Why Bloomberg Won’t Buy the New York Times

Posted on April 21, 2008 by Felix

Newsweek and the NY Post are today resuscitating one of the perennial rumors in medialand: that Mike Bloomberg will somehow end up buying the New York Times. If the Sulzberger family was amenable – and that’s a big if – then Bloomberg could certainly afford it: the New York Times Company has an enterprise value of $3.7 billion, which is less than the value put on the 20% stake in Bloomberg LP held by Merrill Lynch. (The other 80% is owned by Mike Bloomberg personally.)

But the companies simply aren’t much of a fit. Bloomberg makes money from subscriptions; the NYT makes money from selling advertising. Bloomberg’s occasional toe-dips into consumer-facing media have never taken off, and even the highly-respected and enormous Bloomberg News operation is financially largely irrelevant to the fortunes of its parent. It’s not there to make money, it’s there to give Bloomberg a bit more credibility, and to be one more way in which Bloomberg’s clients get better content than anyone else. Certainly Bloomberg has very little interest in non-subscribers reading its content, which is one reason the Bloomberg website is so atrocious.

More to the point, Mike Bloomberg personally is not, and never has been, a newspaperman. If he were to get into a serious battle with Rupert Murdoch, then he would likely lose, just because that’s what happens to people who get into a battle with Rupert Murdoch.

I also suspect that Mike Bloomberg likes having the option to sell Bloomberg LP – something which would, if it ever happened, allow him to ratchet up his philanthropy to a whole new level. If he bought the New York Times, the Sulzbergers would want assurances that he wouldn’t simply turn around and sell it as part of the combined company.

I’ve joshed in the past that the best owner for the New York Times would be Google.org. That almost certainly won’t happen. But my main point there stands: it doesn’t make sense for the Times to be owned by any entity with shareholders who agitate for maximized profits. Maybe Bloomberg’s new charitable foundation might consider buying the Times, although I wouldn’t recommend it. But Bloomberg LP? No.

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Why Private Equity Shops are Recapitalizing Banks

Posted on April 21, 2008 by Felix

Many banks are raising capital these days; the latest to hit the headlines are Washington Mutual, raising $7 billion from TPG, and National City, which is getting something north of $7 billion from a syndicate led by Corsair Capital. Such bilateral deals seem to be more common than the alternative route, taken by Wachovia, of going to the public markets.

Why would banks choose to limit themselves to a small number of sovereign wealth funds or private-equity shops, rather than the millions of potential investors in the stock and bond markets? After all, it’s not as though the big investors can’t subscribe to a public offering if they’re so inclined.

Roger Ehrenberg has a theory on this: that the big funds are jumping in too early, desperate to justify their existence.

I applaud the guts-of-steel necessary to invest in the face of financial panic. The problem is, I just don’t see the panic reflected in the U.S. stock market, notwithstanding all the issues with the global credit markets. And I know that these private equity firms and the SWFs say that they are getting quality assets on the cheap. But I worry about the conflict between the ability and desire to write a big check and the best time to write such a check…

It takes incomprehensible amounts of discipline to let ok deals (from a risk/return perspective) go by in order to wait for the truly great deals with solid margins of safety to present themselves. Because it can get pretty embarrassing sitting on $10 billion (or in the case of SWFs, $100 billion or more) of commitments, getting paid management fees and not putting money to work. There is a natural pressure to pull the trigger, because it may be more painful waiting for the right deal to come along than doing a deal that ends up being mediocre but being busy in the process. And it certainly is impossible to raise a fund V, VIII or XII if one can’t even get past 50% of committed capital for the current fund. This would bring the whole asset gathering operation to a screeching halt. And we can’t have that, can we?

I’m not sure how much this argument works in the case of SWFs, but it does make a lot of sense with respect to the private-equity shops. The bank recapitalizations are one of the few areas where it’s possible to invest multibillion-dollar sums right now on a leveraged basis (all banks, by their nature, are leveraged) without having to actually borrow money from someone. It might even be the case that the private-equity funds need these bank investments more than the banks need the funds – with the implication that the funds are overpaying.

This, of course, is great news for the financial-services industry as a whole: it is being recapitalized by private-equity shops at a time when the public markets are very reluctant to throw good money after bad. The only losers are likely to be the limited partners in the PE funds, and no one’s going to shed too many tears for them.

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Costs and Benefits in Education

Posted on April 20, 2008 by Felix

It’s that time of year again, when students are deciding where they’re going to go to college. And the NYT is on the case. Today Greg Mankiw tells us that "the financial return to education" has never been higher:

In 1980, each year of college raised a person’s wage by 7.6 percent. In 2005, each year of college yielded an additional 12.9 percent. The rate of return from each year of graduate school has risen even more — from 7.3 to 14.2 percent.

So we know that the benefits of going to college are high. Meanwhile, the costs, according to David Leonhardt, are actually going down, at least at the most elite universities, such as Harvard, where Mankiw teaches:

In less than five years, the entire tuition and financial aid system at the nation’s top colleges has been overhauled. Today, it looks a lot like a highly progressive tax code, in which the affluent are bearing an enormous share of the overall tuition burden. No matter how high the published cost — almost $50,000, typically — these top universities have become significantly more affordable for the majority of students.

