Blogging as a Source of Profits

Posted on September 24, 2007 by Felix

Scott Kirsner asks in the Boston Globe yesterday whether

venture capitalists should blog. The general feeling is that the ones who

do blog can’t imagine not blogging: it’s a great way of finding ideas,

and ideas of course are the lifeblood of the VC industry.

The VCs who don’t blog, by contrast, seem to be stuck in a zero-sum world where

information is more valuable if it isn’t shared. But there’s one other interesting

comment:

Charley Lax, managing general partner of Grand Banks Capital in Newton Centre,

says the limited partners who put their money into venture capital funds think

blogging is "stupid. They want you to be working on your portfolio companies

and looking for the next great deal."

This is something which is going to change only veeerrry slowly. I am an avid

consumer of blogs, and there are many blogs which I trust and admire on certain

subjects much more than any major media outlet. In fact, I think it’s fair to

say that for pretty much any subject, if you look hard enough, you’ll

be able to find a blog which covers it with more informed intelligence than

any newspaper. But among people who don’t read blogs for a living, the reputation

of blog is still pretty dreadful: they’re often known primarily as partisan

players at the dirty edges of political campaigns, or else as simple gossip

merchants.

Venture capitalists, of course, are paid to be ahead of the curve, so it’s

maybe not surprising that its among their ranks that we find the first individuals

who are making real money from blogging – not by investing in blogs, not

by selling advertising on blogs, but simply by blogging themselves and using

that information flow as a source of profit.

It’ll be very interesting to me to see which executive will rise above the

popular prejudice and be the next person to proudly blog. Most corporate blogs

are bland to the point of unreadability, especially if they emanate from a public

company, so I suspect that the next person to consider his or her blog a major

contributor to corporate profitability will be an entrepeneur or the CEO of

a privately-owned company. But I can’t wait for that kind of blog to become

much more commonplace, especially outside the technology industry, where it’s

most needed.

In fact, there is a good example of exactly such a blog in my blogroll to the

right: The Big Picture, by Barry

Ritholtz. Barry is a very busy hedge-fund manager, and I suspect that he uses

his blog as an opportunity to think through and discover potentially profitable

investment ideas. Barry? Would you say that your fund is more profitable as

a result of your blogging?

(Via Fred

Wilson, of course.)

Posted in technology | Comments Off on Blogging as a Source of Profits

There’s No Speculative Bubble in the Art World

Posted on September 22, 2007 by Felix

Lauren Schuker has a big piece entitled "Art’s

Anxiety Attack" in the weekend WSJ. Let’s see if we can detect a theme

here:

The soaring prices for art in recent years partly reflect booming financial

markets, with hedge-fund managers delving into collecting and the creation

of new wealth in Russia and China. Those factors have fueled speculative

investments…

Now speculative investments of all sorts are coming under

increased scrutiny in the wake of the subprime real-estate lending meltdown…

In the early 1990s, problems in the real-estate market set off a freeze in

speculative investment and luxury spending that contributed

to the collapse of the art market…

Some dealers and collectors say it’s possible that the speculative

excess seen in contemporary art could come down to earth…

I don’t buy it. A speculative bubble is one driven by people buying assets

which they intend to sell, sooner rather than later, at a substantial profit.

It’s often driven by the "greater fool" theory of investing, which

holds that even if what I’m buying is overpriced, all I need to do is hold on

to it for a few months and there’ll be someone willing to pay even more for

it anyway.

The recent run-up in art prices might be a bubble, but it’s not a speculative

bubble. The new wave of art buyers, be they hedge-fund managers or Russian oligarchs,

isn’t buying art with the intention of flipping it at a proft. Art remains a

means of spending money, not of making it. In fact, one of the reasons I am

convinced that art hedge funds are doomed to fail is that no one has

ever successfully speculated on art. The people who get rich in the art world

are the people providing a valuable service: dealers, consultants, and, of course,

the artists themselves. The collectors are rich too, of course, but they didn’t

get that way by buying and selling art.

There’s a very good reason for this. Tech stocks are fungible: your share of

Microsoft is worth exactly the same amount of money as mine, and they’re both

really easy to sell. The speculative bubbles in the property market have tended

to take place in markets like Miami condos or Orange County McMansions: places

where one property is much the same as the next. Art, by contrast, is neither

fungible nor liquid: my Hirst is probably worth much less than your Hirst, and

neither of them are particularly easy to sell.

People do sell art at a profit, of course. Given how valuable much art has

become over the past few years, it’s only natural that collectors will be tempted

to make millions of dollars by consigning their paintings to Sotheby’s. But

that’s not the reason they bought their paintings in the first place.

Posted in art | Comments Off on There’s No Speculative Bubble in the Art World

The Forbes 400 Fat Tail

Posted on September 22, 2007 by Felix

Now that’s what I call a fat tail: have a look at the latest Forbes

400 list, which features 29 individuals worth more than $10 billion.

There are three whose net worth has a 10 handle; two on 11; one on 12; one

on 13; five on 14; two on 15; five on 16; three on 17; and three on eighteen.

Altogether, there are 25 people with a net worth between $10 billion and $20

billion, but within that range there’s no bunching at the bottom, as you would

expect with most wealth distributions.

Then it gets really crazy. There are two individuals with a net worth between

$20 billion and $30 billion: Sheldon Adelson and Larry Ellison. But there is

no one with a net worth between $30 billion and $40 billion. And there is also

no one with a net worth between $40 billion and $50 billion. Finally, towering

over everybody else, we find Bill Gates and Warren Buffett on $59 billion and

$52 billion, respectively.

