Airlines Lose Their Jet Fuel Credit Lines

Posted on May 28, 2008 by Felix

Another nail in the (legacy) airline industry’s coffin:

A credit controller at a leading European multinational oil company told The Times that the oil industry was moving to jet fuel prepayment. “It’s common in the US and it is moving to Europe. We have been moving to prepayment since Swissair went bust.”

The need to put up money before delivery of fuel is a huge financial burden that has been shifted from the oil companies to the airlines. According to John Armbrust, a US jet fuel consultant, the oil industry had $5 billion (ߣ2.5 billion) of jet fuel credit outstanding to airlines before the 9/11 terrorist attacks. Now they are demanding that airlines leave cash on deposit.

This is much bigger than the holdback issue. When I was writing about holdbacks, I said that they were "one of the three most important relationships that an airline has: the other two are with a global distribution system, for ticketing, and with a jet fuel supplier." Of the three, the jet fuel relationship is clearly the most important, from a cashflow perspective – and now US airlines are having to pay for their jet fuel in advance, rather than only having to pay for it 14 or 21 days in arrears.

There’s nothing here that can be solved by meddling ineffectually with charging for checked baggage. This is a big, central, and pretty much intractable problem – one which won’t be resolved in the foreseeable future unless and until jet fuel prices fall dramatically. And I’m not holding my breath for that to happen.

(Via SAR)

Posted in economics, travel | Comments Off on Airlines Lose Their Jet Fuel Credit Lines

ETFs Go Global

Posted on May 28, 2008 by Felix

It’s taken long enough, but finally Barclays and Vanguard are offering genuinely global ETFs:

the iShares MSCI ACWI fund, and the

Total World Stock fund, respectively. (The latter’s launching next month.) This is great: rather than having to laboriously construct a global stock portfolio, you can just buy one ETF and be done. They’re clean, they’re simple, and, according to Rob Wherry, they’re controversial:

The problem is these ETFs follow static indexes that, more or less, will always own the same countries, sectors and stocks. That means investors can’t pick and choose the spots they want to avoid or own.

Talk about taking a feature and spinning it as a bug! Individual investors have no business picking and choosing, be it either individual stocks or entire countries. The whole point of index funds is that they don’t pick and choose: they just give broad exposure to the market as a whole. And the global market, as a whole, is much broader (and therefore better, from an ETF investor’s point of view) than the US market alone.

But Wherry still seems to be thinking in terms of past performance:

The fund has been trading for only two months. Barclays said the underlying MSCI All Country World Index returned an average annual 17.2% during the five-year period ended March 31.

That was just over six percentage points better than the Spider, but almost four points behind the MSCI EAFE.

The reason to buy these funds isn’t past performance, or even future performance. It’s diversification and simplicity. If you’re greedy, and want to outperform "the market" (whatever "the market" might be), then I daresay these funds aren’t for you. But if you simply want global stock-market exposure, they might well be the way to go. The only thing for the investor to worry about is the fees charged – which is the one piece of information Wherry neglects to provide.

Posted in investing | Comments Off on ETFs Go Global

David Leonhardt Buys a House

Posted on May 28, 2008 by Felix

Many congratulations to David Leonhardt, who has just bought a house in Washington. Leonhardt is the person behind the NYT’s truly wonderful rent vs buy calculator, which should be the first stop of call on the internet for anybody thinking of buying a house.

The reasons Leonhardt always rented, when he was in New York, were very good ones – and the reasons why he’s buying, now, are good as well. Even though he believes the value of his house is going to fall, it can still make sense to buy, since a house is not an investment, or not wholly, and moving house if and when you think prices have bottomed is not easy or fun, and in any case only fools ever try to time the market. Plus, of course, in an inflationary environment, a fixed-rate mortgage is a much better bet than rents which are liable to rise at least in line with inflation and quite possibly even more.

Of course, just because Leonhardt is renting doesn’t make this a good time to buy, necessarily. Like most sensible buyers, Leonhardt is buying now because he’s moving, and not the other way around. And he also says that while he did decide to buy in Washington, he still thinks that renting is almost certainly still the better option in New York.

What he doesn’t mention is that he a very, very rare bird these days: a long-time renter, who has been saving up his down-payment for years, who is now buying his first home. Nationally, the opposite is much more common: people who bought homes they couldn’t afford, who are losing those homes, and who are finding themselves back in the rental market.

Most potential house buyers, then, aren’t just buying a house; they’re selling one, too. In this market, with sales plunging, that can be very difficult indeed. Leonhardt doesn’t have to worry about liquidating his old house in order to be able to make the downpayment on the new one; most Americans don’t have that luxury.

And of course Leonhardt has that downpayment, which, these days, is very likely to be at least 20%. Again, this is very rare: Americans got used to the idea of buying houses with no money down, or at least very little. They’re quite shocked when they discover, today, that even though they could affford a mortgage, no mortgage company is willing to lend to them unless they come up with a large downpayment – one which, most of the time, they don’t have.

The history of the housing boom is one in which potential buyers were perfectly happy to pay as much as the bank was willing to lend them. That’s still the case. Demand has fallen, but not enormously. The thing which has really dropped precipitously is the supply of home credit. Which is another reason why people like Leonhardt aren’t going to help turn the housing market around. In order for house prices to rise, we don’t need more would-be buyers, we need looser lenders. That isn’t going to happen any time soon – and nor should it.

