Peter Schiff: A prophet from the past?

A former student of mine (Charlie) sent this to me. Wow. Talk about getting things right! Peter Schiff was absolutely dead on.




Peter, I do not know you, but my hat is off to you. It is also a great reason why I NEVER watch financial talk shows.

I wonder if Laffer ever paid his penny.

The Public Payroll Always Rises - WSJ.com

One one hand government spending is in a Keynesian way seen as a means of keeping the economy growinging in an economic slowdown, but given the taxes and
The Public Payroll Always Rises - WSJ.com:

"As the recession hits home, all across America businesses and families are having to make hard decisions about what not to buy this year, or whether they can afford a vacation or that plane trip home for the holidays. The exception is the government -- federal, state and city.

"New York City did witness a reduction in public employment in 2002 and 2003, during the last period of slower economic growth. But the city quickly resumed its habit of ever-growing payrolls, and they have kept growing rapidly in the years since -- to an estimated record this June 30 of 313,965 employees on the public dime, according to the Mayor's office. That's an increase of more than 40,000 public workers in a year when Wall Street has been enduring historic losses and laying off tens of thousands of people."

Which means that New York State Taxes will probably go up again, which will further slow the economy of upstate New York. (BTW recently New York State gave up the top spot in taxes, but we are still a solid #2)

Officials charge Mark Cuban with insider trading | Entertainment | Industry | Reuters

Officials charge Mark Cuban with insider trading | Entertainment | Industry | Reuters:

"According to the SEC, Quebec-based Mamma.com invited Cuban in June 2004 to participate in a private placement stock offering after he agreed to keep the information confidential.

When Cuban found out that the offering would dilute the holdings of existing shareholders and be sold at a discount to the market price, he became 'angry and upset,' the SEC said.

At the end of a call with Mamma.com's chief executive, Cuban said: 'Well, now I'm screwed. I can't sell,' according to the SEC's complaint."

And from The SportingNews:

" Stewart, like Cuban, landed on the wrong end of a civil action aimed at forcing her to fork over the money she saved by acting on inside information regarding a stock she dumped just before the price went south. Eventually, she forked over to the feds the $45,000 she saved by ditching the stock, along with three times that amount as a penalty for using inside information. Cuban may be approaching his own situation more prudently, getting "lawyered up" before talking to authorities and avoiding saying anything that could get him indicted (so far). "

You can say what you want about Mark Cuban, but he is a news magnet. Amazing. It will be interesting case to follow. (BTW You can see what Cuban has to say about it(not much) on his blog.)

Are partnerships coming back?

Mark Wilson who teaches Economics here at SBU has been advocating that a solution to the excessive risk taking and misaligned incentives is to return to partnership arrangements where the management would have more at stake.

Last week in Michael Lewis' epic "The End of Wall Street's Boom" piece the same idea was mentioned. Now Clusterstock investigates what Goldman would look like if it did go private:

Goldman Goes Private:

"Goldman spent most of its existence as private partnership. In a sense, by going private Goldman would be returning to its roots. But odds are that this time around, Goldman's partnership will be very different. These days even private partnerships are often far more open than the partnerships in the past, and openness might be exactly what Goldman needs if it is to survive.

University of Illinois law professor Larry Ribstein has been a pioneer in the study of how private partnerships have been used as alternatives to solving sticky problems of corporate management. Much of his work has centered on the problem of aligning managers' and owners' interests. He notes that the private partnership model popular in the private equity world might be very useful for Goldman here."

To Prevent Bubbles, Restrain the Fed - WSJ.com

In another article bemoaning the Fed, the WSJ reports some amazing statistics:

To Prevent Bubbles, Restrain the Fed - WSJ.com:

First on the performance of the stock market:

"On Nov. 14, 2008, the Dow Jones Industrial Average closed at 8497.31. On Nov. 13, 1998, the adjusted (for dividends and split) close was 8919.59. There has been great volatility, but no net capital accumulation as measured by the Dow in a decade. Other indexes, such as the Nasdaq, tell a similar story. Capital has been invested but as much value has been destroyed as created."

