How a Bullish Trade on Subprime CDOs Made Good Profits

Posted on January 14, 2008 by Felix

From Merrill Lynch to Morgan Stanley, everybody who lost boatloads of money on subprime-backed CDOs seemed to be following the same big-picture strategy: they went short the riskiest, most junior tranches of the CDOs, and hedged their bets by buying the safe tranches.

If the short-junior long-senior trade was a money-loser, then one would expect that the long-junior short-senior trade would have been remarkably profitable. And today, the WSJ finds a fund which did just that: Magnetar Capital. Magnetar was instrumental in bringing a lot of these CDOs to market in the first place, because it was willing to buy the lowest-rated equity tranche. Counterintuitively, that bet paid off nicely:

Magnetar helped to spawn CDOs by buying the riskiest slices of the instruments, which paid returns of around 20% during good times, according to people familiar with its strategy. Back in 2006, when Magnetar began investing, these were the slices Wall Street found hardest to sell because they would be the first to lose money if subprime defaults rose.

For the Wall Street firms underwriting the deals, selling the riskiest pieces was "critical to getting the deals done because they were designed to act as a cushion for other investors," says Eileen Murphy, principal at Excelsior CDO Advisors LLC, a structured-finance consultancy.

Magnetar then hedged its holdings by betting against the less-risky slices of some of these same securities as well as other CDOs, according to people familiar with its strategy. While it lost money on many of the risky slices it bought, it made far more when its hedges paid off as the market collapsed in the second half of last year.

In other words, Magnetar was bullish on subprime CDOs, but still managed to make healthy returns when the market collapsed. Nice save!

Posted in bonds and loans, hedge funds | Comments Off on How a Bullish Trade on Subprime CDOs Made Good Profits

Why China Doesn’t Want to Invest in Citigroup

Posted on January 14, 2008 by Felix

The WSJ’s Rick Carew reports today that the Chinese government might prevent the latest proposed injection of Chinese capital into a troubled US institution. For a good backgrounder on where the Chinese government is coming from, it’s worth checking out James Fallows in the latest Atlantic:

While the CIC is figuring out its own future, outsiders are trying to figure out the CIC–and also SAFE, which will continue handling many of China’s assets. As far as anyone can tell, the starting point for both is risk avoidance. No more Blackstones.

China’s investment in Blackstone, according to Fallows, is much more than an equity stake which is trading below where it was bought. It’s also a public-relations nightmare: the Chinse public thinks that Blackstone essentially stole their cash. Indeed, on his blog, Fallows says that "Stephen Schwarzman of Blackstone is about the most reviled foreigner in China at the moment".

Against this background, it’s easy to understand why China might have second thoughts about injecting new equity capital into Citi. The upside is merely financial, and it’s not like China has any shortage of dollars. The downside, by contrast, is political.

Posted in banking, china | Comments Off on Why China Doesn’t Want to Invest in Citigroup

Why Schultz Might Not be Right for Starbucks

Posted on January 14, 2008 by Felix

Jack Flack is underwhelmed by Joe Nocera’s column on Saturday, in which the veteran NYT columnist has a bearish take on Starbucks. I’m more impressed, partly because it came out on the same day as a similar column from equally-veteran WSJ columnist Herb Greenberg.

Greenberg took an empirical approach to judging the prodigal return of ex-CEOs, looking at a paper by Rudi Fahlenbrach, an assistant finance professor at Ohio State University, which concludes that "the stocks of companies run by CEOs on a second tour of duty outperform the market by 6% annually during their comebacks". He then quotes Yale School of Management professor Jeffrey Sonnenfeld:

Mr. Sonnenfeld says those who succeed in coming back have three qualities. The first is they came back with great reluctance; they weren’t trying to undermine their successor. Second is they aren’t coming back for some unmet ego need. Many had better things to do with their time, and came back "because they were being drafted by all of their key constituencies — because of relationships, knowledge and a cultural aura they can do things nobody else can do to fix the problem." Third, and perhaps most important, he said, is "they recognize what they had built isn’t a religion. At Corning, Mr. Houghton had to revisit all kinds of decisions he may have been part of making."

Based on his own comments, including a concession that he may have had a hand in events leading up to what has happened at Starbucks, Mr. Schultz seems to be doing the same.

This all sounds perfectly reasonable – until you read Nocera’s column. (And until you stop and think about, say, Steve Jobs, who flagrantly violates all three of Sonnenfeld’s prescripts.)

Shultz, it turns out, was a very hands-on chairman, who was intimately involved in all the major decisions made by his successor as CEO, Jim Donald. Says Nocera to Schultz:

You never really left, did you? Even after stepping down as chief executive in 2000, you never stopped acting like the guy who was running Starbucks. That door that separated your office from Mr. Donald’s — how often did you swing through it each day? Five times? Six? You were the one who went on CNBC to promote Starbucks’s latest quarter. You were making the big strategic decisions. And you most decidedly were pushing for growth at all costs.

I hear that after Nike’s founder Phil Knight fired his newly installed chief executive, William Perez, a few years ago, Mr. Daniel started asking you practically every day whether he was doing a good job. That is hardly the sign of a chief executive confident of his ability to set the strategic direction.

Thus the inevitable question: Are you really the right guy to bring Starbucks back? I have my doubts.

Greenberg notes that Starbucks is "in need of a quick turnaround". Given that Shultz was instrumental in getting Starbucks to where it is today, I’m far from convinced that he’s the right man to orchestrate the U-turn.

Posted in stocks | Comments Off on Why Schultz Might Not be Right for Starbucks

Why WSJ.com Will Go Free

Posted on January 14, 2008 by Felix

Last week, Henry Blodget made a good point about WSJ.com going free:

The first indication that you WSJ holdouts may not suddenly get your free lunch is this: Murdoch’s owned the thing for several weeks now and it hasn’t yet gone free.

