An Airline Shrugs at Oil Prices - New York Times

An Airline Shrugs at Oil Prices - New York Times:

"Southwest owns long-term contracts to buy most of its fuel through 2009 for what it would cost if oil were $51 a barrel. The value of those hedges soared as oil raced above $90 a barrel, and they are now worth more than $2 billion. Those gains will mostly be realized over the next two years. Other major airlines passed on buying all but the shortest-term insurance against high fuel prices..."

That other airlines were not hedging (or at least not hedging long-term) has been one of my pet peeves going back as far as the newsletter days. Sure it costs money to hedge, and sure is not without some risks (see for instance this story on what happened when oil prices fell), but hedging makes too much sense not to do.

How does hedging work? Why? The best explanation I have ever seen comes from an old Corporate text book I once used by Rao (do not think it is still in print and I can not find my copy). In it he described how hedging allows management to worry about what they do well and can control (service, pricing, safety etc) and not what they can not control (oil prices in this case).

An other view (the two views are definitely NOT mutually exclusive) is that hedgers have both better access to capital markets and less need to go when the asset (oil) moves in teh 'wrong' direction. My favorite paper in this area has long been Carter, Rogers, and Simkins.

Of course that said, all of the good I can say about hedging goes out the window if firms use the same derivatives to speculate.



Thanks to Felix over at Conde Nast's Porfolio.com for the heads-up on this one.

Do International Financial Reporting Standards Live Up to Their Promise? - Knowledge@Wharton

Do International Financial Reporting Standards Live Up to Their Promise? - Knowledge@Wharton:

"Under the lead of the International Accounting Standards Board (IASB), already more than 100 countries, most notably the European Union and many Asian economies, have either implemented International Financial Reporting Standards (IFRS) or plan to do so. So far, the United States has been a holdout. But the winds are changing. On November 15, 2007, the U.S. Securities and Exchange Commission (SEC) -- which up to then was requiring foreign companies to either report using Generally Accepted Accounting Principles (GAAP) or to reconcile to them -- announced that it would promote international compatibility by allowing foreign companies to access U.S. capital markets while reporting under IFRS. At the same time, the SEC is contemplating changes that would grant domestic firms the choice between reporting under GAAP or IFRS."

This change would lower reporting costs by making reporting more consistent.

Is this positive or negative? Probably positive if we can extend the evidence from a new paper by Daske, Hail, L, and Verdi. The authors

"analyze the effects on market liquidity, cost of equity capital and Tobin's q in 26 countries using a large sample that includes over 3,800 first-time adopters [and] find that market liquidity increases around the time of the mandatory introduction of IFRS. The results for firms' cost of capital are mixed but there is evidence indicating an increase in equity valuations. Partitioning our sample, we find that the capital-market benefits exist only in countries with strict enforcement regimes and institutional environments that provide strong reporting incentives."

While it will be interesting to see if the same impact is felt in the US (my guess is we won't as we already have a strong accounting system--but maybe some through reduced accounting costs?), but we will see soon enough). See, accounting and finance do go together very nicely.

The Subprime Drama Continues, but for How Long? - Knowledge@Wharton

Wharton's Knowledge@wharton has a good discussion with Richard Herring on the continuing developments in the real estate and sub-prime lending markets.

The Subprime Drama Continues, but for How Long? - Knowledge@Wharton:

"Has the crisis run its course? Knowledge@Wharton asked that question and several more to Richard Herring, a professor of finance at Wharton and co-director of the Wharton Financial Institutions Center. Herring spoke recently at a meeting in Rome about 'the darker side of securitization.'"

Thanks DH!

Private placements

Another financial instiitution that had had major writedowns gets a cash infusion.

Bloomberg.com: Worldwide: "-- E*Trade Financial Corp., the U.S. discount broker grappling with mortgage losses, will get a $2.55 billion cash infusion from a group led by hedge-fund manager Citadel Investment Group LLC."

This is on the heels of Citi getting $7.5 Billion from Abu Dhabi.

"Investors seem delighted that Abu Dhabi is injecting $7.5 billion into Citigroup, bidding up stocks in general on new confidence that the mortgage solvency crisis might ease. "

Several items of note (BTW these are great for class! Hint hint ;) ).

1. Originally (with the writedowns) leverage ratios had gone up dramatically. Assets had been slashed while debt was largely the same. As this happened, financial distress costs rose.