But the overwhelming majority of college students don’t go to Harvard or even elite state schools like Berkeley. Instead, says MP Dunleavey, they’re making choices like the one facing Taylor Glauser: should he go to the State University of New York at Potsdam, or should he go to Mercyhurst, a small private college in Pennsylvania which will cost him $15,000 a year even after $20,000 in grants and scholarships? Would spending the extra money be worth it, over the long term?

state

Both Dunleavey and Leonhardt cite Princeton’s Alan Krueger, who’s done the most research into this question. Krueger’s main finding is that it makes very little sense from a financial perspective to go deep into debt just for the sake of attending a private college. Once you control for things like SAT scores, it turns out that attending a more prestigious university does not actually improve your lot in life.

But as Leonhardt notes, there is one exception to this rule:

Recent research also suggests that lower-income students benefit more from an elite education than other students do. Two economists, Alan B. Krueger and Stacy Berg Dale, studied the earnings of college graduates and found that for most, the selectivity of their alma maters had little effect on their incomes once other factors, like SAT scores, were taken into account. To use a hypothetical example, a graduate of North Carolina State who scored a 1200 on the SAT makes as much, on average, as a Duke graduate with a 1200. But there was an exception: poor students. Even controlling for test scores, they made more money if they went to elite colleges. They evidently gained something like closer contact with professors, exposure to new kinds of jobs or connections that they couldn’t get elsewhere.

“Low-income children,” says Mr. Krueger, a Princeton professor, “gain the most from going to an elite school.”

I find this a very intuitive result. Just as we saw with secondary school, middle-class kids tend to do pretty well wherever they’re educated, which makes it ironic that middle-class parents are the ones who stress the most about where their kids go to school. Meanwhile, the poor, who really do benefit from a better education, are the ones overlooked. As Leonhardt notes:

Given all this, some have argued that Harvard, Yale and other universities are mistaken in giving financial aid to upper-middle-class students rather than using the money to recruit more low-income students.

He gives some not-particularly-convincing reasons why it might make sense to concentrate on the middle classes, but the main takeaway is still clear: if you’re the kind of person who reads Market Movers, and you’re facing big choices in terms of school, then you’re probably worrying far too much, it really doesn’t matter all that much in the long term. But if you’re an educational institution and you really want to maximize your value added, or whatever the jargon might be, then by far the best way of doing that is to get as many poor students as possible.

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Branding Art

Posted on April 18, 2008 by Felix

Illinois artist Conrad Bakker, whose art has a habit of raising uncomfortable questions about price and value in the art world, popped round this afternoon on a visit to New York. Conrad makes all his own work – he doesn’t outsource anything or have assistants – and he’s pretty much in charge of selling it, too: while he does exhibit in galleries, he doesn’t have a gallery, and once a show is over he’s back on his own. If you buy one of Conrad’s works, then, there’s a good chance you’ll buy it directly from him, and you’ll know that it was very much he who made it.

The contrast with the world’s biggest A-list art stars could barely be greater. And if you think of the artists who are famous for having assistants make their art for them, starting with Andy Warhol and moving on through the likes of Damien Hirst and Takashi Murakami, there’s no indication that taking away the artist’s touch has any kind of negative effect on the value of the art. If anything, the opposite seems to be true.

Part of the reason is that these artists have turned themselves into businesses. Both artists and collectors have at this point embraced the idea that there’s nothing wrong with artists being motivated by money, and indeed they’ve created something of a virtuous cycle: an artist creates the kind of art that rich collectors want, which fuels demand for that artist, which drives up his prices, which makes him even more desirable, and so on. Eventually, collectors, especially hedge-fund managers, start buying an artist like they might a momentum stock: they place faith in the management of the company to continue to maximize shareholder value. And in doing so, of course, they only drive prices higher.

While gallerists have always had commercial ambitions, now artists too are unabashed about it: Hirst has a full-time business manager, Frank Dunphy, while Murakami is in many ways more businessman than artist. Here’s Mia Fineman:

"Business art is the step that comes after art," Warhol wrote in 1975. "I started as a commercial artist and I want to finish as a business artist. Being good in business is the most fascinating kind of art." Warhol never truly fulfilled this ambition during his lifetime. Most of his business ventures lost money, and the widespread licensing of his images came only after his death. Now, with Murakami, the age of business art has arrived. Leaving behind the old-fashioned idea of art as an autonomous form of individual expression, Murakami has fashioned himself as a brand, a trademark, and a corporate identity.

The result of this is that the most expensive contemporary artists are the most branded and immediately visible contemporary artists. You know a Hirst when you see one, or a Murakami, or a Serra, or a Koons. The normal mode of looking at art is reversed: you don’t think "I like that, I wonder who the artist is" but rather "Oh, there’s a Koons, I wonder if I’ll like it".

One can’t help but suspect that these brands might suffer enormously when the art market crashes, just because their values are supported more by branding than by aesthetic fundamentals. A lot has been written about the Jeff Koons – Old Master arbitrage, a trade which has been embraced most visibly by Koons himself, buying up spectacular old paintings for a fraction of what his fresh-out-of-the-factory sculptures sell for. The problem of course is that in order to sell Koons works, it helps very much to be Koons. The rest of us can just watch from the sidelines as the momentum traders continue to get richer. Which is generally what momentum traders do, until they don’t.