Posted in housing | Comments Off on David Leonhardt Buys a House

Extra Credit, Tuesday Edition

Posted on May 27, 2008 by Felix

There won’t be much in the way of posting today, I’m afraid. But in the mean time, here are a few things which caught my eye:

And finally this chart, in honor of Greg Mankiw’s 5 millionth visitor. I’m interested in it mainly in order to see what happened to his traffic before and after October 17, 2007, when he turned off one of the busiest comments sections in the econoblogosphere. Do comments really drive traffic? It’s not obvious from this chart either way. If the natural state of affairs for any blog over time is a slow and steady increase in traffic, then maybe the decision to kill the comments really did do some damage. Of course, Greg isn’t in this for the traffic, but it’s interesting, all the same.

mankiw.jpg

Posted in blogonomics, remainders | Comments Off on Extra Credit, Tuesday Edition

Ben Stein Watch: May 25, 2008

Posted on May 25, 2008 by Felix

Ben Stein is worried about oil prices. We know this because he uses words in his column this week like "frightening", "extreme hardship", "overwhelming trouble", "peak oil" (twice), "true crisis", and "emergency". Plus:

If we keep acting as if the landscape were more important than human life, we will make ourselves the serfs of the oil producers and eventually reduce our country to poverty and anarchy.

Yes, in Ben Stein’s fevered brain, oil = human life, the biggest opponents of oil human life are environmentalists, and "the great Mad Max movies" are a prescient and truthful warning of what will happen if those environmentalists get their way. (Maybe Stein should ask the director of those films, George Miller, what he thinks their message is, and what he thinks of environmentalism. Here’s a clue: Miller also spent four years directing Happy Feet, an anti-global-warming 2006 film about penguins.)

Stein’s solutions to this "true crisis" do not, of course, involve mothballing his "mighty Cadillac STS-V", since that would involve no more "hurtling along I-10 toward Rancho Mirage at 130 m.p.h.". I’m no expert on cars, but I’d love it if someone could tell me – and Stein – what kind of fuel economy the STS-V gets at 130mph; my guess it would make the average Hummer driver feel positively virtuous.

Instead, Stein has a novel solution to the problem of the US using too much oil: drill more! Has he forgotten his father’s famous dictum that if something can’t go on forever, it won’t?

Stein idiosyncratically defines "peak oil" as "that point at which we have pumped out more than half the oil on the planet". (More commonly it’s defined as the point at which oil production stops increasing and starts declining.) But let’s stick with Stein’s definition: if he’s right that we’re close to peak oil, then drilling more will only serve to accelerate the rate at which we draw down what reserves the world has left. But that seems to be exactly what Stein wants: environmentally catastrophic "development" of Canada’s tar sands, "incentives" for big oil companies, drilling for more oil on the continental shelf.

Stein doesn’t, of course, explain how any of these things will avert the "true crisis" he talks of – probably because they wouldn’t. The man who regularly advises his readers to live within their means is simultaneously advising the United States as a whole to do the opposite, on the energy front: not whittle down demand to something sustainable, but rather plunder what’s left of the world’s fossil fuel resources. (Maybe Stein’s anti-Darwinism has something to do with his seeming inability to grasp that fossil fuels are not replaceable.)

He also doesn’t understand that oil is fungible. "If Venezuela stopped sending us oil," he writes, "there would be extreme hardship" – as though we wouldn’t simply import our oil from somewhere else instead. Yes, Venezuela is closer to the US than most other oil exporters – but that’s not a huge consideration, affecting little more than marginal shipping costs. Then again, at least he didn’t resuscitate his silly theory that it matters what currency oil is denominated in.

In Stein’s beloved Mad Max 2, there are two main kinds of people in the world: gas hogs, on the one hand, who seek to slake their insatiable demand by going after obvious sources of fresh oil; and frugal oil conservers, on the other, who try to live within their means. Stein should watch it again, to see which turns out to be the smarter strategy.

Posted in ben stein watch | 1 Comment

Extra Credit, Friday Edition

Posted on May 23, 2008 by Felix

Delta-Northwest: Wall Street’s $80 Million Fee Bonanza: Morgan Stanley’s getting $42 million in fees on a $3 billion merger. I guess some people are getting rich in the airline industry. It’s the first time any bank has got more than $40 million in fees for any deal worth less than $10 billion.

Dear Mr Activist… …and the reply.

Economics: Which Way for Obama? Cassidy on Thaler, Sunstein, and other Obama advisors. Wilkinson responds.

A chart for the corporation-bashers among you: Personal vs corporate taxes, 1929-2007.

Victim Complex: Coping With Bike Theft: "It’s probably a good idea to treat your bike like a stripper. Enjoy it but don’t get too attached, put a few bucks into it now and again, and just shrug and move on when it takes up with someone else."

Posted in remainders | Comments Off on Extra Credit, Friday Edition

Recession: The Forgotten Indicia

Posted on May 23, 2008 by Felix

This piqued my interest (via Mike Simonson):

Ignorance about recessions has taken hold because of a simplistic idea that a recession is two successive quarterly declines in gross domestic product (GDP), a measure of the nation’s output.

