we'll evnetually be able to do without Labor altogether. At least a few of us, anyway.