• The Trouble With Banks Today...

    The U.S. banking system is unique compared with the rest of the world. We have national banks and state banks. We have commercial banks, savings banks, and credit unions. And we have large, money-center banks as well as small, community banks. Lots of them. One of the unique features of the U.S. banking system is the huge number of banks—thousands of them—across the nation.


    So how are they doing?


    According to this recent CNN Money article, the number of problem banks has declined from 884 in 2010 to 612 most recently, which is good but not good enough. In contrast, the number of problem banks before the crisis in 2006 was only 50 and increased to 76 in 2007.


    One of the interesting characteristics of this problem bank list is that it is made up of small banks for the most part.


    From the article:


    The presumption is that most of the banks on the list are relatively small. The average bank on the problem bank list has just under $350 million in assets. JPMorgan Chase (JPM), the largest bank in the U.S., has $2 trillion in assets. And the average size of problem banks has dropped over the past two years from just over $450 million. The FDIC also reported on Wednesday that the conditions at the largest banks in the country continue to improve.


    So part of the problem could be the outsized influence of large banks. The government seems less interested than in the past in helping small banks recover. That's probably because they matter less to the economy than they used to. In the S&L Crisis, regulators launched a multi-year effort to rid the banks of troubled assets. This time around, small banks that wanted it got a piece of the bailout pie. But the small bank bailout has mostly been a disaster. The bailout money seems to have done little to help their finances.


  • What To Do When Rates Are Likely to Rise?

    What’s the wisest choice if you expect rates to rise? The answer depends on whether you’re a borrower or a lender (i.e. investor). A borrower should borrow money for the longest term possible and lock in the low rates now. A lender, on the other hand, should hang on to cash until rates are higher.


    According to Reuters (29 May 2013):


    …The pros are already taking what Albion Financial Group market strategist Jason Ware calls "the prudent approach" and positioning themselves for the big rate increases that might be five weeks - or five years - in the offing.


    You should, too. When rates rise, the value of your bonds and bond funds will fall, and you may find yourself paying more than you can afford to cover your mortgage, auto loan and credit card bills. Here is how to get ready for the next rate era.


    The article goes on to list several ways to take advantage of low rates before rates begin to rise.


    For discussion


    What is the “pure expectations theory” of the term structure of interest rates? How is the article cited above consistent with the pure expectations theory?                                                             



  • How To Build a Nest Egg

    Photo of Blue Eggs In A Nest by Apuch licensed under Creative Commons



    As recent college graduates begin their first jobs, they may need to be reminded of the power of savings. This CNBC article (Sullivan, 29 May 2013) could be just the piece of news to forward to your favorite young person who may be looking for a little financial advice.


    From the article:


    It sounds like a math trick, but it's really just harnessing the power of time: Someone who saves for retirement during their 20s and completely stops a decade later will have more at age 62 than someone who starts saving in their 30s and spends the rest of his or her adult life trying to catch up. Yes, 10 years of savings can be worth more than 30 years of savings. This may be the only time when something that sounds too good to be true really is true.


  • Are Options Right for Individual Investors?

    Several brokerage firms have been encouraging customers to trade options, and the customers have agreed. According to the NY Times (24 May 2013),

    The brokerage firms do not release data about customers’ trading, and they are generally hesitant to detail the expansion of this business. But it has clearly been an area of growth. An analysis of scattered data from company filings and presentations indicates that derivatives trading, which includes options, has risen at all the major firms since the financial crisis of 2008, which left many Americans with big losses in their investment portfolios.

    Options are contracts that give holders the right to buy or sell 100 shares of stock at a predetermined “strike” price on or before an expiration date. Call options give investors the right to buy the shares while put options give investors the right to sell the shares.

    The question is whether these contracts are wise for individual investors. The right to buy or sell does not come free. Investors pay a price for these rights, and that price is money down the drain if the option expires worthless.

    For discussion:

    What is the difference between a futures contract and an option contract?