I have talked to a few investors who had taken that portion of their portfolio above the SIPC's insured $500,000 out of E-trade.
E-trade CEO even acknowledged this in his released statement:

" `This capital infusion will restore investor and customer confidence in the company...' ''

Note to my classes, why? What could this have done to E-Trade? Since it is almost December I will give you a bonus hint: think It's a Wonderful Life!

2. The stock market reaction to these private placements is generally positive at least in the short run. . That much is well known. What is less understood is the "Why". Some of it of course is the reduction of these agency costs, but not all private placements take place in this crisis environment and they are still met with positive (albeit less positive) reactions.

My favorite explanation is that when people who have better information do something, I would be smart to follow their lead. This information hypothesis story goes back at least as far as Wruck's 1989 paper (he also mentions monitoring) and has received quite a bit of support--e.g. this 1999 paper by Goh, Gombolo, Lee, and Liu).

There is another version however. For at least some private placements, the new investors are more apt to be active in monitoring management. This version is consistent with much of what we see in private equity firms as well.

It is undoubtedly true that in some cases monitoring improves, but it often is troubling since a private placement is usually done by management (and not always in a time of need). Why would management actively seek out investors to make their lives miserable.

A recent paper by the late Michael Barclay with Cliff Holderness and Dennis Sheehan (three professors who I owe a great deal of my financial learning both at Penn State and Rochester) further questions this monitoring hypothesis and shows that it can be overstated since often the new investors are passive.

Further antecodal support for the information explanation is that (at least in the resolution of these major financial events) there appears to be a fairly strong industry effect at times when things look bad. The intuition is that these private investors are not just buying the firm, they are also buying into the industry.
(a fascinating version of this is by Besley, Kohers, and Steigner) who actually find a negative reaction in good times (the monitoring may make firm X a stronger competitor) but a positive reaction when in a bear market.

4. Firms do try to get back to their target debt levels. Publicly issuing equity can take months and is generally associated with a stock price decline, so privately placing equity is often a faster (and more positive!) event.

5. And finally, Ben Franklin had it right when he said "Necessity never made a good bargain." The new investors (especially at Citi) seemingly got a pretty good deal. From the Fool.com:

"In general, Wall Street was relieved to hear about the Abu Dhabi Investment Company's infusion, which will boost Citi's ratio of cash to debt and, in turn, make Citi stronger financially. Once the equity units Abu Dhabi bought are converted into stock in 2010 and 2011, Abu Dhabi will hold a 4.9 percent stake in Citi. Until those units get converted, Citi will pay Abu Dhabi a yield, or essentially an interest rate, of 11 percent."

From the NY Times's Dealbook on the ETrade deal:

"Citadel is getting E*Trade’s portfolio for a cut-rate price: It is paying $800 million for assets that had a book value of $3 billion. E*Trade said Thursday it is taking a $2.2 billion haircut on the transaction."

SSRN-Do Buyouts (Still) Create Value? by Shourun Guo, Edith Hotchkiss, Weihong Song

I do not have time to really comment on this one, but I did find it very interesting. I'll try to add some to this later, but at least I can point it out and quote the abstract.

SSRN-Do Buyouts (Still) Create Value? by Shourun Guo, Edith Hotchkiss, Weihong Song:

"For a sample of 176 buyouts completed between 1990 and 2006, we show that these deals are somewhat more conservatively priced and lower levered than their predecessors from the 1980s, but that the deals still impose substantial default risk on the firms. For 89 of these LBOs with post-buyout data available, we find that gains in operating performance are either comparable to or exceed those observed for benchmark firms matched on industry and pre-buyout characteristics....Returns to either pre- or post-buyout capital invested are significantly positive for the sample overall, and are positive for all outcome groups except those ending in a distressed restructuring. Returns to post-buyout capital are greater when the deal is financed with a greater proportion of bank financing, or when there is more than one private equity sponsor involved in the deal, consistent with increased monitoring by these providers of capital."

Fed to Inject $8 Billion to Lubricate Economy - New York Times

Fed to Inject $8 Billion to Lubricate Economy - New York Times:

"Seeking to reassure banks amid the continuing credit crisis, the Federal Reserve said yesterday that it would provide $8 billion in funds to ease concerns about lending during the holiday season.

