Can Talk of a Depression Lead to One? - News Analysis - NYTimes.com

Robert Schiller is a busy person! In the NY Times, he addresses the idea that constantly dwelling on the bad, becomes a self -fulfilling prophecy.

Economic View - Can Talk of a Depression Lead to One? - News Analysis - NYTimes.com:

"The attention paid to the Depression story may seem a logical consequence of our economic situation. But the retelling, in fact, is a cause of the current situation — because the Great Depression serves as a model for our expectations...reducing consumers’ willingness to spend and businesses’ willingness to hire and expand. The Depression narrative could easily end up as a self-fulfilling prophecy.

The popular response to vivid accounts of past depressions is partly psychological, but it has a rational base. We have to look at past episodes because economic theory, lacking the physical constants of the hard sciences, has never offered a complete account of the mechanics of depressions.

The Great Depression does appear genuinely relevant. The bursting of twin bubbles in the stock and real estate markets, accompanied by huge failures of financial institutions and a drop in confidence, has no more recent example than that of the 1930s....To understand the story’s significance in driving our thinking, it is important to recognize that the Great Depression itself was partly driven by the retelling of earlier depression stories. In the 1930s, there was incessant talk about the depressions of the 1870s and 1890s; each of those downturns lasted for the better part of a decade."

Dilbert on Gov't bailouts

Ok, technically it is Dogbert, but...

Short version, the top dog gets it all!

Thanks to Footnoted for this.

General Motors Lost $85 Million Every Day

For perspective from Clusterstock :

"Running General Motors is like lighting a $1000 bill on fire every passing second"

General Motors Lost $85 Million Every Day:

"GM's total loss for the fourth quarter of 2008 was $9 billion. It's hard to imagine any number that large, so we decided to break it down...Minute: $58,333 In short, with every passing minute GM loses slightly more money than the average American household makes in a year."

It really is hard to imagine.

Strategies - The Index Funds Win Again - NYTimes.com

Strategies - The Index Funds Win Again - NYTimes.com:

"Kritzman... set up his study to accurately measure the long-term impact of all the expenses involved in investing in a mutual fund or hedge fund. Those include transaction costs, taxes and management and performance fees....Then he calculated the average return over a hypothetical 20-year period, net of all expenses, of three hypothetical investments: a stock index fund with an annualized return of 10 percent, an actively managed mutual fund with an annualized return of 13.5 percent and a hedge fund with an annualized return of 19 percent. The volatility of the three funds’ returns — along with their turnover rates, transaction fees and management and performance fees — was based on what he determined to be industry averages.

Mr. Kritzman found that, net of all expenses, including federal and state taxes for a New York State resident in the highest tax brackets, the winner was the index fund....Expenses were the culprit. For both the actively managed fund and the hedge fund, those expenses more than ate up the large amounts — 3.5 and 9 percentage points a year, respectively — by which they beat the index fund before expenses.."

7 Courses Finance Students Should Take

We have a mid-term break next week at SBU. Then registration for the fall semester starts. Thus it makes sense to ask: What classes should a finance student take?
A current student (Brendan) forwarded me this. It is from Investopedia:

7 Courses Finance Students Should Take:

"Executives in search of well-rounded finance students look for certain skills, and studies have revealed that these executives want schools to place more emphasis on quantitative, strategic, critical decision-making and communicative skills - skills that are sometimes best developed in classes outside of business schools. If you want to get the best possible preparation for the finance world from your undergraduate education, put some thought into which classes to take that may fall outside the finance curriculum.... John Graham, a finance professor at Duke University's Fuqua School of Business and John O'Brien, finance professor at Berkley's Haas School of Business recommend the following areas of study:

1. Mathematics....
   
   
2. Accounting....
   
   
3. Economics...."

The rest of their list is here.

So what classes do you suggest?

My official list: Economics, stats and econometrics, much math (be it calculus, Linear Algebra, or whatever, it will help), a public speaking class, a writing or composition class, accounting, and computers (be it programming (the ability to think like a programmer is arguably more important than the language you learn), and writing. Oh and finance courses ;) .