One other factoid about the Forbes 400 list: By my reckoning, just 13 of the

64 New Yorkers on the list made their money the old-fashioned way, by inheriting

it – and that includes Si Newhouse and Donald Trump. By contrast, 11 of

the top 25 richest Amerians overall were born into their wealth.

Posted in wealth | Comments Off on The Forbes 400 Fat Tail

How Deteriorating Crediworthiness Can Make You Millions (If You’re a Bank)

Posted on September 21, 2007 by Felix

It’s not quite as laughable as it might seem at first glance that the latest

tranche of investment-bank earnings reports showed hundreds

of millions of dollars in profits from the fact that those banks’ bonds

had fallen in value. Morgan Stanley alone booked $390 million, or about 26%

of its third-quarter profit, from the fact that its bonds are now worth substantially

less than they were when they were issued.

That kind of profit might not, as Moody’s says, constitute "high-quality,

core earnings". But it’s not entirely an accounting fiction, either. After

all, a bank can make money on the asset side of its balance sheet if it buys

assets at a low price and then they rise in value: it’s called mark-to-market

accounting. So the same bank sells bonds at a high price and then they fall

in value, there’s a mark-to-market profit there, as well.

Any investment bank worth its salt is at all times actively managing its liabilities.

That means it’s on the lookout for the kind of opportunities available to the

quick and the market-focused: it might see an attractive swap rate between dollars

and Chilean pesos, for instance, quickly issue a bond in a Chile, and swap its

liability into sub-Libor funding in dollars. Banks’ CFOs can also buy back their

own debt in the secondary market, especially if they think it’s trading at a

substantial discount to fair value. In that case, the profit on the bonds’ fall

in price isn’t just mark-to-market, it’s real. If I sell you a bond for $1 and

then buy it back for 90 cents, I’ve just made 10 cents in cash.

Which is not to say that these are the kind of earnings that banks like to

crow about. But in times like these, they’re not about to look a gift horse

in the mouth, either.

Posted in banking | Comments Off on How Deteriorating Crediworthiness Can Make You Millions (If You’re a Bank)

Transcending English

Posted on September 21, 2007 by Felix

The Metaphor of the Day award goes to Alex

Harrowell:

The European issue in Britain has traditionally swung across the political

spectrum, like a cow on a rolling deck, blundering into political parties

and sending them flying like skittles.

Harrowell, by the way, also manages to use the word "rocambolesque,"

which wipes the floor with Barry

Ritholtz’s "gravamen", and makes my

own "postlapsarian" look positively feeble. I’m beginning to think

that Al Neuharth has

a point with that "interesting bullshit" thing.

Posted in Media | Comments Off on Transcending English

Ethanol Datapoint of the Day

Posted on September 21, 2007 by Felix

Remember the ethanol bubble? Looks like it’s

burst:

The price of ethanol soared earlier this year to record levels of more than

$4 a gallon as the Bush Administration vowed to boost production of alternative

fuels…

Ethanol prices have slumped in recent months, to less than $1.70 a gallon…

Construction on new ethanol plants is down more than 60% from last year.

Is there any hope that once corn farmers give up on their ethanol dreams, the

US government might start allowing the import of much cheaper sugar-cane ethanol

from Brazil? No? Didn’t think so.

Posted in climate change | Comments Off on Ethanol Datapoint of the Day

Prada’s Underperformance

Posted on September 21, 2007 by Felix

Is Prada really going public this time? Bloomberg seems

to think so. But is it taking advantage of a booming luxury-goods market,

or is it having to accept a large discount to the kind of valuation it could

have achieved when it first mulled an IPO? The story seems to want to have it

both ways:

The company’s potential value has halved from the time it first mulled an

IPO in 2001. Analysts then estimated the company was worth as much as 8 billion

euros, before the slump in the luxury industry and world stock markets that

followed the Sept. 11, 2001 terrorist attacks…

The 14-member Bloomberg European Fashion Index has more than doubled since

2002. Bain & Co. estimates the luxury goods market may rise 50 percent

a year in China during the next five years, while annual sales in Russia gain

20 percent.

So a slump in the luxury industry has led to Prada’s valuation halving since

2001, yet at the same time valuations in the luxury industry have doubled since

2002? Something smells a little fishy.

I have a feeling that the reporters are hinting that due to mismanagement,

Prada lost its way in the early years of this decade, buying up money-losing

propositions like Jil Sander and Helmut Lang, taking on too much debt, and losing

money in four successive years ending in 2006. At the same time, the rest of

the fashion industry was actually doing very well.

But because this is the fashion industry, darling, it’s not done to

just come out and say that Prada has been a laggard for most of the decade –

it’s so much easier to blame September 11. It seems to work for Rudy Giuliani,

why can’t it work for Patrizio Bertelli?

Posted in fashion | Comments Off on Prada’s Underperformance

Nasdaq is not a Strategic Asset

Posted on September 21, 2007 by Felix

Matt Cooper today describes

a 19.9% stake in the Nasdaq stock exchange as a "strategic US asset"

– going even further than Chuck Schumer, the only lawmaker who seems to

have any concerns about the deal at all, who said

only that the deal "gives me pause". Still, the idea that a minority

stake in the Nasdaq is in any sense a strategic national asset of the US certainly

proves what the WSJ said this morning, that protectionism in the US is increasing:

The U.S. doesn’t allow foreign companies to buy airlines, shipping firms,

television networks and some security-related businesses. The U.S. has raised

concern about the increasing acquisitiveness of state-owned firms from China,

Singapore and Middle Eastern countries. Yesterday, the Bush administration

said it would scrutinize Nasdaq’s proposed deal, a transaction that would

give the Dubai government a stake in the U.S. stock-market operator.