Then on the relative size of the subprime market:

"In 2001, there was $190 billion worth of subprime loan originations -- 8.6% of total mortgage originations. In 2005, there was $625 billion worth of subprime originations -- 20% of the total. In the same period, the percentage of subprime mortgages securitized -- loans that were packaged and sold to investors -- rose from just about 50% to a little more than 81%. (These numbers all trailed off slightly in 2006.) The great easing in monetary policy ended (with a lag) when the Fed began raising rates in June 2004.

The subprime saga follows a familiar pattern. Easy credit begets a boom and then the inevitable tightening of credit bursts the bubble. What is not familiar is the scale of the devastation wrought in this boom-bust cycle."

To prevent this boom-bust cycle,the author (Gerald P O'Driscoll Jr.) calls for a return to some commodity standard. A view that I do not really hold, but can see why there are more calling for it and given evidence, I may not disagree with it as much as I would have a few years ago.

"Mr. Obama needs to stop the next asset bubble from being inflated by imposing a commodity standard on the Fed. A commodity standard (such as a gold standard) imposes discipline on a central bank because it forces it to acquire commodity reserves in order to increase the money supply. Today the government can inflate asset bubbles without paying a cost for it because the currency isn't linked to the price of a commodity."

Stocks For The Long Run, v. 3

Ouch!
Clusterstock mentions that real returns following a market peak have been very different than after a bottom.
Stocks For The Long Run, v. 3:

"If you invested at the 1929 peak, it took 29 years for the value of your shares to recover in real terms; if you invested at the 1968 peak, it took 24 years.

The takeaways are: 1) dividends have provided the lion's share of long-term stock market returns; real capital gains have been comparatively modest; and 2) if you invest at a peak, you probably won't see a real capital gain for a quarter-century."

Yield Spreads point to bad economic times ahead

In good times even the majority of low rated firms can make their debt payments, but in bad times these low rated firms are the first to get in trouble. Investors know this and the spread between low rated and high rated debt gets larger when the economy slows.

Thus, it is more than a little troubling that the risk premium has grown to historic levels. From Barron's:

Current Yield - Barrons.com:

"THE STOCK MARKET IS PRICED FOR a recession, but the bond market is priced for a depression. So says Rob Arnott, the brainiac who heads Research Affiliates, an institutional advisory.

That's not hyperbole. Corporate bonds rated Baa or triple-B, the low end of investment grade by Moody's and Standard & Poor's designations, offer the biggest yield premium since the early 1930s, notes RBC Capital Markets.

That's a problem for pulling the economy out of the credit crisis, but an opportunity for investors."

Warren Buffett Interview

Clusterstock did it again. They found another really cool article. This is the transcript of Buffett on CNBC:

That Awesome Warren Buffett CNBC Interview (courtesy of Clusterstock):

"It's a tall order to get up at 5am and speak for three hours and never say anything that isn't wise, charming, or funny....Full three-hour transcript here (with minor deletions), courtesy of CNBC. If you don't have time to read it now, save it for the weekend."

A few quick of Buffett's quotes:

Two short ones:

"...you know, you only find out who's been swimming naked when the tide goes out. Well, we found out that Wall Street has been kind of a nudist beach"

"...the country will be doing far better five years from now than it is now, but it won't be, in my judgment, it probably won't be doing better five months from now."

and two longer ones:

On Fannie Mae and Freddie Mac:

"...they also had an added problem in that they had a dual mission. The government expected them to promote housing and the stockholders expected them to raise the earnings substantially every year. And as the years went by, they emphasized the latter more and more. They started talking about "steady Freddie," and Fannie Mae said, `We're going to increase the earnings at 15 percent a year.' Any large financial institution that tells you that sort of thing is giving you a line of baloney. I mean, they may do itfor a while, but when they can't do it with operations, they do it with accounting and they cheat."

and one last one on regulation and management:

"... managing complex financial institutions where the management wants to deceive you can be very, very difficult. Or even when the management doesn't know what's going on, and--just take Bear Stearns. Bear Stearns had--I read it, anyway--750,000 derivative contracts. Now, you know, I could clone Albert Einstein, you know, and--many, many times and have him work 12-hour days for me and he would not be able to keep track of what's going on in an institution like that. It's--the ones that are too big to fail may be too big to manage"

I do have one question for CNBC. Why would you make him go one so early in the morning? Make this prime time.

