finance

Germany: America of Yesteryear

readingbyeugene Leave a comment

This piece in The Los Angeles Times highlights how Germany of today is like America in the 1970s:

In 1975, manufacturing accounted for about 20% of the United States’ economic output, or gross domestic product, about the same as in Germany today. Since then, U.S. manufacturing’s share of GDP has slid to about 12%.

In 1975, the U.S. budget deficit was a manageable 1% of the economy, about the same as Germany’s now. Last year, the U.S. deficit was about 10%.

American families in the 1970s and early ’80s typically saved about 10% of their take-home pay, about the same as in Germany today. The U.S. savings rate these days is in the low single digits.

There story follows a couple in their 50s, the Krugers; the couple has two children. They have paid off their debts and are living much better on a combined $40,000 income than most Americans who earn twice as much.

Bonus Day at Goldman Sachs

readingbyeugene Leave a comment

Today is Bonus Day at Goldman Sachs, or as it is colloquillay known: Compensation Communication Day. On this day:

Most employees are called one by one into a managing partner’s glass-walled office, where they are informed of their bonus numbers, as well as any stock awards or deferred cash payments they will get..

In what may seem like a paradox, many Goldman employees will be hoping that the firm’s stock does poorly on Thursday. That is because the firm is expected to give deferred stock to a large number of employees in lieu of larger cash payments. The exact number of shares an employee receives will be calculated based on the firm’s closing price on Thursday, according to a person with knowledge of the bank’s plans, meaning that the lower the price, the more shares employees will get, and the bigger the potential gains if the company’s fortunes improve.

And:

Even the largest bonuses at Goldman this year are likely to be a far cry from those given out during Wall Street’s prelapsarian (Editor’s note: awesome word!) years. As Charles D. Ellis recounts in The Partnership: The Making of Goldman Sachs, employees at the firm were once paid their yearly bonuses in stacks of $100,000 checks ($100,000 being the biggest single-check amount the firm’s payroll system could process).

Can you imagine carrying a stack of checks larger than your stash of cash in your wallet? I can’t.

Is There a Relationship between IQ and Stock Ownership?

readingbyeugene Leave a comment

Bloomberg reports on an interesting study noting the relationship between IQ and ownership of equities (stocks):

Mark Grinblatt of the University of California, Los Angeles, Matti Keloharju of Aalto University in Espoo and Helsinki, Finland, and Juhani Linnainmaa at the University of Chicago compared results from intelligence tests given by the Finnish military between 1982 and 2001 to government records showing investments the draftees later held. They found the rate of stock ownership for people with the lowest scores trailed those with the highest even after adjusting for wealth, income, age and profession.

It appears the relevant paper is here. However, I am skeptical of the findings. Why look at such a specific populations subset (Finish military, which in this case was only men)? What about confounding factors such as those with higher income having more opportunities to learn about investing in stocks (and hence investing more into equities), or perhaps acting on advice of their peers? Of course, another primary objection is that the IQ exam is highly culture-dependent.

On a related note, some statistics about what percentage of American households invests in stocks:

Economists have debated for decades what they call the participation puzzle, trying to explain why more people don’t take advantage of the higher returns stocks have historically paid on savings. As few as 51 percent of American households own them, a 2009 study by the Federal Reserve found. Individual investors have pulled record cash out of U.S. equity mutual funds in the last five years as shares suffered the worst bear market since the 1930s.

Anyway, I am skeptical of the findings. What do you think?

The Financial Markets in 2011

readingbyeugene Leave a comment

The best summary of what happened in the financial markets in 2011 comes courtesy of James Surowiecki at The New Yorker:

In 2011, the S. & P. 500 finished the year where it started. (To be precise, it fell 0.003 per cent.) But it was anything but a placid year in the stock market. Instead, there was extraordinary tumult throughout 2011, with a series of sharp rallies and brutal selloffs, the biggest of which sent the market down seventeen per cent in a couple of weeks. Even on a daily basis, stocks were startlingly volatile: the Dow Jones Industrial Average moved more than a hundred points on forty per cent of trading days, and there were more than sixty days on which the S. & P. index moved about two per cent or more (which in 2005, for example, it didn’t do once). Ordinary investors, who have watched the value of their 401(k)s yo-yo seemingly at random, have been left feeling understandably dazed and confused as they head into the new year.