A quick look at the dollar is all it takes to show that now is emphatically

not a good time to start putting up barriers to foreign capital. Richard

Branson isn’t allowed to start an airline here unless he owns less than half

of it and doesn’t control it? Dubai Ports World isn’t allowed to buy US ports?

CNOOC isn’t allowed to buy Unocal, a company most of whose assets aren’t even

in the US? Rupert Murdoch can’t buy Fox without becoming a US citizen?

All of these artificial barriers are harmful to the US economy: they reduce

competitiveness, they make it harder for businesses to realize their true value,

and they contribute to the weakening of the dollar because foreigners find it

that much more difficult to buy US assets.

In all of those cases, however, at least the case could be made that a foreign

company was buying a domestic company. In the case of the Dubai-Nasdaq deal,

we’re talking about a stake of less than 20%. How anybody who believes in a

market economy could object to this deal, I have no idea. And Schumer’s comments

just serve to make him look like someone pandering to anti-Arab prejudice. Last

time I looked, Wall Street was in New York State: he really ought to know better.

Posted in geopolitics, regulation | Comments Off on Nasdaq is not a Strategic Asset

Why Goldman Underperformed Bear

Posted on September 21, 2007 by Felix

Doncha just love commentary on share-price movements? Sometimes it’s just

so easy:

Is there such a thing as a “buy Goldman Sachs, sell Bear Stearns”

trade? If so, it’s happening this morning. Shares of Goldman Sachs were

up 2.2% in premarket action after the company reported another quarter of

printing money, as net income rose 79% despite the tough market conditions.

Bear Stearns was another matter, losing 1% after the company said net fell

61% on a massive 88% drop in fixed income revenue. Both issues were among

the top five traded this morning, according to Nasdaq.

But sometimes it’s

much harder:

Investors took a different tack when it came to Bear, sending its shares

down 0.16%, a slightly better performance than Goldman’s 0.96%. Analysts reasoned

that investors, who in recent weeks had questioned whether Bear could weather

the markets’ turmoil, now believe the firm is a survivor because its book

value, a widely watched measure of a firm’s net worth, has held up despite

its recent woes.

If that’s the case, Bear’s shares looked cheap and offered more opportunity

for improvement than Goldman. In recent weeks, for example, investors drove

Bear’s share price down to a level that was almost equal to its book value

per share, a measure of a firm’s net worth. The lower that ratio goes, the

cheaper, a stock becomes, signaling trouble. Goldman, on the other hand, is

trading at a multiple of about 2.3 times book value, according to Credit Suisse

estimates. Bear’s price-to-book multiple is at 1.2 times.

"The market looks and says can Goldman sustain a 32% return on equity,

whereas Bear is at a 5% return," said Brad Hintz, an analyst with Sanford

C. Bernstein & Co.

It’s almost a spectator sport, really: watching analysts and journalists tie

themselves in knots trying to explain why the company with spectacular earnings

underperformed the company with atrocious earnings. Maybe it was just one big

squeeze on people playing the “buy Goldman Sachs, sell Bear Stearns”

trade?

Of course, there’s absolutely no reason why a 4pm share-price snapshot should

give the best possible indication of how the market reacted to the two brokerages’

earnings news. Why not use the pre-market trading instead? Or wait a few more

days to see how things shake out? I’m hoping that as journalism moves away from

daily newspaper deadlines and towards a web-based, real-time operation, these

kinds of stories, reporting on share price movements between one day and the

next, will become increasingly rare. They certainly add precious little value.

Posted in stocks | Comments Off on Why Goldman Underperformed Bear

How to Mitigate the Pain of Foreclosure

Posted on September 21, 2007 by Felix

Equity Private has a

bright idea for how to help mitigate the worst effects of the housing mess:

include mortgage debt in bankruptcy proceedings. She doesn’t go into a lot of

detail – that’s promised for later today – but I assume the idea

is that the lien on the property would remain, but that the principal amount

of the mortgage could be written down.

Certainly, such a proposal would avoid the costs of foreclosure, which is expensive

for lenders and disastrous for homeowners. But I do fear for the unintended

consequences of messing with the very foundations of secured lending.

I’m still a fan of the proposal

from Dean Baker and Andrew Samwick. Allow lenders to take possession of

the property, but allow the (former) homeowner to continue to live in it, paying

a market rent. The costs of foreclosure to the homeowner are minimized, while

the lender continues to get an income from the property as well as owning it

outright.

I suspect deals like that will happen more frequently as the foreclosure rate

rises, even if they’re not mandated by law. Lenders at the moment tend to be

inflexible and unimaginative in foreclosure situations, but sooner rather than

later they’re going to realise that they’re shooting themselves in the foot

and that owning a large inventory of empty, unsold, and borderline-unsellable

homes is not a business they really want to be in. In other words, even if Congress

doesn’t step in, the market just might find a sensible solution on its own.

Posted in housing | Comments Off on How to Mitigate the Pain of Foreclosure

UK Sold to Foreigners

Posted on September 21, 2007 by Felix

How’s this for a front-page headline? "Foreign

Owners May Be Secret of U.K.’s Success" is the first thing you see

when you look at the dead-tree WSJ this morning; the headline on the jump is

"Foreign Owners Spur U.K. Revival". You’d never guess that two-thirds

of the way in to the 2500-word story there’s actually a long caveat, which explains

that although foreign investors are good at injecting money during the bull

years, they’re also more likely to protect their domestic operations during

bad times, with foreign plants the first to be culled. Plus, of course, senior

management positions are valuable things, and those are nearly always based

domestically rather than abroad.