A look at volatility: Levels, Surprises, and History By Risk Metrics's Chris Finger

Doomed to Repeat it? Over at RiskMetrics, Chris Finger has examined the volatility of the US stock market for over one hundred years. While lacking any grand slam home runs, it is an interesting article for a number of reasons.

Short version:
It starts by breaking the time period into two periods (1940-1945, 1945 to present) and like other researchers the author shows that the volatility has in fact declined over time. Finger then makes forecasts of volatility and looks for surprise volatility events (that is when the forecast is off by a bunch). This is followed by an event study on volatility. True to form given the surprise definition the event study finds a "right angle" in increased volatility. And since volatility is not ever increasing, this spike in volatility declines back to the longer run average overtime. This may help to estimate the duration of current high volatility levels.

Some look-ins:

"the recent peak of 70% is extremely high, though lower than the spikes after the crashes in 1929 and 1987, when volatility jumped to 95% and almost 120%. Today’s level is comparable to what we saw in the early 1930s"

and

"With this large set of residuals...we choose a threshold, and compare how many residuals we actually see of this magnitude to what our assumed statistical distribution predicts. For instance, the t-distribution predicts that over the history in question (about 30,000 trading days), we should see between 29 and 49 days on which the market loss is a five-standard deviation event or greater; there are in fact 32 such days."

Because volatility had already been high (and high standard deviations of the residuals), this increase in volatility has not been that surprising since February 2007.

"Like these other crises, the current one seemed to have begun with a surprise—the 7.8-standard deviation loss in February 2007.....Since February 2007, however, despite all that has happened and the historic run-up in volatility, there have been no large surprises: the largest was the fall on September 29, 2008, the day the US Congress rejected the first bank bailout plan. This loss was one of the twenty largest ever, yet registered as only a 3.7-standard deviation event amid the already high volatility."

In other words, this increase in volatility has been more like a flood than a tsunami. It began raining in February 2007 has largely not stopped. While the author finds little evidence of similar patterns in the past [a very important fact given the difficulty/impossibility of forecasting off one data point], the one time this seemingly happened does not give great hope for a quick volatility decline:

"...volatility has risen in an orderly way, with no true surprises. The run-up in volatility in 1931 is the best example of this phenomenon, and in that case, volatility stayed elevated for quite a long time: it spent more sixteen months over 35%, during which time the index fell by 50%.

Good stuff. Go on and read the rest of it at RiskMetrics (and if you are in my class, be sure to note the figures too. A picture tells a thousand words and this may help you make sense of it quickly.)

Accounting changes are coming, and I feel fine

With all apologies to REM It's the end of the world as we know it, and I feel fine.

A New Vision for accounting:

"Some of the major changes under discussion: reconfiguring the balance sheet and the income statement to follow the three categories of the cash-flow statement, requiring companies to report cash flows with the little-used direct method; and introducing a new reconciliation schedule that would highlight fair-value changes. Companies will also likely have to report more about their segments...Meanwhile, net income is slated to disappear completely from GAAP financial statements, with no obvious replacement for such commonly used metrics as earnings per share."

As the replacement for EPS, let me suggest cash flow from operations per share.

Now the final product is far from done and there are many detractors. From the same article:

"FASB, working with the International Accounting Standards Board (IASB) and accounting standards boards in the United Kingdom and Japan, continues to work out the precise details of the new financial statements. ...If the standard-setters stay their course, CFOs and controllers at every publicly traded company in the world could be following Kelly's lead as soon as 2010... "

The article then goes on to say that many do not want to see the changes. for instance:

"December CFO survey of more than 200 finance executives, only 17 percent said the changes would offer any benefits to their companies or investors"

Of course there will be problems, but a move to more transparency and cashflow measures will be a good step. Sure the new reports will at first be more difficult to create and there will be more line items, but it is important to remember that managers and accountants have a large investment in the current system and as a bunch not known for being enamored with change.

Further, managers in particular often have a vested interest in preventing transparency so that CFOs and accountants are against the new changes may say less about the changes and more that they are just REMMS that do not want to lose their informational advantages.

Read the entire CFO piece here.