Traders and professional money managers don’t seem to have any real clue about what’s going to happen, either. You might think that volatility would allow people with superior information and market sense to get ahead. But last year money managers did a very poor job of playing the market. According to estimates made by Goldman Sachs, as of the last week in December seventy-two per cent of core large-cap mutual funds had underperformed their market indexes. The average stock-market mutual fund was down almost three per cent for the year. And hedge-fund managers, who are supposed to thrive on volatility, did even worse, with hedge funds that focus on stocks falling more than seven per cent. Strikingly, some of the biggest flops came from superstars: Bruce Berkowitz, whom Morningstar named one of the money managers of the past decade, saw his flagship fund fall more than thirty per cent; the hedge-fund manager John Paulson, whose bet against mortgage-backed securities a few years ago has been called “the greatest trade ever,” saw one of his funds drop nearly fifty per cent.

Surowiecki then mentions that ordinary investors “chase performance” and suggests:

The sensible solution would be for investors to put their money into low-cost index funds and just keep it there. But that’s hard to do when the market is extremely volatile. Most of us find it difficult enough in normal times to take a long-term approach. So when prices are rising and falling two per cent a day, and when it seems like getting in or out of the market could be worth ten per cent of our portfolio’s value, the temptation to try to time the market is hard to resist.

Here’s where I don’t agree with Surowiecki. What’s so hard about choosing to allocate a certain percentage (or a set sum of your savings/salary) per year to index funds (regardless of market volatility)? You can’t time the market, so you might as well invest in an index (or a fund) that tracks the S&P 500 and let your cash sit there for as long as possible.

I had a positive return on my portfolio in 2011, the majority of which consists of index funds. The key is diversification and a “buy and hold” strategy.

On the Complexity of Finance

readingbyeugene 1 Comment

Steve Randy Waldman of Interfluidity has a very smart post outlining his thoughts to this question: why is finance so complex? He argues that, in fact, finance has always been complex. And not only that, finance has been opaque, and “complexity is a means of rationalizing opacity in societies that pretend to transparency.” Opacity in modern finance is a feature, not a bug. If you fully understood the risks of all your investments, he argues, you might be wary of investing…

Using examples from game theory (see stag hunt), Waldman continues:

Like so many good con-men, bankers make themselves believed by persuading each and every investor individually that, although someone might lose if stuff happens, it will be someone else. You’re in on the con. If something goes wrong, each and every investor is assured, there will be a bagholder, but it won’t be you. Bankers assure us of this in a bunch of different ways. First and foremost, they offer an ironclad, moneyback guarantee. You can have your money back any time you want, on demand. At the first hint of a problem, you’ll be able to get out. They tell that to everyone, without blushing at all. Second, they point to all the other people standing in front of you to take the hit if anything goes wrong. It will be the bank shareholders, or it will be the government, or bondholders, the “bank holding company”, the “stabilization fund”, whatever. There are so many deep pockets guaranteeing our bank! There will always be someone out there to take the loss. We’re not sure exactly who, but it will not be you! They tell this to everyone as well. Without blushing.

If the trail of tears were truly clear, if it were as obvious as it is in textbooks who takes what losses, banking systems would simply fail in their core task of attracting risk-averse investment to deploy in risky projects. Almost everyone who invests in a major bank believes themselves to be investing in a safe enterprise. Even the shareholders who are formally first-in-line for a loss view themselves as considerably protected. The government would never let it happen, right? Banks innovate and interconnect, swap and reinsure, guarantee and hedge, precisely so that it is not clear where losses will fall, so that each and every stakeholder of each and every entity can hold an image in their minds of some guarantor or affiliate or patsy who will take a hit before they do.

Opacity and interconnectedness among major banks is nothing new. Banks and sovereigns have always mixed it up. When there has not been public deposit insurance there have been private deposit insurers as solid and reliable as our own recent “monolines”. “Shadow banks” are nothing new under the sun, just another way of rearranging the entities and guarantees so that almost nobody believes themselves to be on the hook.

This is the business of banking. Opacity is not something that can be reformed away, because it is essential to banks’ economic function of mobilizing the risk-bearing capacity of people who, if fully informed, wouldn’t bear the risk. Societies that lack opaque, faintly fraudulent, financial systems fail to develop and prosper. Insufficient economic risks are taken to sustain growth and development. You can have opacity and an industrial economy, or you can have transparency and herd goats.

At the height of the financial crisis, so-called collateralized debt obligations (CDOs) were all the rage with investors. There were also CDOs on CDOs, dubbed CDO^2. This quote by Bank of England official Andrew Haldane illustrates the complexity of such a product:

To illustrate, consider an investor conducting due diligence on a set of financial claims: RMBS, ABS CDOs and CDO^2. How many pages of documentation would a diligent investor need to read to understand these products? Table 2 provides the answer. For simpler products, this is just about feasible – for example, around 200 pages, on average, for an RMBS investor. But an investor in a CDO^2 would need to read in excess of 1 billion pages to understand fully the ingredients.