I don’t want to sound too harsh, here: I think the WSJ gets the balance largely

right, even if the headline doesn’t exactly reflect the subtleties of the story.

I came to much the same conclusion

myself, using exactly the same Mini example as the WSJ uses, 18 months ago.

But in the comments to that blog entry, Lance Knobel struck an important cautionary

note:

In general I agree with your assertion that country of ownership shouldn’t

matter. But there is a significant amount of research showing it does matter.

Over time, high value-added activity tends to concentrate in country of ownership.

I suspect it’s easy to overstate how big of an issue this really is. Look at

the WSJ’s league table of UK companies acquired by foreigners, for instance,

and you see things like Shell being bought by Royal Dutch, or Allied Zurich

being bought by Zurich Allied. These are examples of corporate fiddling; they’re

not substantive changes. And I think there’s a limit to how much of the UK can

realistically be run from Reykyavik, no matter how many high-street chains are

bought up by Icelanders.

Posted in M&A | Comments Off on UK Sold to Foreigners

$0 vs $500

Posted on September 21, 2007 by Felix

By now, there’s a very good chance that most of my readers are quite bored

with my explanations of why it’s a Really Good Idea for WSJ.com to go free.

But when I read Marek

Fuchs yesterday, I couldn’t just let his final question go unanswered. So

instead I turned to someone with a much greater knowledge of the (new) media

business than I have: Chris Anderson, the editor of Wired, and author of an

upcoming

book called "Free".

Here’s Marek’s question:

By about 10 to one, the articles I’ve seen have not examined this central

point: When you charge $500 or so for your product under one form of distribution

and give it away free as air on the other … how many people eventually switch?

The question is tantamount to the survival of these companies, since, any

way you slice it or cross your fingers, newspaper readers are worth so much

more (to advertisers) than online readers. Has anyone ever prospered by giving

away the same product they were selling for a lot of money at another place?

I can’t conjure one up … but since the business media failed, maybe you

can educate me.

And here’s Chris’s answer:

Marek asks a good question: "Has anyone ever prospered by giving away

the same product they were selling for a lot of money at another place?"

Although I’m sure someone has, somewhere, his point is generally well taken.

But he’s phrased the question wrong. Nobody that I can think of wants to give

away in one domain what they sell in another. They want to give away something

different.

For example, we at Wired give away what’s basically a stripped-down version

of the magazine online. We also sell a premium version–an immersive, integrated

package of photography, long-form journalism and design, all delivered on

a high-resolution medium with infinite battery life and equal indoor/outdoor

readability (we call it "glossy paper").

The online version incorporates multimedia, user comments and other contribution,

and links elsewhere. The print version, on the other hand, is a visual feast

and the only good way to read our longer stories, which don’t translate well

online at all.

In short, the two products are not the same. The free one is optimized for

a medium with near-zero marginal costs. The non-free one is optimized for

an immersive visual medium that computer technology still can’t touch.

The problem with daily newspapers is that paper doesn’t add much value to

short-form, non-visual news. Indeed, I think of it as a "value subtract"

medium–you get the same news as online, just 18 hours later and with smudges

on your fingers. Shifting the audience to a free online version is not such

a radical step–after all, most broadcast is "free to air" because

the marginal cost of reaching each additional audience member is zero, and

it’s often said that if you can understand why they sell newspapers on the

street in boxes that don’t limit how many copies you take, you’ll really understand

the newspaper business. They’re not selling papers, they’re selling audiences

to advertisers. Online does that just as well.

Anyway, they don’t have a choice. The web is a conversational medium, and

if you’re behind a subscriber wall you’re not in the conversation.

I basically agree with Chris here, except I see more value in newsprint than

he does. I probably consume more news online than 99% of the population; I subscribe

to 348 RSS feeds just for starters. Yet I also subscribe, with my own money,

to the print version of the WSJ.

Every morning I leaf through the dead-tree version of the WSJ while drinking

my coffee, and I get valuable information that way which I wouldn’t get around

to reading once I sit down at my computer, check my emails, and jump in to all

the different demands of the workday.

The print version of the WSJ is a commuter medium, a morning ritual. People

read it on their way in to the office, even if their office is only a few feet

from their kitchen counter. Once the day is up and running, no one ever finds

the time to sit down and read the paper. For that reason, the paper can’t really

be replaced by anything online, since almost by definition once you get online

you’re in that "up and running" state.

In any case, I’d like to take this opportunity to ask my readers a question.

Often, here, I link to WSJ articles. Is this an annoying habit which should

cease, as much as practicable, because those articles are behind a subscriber

firewall? Or do most of you have access to them?

Posted in Media | Comments Off on $0 vs $500

Bernanke Gets Pwned

Posted on September 20, 2007 by Felix

The rules of being Fed chairman are simple. When you cut rates you make everybody

happy, and when you raise rates you make people unhappy. Your job, of course,

isn’t to make people happy, it’s to steer the economy. But still, you should

be making people happy half the time, on average – when rates are going

down and not up.

Which is why it’s a little surprising to see the punditosphere laying into

Bernanke with such gusto. Jeff

Matthews is positively restrained when compared to Long or Short Capital,

who starts his letter to Bernanke

with "You suck" and gets nastier from there. A few choice bits and

pieces:

You don’t have a backbone and as a result you are slowly and very surely

making our country and our currency irrelevant… you will be our ruin…

Grow a spine you slimy invertebrate…

I feel like I’m at a gathering of the flat earth society or in Zimbabwenomics

101…

Oh, and there are actually some well-aimed substantive barbs in there as well,

about the way the Fed measures inflation and GDP. Read the whole thing, just

not out loud if Ben Bernanke is in the room, please.