The idea originated in a 1974 New York Times article by Julius Shiskin, who provided a laundry list of recession-spotting rules of thumb, including two down quarters of GDP. Over the years the rest of his rules somehow dropped away, leaving behind only "two down quarters of GDP."

Of course, now that the NYT’s archives are available online, I went straight to the original article to see what the other rules of thumb were.

Shiskin breaks his rules down into rules of thumb for duration, depth, and diffusion – all of which are necessary, in his view, for a bona fide recession, although ultimately identifying recessions must be qualitative and not quantitative. In any case, here are the rules of thumb:

  • Duration
    • A decline in real GNP for 2 consecutive quarters
    • A decline in industrial production over a six-month period
  • Depth
    • A 1.5% decline in real GNP
    • A 1.5% decline in non-agricultural employment
    • A two-point rise in unemployment to at least 6%
  • Diffusion
    • A decline in non-agricultural employment in more than 75% of industries, as measured over six-month spans, for 6 months or longer

If you use these criteria, I think it’s pretty clear we’re not in a recession – I mean, we’re not even close to a 1.5% decline in real GNP, nor to a two-point rise in unemployment. I’m not sure I fully understand Shiskin’s diffusion criterion, but I don’t think it obtains, either.

Of course, there’s no particular reason we should judge a 2008 recession using 1974 criteria. It’s just worth noting that if all of Shiskin’s rules of thumb were actually happening, people would be moaning a lot more loudly than they are right now.

Posted in economics | Comments Off on Recession: The Forgotten Indicia

Annals of Pathetic CEO Communications, Moody’s Edition

Posted on May 23, 2008 by Felix

When a company runs into trouble, it turns to its chairman and CEO (if they are the same person) for leadership. If that person is someone like MBIA’s Jay Brown, he provides it, showing backbone and passion and clarity of vision. On the other hand, if that person is someone like Moody’s Raymond McDaniel, he utterly flubs the test, coming out instead with a formal statement lacking so much as a hint of humanity or certitude. Just look at the thing:

As you may be aware, there have been reports in the news media of an error in a model that Moody’s Investors Service used in certain of its ratings of European constant proportion debt obligations (CPDOs). Moody’s rated a total of 44 European CPDO tranches, representing approximately $4 billion in rated securities.

Reports in the news media of an error in a model? Ugh. A horrible passive-voice construction which doesn’t thank the FT for exposing the error, or even mention the paper by name at all – and which also deliberately misses the main point of the FT’s article, which was the cover-up, not the original computer bug.

We recognize the seriousness of the questions raised by these media reports. Upon learning of this situation, I directed our Legal and Compliance staff to undertake a thorough review of our European CPDO rating process. The law firm of Sullivan & Cromwell has been retained to conduct this review and will report back to me upon completion of their fact-finding and assessment. I will then take appropriate action to respond to the findings.

"We"? Who is this "we"? And what are these serious questions which have been raised? Are they all about the error in the model? Or are there other questions, much more serious, which you can’t even bring yourself to directly address?

What does "upon learning of the situation" mean? Do you mean upon learning about the FT report? Or do you mean upon learning of the substance of the allegations in the FT report? If it’s the former, why didn’t you take any action originally? And if it’s the latter, why didn’t you tell anybody at the time? Or, if you only learned of the substance of the allegations at the same time that the rest of us did, then what does that say about your control of the company?

And most importantly, are you so bloodless as to think that ordering one set of lawyers to hire another set of lawyers was really the only appropriate reaction to what had happened? Did you feel incapable of simply calling the principals concerned into your office and asking them directly? Do you really, today, not know whether the FT article is true or false, and need Sullivan & Cromwell to tell you?

I should note that as a rating agency, Moody’s often adjusts its analytical models and enhances its methodologies for a variety of reasons, such as to reflect changing credit conditions and outlooks. While the agency has modified analytical models on the infrequent occasions that errors have been detected, it is inconsistent with Moody’s analytical standards and company policies to change models and methodologies for any reason other than to improve the accuracy of our ratings.

And why are you quoting, almost verbatim, earlier press releases from your own company? Your PR people said that "it would be inconsistent with Moody’s analytical standards and company policies to change methodologies in an effort to mask errors"; you say something pretty much identical. This isn’t leading, it’s following. Worse, it’s following flacks.

Needless to say, our relationships with customers are of the utmost importance to us. We recognize that you may have questions or concerns that relate to this matter, and remain committed to a transparent, open dialogue with you.

If you’re genuinely committed to a transparent and open dialogue, you could start by being transparent and open about what you know, when you learned it, and why all of these actions are only being taken in the wake of the allegations being published in the FT. Instead, you come across like a corporate puppet. Weak.

Update: A coupla bits I missed. First,

I assure you that we will be vigilant in our efforts to establish the facts of this situation and will act quickly and decisively to address any need for changes to our processes.

Yeah, he said "processes".

But more to the point, Gari notes in the comments exactly what this means:

Needless to say, our relationships with customers are of the utmost importance to us.

Who are Moody’s customers? Not the people using the ratings, but rather the people paying for the ratings. In other words, it’s exactly Moody’s putting far too much emphasis on its relationships with its customers which got us into this mess to begin with. Moody’s is one of the very few companies which shouldn’t worry too much about its relationship with its customers.