Waldman’s post is worth checking out in entirety if you want to follow along the game theory examples. They’re fascinating.

Your Credit Score and Social Media

readingbyeugene 1 Comment

Well, this is slightly unnerving. In a BetaBeat post titled “As Banks Start Nosing Around Facebook and Twitter, the Wrong Friends Might Just Sink Your Credit,” we learn about a new wave of start-ups that is…

working on algorithms gathering data for banks from the web of associations on the internet known as “the social graph,” in which people are “nodes” connected to each other by “edges.” Banks are already using social media to befriend their customers, and increasingly, their customers’ friends. The specifics are still shaking out, but the gist is that eventually, social media will account for at least the tippy-top of the mountain of data banks keep on their customers.

“There is this concept of ‘birds of a feather flock together,’” said Ken Lin, CEO of the San Francisco-based credit scoring startup Credit Karma. “If you are a profitable customer for a bank, it suggests that a lot of your friends are going to be the same credit profile. So they’ll look through the social network and see if they can identify your friends online and then maybe they send more marketing to them. That definitely exists today.”

And in the last year or so, financial institutions have started exploring ways to use data from Facebook, Twitter and other networks to round out an individual borrower’s risk profile—although most entrepreneurs working on the problem say the technology is three to five years away from mainstream adoption.

Here’s what I am thinking. If you have a solid credit rating, then exposing your social media outlets could potentially hurt you. On the other hand, these algorithms may be devised such that you take a bigger hit if you don’t divulge your information. If you have a poor credit rating but a strong network of friends, then divulging your social media crumbs could help you in your overall credit score. One thing is for certain, however: if there is any way that a bank could find out more information about you to better predict your ability to repay a loan, the more aggressively it will try to implement the schema into its arsenal of judging your credit score.

We live in a brave new world.

Jon Corzine and the Romance with Risk

readingbyeugene Leave a comment

By now, I’ve read dozens of articles about Jon Corzine and the fall of MF Global. But I think this piece in Dealbook is a best all-around explainer about Jon Corzine and his appetite for risk:

[Jon Corzine] pushed through a $6.3 billion bet on European debt — a wager big enough to wipe out the firm five times over if it went bad — despite concerns from other executives and board members. And it is now clear that he personally lobbied regulators and auditors about the strategy.

His obsession with trading was apparent to MF Global insiders over his 19-month tenure. Mr. Corzine compulsively traded for the firm on his BlackBerry during meetings, sometimes dashing out to check on the markets. And unusually for a chief executive, he became a core member of the group that traded using the firm’s money. His profits and losses appeared on a separate line in documents with his initials: JSC.

This seems like a surprise, however:

He was a popular manager, former employees say. An avuncular presence with a beard and sweater vest, he had a knack for remembering names. Even in the firm’s final hours, they recall that Mr. Corzine never lost his temper. His work ethic also impressed colleagues. He often started his day with a five-mile run, landing in the office by 6 a.m. and was regularly the last person to leave the office.

But the most mind-boggling revelation is that MF Global, through Jon Corzine’s insistence, shied away from implementing a rigorous risk management system at the firm:

Yet soon after joining MF Global, Mr. Corzine torpedoed an effort to build a new risk system, a much-needed overhaul, according to former employees. (A person familiar with Mr. Corzine’s thinking said that he saw the need to upgrade, but that the system being proposed was “unduly expensive” and was focused in part on things the firm didn’t trade.)

Risk management is perhaps the most important function for a bank/financial firm. There is no too steep a price to pay for having a system of checks and balances that would have caught MF Global’s downward spiral and perhaps have done something about it. I need not even mention the lost customer deposits that is now at the core of the investigation following MF Global’s bankruptcy.

Financial Bombshell of the Day

readingbyeugene Leave a comment

The details unveiled in the Bloomberg Markets Magazine piece “Secret Fed Loans Gave Banks Undisclosed $13B” are stunning. And here we thought we knew everything we knew about the 2007-2008 financial crisis. Think again:

The Federal Reserve and the big banks fought for more than two years to keep details of the largest bailout in U.S. history a secret. Now, the rest of the world can see what it was missing.

The Fed didn’t tell anyone which banks were in trouble so deep they required a combined $1.2 trillion on Dec. 5, 2008, their single neediest day. Bankers didn’t mention that they took tens of billions of dollars in emergency loans at the same time they were assuring investors their firms were healthy. And no one calculated until now that banks reaped an estimated $13 billion of income by taking advantage of the Fed’s below-market rates, Bloomberg Markets magazine reports in its January issue.

