Dec 31, 2008

Home value indexes

The S&P Case-Shiller index of home values posted an annual drop of 18% (high: Phoenix -32.7%, low: Dallas -3.0%) yesterday. But what goes into an index of home prices?
  • Which geographic regions are covered
  • Property value weighting (do more expensive homes have a larger impact on the index)
  • Are appraisal values included rather than just sales transactions
  • Are houses financed with subprime mortgages and/or non-conforming loans (jumbos) included
  • Should foreclosed homes sales be included, given that they may not represent a normal transaction

Here's the Wall Street Journal's look at several different home value indices from November.

Dec 30, 2008

Google Trends

This link to Google shows search terms that are experiencing a rapid rise in popularity. Sort of, if you took the first derivative of search words, which ones are increasing the fastest.

Dec 28, 2008

Christmas spirit and the number of shopping days

It's often reported that a longer shopping season (the number of days between Thanksgiving and Christmas) translates into higher retailer receipts. But does this make sense? Just because Thanksgiving falls a few days earlier doesn't mean your gift list increases. With fewer days, one might reduce their trips to the mall but make more purchases on each trip, leaving the total amount spent unchanged. But a longer shopping season does increase the opportunity for impulse purchases.

This paper from 2005 found that a longer shopping season increased per capita retail sales by $6.50 per additional day over the relevant range, and the effect is most noticeable in electronics, apparel, food, and general merchandise. The author studied the November-December shopping season and deflated results based on October sales to adjust for the strength of the overall economy at that time to arrive at excess sales. Interestingly, increased sales in the holiday season don't translate into reduced spending in January, and since the total amount of household wealth is unchanged, the deficit must come out of savings.

Dec 27, 2008

Confirmation bias in web forums

If you believe that low-cost, buy-and-hold, index investing is the way to go, read the Bogleheads forum (named for John Bogle, founder of Vanguard).

If you want to daytrade your way to happiness with Jim Cramer, checkout the Online Traders Forum.

And if you have a love for shiny things coupled with a distrust of fractional reserve banking policy, the Kitco Bullion Dealers forum is the place for you.

Dec 25, 2008


Normally when a publicly traded company wants to issue more equity, they call up their investment bankers and put together a large follow-on offering. The stock price usually declines when this is announced since analysts interpret equity issuance as a sign that management believes the stock is overpriced (rational managers buy back their equity when it's cheap, issue more then it's pricey).

The equity markets being what they are right now, some firms are turning to dribbles to issue small amounts of equity without all the fanfare associated with a follow-on offering. This avoids depressing the share price due to a rapid increase in supply, allows the firm to be a bit more squirrelly with its disclosure, and gives the firm more control over the timing of share sales since they blend in with the normal trading activity.

Dec 24, 2008

Pension plans, firm risk, and the cost of capital

This Times article discusses some firms that are dealing with the impact of shrinking pension plan funds. Another one at Bloomberg mentions a $230B decline in pension plan funding just in October and November of 2008, reducing funding levels from 97 percent down to 80 percent.

Unless you are in a very countercyclical industry and/or your stock has an extremely low beta, it's likely that your pension plan returns are going to be correlated with your overall business. So right as the economy tanks, your business slows, and the value of your pension assets declines - this is what's happening right now to many firms. That's one argument against putting all your pension funds in high risk, high return equities.

Zvi Bodie published an interesting paper that explored another reason not to invest pension funds in risky assets: Do a Firm's Equity Returns Reflect the Risk of Its Pension Plan? He argues that the market beta for your stock reflects the risk implicit in your pension plan assets. Even though these funds are technically segregated, most analysts combine all assets and liabilities when looking at the firm as a whole. This makes sense, as the company is still on the hook to pay its retirees even if the pension's investments decline in value. Therefore, the observed firm beta in the market may overstate the true risk of the firm's operating assets, which would lead to a higher discount rate than is warranted for capital budgeting projects. In turn, this could lead to incorrect rejection of positive NPV projects.

Maybe they should just put all the pension funds in fixed income?