That said, you should also try to learn in every class and in every encounter. For instance, in history, in foreign language classes, and even when listening to the radio. You can pick up financial insight. Which may be my biggest suggestion: learning finance does not stop when you leave the classroom. You should learn MUCH more out of the classroom than in. So whatever class you do register for (be it a required class, an elective, or if you are not registering for any class) take a look at it through financial eyes. Finance is all encompassing so you will be able to use that knowledge both in your career and your life.

Business leader David Campbell speaking at SBU

One of the better things about teaching at a University is that you constantly get new ideas and meet great people. This week we had David Campbell on campus. Who is David Campbell? From my announcement:

"Mr Campbell has also served as a member of the Board of Directors of Tektronix, M&T Bank, MRO Software, Gibraltar Industries, and PowerSteering software, and Niagara University and SUNY-Buffalo, as well as civic positions including Chairman of Roswell Park Cancer Institute Council, the Buffalo United Way campaign, and the Erie County IDA and Chamber.

Recognitions include an honorary doctorate from Niagara University, citizen of the year from The Buffalo News, and inclusion as a Fellow in the first year awards of the Purpose Prize.

He gave two lectures this week. The first which was aimed at the campus-wide audience focused on HODR, the benefits of volunteering, and the challenges of running a volunteer organization in challenging economic times. (The first speech is available on the BonaResponds blog.)

The second lecture was tailored to business students (and faculty!). He talks about the current economic problems (he thinks unemployment will go above 10%), governance, auditing, regulation, globalization, and what students (and others) can do to "wait out" the recession.




Both are very good. Thank you very much David! We really appreciate your visit!

REFLECTIONS ON A CRISIS Daniel Kahneman & Nassim Taleb, Moderated by John Brockman

Fascinating. Take a look at the video.

Edge: REFLECTIONS ON A CRISIS Daniel Kahneman & Nassim Taleb, Moderated by John Brockman:

"View the complete 1-hour HD streaming video of the Edge event that took place at Hubert Burda Media's Digital Life Design Conference (DLD) in Munich on January 27th as the greatest living psychologist and the foremost scholar of extreme events discuss hindsight biases, the illusion of patterns, perception of risk, and denial.....


Two men sitting on the stage. Left. Daniel Kahneman, 74, bright-eyed, Nobel Prize winner. Right Nassim Taleb, 49, former Wall Street banker, best-selling author. Both speak on the future of Digital Life Design Conference (DLD) in Munich on the financial crisis, about the beginning--mainly they talk about people. They say it is due to human nature, that the crisis has broken out. And they choose harsh words in discussing the scale of the disaster."

Thanks to Mark for this one! He used it in class today. Thanks for sharing!

Financial Quote of the day

"...outwardly and according to its balance sheer, the [Knickerbocker] Trust Company was flourishing..."

Herbert Satterlee


From the Panic of 1907: Lessons Learned from the Market's Perfect Storm by Robert F. Bruner (yes from Darden) and Sean Carr (also from Virginia)

Interestingly, this was the "panic" that resulted in a Fed. From Wikipedia:

"The resulting Panic of 1907 exacerbated an ongoing decline in the stock market that saw the Dow Jones Industrial Average lose 48% of its value from January 1906 to November 1907. The banking crisis is also seen as the final straw that led Congress to form the Federal Reserve System in 1913"

Shiller: House Prices Still Way Too High

As people across the globe hope that real estate prices are done falling, Yale's Robert Shiller suggests we may not be real close to the bottom yet.


From Clusterstock and from Financial Sense:

"The median value of a U.S. home in 2000 was $119,600. It peaked at $221,900 in 2006. Historically, home prices have risen annually in line with CPI. If they had followed the long-term trend, they would have increased by 17% to $140,000. Instead, they skyrocketed by 86% due to Alan Greenspan’s irrational lowering of interest rates to 1%, the criminal pushing of loans by lowlife mortgage brokers, the greed and hubris of investment bankers and the foolishness and stupidity of home buyers. It is now 2009 and the median value should be $150,000 based on historical precedent. The median value at the end of 2008 was $180,100. Therefore, home prices are still 20% overvalued. Long-term averages are created by periods of overvaluation followed by periods of undervaluation. Prices need to fall 20% and could fall 30%....."