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SocGen CEO Finally Resigns

Posted on April 18, 2008 by Felix

Finally. SocGen CEO Daniel Bouton will officially resign as of May 12, and it seems like SocGen’s head of investment banking, Jean-Pierre Mustier, won’t last much longer either. Bouton will remain as chairman, but my guess is that’s a face-saving measure and that he’ll quietly step down from that role too, sooner rather than later. So this kind of reaction might yet prove to be premature:

"When organizations get into trouble that can provide an impetus" to consider separating the leadership roles, said Eleanor Bloxham, president of the Corporate Governance Alliance, an education and advisory company in Columbus, Ohio. "It’s smart to do."

Does Bloxham not remember what happened when Sandy Weill stepped down as CEO of Citigroup? He stayed on as chairman for a while, but when he finally gave up that role, it was taken over by his successor as CEO, Chuck Prince. The odds-on favorite for the next chairman of SocGen must, similarly, be the new CEO, Frederic Oudea. Yesterday’s announcement of Bouton’s departure might be good for accountability, but it’s not necessarily great news in terms of governance.

Update: A reader asks:

When you’re president of something called the Corporate Governance Alliance, it sounds pretty important, doesn’t it? But it’s really just an obscure, Ohio-based consulting company that is, as far as I can tell, little more than two persons and a dog. (Actually, I’m not sure they have a dog.) Eleanor Bloxham is also president of The Value Alliance, whatever that is. So why should Bloxham know anything about governance at SocGen?

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Lawrence Niren Reappears as a Pig

Posted on April 18, 2008 by Felix

Convicted fraudster Lawrence Niren still hasn’t given up: I just received another fabulously crazy email from him, calling me an "egomaniac liar" and saying that his fake bid for Gold Fields wasn’t fake at all:

For your information the Gold Fields was a real deal.

It only died because Gold Fields was so frightened

when they saw our documents that they leaked the story

to Bloomberg who ruined the deal for us before we even had a chance to finalize it. You media people are just

incredible! You simply have no interest in the truth,

and you are obsessed with lying and printing nothing

but negative untrue articles about people.

Niren goes by many names, foremost among them Theodore Roxford. I will give him credit for his ability to come up with new names: his alias for the Gold Fields bid was Edward Pastorini, which Helen Thomas worked out to be an anagram of "Top Insider Award".

As for the email I got today, which was signed "LN", it ostensibly came from one "Arnold Ziffel". Which turns out to be the name of a sitcom pig. Nice.

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Deconstructing Libor

Posted on April 18, 2008 by Felix

Henri, in my comments yesterday, has a smart way of looking at the TED spread. The TED spread between Treasuries and Libor, he says, is the sum of two other spreads: the Treasuries-OIS spread plus the OIS-Libor spread. OIS stands for "overnight index swap", and it gives a good indication of where interest rates are when there isn’t any credit risk.

So if you’re worried about interbank credit risk, it makes sense to look at the OIS-Libor spread rather than the TED spread; the Treasuries-OIS spread is more of an indication of how extreme the flight-to-liquidity play is. As Henri says of the OIS-Libor spread:

This is the true "banking liquidity" component of the TED spread, and the only scary bit… It is the nux of the crisis.

So, how’s that OIS-Libor spread doing?

The three-month Libor OIS spread, viewed as an indirect measure of funds availability in the money market, widened to 87 basis points from 77 basis points yesterday. It was as narrow as 24 basis points on Jan. 24. The spread peaked last year at 106 basis points on Dec. 4.

Clearly this is a volatile indicator, if it managed to go from 106bp to 24bp in the space of seven weeks. But equally clearly it’s high and rising, as Libor ticks up yet again.

Accrued Interest has a good post today on the usefulness of Libor as an indicator: one thing worth remembering is that it’s largely a European interbank rate, with only two American banks participating in the fixing. And one way of looking at what’s going on is that illiquidity in the US money markets is increasingly spreading globally. Which can’t be a good thing.

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Another Horrible Quarter for Citi

Posted on April 18, 2008 by Felix

Citigroup’s earnings this quarter were horrible. So what’s the reaction? Internally, it seems weak: Citi’s announced the culling of 9,000 jobs, which sounds like a lot until you step back and look at the big picture. As CFO Gary Crittenden said on the conference call, investors should look at total headcount growth. This time last year it was positive: up 12%. And how much difference has a year made? It’s now up another 8%. For every person Citi’s fired, it seems, the bank has hired even more.

The external reaction is also weird: the stock is up more than 6% this morning. There seems to be a pendulum swinging: the first big tranche of write-downs sends the stock up, the second tranche sends it down, the third tranche sends it up. Is this really, really the kitchen-sink quarter after which there will be no more write-downs? Well, that depends on debt markets. March was a brutal month, and if these marks are all to end-March prices, it’s possible that the worst is over. But given the vicious cycle in which the debt markets are still embroiled, I wouldn’t count on it.