Posted in credit ratings, leadership | Comments Off on Annals of Pathetic CEO Communications, Moody’s Edition

Wikipedia: A Perfectly Acceptable Data Source

Posted on May 23, 2008 by Felix

Bess Levin is taken aback by the fact that Morgan Stanley is now citing Wikipedia as a source in its research reports. Why? We’re talking here about a pretty simple chart, showing the price of gasoline in different countries around the world. It doesn’t need to be triple-checked in terms of accuracy: it doesn’t really matter if the USA is in the 78th percentile or the 83rd percentile. And it’s much easier to go to Wikipedia for such information than it is to try and dredge it up manually, country by country.

So well done, Morgan Stanley, for having the balls to do in public what everyone else has been doing in private for years. Like all data, anything retrieved from Wikipedia should pass the smell test – and it might be worth looking at the edit history, too, just to double-check that you’re not arriving at just the wrong time, when some prankster’s changed everything. But I see no reason why Wikipedia should never be used.

Posted in charts, statistics | Comments Off on Wikipedia: A Perfectly Acceptable Data Source

InBev-Bud: The Brazilians Are Coming

Posted on May 23, 2008 by Felix

There’s an air of inevitability about this InBev bid for Anheuser Busch: it might take a while, it might end up having to be raised, but I have a feeling that, sooner or later, it’s going to happen. When it does, the world will finally have a truly global brewing company – and that company will be run by Brazilians.

InBev, of course, is the result of a merger between Brazil’s Ambev and Belgium’s Interbrew. But although the Belgian company was larger, it was the Brazilians who took the reign, with InBev being run by CEO Carlos Brito and CFO Felipe Dutra. These guys think big: Dutra has been negotiating with Jamie Dimon directly about a $40 billion syndicated loan plus a bridge of somewhere between $10 billion and $17 billion.

Banks like JP Morgan and Santander are happy to lend Dutra the money because he’s the kind of client they love: global, powerful, and very efficient. The storied Busch family might not like this kind of thing, but then again they might not have much choice:

After delivering better-than-announced savings in the merger of Interbrew and AmBev, the management team at InBev has a reputation for ruthless efficiency in cutting costs. The mooted cost savings in a deal with Anheuser would be in line with other deals in the beer industry – though those close to the company expect that the level of savings announced would be exceeded by InBev’s cost zealots.

A large portion of the savings would come through extending zero-based budgeting – a savings system which requires businesses to justify every expense anew each year – to Anheuser’s business.

In this sense, the Brazilians are to beer as the Mexicans are to cement: one of the few huge companies which has a proven track record of successfully implementing large acquisitions around the world. As such, they can pretty much raise as much money as they like, whenever they like. Even now.

Posted in M&A | Comments Off on InBev-Bud: The Brazilians Are Coming

Citi’s Dreadful Succession Planning

Posted on May 23, 2008 by Felix

Sandy Weill is sniping at Chuck Prince via the FT – again. Why? It makes him look like a petty and bitter old man, rather than any kind of elder statesman of finance.

Interestingly, this time he’s not just blaming Prince, he’s blaming the rest of the Citigroup board as well, including Bob Rubin:

Mr Weill said he and the board should have fostered competition among Citi’s top managers for the chief executive post rather than handing the job to Mr Prince…

The comments by Mr Weill, who remains chairman emeritus and a large shareholder in Citi, raise questions over its succession planning – a key duty of corporate boards. Eight of Citi’s 14 current directors, including former Treasury Secretary Robert Rubin, chairman of Citi’s executive committee, were on the board at the time of Mr Prince’s appointment.

Clearly the board was under Weill’s heavy thumb at the time, and incapable of organizing themselves on the succession-planning front. But that doesn’t explain how they managed to make exactly the same mistake when Prince resigned: it turned out that there was no succession plan in place then, either.

The board does now have its own chairman, Win Bischoff, who is not also the CEO. That’s good. But I wonder how far he’s come in terms of planning for a successor to Vikram Pandit. After all, if Pandit carries on the way he’s going, there’s a good chance he won’t last long.

Posted in banking, governance | 1 Comment

The Art Trading Fund: Getting Desperate

Posted on May 23, 2008 by Felix

Liz Gunnison has an interesting take on the news that Charles Saatchi has been appointed an advisor to the Art Trading Fund. You might recognise the name: I said twice last summer that it was doomed to fail, and this news only confirms my take. Let’s start with the fund’s assets under management: in May 2007 it had reportedly raised ߣ10 million (that’s pounds); the following month, Kit Roane reported that "it has attracted about $40 million from investors". Now, a year later, we’re told that the fund "closed in August 2007, with a capitalization of $10 million". Oops. We’re not told how many outside investors there are in the fund, but my guess is that it’s somewhere between zero and five.

The same story seems to be playing itself out with respect to ATF’s second fund:

ATF’s Fund 2 will close at the end of June, said Carlson and Williams, and has a target capitalization of $50 million. So far the second fund has received $35 million in inward investment, they said.

Let’s just say I’ll believe it when I see it.

Gunnison thinks that Saatchi has been brought on board in order to take advantage of his art-world expertise:

ATF’s decision to turn to Saatchi in the midst of raising its second fund suggests that the fund is realizing the importance of high-profile art expertise in attracting warier investors.

But isn’t that expertise, in the end, the value added by auction houses and galleries, too?

