Thursday, September 30, 2010

AIG Pays The Government Back With Its Own Money AGAIN

Say this about AIG - the smoke and mirrors they are employing will fool the vast majority of the American people.  I sent out an article on twitter last night about the mechanics of Petrobras's recent massive share offering.  AIG's announcement today is like deja vu all over again.  It was only December of 2009 when I wrote about how AIG was doing the old Teddy KGB: "I'm paying you with your money."   

This gets complicated quickly, so let's review Fed/Treasury stakes in AIG:

1) AIG owes the Fed $20B in senior secured debt under the FRBNY credit facility
2) The Fed owns $26B in preferred shares of AIG/ALICO, held in a special purpose vehicle (aka, the Teddy KGB Transaction)
3) Treasury owns $49B in AIG preferred shares from TARP, and warrants for 80% of the common stock

Today's announcement about AIG squaring away all its debts made me scratch my head:

First, they addressed the $20B in FRBNY debt:
"AIG owes the FRBNY approximately $20 billion in senior secured debt under the FRBNY credit facility. Under the plan, AIG expects to repay this entire amount and terminate the FRBNY senior secured credit facility with resources from the parent as well as with proceeds from a variety of asset dispositions underway, including the initial public offering of its Asian life insurance business, American International Assurance Company Ltd. (AIA), and the pending sale of its foreign life insurance company American Life Insurance Company (ALICO) to MetLife, Inc."

Ok - so they're going to repay that using asset sales (ALICO is in progress, and AIA has been "announced" - they hope all of AIA is worth roughly $25B) and cash on hand.  Let's proceed:

Facilitating the Orderly Exit of the U.S. Government’s Interests in Two Special Purpose Vehicles (SPVs) That Hold AIA and ALICO: Today, the FRBNY holds preferred interests in two AIG-related SPVs totaling approximately $26 billion. Under the plan, AIG will draw down up to $22 billion of undrawn Series F funds available to the company under the Troubled Asset Relief Program (TARP) to purchase an equal amount of the FRBNY’s preferred interests in the SPVs. AIG will then immediately transfer these preferred interests to the U.S. Treasury as part of its consideration for the Series F preferred shares.

The $26B in preferred AIA/ALICO is the Teddy KGB piece I wrote last December.  AIG is going to - get this - borrow {MORE} money from the Treasury to buy the preferreds back from the Fed, and transfer the interests to the Treasury!  Voila!  Smoke and mirrors!  the Fed is paid back, and now AIG owes... wait for it.. The Treasury instead!  SOLVED ! (???)

The AIG press release continues:

"AIG also will apply proceeds from future asset monetizations, including the announced sales of the AIG Star Life Insurance Co. and AIG Edison Life Insurance, to retire the remainder of the FRBNY’s SPV preferred interests. When these transactions are completed, AIG expects that it will have repaid the FRBNY in full. To retire the U.S. Treasury’s preferred interests in the SPVs, AIG will apply the proceeds of future asset monetizations, including its remaining equity stake in AIA and the equity securities of MetLife that AIG will own after the sale of ALICO to MetLife closes."

Ahhh.  Treasury will be repaid by FUTURE asset monetizations.    And what's this about the Metlife Shares?  Let's check the footnotes:

"On March 8, 2010, AIG announced a definitive agreement for the sale of ALICO, one of the world’s largest and most diversified international life insurance companies, to MetLife, Inc. for approximately $15.5 billion, including $6.8 billion in cash and the remainder in equity securities of MetLife, subject to closing adjustments. This transaction is expected to close in the fourth quarter of 2010."

Notice anything important?  That's right:  the majority of the deal is in MetLife stock - with only $6.8B in cash.  So, the Treasury will own MET stock also!  We're putting together quite the diversified insurance equity portfolio! (/sarcasm)

Then, of course, there's the matter of Treasury's $49B in preferreds, which will be converted to AIG common stock and sold over time.

In short, I'd say that today's headlines "AIG, US Government Agree on Exit Plan," might be just a slight distortion/exaggeration of the facts.  Yes - they have a plan - the plan is to sell assets and pay everyone back.  Of course, that was always the plan.  Today's "plan" still leaves us a long ways away from the day that the government will recoup all of it's AIG investments. 

All AIG has to do now is complete the sale of ALICO to Metlife, sell off the $9-odd billion of MetLife stock they receive, complete the sale of AIG Star Life and AIG Edison Life to Prudential,  manage to sell AIA for $25 Billion, and sell off over $50B of AIG common stock!  We'll be watching the progress...


Wednesday, September 29, 2010

The Difference Between BID and ASK: Liberty Mutual

Liberty Mutual's announcements this month about the IPO of their Liberty Mutual Agency Corporation business, and then the subsequent postponing of that IPO illustrate a simple key concept that many people miss - the difference between BID and ASK.   

When you look up tickets for Justin Bieber on StubHub, for example, you see ASK prices - just because someone posts that they will sell tickets for $1500 each does not mean that someone will pay $1500 each.  $1500 is the ASKING price, and can be, in some ways, arbitrary.  The other essential part of the trade, of course, is what someone is willing to pay - the BID - and if there is a seller who is willing to meet the willing buyer at that price.

What does this have to do with Libery Mutual?  First, their announcement from two weeks ago:

"Liberty Mutual Agency Corporation, a unit of Liberty Mutual Holding, will seek to raise as much as $1.41 billion in what would be the biggest initial public offering in the United States so far in 2010, Bloomberg News reported.

The company, the second-largest writer of property and casualty insurance distributed through independent agencies in the United States,  plans to sell 64.3 million Class A shares at $18 to $20 each, according to a filing with the Securities and Exchange Commission. The proceeds would be used to reduce debt. Underwriters have the option to buy an additional 6.43 million shares if demand warrants, the filing showed."

See - that's an ASKING price.   That's how much Liberty Mutual wanted to get for their business.  But how much were the bids?  We don't know - we do know one thing - they were less than the asking price!  How do we know this?  From Liberty's announcement today that they were postponing the IPO:

"SAN FRANCISCO (MarketWatch) -- Liberty Mutual Group said Wednesday that it postponed a planned initial public offering of stock in Liberty Mutual Agency Corporation. The company said the "stalled" economic recovery, "volatile" stock market and undervalued property and casualty insurance stock prices create an "unfavorable" environment for receiving appropriate value for the business. "The delay will not impact our business or our day-to-day operations," Edmund Kelly, Liberty Mutual Group chief executive, said in a statement. "While we still believe this transaction is a useful step in giving the group additional capital flexibility, we have more than adequate capital to conduct our business successfully.""

You have to love the euphemisms Liberty used: "stalled economic recovery"  (in the last two weeks?  really? everything has changed?)  "volatile stock market" (it's up 2% from when they announced the IPO - with very little volatility) and "undervalued property casualty insurance stock prices."  

What Liberty is trying to tell you is that they were unable to sell the business for their asking price.  The rest is just smoke and mirrors.


disclosure: Liberty Mutual insures my house and car

Tuesday, September 28, 2010

Icahn as Gekko - Just in Time for Wall Street 2

Bud Fox: "Why do you have to wreck this company?"
Gordon Gekko: "Because it's WRECKABLE" - Wall Street

Now, I'm not saying that Carl Icahn wrecked the Fontainebleau - the Fontainebleau's ample ambition wrecked itself.  But I couldn't help but think of Gordon Gekko's "Wreckable" comment when I read the NY Post story (h/t VegasRex) about Gekko selling off the furniture out of the Fontainebleau.