I was particularly interested by one component of the $13 billion in write-downs: $1.5 billion on auction-rate securities. Citi had $11 billion of these animals in February, but by the end of March, after write-downs and sales, it had brought its exposure down to $6.5 billion. Let’s say that it managed to sell $3 billion at or around par, and that it wrote down the remaining $8 billion by $1.5 billion. That would mean that Citi is valuing its unsold ARS portfolio at just 81 cents on the dollar.

No wonder Andrew Cuomo is investigating the ARS market. This stuff was meant to be like cash, and so far there have been few if any defaults. So why is it being marked at distressed levels?

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JetBlue Pushes PayPal Option

Posted on April 18, 2008 by Felix

As we saw with Frontier, airlines are at risk not only from high jet fuel prices but also from their credit card companies, who have the right to unilaterally hold back a very large percentage of any airline’s cashflow. I’m quite sure that’s the reason that offers like this one are now appearing: if you pay for your JetBlue plane ticket with PayPal rather than a credit card, they’ll immediately give you $20 cash back straight into your PayPal account.

The present offer is quite restrictive: they’re doing this for the first 4,500 customers only, and only once per customer, and you need to fly in the next two months. But if it proves popular, and if their credit card company starts making growling noises, expect to see much more along these lines in future. (I suspect one reason for the restrictions is that the airlines have promised the credit-card companies that the cost of buying a plane ticket will not be contingent on the means of payment. But that promise has gone out the window for low-cost airlines in Europe, and it might not last forever in the US, either.)

Should consumers take JetBlue up on its offer? As a rule, no. The insurance you get by paying with a credit card is valuable; PayPal, debit cards, and the like are essentially cash, and come with no insurance at all. $20 cashback is attractive, and it’s hard to put a dollar value on insurance, but it’s definitely worth knowing what you’re giving up when you take that route.

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Extra Credit, Thursday Edition

Posted on April 17, 2008 by Felix

O’Neill Says U.S. `Strong Dollar’ Policy Is `Vacuous Notion’

Food prices: How corn ethanol helps cause riots in Haiti and Bangladesh.

A Transit Miracle on 34th Street

Merrill’s Muppet Moment

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How Jingle Mail Might Help Make Short Sales Easier

Posted on April 17, 2008 by Felix

Remember youwalkaway.com? It was $995. Sound a bit too expensive? Well, do I have good news for you! Youwalkaway.com now has a competitor, walkawayplan.com, which is only $495! And the new site quotes bloggers, to boot! Apparently, if you go by Mish, homeowners don’t have a moral obligation to honor their mortgage agreements, which is good news for those websites trying to cash in on the nascent jingle-mail phenomenon.

I’m actually quite glad that these sites are popping up, if only because it might help light a fire under the rear ends of mortgage servicers who are being unconscionably slow in approving short sales. The WSJ has a good article on short sales today, which lists some of the silly reasons why short sales are so hard:

Gathering all the information needed to evaluate a short-sale offer can take time, says Patrick Carey, an executive vice president with Wells Fargo. The loan servicer must first determine whether the homeowner really can’t continue meeting the loan payments, then get an appraisal or broker’s opinion of the home’s value.

Mortgage servicers also try to ensure that the proposed sale is an "arm’s length" transaction between two parties rather than, say, a sale to a relative on sweet terms. They must also determine whether the buyer has sufficient funds or the ability to get a loan. If all those hurdles are cleared, the servicer may still need to get approval from the investor that owns the loan and provide an analysis showing that the investor will be better off with a short sale than with another solution.

There are additional complications if the borrower has a mortgage and a home-equity loan. In that case, both parties must approve the deal — which is a challenge when the sales price may not even be enough to cover the mortgage balance.

The idea that the servicer has to confirm that the homeowner is in real financial distress is, I think, a relic from the housing-boom days which ought to be unceremoniously jettisoned. Remember that most mortgages, including pretty much all mortgages in California, are, to all intents and purposes, non-recourse. If servicers were reminded that the alternative to a short sale was jingle mail rather than continued timely payments, then they might be more inclined to help the market in short sales get a bit smoother.

I also don’t see why the servicer should worry about the buyer’s ability to get a loan. The worst case scenario is that the buyer loses their deposit if a loan doesn’t come through — and that deposit will just increase the amount of money available to the homeowner to pay down their mortgage.

As for the Helocs, those lenders are very likely to have written off everything, and will generally be quite happy to take some small positive sum for their trouble if asked nicely by the first lien holder.

It seems to me that mortgage lenders are just coming up with excuses, here, not to accept short sales. With any luck, as the likes of walkawayplan.com catch on, those excuses will rapidly evaporate.

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727-727 vs 727

Posted on April 17, 2008 by Felix

A curious postscript to the post below: both the NYT and Slate have slide shows about the Murakami show. Both of them talk about 727-727, and attempt to illustrate it, on slide 10 of the NYT slideshow, and slide 8 of the Slate sideshow. And both of them use an illustration of a different painting, 727, rather than 727-727. Both paintings are on show in Brooklyn right now, but they are definitely distinct: 727-727 is more expressive and painterly. It’s not that hard to tell them apart, you’d think that a professional art critic could manage it. (See here, or below, for what 727-727 really looks like.)