The art market isn’t really inefficient. Dealer and auction house commissions are the price at which the market values their expertise. By paying Charles Saatchi an advisory fee, ATF is eroding its own margins and just recreating the same art market formula in different terms.

I think that this move is simply an act of desperation by ATF, a final attempt to raise some some – any – outside money. Their first try, which involved talking nonsensically about being able to short the art market, failed miserably, so now they’re waving a famous name in potential investors’ faces and hoping that they’ll be so dazzled they won’t ask the obvious pointed questions.

Here’s how the agreement with Saatchi works: "The fund will pay the Saatchi Gallery a percentage of the profits it makes from works acquired through the gallery." In other words, Saatchi will be a seller to the fund, and will retain a certain amount of upside on any works he sells them, even after he’s sold them. A nice deal if you can get it!

Saatchi may or may not have valuable insight into where the art market is headed. But if he really thinks one of his artworks is going to rise substantially in value, he has no reason to sell it. I said in June that the Art Trading Fund was "is just another punter to be exploited by art-world insiders," and this deal seems to prove me right.

But the biggest irony of all is that even Saatchi himself doesn’t consider himself much of a collector, in terms of dollar returns. A while back he gave an interview to Deborah Solomon:

Saatchi says heatedly: ”If I were interested in art as investment, I would just show Picasso and Matisse. But that’s not what I do. I buy new art, and 90 percent of the art I buy will probably be worthless in 10 years’ time to anyone except me."

He’s right. Saatchi has certainly been a successful art collector, but he would probably have made more money if he’d simply sat on the Warhols he bought with his ex-wife Doris, rather than selling them just before the market in Warhol started exploding.

Does the ATF know that Saatchi isn’t interested in art as investment? Do its potential investors? My guess is that the ATF does, and they’re hoping desperately the potential investors don’t. There’s transparency for you.

Posted in art, hedge funds | Comments Off on The Art Trading Fund: Getting Desperate

Why ETF-Squareds Are a Bad Investment

Posted on May 23, 2008 by Felix

Floyd Norris today brings up the question of mutual fund fees, which gives me a good excuse to revisit the ETF-squareds I wrote about yesterday. By coming up with an extra service (quarterly rebalancing) they justify an extra 25bp in annual fees; I was dubious as to whether that was much of a deal for any investor. After all, there are S&P 500 index funds charging just 7bp which have to benchmark a very specific portfolio of 500 stocks.

The Condor Options blog agrees that 25bp seems a bit steep:

The sponsors (PowerShares) should set the rebalancing back to annual, and cut the fee to 5bp. We’d buy that, or at least might consider putting our cousins and neighbors in such a fund.

I also corresponded with Russ Koesterich of ETF giant BGI, who’s recently written a book called The ETF Strategist. He was reluctant to talk about a rival (PowerShares) product directly, but he did say this:

The real value of the ETF is the ability to build multi-asset class diversification at a low cost, and with a great deal more ease than you ever could trying to assemble a portfolio of individual stocks. At the end of the day, I would still be suspicious of outsourcing periodic portfolio rebalancing.

There are three reasons why I would be suspicious of the PowerShares product, beyond the fact that I’m just not sure the rebalancing service is worth 25bp.

Firstly, the rebalancing only takes place between the pre-ordained constituent ETFs. Any sensible investor will take advantage of the rebalancing process to do a quick check on how the ETFs are doing: if they’re underperforming their benchmarks by a large margin, or if they are truly atrocious, then they can be sold outright and replaced with something better.

What’s more, there’s a slow but steady increase in bargain-basement ultracheap ETFs. As these funds come on to the market, it makes sense during the rebalancing process to rotate out of your older, more expensive, funds, and into the cheaper ones. The ETF-squareds don’t do that: you’re stuck with what was available when the ETF-squared was formed.

Finally, the ETF-squareds will look at the balance between funds, but not the balance within funds. Here’s Koesterich, again:

While investors should always be focused on minimizing unnecessary

transaction costs, it is sometimes worth rebalancing if the

composition of an ETF’s underlying index changes dramatically.

Consider the case of an investor who bought an ETF providing

exposure to large cap stocks in the mid 90’s. By mid-2000,

Technology stocks made up over one third of a US large

capitalization index. An investor in the SPY or other US large cap ETF

now owns a fairly concentrated portfolio, heavily weighted to Tech,

rather than a diversified portfolio of securities, which was

probably their original intention. In that instance, it would

certainly of been worth the time, effort, and expense to rebalance

given that Technology stocks proceeded to lose 80% of their value

over the next two years. The point is not to engage in market

timing, but to adjust your portfolio when the instruments you own no

longer reflect the exposures you were looking for in the first

place…

If you bought a broad commodity ETF a few years ago, and

due to the runnup in oil the fund is now mostly weighted to energy,

youi may want to rebalance so as to ensure that your portfolio has

the desired exposure to a broad basked of commodities as opposed to

a single commodity, such as crude oil.

This kind of rebalancing, where you look at the constituent parts of the funds you bought and you ask yourself whether that was what you wanted when you bought the funds in the first place, is something I think the ETF-squareds don’t do. For them, a stock fund is a stock fund; a commodity fund is a commodity fund.

For all these reasons, then, I’d be wary of recommending the ETF-squareds to anybody, really: they’re an expensive way of putting together a hard-to-change ETF portfolio. If you want an idea of a good mix of which ETFs to buy, then by all means check out the ETF-squareds for ideas. (Or go here.) But I don’t see any good reason to actually pay PowerShares the extra 25bp for doing that for you.