Unfortunately, that’s pretty much the only good point that he made. I like Blodget’s attempt at contrarianism, and he does admit that even he still thinks that WSJ.com is going to to go free. (If he really thinks it isn’t, I’m very happy to take that bet.) But Blodget has put the anti-free argument out there, so I feel compelled to respond.

First, says Blodget, Rupert Murdoch doesn’t want to give away "a growing revenue stream of $75 million + in free money". Au contraire, that’s exactly what any smart media mogul would want to do in this situation – and Rupert Murdoch is definitely a smart media mogul. The reason is that the revenue stream is not "free money" at all – it carries an enormous opportunity cost.

Murdoch is a newspaperman to his toenails, and he understands the first rule of newspaper economics, which is that circulation is everything. A newspaper doesn’t sell news to consumers: it sells consumers to advertisers. Consumers, and consumers’ attention, are hugely valuable things: they always have been, and they always will be. And the more of them that a media mogul has, the richer and more powerful he becomes. That’s why Murdoch bought MySpace – one of the smartest acquisitions of the digital era. And that’s why Murdoch is going to want as many people as possible to read WSJ.com. To wall them off is to voluntarily give up consumers – and that’s something Murdoch’s never done.

Second, says Blodget, Murdoch might want to preserve the WSJ’s "exclusivity". What? The WSJ is the second-biggest-selling newspaper in the Americas, and that’s only if you count USA Today as a newspaper and not merely an an annoyance which people trip over when they leave their hotel room in the morning. Any newspaper with a daily circulation of over 2 million is no one’s idea of exclusive. Indeed, it’s the WSJ’s very ubiquity which makes it so valuable. People read the WSJ because everybody else does: it’s literally must-read material for an enormous number of business professionals. No one is going to stop reading the WSJ, or read it less often, just because the website, like all other newspaper websites, becomes free.

Third, says Blodget, WSJ.com can charge premium ad rates as a result of its known audience. This is true, up to a point. I don’t know what WSJ.com’s ad rates are, or how much they might have to come down if the site went free. Frankly, no one knows that – the only way to find out is to do it. But the worst-case scenario would be that the WSJ went free and pageviews barely budged. That would be a sign that the readership hadn’t changed, and so CPMs could stay high. If CPMs go down, its only insofar as pageviews go up. And if WSJ.com’s readers actually get richer as a result of the site going free – which is possible, if the site starts getting a lot of new traffic from businessmen in countries where no one buys web subscriptions – then it’s entirely possible that CPMs would not come down at all.

Fourth, Blodget is worried about cannibalization: readers dropping their print subscriptions if they can get all the same content online. Again, Murdoch is a newspaperman, and he’s put his content online for free at all (I think) of his other newspapers. He’s done it dozens of times, he knows the effect on circulation (not nearly as big as many newspaper publishers feared), and he knows it makes sense anyway.

Finally, Blodget says that "once you go free, you’re never going back," and that Murdoch wants to keep his options open. Which is a bit weird. The reason that people don’t go back after going free is that free makes more money. And there have been attempts to go paid after being free: think of Slate, or the NYT’s op-ed columnists. They weren’t very successful attempts, but they were genuine attempts all the same.

Blodget also gets the argument why WSJ.com should go free wrong. He says it hinges on the idea that an increase in traffic "will immediately offset the lost revenue" – and that’s simply not the case. Murdoch won’t make WSJ.com free in order to increase News Corp’s quarterly cashflows. He’ll do it to increase the value of the WSJ as a global property, looking decades into the future. The WSJ is one of the few franchises in the world which has the ability to get the daily attention of the elite class in every country. But in order for that to happen, it has to be free.

Blodget is also worried about WSJ.com’s inventory.

Do you think the WSJ Online sells out its inventory now? Our guess is it doesn’t. So what do you think will happen when that inventory gets multiplied by 10X? Revenue goes up 10X? No. Revenue per page goes DOWN 10X…and then the company prays that its salesforce can start to steal market share from other players.

Murdoch is perfectly good at selling online inventory, and when he bought the WSJ he also bought Marketwatch, which is expert at doing just that. When WSJ.com goes free, it immediately tops the list of a hundred different advertisers who want to reach a large and affluent audience. Yes, it will hope to steal market share from other players – but those other players will not primarily be other websites, they’ll be network TV shows which skew rich. The cost of reaching a rich viewer on network TV has been rising steadily; now, finally, advertisers will have an alternative way of reaching that demographic. Online adspend is still tiny as a percentage of TV adspend; that is certain to change, and Murdoch is going to want to be ahead of the curve and have a first-mover advantage as it happens.

So why hasn’t WSJ.com gone free already? My guess is simply that Murdoch wants to announce the move with a bang, not with a whimper. He could take the present crappy website and make it free, but it wouldn’t get an enormous traffic boost, because it’s crappy. Better to build a completely new best-in-the-world website and make that free at launch. The first day that WSJ.com is free will be the first day that millions of people really get to explore the site. Rupert Murdoch wants that day to be a great one for those people, not a disappointing one.

(HT: Karbasfrooshan)

Posted in Media, publishing | 7 Comments

Extra Credit, Monday Edition

Posted on January 14, 2008 by Felix

If, When, How: A Primer on Fiscal Stimulus: "Policies that are potentially most effective include temporary and refundable tax credits,

temporary increases in food stamps, and a temporary extension of unemployment insurance

benefits. Policies that are especially counterproductive include permanent reductions in tax rates

and making the 2001 and 2003 tax cuts permanent." (See also)

Budget Non-Reporting at the Post: "Massachusetts will not be facing budget problems because it allows the children of illegal immigrants to pay in-state tuition, and it is outrageous for the Post to publish an article implying that this is the case."

Libertarians deserve a listen: Kinsley’s always worth a read. But: "no one should want to drink unpasteurized milk"? Everyone I know in NYC is desperate for the stuff!