Dec 23, 2008

The best site for buying and selling cheap MBA textbooks

You'd think that MBAs would understand better than anyone the value of a free market to set prices. Do you really think the campus bookstore, with their monopolistic, rent-seeking tendencies and overhead expenses is really going to sell you a textbook at the lowest price possible? And at the end of the semester, are they going to give you top dollar for your buyback? Unlikely.

Enter, the pure intersection of supply and demand, with an excellent selection of textbooks.

Granted, there are a few drawbacks. You don't get instant gratification, so you might not have the textbook in time for the first day of class (you overachiever!). But can't you just borrow a copy from one of your classmates? And if you decide to drop a class after you've ordered the text, you're subject to market forces when you remarket that asset.

Dec 17, 2008

The myth of the Ford Pinto

This article raises some interesting points about the much maligned Ford Pinto. Statistically, it appears that the car was no more dangerous than other cars in the same class, which all suffered from design flaws that reduced safety (though different flaws than the Pinto's behind-the-axle gas tank). The value placed upon human life by Ford was provided by a government agency seeking comments on the potential impact of new safety regulations, not developed internally. And court rulings at the time recommended that firms use economic cost-benefit analysis to determine the appropriate balance between cost and safety. While Ford deserved criticism for an unsafe design, the reality of the situation is much more complicated than the oft-repeated story would lead you to believe.

Dec 14, 2008

Hawaii: Days 7 & 8

Saturday is our last full day here. We started off at 6:30AM with the Kanaio coast & Molokini snorkeling tour with Blue Water Rafting. Despite the early morning it was totally worth it. Great lava flows along the coast as well as excellent snorkeling, especially at Molokini island. There was a little chop on the ocean so the ride was a bit rough, but if you're interested in an adventure it's not a problem. On the way back, the captain got a radio call from another tour boat that whales had been spotted, so he turned the boat around and took us back out. Saw three whales and a pod of dolphins. Dinner was excellent fish ka-bobs at Pita Paradise in Kihei. They were made with opakapaka (snapper) which I liked more than the ono we had the night before.

Sunday we checked out, did a little shopping in Wailea and then drove north. Stopped at the Iao Valley State Park to see the Iao Needle which was cool. Lunch at McDonalds was a McTeri burger - basically a burger with teryaki sauce.

Dec 12, 2008

Hawaii: Day 6

The clouds have disappeared so we drive up to Haleakala Crater. At 10,000 feet, the air is noticeably thinner and we're above most of the clouds. Fantastic. After driving back down the mountain (43 switchbacks!) we stop at Maui Taco for lunch. Ok, they have locations in the continental US but the burrito seems more authentic here. The rest of the day: Wailea beach and the amazing saltwater infinity edge pool at the Marriott. Funnily enough, I run into one of my MBA classmates who happens to be here on vacation.

Dec 11, 2008

Hawaii: Day 5

First day in Maui is disappointing due to the weather - constant rain. I hear they're getting it worse on Oahu. Most of the fun stuff to do here is outside, normally not a problem except for times like this. We drive to the Bailey House museum which provides a nice perspective of old Hawaii. Despite the rain, we head to the Ioa Valley State Park but find that the road up the mountain has been closed due to the weather. Given the runoff coming down a nearby creek, seems sensible. Back to the resort for the afternoon and then a nice dinner at Cafe O'Lei Kihei.

Dec 10, 2008

Hawaii: Day 4

Wednesday started off a bit later than Monday and Tuesday as we started to adjust to the new time zone. We grabbed some malasadas and coffee at Leonard's Bakery. They're similar to doughnuts in that they're fried dough, but they are doughier - maybe more egg and yeast. No hole in the middle, and covered in sugar or cinnamon sugar (fillings optional). Then to the Honolulu Academy of Arts for a tour of their exhibits. 45 minute flight to Maui then check in at the Marriott Wailea Resort. Dinner time at Da Kitchen in Kihei; big portions and low prices; great fried mahi mahi.