Posted in fiscal and monetary policy | Comments Off on Bernanke Gets Pwned

The Victims of Options Backdating

Posted on September 20, 2007 by Felix

Sam Gustin, it turns out, contra my earlier assertion,

does know who the victims of options backdating are after all. They’re Mr

and Mrs Investor Confidence, and apparently they’re both "nebulous"

and also "a pillar of the market system".

Which is all fine and good, except for one thing: there’s no evidence that

the options backdating scandal had any impact on investor confidence whatsoever.

Indeed, investor confidence steadily improved all the way through the months

that the scandal was unfolding, and only really started falling apart at roughly

the same time that everybody pretty much forgot about it.

I’m afraid that Gustin, here, is falling victim to a common fallacy: the idea

that where there’s a crime, there must be a victim. And that if there’s no obvious

victim, there must be a "nebulous" one instead.

At the most basic level, I suppose that’s true. A crime is a violation of the

law, and every violation of the law reduces the public’s faith in the lawfulness

of society, or something like that. But it’s all very theoretical and ex

ante. Ex post, on the other hand, there really isn’t any indication

that society or anybody else has been harmed to any significant degree by options

backdating.

Remember (and I’ve

said this before, but it’s worth repeating) that options backdating isn’t

illegal. Insofar as any crime has occurred, it’s a question of companies

not reporting something they were meant to report, either to the IRS or to their

shareholders.

Which means that Gustin’s being very unfair when he accuses boards of "rigging"

options grants, and "exploiting their insider status". In reality,

the boards did exactly what boards were meant to do: they decided on a compensation

package for their senior executives. One part of that compensation package was

a certain number of options with a certain strike price, and there’s nothing

unusual about that: options grants are SOP in contemporary executive compensation.

So where’s the scandal? Simply and only here: that the board meeting was not

held on a day when the share price was the same as the strike price, but someone

at the company made it look as though the board meeting was held on

a day when the share price was the same as the strike price.

Now at this point I think Sam and I part company. My view is that in most of

the backdating cases, the number of options and the strike price would have

been exactly the same if they had been reported accurately. Here’s David Harper:

I think what some people don’t understand is that a lot of these backdating

gaffes were (irresponsible, for sure) simply oversights. I saw it many times;

e.g., company intends to make a grant on Jan 1st, delays ensue, tries to backdate

merely to stay on the original plan.

My guess is that Sam, on the other hand, reckons that the companies would never

have wanted to admit to granting in-the-money options, and that therefore the

strike price would have been higher.

But here’s the thing: even if the companies had awarded options with

a higher strike price, that doesn’t mean the executives would have been less

well remunerated. Why? Because compensation comittees generally work backwards

from a value. They decide that they want to award an options grant worth $1

million, say, and then they calculate how many options that should be. So if

they had awarded options with a higher strike price, chances are they would

just have awarded more of them.

In a couple of the most egregious cases, there was outright fraud aimed at

deceiving shareholders and the taxman in order to illegally line the pockets

of senior executives. But in the vast majority of the options backdating cases,

the only fraud was that options were reported as at-the-money when in fact they

were in the money when they were awarded. And shareholders really don’t care

whether options grants are at the money or in the money, all they care about

is how much they’re diluted. Which is why this particular crime is so close

to victimless.

Posted in governance, pay | Comments Off on The Victims of Options Backdating

Hedge Funds: When to Bail Out

Posted on September 20, 2007 by Felix

Now this is what is known as a sell signal:

We are actively working to adjust our process to minimize the negative impact

of future market dislocations and position the fund for positive returns going

forward.

Now there’s an idea! Why didn’t they think of that before?

And who came up with this piece of genius? It’s actually from the letter

sent out by Goldman Sachs hedge fund managers Mark Carhart and Ray Iwanowski

to investors in their Global Alpha fund. And that’s not the only laugh-out-loud

moment, either. A bit further down, they come out with this gem:

Our intent under these circumstances is to more aggressively limit the size

of our fund to reflect this new environment and to increase our agility in

times of market stress.

Hm. Aggressively limiting the size of a fund which is down 35% year-to-date.

Shouldn’t be too hard, I don’t think.

Posted in hedge funds | Comments Off on Hedge Funds: When to Bail Out

Loonie Tunes

Posted on September 20, 2007 by Felix

There’s a lot of buzz in the blogosphere today about the fact that the Canadian

dollar this morning finally

reached parity with the US dollar. It’s a big deal for those of us who used

to think of Canada as a cheap place to visit, and I can’t imagine it’s good

news for the Whistler ski resort. But on a macroeconomic level it makes sense,

as Stephen

Gordon explains today.

For one thing, US interest rates are going down while Canadian interest rates

aren’t; there’s even a chance they might go up. And for another thing, a slowing

US economy is much less likely to drag the Canadian economy down with it than

it has in the past. Canadian exports to US have been mediocre of late anyway,

but more importantly the big Canadian export right now is energy, and oil prices

continue to hit new record highs. So it’s entirely possible that the US could

go into recession without causing any visible harm to Canadian exports.

Meanwhile, the Concatenation of the Day award goes to Bloomberg

News, for this:

The Canadian currency last closed above par on Nov. 25, 1976, the day before

the Sex Pistols punk band released their first single, "Anarchy in the

U.K."

Posted in foreign exchange | Comments Off on Loonie Tunes

The Emerging Markets Bubble

Posted on September 20, 2007 by Felix

If the Fed’s cutting rates, then it must be blowing another bubble, right?