* Thanks to MBA Depot for pointing this one out to me! Oh and I know I have used the REM reference before, but figured I have to give Michael Stipe some credit since I have been accused of looking like him. I feel really sorry for him!

The End of Wall Street's Boom - National Business News - Portfolio.com

WOW!! Have some time? You may just want to drop whatever your plans were for this. It is that good. By Michael Lewis (he of Liar's Poker and Money Ball fame).

The End of Wall Street's Boom - National Business News - Portfolio.com: "The era that defined Wall Street is finally, officially over. Michael Lewis, who chronicled its excess in Liar’s Poker, returns to his old haunt to figure out what went wrong"

one and only one look-in:

"We always asked the same question,” says Eisman. “Where are the rating agencies in all of this? And I’d always get the same reaction. It was a smirk.” He called Standard & Poor’s and asked what would happen to default rates if real estate prices fell. The man at S&P couldn’t say; its model for home prices had no ability to accept a negative number. “They were just assuming home prices would keep going up,” Eisman says."

What a great writer. You simply have to go read it.

And a HUGE thanks to ClusterStock for pointing it out--and giving long excerpts. Longer than I am comfortable giving--it has quickly become a mandatory morning read for me.

SSRN-Modeling the Economic Effects of Bank Regulation and Supervision by Bilin Neyapti, Gonca Senel

This one sort of surprised me. Short version: banks and economies improve with supervision.

SSRN-Modeling the Economic Effects of Bank Regulation and Supervision by Bilin Neyapti, Gonca Senel:

"...reveals that the higher the RS [Regulation and Supervision], the higher are per capita output, wages and credit, and the lower are the interest rates. Moreover, simulations reveal that bank profitability is higher under monitoring and it is also more highly correlated with RS the higher the level of development"

The paper is my Neyapti and Senal:

Cite: Neyapti, Bilin and Senel, Gonca,Modeling the Economic Effects of Bank Regulation and Supervision(July 2008). Paolo Baffi Centre Research Paper No. 2008-32. Available at SSRN: http://ssrn.com/abstract=1284906

Is Now the Time to Buy Stocks? - WSJ.com

In class just the other day we talked about Efficient Markets and concluded that while markets are exceedingly difficult to beat on a risk adjusted basis, it does appear that as we learn more perfect efficiency in the sense of a random walk, is not really the case. So it is a great coincidence that in the Wall Street Journal there is the following by the University of Chicago's John Cochrane.

Is Now the Time to Buy Stocks? - WSJ.com:

"The correlation is obvious: When prices are low relative to dividends, subsequent seven-year returns are likely to be high. Stocks do not follow a "random walk." More deeply, price declines above and beyond declines in dividends over the following year have entirely rebounded. This finding is confirmed by 30 years of research, ranging from "behaviorists" such as Robert Shiller and Richard Thaler to "efficient marketers" such as Eugene Fama and Ken French, to "economists" such as John Campbell and myself. The same pattern also appears in price/earnings, book/market and other ratios, and in many other markets.

The interpretation is pretty clear too. In a recession, or following losses, many investors become more averse to holding risks. They want to sell. But we can't all sell -- a fact routinely ignored in much financial advice and commentary. Instead, prices must fall and prospective returns rise until some investors are willing to buy. Unsurprisingly, upward spikes in the dividend yield came in bad economic times.

Which means that there is some predictability in stock prices due to changing risk aversion levels that correlate with economic conditions. That is not to say that tons of people are correctly predicting these changes in aversion (and price levels) and does not change my view that largely passive investing (index funds or in some cases ETFs) are the way to go, but does help explain the long held view that stock returns tend to be too volatile relative to firms' dividends.

By the way the article also gives an always well placed warning:

"History is not a guarantee -- this time could be different."

The Lipstick index from NY Times

Pulse - Frown Fighters - Caption - NYTimes.com:

"...the Lipstick Index — that frivolous financial barometer that says cosmetics sales rise in direct relation to free-falling finances — has jumped."

From The Business Sheet:

"The gist is that women couldn't afford luxuries in the depression but wanted to buy something to treat themselves. Something small, cheap, and with a big impact. Lipstick. During the Depression sales went up"

Thanks to ClusterStock for this.