Incidentally, I emailed the NYT on April 6 to inform them of their mistake, on their inform-us-of-errors email address of nytnews@nytimes.com. I got a form reply saying “your e-mail will reach the appropriate editor promptly,” but so far there’s been no correction. I’m trying the same thing with corrections@slate.com, we’ll see if the response is different. Who knows, maybe this blog entry will prompt a correction. Probably not.

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A Little Financial Knowledge is a Dangerous Thing

Posted on April 17, 2008 by Felix

The Citi Smith Barney chap at my local Citibank branch is very sweet. Whenever anybody asks to open a brokerage account, he tells them that he’s not a discount brokerage, and that there are lots of discount brokers like E*Trade who can provide brokerage services at a much lower cost. But I have a feeling that a discount broker might not actually save you money. Dean Baker explains, in the context of talking about cuts in capital-gains taxes:

There is one other important point worth noting about the [lower] capital gains leads to more taxes story. Presumably the greater collections are supposed to come from people selling their stock or other assets more frequently. This means more fees for the financial industry, but is this what we really want to promote. The fees from these trades are a drain on people’s investments. There is a lot of research showing that active traders typically lose money.

When a stock trade costs less than a latte, the barriers to trading in and out of stocks become so low as to be all but nonexistent. And that’s not necessarily a good thing at all.

Lauren Willis at the Loyola Law School in LA takes this argument one step further, and says that consumers shouldn’t even bother with financial literacy:

The pursuit of financial literacy poses costs that almost certainly swamp any benefits. For some consumers, financial education appears to increase confidence without improving ability, leading to worse decisions. When consumers find themselves in dire financial straits, the regulation through education model blames them for their plight, shaming them and deflecting calls for effective market regulation. Consumers generally do not serve as their own doctors and lawyers and for reasons of efficient division of labor alone, generally should not serve as their own financial experts. The search for effective financial literacy education should be replaced by a search for policies more conducive to good consumer financial outcomes.

I do think that it’s worth taking an empirical look at the outcomes of financial education: if it doesn’t make people better off, then it’s probably not a good idea. And I also think that any intuitions I might have about the usefulness of financial education are pretty useless, since a lot of things which are obvious to me turn out to be really difficult for most people to understand. There’s a lot of ignorance out there:

Olivia Mitchell and Annamaria Lusardi found many people do not even have the most basic financial knowledge. Most people do not know the difference between debt and equity, yet are responsible for saving and investing for their retirement. We have a population of people responsible for their financial future and ill-equipped to do so.

And we’re not just talking about saving and investing, either: we’re also talking about home buying. In my experience, almost nobody understands the concept of opportunity cost or is capable of really internalizing the idea that renting can genuinely be cheaper than buying. Rent is always considered "wasted", while interest payments (not even principal payments) on a mortgage are considered, well, not wasted.

In general, I’d say that financial education is worthwhile only insofar as (a) it actually works, and (b) it not only gives people new information but also hammers home to them that even after their education they still know almost nothing and can’t expect to beat the market or make huge amounts of money by doing things like buying a large house with a large mortgage. What I call "financial wellness" is basically the art of spending less than you earn, not being greedy, and minimizing indebtedness. Learning about the ins and outs of the stock market is probably going to be more damaging than useful, much of the time.

Posted in personal finance | 2 Comments

The TED Spread and the Flight to Liquidity

Posted on April 17, 2008 by Felix

Paul Krugman tries today to explain why he’s so obsessed by the spread between Treasuries and Libor:

I got to ask Fed officials about [it], and was told that they preferred the OIS spread, based on Fed funds futures prices. They didn’t like the Ted spread, they said, because they thought liquidity issues distorted Treasury rates.

But I gradually became convinced that those liquidity issues were actually at the heart of the story. Basically, even Fed funds suffers from fear of bank defaults: it’s an unsecured loan, just like LIBOR. So the comparison between 3-month Treasuries and LIBOR is telling you how much of an interest rate loss investors are willing to accept in return for something that’s really, truly safe.

Well, yes, up to a point. But "liquidity issues" includes a hell of a lot more than just credit risk, otherwise there wouldn’t be any spread between on-the-run and off-the-run Treasuries. (Which spread, as I recall, was in large part responsible for the implosion of LTCM.) Indeed, it might be interesting to look at the TED spread in light of what’s happened to the spread between on-the-run and off-the-run Treasury bonds, using the latter as a proxy for the flight-to-liquidity (as opposed to flight-to-no-credit-risk) trade.

Meanwhile, John Jansen has a more optimistic take on three-month Libor widening out:

A second factor to consider is the developing notion that the FOMC is nearly finished with this ease cycle. Against that backgound, the money market curve should steepen and it has… I am hearing that one month Libor will set about 5 ßøßø basis points higher tomorrrow and 3-month libor is indicated 6 basis points higher.

One imagines that if the money market curve is steepening then the Treasury curve should be steepening too, with no net effect on the TED spread. But there’s so much weirdness going on in the markets right now that one shouldn’t take anything for granted.

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JP Morgan: $6 Billion Capital Raising is “Routine”

Posted on April 17, 2008 by Felix

Joe Giannone managed to get someone at JP Morgan to try to explain what on earth is going on with their $6 billion issue of preferred stock:

The bank declined to comment on the transaction, but our sources at JPMorgan said the bond sale was routine, one of more than a hundred such deals over the past decade. Moreover SEC rules prevent banks from disclosing material information in the days ahead of an earnings announcement.