"After picking up the bankrupt Fontainebleau Las Vegas on the cheap, billionaire investor Carl Icahn is now holding a fire sale at the massive unfinished casino resort. 
While the project, which is 70 percent complete, sits idle on the Las Vegas Strip, Icahn has started selling off beds, dressers, TVs and other furnishings, according to a source. 
The sell-off, first reported on, comes after the billionaire investor conceded last month that he has no imminent plans to restart construction.

Icahn raised eyebrows in January, when he bought the 3,800-room resort for $151 million, allegedly without doing any due diligence. The cost to finish the project could hit $1.6 billion -- not including furniture"

I'm no sort of Icahn fan-boy at all - I thought he screwed up royally when he bought the Fontainebleau - but is it possible that this was his plan all along?  People said "Carl - you're crazy - Vegas is dead, and this project still needs billions,"  but maybe all he was after was bulk discount furnishings?  Seems unlikely.  Also, I'm a little surprised that the project has much in the way of furnishings, considering that it's $1.6 Billion away from completion ???   I would have thought that furnishings would be done much closer to the completion. I'd love to know if Icahn turns a profit on his distressed purchase/liquidation.

The NY Post article does provide us with some fantastic No-Shit-Sherlock quotes:

"The move by Icahn, who is known for picking up distressed assets and flipping them, suggested he was betting on a recovery in hard-hit Las Vegas and would eventually turn around and sell the casino for a higher price.
Stripping the rooms one by one is yet another sign that he plans to unload the project rather than resume construction, according to one source."

Ya think?  You don't think he was just unhappy with the firmness of the mattresses? That's something Steve "The Nuts" Wynn would actually probably do - replace all of the mattresses before they'd even been used once because he didn't like the firmness - but not Icahn.

We get another version of the same quote:

"Jefferies analyst David Katz said if the Fontainebleau is selling furniture, "It suggests Icahn's view is a rapid recovery in Las Vegas is not at hand."

Either that or he's like Harvey Keitel's Winston Wolf from Pulp Fiction - an "oak" man (I hope someone gets that reference).  

Which brings me to Vegas and general American Economy bull, John Paulson, who took a large stake in MGM common stock earlier this year.   Dealbreaker recounts John Paulson's quote at a recent dinner:

"As this is the best time in 50 years to buy homes,Paulson advised a group at New York’s University Club, crowded into 3 separate dining rooms, to issue 30 year mortgages to buy a home as “your debt and interest payments get locked in at record lows, while the price of your home will rise.”

“If you don’t own a home buy one,” Paulson recommended. “If you own one home, buy another one, and if you own two homes buy a third and lend your relatives the money to buy a home.”"

Oy vey.  Really, Paulson?  Buy another?  Buy a third?  Lend to your relatives?   Yeah - I don't see how that could possibly go wrong.   Maybe Paulson should have bought the Fontainebleau - furniture and all, from Icahn...



Two quotable passages today:

"“I have heard many times that atheists know more about religion than religious people,” Mr. Silverman said. “Atheism is an effect of that knowledge, not a lack of knowledge. I gave a Bible to my daughter. That’s how you make atheists.”"

2) Josh Brown, The Reformed Broker: WMT's African Adventure Begins: Pay Attention

"What the critics and pundits failed to understand about the India initiative was that Wal-Mart is one of the most gangsta companies in the history of the world.  They are as ruthless as their customers are fat."


Monday, September 27, 2010

A Plethora of Posts - ETFs and Others

Are you looking for the two posts I wrote about ETFs last week?

I've cranked out a ton of stuff over the past week, and I just wanted to summarize some of it here:

-We had new financial products from Ally (Raise Your Rate CD) and Citi (Inflation Hedge Portfolio)

-My "Dear Penthouse or NY Times" post was under-appreciated

-Another guaranteed box full of crap, this time courtesy of the Credit Unions

-And the conclusion of the story of the impossibly small SEC-Citi fine

There are even a few more posts that you can scroll down and read, or find on the sidebar in the recent posts calendar.


New Financial Products Part II - Citi's Inflation Hedge Portfolio

I got an email from my Morgan Stanley Smith Barney broker today about a new product they were offering.  It was a 2 page .pdf, with the opening paragraph:

"When it comes to investing — whether for income or for growth — you can’t afford to ignore the eroding effect inflation can have on the value of your assets. Inflation is essentially a measure of the increase in the price of goods and services. According to the U.S. Bureau of Labor Statistics, inflation has reduced Americans’ purchasing power in every year but two dating back to 1945."

They proceed to describe some asset classes used to protect against inflation: gold and precious metals, TIPS, and short bond positions.  Then, they offer details on the portfolio - the product will basically trade like a mutual fund, I think (ticker: FHDGFX) , and have some juicy fees - ranging from 3.95% for lots under $50k, to 2.45% for investments larger than $1mm.

So what's in it?  

49% ETFS:  GLD, SLV, IAU, TIP, TBT, PST (individual weights not given)
51% Materials Stocks:  AAUK, BHP, RTP, FCX, IMPUY, AUY

For what it's worth....


Sunday, September 26, 2010

New Financial Products - Part I: Ally's Raise Your Rate CD

Have you seen the ads for Ally Bank's "Raise Your Rate" CD?  Basically, it's a 2 year CD with a yield (1.74%) that's already above well above that offered by the competition (Citi, for example, offers .65%:  65 bps, on a 2 year CD - you have to go to 5 years to get a 1.75% yield from Citi!).  

What's the catch?  The catch is supposedly in your favor too!  The "Raise Your Rate" clause means that, should rates rise, you can, at any time, once and only once, reset your rate to the then-current rate.  In other words, should something crazy happen and CD rates spike to 5%, you can say "SHIP IT - I want 5%" and get your rate re-struck to the higher yield.

Now, I ask you, the readers, how do they do this?  How do they offer a premium yield as well as a free option for the CD buyer?  I asked Ally if there was a prospectus or term sheet available, and was told that you get the details in the mail after you sign up.

Anyone have ideas?  I think it's extremely unlikely that rates will rise over this time period, but that's not material to the discussion - Ally is offering a premium rate and a free option.  HOW?

And yes - Ally Bank is the Bank Formerly Known as GMAC.


Hard Rock Cafe Sues Hard Rock Hotel

Vegas Rex is at his finest in his recent piece about the lawsuit Hard Rock Cafe has filed against Hard Rock Hotel.

First, the suit:

"Owners of the Hard Rock Cafe restaurant chain are suing owners of the Hard Rock Hotel & Casino in Las Vegas over its name, saying the casino's party image has damaged the moniker enough to justify ending a 14-year-old licensing agreement.  The lawsuit says that the cable reality show "Rehab: Party at the Hard Rock Hotel" on truTV casts its brand in a bad light. The lawsuit says the show portrays the Hard Rock Hotel and Casino as a place that "revels in drunken debauchery, acts of vandalism, sexual harassment, violence, criminality and a host of other behavior" that most people would find offensive, including patrons of Hard Rock restaurants.