But it’s not going to be tech stocks or housing again, so what’s left? Green

technology, obviously, is

bubblicious right now, but it’s also tiny: investment of $6 billion this

year might be up 60% from last year, but it’s still a long way from the point

at which a crash could cause any real damage.

In today’s WSJ, Justin Lahart and Joanna Slater put forward a different asset

class: emerging

markets, which are now officially trading on higher multiples than their

developed-market counterparts. Everybody seems to think a bubble is forming,

and everybody is very excited about this: after all, bubbles have the ability

to make a lot of money for a lot of people before they burst, and most people

in any case tend to overestimate their ability to get out before the crash.

The frothiness in emerging-market debt has already been and gone, and it does

make a certain amount of sense that emerging-market equity will be next, especially

so long as commodity prices – which drive many emerging-market economies

– remain elevated, and China’s astonishing growth record shows no signs

of coming to an end.

On the other hand, the markets as a whole do seem to have forgotten that emerging-market

crises are pretty regular occurrences, and tend to be extremely painful indeed.

I have no idea when or where the next one will come, but I do think that when

it happens, liquidity in EM will seize up so quickly that almost nobody will

be able to get out. The only question is how much contagion there will be: if

there’s a crisis in India, say, will Brazil suffer greatly? My guess is yes.

EM is still a risky asset class, even – or perhaps especially –

when it looks like more of a safe haven.

Posted in emerging markets | Comments Off on The Emerging Markets Bubble

The Scandal of Options Backdating

Posted on September 20, 2007 by Felix

One of the reasons Sam Gustin is underwhelmed

by the Fake Steve Jobs book is that its author doesn’t take options backdating

seriously enough. It’s "nothing short of an epidemic", he says, and

"there is something slightly unfunny about basing a satire on the single

largest corporate scandal of the past year".

Well, I’m not sure about that. I’d say the single largest corporate scandal

of the past year was the way in which mortgage originators, having made millions

of dollars in the housing boom by selling inappropriate mortgages to people

who couldn’t afford them and then flipping the paper to Wall Street at a profit,

quickly declared themselves bankrupt or out of business when the mortgage market

turned, thereby holding safely on to all of their earlier ill-gotten gains.

That corporate scandal, as we are now seeing, is having enormous real-world

repercussions in the form of bankruptcies, foreclosures, and even a possible

recession. Options backdating? Not so much.

But Gustin is on the lookout for victims of options backdating all the same.

He’s not sure who they are, but he’s sure they must be out there somewhere:

It’s easy to chalk the story up to yet another esoteric corporate-accounting

scandal, but in the zero-sum game of stock market investing, for every ill-begotten

dollar obtained through illegal backdating, there is a loser on the other

side of the deal.

Stock-market investing is not a zero-sum game: in fact, it’s probably

the best example the world has ever seen of a positive-sum game. Stock prices

generally go up over time, for all investors: if I buy Google shares at $200

and they go to $300, I might have made $100 per share, but there isn’t someone

else on the other side of the trade who is sitting on a $100 loss.

Derivatives are a bit different: traded options are a zero-sum game.

But options issued by companies are not. If a company sells its stock for $200

when the market price is $300, that company is not losing money. And if its

shareholders know the details of the company’s option scheme, and they know

that the company is going to have to sell a certain number of shares at $200

after a certain date, then they’re not losing money either: all the dilution

should be priced in to the stock price.

If there is anybody losing dollars from options backdating, it’s Uncle Sam,

and even that’s debatable. As David Harper said on an earlier

post about options backdating, "I don’t understand how the IRS ever

lost here; the gains are taxed one way or another."

Options backdating is bad because it involves senior management lying to shareholders.

It’s illegal, and it’s deceptive. But it causes very little in the way of financial

harm.

Posted in governance, pay | Comments Off on The Scandal of Options Backdating

Bear Earnings Bad, Market Response Good

Posted on September 20, 2007 by Felix

Bear

Stearns’ earnings today were atrocious. Never mind the fact that sales and

trading revenue slumped by an eye-popping 88%; Bear also, uniquely, saw its

investment-banking revenues fall as well.

Interestingly, the bank’s stock

is unchanged in early trading, and a good 15% above its lows of last month.

I don’t buy the argument that this is because of the announced share buy-back;

more likely, it’s a bit of a short-squeeze on speculators who strongly suspected

that Bear would fall short of expectations.

And there’s another aspect to the share price, too: there’s simply more confidence

in the financial system now than there was during the darkest days of August.

Given that Goldman Sachs is doing so astonishingly

well, I still – for the third day running! – have a

feeling

that some kind of corner has been turned.

Posted in banking | Comments Off on Bear Earnings Bad, Market Response Good

Goldman’s Stunning Earnings

Posted on September 20, 2007 by Felix

Hank Paulson surely has a hint of a smile on his face this morning. Even as

he earnestly tries to protect

Main Street from suffering too much as a result of the Wall Street crunch,

in the back of his head he’ll know that his his alma mater, Goldman Sachs, just

reported earnings

of $2.85 billion in the third quarter.

For a firm whose hedge funds are imploding, Goldman Sachs certainly seems to

be doing astonishingly well: everything else it touches turns to gold. Profits

were up 79% from a year ago; revenue is up 63%; return on equity is now well

over 30%. The firm made money in mortgages, thanks to its hedging strategy,

monetized the green-technology bubble by flipping a wind-power company for $2.15

billion, and, oh yes, saw investment-banking revenues rise above $2 billion

for the quarter as well. That $1.5 billion write-down on junk-rated loans? Who

cares?