Besides, the source said, bond buyers all over the market knew a deal was in the works and proved to be very hungry for the paper, which was structured so that common shareholders will not see their share of profits diluted.

This is utterly unconvincing. Taking the points one at a time:

  • A $6 billion capital raise is not "routine". If JP Morgan had done a hundred such deals it would have raised, um, $600 billion. Which I’m quite sure it hasn’t.
  • You can’t disclose material information ahead of an earnings announcement? That’s because you’re meant to disclose material information in your earnings announcement, or at least on the conference call afterwards. Once the earnings are out, there’s no SEC constraints. Why didn’t JPM say anything yesterday, after the earnings were out? And why are they still declining to comment?
  • If "bond buyers all over the market knew a deal was in the works," doesn’t that mean that they were in possession of material information, ahead of the earnings announcement?
  • And while it’s true that shareholders won’t see their share of profits diluted, it’s also true that total profits will now be about $500 million a year lower thanks to the interest payments on this new debt. JP Morgan’s earnings were $2.37 billion in the first quarter, so that kind of money is hardly immaterial.

JP Morgan’s shares opened at $44.34 this morning, erasing 22% of the gains they made on Wednesday. Since then they’ve risen, but it’s not completely outlandish to suppose that some investors were spooked by the capital raise.

In general I think it’s a great idea for banks to raise capital in this environment, especially when their derivatives exposure is as large as JP Morgan’s is. But I also think it’s a great idea to do so transparently.

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Why do Investors Pay Fund-of-Funds Managers?

Posted on April 17, 2008 by Felix

Tim Price isn’t impressed with the way that fund-of-funds managers navigated the volatility of the past 12 months:

Hedge funds, often erroneously referred to as an asset class (talent class might be more appropriate, only the phrase smacks of leaden irony given 2008’s returns), have disappointed. The CSFB / Tremont Hedge Index, as at end March, was showing year-to-date returns of -2.01% (not bad considering the stock market, but uninspiring given the essential mission to generate absolute returns in all market environments). Whether hedge fund investors are waving or drowning will be almost entirely down to strategy selection. The “traditional” strategies – convertible arbitrage (-7.6%), event driven (-3.3%), equity long/short (-4.1%) – were largely rubbish. A degree of honour was restored by dedicated short bias (+9.8% – every dog has his day), global macro (+6.9%) and managed futures (+10.4%)…

A final aside: “multi-strategy” delivered -3.9% for the quarter. Fund of funds managers will have to work hard at regaining the trust of investors newly sceptical of their ability to locate alpha as opposed merely to creaming off fees.

They’ll have some help, it turns out, from Andrew Ang, Matthew Rhodes-Kropf, and Rui Zhao:

We use asset allocation concepts to estimate characteristics of the fund-of-funds benchmark distribution. Since the benchmark characteristics are reasonable, we conclude that funds-of-funds, on average, deserve their fees-on-fees.

I do understand that picking hedge funds is a scary prospect, and that any smart person would want expert help in doing so. But given the amounts of money involved, I don’t see why people would want to pay a fixed-percentage management fee rather than a lump-sum consultancy fee. Whatever the hourly rate, it’s unlikely to approach 1% or more of total assets.

(HT: Cowen)

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Welch Gets It: Don’t Criticize Your Successor

Posted on April 17, 2008 by Felix

Good on Jack Welch for his loud and public mea culpa both on this morning’s CNBC and in Business Week, after he screwed up big time on CNBC yesterday. His criticism of his successor was pretty harsh, but his backtracking is frank, unambiguous, and clearly not forced upon him by some PR guy.

"Nothing, nothing, nothing is as disgusting to me as some old CEO chirping away about how things are not as good under the new guy as they were under him," Welch said in a Thursday appearance on CNBC. "… GE is a great company, with a great model, with a helluva CEO who’s reshuffled the business portfolio to make it stronger … and I’m in 100 percent support of everything going on there."

I’m not by nature a big fan of Welch, but in this instance the likes of Alan Greenspan and Paul Volcker should really listen to him. Let the guy in charge be the guy in charge, and don’t second-guess or undercut him. You used to be an important leader; don’t weaken your successor’s legacy and your own by becoming just another media pundit. It might seem unfair for you to be singled out as the one person who isn’t allowed to criticize your successor’s performance; if it does, then just suck it up anyway. There are worse problems to have.

Of course, if you make too many public pronouncements on such issues, you reveal yourself to be little more than a rentaquote, and at that point you’ve pretty much lost your credibility. At that point, pundit away, you can’t do any harm any more.

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JP Morgan’s Really Weird Capital Raise

Posted on April 16, 2008 by Felix

File under "WTF?":

JPMorgan Chase & Co., hours after saying the credit-market crisis is almost over, made plans to raise $6 billion in its biggest offering of perpetual preferred stock, according to data compiled by Bloomberg.

The non-cumulative securities priced to yield 419 basis points more than U.S. Treasuries due in 2018 and pay a fixed rate of 7.9 percent for 10 years. If not called, the debt will begin to float at 347 basis points more than the three-month London interbank offered rate, a borrowing benchmark, currently set at 2.73 percent…

Joseph Evangelisti, a JPMorgan spokesman, declined to comment about the preferred stock sale.

