S&P cuts Berkshire Hahaway's rating, but barely.

S&P cuts Berkshire Hathaway rating by one notch to 'AA' - Yahoo! Finance:

"The lower credit rating on BRK better reflects our view of BRK's dependence on its core insurance operations for most of its dividend income," said Standard &Poor's credit analyst John Iten."

How to bond rating agencies work? Here are a few good links:

From Wikipedia:  (they have really cool tables showing defaults by rating_

A straight forward primer:  
http://www.investinginbonds.eu/Pages/LearnAboutBonds.aspx?id=6186

and a slightly more academic version here is from  JF piece:
http://onlinelibrary.wiley.com/doi/10.1111/0022-1082.00311/abstract

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SEC subpoenas ‘political intelligence’ firms in a case of leaked information - The Washington Post

SEC subpoenas ‘political intelligence’ firms in a case of leaked information - The Washington Post:

" The latest case emerged April 1 when Height Securities, a Washington-based stock brokerage firm, alerted its clients that the government would soon make a decision favoring private health insurers who participate in a Medicare program.

The alert went out 18 minutes before the end of the trading day, sparking a surge in trading in the shares of several major health-care firms, including Humana and Aetna. The official government announcement was made after trading closed for the day."

Futurity.org – Bad deeds can tarnish money’s value

Futurity.org – Bad deeds can tarnish money’s value:

"Our work suggests morality is an important force shaping economic decision-making,” says Jennifer Stellar, a doctoral student in psychology at University of California, Berkeley, and lead author of the study. “Though we often think $50 is $50, these results demonstrate that when money takes on negative moral associations, its value is diminished.”

The findings help explain the psychology behind such economic trends as socially responsible investing and the boycotting of sweatshop-produced goods. They also shed some light on why companies go to great lengths to avoid the perception that they are accepting money from corrupt investors or are themselves profiting from illegal or unethical practices, researchers say."

 A more cynical author would suggest this is a possible explanation for high CEO pay?  I wouldn't of course ;)   

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Are hedge fund investors beginning to relaize returns are not that great?

In some recent papers, researchers argue that the return from an investment mainly results from exposure to systematic risk factors. Jaeger, L., Wagner, C., “Factor Modelling and Benchmarking of Hedge Funds: Can passive investments in hedge fund strategies deliver?”, Journal of Alternative Investments (Winter 2005) (Photo credit: Wikipedia)

First the "what": Investors are redeeming hedge funds, especially equity funds:

Hedge fund investor inflows turn negative in March - preference for credit strategies continues - Opalesque:

"After a seven month span of consistent positive flows ending November 2012, during which MBS focused funds took in an estimated $6.1 billion, the group has seen outflows in three of the last four months. Despite having net positive investor flow during this time frame, it is of interest that the group’s flows are no longer universally positive....Investors again were net redeemers of assets from directional equity strategies in March. Q1 marked the seventh consecutive quarter of redemptions from equity strategies, matching the duration of outflows the group endured during/after the financial crisis."

The "why" is unknown, but one possibility is that investors are starting to see that just because a fund has the word "hedge" in it, does not mean it is a great fund.  Indeed, it may be far from that great.

To wit:

Rob Arnott: Why I've had it with hedge funds - The Term Sheet: Fortune's deals blogTerm Sheet:

"Arnott's colleagues started with a portfolio with a basic mix -- 60% stocks and 40% bonds. They then took a look at what would happen if the portfolio was shifted gradually, 10% at a time, into hedge funds. The result: Returns went down, and risk went up as the exposure to hedge funds increased, which is the opposite of what you want.

"Portfolio efficiency didn't improve," says RA's John West, author of the firm's hedge fund study. "In fact, it deteriorates with each additional allocation to hedge funds."

Hedge funds did a little better over the past 15 years. But even over that period, West found that a pension fund would have done better by adding a passively managed mix of commodities, real estate, and other assets, rather than expensive hedge funds."

And yet money flows into hedge funds.  What is the allure?  Maybe Statman is right and it is just that people want to brag (appear rich) and investing in hedge funds does that!

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Mercury News interview: Meir Statman, Santa Clara University professor of finance - San Jose Mercury News

Finance (Photo credit: Tax Credits)

Mercury News interview: Meir Statman, Santa Clara University professor of finance - San Jose Mercury News:

"Santa Clara University finance professor Meir Statman believes that American employers should be forced to set up retirement plans for their workers for one simple reason: "People are stupid," he said.

Statman, an expert in behavioral finance, includes himself among people who sometimes make stupid financial decisions."