It’s a commonplace to describe Goldman Sachs as a glorified hedge fund, but

in fact it’s much better than that, as these results show. Somehow, its prop

traders can consistently make enormous sums of money with Goldman’s own capital

much more effectively than the same traders can do with other people’s money

when they start up a hedge fund either internally or externally.

Goldman’s results also make it much harder for Morgan Stanley or Bear Stearns

to blame market conditions for their weak earnings. A good investment bank should

be able to thrive on volatility; Goldman certainly seems to be doing so.

Posted in banking | Comments Off on Goldman’s Stunning Earnings

Long Term Leases

Posted on September 19, 2007 by Felix

One idiosyncracy of my native England is that many property owners don’t technically

own their homes at all; instead, they have very long-term leases, which are

typically initially 99 years long, and which can be bought and sold and speculated

upon just like regular property. Now the Italians are getting into the act,

too, proposing to sell

50-year leases on deteriorating national treasures such as the 14th-Century

Villa Tolomei, outside Florence.

And if it works for buildings, why can’t long-term leases like this work for

art, as well? In Slate, Tim

Harford reports on the proposal of MIT’s Michael Kremer, who thinks that

countries should lease out their antiquities for a few decades. The long-term

nature of the lease would ensure that the leaseholder took good care of the

object, while many of the perenially heated arguments about national patrimony

would be rendered moot.

There’s also no reason in theory why museums, too, shouldn’t sell long-term

leases as an alternative to deaccessioning works. A hedge-fund manager might

well be primarily interested in having a magnificent painting on his wall: once

he’s dead, there’s no reason it shouldn’t ultimately revert back to the museum

whence it came. If the lease is long-term enough, the hedge-fund manager, if

he gets bored of the work, might even be able to sell it at a profit, just as

many people sell their UK leasehold properties for more than they bought them

for.

No one really knows what kind of discount the art market might apply to a 50-year

lease as opposed to outright ownership, but certainly a 50-year bond trades

at pretty much the same price as a perpetual bond with the same coupon, so the

discount might be quite small. There’s only one way to find out.

Posted in art | Comments Off on Long Term Leases

Civics lesson

Posted on September 19, 2007 by Felix

Megan

McArdle is smarter than I am – or she knows more, at least. Apparently

she got 60 out of 60 questions right on this

quiz; I got 50 out of 60 and was pleased with that. I blame the fact that

I am not an American and did not receive an American education: I had no idea

there even was a president named Andrew Johnson, let alone what his fight with

the Radical Republicans might have been about. That said, the average Harvard

senior got fewer

than 42 questions right, so maybe it’s just a really hard test, or maybe

Harvard seniors aren’t as clever as everybody seems to think they are.

I’d be fascinated to find out the scores of the various presidential candidates

if this test were sprung on them. It would almost certainly tell us more than

any number of interminable debates. Interestingly, nearly all of Megan’s readers

(who revealed their score) got at most two or three questions wrong. I guess

they’re smarter than me, too.

Posted in Not economics | 11 Comments

Rational Exuberance Over Free Content

Posted on September 19, 2007 by Felix

I’m convinced that WSJ.com, FT.com, along with every other newspaper website,

will be entirely free sooner rather than later. Jeff

Bercovici, on the other hand, isn’t:

Are all the triumphalists ready to rule out the possibility that, somewhere

down the road, someone will replicate what HBO did in television, creating

programming so good people will be willing to pay for a commodity they were

used to getting gratis?

What Jeff doesn’t understand is that this is entirely the wrong question to

be asking. There’s always a group of people willing to pay for online content.

Slate and TimesSelect both had subscribers. Salon still has subscribers. Even

calendarlive.com, during the short and unhappy time that it was a paysite, had

one or two. So clearly the ability to find people willing to pay a subscription

charge is not the issue. The issue is whether the benefit of charging it outweighs

the costs.

Remember that HBO would never be a broadcast network, so it would never be

really free. "Free", in terms of the options facing HBO, means "free

once you’ve paid for a basic cable subscription" – and if HBO ever

went down that road, it would severely restrict the network in terms of the

content it was allowed to show.

More to the point, if you’re paying for a basic cable subscription, you’re

already paying for television. All that HBO is asking is that you pay

more, for more television. The vast majority of web users, by contrast, pay

for no online content at all. They may or may not pay an ISP a monthly fee to

get online in the first place. But once they’ve done that, everything else is

free, and there’s no way that they’re going to be able to subscribe to WSJ.com

or any other site by paying more to their ISP.

Even in the US, most people never spend a penny online: not at Amazon, not

at eBay, not at iTunes, and certainly not for what the likes of Jeff

and I somewhat ridiculously refer to as "content". And the web is

global, of course – if you start charging for content, you essentially

wall yourself off from all but the tiniest minority of web surfers from any

other country in the world, no matter how valuable they might be to advertisers.

That said, there will always be subscription sites, generally for trade publications

and high-value newsletters – the type of publications where a print subscription

costs substantially more than the costs of printing and distribution. But newspapers

are very different: by their very nature, they’re a mass medium. All newspaper

owners want as many readers as they can possibly get, and Rupert Murdoch is

no exception. Because of that, WSJ.com will go free, and in turn that will force

FT.com to go free as well. And the triumphalists will have been proved right.