Posted in investing | Comments Off on Why ETF-Squareds Are a Bad Investment

Extra Credit, Thursday Edition

Posted on May 22, 2008 by Felix

Amazon – The Stock that Defies Gravity: "Goldman has a novel argument: Amazon has now proven its business model, so itßís safe to assume stable margins going forward. I thought it was supposed to be the other way around."

Odd Data Point: Tech Passes Finance in SPX

The Sad Tale of Lewis Ranieri and Franklin Bancorp

TimesMachine: Fun and informative. Nicholson Baker must love this.

And finally, Mark Bittman on "the cycle of dietary and planetary destruction" and how it can be halted by eating more plants:

Posted in remainders | Comments Off on Extra Credit, Thursday Edition

Canadian Law: No Friend to LBOs

Posted on May 22, 2008 by Felix

The news out of Quebec today really is quite stunning: a court has held that bondholders in Canada can effectively block a leveraged buy-out if their bonds will be downgraded to junk (as most are, in such situations). Steven Davidoff is incredulous:

If this decision stands, it likely will upend corporate law practice in Canada…

I am not sure the Canadian court fully appreciated the difference between debt and equity in rendering this decision.

All I know is that if this decision stands, expect a lot of interest in Canadian bonds. They’ve suddenly become significantly more attractive.

Posted in bonds and loans, law | Comments Off on Canadian Law: No Friend to LBOs

Annals of Hypocrisy, John Mackey Edition

Posted on May 22, 2008 by Felix

Thanks to Jeff Cane for alerting me that John Mackey is back, and defending his sockpuppet antics:

I strongly believe in the First Amendment of our Constitution and our right as citizens to express our opinions to each other. I believe I was exercising this right.

When a CEO has to fall back on the First Amendment to defend his actions, you know his case is pretty weak. The fundamental fact of what happened here is simple: a senior officer of the company – the senior officer of the company, the founder and CEO – lied about who he was in public.

If the CEO of a company makes a public statement about his company, let alone 1,400 such statements, then simple common sense – not to mention the basic underpinnings of corporate governance – demands that he do so in a transparent manner.

Mackey seems to think that it was his status as a public figure which made what he did wrong:

Perhaps part of the problem here is that when I first started participating in these Yahoo! online communities back in 1998, Whole Foods Market was only 15 percent as large as we are today. We had yet to open any stores in New York City and we weren’t taken particularly seriously by most of our competitors or the media. Whole Foods Market’s tremendous growth over the past 10 years hadn’t yet occurred. As the CEO of Whole Foods Market I was seldom interviewed and few people knew or cared who I was. I wasn’t a public figure and had no desire to become one. However, as Whole Foods Market continued to grow and as we opened large and exciting new stores around the United States, both the company and I became better and better known. At some point in the past 10 years I went from being a relatively unknown person to becoming a public figure. I regret not having the wisdom to recognize this fact until very recently.

No! This has absolutely nothing to do with the fact that Mackey is a public figure, and everything to do with the fact that he’s a senior executive of a public company. When a senior executive of a public company makes statements – especially forward-looking statements – about that company and its stock, it is unforgivable for him to do so without disclosing who he is and what his position is in the company.

Mackey can talk till he’s blue in the face about his dialectical predilections and his competitive spirit, but none of that alters the fact that he shouldn’t even have his job any more. Whole Foods should be run by a grown-up, and the board should have fired him the minute it became obvious he wasn’t going to resign.

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The Romer-Harvard Affair

Posted on May 22, 2008 by Felix

If you haven’t been following the peculiar story of Harvard’s failure to poach Christina and David Romer from Berkeley, Shan Wang of the Harvard Crimson has a good round-up. Basically, it was all going to happen, until the very last moment, when Harvard president Drew Faust vetoed the offer made to Christina Romer by the Harvard economics department. No one seems to even understand why she might have done such a thing, and there’s certainly no one willing to defend her actions.

David Warsh kicked things off on Tuesday with a column explaining why attracting Romer would have been a great coup for Harvard:

By any measure, Mrs. Romer is one of the most distinguished women in economics, co-director of the National Bureau of Economic Research program in monetary economics, a member of its business cycle dating committee, former vice president of the American Economic Association (and, probably, a future president), Guggenheim Fellowship recipient, member of the American Academy of Arts and Sciences, and winner of the Berkeley Distinguished Teaching Award.

The Harvard offer to her, and a Kennedy School offer to her husband, a prominent macroeconomist, had been widely reported in the profession and, at Berkeley, greatly feared. The pair had been instrumental in putting the graduate program there back on its feet, after their arrival from Princeton in the early 1990s. Because each has an aging parent in Massachusetts, and because two of their three children will be attending the Massachusetts Institute of Technology in the fall, the Harvard offer was viewed as being, as one colleague put it, “less of a bullet than a small nuclear device” aimed at Berkeley macro.

Given the difficulty Harvard has had hiring female professors – its treatment of women was a proximate cause for the resignation of president Lawrence Summers in 2006 – the decision to reject the offer came as a shock.

Brad DeLong followed up:

"Early onset Alzheimer’s" is the kindest explanation I have heard from anyone currently in Cambridge. Other candidate explanations are crueller and less flattering.