The $8 billion — essentially a low-interest loan to the nation’s banks — will be issued Wednesday and repaid Jan. 10. The 43-day loan period is the longest in three years for this type of year-end injection. While it is not an unusual step for the Fed, the injection usually takes place later in the fourth quarter and involves a smaller amount. In 2005, the last time the Fed issued year-end funds, it issued 28-day repurchase agreements for $5 billion, starting Dec. 8."

I may NEVER say this again (it really was not my favorite class--sorry Rich ;) ), but I wish I were teaching Money and Banking right now.

BonaResponds "commercial"

My day job is a financeprofessor, but what most on campus know me for is my role in BonaResponds. In that light, you can call this an agency cost problem if you must, but here is an unpaid for advertisement...

Help BonaResponds While Shopping!

Ok, this is easy. All you have to do is click through this link and then shop at any of 100s of stores (Barnes and Noble, Best Buy, Buy.com, Ebay, even Wal Mart, Hotels.com, Travelocity, Verizon, etc etc. (scores and scores of retailers in all categories!)

Just type in BonaResponds as your charity (in their terms who do you Goodsearch for) and then shop like you would anyways. The retailer will donate a portion of the sale (generally about 3%, but in some cases 5%, 9%, or even 25%) to BonaResponds!!

Support BonaResponds here


And if you are curious about what BonaResponds does, checkout BonaResponds.org. Or better come volunteer with us. You will love it, and if you want we can even talk finance (I actually have two students who are are going in January who have asked me to cover material in the van! So we will be doing international finance and derivatives on the drive down and back in my van.)

I think someone has been spying on our Faculty meetings!

Somehow the Unknown professor has been spying on our faculty meetings. He has to have been. There is no way he could have had so many items EXACTLY correct! LOL... Hi is starting a faculty meeting Bingo--the games won't last long!

Seems like Bonuses won't suffer as much as most expected

Bloomberg.com: U.S.:

"Securities firms typically use slightly less than 50 percent of their revenue to pay salaries, benefits and bonuses....Year-end bonuses usually account for about 60 percent of compensation. In the first nine months of 2007, Goldman, Morgan Stanley, Merrill, Lehman and Bear Stearns told their shareholders that they set aside $52.4 billion for compensation, up 9 percent from a year earlier. For the whole year, the figure rises to $62.5 billion...The total increases when bonuses for employees at hedge funds, leveraged buyout firms and banks such as New York-based JPMorgan Chase & Co. and Frankfurt-based Deutsche Bank AG are included. The industry's bonuses are larger than the gross domestic products of Sri Lanka, Lebanon or Bulgaria. The average $201,500 bonus is more than four times the $48,201 median household income in the U.S. last year, according to U.S. Census Bureau statistics."

Congratulations to Robert Strong!

The University of Maine - News - November 16, 2007 - Carnegie Foundation Names UMaine's Strong 2007 Maine Professor of the Year:

"Robert A. Strong, a University of Maine professor of finance, has been selected as the 2007 Maine Professor of the Year by the Carnegie Foundation for the Advancement of Teaching and the Council for the Advancement and Support of Education (CASE.)"

A very good choice. Congratulations! (and note, he is a Penn State Alum :) )

The Sums of All Parts: Redesigning Financials - Accounting - CFO.com

Look for changes in financial statements soon:

The Sums of All Parts: Redesigning Financials - Accounting - CFO.com:

" ...another large step towards the most dramatic overhaul of financial
statements in decades, the Financial Accounting Standards Board Wednesday laid
out a series of subtotal figures that companies would be required to include on
their balance sheets, income statements and cash flow statements. The new look
for financials will break all three statements into five general categories:
business, discontinued operations, financing, income taxes, and equity (if
needed). "

Fannie Mae's credit losses still in doubt - Nov. 16, 2007

Well that didn't take long. The day after I speculated with zero evidence of the nightmare that would exist if one of the big agencies got into trouble, Fortune had the same idea but they backed it up with the troubling accounting game that Fannie Mae apparently was playing:

As usual when you try to hide something on investors, they tend to get annoyed and more distrustful. The result? A falling stock price.