Dec 9, 2008

Hawaii: Day 3

Another early morning wake-up took us to Cafe Kaila for breakfast where we found a nice change of pace from Waikiki. Then we drove north on the Kamehameha highway to the Dole pineapple plantation and enjoyed the tour of their garden and trainride through the pineapple fields. Continuing north, we stopped at Haleiwa beach to crash through the giant waves and watch the surfers further out. Lunch was Giovanni's shrimp truck and shaved ice from Matsumoto's. In the afternoon we headed up to the Polynesian Cultural Center in Laie. This complex is clearly one of the island's biggest tourist traps, but they overcame my skepticism and I actually enjoyed the island exhibits as well as the dinner and Luau. Worth doing once but I probably wouldn't go back. The only downside was the hour long drive from the north shore back to Waikiki in the dark.

Dec 8, 2008

Hawaii: Days 1 & 2

We landed in Honolulu on Sunday and proceeded to baggage claim and ground transportation, waiting for our Advantage rental car shuttle to arrive. We waited, and then we waited some more. Finally calling them and getting through the generic prompts, we were informed that they had filed for bankruptcy 2 days ago and closed the Honolulu location. I guess their rate really was too good to be true.

Checked into the Marriott Waikiki Resort and managed to get a nice upgrade to a 22nd floor room (Paoakalani tower) with a partial view of the ocean and Diamondhead as well. The reception desk said that their traffic is definitely down for this time of year, must be the slow economy. They wanted an obscene $25/night for parking but I found out on TripAdvisor that we could park at the Banyan for $10 and it's literally across the street. After driving around some more, found a free "Shell" parking lot next to the Waikiki Zoo - even better. The hotel also wants $13/day for internet access, but I can pick up a free wifi signal on our balcony.

Spent Sunday afternoon recovering from the 9 hour flight by walking up and down Kalakaua Avenue and checking out the beach. Dinner at Tiki's Bar and Grill in the ResortQuest Waikiki. Nice ambiance and decent food but a bit overpriced for what you get. Did not find poi to be all that great. Must be an acquired taste.

Monday, woke up at 5AM due to the jet lag and decided to climb Diamondhead before the sun came up. First, a quick breakfast at McDonald's (they offer a Polynesian platter with Spam, or a burger with teriyaki and a pineapple). Scurried down the mountain and drove to Pearl Harbor and took the ferry out to the USS Arizona memorial. A moving experience and well worth it. We arrived at 8:30AM and were able to get on the 9AM tour. Definitely a place to visit early as the wait was stretching much longer once the tour groups started to show up. Headed to Chinatown in the afternoon and it was pretty much what you'd expect. The rest of the afternoon was at the beach. Tonight, dinner at the Hula Grill Waikiki was the best meal so far. Great food, service, and ambiance. And compared to some of the offerings on Waikiki, a decent value as well.

Dec 7, 2008

SMU Law has top bar passage rate in Texas

Southern Methodist University's Dedman School of Law had the highest bar passage rate for the July 2008 exam, according to the Dallas Morning News. Another feather in the cap for SMU!

Dec 6, 2008

Looking on the bright side

Yesterday's jobs report was quite dismal. But here are three reasons the economy is not as bad as it could be (from a comment on another blog):
  • We're not in a trade war with Europe (Smoot-Hawley)
  • We do NOT have a famine (Dust Bowl)
  • We do not have wholesale collapse of the banking system (50% of banks failing)

You could probably argue that last point, but still.