DeLong also told the Crimson he was "outraged" at the way Harvard had treated Romer, although it must be a bittersweet outrage, given that as recently as Monday he was bemoaning the difficulty that Berkeley faces in retaining its top economists.

It’s interesting that the blogging economists seem to be the only ones willing to go on the record about this, or maybe they’re the ones that reporters first approach. In any event, Harvard’s Greg Mankiw is not a happy bunny:

“I have great admiration for Christy Romer as a teacher and scholar, and I was looking forward to having her as a colleague,” economics professor N. Gregory Mankiw wrote in an e-mailed statement. “I am personally disappointed that she will not be joining the Harvard faculty.”

With everything in the public realm on one (Romer’s) side of the story, Harvard would seem to have a great deal of egg on its face right now. The decision to veto Romer’s appointment won’t in and of itself damage Faust’s position as president, but it might yet come back to haunt her if and when she runs into more trouble in future. Certainly she doesn’t seem to have made a lot of fans in the economics department.

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The Economics of Carl Icahn

Posted on May 22, 2008 by Felix

Carl Icahn has an interesting take on basic macroeconomics:

Icahn kicked off his political rant by saying that it would be "devastating" if this country elected a Democratic president… He said that "Obama doesn’t understand the economy," adding that he and a Democratic-weighted Senate would boost spending significantly, sending inflation soaring.

There are two big assumptions here, both of them false. The first is that Obama’s fiscal policy would be looser than Bush’s – between Bush’s tax cuts and his defense spending, that’s hardly feasible. And the second is that loose fiscal policy has a clear upward effect on inflation. As Rick Mishkin explains, a one-off spike in spending can result in a step-rise in prices – but not in sustained inflation.

In any case, Icahn should relish the prospect of soaring inflation, which is a great way of redistributing wealth from the poor to the rich. Or is he hinting at some hitherto unsuspected socialistic tendencies, that what he really cares about is the fate of the poor?

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Trickle-Down Economics, Art Edition

Posted on May 22, 2008 by Felix

There’s been a lot of talk about the UK’s "non-doms": rich foreigners who generally live in very expensive London property, thereby driving up the cost of living for everybody else while paying little or nothing in the way of taxes. Commentators like Willem Buiter reckon that, at the margin, the UK’s non-doms don’t really benefit the country all that much, net-net.

But then I saw the news that über-non-dom Roman Abramovich was the high bidder on both the $33.6 million Lucian Freud and the $86.3 million Francis Bacon, and I got to thinking: there’s no way he would be driving the top end of the market for post-war British art were he not a UK resident.

Those prices for Freud and Bacon will, in turn, going to help support the market for many other artists, both living and dead, as well as their dealers and collectors.

Why is it that so many of today’s top-selling artists are British or American, while so few are, say, French? I’m not saying that the reason for that, if there is one, is necessarily related to the fact that both Britain and America are uncommonly welcoming to rich foreigners. After all, there aren’t all that many superstar Swiss artists, either. But I do think that when the megabucks start to enter a country, they often end up in the art world, sooner or later. And every country’s art world has a soft spot for its home-grown artists.

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The Fed Scales Back its Growth Forecasts

Posted on May 22, 2008 by Felix

A quick note about the new GDP forecasts from the Fed:

Policy makers estimate U.S. gross domestic product will increase by 0.3 percent to 1.2 percent this year, compared to the 1.3 percent to 2 percent growth they predicted in January, according to Fed records released today…

Total inflation will run between 3.1 percent and 3.4 percent, the Fed said, compared with a January forecast of 2.1 percent to 2.4 percent.

It’s not true to say, as SAR does today, that if GDP growth is less than inflation, then we’ve got negative real growth. Headline GDP figures are real, not nominal, and are reduced by a very broad inflation measure known as the GDP deflator.

All the same, a CPI above 3%, accompanied by GDP growth below 1%, is definitely a move in the direction of stagflation. It’s also worth noting that US population growth is running about 0.9% per year, so anything below that means that real GDP is declining in per-capita terms.

And yet. Oil’s at $135 a barrel, and I remember reading all manner of stuff when it was in the $30 to $50 range about how every $10 rise in oil prices meant half a percentage point being cut off GDP growth. By which yardstick we would be growing at a breakneck pace right now were it not for those pesky oil prices – never mind the credit crunch, housing crisis, and everything else. Obviously, that oil-to-GDP yardstick proved to be faulty. But even so, I think if you told any economic forecaster a couple of years ago that in 2008 oil prices would be at $135 a barrel, they woud have told you that in that event 1% GDP growth would actually be quite a good outcome.

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Is Ben Bernanke Too Inventive?

Posted on May 22, 2008 by Felix

Steve Waldman has a great description of the powerful and inventive Ben Bernanke today:

Our man Ben is like an Amadeus-cum-MacGyver, he’s brilliant, unpredictable, he’ll improvise a Delaware company from paper clips and vacuum up your derivative book with a toenail clipper.

The problem is, in the words of Steve’s headline, that we seem to be suffering "a run on central banks," and that there’s a need in such circumstances not for someone brilliantunpredictableinventive, but rather for someone stodgy and boring and predictable and trustworthy.

