A look at whether futures market contracts inpact spot pricing

Interesting:

FRB: FEDS Abstract 2009-29:

"This paper finds no evidence that speculative activity in futures markets for industrial metals caused higher spot prices in recent years. The empirical analysis focuses on industrial metals with and without futures contracts.....

...comovement between metals with and without futures contracts has not weakened in recent years as speculative activity has risen.....This comovement is driven by economic fundamentals because world GDP growth is strongly correlated with metal price growth, especially after 2002. The structural change in 2002 is also consistent with supply and demand information found in industry newsletters.....

...final test follows storage models, which suggest that speculation can affect spot markets only if it leads to physical hoarding. Focusing on metals with established futures markets, I find no evidence of physical hoarding because inventory growth is found to be negatively correlated with price growth rates."

A few questions remain unanswered to me, but very interesting. This topic has been in the news a great deal lately.

Whose house is this? "He must know nothing about finance"

This is hilarious.

The Daily Show With Jon Stewart	Mon - Thurs 11p / 10c
Home Crisis Investigation
www.thedailyshow.com
Daily Show Full Episodes Political Humor Joke of the Day

Thanks to Greg Mankiw for the link via WayneMarr

House Panel Approves Restraints on Executive Pay - NYTimes.com

House Panel Approves Restraints on Executive Pay - NYTimes.com:

"The bill does not set pay limits. Instead, it gives shareholders the right to vote on pay and requires that independent directors from outside of management serve on compensation committees.

The shareholder votes would not be binding on company management.

The measure tries to reduce the potential conflicts of interest involving compensation consultants who play a central role in blessing pay packages. Many of those consultants also provide other services to the companies, putting them in a conflicting role for issuing fairness opinions about pay."

SSRN-House Prices and Fundamentals: 355 Years of Evidence by Brent Ambrose, Piet Eichholtz, Thies Lindenthal

As a part time landlord, I will definitely agree with this this one. I am not sure the reason, but rent prices take much longer to adjust than do real estate prices. Now we have 355 years of data (amazing btw) to back up that statement.

SSRN-House Prices and Fundamentals: 355 Years of Evidence by Brent Ambrose, Piet Eichholtz, Thies Lindenthal:

"This paper examines the long run relation between prices and rents for houses in Amsterdam from 1650 through 2005. We first demonstrate that these series are cointegrated, a necessary condition for studying movements of the rent-price ratio. We then estimate the deviation of house prices from fundamentals and find that these deviations can be persistent and long-lasting. Lastly, we look at the feedback mechanisms between housing market fundamentals and prices, and find that market correction of the mispricing occurs mainly through prices not rents. This correction back to equilibrium, however, can take decades"

YouTube - Inflation or Deflation?

Ok, another song. I had never hear this one either. Pretty funny but so bad. LOL. By Merle Hazzard and Bretton Woods. lol.

YouTube - Inflation or Deflation?: "Inflation or Deflation? "



BTW if you can decide between inflation or deflation, vote on the front page of FinanceProfessorblog.blogspot.com

H-E-D-G-E song

No one will ever confuse this with a country classic, but it is very funny and actually is all about finance.



Thanks to PlanetMoney for the tweet.

Rethinking Brownian Motion With The 'Emperor's New Clothes'

Thinking back to the classes that covered this, I NEVER thought Brownian Motion would be interesting but this is.....


Rethinking Brownian Motion With The 'Emperor's New Clothes':

"'Like Einstein, we used to think we could describe Brownian motion with a standard bell-shaped curve,' Granick said. 'But now, with the ability to measure very small distances much more precisely than was possible 100 years ago, we have found that we can have extremes much farther than previously imagined.'

....there were many features in full agreement with Einstein and the bell-shaped curve; but there were also features in significant disagreement. In those cases, the beads moved much farther than the common curve could predict. In those extreme displacements, diffusion behavior was not Gaussian, the researchers report. The behavior was exponential.

"These large displacements happen less often, but when they do occur, they are much bigger than we previously thought possible," Granick said."

Told you it was interesting!