Dec 5, 2008

Jeremy Grantham Speaks

He's not a household name like Jim Cramer but his company, GMO, does have $107B in assets under management, so the self-described "perma-bear" Jeremy Grantham probably has some idea what's going on in the financial world. He started telling investors in 2006 to avoid risk because things were going to get ugly. Jeremy's 3Q'08 newsletter is available here. I had the opportunity to hear him speak recently, along with another GMO portfolio manager, and wanted to capture some of their thoughts in a very disorganized fashion here:
  • A dim view of future prospects for humankind, very Malthusian. Basically, there will be too many people and resources will not increase fast enough, so standards of living will drop.
  • We're going to write off wealth equal to 1.5 times GDP ($20T) with a 60% peak-to-trough decline for the stock market.
  • If you looked at the entire world's balance sheet, we had leveraged $50T of assets with $42T of debt (80% leverage!). Now those assets are only worth $30T, but the amount of debt hasn't declined and remains stranded out there. How are we going to get rid of it? Inflate it away or offload it to the government.
  • 2003-2007 was one of the biggest suckers' rallies of all time.
  • The ratio of median house price to median family income was more than 3-sigma above its long term average when Ben Bernanke said that the housing market has never declined. Now it's going to overcorrect on the downside. A housing bubble is much worse for the country than a stock bubble, because it's easier to get leverage and the majority of people who own houses will be affected by it.
  • The UK housing market is in a similar situation, but UK banks have yet to take a single writeoff for loans there.
  • Fair value for crude oil is about $75, but it will trade between $32 and $150.
  • What we have seen is the result of a "risk bubble." As investors' perceived risk decreased due to low volatility, they decided to increase risk back to their tolerance level by increasing leverage.
  • In 1981, debt was about 125% of US GDP. Now it is 300% of GDP. Increase credit will probably lead to more frequent credit bubbles.
  • In the 1970s, the price of treasuries implied 11% inflation for 30 years. We know how that turned out. Today, the price of treasuries implies 2% inflation for 30 years. Is that any more likely?
  • The efficient market camp couldn't be more wrong. Buy and hold investing is a joke. Every asset bubble over corrects by 50% below the long term trend. We're not there yet. If you had a 3-sigma increase in asset prices based on a random walk model, you'd never get a similar 3-sigma decrease directly following it on the way down. Yet this is what every bubble looks like.
  • Things can get so beaten down that even on bad news, they recover. Example: June of 1932 had terrible news every month, yet the market went up 100%.
  • Japan's great recession in the 1990s was remarkable because unemployment never became a big problem.
  • Most interesting was his prediction in September 1998 that the S&P 500 would have a real return of -1.1% over the next ten years. It turned out to be +0.1%, but that is still pretty close. His 1998 forecast also correctly tagged emerging markets and REITs as the biggest winners over the decade. Here's his forecast going forward. He likes high quality US stocks (low volatility, low debt), emerging markets, and commodities.

His associate also spoke about some of the unintended consequences we're seeing in the fixed income markets right now.

  • In 1997 when LTCM blew up, the spread between on the run and off teh run treasuries had increased from 5 bp to 15 bp. In October of 2008, that spread had widened to 100 bp. There were basically $20 bills available to be picked up by any arbitrageur.
  • Earlier this year there was a rally in Fannie Mae's bonds and some assumed it was because their financial health was improving. What actually happened was that the fed started accepting FNM bonds as collateral, so traders were buying the debt at $0.80 on the dollar and then using it to borrow $0.96 from the discount window.
  • AIG's first bailout was at LIBOR+800 bp, a punitive interest rate. A few weeks later when the government opened their commercial paper facility, AIG said "can we use that?" and then proceeded to pay off several billion of L+800 debt with much cheaper government backed CP. The government was arbitraged against itself.
  • The federal reserve now has $3T on its balance sheet. So far, this hasn't contributed to inflation. Most of that $3T is short term. However, there is talk of the fed buying longer term assets. This presents a problem once the economy recovers, if they are stuck holding longer term assets that may have gone bad, they will not be able to easily sell them and take money out of circulation. This could lead to problems controlling inflation down the road.

Dec 4, 2008

Hedge funds: short on original ideas

A month has passed since the massive short squeeze on Volkswagon, which briefly made the company the most valuable in the world (by market cap). As hedge funds have reported results since then, it has been interesting to note that many of them were playing this same trade and were caught trying to close out their positions at the same time (they took a bath), even funds whose established strategy had nothing to do with German automaker equities. Why would

This presents a problem for an endowment or pension fund (or even a fund of funds) that diversified its investments across several HFs that are supposed to play in uncorrelated market spaces. When things go bad, they go bad across several HFs at the same time as correlation = 1.0 just when it hurts you the most. Not to mention that it seems antithetical to the original premise of HFs - that they're supposed to be hedged against risk in one position by an offsetting position somewhere else.

Will hedge funds stop telling all their friends about their trades to encourage massive piling-on?Unknown. But it's an interesting contrast to private equity shops that try to keep their deals as quiet as possible until the last possible moment, lest more bidders show up at the auction.