Fannie Mae's credit losses still in doubt - Nov. 16, 2007:

"In announcing quarterly results Nov. 9, Fannie Mae (Charts) used a different methodology for calculating its credit-loss ratio -- one that had the effect of making the ratio appear more reassuring to investors than it is. In response to investor concerns about the change, first reported this week on Fortune.com, Fannie Mae executives held a conference call with analysts Friday morning that did little to placate investors. Fannie Mae shares fell $2.32, or 5.39%, Friday. The company's stock price has plunged 17% since Fortune revealed the change in disclosure in a story posted online Wednesday"

Steven Levitt Lecture

at the Steven Levitt lecture,
originally uploaded by FinanceProfessor.

I took a small group to the Steven Levitt(of Freakonomics' fame )Lecture at UB this week. I will give you some highlights soon.

Weird going to an academic lecture (more or less ;) ) in a basketball arena and having the crowd feel like a basketball game.


A few thoughts: overall VERY interesting.

Random comments and notes from the Levitt Lecture in Buffalo.

Before: Seems weird going to an academic lecture in a basketball arena with a few thousand others. Interestestingly a large portion of the audience were high school students which proves something for about economics but I am not sure what. Some possibilities:

1. they have a lower opportunity cost of time than others
2. demand curves slope down and they were offered free tickets.
3. They were told to go by their teachers and thus had more of an incentive

The first speaker was a high-up at UB (I think VP of academic affairs at UB—I THINK) who was good. His best line was: “only by asking the right questions can world make sense.” (or something like that).

The second speaker was Issac Ehrhlich. He spent most of the time introducing Levitt. His best line: “He [Levitt] proved that economics is not the abysmal science it had been known as.”

Levitt then came on. Some of his comments:

• “Incentives are at the heart of what economists do.”
• He then told the story of John S___ an IRS employee who caused 7 million children to disappear. No, he was not a mass murderer but it was his idea to mandate Social Security numbers for children on parents’ tax returns to qualify for deduction. Many had been lying to get the deduction. With this rule change they could not do it anymore. Makes the IRS about $2B per year! One great idea. Unfortunately for him, he worked in government and was not well paid for the idea: he had to fight (and get congressional help) to get a bonus of $25,000.
• His mom was a psychic. His dad was a doctor specializing in “internal gas”. He then told the story of how he chose to get a PHD in Econ and his math difficulties (indeed his story of his first PHD math class was not unlike mine. Only difference is that he overcame his problems ;) )
• His dad told him if he could not compete against smarter competition “in real economics”, choose a niche that others do not want and excel there.
• His favorite story in Freakonomics is that of the drug dealers (See video below).
• Altruism may or may not increase utility, but the research into altruism definitely showed that people care of how they appear to others.
• My favorite story was about his new work on prostitutes. He said that the world’s oldest profession may also be the world’s worst. Big risks, little money etc. He had a prostitute speak to his class. Had to pay her out of own pocket as paying for a prostitute is frowned upon. Among findings: probably more likely to have sex with a police officer than be arrested by one. The type of “service” has changed over time as premarital sex has become more common. Now take the “weird stuff” to prostitutes (Gary Becker thought that up—I might add internet as well—or so I hear!).

Q&A (others Questions were left out)

• Q. On Trickle down economics. (person clearly wanted to hear it did not work)

A. Tough question. Tradeoff between a bigger pie and more equality. Lower taxes do increase economy but also inequality. In the end “we really do not know”.

• Q. How do you come up with some of your metaphors?

A. Having a mom as a psychic who channels dead people and a father who studies intestinal gas really created an atmosphere where anything was ok. This cuts down on his self-censorship.

• Q. On Health Care:

A. Health care is tough. For some reason people expect it for free. Health care not really different. If you want it, you pay for it. Healthcare is a hige share of GNP, but we do get a lot for it….somehow need to encourage innovation. For instance years ago people expected polio to take up large percentage (30%) if healthcare costs. Then vaccine. Polio costs fell. But now it is difficult to keep patents etc, so vaccines are less profitable, so less of an incentive to develop new ones.

Here is an example of what it was like. This was from a few years ago, but VERY VERY similar to what he did. Some of it even in the same words.

Interesting history lessons

Yeah this is probably sort of trivial, but I love history and finance so the combination of the two is too good to pass up. This is on the 1920s. It shows the how the stock market worked with specialists at posts and how the ticker tape was created--the video of order confirmations is fascinating and reminscient from my mental picture of Orwell's 1984), the risks of buying on margin, and the crash of 1929.