Bernanke Feared a Second Great Depression - WSJ.com

Bernanke Feared a Second Great Depression - WSJ.com:

"Federal Reserve Chairman Ben Bernanke on Sunday said he engineered the central bank's controversial actions over the past year because 'I was not going to be the Federal Reserve chairman who presided over the second Great Depression.....

And later:

"Mr. Bernanke responded that "nothing made me more frustrated, more angry, than having to intervene" when firms were "taking wild bets that had forced these companies close to bankruptcy."

More than 20 people asked questions...on topics ranging from bailouts to mortgage-regulation practices to the Fed's independence....Mr. Bernanke suggested that a movement by lawmakers to open the Fed's monetary-policy operations to audits by the Government Accountability Office is misunderstood by the public....

"I don't think that's consistent with independence," he said. "I don't think people want Congress making monetary policy."

Is Your iPod Unpatriotic? Why America Shouldn't "Buy American"

A well-done piece showing the silliness of trying to only "Buy American" on many(indeed most) items. As much as some may not like it, it is an integrated world.

(Uh I should worn you, their are bikini clad women (and one man), not sure if you want to watch at work or not.)


YouTube - Is Your iPod Unpatriotic? Why America Shouldn't "Buy American":

"Is your iPod unpatriotic? Its 451 parts are made in dozens of nations, and creating the little doodads employs thousands of foreigners."

Can Lance Armstrong Save RadioShack?

If you missed it this week, Lance and Radio Shack teamed up for next year.

Yes this is the same RadioShack that the Onion lampooned back in 2007 joking that even their CEO can't understand how they are in business.

So can Lance turn their fortunes around? What does the market think? There was no impact on the announcement of the deal (12:00 on Thursday) which was timed to correspond with the finish of the final time trial stage of the Tour de France.

BUT then yesterday it was up over 10%. There was news on the day: an upgrade and a new deal with T-Mobile that may have affected it. Or was it that small investors (cyclists?) take more time to trade? Only time will tell.

Here is a finance article (ok, at least a business article) from Bicycling.com that addresses some of the same issues.

Boulder Report » Blog Archive » Can Lance Armstrong Save RadioShack?:

"But the upsides aren’t quite as crystal clear for RadioShack. The company’s fortunes have been slowly sagging - along with its stock price - for almost a decade.

The stock itself peaked at $76.62 a share in November…of 1999....It trades now for $14.67 per share. That’s up over 100 percent from a March 9 low of $6.47, but well below its last peak, in June 2007, at over $34 a share.

....But stock prices and short interest are not the problem; rather, they represent the real problems the company faces.

For years, RadioShack has had an image as a somewhat dowdy retailer of necessary but unsexy items, including a whole roster of small electronics components whose purposes are dimly understood outside of a small subset of tinkerers."

Don't bet against Lance

As we've seen first when he came back from cancer to win 7 tours, and then again this year when he showed not only great marketing savvy and a strong base of support (he has over a million followers on Twitter alone) but also amazing determination when he came back from a three year absence AND a broken collarbone as one of the oldest riders in the Tour to get a podium finish (which he basically assured less than an hour ago on the slopes of Mont Ventoux), most people do not get rich betting against Lance.

Either way it will be a great case study (for marketing if not finance) to follow. Stay tuned!

Seven banks were closed today. Is that a big number?

I just tweeted this but I am so amazed I have to report it here too.

Seven banks failed today. That is more the same number as were reported on July 2. But for a recent history perspective it is quite high.

Indeed from January 1 2000 to December 31, 2008 53 banks failed.

Data from FDIC

Bank Failing July 24, 2009: 7

Bank Failings per year

2000 02
2001 04
2002 11
2003 03
2004 04
2005 00
2006 00
2007 03
2008 26
2009 64*

All numbers annual except 2009 which is through July 24/2009.

From this relatively short term perspective, the number of failed banks looks quite large.

HOWEVER, from a longer term perspective this number is quite small. In the late 1980s, this number was above 500 per year!