This is really, really weird. Paul Jackson has the obvious reaction:

“I can’t imagine that a $6 billion capital raise would just have slipped the minds of the execs [at JPMorgan],” said one source, who asked not to be named. “I really don’t know what to say.”

A yield of 7.9% over 10 years is expensive capital indeed for a bank which is (a) profitable, (b) currently well capitalized, and (c) doesn’t have an obvious stock of loans needing to be written down. That’s $474 million a year in interest payments: three years’ interest, and you’ve got the entire Bear Stearns acquisition price. And raising this money the day of your earnings announcement, without so much as mentioning it on the conference call?

I’m assuming that more details will emerge on Thursday. But something very unusual does seem to be going on.

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Extra Credit, Wednesday Edition

Posted on April 16, 2008 by Felix

Here Comes the Next Mortgage Crisis: Add Mark Gimein to the list of people convinced that prime borrowers will walk away from their homes if they’re underwater.

Fannie, Freddie Could Hurt U.S. Credit: S&P makes ominous noises about the USA’s triple-A rating. But of course they won’t actually downgrade.

Rent your office for the price of a coffee: Are we more productive when we work in coffee shops?

It ain’t easy getting to work by 8: On the laziness of reporters. Incidentally, for any PR people out there: no, I won’t come to your breakfast meeting on the outlook for the global economy. I’m even less of a morning person than Scribbler A and Scribbler B.

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Can Restaurants Auction Their Reservations?

Posted on April 16, 2008 by Felix

Adam Platt’s rave review of Momofuku Ko won’t make it any easier to get a table at the white-hot 12-seater in New York’s East Village. But one of the most interesting things about the four stars that Platt awarded the restaurant is that they’re based at least a little bit on the fact that Ko is, for what you get, extremely good value: one commenter calls it "a steal".

Chang’s inspiration is the classic Japanese bar-dining model practiced, most notably in New York, by Masa Takayama at his uptown restaurant, Masa. But the price of a single omakase meal at Masa is $400. At Momofuku Ko, my leisurely, inventive, often wickedly delicious ten-course dinner cost $85.

“We charge cook’s prices” is how Chang puts it to one of the patrons at the bar…

Should we subtract a star for the absurd reservation system? But then we’d have to add it right back because the price is so good.

I kinda like the "absurd reservation system", actually, although I haven’t been able to make it work for me yet: at least it’s about as egalitarian as these things come. But at the same time I know that restaurants exist to make money, and that hot restaurants in particular tend to raise their prices quite a lot over the first couple of years they’re open, especially in New York’s largely price-insensitive market. So if it takes a few months before I’m able to get a reservation, there’s a good chance the price will have risen from $85.

I would be fascinated to see what happened if, one or two days a week, Chang altered his reservations system a little. Rather than the first-come-first-served lottery, he could simply accept bids, over the course of the day from anybody wanting a reservation in one week’s time, along with the preferred time that person would like to eat. If he serves say 30 covers per night, he could then accept the top 30 bids, and charge them all the same clearing price: he’d give the highest bidders their first choice on timeslots, but wouldn’t charge them any extra.

The clearing price would, right now, be well over $85; it might even approach the $400 level seen at Masa. The extra proceeds could be used to improve the quality of the ingredients over the entire week, to boost the cooks’ wages, or just to give David Chang a bit more income. And I’m sure that a very large number of urban sociologists would be fascinated at the time series of how the clearing price evolved over the course of a couple of years.

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George Bush Gets Good News on Oil

Posted on April 16, 2008 by Felix

George Bush, who wants to slow down the growth of US carbon emissions, got great news today: oil’s over $115 a barrel! I look forward to the White House statement embracing the fact that market mechanisms are sure to reduce carbon emissions, and looking forward to oil prices rising even higher.

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The Limits of Market Capitalization

Posted on April 16, 2008 by Felix

Kevin Maney today looks at the mooted $17.7 billion valuation of a merged Delta and Northwest, and contrasts it unfavorably with the market capitalization of Yahoo. "It’s almost hard to believe that all those planes, all those people, all that activity, would be worth one-third what Yahoo is worth," he says.

Let’s not niggle over the actual ratio: what this points up is that in Kevin’s beat of Silicon Valley, the value of a company generally is its market capitalization, because it’s extremely rare for technology companies to raise much if any debt. That makes it very easy to compare the value of any two companies: whichever one has the higher market cap is worth more.

In the real world, of course, companies have lots of debt, and very complicated capital structures, which means that market cap is a much less useful metric. Enterprise value is much more useful: essentially, the amount of money you’d need to buy the company. As a first approximation, we can consider it to be market capitalization, plus total debt, minus total cash.

Delta Airlines, for instance, has total debt of $9.3 billion, while Northwest has total debt of $7.1 billion. Add that total debt to a market capitalization of $17.7 billion, subtract cash of $5.8 billion, and you get a total enterprise value of $28.3 billion. Yahoo, by contrast, has a market capitalization of $37.7 billion, total debt of $0.7 billion, and cash of $2 billion, for an enterprise value of $36.4 billion. Bigger, but not remotely three times bigger. And if you add in liabilities not included in "total debt" – things like future pension and healthcare costs for retirees – then the merged airline I’m sure easily eclipses Yahoo in size.