The hotel is owned by Morgans Hotel Group -- a company that is entirely separate from the cafe chain. Hard Rock Cafe agreed to let the hotel use its name, but now wants to rescind the deal. If the restaurant chain wins its lawsuit, the Hard Rock Hotel & Casino would be forced to change its name and brand, which have been central to its strategy of marketing to music lovers and others who know the Hard Rock name. The cafe owners said in the lawsuit that the casino's pool parties, which are also titled "Rehab," have been associated with criminal activity, damaging the Hard Rock name."

Then, a snippet of  Rex's inimitable take:

"Personally, I have never seen the reality show referenced by the Hard Rock Cafe, but from its name, I'm pretty sure I get the idea.  My guess is that watching this particular show is like watching the Douchebag Olympics.  You probably have 1,000 people on camera trying to out-vinegar one another, with throngs of spectators yelling "Whooooooooo!" the entire time.

Again, this is probably not wholly inconsistent with the clientele of the Hard Rock Cafe.  I am aware that the Cafe is a bit more family-friendly, but it may be a little disingenuous for the HRC to cite "drunken debauchery" as something that they do not want to be associated with.  Again, it is named the HARD ROCK Cafe.  Not just rock, but hard rock:  Pot-smoking, head-banging, skank-banging, devil-horn-making, hard fucking rock.

It's hard to believe that a few douchebags squirting around in an artificial pond in Desert Detroit would really tank their image, but I can kind of see where they are coming from. "

Head over to Rex's site to read the whole thing.


Guaranteed Box of Crap, Part NINE

I've used this quote (Tommy Boy) before, and I'll use it again - every time we stamp a Government guarantee on crappy assets:

"Because they know all they sold ya was a guaranteed piece of shit. That's all it is, isn't it? Hey, if you want me to take a dump in a box and mark it guaranteed, I will. I've got spare time."

Today's occasion?  >The Wall Street Journal explanation of the Credit Union takeover.

First, let's hope around the article and pull out some direct quotes:


"Friday's moves include the seizure of three wholesale credit unions, plus an unusual plan by government officials to manage $50 billion of troubled assets inherited from failed institutions. To help fund the rescue, the National Credit Union Administration plans to issue $30 billion to $35 billion in government-guaranteed bonds, backed by the shaky mortgage-related assets.
Officials said the plan won't cost taxpayers any money."


"Losses on the mortgage-backed securities held by the five seized credit unions are expected by regulators to total about $15 billion. Wiping out the capital of the failed institutions will cover a chunk of those losses. But the remaining $7 billion to $9.2 billion eventually will be passed along to the nation's 7,445 federally insured credit unions in the form of future assessments."


 "Together they had about $50 billion in shaky mortgage-backed securities on their books, according to Larry Fazio, NCUA's deputy executive director. 

Based on current market values, those securities are worth roughly half of their face value, representing a potential loss of $25 billion"

So, to summarize:  We have  $50B in bad assets, which are currently worth roughly $25B, which will be stamped "GUARANTEED" by the government and sold for $30-$35B.   Since it seems that this time the Powers That Be actually realize up front that there will be losses (though they are careful to note: not to taxpayers, and not to buyers of the "guaranteed" paper), this may be the best use of "guaranteed box full of crap" thus far.  Who will eat the losses?   The remaining credit unions - you can think of this as a kind of FDIC for credit unions - their regulator will assess fees as a way to recoup the losses that will eventually be taken.  Magically, these losses are delayed/spread out via the "guarantee,"  allowing the pain to be taken over a longer period of time.

Maybe this one will actually work!


Saturday, September 25, 2010

Attempting to Wrap Up the Absurd Citi-SEC Settlement Story

I started writing about this story a few months ago, when Citi was given the equivalent of two minutes in the penalty box for misleading investors as to the extent of their subprime exposure.  I pointed out that the $75mm fine was especially absurd in light of GS's recent $550mm fine for an offense that involved much smaller notional amounts and much more sophisticated counterparties.

The settlement was subsequently rejected by a judge, which led me to write about exactly how absurd the $75mm fine was, in light of the fact that Citi's deception allowed it to raise nearly $40 Billion of new capital between Q4 2007 and Q2 2008.

Today, the story is that a judge has approved the settlement, including the quote:

"Judge Huvelle said that given the S.E.C.’s economic analysis in reaching the $75 million settlement, “I can’t really in good faith say that this figure is right or wrong.”"

Oooh - OOOOH - PICK ME PICK ME! *raising hand, waiving it violently*
I can in good faith say that the figure is wrong - I went through a simple argument to show that it can't possibly be right.  Take $75mm and divide it by the $40B in capital that Citi raised with false pretenses.  You get 19 basis points, or 0.19%.  You don't have to be a financial markets wizard to assess that the benefit Citi got by not telling investors about their extra $38Billion or so in subprime exposure and thus managing to raise a crap-ton of new capital was more than 19bps.    The real number is probably well into the multiple billions - or more.  After all, once investors realized the truth, the stock collapsed.  I don't think I need to offer proof that had investors known that Citi had massive subprime exposure, they might not have provided capital so readily.

"The judge also directed that the settlement agreement be reworded to make clear that the $75 million would be used to compensate shareholders who suffered losses because of Citigroup’s misstatements, and she told the S.E.C. and the bank to return in two weeks with new language that did that."

Which leads me to the next story - Norway's Central Bank is now suing Citi, for, you guessed it,  precisely the same thing.
"Norway’s central bank has sued Citigroup over $835 million in losses on Citi shares and bonds.
Citi is accused of making “repeated material untrue statements and non-disclosure of material information to investors” from Jan. 19, 2007 through Jan. 15, 2009 that caused Norges Bank, the central bank, to buy the securities at inflated prices."

Citi responds by saying:

"“We believe the suit has no merit and will defend ourselves vigorously,” a Citigroup spokeswoman said in a statement."

I find their denial especially odd, considering that the other suit (the one I wrote about above!) established that Norway's allegations are basically undeniable!

And so it goes...

disclosure: I am LONG Citi, for some inexplicable reason

Thursday, September 23, 2010

ETF Mechanics are Positively NOT Beyond Comprehension - Contrary to Herb Greenberg

Herb Greenberg did a segment on CNBC today about Bogan's "Can ETFs Collapse Piece."  I used to read Greenberg 10 years ago when he was the voice of reason in finding overvalued internet stocks, and found him to be intelligent, informed, and useful.  I guess times have changed.  In this segment, he talks about ETFs like he has absolutely no knowledge of stocks, markets, or mechanics whatsoever and ascribes to them a complexity that would be more aptly associated with particle physics.  If you watch this piece, you'll shake your head in awe that a guy like Herb Greenberg, who should know better, describes hysterically the "complicated" creation units.

Greenberg repeats the hysterical plea of "WHO WILL BE LEFT HOLDING THE BAG?" Which, of course, we already went over in my earlier piece.  Bogan, in the video, even bites my "fractional reserve lending" analogy, but puts a pejorative spin on it.  It happens to be how all stock lending works, not just ETFs.

Greenberg has an article on the subject too, but frankly, when a guy who has been writing about stocks in depth for as long as Greenberg has writes this paragraph, it makes me, simply, sad, and it's an indication that you'll be doing yourself a disservice by reading his article:

"I can’t stress the complexity of the structure. If the very nature of these “creation units” is beyond the comprehension of most investors the actual mechanics of ETFs involve an even far more complex matrix of transactions."