Saved by the bailout, bankers lobbied against government regulations, a job made easier by the Fed, which never disclosed the details of the rescue to lawmakers even as Congress doled out more money and debated new rules aimed at preventing the next collapse.

This statistic is just astonishing (half the value of U.S. GDP!):

The amount of money the central bank parceled out was…dwarfed the Treasury Department’s better-known $700 billion Troubled Asset Relief Program, or TARP. Add up guarantees and lending limits, and the Fed had committed $7.77 trillion as of March 2009 to rescuing the financial system, more than half the value of everything produced in the U.S. that year.

There’s a lot more quotable material here, so I suggest you read the whole thing…

The United States of Europe

readingbyeugene 1 Comment

Niall Ferguson, author of the excellent The Ascent of Money (which I highly recommend reading), peers into Europe’s future and sees Greek gardeners, German sunbathers—and a new fiscal union. Welcome to the other United States…in 2021:

Life is still far from easy in the peripheral states of the United States of Europe (as the euro zone is now known). Unemployment in Greece, Italy, Portugal and Spain has soared to 20%. But the creation of a new system of fiscal federalism in 2012 has ensured a steady stream of funds from the north European core.

Like East Germans before them, South Europeans have grown accustomed to this trade-off. With a fifth of their region’s population over 65 and a fifth unemployed, people have time to enjoy the good things in life. And there are plenty of euros to be made in this gray economy, working as maids or gardeners for the Germans, all of whom now have their second homes in the sunny south.

The U.S.E. has actually gained some members. Lithuania and Latvia stuck to their plan of joining the euro, following the example of their neighbor Estonia. Poland, under the dynamic leadership of former Foreign Minister Radek Sikorski, did the same. These new countries are the poster children of the new Europe, attracting German investment with their flat taxes and relatively low wages.

But other countries have left.David Cameron—now beginning his fourth term as British prime minister—thanks his lucky stars that, reluctantly yielding to pressure from the Euroskeptics in his own party, he decided to risk a referendum on EU membership. His Liberal Democrat coalition partners committed political suicide by joining Labour’s disastrous “Yeah to Europe” campaign.

Egged on by the pugnacious London tabloids, the public voted to leave by a margin of 59% to 41%, and then handed the Tories an absolute majority in the House of Commons. Freed from the red tape of Brussels, England is now the favored destination of Chinese foreign direct investment in Europe. And rich Chinese love their Chelsea apartments, not to mention their splendid Scottish shooting estates.

If for nothing else, read the piece to find out who Ferguson thinks won the 2012 Presidential Election in the United States.

A Blow to Pinstripe Aspirations: Wall Street Layoffs

readingbyeugene Leave a comment

This piece in today’s NYT’s Dealbook has generated a flurry of comments. It’s about young people losing their jobs from investment banks and other financial firms. Read the entire piece here and then judge for yourself…

The money quote:

Sam Meek, 27, who was laid off in September when his Connecticut hedge fund decided to downsize, used to spend $500 on charity dinners and lavish golf outings. Now, it’s home-cooked meals and beer on the sofa. Recently, Mr. Meek and his roommate, another unemployed banker who spoke on the condition of anonymity because he did not want to jeopardize his job search, sat together in the kitchen filing for unemployment and drinking a bottle of Champagne.

“I’m scraping by right now,” he said.

Scraping by, huh? Needless to say, the majority of the 300+ comments have been pejorative; many have been deleted for abusive language and/or content.

And this was a good quote about the sentiment of elite/prestigious jobs:

The mood has darkened so much that even the young Wall Street workers who still have prestigious jobs are considering letting go of the brass ring.

“It’s lost its luster,” said a former Goldman analyst who left the financial sector this year. The former analyst, who spoke on the condition of anonymity because he signed a confidentiality agreement with the firm, said that in addition to losing some of the monetary benefits of their jobs, his friends who remained in finance were suffering from peer envy. “The new status jobs aren’t at Goldman Sachs. They’re at Google, Apple, and Facebook.”

A brief collection of comments was posted in another post here. I will agree with the nuanced comment by Timothy C. from Queens:

“Let’s not be too harsh here. I work in the financial industry, and in my own company, about half the workers (myself included) are in the back office, where salaries are generally in the middle-class range. Cuts in the financial industry tend to hit support staff much harder than the headline-grabbing six-figure earners in the front office. Many of my friends who have been laid off were making $40 or $50K a year. Not bad, of course, but nowhere near the stereotype of the financial industry worker.”

What are your thoughts on these young unemployed? Do you have any sympathy for them?