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

Steve Jobs on “Pungent Odors”

Posted on January 13, 2008 by Felix

This might be a little off-topic, but it’s too good not to share. It’s from the Fort Greene Kids listerv on Yahoo, where a member shared an email she sent to Steve Jobs:

hi steve,

i have enjoyed watching apple grow and have fully participated in

each of the technologies (with the exception of the iphone) and i

love the apple retail stores.

however, i have one issue i would like to get an answer about.

why aren’t there diaper changing tables in the nyc soho store? (i

don’t know about the other locations as i only visit this one in new

york.) i am terribly disappointed there are no changing stations.

my son is 3 1/2 and hasn’t worn diapers for awhile, so it doesn’t

particularly affect me any longer. but, i can’t understand why a

company that is so on the cutting edge and seems so understanding

wouldn’t install baby diaper changing tables? they really are quite

simple and practical. there are many parents (male and female –

could you install in both bathrooms??) i see visiting the apple

store with kids. i know myself i spent a few hours at the genius

bar getting support and i spent a few hours browsing the store and

purchasing items. it’s a challenge to find a bathroom in nyc and

it’s great you made such nice ones for the grown folks, but how

about installing a few pull down tables to change those little

future customers?

when the store redid the bathrooms a few years ago, i thought maybe

there would be one when i opened the door? alas – there is not.

no one in the store has been able to answer my question.

can you?

🙂

thank you.

And this is the reply she (allegedly) received:

From: Steve Jobs <sjobs@apple.com>

Date: January 3, 2008 10:33:14 PM EST

To: [redacted]

Subject: Re: apple retail store – soho nyc – baby diaper changing table???

There doesn’t seem to be a demand for it, and it usually is accompanied by rather pungent odors.

Steve

Posted in technology | Comments Off on Steve Jobs on “Pungent Odors”

Ben Stein Watch: January 13, 2008

Posted on January 13, 2008 by Felix

It’s been three weeks since the last installment of the Ben Stein Watch: had no column appeared today, I would have been ready to declare victory. But it was not to be, and a predictably bad column has arrived, along with an elegant fisking from Yves Smith.

It turns out that "Little Benjy Sunshine", as Stein called himself on October 21, has died. He’s now saying that Ben Bernanke "did not leave the door [to further rate cuts] open wide enough" in his speech last week: "the Fed is still behind the curve," he writes.

He’s also developed an extremely annoying new rhetorical tic:

It’s pretty much agreed by now that inflation comes from the demand side…

Ethanol, at this point, is believed by many to be an energy loser… It is also believed to be more inefficient at powering vehicles than gasoline.

What’s with all these weird passive constructions? It’s pretty much agreed? It’s believed by many? Dude, it’s believed by many that Elvis is still alive. Without any indication of who’s doing the agreeing or the believing, these kind of arguments are simply vapid.

I, for one, would be perfectly happy to take the other side of Stein’s argument, and say that high oil prices are just as much a function of reduced supply (from countries like Iraq and Mexico) as they are of increased demand. You don’t need to be an overzealous Peak Oil type to believe that oil prices go up when production goes down.

But it’s at the end of his column that Stein goes completely bonkers. After saying that "there is a real solvency fear out there right now," Stein decides that what’s needed is a massive recapitalization of large banks, whereby sovereign wealth is used to buy banks’ equity.

Hm. Isn’t that already happening? Aren’t banks doing quite well at attracting new equity investments from governments across the Middle East and Asia?

Well, it turns out that countries like Abu Dhabi and Singapore aren’t quite the sovereigns that Stein had in mind.

The Fed must act decisively to calm these fears by reassuring lenders.

This might even take the form of legislation allowing the Fed to buy stock in large banks on a temporary basis. The banks are already largely socialized through federal deposit insurance. To add the prop of government capital infusions is not such a big step.

Yeah, Stein wants the Federal Reserve to start taking equity risk in big lenders. I’d love to know which "large banks" in particular Stein thinks the Fed should start buying stock in – presumably only the ones where "there is a real solvency fear". Would he care to give any examples of these possibly-insolvent large banks?

If Stein’s idea were implemented, the Fed’s actions would be the ultimate ratification of the market’s solvency fears, and would send the bank’s stock plunging. And in any case it’s hard to square Stein’s fears of bank insolvency with the sanguine declaration with which he finishes his column:

No matter what, we’ll get through it all, but why make it more painful than it needs to be?

Why indeed.

Posted in ben stein watch | Comments Off on Ben Stein Watch: January 13, 2008

Japanese Garbage Datapoints of the Day

Posted on January 12, 2008 by Felix

The value of indium in Japan’s garbage dumps: $833 million

The value of lead in Japan’s garbage dumps: $15 billion

The value of silver in Japan’s garbage dumps: $30 billion

The value of gold in Japan’s garbage dumps: $178 billion

The value of copper in Japan’s garbage dumps: $283 billion

The 6,800 tons of gold in Japan’s "urban mines" compares to 765 tons in Japan’s official reserves; it’s more even than the official reserves of Germany and the IMF combined.

(Source, via Schiff.)

Posted in commodities | Comments Off on Japanese Garbage Datapoints of the Day

Extra Credit, Weekend Edition

Posted on January 12, 2008 by Felix

Huckabee’s Tax Plan Is Brilliant: Landsburg defends the Fair Tax. Kleiman rebuts.

Mozilo severance: $110 million and change

Street Smarts: Economists Take on Traffic Safety

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

Nick Denton’s task at Gawker

Posted on January 12, 2008 by Felix

I’m quoted* in Allen Salkin’s NYT article on Gawker tomorrow. I thought that he’d place more emphasis on the importance of Gawker’s commenters for generating pageviews, since we talked quite a lot about that, but I guess Sunday Styles doesn’t like getting into numbers.

So here’s the big idea which didn’t make it into the article. Gawker’s unique visitors have been stagnant for two years: they essentially reached their present level at the end of 2005. Gawker’s pageviews continued to grow through 2006, as (a) Nick Denton increased the number of blog entries with a “jump” which required navigating away from the home page; and (b) the comments system became very sophisticated and capable of drawing people back to the same post dozens of times in succession.