Ok kids - it's time to dump Herb Greenberg as your source for lessons on market mechanics.  Instead, come to Kid Dynamite's World, because, you see, these "Creation units" are such a simple concept that I could explain it to your grandmother in 5 minutes.  In fact, of course, I already did.  Here's what I wrote:

"One of the great things about ETFs is that they can be created and redeemed.   This means that "authorized participants" (read: big broker dealers) can take a basket containing the underlying stocks of the ETF, in specific weights, deliver them to the ETF trust and receive the ETF shares - that's called creating.  They can also do the opposite:  deliver the ETF itself to the trust, and receive the underlying basket of individual stocks - that's called redeeming.  "

(SARCASM ON)  Holy cow - that is incredibly complex - and nearly impossible for all but the most elite among us to understand. (/SARCASM OFF)  

You take a basket of stocks and give it to the Trust - they give you the ETF.  Or, you take the ETF and give it to the trust - they give you the basket of stocks.  WTF is complex about that?

A key realization is that the larger the short interest in an ETF is, the higher the probability that you get a short squeeze if and when people want to redeem their shares.  This short squeeze kicks off a "self healing" process that I described in the previous post, resulting in arbitrageurs creating the shares that are needed, and avoiding the feared collapse.
Amazingly, neither Bogan nor Greenberg realize that an ETF is probably more likely to "collapse" - in the sense that everyone wants to redeem and can redeem because they haven't lent their stock out -  when there is NOT massive short interest.  Imagine the simplest case where there is ZERO short interest - no shares are lent, and long holders can simply redeem their shares. (In order to redeem, you have to actually deliver your shares to the Trust, which you can't do if they are lent out, until, of course, you get them back). In the massive short interest case (Bogan's XRT example), shares have been lent (to short sellers), and thus cannot be redeemed until they are recalled from the short seller (again, I explained all of this in the other piece already) - and that borrow recall process results in short squeezes and creation of new shares, which self-heals the problem of "missing" shares (which, of course, aren't really missing at all - because only the shares that are actually outstanding can be redeemed.)

Just to help you guys sleep at night, after Greenberg rants aloud "Who will be left holding the bag? Will it be the Federal Reserve?"   No - it will not be the Federal Reserve. I answered this question already also.  In the event that an ETF gets "redeemed" out of existence (which, again, Herb and Andrew, is MORE likely to happen if there is LESS short interest),  shorts owe longs the value of the underlying basket.  Cricket.....  Cricket.  The sky doesn't fall,  the oceans don't boil, locusts don't swarm, and the Fed doesn't have to pick up the tab - it's just an exchange of cash from the shorts to the longs (and it's already collateralized when the short seller shorts the stock and posts margin).

It would be somewhat understandable for a mass media business section author to write a piece like the one Greenberg did today, but Herb - you have no excuse - you should know better.


author's note:  If you haven't read my first piece on this subject, you should do so.

also, a question for my readers:  In the first few seconds of the video clip, Faber mentions "the gold ETF" failing to track the price of gold.  Does anyone know what he's talking about?  Surely not GLD, which has tracked the price of gold tightly. (And this is not an invitation for people to leave "GLD IS A SCAM" comments - I just have no clue what Faber was talking about)

GM Political Donations - I Have a Bad Feeling About This

Something about this story makes me feel nauseous.

"General Motors Co. has begun to once again contribute to political campaigns, lifting a self-imposed ban on political spending put in place during the auto maker's U.S.-financed bankruptcy restructuring last year.

The Detroit company gave $90,500 to candidates running in the current election cycle, Federal Election Commission records show."

Ugggh.  GM, government owned, is making political contributions to those running for political office.  How do they justify it?

""As we've emerged as a new company, we're not going to sit on the sidelines as our competitors and other industries who have PACs are participating in the political process," Mr. Martin said. He called GM's political action committee is "an effective means for our employees to pool their resources and have their collective voice heard."

Ahhh.. I see. .and by "effective means for our employees to pool their resources and have their collective voice heard," he of course means "a way for us to continue to support positions of power for those who will continue to give us handouts to cover our asses when we screw up."  This is pretty sick. And what's even sicker is that someone will probably write in the comments about how we don't want GM to be disadvantaged, since we own them, so we should be in favor of their political meddlings.


Wednesday, September 22, 2010

GOP: A Pledge To America

You'll probably read a lot about this tomorrow:  A Pledge To America

I debated closing comments for this post, since I have zero interest in a partisan debate here, but I decided to leave them open so that people can pick specific quotes from the "Pledge" that they like or dislike.  If you have something to say, please refer to a specific quote and page number.

I'll start:  I liked this, from page 5:

"We will also prevent Washington from forcing responsible taxpayers to subsidize irresponsible behavior by ending bailouts permanently, canceling the Troubled Asset Relief Program (TARP), and reforming Fannie Mae and Freddie Mac."

I'm interested in this claim, from page 7 (although I immediately expect all such claims - by both parties - to be suspect):
"So far, Washington Democrats have passed, and the president has signed into law, at least 14 violations of his pledge that “no family making less than $250,000 a year will see any form of tax increase.”"

Oh wait - here's a clue, from page 14:

"Taxes. The new health care law includes at least a dozen violations of President Obama’s pledge not to raise taxes on middle-class families. The Obama administration has conceded that the ‘individual mandate’ at the heart of the new law is indeed a tax, a notion the president “absolutely” rejected last fall."

So there's "at least a dozen" of the "14" violations cited above - seems like a slightly twisted way to look at it... Anyway.

I laughed at this, from page 15:

"Strengthen the Doctor-Patient Relationship: We will repeal President Obama’s government takeover of health care and replace it with common-sense reforms focused on strengthening the doctor-patient relationship."

That reminds me of my first job on Wall Street, at a firm I will not name.  This firm, back then, was one of the also-rans, a commercial bank trying to compete with the big broker dealers who were ruling the roost.  The CEO came and talked to us, the new hires, in the first week, and blathered about teamwork, and about how we'd crack the top 3 in the next 5 years.  Not wanting to waste the opportunity to fire a question at the CEO, when the floor was opened for questions I raised my hand and asked, simply, "Look, I understand the pep talk, but what are we going to do - call up Goldman's clients, Morgan's clients, and say "Hey - come to us - we've got teamwork?""

Needless to say, the CEO was slightly taken aback, there was an uncomfortable silence in the room,  and the coordinator for the new hires program looked at me with his jaw open and his eyes wide.    The CEO cleared his throat,  gave some BS response, and went back to answering mindless rote questions from MBA grads.  

The new hires coordinator came up to me after and said "Where do you keep the wheelbarrow?"  "Huh?"  I was puzzled.  "To carry your gigantic balls!" He explained. 

"Look," I responded "I wasn't trying to show my "balls" - I was trying to take advantage of a rare opportunity to gain some insight from the CEO and hoped that he could tell us something that wasn't fluff and bullshit."  Turned out, he couldn't.

Oh - by the way - this firm, 12 years later, is the king of the mountain.  They have a new CEO (perhaps have had more than one, I don't know), and have surpassed all the competition, just like the 1998 CEO said they would.  I don't think it had anything to do with him, his decisions, or "teamwork," but hey - he was right - it just took a little longer than he expected, and required a complete meltdown of the entire financial system.

What's my point?  That's what "We want to strengthen the Doctor-Patient Relationship" sounds like to me.  Really? You're going to legislate that?  Good luck...