Posted in Media, publishing | Comments Off on Rational Exuberance Over Free Content

Why WSJ.com Should Go Free

Posted on September 19, 2007 by Felix

Sarah Ellison of the WSJ has more

detail today on whether or not WSJ.com is likely to go free. Although Murdoch

himself seems to see what a good idea it is, he is apparently getting pushback

from Dow Jones CEO Richard Zannino:

Mr. Zannino and other Dow Jones executives, however, have made the case that

there is value in keeping the Journal’s Web site — with its 983,000 subscribers

— at least partially a paid site…

Mr. Zannino and other executives have said that given the nature of the Journal’s

content, opening up the Web site to nonsubscribers might not attract enough

new readers to make up for lost subscription revenue. Furthermore, according

to an internal Dow Jones review of WSJ.com, nonsubscribers only stay on the

site for an article or two, unlike subscribers, who stay on the site much

longer.

The lofty ad rates the Journal can charge online would be eroded by a less

loyal, nonsubcriber base. Lehman Brothers estimates that the average page

view on WSJ.com commands four times the ad revenue of a page view the New

York Times site.

Thankfully, all of this is offset by the much more bullish and sensible ideas

of Rupert Murdoch, who realises how silly it sounds.

For one thing, the only value in keeping WSJ.com a paid site is the

immediate subscription revenue that it generates. If you’re owned by a Bancroft

family which wants to maximize its dividends, then I can see why you might want

to do that. But if you’re a tiny part of the giant News Corp, your online subscription

revenue is barely a rounding error when it comes to overall profits. Rupert

doesn’t want WSJ.com to contribute to News Corp’s profits, he wants it to contribute

to News Corp’s share price. And the way to do that is to make it as

popular and successful an internet property as he possibly can.

Besides, I reckon that ad revenues can make up for lost subcription

revenues. According to Dow Jones, WSJ.com gets 8.3 million unique visitors a

month, and would need to raise that number to something over 20 million uniques

in order to keep total revenues constant. Never mind the accuracy of the numbers,

the key thing here is the percentage increase: readership would have to go up

by about 140%. Slate’s readership went up by many multiples of that after it

went free, and I reckon the WSJ’s would as well. People looking for financial

news right now don’t visit WSJ.com because they know it’s a pay site. If they

know it’s free, it could easily become the first best source for all financial

news and analysis online.

As for the idea that subscribers are more valuable than nonsubscribers because

they spend more time on the site – well, duh. Of course

nonsubscribers don’t spend much time on the site: they’re barred from reading

most of it! Let’s see what happens when WSJ.com goes free: my guess is that

it will find itself with an extremely loyal nonsubscriber base indeed –

a nonsubscriber base, what’s more, which will continue to be very attractive

to advertisers. After all, financial professionals are very busy, and very hard

to reach; I have a hunch that they spend much more time online than they do

reading newspapers or watching TV. If advertisers want to reach these professionals,

WSJ.com will be a must-buy platform.

And all of these considerations don’t even take into account the value of the

WSJ in emerging markets such as Brazil, India and China. The emerging business

elite in those countries will probably never be particularly inclined to shell

out for a WSJ.com subscription, but if they grow up reading WSJ.com regularly,

that relationship could be worth a fortune to advertisers in the future. As

Jeff Jarvis says,

"it’s the relationship that is valuable. It’s the relationship

that is profitable, not the control of the content or the distribution."

Murdoch gets this; Zannino, it seems, doesn’t. Which doesn’t bode well for Zannino’s

tenure as CEO.

Posted in Media, publishing | Comments Off on Why WSJ.com Should Go Free

John Cassidy vs Brad DeLong

Posted on September 19, 2007 by Felix

Brad DeLong is clearly much more important than I am. When I say

rude things about John Cassidy, nothing much happens. But when Brad says

rude things about John Cassidy, he gets a stinging riposte from Cassidy

in his comments section, where Cassidy calls DeLong’s posting "misleading

and intemperate," and finishes with quite a flourish:

Brad, you are forever berating economic journalists. Some of that is healthy:

we all make mistakes. But somebody who sets himself up as a professional arbiter

needs to have high standards. In this instance, the quality of your research

was unworthy of a wire service rookie, let alone a tenured professor at a

prestigious university.

The substantive disagreement between Cassidy and DeLong concerns the US economy’s

growth prospects in mid-2002. Cassidy

says they were healthy:

By the middle of 2002, however, it was clear that for whatever reason—low

interest rates, the Bush tax cuts, increased military spending—the economy

was staging an amazingly robust recovery.

DeLong says that Cassidy is wrong, and that "the recovery did not become

anything anybody could call ‘robust’ in any sense until 2004."

In his note on DeLong’s blog, Cassidy points out that in June 2002, the official

GDP report for the first quarter of 2002 showed extremely strong growth of 5.6%

– which certainly looks pretty robust on its face.

I’m not qualified to adjudicate this debate, but I can dig up some contemporaneous

accounts of that GDP report. In fact, it was even stronger than Cassidy remembers:

the final estimate of Q1 GDP growth, as reported

by CNN Money on June 27, 2002, was a stunning 6.1%. On the other hand, no

one at the time seemed to view the report as evidence of "an amazingly

robust recovery" – Mark Gongloff’s report

card on the US economy, which was published the day after the 6.1% figure

came out, concluded with an overall rating of just C+.

If I had to pick between the two sides, I think I’d come down in the middle.

I don’t think that the US economy was obviously doing very well in mid-2002,

but I don’t think that Cassidy’s more upbeat view qualifies him for DeLong’s

"Stupidest Man Alive" crown. The cohort of economics commentators

who say vastly more idiotic things than John Cassidy is legion, which implies

that DeLong was too harsh on Cassidy, at least in his headline.

Posted in economics | Comments Off on John Cassidy vs Brad DeLong