But then, at the end of 2006, Denton found himself unable to grow the pageviews-to-unique-visitors ratio any further, and both pageviews and uniques were basically unchanged through 2007.

At the moment, Gawker is going through the biggest change in its history, and no one knows how it’s going to turn out. But I’m quite sure that Denton, having maximized the pageviews-to-uniques ratio, has realized that the only way of increasing pageviews at this point is to increase the number of unique visitors that the site receives.

But here’s the problem: the very posts which will help bring in new unique visitors (Denton wants Gawker to be “a national media gossip and pop culture site, which is based in new york, but can attract a national audience”) also risk being the posts which alienate Gawker’s core commenter audience.

In other words, Denton might succeed in goosing Gawker’s uniques — but only at the cost of a declining pageviews-to-uniques ratio. Which is why I think it’s going to be hard for him to boost pageviews.

Meanwhile, the “creative underclass” which used to owned by Gawker has increasingly migrated to Jezebel — after all, there’s no doubt that the creative underclass skews very female. In November and December, Jezebel got more pageviews than Gawker — which is really impressive for a site which only launched in May.

So Nick Denton, qua Gawker Media overlord, is sitting pretty: he’s getting more pageviews and creative-class attention than ever, thanks to Jezebel. But as Gawker editor, Denton has a tougher job.

*For the record: I did use the word “skeevy” in my conversation with Salkin; I was not misquoted. But I used it in the context of the title of a blog entry I wrote in 2006 — which is something no NYT reader is going to understand. But hey, insofar as Salkin’s Sunday Styles piece is saying that Gawker’s getting skeevy, it’s only two years behind the felixsalmon.com curve!

Posted in Not economics | 7 Comments

Trading Recession Probabilities

Posted on January 11, 2008 by Felix

According to InTrade, there’s a 58% chance that the US will see a recession in 2008. That number is higher than the 43% probability assigned to recession by economists polled by the WSJ. But there’s no real discrepancy there, says Dean Baker:

Economists don’t predict recession. Economists don’t predict recessions. (I’m not in the fraternity.) Say it one thousand times until it sinks in. Economists, when we are lucky, recognize recessions after we are already in them. The fact that so many economists are now willing to say that we are facing recessions should be viewed as a lagging indicator of a recession. It is very reliable — I am fairly certain that there has never been a period in which a sizable share of economists forecast a recession and we have not actually been in a recession.

The real question, if Baker is right, is not why InTrade’s recession contract is trading so high; it’s why InTrade’s recession contract is trading so low. There are basically only two explanations: either InTrade’s traders are placing too much faith in the literal accuracy of economic forecasts, or else Baker is placing too much faith in economists’ inability to predict recessions. If you have little faith in economists, maybe the contract is decidedly cheap at these levels. Here’s a live chart:

Posted in economics, prediction markets | Comments Off on Trading Recession Probabilities

How to Trade a Bear Market

Posted on January 11, 2008 by Felix

Baruch at Ultimi Barbarorum gives us his tips on how to trade a bear market:

Let the Constanza Doctrine be your guide: do The Opposite of what feels good. You are not alone, and at the moments of maximum stress when you think they’ll never, ever go up again, everyone else will be thinking the same thing. Take your hedges off because that’s when we are about to go up. Similarly, watch out for when you feel really positive about the market. When you think everything is going to be all right for a while, add those puts back. This of course will drive you mad, and if you are successful you will eventually stop being able to recognise what it is you actually think about things, at which point you will no longer know what The Opposite is. I am there already.

Baruch is hopeful that the bear market will come to an end in three to six months, at which point he can go back to simply buying stocks he thinks are going up. So the key, it seems, is to know when you’re in a bear market and when you’re not. If you are in a bear market, then feeling good about something is a bad sign; if you’re not in a bear market, then feeling good about something is a good sign.

Baruch tells me that I will "suffer appropriately" for being invested in index funds. Frankly, the suffering involved by being in index funds seems small compared to the suffering involved in perpetually second-guessing oneself.

Posted in investing, stocks | Comments Off on How to Trade a Bear Market

Why FT.com Charges for Subscriptions

Posted on January 11, 2008 by Felix

Jeff Bercovici has an interesting interview today with John Ridding, the chief executive of the Financial Times. He does his best to defend the FT’s weird and counterproductive online pricing model, and it’s worth reading between the lines of some of what he told Jeff. Take this, for instance:

On the numbers front we’ve seen what we want to see, which is the growth

of traffic and the growth of registrations, and we’ve been pleased with the

subscribers. That’s got to play out a bit, the subscriber element, because the

idea is you’re constantly funneling them through, and we’re not sure yet how the

old subscribers will react, but so far so good.

Note that Ridding starts off by saying that he’s happy with traffic growth as well as the increase in registrations; he seems less sure about the subscription side of things, saying that it’s "got to play out a bit". My feeling is that when he says that "so far so good" he means that so far subscribers haven’t unsusbscribed because they can get (most of) the same content for free. I’d wager that the new-subscription rate has actually fallen substantially, because now people can read much more of FT.com without subscribing, and it’ll take people a while to reach their quota of 30 stories and then be asked to subscribe.

What’s more, I suspect that the 30-story quota isn’t really being enforced very strongly. Do you know anybody who’s tried to read an FT.com story and has been unable to do so because he’s exceeded his quota? My gut feeling is that people can in reality read much more than 30 stories per month before being locked out of the site: the FT has no real interest in preventing its most loyal readers from visiting the site to get their news and analysis.

So why does it have the online subscription rate at all? Why not make everything free? Ridding answers that question:

And then the other dimension is the corporate consumer channel. For us in particular, being who we are — this specialist business publication — the corporate channel is very important, and I think it has very substantial potential which people don’t always factor in.

And to utilize that channel effectively, it’s very useful to have that subscriber pricing

threshold because otherwise we’re not going to have a price level for the corporate market.