The Problem With Pensions II - A Blast From the Past

I wrote about pension fund return assumption problems a few days ago.  Then, while discussing another matter, a friend forwarded me this letter from Warren Buffett from December of 2001.  While reading it, I came to a part near the end where Buffett addresses the very point I was trying to make about buying long duration assets below your portfolio return assumption (I put this part in italics below).  Without further ado, I think this entire excerpt is worth reading (starts on page 8 of the link). Remember, this is from nearly 10 years ago:

"Let me show you another point about the herd mentality among pension funds--a point perhaps accentuated by a little self-interest on the part of those who oversee the funds. In the table below are four well-known companies--typical of many others I could have selected--and the expected returns on their pension fund assets that they used in calculating what charge (or credit) they should make annually for pensions.

Now, the higher the expectation rate that a company uses for pensions, the higher its reported earnings will be. That's just the way that pension accounting works--and I hope, for the sake of relative brevity, that you'll just take my word for it.

As the table below shows, expectations in 1975 were modest: 7% for Exxon, 6% for GE and GM, and under 5% for IBM. The oddity of these assumptions is that investors could then buy long-term government noncallable bonds that paid 8%. In other words, these companies could have loaded up their entire portfolio with 8% no-risk bonds, but they nevertheless used lower assumptions. By 1982, as you can see, they had moved up their assumptions a little bit, most to around 7%. But now you could buy long-term governments at 10.4%. You could in fact have locked in that yield for decades by buying so-called strips that guaranteed you a 10.4% reinvestment rate. In effect, your idiot nephew could have managed the fund and achieved returns far higher than the investment assumptions corporations were using.

Why in the world would a company be assuming 7.5% when it could get nearly 10.5% on government bonds? The answer is that rear-view mirror again: Investors who'd been
through the collapse of the Nifty Fifty in the early 1970s were still feeling the pain of the period and were out of date in their thinking about returns. They couldn't make the necessary mental adjustment.
Now fast-forward to 2000, when we had long-term governments at 5.4%. And what were the four companies saying in their 2000 annual reports about expectations for their pension funds? They were using assumptions of 9.5% and even 10%.

I'm a sporting type, and I would love to make a large bet with the chief financial officer of any one of those four companies, or with their actuaries or auditors, that over the next 15 years they will not average the rates they've postulated. Just look at the math, for one thing. A fund's portfolio is very likely to be one-third bonds, on which--assuming a conservative mix of issues with an appropriate range of maturities--the fund cannot today expect to earn much more than 5%. It's simple to see then that the fund will need to average more than 11% on the two-thirds that's in stocks to earn about 9.5% overall. That's a pretty heroic assumption, particularly given the substantial investment expenses that a typical fund incurs.

Heroic assumptions do wonders, however, for the bottom line. By embracing those expectation rates shown in the far right column, these companies report much higher earnings--much higher--than if they were using lower rates. And that's certainly not lost on the people who set the rates. The actuaries who have roles in this game know nothing special about future investment returns. What they do know, however, is that their clients desire rates that are high. And a happy client is a continuing client.

Are we talking big numbers here? Let's take a look at General Electric, the country's most valuable and most admired company. I'm a huge admirer myself. GE has run its pension fund extraordinarily well for decades, and its assumptions about returns are typical of the crowd. I use the company as an example simply because of its prominence.

If we may retreat to 1982 again, GE recorded a pension charge of $570 million. That amount cost the company 20% of its pretax earnings. Last year GE recorded a $1.74 billion pension credit. That was 9% of the company's pretax earnings. And it was 2 1/2 times the appliance division's profit of $684 million. A $1.74 billion credit is simply a lot of money. Reduce that pension assumption enough and you wipe out most of the credit.

GE's pension credit, and that of many another corporation, owes its existence to a rule of the Financial Accounting Standards Board that went into effect in 1987. From that point on, companies equipped with the right assumptions and getting the fund performance they needed could start crediting pension income to their income statements. Last year, according to Goldman Sachs, 35 companies in the S&P 500 got more than 10% of their earnings from pension credits, even as, in many cases, the value of their pension investments shrank."


Online Gambling IPO

The large UK gambling house, Betfair, announced plans for an IPO yesterday.  As I've mentioned previously, I've been a shareholder in PartyGaming for a long time now, and I'm anticipating the time when online poker (at least, if not online sports betting, etc) will be re-legalized in the U.S. from both an investor's and a poker player's point of view.

I think I also mentioned previously on this blog that the time for such discussions seems likely to be near, as we look for new sources of revenue, and the "tax and regulate" model for online casinos starts looking fiscally attractive.

What will be interesting, of course, is that what's fiscally attractive to legislators isn't always morally attractive.  I don't really have much interest in debating the merits or morals of online gambling here.  I think that in general, readers will already understand that I'm in favor of personal freedom and personal responsibility, which means allowing people to do what they want.  I even agree with Barney Frank on this.  I think the objections to online gambling are often especially hypocritical, considering that most states have easily accessible lotteries, while others have abundant OTB parlors (off track betting).

I also want to point out that poker is a game of skill, and that I would definitely view it differently from online blackjack.  Sports betting is a tricky one - I guess you could also say it's a game of skill (handicapping) , although I'd say that the vast majority of the people who do it probably don't have the necessary skill to do it profitably.  On the other hand, you can probably make the same argument about poker.

Finally, I found it interesting that Harrah's has been developing their own WSOP branded online site, where they are trying to develop a play-money player base, with prizes as the incentive.  I always expected the Vegas big boys to simply buy one of the existing online poker infrastructures if/when online poker is re-legalized, but Harrah's may be trying to build their own generic site.  They do have the advantage of the WSOP (World Series of Poker) brand.


Channel Check - Crossgates Mall - Apple

I'm up in Albany at "Mulch Camp," watching my father-in-law's mulch business while he's away.  I went over to the massive Crossgates Mall today to wander around.  The mall was virtually deserted - I saw people in only one store:  Apple.  I wandered in to play with the new Nano and Ipod Touch.   There were nearly as many employees as customers, and I can't be sure that the customers were actually buying stuff, but it was the only store in the whole mall where customers were noticeable.


disclosure: no AAPL positions

Tuesday, September 21, 2010

Where are all my MMT'ers At?

Bill Gross, speaking after the Fed announcement today on CNBC, was asked by Erin Burnett 

"Can we afford $2Trillion never mind $4Trillion in tax cuts?"

Gross responded: 

"Well no we can't - we can afford $2Trillion in quantitative easing because that basically is printing money, but the deficit is out of control and ultimately the dollar will pay the price."

I took him to mean that we couldn't cut taxes by $2T because the deficit is out of control.

It's around the 9 minute mark in this video.

Gross proceeded to say that he did want tax cuts for the middle class, but not the top brackets.

So, here's the question:  Gross acknowledged "printing money" for quantitative easing, and advocates it heartily.  We already know from our prior discussions of Modern Monetary Theory (MMT) the government need not tax in order to spend - they can just spend - they can just print money (of course, there may be consequences if they do this). Why then, is it a problem to cut taxes by $2T, but not a problem to just print $2T for QE?  Said differently, we don't need taxes to "pay" for the budget - we can just print money for that too/instead.  Said a third way, why not get rid of QE, and use the $2 Trillion for tax cuts instead?