    Why are these contracts called “derivatives?”


  • Investing Life Lessons

    In this video, Jim Cramer describes what he learned about money management in his days at Goldman Sachs. Some of these lessons include:


    1.      Individuals can and do beat the market. But they had to understand the investments they were choosing.

    2.      This business is humbling. If you have a good investment, don’t turn it into a trade by making it short-term. If you have a trade, don’t make it an investment by holding a loser for too long.

    3.      Investment objectives are important when building a portfolio. Decide whether you want capital preservation or capital appreciation and invest accordingly.


  • Life of the Young Investment Banker

    Young analysts at top banks are being wooed by hedge funds, private equity firms, and venture capital firms. Traditionally, analysts were recruited after they’d spent two years at their first job, but the competition for these young minds is getting more fierce and the recruiting is beginning in the first year out of college.


    According to the NY Times (23 May 2013)


    “Every year recruiters get hold of full lists of analysts in the top groups at the top banks,” said a second-year analyst at JPMorgan Chase who secured a private equity job a year ago. “Private equity funds want kids from the mergers and acquisitions, leveraged finance and financial sponsors groups so headhunters will call the main line at these desks and just recruit the analyst that picks up the phone.” It is difficult for these analysts to resist when recruiters sell the promise of high salaries and better hours.


    “Right now, major investment banks are so highly regulated that they are no longer the most exciting places to be,” said Skiddy von Stade, the chief executive of OneWire, a technology recruiting platform focusing on the financial services industry. “Private equity shops are smaller, leaner and much less bureaucratic. You’re given the leeway to be creative and take risks. You may put in long hours when there’s a lot of work, but you don’t have to put in the face time when things are slow.”


    For discussion:


    What is the difference between a “buy-side” firm and a “sell-side” firm? Why would an analyst choose to leave the sell-side for the buy-side?


  • The Power of Compounding

    “Compound interest is the most powerful force in the universe.

    ~ Albert Einstein



    This report shows that $1 invested in 1925 would be worth $18,000 if you had invested in small cap stocks. Government bonds would only have yielded $123 and gold even less.


    For discussion:


    What is the compounded annualized return on each of the investments listed in this video? How much would you have earned if you invested $1,000 back then? What if it was $10,000? How much would you have earned if you had only invested for half of that time?


  • The "Narcissist" Stock Rally

    Why do stocks go up?


    Stocks rise on good news: corporate earnings, growth potential, economic growth. But one little mentioned reason for a stock rally is stock buybacks.


    Dubbed the “narcissist rally,” the increase stock prices is being driven to some degree by the demand for shares by the issuing companies themselves.


    According to NBC News (19 May 2013):


    Flush with cash and a world of opportunity at their doorstep, companies have decided there's nothing more attractive than themselves. So, they're offering big money to buy back their own stock. This year, big U.S. companies have given the go-ahead for $286 billion of buybacks, up 88 percent from the same period last year, according to Birinyi Associates, a market research firm. If the pace continues for the rest of the year, the tally will exceed the record set in 2007.


    The question is: just how much of an impact can companies have by announcing stock repurchase programs?


    From the article:


    Stocks move up for all sorts of reasons, so the exact impact on prices of individual stocks when companies buy their shares is unclear. In any event, the total amount of buybacks doesn't appear to be enough to have a big effect on the whole market. If companies in the S&P 500 follow through on their plans this year, the buybacks will amount to just 1 percent of total trading, estimates Robert Leiphart, an analyst at Birinyi.


    Still, companies that do buy back their own stock are seeing prices soar, and almost immediately.


    For discussion:


    Why do companies buy back their own shares?



  • Are Stocks On Course to Win?

    According to experts, the evidence in favor of stocks is “overwhelming”.

    In a CNBC interview, hedge fund manager David Tepper lists the evidence in favor of stocks. In the words of My Cousin Vinny, in fact, the evidence is so overwhelming that stocks will beat bonds, that Mr. Tepper says, “Case dismissed.”