You could be forgiven for not understanding a word of this. When Ridding talks about "the corporate channel," what he means is the way in which FT content is delivered over Reuters screens and other ways that information gets "pushed" to financial professionals. The FT makes a lot of money from this screen-based delivery system (which is entirely separate from the website), and it reckons that banks and institutional investors and other buyers of screen-based information won’t pay more than the regular subscription rate. If all the same content is available on the web for free, goes the thinking, the FT’s sales force will find it much harder to ask people to pay for it on their screens.

Later on in the interview, Ridder says that "we want more subscribers because it gives a stability to the business". Ad spend is volatile; subscription revenue is much more predictable. And in fact the FT has been hiking its cover price in an attempt to boost those subscription revenues, with quite a lot of success.

But in the world of print newspapers, the best you can hope for from subscription revenues is that they will offset printing and distribution costs: they certainly don’t come close to paying for the cost of newsgathering, which is paid for not by subscription revenues but by advertising revenues. Given that printing and distribution costs online are (to all intents and purposes) zero, any subscription revenues from FT.com are pure gravy. Gravy’s nice, but it’s not necessary.

So expect the FT to continue to charge a nominal rate for its FT.com subscriptions, but not to be too worried if those revenues fall off a bit, so long as pageview growth and CPMs remain strong. The nominal subscription rate will get paid by the large number of readers who aren’t spending their own money; it will also make it easier for the FT’s sales force to sell into that "corporate channel". And all of that is good for the FT’s bottom line.

But in the long term, the FT is losing its chance to cement itself as the go-to site for financial news and information. When WSJ.com goes completely free and FT.com retains all its registration and subscription firewalls, Rupert Murdoch will be incredibly well placed, in this winner-takes-all world, to pick up a huge proportion of the fast-growing ad revenues in the online financial space.

Posted in publishing | Comments Off on Why FT.com Charges for Subscriptions

BofA-Countrywide: The Main Street Implications

Posted on January 11, 2008 by Felix

I’m going to be on Fox Business this afternoon at 4pm, talking about the Countrywide acquisition. Befitting the channel’s "Wall Street meets Main Street" concept, I’m sure they’re going to ask me less about the finances of the deal and more about the implications for buyers and sellers of homes.

The really big change, I think, is that Ken Lewis has explicitly stated that a BofA-owned Countrywide will not make any subprime loans. Which means that for subprime borrowers, it’s going to be harder than ever to find a mortgage. And for everybody else, less competition in the mortgage-origination sector is likely to mean higher mortgage prices. The combined company will have 25% of all mortgage-origination business: in the UK, that would officially make it a monopoly.

Now mortgages are sold almost entirely on price: borrowers don’t care who their lender is, so long as they’re getting the cheapest possible rate. So BofA-Countrywide isn’t going to have a huge amount of price-setting power. But at the margin, I think mortgages are going to be harder to get and more expensive in the wake of this deal.

On the other hand, existing homeowners whose mortgages are being serviced by Countrywide should probably be breathing a sigh of relief. No one wants a bankrupt loan servicer, and now they know that isn’t a risk any more.

Are there other Main Street implications I should be thinking about?

Posted in housing | Comments Off on BofA-Countrywide: The Main Street Implications

How Merrill Spun its Write-Down News

Posted on January 11, 2008 by Felix

Shares in Merrill Lynch are flat this morning: investors seem unconcerned about the news that the company will take a whopping $15 billion write-down in the fourth quarter.

Last month, after Merrill got a $5.6 billion cash injection from Temasek and Davis, I asked what would happen in the event of an eleven-figure write-down. In the event, it seems, the write-down is going to be even bigger than the most pessimistic December estimates: $15 billion is more than a third of Merrill’s market capitalization, and is over 37% of Merrill’s book value. No wonder the bank is going to need more capital.

I do think there’s some strategic leaking going on here: Merrill doesn’t want the market to be surprised at a $15 billion write-down. So first it started hinting to analysts that the fourth-quarter write-downs could be enormous; then, just before the actual announcement, it let the press know just how big the actual number was likely to be. This strategy isn’t exactly transparent, but it does seem to have been reasonably effective: Merrill shares remain above the crucial $48 level at which Temasek and Davis are buying in.

But if Merrill knew back in December that it would have to take a huge write-down, it really should have informed its shareholders in a more direct manner. That’s not just proper investor relations, it’s the law.

Posted in banking, stocks | Comments Off on How Merrill Spun its Write-Down News

Why BofA Bought Countrywide

Posted on January 11, 2008 by Felix

Countrywide’s Angelo Mozilo has had many opportunities, over the years, to sell his company for a huge sum to Bank of America. There’s only one reason why he would say yes to a deal now, at $4 billion, when he said no to a deal at $30 billion: yesterday’s rumors were true, and Countrywide really was insolvent. Mozilo didn’t particularly want a deal, but it was better than bankruptcy.

So maybe the real question is this: why is Bank of America willingly paying billions of dollars to take on Countrywide’s liabilities? If Countrywide had entered bankruptcy, BofA, as a major creditor, would have likely walked away with most of the firm’s assets in any case. And, according to the WSJ, it would have shared bail-out duties with the GSEs:

A failure of Countrywide would have posed a major risk to the U.S. economy, since the lender services about one of every six loans in the country. Bankruptcy likely would have shifted huge financial risk to Fannie Mae and Freddie Mac. A spokesman for the U.S. Treasury Department said agency officials didn’t encourage Bank of America to rescue the huge mortgage firm.

I’m not sure how true this is, since as I understand it Fannie and Freddie generally take on borrower credit risk, not servicer credit risk. I’m sure that Countrywide would have continued to service its loans through the bankrupcy process, at no real cost to Fannie or Freddie.

Rather, I think that the thing to remember is that BofA’s Ken Lewis has coveted Countrywide for years: he has pretty much always been willing to buy the company at or slightly above the market price. He was faced with an opportunity to by Countrywide for little more than a rounding error in the BofA balance sheet: if he let it slip away from him now, he’d never forgive himself.