I guess it's possible that what Bill Gross really meant is that we can print $2T for QE, but we can't print another $2T in the form of tax cuts, because THAT would be too much for the dollar to handle...


An ETF Lesson - Part I

I really don't want to write a post debunking the hysteria thrust upon the quivering masses (who reply: "OH NO! HOW IS THIS LEGAL?!!")  by Andrew Bogan in this FT Alphaville piece (and now re-hyped by Clusterstock).  Since Steve Waldman addressed a number of Bogan's errors in the comments section of Bogan's own post (if you're interested in this topic, you must read swaldman's comments before continuing!), I figured now would be a good time to explain a little bit about how ETFs work to the masses, who remain terminally confused.

One of the great things about ETFs is that they can be created and redeemed.   This means that "authorized participants" (read: big broker dealers) can take a basket containing the underlying stocks of the ETF, in specific weights, deliver them to the ETF trust and receive the ETF shares - that's called creating.  They can also do the opposite:  deliver the ETF itself to the trust, and receive the underlying basket of individual stocks - that's called redeeming.   

A great source of confusion that many folks have regarding ETFs is the concept that when you buy an ETF, like, say SPY - the S&P 500 ETF - the trust itself does not take your money and go out and buy the underlying S&P 500 stocks with it.  Similarly, when you sell SPY, the trust does not go out and sell stocks to raise money to give you.   The trust has nothing to do with it.   When you buy SPY (just like when you buy IBM) , you buy it from another participant in the market  - not from the trust (not from the company itself).  Contrast this to mutual funds: when you buy an S&P 500 mutual fund, that mutual fund does take your money and go out and buy their portfolio of stocks with it, and vice versa when you sell.

So, back to our SPY ETF - the reason this works is precisely because of the creation/redemption mechanism.  If "the market" is lacking SPY sellers, and the price of SPY rises so that it is in excess of it's NAV (net asset value)  there are arbitrageurs standing by ready to short you shares of SPY while they simultaneously buy the underlying basket of SPY components as a hedge.  Since they are selling SPY "rich" to it's fair value, they will make a profit when they eventually collapse their position.  How do they collapse it?  Well, they take their long basket of SPY component stocks and "create" SPY by delivering the individual stocks to the trust, receive newly created SPY, and use that to cover their SPY short position.  Voila - they're now flat, and the SPY's assets have increased, as have the shares outstanding. 

Of course, if everyone wants to sell SPY, the opposite happens - the arbitrageurs, if SPY is trading "cheap" to it's NAV, will buy SPY while simultaneously shorting a basket of the underlying components.  Then, they'll take their SPY shares, deliver them to the trust, redeeming them for the underlying components which they use to close out their short underlying stock positions.  In this case, the assets held by the trust decrease, as do the shares outstanding (after all, the arbs have taken SPY shares out of circulation, and given them back to the trust, effectively "retiring" the shares temporarily.)

The next level of this discussion gets somewhat complicated pretty quickly.  Bogan is worried about "naked short sellers" but he demonstrates a thorough lack of understanding of what a naked short seller is.  Bogan writes:
"Take the SPDR S&P Retail ETF (NYSE: XRT) as an example. The number of shares short was nearly 95 million at the end of June, while the shares outstanding of the ETF were just 17 million. The ETF was over 500% net short! Or to look at it from another perspective, the ETF’s operator, State Street Global Advisors, believed that there were 17 million shares of the SPDR S&P Retail ETF in existence and owned shares in the S&P Retail Index portfolio to underlie those 17 million ETF shares. But, in the marketplace there were another 95 million shares of the ETF owned by investors who had purchased them (unknowingly) from short sellers. 78 million of those ETF shares were naked short–the short seller had promised their prime broker to create those non-existent shares if necessary to cover their short in the future. In both cases the share buyer, however, is completely unaware his ETF shares were purchased from a short-seller and no doubt assumes the underlying assets in the index are being held by the ETF operator on his behalf, but no such underlying stock is actually held by anyone. Clearly this creates a serious counterparty risk and quite possibly the potential for a run on an ETF—where the assets held by the fund operator could become insufficient to meet redemptions."

First, it's perfectly possible to have 95mm shares short with only 17mm shares of XRT outstanding, although this is a concept that many people hate and are confused about.  How?  It's just like fractional reserve banking.  First, remember that in order to short shares of stock, you first need to borrow those shares from somebody (so that you can deliver them to the buyer on the other side of your short sale).  If you don't borrow the shares, that's called naked shorting, which is different from what Bogan describes.  These ownership chains get hard to follow pretty quickly, but let's pretend that I, Kid Dynamite, bought shares of XRT in the initial public offering.  I own the shares.  I take my shares and lend them to Steve, who goes and shorts them.  Now, I no longer have shares to lend - I've already lent them out   Steve has borrowed them and shorted them, and the buyer of that stock is Dave.  Dave then takes the stock which Steve delivers to him, and lends it out again, to Mike, etc...  Thus, multiple people end up short the "same" share of stock, everyone has delivered the stock they promised to, no one failed to deliver, and no one is naked short.  (if you haven't read Swaldman's comment explanations, now would be a good time to do so.  first, second).   Like fractional reserve banking, there's collateral in each step of this chain - if I want my shares back and Steve can't get them for me, I'll take his collateral instead.  SWaldman describes it thusly:

"Lending of securities creates synthetic supply of shares, just as lending by [banks] creates a synthetic supply of money. With shares and with money, the lending arrangements are sufficiently well guaranteed that most holders consider the synthetic to be a perfect substitute for the original. Most people don't fret over the distinction between bank deposits and cash-in-hand, just as most stock traders don't fret over the distinction between owning a share and owning a promise to deliver a share on demand by their broker."

Now, Bogan fears a "run" on the ETF.  That's not going to happen (at least not for the reasons he fears), for a few reasons.  Let's start with the more complicated one, using Bogan's own numbers:  as Bogan notes, now 95mm people think they "own" the XRT.  Well, we know that only 17mm of them actually have possession of the XRT, since the other 78mm have lent their shares out to others.  You can't redeem something you don't have (remember, you've lent it out), so it's not possible for 95mm shares to be redeemed.  If some of the people who have lent their XRT out (maybe they even lent it out unknowingly) decide they want their shares back, it's not the end of the world!  The short sellers of XRT will have a few choices to return the XRT that they "owe."  They might go out in the marketplace and simply cover their short positions, or they might buy the underlying basket of XRT stocks, deliver them in to the trust, and "create" new XRT shares to deliver to the person they borrowed them from.   As Swaldman puts it, "The missing supply of ETFs would create itself."

Now that we've explained the concept of possession of stock, let's go to Bogan's worry of how the implosion might happen:  He writes:

"Redemptions occur when more owners wish to sell out of their holding in the ETF than there are new buyers for the existing shares, so unwanted blocks of 50,000 ETF shares each are redeemed through the authorized participants with the ETF operator for cash, or more typically for in-kind shares in the ETF’s underlying index’s stocks."

I hope that Bogan is oversimplifying (and I think he is), because I explained above that owners of XRT wishing to sell their shares do not directly cause redemptions.  I have a feeling that Bogan knows this, and that he's basically explaining what will happen after the arb situation I described above takes place:  when there are insufficient buyers of XRT (ie, too many natural sellers), arbs will step in as buyers, while shorting the underlying basket of stocks, and then redeem their XRT to the trust.  Now, as long as the sellers deliver their shares, the arbs (the XRT buyers) can take the XRT and redeem them with the trust.  If sellers don't deliver the shares they owe, we are back to the scenario a few paragraphs above - they will have to make good by buying back the shares in the market, or by creating more XRT by buying the underlying basket and delivering it to the trust.