    This video below with hedge fund manager Ray Dalio tells the same story. He describes why bonds are less attractive than stocks in this market. The search for safe returns has driven short term rates to a negative real return and bond rates to less than 1%. Investors are searching for yields, leading them to explore other financial assets. Good news for stocks.


  • Is Powerball The Winning Investment?

    This video describes who the real winners of the Powerball lottery are:


    1.    The state keeps 50% of the proceeds.

    2.    The federal government takes 40% of the winner’s share.

    3.    The city and state also win, depending on where the winner lives.


    All told, the winner of the $600 million Powerball lottery on Saturday night will take home about $200 million. Not bad.


  • Are Oil Prices Manipulated?

    Several oil companies are under investigation for colluding on oil prices. In a series of surprise inspections, the European Commission is looking into whether BP, Royal Dutch Shell, and Platts colluded to manipulate the price of oil.


    According to the NY Times (14 May 2013):


    The authorities are focused in part on the price reporting system for oil and other petroleum products, which is dominated by a small group of companies like Platts. Such companies determine prices by polling traders and using other industry data.


    In recent years, Platts has instituted a so-called electronic window through which a significant amount of oil is traded. At the end of each day, Platts determines prices based on the trades that go through this system, rather than by simply relying on polling companies.


    There are concerns in the industry that companies could distort the prices through a blizzard of last-minute trades. “If you want access to liquidity you are forced to use the window,” said a senior oil trader. But he also said that the window, in theory, should be more accurate than prices determined just by polling traders because the prices were determined by actual trades.


    For discussion:


    Why is the price setting mechanism for oil and oil related products so important to regulators?


    What are the concerns about the use of the Brent crude oil price as a benchmark?


    What are some characteristics of a “good” benchmark price?


  • Theme Park Investing

    Despite the problems with the economy, consumers still go to theme parks for fun. Maybe because when times are tough, people find “stay-cations” more attractive or maybe because theme parks remind them of their own childhoods, parks like Cedar Point continue to bring in the profits.


    For discussion


    The video above describes how long it takes to bring a new roller coaster to market. In terms of capital budgeting, what details must the theme park operator consider before it can unveil a new roller coaster?

  • How to Judge an IPO

    IPO investing seems to be the ticket to success in the stock market. However, not all IPOs have been winners, as investors in Facebook can attest.


    According to Cramer, here are three things to evaluate when considering whether to invest in an IPO. Possibly more important than what the company makes is:


    1.   The company’s pedigree. Who comprises the management team? What do we know about the folks who will be running the company?


    2.   The company’s investors. If the current owners are private equity firms, then the investment may be difficult to judge. And the firm may not necessarily be profitable.


    3.   The brokerage house bringing the deal. Large, well-known investment banks have their reputation on the line, so are perhaps less likely to bring a bad deal to market.


  • Beach Boys Market Value

    The largest collection of memorabilia is up for auction. One thousand pieces of Beach Boys memorabilia will be sold as one lot, including sheet music of Good Vibrations and their first royalty check for $990. The collection was found in a Florida storage unit and, after a long legal battle for control, is expected to bring millions at auction.


    For discussion:


    What is the book value of this collection? What is the difference between book value and market value?


  • Monitoring Before the Crisis

    In his recent speech at the Conference on Bank Structure and Competition, Federal Reserve Chairman Ben Benanke discussed one of the responsibilities of the central bank, namely monitoring of the financial system. In the excerpt below, he explains the differences between triggers of financial crises and vulnerabilities associated with a financial crisis.