And Bank of America has now, overnight, become by far the biggest and strongest and most important operator in the world of US mortgages. Over the long term, that status is going to be hugely valuable for Lewis, even if he has to take some write-downs along the way.

Finally, the Countrywide acquisition solidifies BofA’s status as a consumer bank, and helps Lewis’s decision to move slowly out of the investment-banking business look strategic. Investors know that if BofA suffers losses, it will be because of errors in lending, and not because some trading desk suddenly blew up one morning. Given that commercial banks trade at higher multiples of earnings than investment banks, that’s valuable to Lewis too.

Posted in banking, housing, M&A | Comments Off on Why BofA Bought Countrywide

Extra Credit, Friday Edition

Posted on January 11, 2008 by Felix

RiskMetrics’ IPO promises payoff: Soon, Institutional Shareholder Services will be advising how shareholders should vote on its own parent.

NYSE Euronext Is in Talks to Buy Amex

Hans Monderman, Engineer of Livable Streets, 1947-2008

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Blackstone: The Stock Buyback Which Isn’t

Posted on January 10, 2008 by Felix

Stock buybacks are good news for shareholders for two reasons. Firstly, they increase demand for the stock, which helps boost the share price – but that effect is one-off, and temporary, and mostly benefits the shareholders who sell their stock – ie, it benefits ex-shareholders more than current shareholders. Secondly, all the ownership benefit which used to belong to those ex-shareholders now belongs to the current shareholders. That’s the main benefit of a buyback, from a long-term shareholder’s point of view: it’s essentially the opposite of a dilution. (A reduction, perhaps?)

Today, Blackstone announced a $500 million stock buyback, as part of its $930 acquisition of fund manager GSO. But this buyback doesn’t benefit shareholders nearly as much as most buybacks do. Steven Davidoff explains:

The real winner here is Stephen A. Schwarzman, chairman and chief executive officer of Blackstone. Blackstone Holdings, the publicly-traded Blackstone partnership, is issuing these units to GSO but the purchaser of the units in the market will not be this entity. This is unusual, as typically in share repurchases it is done by the company itself so that all shareholders can share in the effect of the buyback and the presumably undervalued price realized.

Rather, here a Blackstone company owned by Mr. Schwarzman and the other Blackstone partners, Blackstone Group Management LLC, will make the purchase. The Blackstone partners are thus buying back the equity they sold for a significantly higher price six months ago and depriving their remaining public shareholders the primary benefit of that repurchase. Chutzpah.

Got that? The shareholders (technically unit holders) own a company called Blackstone Holdings. But Blackstone Holdings isn’t the entity doing the buyback – that would be Blackstone Group Management, which is owned not by the shareholders but rather by Blackstone’s senior management. So all the ownership benefit from those shares will go straight to Steve Schwarzman and friends, not to the long-suffering shareholders.

Recommendation: Sell. Blackstone might be a good company, but it treats its shareholders like shit, and if you own a minority stake in the company you simply can’t expect to be treated fairly.

Posted in private equity, stocks | Comments Off on Blackstone: The Stock Buyback Which Isn’t

BofA-Countrywide: An Acquisition Which Makes Sense

Posted on January 10, 2008 by Felix

Countrywide shares are up over 40% today as the WSJ reports the company might be taken over by Bank of America.

You gotta love the WSJ’s hedging:

It isn’t clear how quickly a deal might be struck, but two people familiar with the matter said it could occur very soon. It also is possible that an agreement could be delayed or fall apart altogether.

It’s also worth checking out the NYSE press release:

In view of the unusual market activity in the company’s stock, the Exchange has contacted the company and requested that the company issue a public statement indicating whether there are any corporate developments which may explain the unusual activity.

The company declined to comment.

They’re probably so stunned their stock is going up rather than down that they have no idea what else to do.

It would make sense for BofA to buy Countrywide: the Charlotte bank has deep enough pockets to be able to sustain any last losses that might still be lurking in Countrywide’s portfolio, and by buying Countrywide at a steep discount it would get very cheap market share in the mortgage business.

What’s more, Countrywide has big liquidity problems, which would be solved at a stroke if it was bought by BofA. That alone justifies today’s share-price hike.

Posted in banking, housing, stocks | Comments Off on BofA-Countrywide: An Acquisition Which Makes Sense

The CNBC-PZE Fiasco

Posted on January 10, 2008 by Felix

It’s a fun game, this stock-market malarkey. You watch CNBC, see a talking head recommend a stock ticker symbol, and then jump onto your computer to execute the trade. It’s so easy! And, for all that investors are continually advised not to act like brainless lemmings, that’s exactly what seems to happen.

You want proof? Check this out.

CNBC has, over the past couple of weeks, suddenly discovered an obscure Argentine energy stock called Petrobras Energia. On December 28, it ran an interview with fund manager Ken Heebner, who said that he really liked energy stocks in general, and Petrobras in particular. Except that the chart that CNBC ran to accompany the interview showed not Petrobras shares, which trade under the ticker symbol PBR, but rather those of its Argentine subsidiary, Petrobras Energia, which trades under the ticker symbol PZE.

That day, volume in PZE, which is normally around 360,000 shares, spiked tenfold to 3.6 million. Quite impressive for the quiet week between Christmas and New Year.

CNBC did acknowledge the error, but apparently it now had PZE on the brain, because the Argentine company was then featured on Jim Cramer’s show on Monday, where the madman said that it was an "underexposed Latin American energy stock that could be poised for big gains". Apparently he was believing his own hype: three days previously, in a call-in segment, he’d told a caller that PZE was a great way of playing Brazil, despite the fact that PZE has a separate listing largely because it’s not a Brazil play. "You should buy this stock. I got to tell you, I like Brazil so much," he said.

And on the same day that Cramer was plugging PZE for a second time, CNBC had Ken Heebner on for a second time. You’re going to love this: he recommended Petrobras again, and CNBC showed a stock chart of PZE again – exactly the same mistake that they’d made less than two weeks previously.