Shiller's Interesting video discussing real estate prices. For instance, prices still well above average and a look at rental prices (which never went up much to start with):

Shiller House Prices Still Way Too High: Tech Ticker, Yahoo! Finance:

"Yale professor Robert Shiller stopped by recently to discuss Obama's housing fix, I also asked him about the housing market in general.

Specifically, where are we in this historic price collapse? Finally nearing the bottom?

Not a chance, said professor Shiller--unless the government finds some way to miraculously levitate prices again.

Despite the 25 percent nationwide decline since the 2007 peak, U.S. house prices have still only fallen halfway to fair value. So whatever you think of Obama's plan, don't count on a quick housing-market turnaround."

Oh, and lest you think Schiller is just some idiot financeprofessor, remember he called the internet bubble and the Real Estate Bubbles long before the general market collapsed.

After Losses, a Move to Reclaim Executive Paychecks - NYTimes.com

This will almost assuredly not happen, but it would the kind of ex-post settlement that we keep mentioning in class.

After Losses, a Move to Reclaim Executive Paychecks - NYTimes.com:

"...now, with a public backlash against excessive pay and taxpayer lifelines extended to crippled companies, the idea of recouping compensation, known as “clawback,” is gaining traction.

Currently there is no legal mechanism for forcing the regurgitation of past pay, so such efforts would need to be bolstered by new legislation. Clawbacks also promise to be a hot-button issue at shareholder meetings in coming months."

Endowment Director Is on Harvard’s Hot Seat - NYTimes.com

What goes up, sometimes goes down too!

Endowment Director Is on Harvard’s Hot Seat - NYTimes.com:

"....the endowment is on the verge of posting its biggest loss in 40 years. With much of its money tied up for the long term, it is scrambling to meet some obligations.

Harvard has frozen salaries for faculty and nonunion staff members, and offered early retirement to 1,600 employee.....

[Years ago] Lawrence H. Summers, then Harvard’s president, had raised the possibility of locking in interest rates that appeared to be at historic lows, a plan the university adopted....All went well at first. But in the second half of last year, interest rates plummeted, and Harvard turned to the endowment to meet hefty collateral calls, which could rise to $1 billion if rates remain weak....

The endowment was squeezed partly because it had invested more than its assets, a leveraging strategy that can magnify results, both good and bad. It also had invested heavily in private equity and related deals, which not only lock up existing cash but require investors to put up more capital over time. "

Now the overall portfolio loss (21%) really is not bad, so I am not sure what the hullabaloo is, but from a teaching perspective, seeing that cash needs must be accounted for and planned for is a valuable lesson (as is the effects of leverage).

SIMM is looking better and better!

Modified Internal Rate of Return

Spreadsheets at Work: Rating Your Own IRR - Technology - CFO.com:

"...might you be vulnerable to the weaknesses long pointed out — if too often ignored — by researchers who have warned that IRR calculations often contain built-in reinvestment assumptions that improperly improve the appearance of bad projects....the MIRR function permits both a finance and reinvestment rate to be associated with the stream of cash outflows and inflows in our investment evaluation example"

An article on MIRR (Modified Internal Rate of Return)!!??! Wow. Talk about your exciting articles. Yeah, ok, too much, but given anyone who is doing any capital budgeting (which is essentially everyone if you think about capital budgeting as nothing more than making decisions about what assets you want to have) should know the limitations of their tools (IRR in this case) and better technologies (MIRR in this case), it is a worthwhile read! Especially if you are in my classes since it now make MIRR and IRR instantly testable for any upcoming exam.

BTW it also has a really useful example that could be used in class.

A populist revolution?

A few weeks ago I commented to a friend that everyone seemingly was in a bad mood. We talked about it and figured it was in large part the result of a added stress from the poor economy. We speculated what would happen next and if people were already in a bad mood, how much worse might it get if this dragged on for years.

So now about two weeks later and already the stress is showing more and more. For instance, you probably saw what is being called the Rick Santelli's Tea Party. Here is the clip from CNBC:

Video - CNBC.com:

"CNBC's Rick Santelli and the traders on the floor of the CME Group express outrage over the notion they may have to pay their neighbor's mortgage, particularly if they bought far more house than they could actually afford,"

And here is the same from YouTube.