    Ongoing monitoring of the financial system is vital to the macroprudential approach to regulation. Systemic risks can only be defused if they are first identified. That said, it is reasonable to ask whether systemic risks can in fact be reliably identified in advance; after all, neither the Federal Reserve nor economists in general predicted the past crisis. To respond to this point, I will distinguish, as I have elsewhere, between triggers and vulnerabilities.2 The triggers of any crisis are the particular events that touch off the crisis--the proximate causes, if you will. For the 2007-09 crisis, a prominent trigger was the losses suffered by holders of subprime mortgages. In contrast, the vulnerabilities associated with a crisis are preexisting features of the financial system that amplify and propagate the initial shocks. Examples of vulnerabilities include high levels of leverage, maturity transformation, interconnectedness, and complexity, all of which have the potential to magnify shocks to the financial system. Absent vulnerabilities, triggers might produce sizable losses to certain firms, investors, or asset classes but would generally not lead to full-blown financial crises; the collapse of the relatively small market for subprime mortgages, for example, would not have been nearly as consequential without preexisting fragilities in securitization practices and short-term funding markets which greatly increased its impact. Of course, monitoring can and does attempt to identify potential triggers--indications of an asset bubble, for example--but shocks of one kind or another are inevitable, so identifying and addressing vulnerabilities is key to ensuring that the financial system overall is robust. Moreover, attempts to address specific vulnerabilities can be supplemented by broader measures--such as requiring banks to hold more capital and liquidity--that make the system more resilient to a range of shocks.


    For discussion:


    Discuss each of the four components of the financial system that are most closely monitored by the Federal Reserve.


  • Advice for Investors

    Winning a winner’s game requires skill. The winner’s decisions must be superior to the opponent’s decisions. The loser’s game is different. Winning a loser’s game means staying in the game long enough to let your opponent lose. That is, winners must make fewer bad decisions than their opponents.


    Charles Ellis, founder of Greenwich Associates and former director of Vanguard, is well-known in the investment management industry for describing the investment process as winning the loser’s game.


    From a recent interview with Money Magazine (7 May 2013):


    He shook up Wall Street in 1975 with a landmark article in a financial trade journal that attacked the notion that professional money managers consistently beat the market.


    Nonprofessionals stand even less chance of outperforming the benchmarks, argued Ellis, so individuals need to rethink their approach to building wealth. That influential piece was the basis for Ellis's classic investing book, Winning the Loser's Game, the sixth edition of which is due in July.


    For discussion:


    According to this Vanguard blog about Charles Ellis, how can an investor outperform the market?


  • Academic Research Meets Economic Policy

    A recent Washington Post opinion piece by Lawrence Summers, past president of Harvard University and former Treasury secretary in the Clinton administration, sheds some light on the academic study being blamed for the current economic woes.


    The study in question is a paper by Reinhart and Rogoff “Growth in a Time of Debt” which was then criticized by researchers at the University of Massachusetts, Amherst. In response to the criticism, Reinhart and Rogoff issued the following statement:


    In May 2010, we published an academic paper, “Growth in a Time of Debt” in the American Economic Review.  Its main finding, drawing on data from 44 countries over 200 years, was that in both rich and developing countries, high levels about of government debt — specifically, gross public debt equaling 90 percent or more of the nation’s annual economic output — was associated with lower rates of growth.


    On April 15, 2013, three economists at the University of Massachusetts, Amherst, released a paper criticizing our findings. They correctly identified a spreadsheet coding error that led us to miscalculate the growth rates of highly indebted countries since World War II. They also accused us of “serious errors” stemming from “selective exclusion” of relevant data and “unconventional weighting” of statistics.


    Summers points out a few lessons worth remembering:


    1.      Though the researchers being criticized are careful and credible, journals should confirm the accuracy of results before publishing.

    2.      Even when the results are accurate, we should be careful about relying on prior data when forecasting.

    3.      These researchers are not to blame for the economic policy, nor should people of differing political viewpoints take pleasure in embarrassing them.


  • Are Rolling Stones' Tickets Too Rich?