PZE shares spiked up on Tuesday as result – just in time to receive a simultaneous double downgrade on Wednesday from the rather sensible analysts at Bear Stearns and Citigroup, who had seen the stock rise 30% on buying by CNBC-addicted sheeples, and who couldn’t believe their luck in being able to get out at a ridiculously high price.

Thus did PZE fall 15% in one day on Wednesday, and it’s falling further today, as well.

Now to be fair, CNBC isn’t the only media company to make this mistake. Forbes did it too, in November, but not in the context of a stock pick: it was writing about pipe manufacturer Vallourec, and said that it made pipes for Total, Exxon Mobil, and Petrobras, giving the wrong ticker symbol for Petrobras. That’s no big deal.

What’s truly ridiculous is the fevered atmosphere on CNBC, where viewers get so caught up in the rush of ticker symbols coming at them from their television that they don’t even stop long enough to notice that they’re actually buying an Argentine company when they thought they were buying a Brazilian company. And now Fox Business has started competing with CNBC, one has to assume that CNBC is going to become even more breathless and shallow.

The PZE fiasco might be an extreme example of what can result, but be assured that every time you buy a stock which was featured on CNBC, you’re acting in tandem with some very, very foolish investors.

Posted in stocks | Comments Off on The CNBC-PZE Fiasco

Bernanke Now Fully On Board the Rate-Cutting Bus

Posted on January 10, 2008 by Felix

Was Ben Bernanke reading this morning’s New York Times? "Many on Wall Street," wrote Louis Uchitelle, "argue that with the stock market falling, unemployment rising and the economy flirting with a recession, Mr. Bernanke should be dealing with the situation more aggressively than he has so far."

What the markets were calling for, said Uchitelle, was a strong indication that the Fed was willing and ready to cut rates aggressively – to 3%, or maybe even more. Well, it seems like the markets now have that indication. Here’s Bernanke, today:

In light of recent changes in the outlook for and the risks to growth, additional policy easing may well be necessary. The Committee will, of course, be carefully evaluating incoming information bearing on the economic outlook. Based on that evaluation, and consistent with our dual mandate, we stand ready to take substantive additional action as needed to support growth and to provide adequate insurance against downside risks.

Financial and economic conditions can change quickly. Consequently, the Committee must remain exceptionally alert and flexible, prepared to act in a decisive and timely manner and, in particular, to counter any adverse dynamics that might threaten economic or financial stability.

Greg Ip underlines the importance of these words:

His speech suggests he now considers weak economic growth a bigger threat than inflation, and the Fed may say so explicitly at its next meeting. That would be an important shift. In the prior five months the Fed has either called those risks balanced or refused to say which is more worrisome.

Bernanke’s speech is not, in truth, as bearish as Paulson’s speech was on Monday. This is as downbeat as Bernanke got:

Although economic growth slowed in the fourth quarter of last year from the third quarter’s rapid clip, it seems nonetheless, as best we can tell, to have continued at a moderate pace. Recently, however, incoming information has suggested that the baseline outlook for real activity in 2008 has worsened and the downside risks to growth have become more pronounced.

Still, the markets don’t really care how bearish Bernanke sounds; what matters is what he does, in terms of cutting interest rates. And the base-case scenario must now be that the Fed will cut at every meeting unless or until growth starts picking up again.

By the way, Bernanke’s speech is very long, and gets nicely wonky in places. The markets only really care about the monetary-policy bits, but I was interested in this bit, too, where Bernanke explains that one reason the Fed funds rate was rather volatile in the second half of 2007 was that the Fed reduced the spread between the funds rate and the discount rate.

To maintain the federal funds rate near its target, the Federal Reserve System’s open market desk must take into account the fact that loans through the discount window add reserves to the banking system and thus, all else equal, could tend to push the federal funds rate below the target set by the FOMC. The open market desk can offset this effect by draining reserves from the system. But the amounts that banks choose to borrow at the discount window can be difficult to predict, complicating the management of the federal funds rate, especially when borrowings are large.

Now that the Fed has largely replaced the discount window with the new Term Auction Facility, says Bernanke, funds-rate volatility should decline. We’ll see.

Posted in fiscal and monetary policy | Comments Off on Bernanke Now Fully On Board the Rate-Cutting Bus

International Capital Flows Datapoint of the Day

Posted on January 10, 2008 by Felix

The most money the IMF ever lent to the emerging world in one quarter: $13.7 billion (Q3, 2001)

Total capital infusions from emerging-market sovereigns into US and European banks in Q4 2007: $28.4 billion

(Via Setser, natch; he reckons that these capital infusions are going to remain high through 2008.)

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It’s OK for Tony Blair to Cash Out

Posted on January 10, 2008 by Felix

Yves Smith says that Tony Blair’s decision to work as a part-time adviser to JP Morgan is "reprehensible". I’m more sanguine about it. Yes, the amount that Blair is pulling in is huge: 5 million pounds for his memoirs, millions more for speeches, (including $500,000 for a 20-minute speech in China), and now "a series of positions" in the private sector, some if not all of which are likely to carry seven-figure stipends.

One can’t explain all of this by saying that he has a large mortgage: after all, his wife is a very big earner in her own right, and Blair could probably have paid the full 3.5 million pounds that his house cost from his book advance alone.

On the other hand, Blair has four children, and I’m sure he wants to do well by them. His main job, as Middle East envoy, is unpaid. And if he does become president of the EU, he’ll have to give up his lucrative private-sector positions, so he might not have a lot of time to cash in between now and then.

If JP Morgan wants to pay Blair something north of $1 million a year to schmooze clients and add his lustre to the bank, that’s great: I don’t think there’s much in the way of conflict there. Hell, the bank might even take his advice now and then: Blair certainly knows a lot about the inner workings of UK politics at its highest levels, and that’s something that any major bank in London has to be able to navigate.

Besides, Tory PMs do this kind of thing all the time; there’s no reason why Labour PMs shouldn’t follow suit. And what’s more, if people thought that going into British politics could make you rich, the country might get itself a better class of people wanting to become MPs in the first place.