Bogan worries about the rapid contraction in XRT shares outstanding in July/August:

"The SDPR S&P Retail ETF was one of the fastest contracting ETFs in July due to redemptions and as of July 31, it had just 7 million shares outstanding. However, the short interest was little changed—still over 80 million shares short. Suddenly, 11 times the number of shares outstanding was short, which is even more worrisome than 5 times back in June. By late August, the shares outstanding in XRT had dipped briefly below 5 million shares with 80 million shares still short (16 times the shares outstanding). Mercifully, net buying interest has rebounded somewhat for the SDPR S&P Retail ETF with the improving outlook for retailers and shares outstanding in XRT had rebounded to 12 million by mid-September. But if the rate of contraction last month had continued, the ETF was just days away from running out of underlying shares altogether."

No - the ETF was probably not days away from running out of shares. This phenomenon is self-healing.  This is the important part, but it's not as complicated as it sounds.  As we've established,  shares can only be redeemed when they are actually delivered into the trust.  If everyone wants to redeem their shares, then the shorts need to cover their positions - we have also already discussed this above.  The shorts can either borrow the XRT from someone else (impossible if everyone wants to redeem), cover in the marketplace (again, if everyone wanted to redeem, that would also be impossible, but we can pretend that I overpay for XRT to the extent that one of the redeemers is happy to not redeem and instead sell it to me for a premium to NAV), or buy the underlying basket and deliver it to the trust and create more shares (and more underlying assets for the trust to distribute). 

Thus, the most likely result if everyone wants to redeem XRT when there is 500% short interest is actually a massive short squeeze, or a rally in the instrument, as longs scramble to re-take delivery of shares that they have lent out.  But what happens if the actual physical holders of XRT do all want to redeem, and the "self-healing" I described doesn't happen in time?  Is the trust then "days away from running out of assets altogether"?  Read on.

Bogan's final few paragraphs are some confused hysteria asking who is left holding the bag if all the holders of the actual outstanding shares manage to redeem their shares. 

"Who gets left holding the bag? Is it the retail account holders who own defunct shares in a closed ETF? The prime brokers that were counterparties to all those short sellers? The hedge funds that sold non-existent shares in an ETF assuming they could always be created another day? The ETF operator? Or the Federal Reserve?"

First of all, it is indeed entirely possible to imagine a scenario where all of the actual holders want to redeem their shares, which results in the trust "running out" of assets.  In our example, 17mm people could redeem shares and receive the assets of the trust, and that would leave 78mm longs and 78mm shorts outstanding.   As commenter "Crookery" notes, the results are not apocalyptic.  The trusts have a mechanism built in to liquidate when their assets get below a certain point, and the outstanding shorts simply owe the outstanding "synthetic" longs the cash value of the trust.  There is no "bag" to be left holding - short sellers owe long holders.  

Furthermore, I think that if there is a greater supply of shorts outstanding, it actually makes it less likely that this happens, and more likely that the "self healing" scenario occurs, since there are more shares to get "bought in" and cause a short squeeze.  Said differently, the trust runs out of assets when the actual physical XRT holders all redeem their shares - not when the "synthetic" XRT holders want to redeem their shares.  "Synthetic" holders wanting to redeem causes the self healing short squeeze phenomenon, and there are more "synthetic" holders if there is more short interest.

Now, let's answer Bogan's headline question: "Can an ETF collapse?"  Sure - of course it can, but not for the reasons Bogan fears, and not with the subsequent effects he ponders either.

At this point, I feel like we've gotten into some confusing topics, so I'll close with another Swaldman comment:
"Shareholders end up with synthetic long positions by their own consent, when they agree to lend shares from their account to potential short-sellers. It is true that more people consent to this than understand they are consenting to it: retail investors with margin (as opposed to cash) accounts may fail to read the boilerplate that gives their broker the right to lend their shares. But those retail investors' credit exposure is to their broker, not to the speculative short-seller that eventually borrows and resells her stock. In general, then, retail investors in margin accounts may have credit exposure to their broker by virtue of short-selling that they do not understand. And if brokers are incautious in their securities borrowing and lending, they could blow-up and force losses on clients holding margin accounts. In theory, that is a real concern, but it has nothing to do with ETFs. We should be concerned that brokers who lend the shares of customers are regulated to prevent credit losses that impact their solvency, whether those losses result from share-lending or any other practice. This is the LTCM issue, not something specific to short-selling or ETFs."


Monday, September 20, 2010

"Whining" By the Super Rich

I feel like I can't avoid the elephant in the blogosphere, which is Todd Henderson's writeup about how he's "super rich" yet really doesn't feel that way.

"We pay about $15,000 in property taxes, about half of which goes to fund public education in Chicago. Since we care the education of our three children, this means we also have to pay to send them to private school. My wife has school loans of nearly $250,000 and I do too, although becoming a lawyer is significantly cheaper. We try to invest in our retirement by putting some money in the stock market, something that these days sounds like a patriotic act. Our account isn’t worth much, and is worth a lot less than it used to be.

Like most working Americans, insurance, doctors’ bills, utilities, two cars, daycare, groceries, gasoline, cell phones, and cable TV (no movie channels) round out our monthly expenses. We also have someone who cuts our grass, cleans our house, and watches our new baby so we can both work outside the home. At the end of all this, we have less than a few hundred dollars per month of discretionary income. We occasionally eat out but with a baby sitter, these nights take a toll on our budget. Life in America is wonderful, but expensive.

If our taxes rise significantly, as they seem likely to, we can cut back on some things. The (legal) immigrant from Mexico who owns the lawn service we employ will suffer, as will the (legal) immigrant from Poland who cleans our house a few times a month. We can cancel our cell phones and some cable channels, as well as take our daughter from her art class at the community art center, but these are only a few hundred dollars per month in total. But more importantly, what is the theory under which collecting this money in taxes and deciding in Washington how to spend it is superior to our decisions? Ask the entrepreneurs we employ and the new arrivals they employ in turn whether they prefer to work for us or get a government handout."

Now, there are a few very important things to note here.  First of all, Henderson isn't "whining," as some commentators have described him.  He's not claiming that he has some entitlement to his big fat house, his two cars, his dining out, his housekeeper, or his landscaper.  He's not asking anyone to feel sorry for him, or saying that he "deserves" these things.   What he's saying is simply that he spends most of the money he makes, and thus, if he has to pay more in taxes, he'll have to cut expenses, which will make every merchant who currently receives a share of his spending worse off.

Basically, I take him to be saying that trickle down economics is very real for him, even though he's considered "rich."  For me, the point isn't about how "rich" someone is, it's about how much money that person spends relative to what they make.  Trickle down economics works only if the people with the money SPEND the money, thus allowing it to trickle down.  (And I think lots of people would say that trickle down economics in general doesn't work well at all - that's not really an argument I'm interested in having)

In other words, if someone makes $10mm a year and spends $1mm, then the claim "If you raise my taxes, I'll spend less, and everyone will be worse off,"  isn't nearly as credible as if Todd Henderson, making somewhere in the neighborhood of, let's say $350k, and spending most of his post-tax dollars makes the same claim.  That's what I took Henderson's point to be - that even though he's considered "rich,"  he doesn't have surplus funds to pay higher taxes with - and that higher taxes will impair his spending.