That was interesting. I did not expect a populist revolution led by people NOT wanting a mortgage bailout.

Then tonight I was listening to the radio and a new song by John Rich came on. It is entitled shutting Detroit down. The basic theme is that Wall Street got itself into this mess, and Wall Street can get itself out of this mess.




What is next? Class warfare?

Incidentally, The White House taking this seriously enough that he has invited Santelli to DC to talk about things. Wow.

http://www.cnbc.com/id/15840232?video=1041588591&play=1

Will there be any "green" in a Green Economy?

Not sure if this has much finance content. More of an editorial. Sorry, but I dislike when a major variable is left out of the analysis of things.


From Clusterstock: Green Economy Not Yet Ready For Primetime... But It Will Be Soon:

"The WSJ throws around some scary subsidy numbers, saying the government pays too much for renewable energy, and its still not cheap. The Journal says that if we try to hit Obama's mandate for 25% of our energy from renewables we will kill manufacturing. The high price of alternative energy means factories will go under as they struggle to pay the outsized electricity bills....The flaw in this argument is the time frame: Obama only wants to raise our current level of alternative energy consumption from 1% to 10% over the next four years. And then hit the 25% mark by 2025....Also, as long as we keep investing in green technology, technology improvements should rapidly reduce the cost of green power. In the next two years, for example, solar power could reach grid parity"

Let me state up front that I am biased. Not because of any stock holdings. Not because I have forgotten all of my economics (at least I hope not!) But because as a runner/cyclist/outdoors aficionado/citizen worried about the future, I really hope "The Green Economy" takes does well. Why? For a reason that both the WSJ and Clusterstock seemingly ignore: the externalities of traditional energy sources.

Externalities are those costs that the user of the product do not bear. For instance, I can drive around all day in a car that pollutes the atmsophere and yet most of that cost of pollution falls on others. Externalities are notoriously difficult to measure so often we assume them away. But they are real and in any economically correct discussion must be included.

All energy comes with costs. And it is definitely true that "Green" sources have externalities as well (locally there is a major controversey about wind power right now). But I believe (and this is something that can not be proven since we each may have different probabilities on future events) that the expected present value of the externalities from "Green" energy appear to be lower than those of other sources of energy.

Of course this is just my opinion and your mileage may vary.

To compare differing power sources, we really want to be comparing apples to apples and this is not being done.

The question that needs to be answered convincingly is whether government subsidies (which are easily measurable) are greater than or less than the the externalities (largely not measurable) that accompany more traditional energy sources?

What are these "difficult to measure" externalities? To name a few: pollution (carbon and other), reliance on oil from politically sensitive areas, drilling in pristine wilderness areas, risk of spills, poor diversification of supplies (if I could steal from Taleb "over optimized") which leads to excessive volatility etc.). These externalities are generally not priced in oil (and hence oil is priced "artifically" low), so oil is used more than is strictly optimal in an economic sense.

But "what about nuclear?" some may say. "Look at France. They use much nuclear and have had very few problems" And at some point these nuclear activists have a point. But while the unpriced costs are different, they still exist. The easiest is to understand is the risk of a catastopic event (meltdown etc.). Oh sure the odds are low, but remember Black Swans do happen. And the true cost of that has to be borne in advance.

Why should it be borne in the present you ask? Doesn't this appear to be very similar to the idea of paying large bonuses for good earnings when looming off in the distance was a financial meltdown? Only if the costs are considered a priori will be make the correct decisions. Or in simpler terms, just because something has not happened, does not mean it won't. And if it can, we have to include that in our decisions today.

[Here the reader can flash back a few years to an imaginary conversation at a large investment bank: "Look at Bear Stearns. They take big risks and are heavily levered and they have had very few problems. The cost of debt is lower than the cost of equity. Why don't we do the same? "]

So what should be do? I do not know. I do not think anyone knows for sure, but I will argue long and hard that externalities (both current and future) are as much a cost as the billions of dollars of subsidies for green energy and should be factored into any analysis. Otherwise we are comparing apples and kiwi fruit.