Statman's book What Investors Really Want: Know What Drives Investor Behavior and Make Smarter Financial Decisions is one of my all time favorites.

Here is an audio interview I did with him a few years ago:  podcast with Meir Statman.

Kill the 30-Year Mortgage - Bloomberg

Kill the 30-Year Mortgage - Bloomberg:

Bloomberg makes an interesting call for more adjustable mortgages that reduce the boom and bust cycles in real estate: 

"New homes are being built at the fastest rate in years and prices are increasing across the country....

What’s wrong with this picture? None of this would be possible without massive government support. Today, the government owns or guarantees about 90 percent of new mortgages, up from about 50 percent in the mid-1990s. It isn’t sustainable, let alone fiscally acceptable, for the U.S. to have such a domineering presence in what should be a private-sector function."

One more look in:

"The U.S. must figure out a way to better manage these risks if it is to turn housing back over to the private sector. Fortunately, economists have lots of ideas. The common theme is that mortgage principal should be keyed to economic conditions, and monthly payments should rise and fall proportionately. These features ensure that borrowers have a stake in repaying their loans, while also making it easier for them to do so when times get tough."

Insider trading at KPMG?

KPMG Fires a Senior Partner in an Insider Trading Episode - NYTimes.com:

"KPMG said late Monday night it had fired a senior partner in its Los Angeles office after learning that he had provided inside information to an unnamed individual “who then used that information in stock trades involving several West Coast companies.”"

It seems that the company involved was Herbalife:
Again from NY Times:

Herbalife is poised to disclose on Tuesday that KPMG will have to resign as the company’s auditor, after the accounting firm fired a senior partner, according to a person briefed on the matter.

 

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Carl Icahn Unleashed: Wall Street's Richest Man Is On The Attack -- Just Ask Michael Dell - Forbes

Carl Icahn Unleashed: Wall Street's Richest Man Is On The Attack -- Just Ask Michael Dell - Forbes:

Forbes has a fascinating article on a fascinating man: Carl Icahn.

"He used to make runs at companies via junk bonds and other tools of leverage. Then he figured out how to use other people’s money via a hedge fund structure. Now, though, it’s all Carl–with a net worth that FORBES estimates at $20 billion (which makes him the richest Wall Streeter, edging out George Soros). He doesn’t need anyone’s help or approval anymore. And that now makes him very, very dangerous."

Want more on him?  Here is from Wikipedia:

 " Icahn was raised in Far Rockaway, Queens, New York City, where he attended Far Rockaway High School....began his career on Wall Street as a stockbroker in 1961. In 1968, he formed Icahn & Co., a securities firm that focused on risk arbitrage and options trading. In 1978, he began taking control of positions in individual companies.^[2] He has taken substantial or controlling positions in various corporations including RJR Nabisco, TWA, Texaco, Phillips Petroleum, Western Union, Gulf & Western, Viacom, Uniroyal, Dan River, Marshall Field's, E-II (Culligan and Samsonite), American Can, USX, Marvel Comics, Revlon, Imclone, Federal-Mogul, Fairmont Hotels, Blockbuster, Kerr-McGee, Time Warner, Motorola, and Herbalife."

Someone should make a movie!  

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Why Do Firms Pay Stock Dividends: Is it Just a Stock Split? by Xi He, Mingsheng Li, Jing Shi, Garry Twite :: SSRN

Why Do Firms Pay Stock Dividends: Is it Just a Stock Split? by Xi He, Mingsheng Li, Jing Shi, Garry Twite :: SSRN:

Abstract:

"This paper examines why firms choose to pay stock dividends. Using a sample of listed Chinese firms, we find that younger, more profitable firms, with lower leverage, high levels of retained earnings, private ownership prior to listing, investing more in fixed assets and operating in regions with lower shareholder protection are more likely to pay stock dividends. Consistent with stock dividends substituting for stock splits, our evidence indicates that the initiation of a stock dividend is associated with a significant positive market reaction and increased analyst following, suggesting that firms use stock dividends to attract analysts’ attention. In addition, the positive announcement effect for stock dividends increases with the size of the split factor, suggesting that management making use of stock dividends to keep the firm’s stock price within its acceptable trading range."

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Deregulation of Bank Entry and Bank Failures by Krishnamurthy Subramanian, Ajay Yadav :: SSRN

Deregulation of Bank Entry and Bank Failures by Krishnamurthy Subramanian, Ajay Yadav :: SSRN:

Short version: after deregulation there are fewer bank failures. 