From BestCashCow



So while the banks may be larger this time around (although today's were quite small), from a historic perspective, today's bank number of bank closings was not all that great.


* Note these numbers have been corrected from those I reported on twitter originally (I wrote down 58 not 53 for the 2000-2008 period).

Did Goldman learn anything? Did shareholders?

Asymmetric and short-term oriented pay packages have largely been seen as major causes of the financial meltdown we saw last year. So since everyone has seen the problems, we are no longer going to pay people in the same manner. Right? Well, hold on, not so fast.

First from the NY Times:

"Goldman posted the richest quarterly profit in its 140-year history and, to the envy of its rivals, announced that it had earmarked $11.4 billion so far this year to compensate its workers. At that rate, Goldman employees could, on average, earn roughly $770,000 each this year — or nearly what they did at the height of the boom."

Now it should be noted, that the firm has not said what they are doing with all of this money that is being set aside, but it does seem like a potential problem.

In the WSJ, Harvard's Lucian Bebchuk stresses the short-term focus of plans. (Remember the firm was losing billions last year).

"...if Goldman proceeds to pay record cash bonuses this year, as many now expect, these payments would reflect a return to flawed pay structures, as well as a failure to implement effectively the compensation principles Goldman recently put forward....The crisis has highlighted a substantial flaw in compensation structures that provide rewards for short-term performance – which is what Goldman’s paying super cash bonuses for 2009 would do. Such rewards can over-compensate executives as well as produce excessive incentives to take risks."

On the same theme later:

"The short-term distortion caused by standard compensation structures, ...highlighted in our “Pay without Performance” book, has recently become widely accepted. Treasury Secretary Geithner stated last month that “[s]ome of the decisions that contributed to this crisis occurred when people were able to earn immediate gains without their compensation reflecting the long-term risks they were taking for their companies and their shareholders.”"

What can be done? Bebchuk suggests a partial solution that is being used by some firms:

"At a minimum, even if some bonuses are based on 2009 results alone, Goldman would do well to prevent the immediate cashing out of these bonuses....any 2009-based amounts should be parked in a company account for an extended period of time and adjusted downward if subsequent information indicates that the basis for the bonuses no longer holds up."

This piece brings to mind two cliches which I will allow the reader to apply as needed:

1. "Fool me once, shame on you. Fool me twice, shame on me."
2. "Learning from our past mistakes is a sign of intelligence."

BTW the article is also largely available on the Harvard's Governance blog.

Banning ‘Naked’ Default Swaps May Raise Corporate Funding Costs - Bloomberg.com

What's next? No "Skinny Dipping?"

Ok, before I get fired, let me explain. Naked trading is when a speculator trades a derivative security without a position in the underlying asset. For instance, if I were to short a corn futures contract, I would be "naked" since I do not own corn to sell. So prior to settlement I either have to buy back the contract or purchase corn to cover the trade. (The other type of position is covered which is when you do own the underlying asset).


Banning ‘Naked’ Default Swaps May Raise Corporate Funding Costs - Bloomberg.com:

"A ban on “naked” trading in the $26.4 trillion credit-default swaps market being considered by U.S. lawmakers would have the unintended consequence of making it more expensive for companies to borrow, traders said...."

more from the article:

"Credit-default swaps were created as a way for corporate lenders and bondholders to protect themselves from defaults. Naked swaps, where the investor doesn’t own the debt on which the contracts are based, have proliferated in the market and may be prohibited under legislation being drafted by House Financial Services Committee...."

Why?

"Credit-default swaps were used by American International Group Inc. to bet on residential mortgage debt, driving the insurer to the brink of bankruptcy when it couldn’t come up with collateral as prices plunged, and regulators have blamed the market for exacerbating the financial crisis. "

additionally many have argued that naked Credit Default Swaps create an misaligned incentives. Some have compared them to buying life insurance on another person. If you buy too much you might have the incentive to hire a local hit-(wo)man.