Steve sees high commodity prices as indicative of a loss of faith: in financial assets in general, and central banks in particular:

We lose faith. When we lost faith in Northern Rock, Bear Stearns, Citigroup, or Lehman, the central bankers stepped into the fray, and stood behind them. So, we ask, who stands behind the central bankers? We take a peek, and all we see is our own money. Which we quickly start exchanging for something else.

That "something else", of course, is "the only money that is no one’s liability": commodities. Or, for that matter, art.

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The ETF-Squared: It Reallocates For You

Posted on May 22, 2008 by Felix

Remember Ron Lieber’s catchy little slogan? "Index (mostly). Save a ton. Reallocate infrequently." Turns out, here’s a new ETF out there which doesn’t just do the indexing for you, it does the reallocation as well. To be precise, there are three of these ETF-squareds, and they’re listed on the Amex under the tickers symbols PTO, PAO, and PCA. All of them, interestingly, comprise nothing but other ETFs.

PTO is the most aggressive, with 90% equity and 10% debt; PCA is the most conservative, with 60% equity and 40% debt. All of them have a 5% or 6% real-estate component (included in equity), with the rest of the equity split roughly 42-58 between US stocks and the rest of the world. Both the equity and the bond holdings are very diversified, and there’s even a small 2% to 3% stake in commodities and currencies, included in the debt allocation.

All of these seem like pretty sensible allocations, depending on your risk profile. And the funds seem to reallocate sensibly too:

The underlying indexes are rebalanced on a quarterly schedule but can be rebalanced more often if market conditions cause the indexes to deviate from their targeted risk levels.

I have two issues with these ETFs. The first is that, since they’re sponsored by PowerShares, PowerShares also gets first dibs on providing the underlying ETFs, even if those undelying PowerShares ETFs might not be the best or cheapest option.

And then there’s the whole question of the value of rebalancing. The ETF-squareds charge a fee of 25bp on top of the fees charged by the underlying ETFs. Basically, it’s a fee charged for the quarterly rebalancing service.

Now you don’t need to reallocate quarterly: annually is just fine, especially if the reallocation involves actually selling some of your holdings, rather than just investing new savings so as to rebalance your portfolio. But just how important is reallocation, and is it worth paying PowerShares 25bp per year for them to do it for you? Has anybody tried to quantify the costs of not reallocting, or of doing it badly?

(Via Alea)

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When Hedges Fail

Posted on May 22, 2008 by Felix

Here’s a gentle reminder for CFOs and risk officers at major international banks: if you hedge your position but you don’t hedge it 100%, then you haven’t fully hedged your position.

Last month, it was UBS, which made a decision based on "statistical analyses of historical price movements" that if it hedged its super-senior bonds against a price fall of somewhere between 2% and 4%, then those bonds were fully hedged. Now, it’s Lehman Brothers:

Erin Callan, Lehman chief financial officer, has said publicly that Lehman’s previously successful hedges, which included bets against indexes such as the CMBX, which tracks the performance of commercial mortgage backed securities, are no longer performing well…

Any second-quarter loss would be driven by both a reduction in the value of those holdings as well as the less effective hedging.

Many hedges are limited: they give you protection against some of the possible downside, but not all of it. That’s clearly what’s happening here – as the holdings continue to decline in value, the hedges have essentially been used up.

The worrying thing is that Lehman has some seriously enormous exposures here:

At the end of the first quarter, Lehman said it had exposure of $36.1bn to commercial mortgages and related securities and $31.8bn in exposure to residential mortgages and securities.

Add those two together and you get $67.9 billion, which is three times Lehman’s market capitalization and (since the bank is trading on a price-to-book ratio of 1) three times its book value, too.

Maybe it’s time to revisit Jesse Eisinger’s column about Lehman’s balance sheet.

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Moody’s Brings In the Lawyers

Posted on May 22, 2008 by Felix

Moody’s second statement on the CPDO scandal shows – in the wake of their stock falling 16% yesterday and Chuck Schumer breathing fire – that they’re finally beginning grok just how serious it is. The first statement, you’ll recall, merely said that they were "conducting a thorough review of this matter". The new one goes further, and explains that the thorough review will be an external review, by Sullivan and Cromwell. Better.

I do hope that the review, although it is confined to the "European CPDO ratings process," will be given the freedom to examine more generally the pressure on Moody’s structured products group to deliver the triple-A ratings that investment banks were paying millions of dollars for. In this case, when Moody’s found out that it couldn’t get to triple-A one way, it lost no time in getting to triple-A some other way instead. If that happened in the European CPDO ratings group, it could have happened anywhere.

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Extra Credit, Wednesday Edition

Posted on May 21, 2008 by Felix

Stocks Don’t Like Obama: Kudlow descends into self-parody. "This idea of rewarding work instead of wealth is just insane"!

Stein’s law, China edition … What can not go on forever: "Chinese exports are still expanding by about $250b a year. For reference, total Chinese exports in 2000 were only about $250b a year. $250b is a big number."

How is the housing bust like Hillary Clinton’s campaign? "Here’s a rule of thumb: When someone starts to blame the media for their own miseries, it means the game is over, they know they’ve lost, and now they’re just trying to avoid taking the heat by spreading collateral damage as far as possible."

Co-operative Bank boycotts funds over human rights: No money for SWFs from lefty banks.

The Baseball Game That Won’t End: Please let this mark the end of facile baseball metaphors.

And finally,

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