From the paper:

"we find that deregulation of bank entry enhances bank stability by lowering instances of bank failures. Consistent with the effects being strongest in environments where the structure of banking markets changed the most, the effects are mainly due to intra-state deregulation and in states that had unit banking laws. In falsification tests, we find no effect of the deregulation on thrift failures. Furthermore, pre-existing bank failures in a state did not determine its timing of deregulation, which assures against any reverse causal effects. The reduction in bank failures seemed to result from: benefits from greater geographic diversification; and banks becoming more efficient post deregulation."

cite: Subramanian, Krishnamurthy and Yadav, Ajay, Deregulation of Bank Entry and Bank Failures (November 18, 2012). Available at SSRN: http://ssrn.com/abstract=2219809 or http://dx.doi.org/10.2139/ssrn.2219809

Earthquakes and the Mind-Bending Laws of Markets - Bloomberg

To summarize: markets (and earthquakes) are not "normal".

Earthquakes and the Mind-Bending Laws of Markets - Bloomberg:

"Unfortunately, centuries of science and mathematics tradition, focusing on the normal statistics of things like weights, heights, and test scores, has taught us to see the world incorrectly. It was a telling moment on April 27, 2010, when Goldman Sachs Chief Financial Officer David Viniar testified to the Senate Permanent Subcommittee on Investigations....

“We were seeing things,” Viniar said... “that were 25-standard-deviation events, several days in a row.”

In Gaussian mathematics, even an eight-standard-deviation event is expected only about once in the entire history of the universe. A 25-standard-deviation event should be expected about once every 10 to the 135th power years -- one followed by 135 zeros. Stocks over a single day typically change less than about 2 percent, so a movement of even 10 standard deviations means a movement of at least 20 percent. While normal statistics says this should happen once every 10 to the 22nd power days, market data show that it happens essentially every week for at least one of the few thousand stocks in the market. So perhaps we should reexamine our assumptions."

Don't be normal: markets, earthquakes, and life often have fat (and important) tails! 

Great article!  Thanks Dave for sending it to me!  (FYI Dave is a hedge fund manager who speaks to my class at least once a semester.)

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Spreadsheet for calculating interest payments

My MBA 604 class was asking about this, so I figured I would share it with everyone.  It is simple but shows how early payments go primarily to paying off interest. 

Weighted average cost of capital (WACC) - YouTube

Weighted average cost of capital (WACC) - YouTube  THANKS Bionic Turtle!!!

California Schools Finance Upgrades by Making the Next Generation Pay - NYTimes.com

California Schools Finance Upgrades by Making the Next Generation Pay - NYTimes.com:

This past week I was at a conference where one of the presentations was on these Capital Appreciation Bonds.  Essentially while these look like zero coupon bonds to investors, they take advantage of accounting loopholes that allow the price appreciation to be catergorized at deferred interest. And hence only the loan amount is reported on financial statements not tHE total amount (debt and interest) is due.

Moreover, these are non callable and at rates which are generally higher than current market rates would suggest. 

 From NY Times:

Since 2007, hundreds of school districts and community colleges across California have used capital appreciation bonds to raise nearly $7 billion for various construction projects, according to data from the state treasurer’s office. The bonds have allowed school districts that are short on cash to finance classroom renovations and new athletic facilities while delaying payment for years, or even decades.

and later:

" And in the most expensive case yet, the Poway Unified School District borrowed $105 million to finish modernizing older school buildings, which local property owners will be paying off until four decades from now at an eventual cost of nearly $1 billion. Because payments on the bond do not start for 20 years, current school board members faced little risk of resistance from property owners."


A few comments:

1. The PV of these is not as outrageous as the articles lead you to believe.  Yes the borrower has to pay back 10-20 times the amount borrowed, but paying back in future dollars.  This is a cardinal mistake (dollar today does not equal a dollar tomorrow!). 
2. Genius move to say that the interest accumulates and hence keep it off the balance sheet.  Shaking my head at this one.  Also gets around rules that attempt to limit borrowing as a percentage of assessed valuation etc.  I don't like it as it keeps taxpayers uninformed as to the true amount of their liabilities, but none-the-less I must recognize the creativity and genius to get around the stated rules. 
3. The accounting rule has to be amended.
4. It is a near perfect example of future generations having to pay off our debts.   
5. As general obligation bonds, the school district is not allowed to default.  In the event of a default their will be a special assessment (think tax) that will be used to pay off the loan.  (at the conference the speaker cited examples from the 1930s (Great Depression) where cities closed down and were foreclosed as a result failure to pay off general obligation muni debt.
6. Look for a more on this coming soon!  (Several large media outlets reportedly doing pieces on this from across the US.)

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