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Can Pandit Cut Citi’s Dividend?

Posted on January 10, 2008 by Felix

In the WSJ report on Citi shoring up its capital base, we’re told that a dividend cut is now a real possibility:

The board of Citigroup is expected to meet on Monday, a day before it reports earnings, and to discuss cutting the firm’s hefty dividend in half. This could save more than $5 billion a year. Citigroup has repeatedly said its dividend was safe. But Vikram Pandit, its new chief executive, is seen as more willing than his predecessor to take radical steps.

Named: Vikram Pandit. Not named: the board’s chairman, Win Bischoff, or the chairman of the executive committee, Robert Rubin. Remember that dividend decisions are made by the board and not by the CEO. But the fact is that the CEO is one of the 15 board members, and one imagines that if Pandit is strongly in favor of a dividend cut, the rest of the board will go along with him.

That said, however, one also wonders what the point is of splitting the jobs of chairman and CEO if the CEO still gets a seat on the board and has de facto ability to make decisions on things like dividends. What’s left for the chairman to do?

It’ll definitely be interesting to see how the stock market reacts to any dividend cut. In case you didn’t notice, the stock of MBIA tanked on Wednesday after the bond insurer said it was cutting its dividend, before recovering on speculation of a rescue from Warren Buffett. Sam Jones is puzzled by the stock-price action:

If you had shares in MBIA and you were smart, why on earth – having held on this long – would you suddenly sell having heard that, oh, actually, the bond insurer wasn’t going to collapse over the next fortnight like everyone said it would. But wait – horror of horrors – now you’re only going to get a dividend worth 13 cents a share, not 34!

Evidently there are a lot of investors who Really Care about dividends. I’m on the record advocating that Citi cut its dividend, but I’m not at all convinced that such a move would come without negative consequences for the share price. Still, Citi’s share price has now sunk so low that the dividend yield has hit 8%. And given the tough operating environment that Citi faces in 2008, I just don’t see how the board can justify paying out 8% of the bank’s market capitalization to its shareholders, rather than using that money to shore up a rapidly-shrinking capital base.

By the way, Citi is currently trading on a multiple of 1.08 times book value. When it releases its fourth-quarter earnings next week, that ratio should rise, if only because the write-offs are going to mean that its book value has fallen. Even so, the bank is still getting dangerously close to following Bear Stearns into trading on a price-to-book ratio of less than 1.

Posted in banking, stocks | Comments Off on Can Pandit Cut Citi’s Dividend?

Capital Injections at Citi and Merrill: The Shorter Version

Posted on January 10, 2008 by Felix

The WSJ’s massive front-page story this morning, headlined "Citigroup, Merrill Seek

More Foreign Capital", is an important one. But you might well not have time to read the entire 2,365-word article, so let me summarize it for you. Here’s the article’s contents, in decreasing order of importance:

  1. Citigroup is looking to raise as much as $10 billion in new equity capital, to help offset a fourth-quarter write-down of as much as $15 billion.
  2. Merrill Lynch is looking to raise as much as $4 billion in new equity capital, to help offset a fourth-quarter write-down of as much as $10 billion.
  3. Citi is seriously considering cutting its dividend in half.
  4. The political risk involved in accepting multi-billion-dollar investments from foreign governments is growing.
  5. Big equity injections can also raise significant regulatory issues, regardless of the investor.
  6. Looking forwards, prospects for banking-industry profitability in 2008 are dimming.
  7. There have been big management changes of late at both Citi and Merrill; they might not be over.
  8. Other bits and pieces: Citi is working on selling off both domestic and international business lines; Merrill is likely to accelerate stock awards to employees; both are likely to scale back bonuses.

(Everything from here on down is meta-media stuff. If you’re only interested in banks and not in the WSJ, you can stop reading here.)

Boy is Rupert Murdoch right that the WSJ’s front-page stories are too long. There’s absolutely no need to squeeze all of this stuff into one huge story with three bylines and another two contributing reporters credited at the end. Break it up into easily-digestible chunks, and lead with the news. Consider my first bullet, with the $10 billion injection helping to offset a $15 billion write-down at Citi: those two numbers, in the article, are separated by more than 1,700 words.

There are at least four different stories here, which have been smushed into one. First is 1/2/3: Citi and Merrill are shoring up their capital base. Second is 4/5: political and regulatory hurdles are growing as the total size of these capital injections continues to increase. Third is 6: a chin-scratcher on banking-industry profitability in 2008. And fourth is 7/8: the way that management at these banks is dealing with the new realities internally. All four would make interesting stories, and would be much easier to read than the article which landed with a thud on a million doorsteps this morning.

And just look at how the article begins:

Two of the biggest names on Wall Street are going hat in hand, again, to foreign investors. [A cute lede, which says nothing that isn’t in the headline.]

Citigroup Inc. and Merrill Lynch & Co., two companies that just named new chief executives [old news] after being burned by the troubles in the U.S. housing market [needlessly put into context], recently raised billions of dollars from outside investors. [old news] Now, they are in discussions to get additional infusions of capital from investors [that’s the third time you’ve told me this, and I still don’t have the beef], primarily foreign governments. [a tidbit of something new]

Merrill is expected to get $3 billion to $4 billion, much of it from a Middle Eastern government investment fund. Citi could get as much as $10 billion, likely all from foreign governments. [Finally! The news!]

Such large investments would be the latest sign big banks are undergoing a rapid recapitalization to stabilize their shaky financial foundations. [And straight into more analysis] Already, foreign governments have invested about $27 billion in Merrill, Citi, UBS AG and Morgan Stanley. [old news]

Essentially, the first four paragraphs of the story contain precisely one piece of newsworthy information – and as we’ve seen, there’s a lot of other news in this article which all the extraneous guff is crowding out. It’s not until the tenth paragraph, for instance, that we learn that Citi’s board is expected to talk about cutting its dividend in half on Monday.

The WSJ has a great team of reporters. Now all it has to do is package their work more intelligently.

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