Alternatively, look at the area which investors really care about: earnings. Yahoo had net income of $660 million in 2007; Northwest earned $2.09 billion, while Delta made $1.61 billion. In other words, the airlines, between them, made well over five times as much money as Yahoo, and that’s after paying interest on their debts. (Admittedly, Delta lost $6.2 billion in 2006, and Northwest lost $2.8 billion, so it’s not clear how sustainable those profits are.)

While market capitalization is useful when looking at technology companies, then, it’s not particularly useful when looking at airlines. And it’s certainly not a great way of comparing the two.

Update: See also Barry Ritholtz, "Apple Now Bigger Than Citi".

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Merrill’s Six Mistakes

Posted on April 16, 2008 by Felix

The WSJ has a wonderful narrative today of how Merrill Lynch managed to get so badly hit by the mortgage-bond crisis: apparently it’s going to take even more write-downs in the first quarter, making an unprecedented three successive quarterly losses. So much for the kitchen sink theory.

The story in short:

Merrill was making a lot of money structuring mortgage-backed bonds. The junky bits were popular, the super-senior tranches at the top of the waterfall, less so, and the risk there had to be laid off to insurer AIG. But at the end of 2005, AIG said it didn’t want that risk any more. What did Merrill do? It simply self-insured, keeping those super-senior tranches for itself. That was the first mistake.

The MBS business was now riskier than ever for Merrill, because it was putting its own balance sheet at risk with each deal. So how did Merrill respond to the extra risk? By doing even more deals. That was mistake number two.

With all the new deals, Merrill’s internal risk officers started getting worried. And how did Merrill respond to such concerns? By overruling the risk officers. Mistake three.

It wasn’t just the risk officers who were worried, however: the bond desk was worried too. Merrill’s response bond traders and executives like Jeffrey Kronthal who wanted to throttle back on the MBS business? It fired them. Mistake four.

Eventually, the MBS market started falling, and Merrill started "de-risking". Except instead of just selling risky assets, Merrill decided that the smart move would be to bundle them up into CDOs, sell off the risker tranches of the CDOs, and hold on to the safer bits. Mistake five.

When the CDO market dried up, Merrill moved to Plan B: simply insuring its assets against default. But its counterparty of choice, XL Capital, didn’t want the business. And neither did MBIA. So Merrill turned to tiny ACA, an insurer with just $400 million of capital underpinning $60 billion of insured securities. Mistake six.

And that’s just the big mistakes which managed to make it into the WSJ’s story. Yes, it’s a catalogue of incomeptence and nearsightedness and greed. But it’s also a cautionary tale: if this can happen to Merrill, it can, realistically, happen to any investment bank. Financial services is a risky business to be in.

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WSJ.com Gets its Redesign

Posted on April 16, 2008 by Felix

Rafat Ali reports today that after spending "millions" on a redesign, the all-new WSJ.com will launch "in the next few weeks", with a simple aim: "to drive more traffic in a bigger way".

At the margin, resdesigns can and do increase traffic. But the subscription firewall is a big problem: it’s very hard to persuade people to read a site where they find themselves running into error pages saying "sorry, you’re not allowed to read this".

I’m quite sure that the resdesign will continue the trend that WSJ.com has been following for the past few months, of having bigger headlines and more flexibility. But at heart it will remain a conservative site, which means that it won’t adopt a truly revolutionary idea for a newspaper website: having outbound links on its home page. I’d love to see some major media organization do that, though. Portfolio.com’s sister website Wired.com almost does it: it has a list of "hottest web links" on the home page, but it’s on a tab which you need to click on first. Who will take the plunge? On the internet, the more you send people away, the more they come back. Why don’t any newspaper websites understand this?

(Via Bercovici)

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Credit Derivatives Datapoint of the Day

Posted on April 16, 2008 by Felix

Isda:

The notional amount outstanding of credit default swaps (CDS) grew 37 percent to $62.2 trillion in the second half of 2007 from $45.5 trillion at mid-year. CDS notional growth for the whole of 2007 was 81 percent from $34.5 trillion at year-end 2006. The survey monitors credit default swaps on single names and obligations, baskets and portfolios of credits and index trades.

Up until now, I’ve been relatively sanguine about counterparty risk in the CDS market. Since most players are reasonably sophisticated and very hedged, net exposure is a tiny fraction of gross exposure. But at this point, even a tiny fraction of gross exposure is a mind-boggling sum. If there’s one bad apple in the barrel of players in the CDS market, the whole thing could go supercritical very, very quickly.

Even ignoring the systemic risk associated with the magnitude of the CDS market, however, the $62 trillion number means that bankruptcies and workouts during the upcoming slowdown are going to be very different to what most practitioners are used to. Many if not most major credits are now in the Delphi position, where the amount of protection written is vastly larger than the amount of debt issued. So far, that’s served to prop up distressed bond prices, which is probably not a bad thing. But it could serve to massively complicate bankruptcy proceedings as well, which would not be helpful.

(Via Kedrosky)

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