Reviews of "Too Big to Fail" and "The Inside Job"

A review of two movies related to the financial crisis.  I've seen "the Inside Job" and I think the review pretty much captures it - it has a very populist bias.   I haven't seen Too Big to Fail - its not on Netflix yet - but it seems a more reasonable account of events.

Reblogged from Greg Mankiw.

One of the wealthiest B School Profs ever

Re-posted from my colleague, Craig Newmark's excellent blog.

Gene Brigham - author of countless finance text books and actually an Emeritus Professor at my alma mata - the University of Florida.   The article is a nice discussion of the evolution of B-School text books from dense academic tomes to the more readable volumes produced today.

A college degree returns 15% after inflation.

A new study reports that getting a college degree returns an inflation adjusted return of 15%.  I haven't checked the math - but at face value that seems a pretty good return on your (or your parents') money.

The Inside Job - a review.

I finally got around to watching "The Inside Job" - the documentary about the causes of the financial crisis.  It was actually rather tedious - with relatively little technical detail and mostly lots of broad statements about who is to blame.  On the list: Presidents, Wall Street, The Fed, Rating Agencies, Derivatives and economists.  There was a bit of a bias in that several causes were ignored - for example congressional pressure to expand home ownership to lower income families, homeowners who actively engaged in speculative activities and the media that continually promoted housing as a no-lose investment.  But overall it covered most of the bases.

The basic format of the film was to try and skewer various individuals in interviews.  The smart folks declined to be interviewed, but some economists did agree and presumably thought that they were being interviewed for their expertise on the issue.  In fact they were being pilloried.  Case in point: Glenn Hubbard (Dean of Columbia Business School).

Overall - probably worth watching if you are interested in the topic, but don't treat it like a definitive explanation.  A recent article in the Washington Post sums up the movie perfectly.

 It was an excellent documentary for people who don’t want to understand the financial crisis but want to believe they would’ve seen it coming.

A collection of retirement resources

Lifehacker has put together a nice page of retirement calculators.   Well worth checking out to see if you are on track or if you'll be living with your kids.

French Fries and Compound Interest

An article in my local paper today (reprinted from the LA Times) talks about how much weight the average person puts on per year from eating potatoes.  Why is this relevant to a finance blog you ask?  Well, the article states that:

The research team calculated that participants gained an average of 0.8 pound a year...It may not sound like much, but as the years go by "it becomes like compounded interest," adding up to 16 pounds over 20 years, said Dr. Jeffrey Schwimmer  (emphasis added)

I hate to be a boring finance pedant, but actually that is like simple interest, not compound interest.  If eating french fries was like compound interest - then the amount of weight you'd put on would be a function of your existing weight.

Does Wall Street "hate" solar stocks?

I came across this article by the manager of the Green Alpha Fund - an environmentally focused mutual fund that is run out of the Sierra Club.   In full disclosure, I am a member of the Sierra Club and very supportive of much of their work, but this article seemed a little over the top.

The basic premise is that several solar power related stocks, such as LDK Solar, are being shorted irrationally by Wall Street firms that somehow "hate" solar power.  Without getting into a debate on whether or not LDK is fairly valued or not, it is worth noting a few things.

1. Short selling is a risky strategy - you are exposed to losses that can be potentially far greater than your gains.  You also have to pay to borrow the stock (in order to short), and thus you are constantly incurring losses if the stock just does nothing.  As a result, it is not that surprising to find that most of the evidence on short selling supports the idea that short sellers tend to be pretty informed.  These traders have a lot to loose and their positions are expensive to put on and as a result they tend to have done their homework.

2. To say someone has an "irrational hatred" of a stock because they short it, is quite frankly, stupid.  I am sure that short sellers as a group don't have any pathological desire to see solar power fail as an alternative energy source, they are just interested in making money on overpriced stocks.

3. The price level of solar stocks is not really a barometer of the viability of solar power.   In fact, it seems reasonable to think that specialty solar stocks may do poorly in the long run as the technology becomes more of a commodity and their competitive advantage gets eroded.  We've seen this happen in the LED lighting market.

4. If the Green Alpha Fund really thinks these shorts are irrational, then they should keep quiet and buy more solar stocks - they'll be proven right in the end (if they are correct).

Short sellers are frequently vilified in the press, by politicians, and by the management of shorted firms.  They are cast as some sort of unpatriotic group that is only interested in ruining everyone's fun.   In reality the evidence shows that markets that have active short sellers are priced much more efficiently and show less tendency to develop speculative bubbles.  In the end, short sellers are good for markets and that includes the market for solar stocks.

Why Greece needs another 110 billion Euros.

A good explanation of why Greece needs more money just to pay maturing debts.  But the money won't be cheap as Greece's borrowing costs are already sky high - the yield on 10 year bonds is about 17%.

Default is being discussed, but for euro-zone banks that are holding Greek debt, that would be a disaster - further amplified by holders of Credit Default Swaps who would promptly demand payment on their contracts.

The bottom line is that Greece is probably too big to fail.  But it may be politically impossible for Euro zone politicians to convince their electorate that a bailout is the better of two very bad options.