For instance William Buiter writing in the FT:

"The obvious reason for limiting my capacity to take out insurance on the life of a complete stranger (whose life presumably has little intrinsic value for me) is moral hazard - what I will call micro-level endogenous risk. If the stranger’s life is insured for a sufficiently large amount, and if I can overcome the internal resistance of conscience and ‘thou shalt not kill’, I could arrange to have the highly insured stranger bumped off. When the probability of the insured-against contingency occurring is not exogenous, but can be influenced by the party purchasing the insurance, and if this cannot be verified and deterred by the party selling the insurance or by the forces of law and other and of contract enforcement, we have moral hazard."

If the position is great enough a naked CDS position would create a similarly bad moral hazard problem.

So what is the cost associated with banning naked trading?

CDS are not all bad. They do allow banks to offset default risk. They thus make borrowing easier and cheaper.

If naked trading forbidden, the ban would almost assuredly reduce liquidity and thus make it costlier for lenders to offset default risk.

Again from the Bloomberg article:

"...making it costlier for investors to hedge their stakes, said Robert Pickel, chief executive officer of the International Swaps and Derivatives Association, a New York-based industry group that sets rules and guidelines for the market....“Having people who are in there speculating adds liquidity and depth to the market so that anybody who is a pure hedger,...can tap that market and know they have a deep and liquid market...."

To turn back to the corn example, suppose that only farmers and large corn consumers ("bakers" in a typical in class example) were in the market. When a farmer went to trade, there might not be a liquid market so (s)he may end up selling at a lower price (of course it also works the other way and the baker may end up paying more). This makes hedging more expensive, and at the margin, would be likely lead to fewer farmers hedging which would be expected in the long run lead to fewer farmers period, and hence more expensive corn.


This is a particularly important issue since most participants in the Credit Default Swaps market are naked.

"As much as 80 percent of the credit-default swap market is traded by firms that don’t own the underlying debt, Eric Dinallo, the former superintendent of the New York State Insurance Department, estimated in a January interview."

Now the world won't quit spinning one way or the other, but that liquidity would be less seems a very logical conclusion.

And if you want more to chew on, consider this WSJ piece that reports that these new rules might be used in more markets than just credit default swaps.

Buffett’s Goldman Stake Pays Richly - DealBook Blog - NYTimes.com

Buffett’s Goldman Stake Pays Richly - DealBook Blog - NYTimes.com:

"Mr. Buffett’s stake in Goldman is now worth $9.1 billion, or about $4.1 billion more than what he paid 10 months ago, according to an analysis by Linus Wilson, an assistant professor of finance at the University of Louisiana at Lafayette.

According to Mr. Wilson’s calculations, Mr. Buffett would realize an annualized return of about 111 percent if he sold his Goldman stake, which is held by his conglomerate Berkshire Hathaway.

In comparison, the federal government received a 23 percent annualized return for its Goldman investment, the bank said after it agreed on Wednesday to pay $1.1 billion to settle warrants the Treasury Department received after injecting $10 billion into the bank in November."

And added bonus in this article is it briefly discusses how to value warrants (price the option but realize you must adjust dilution).

"Wilson...ascribed a $5.5 billion valuation to Mr. Buffett’s preferred shares and $3.2 billion to the warrants.... The valuation of the warrants was based on Goldman’s closing share price of $160.46 on Wednesday and the 10-year historic volatility of the shares. (For financial wonks, Mr. Wilson used the Black-Scholes and Merton option pricing models with the dilution adjustments of Galai and Schneller.)

BTW I am currently ristening to Snowball and definitely recommend it. I have been amazed at how similar the Goldman deal was to his Salomon deal back in the early 1990s. The book is well done financially (talks about Junk Bonds days, takeovers, spin-offs, etc) and I have learned a great deal about Buffett.

It also has good "class examples" and trivia. For instance, did you know that Warren owned a farm while in High School? Or that when growing up he considered the cost of an item not how much it cost now, but what he would be giving up in the future after the money grew--I mention that since I used to do that too. Alas the similarities stop before getting to my wallet. lol.

Total Disclosure: BonaSIMM (to which I am the faculty leader) has a stake in Goldman. It is however, a bit smaller than Mr. Buffett's.