Dec 3, 2008

Volatility strikes the S&P

Using data downloaded from Yahoo Finance, I looked at the value of the S&P 500 over the last 25 years, from 12/1/1983 to 12/1/2008, and counted the number of days where the index changed by more than +/- 4.0%. Here are the results (years not listed had zero occurences):

1986 1
1987 7
1988 2
1989 1
1997 2
1998 3
2000 2
2001 4
2002 6
2008 27

Quite a jump in 2008! And 26 of those 27 moves came in the 3rd and 4th quarters of the year. This is a crude measure of volatility compared to something like the standard deviation of returns or the VIX, but certainly one that individual investors can easily identify with. And we still have a month to go...

Dec 2, 2008

Microsoft pays customers $180 million to use its search engine

You're the world's largest software company, but you can't get people to start using your search engine as Google becomes more firmly entrenched every passing day. How do you get them to come to your site instead? Microsoft has decided that cold hard cash is the answer, and they have the funds to back it up. Since June, they've been pushing a cashback promotion with its product, discussed in great detail at Fatwallet.

The normal cashback program offered discounts around 2-5% for purchases made from merchants through the site and presumably they helped foot the bill for the cashback. More unusual was the 35% cashback offered on almost any eBay purchase. This led to many sellers touting the cashback in their item descriptions, since it came at no cost to them and increased the amount buyers were willing to bid. I don't see any reason why eBay would pick up the tab for this, so that leaves Microsoft writing a lot of checks. Here's a very rough estimate of how much they've spent on this promotion so far:
  • A search on eBay for "" turns up over 30,000 items with an average price around $500 (items featuring the discount probably skew expensive - not much point in saving 35% on a $20 purchase)
  • With an average 20% discount (it's ranged between 8% and 35% since the summer), that's $100 paid in cashback per item
  • Assume items listed turn over every 3 days, over 6 months that's 60 times sales
  • 60 x 30,000 x $100 = $180 million in cash paid directly to consumers

Granted, this is a back of the envelope calculation. There are certainly items that will qualify for the cashback that don't feature "" in the description which would increase the amount paid. The average cashback and velocity of sales may also vary from what I've assumed. As if the legitimate users weren't charging enough cashback, I'm sure others have been gaming the system by buying items for resale (gold bullion, gift cards) or setting up fake auctions under multiple accounts.

How many companies have the resources to make almost $200MM in cash payments to entice customers to use something as ephemeral as a search engine? A bank may spend a couple hundred to acquire a new retail customer, but at least they're protected by some switching costs. Has "Helicopter Ben" taken over Microsoft's marketing department? They're is throwing money at this problem, demonstrating the seriousness of their predicament, but I don't see the long term payoff from it.

Well, it's probably still cheaper than buying Yahoo at $31/share ($44B market cap).

Dec 1, 2008

Securitization and the real estate bubble

Some researchers at the University of Chicago recently revised an interesting paper regarding The Consequences of Mortgage Credit Expansion. A few of the possible explanations for the growth in subprime mortgage lending:
  • Income growth prospects: borrowers are earning more, so they can afford more credit
  • House price appreciation expectations: houses are appreciating faster, so lenders are more willing to take on credit risk since the more valuable collateral reduces their loss given default
  • Supply of credit growth: securitization enabled mortgage originators to sell loans to other entities, increasing their capacity to make more loans

Their study of zip code level data finds that in spite of flat or declining incomes and stagnant house prices, lending increased substantially from 2002 and 2005. Over that period, credit provided to subprime zip codes doubled and since 2006, the foreclosure rate for those same areas is three times as high as neighboring metropolitan areas. They cite securitization as the main force behind the expansion of subprime credit, a supply-based explanation. There may also be some moral hazard at work here: increased securitization is much more prevalent among subprime zip codes and default rates increase much more rapidly for loans originated in areas of high securitization.

The next question is: why did securitization increase so much? They leave that for another paper, but it might be related to technological innovations in risk management, demand from GSEs like Fannie and Freddie, or the flood of capital into the US during this time period.