    This Bloomberg video shows that the $600 tickets to the Rolling Stones concert are a tough sell. Not that there isn’t demand for the tickets. After all, when the promoter had a “flash sale” on tickets for $85, they sold 1,000 tickets and nearly crashed the ticketing system.


    The ticket promoter is on the hook if tickets don’t sell. They’ve already guaranteed a specific amount of money to the band, so unsold tickets are not the Rolling Stones’ problem.


    Supply and demand. It’s a tricky thing sometimes.


    For discussion


    Based on this Bloomberg video, how is the promotion and sale of Rolling Stones tickets similar to a “Best Efforts” underwriting in the new issue bond market?


    What are other ways that a bond underwriter can bring a deal to market without taking on so much risk?


  • Should We Buy LinkedIn Shares?

    LinkedIn’s shares were down in spite of increased revenues and profits. Though revenues doubled and profit quadrupled, the numbers did not hit analyst estimates.


    Jim Cramer likes the stock anyway.


    Do you?


    For discussion:


    What negative news caused the stock to fall?


    How does LinkedIn generate a profit?


    Is the business model for social media firms like LinkedIn likely to be profitable in the future? What do you think of LinkedIn’s growth prospects?


  • Betting on Boeing

    Would you bet on Boeing?


    According to this interview, Boeing stock has the potential to go higher. Recently, options activity suggested that investors were optimistic that the stock would go up. That is, investors bought call options and the stock rose above $90/share. Some believe the stock could rise to over $100/share. The trader in this interview suggests several compelling reasons to buy the stock. One reason is the 2.1% dividend yield, which is better than buying US Treasury bonds.


    For discussion:


    What is a call option? What is a put option?


    What does it mean to be long or short calls and puts?


    Which option contract would you buy if you thought the price of a stock was going up? Which one would you buy if you thought that the price was going down?


  • Show Me The Money

    Imagine a world where you get paid your monthly salary in cash, and you in turn then paid your rent and bought your groceries entirely in cash. To buy anything—a car or a house—would require suitcases full of cash. The inconvenience alone would cost you hours in productivity each week.


    No need to imagine. In China, people still prefer cash over other forms of payments. And to make matters worse, the largest denomination currency is the 100-renminbi note (approximately $16). All large ticket items take armloads of paper currency.


    From the NY Times (Barboza, 30 April 2013):


    This is a country, after all, where home buyers make down payments with trunks filled with cash. And big-city law firms have been known to hire armored cars to deliver the cash needed to pay monthly salaries.


    For all China’s modern trappings — the new superhighways, high-speed rail networks and soaring skyscrapers — analysts say this country still prefers to pay for things the old-fashioned way, with ledgers, bill-counting machines and cold, hard cash.


    Many experts say it is not a refusal to enter the 21st century as much as wariness, of the government toward its citizens and vice versa.


    For discussion:


    Explain the other reason given in the article that the government resists printing larger denominations of the currency.


  • Question: Why borrow? Answer: Because we can

    Apple borrowed a record $17 billion on Tuesday in a much-discussed bond deal. The question is why. With $145 billion in cash on the books, what could possibly motivate the firm to borrow more?


    According to the NY Times (Lattman & Eavis, 30 Apr 2013):


    The answer has a lot to do with the frenzied state of the bond markets. Companies are issuing hundreds of billions of dollars in debt to exploit historically low interest rates and strong investor demand for bonds as an alternative to money market funds and Treasury bills that paying virtually nothing.


    … But Apple’s move also reflects the challenges of a highly successful business with a flagging stock price. In an effort to assuage a growing chorus of concerned and disappointed Apple investors, the company is issuing bonds to help finance a $100 billion payout to its shareholders. It will distribute most of that amount over the next two and a half years in the form of paying increased dividends and buying back its stock.


    So Apple is using the borrowed money to return cash to shareholders. And while that may work in the short run, what really makes shareholders happy is innovation. There is no substitute for growing, profitable projects.

    In the competitive market for technology, Apple must do more than borrow money to satisfy shareholders.