Groupon not being quiet in the quiet period.

Felix Salmon posts on how Groupon is having a hard time being quiet in the quiet period before its IPO.  (The quiet period is where the company isn't supposed to make any substantive claims).  But Groupon can't take the fact that people keep criticizing the company and posted this - with the great line:

During this sensitive time, it is the duty of the press to force the adolescent company through a series of brutal hazing rituals, designed to desensitize it to public criticism.

Let's be clear here - this company is about to go public on a business model which appears to be largely unsustainable and the execs are whining because people are pointing this out?

I do have to give Groupon's management credit for making corporate finance funny though.

 

Twitter

I've started posting links to my blog postings on twitter.  We'll see how it goes.
My twitter account is http://twitter.com/#!/richardswarr

Financial Times' ranking of Global Finance Masters degrees

SKEMA, the French B-school that just opened up a campus here in Raleigh, is number 9.  I'm teaching a financial modelling class on their Masters in Financial Markets degree in the fall.

The perfect finance degree?

A guest columnist in the FT describes what he sees in his "perfect finance masters degree".

GDP or Cap weights?

Fama and French discuss whether you should weight your international equity portfolio based on country GDP or on market cap.   Clearly market cap makes the only theoretical sense.   Country GDP is just arbitrary.

IPO valuations...Pandora and Groupon.

Pandora went public today.  Unsurprisingly the stock shot up in price.   The 1990s are such a distant memory for many.

While we are on the subject of internet companies that don't make money, Groupon also filed papers to go public.  In an excellent blog posting, Aswath Damodaran takes issue with Groupon's accounting practices - notably its use of "Adjusted Consolidated Segment Operating Income".  In essence what Groupon is trying to do is to strip out the expense that it incurs to acquire customers as it views these customers as a long term investment.
Groupon isn't the first internet company to try such a trick.  AOL tried to treat the cost of aquiring new customers (using those AOL CDs that used to show up everywhere) as an investment.  Eventually AOL had to take a big bath adjustment and report a $385 million one time charge.

As Damodaran points out, we can play games with accounting income all day long, but you can't fool with cash flow.   This is why we focus on cash flow in valuation and capital budgeting.

IPO Fees

In class last night we talked a little about IPOs and I mentioned that in the US IPO fees tend to run around 7%.   This finding was originally documented by Hsuan Chi Chen and Jay Ritter in their 2000 paper "The 7% solution".  A new paper shows that the fees charged in Europe are generally lower than in the US and concludes that the 7% fee in the US is consistent with models of implicit collusion.

Felix Salmon has an excellent summary.

Kahn Academy

Here is an amazing resource:  Kahn Academy is an online free website that aims to provide instruction in pretty much everything.   The founder, Sal Kahn, has received funding from the Gates Foundation and Google.  

You can practice high school math or (and more relevant to this blog) check out videos on many finance topics.  For example - here is one on the yield curve.

Fees punish hedge fund investors

Investors who buy in to a mutual fund that then invests in hedge funds have seen their wealth eaten up by fees.

Let's be clear here.  You cannot consistently beat the market, so don't waste money trying and don't waste money paying someone else to try for you.  There are really only two things you have control over: 1) how much you save and 2) what fees you pay.   You should maximize 1, minimize 2 and stop kidding yourself that you know which way the market is going.

Socially responsible investing

Fama and French opine on socially responsible investing.

My view has always been invest to maximize your risk return trade off and then give generously to well run charities.

Performance of Fund Managers

Reposted from my colleague, Craig Newmark, a study that shows that Fund Managers in the past 3 years have failed to deliver consistent performance.

The study shows that only a tiny fraction of all funds have been able to consistently perform in the top 25% of all funds.  As Craig notes, "this is no surprise for academics",  i.e. markets are very efficient.   But the authors of the study don't quite see it that way.

However, while these findings suggest that investors might be better off settling for the consistently average returns of index-tracker funds, Potter of TRMC says that would be a mistake. “This is not about changes in the quality of fund management,” he emphasises. “It’s a reflection of the fact there hasn’t been any consistency in the market itself.”Fund managers generally find it easier to outperform when the equity markets have followed a steady trend for some time. Potter notes that there were relatively high consistency ratios around 2003, after a downward market slide, and in 2007, towards the end of a long bull market.

Actually, I'd argue that Mr. Potter is completely wrong here.  It is entirely about the quality of fund management - and this is not to say fund managers are good or bad.  The key issue is that investment markets are so efficient that if a manager does post three years of superior performance, it is more likely that this is due to luck rather than skill.   The probability of being in the top 25% 3 years in a row is just (1/4)(1/4)(1/4)=1.5%.   The fact that the study finds only 1.3% achieve this feat over the past 3 years seems entirely consistent with an efficiently operating market.   Sure there are some time frames when a few more outperform, but again this is luck.  For a summary of luck vs skill check out my earlier post.

So what is the average investor to do?  One word:  Index.

Homeowner forecloses on Bank of America

This one is pretty much going viral.