It should also be noted that this same argument can translate to someone who makes much more than Henderson.  Richie Rich could earn $10mm a year, and spend all that money, and still have to cut back if his taxes are raised.  I think my readers are smart enough to understand that my argument is not that Richie Rich needs to build his $10mm house, or drive a $100k car - my point is merely that if you take more of Richie Rich's money (which he's spending almost all of) via taxes, then he will have to change his spending patterns, and the guy who sells him the $100k car will suffer, as will the guys that are building his $10mm house, and the companies that make the fixtures in his $10mm house, and the restaurants where he no longer spends so much money every week, etc etc etc.  


Dear Penthouse? or New York Times?

Ok, it's time for a new game here at Kid Dynamite's World.  I'll give you an excerpt of text, and you have to tell me if it's from Penthouse Letters, or the New York Times.

first up:

"The shirtless men circled and lunged at each other under the bright sun as the crowds watched, rapt, from the sidelines."

Ideas? Anyone?  Correct - NY Times.


"The men were barefoot and in shorts, their well-muscled torsos shaved and glistening with oil that flashed brute power as well as the ability to slip from an opponent’s grasp."

Ah HAH!  Tricked you - that's from the NY Times also - same article.  Seriously.
Last try:

"When I was a senior in college I was quarterback on the college football team, but what I was most interested in was my English teacher, Mrs. Miller, who I spent many nights dreaming about."

No, that's not a fond memory from Krugman's latest NY Times Op-ed, it's from Penthouse Letters (NSFW).


Sunday, September 19, 2010

Mott's Strike Resolved!

I wrote about this a month agoThey have reached a resolution.


"Dr Pepper Snapple and the union representing 300 workers at the Mott’s apple juice plant in Williamson, N.Y., announced a settlement late Monday that ends a 16-week strike and includes a wage freeze, but not the pay cuts the company had demanded. 

In the three-year deal, the Retail, Wholesale and Department Store Union persuaded the company to drop its demand to freeze pensions for current workers, although newly hired workers will not have pensions, but 401(k) plans..."

"Under the agreement, Dr Pepper Snapple, which also markets 7Up, Hawaiian Punch and Canada Dry, will save money on its retirement plans. While the company dropped its proposal to freeze pensions for current workers, the union in exchange agreed to lower the dollar-for-dollar match for current workers’ 401(k)’s to the first 2 percent of pay from the originally proposed first 4 percent. Before the strike, the match was for the first 5 percent of pay. For newly hired workers, the company will match the first 4 percent of their pay. 

The deal calls for a $1,000 signing bonus and for the company to absorb 80 percent of health-care costs and the workers 20 percent."


Saturday, September 18, 2010

The Problem With Pensions

If only it were as simple as a single "problem."  The issue of who makes up the difference when pensions are underfunded is a tricky one, and will certainly depend on the readers philosophical beliefs.  I prefer to start with what I consider the bigger problem - the reason pensions end up being underfunded is because their return assumptions are, well, to put it bluntly:  wrong.

Thus, even though pensions are being reformed so that workers contribute more to their pensions, perhaps work for more years, and may have capped benefits, the damage done by overstating long term compounded annual returns by even a little bit is catastrophic, and still results in massive underfunding. Of course, if we're lucky, we won't actually have to recognize this reality for another 10, 20, or 35 years.  Extend and pretend, bayyyy-beee!

"The median expected investment return for more than 100 U.S. public pension plans surveyed by the National Association of State Retirement Administrators remains 8%, the same level as in 2001, the association says.

The country's 15 biggest public pension systems have an average expected return of 7.8%, and only a handful recently have changed or are reconsidering those return assumptions, according to a survey of those funds by The Wall Street Journal.

Corporate pension plans in many cases have been cutting expectations more quickly than public plans, but often they were starting from more-optimistic assumptions. Pension plans at companies in the Standard & Poor's 500 stock index have trimmed expected returns by one-half of a percentage point over the past five years, but their average return assumption is also 8%, according to the Analyst's Accounting Observer, a research firm.

The rosy expectations persist despite the fact that the Dow Jones Industrial Average is back near the 10000 level it first breached in 1999. The 10-year Treasury note is yielding less than 3%, and inflation is running at only about 1%, making it tougher for plans to hit their return targets.

Return assumptions can affect the size of so-called funding gaps—the amounts by which future liabilities to retirees exceed current pension assets. That's because government plans use the return rates to calculate how much money they need to meet their future obligations to retirees. When there are funding gaps, plans have to get more contributions from either employers or employees.

The concern is that the reluctance to plan for smaller gains will understate the scale of the potential time bomb facing America's government and corporate pension plans."

Of course, they might do better than their benchmark assumptions:
"The Oregon Public Employees Retirement System has had an 8% assumption since 1989. Its actual return averaged 10.7% annually from 1970 through 2009. The Teachers Retirement System of Texas has had a similar expectation since 1986, with an annual return of 9% return since then. 

A spokeswoman for the Texas system said it doesn't change assumptions "in response to short-term situations," and currently "sees no reason to change our investment-return assumption." A spokesman for the Oregon system said there are no special plans to review its return expectation."

I guess, for me, the point is that managers are failing to recognize the economic paradigm shift we've undergone.  The last thirty years of leverage and debt expansion are finally coming home to roost, and since we don't want to recognize the reality of that, preferring instead to try to delay taking the losses that are inevitable, growth will be impaired for as far as my eyes can see.

But obviously, there's a reason why they don't want to lower return assumptions - it creates more pain!

"The Colorado Public Employees Retirement Association showed in its 2009 financial report the impact of reducing the rate. Using a 8% expected return rate, the plan faced a $23.4 billion deficit, based on market values, at the end of 2009. If the rate was cut to 6.5%, the shortfall would jump to $34 billion.

Meredith Williams, the Colorado plan's chief executive, says cutting the rate "creates pain." Nevertheless, Colorado at year-end of 2009 cut its return assumption to 8%, from 8.5%. Mr. Williams says the rate may be lowered again later this year.

Others have been more hesitant. In 2009, Matt Smith, state actuary for Washington state, recommended that its retirement system cut its return expectation to 7.5%, from 8%. That advice was rejected by the state's pension-funding council.

Mr. Smith says he thinks Washington and other states eventually will lower expected returns, but that it will be a slow process because reduced assumptions "will increase the cost of pension benefits, and right now the budgetary environment is a big obstacle to that.""

One thing that still makes no sense to me, and perhaps a reader can help me out with this, is how pension funds can be buying long term corporate bonds (I mean REALLY long term, I'll get to that in a second) with returns below their annualized bogey.  Last month Norfolk Southern issued "century bonds," due in 100 years.  Their yield was around 6%.  Last week, Rabobank did the same thing, issuing 100 year bonds with a yield of around 5.8%.  The WSJ says "Life insurers and pension funds tend to be the main buyers for such lengthy bonds because they need to match their long-term liabilities with assets of a similar duration."

Now, correct me if I'm wrong, but if you're making a super long term investment with a 6% return, your long term return assumptions probably shouldn't be in the vicinity of 8%, right?  What do you do to recoup the difference  - make up for it in volume?   wink wink...