The Big Picture - Macro Perspective on the Capital Markets, Economy, Technology, and Digital Media

Austan Goolsbee, Chairman of the Council of Economic Advisers, discusses the decisions on the American auto industry in light of the General Motors IPO. (See also Too Bad Banks Missed Out On the GM Treatment)

The WSJ occasionally buries huge stories in its much less read weekend edition; recall the option backdating investigation in 2006.

This past weekend was a classic example of this:

“Federal authorities, capping a three-year investigation, are preparing insider-trading charges that could ensnare consultants, investment bankers, hedge-fund and mutual-fund traders, and analysts across the nation, according to people familiar with the matter.

The criminal and civil probes, which authorities say could eclipse the impact on the financial industry of any previous such investigation, are examining whether multiple insider-trading rings reaped illegal profits totaling tens of millions of dollars, the people say. Some charges could be brought before year-end, they say.

The investigations, if they bear fruit, have the potential to expose a culture of pervasive insider trading in U.S. financial markets, including new ways non-public information is passed to traders through experts tied to specific industries or companies, federal authorities say.”

The criminal investigation was examining how nonpublic information was being passed to traders by consultants. These people work for companies that provide “expert network” services to hedge funds.

• Primary Global Research LLC, a Mountain View, California, firm
• Goldman Sachs Group Inc. bankers
• Broadband Research LLC in Portland, Ore

There is a laundry list of potential targets for SEC violations. Trading firms possibly under investigation include SAC, First New York Securities, Wellington, MFS, Janus,  Citadel, Ziff Brothers, Jana, TPG-Axon, Jennison, UBS and Deutsche Bank.

Companies whose stock trading were under review include Schering-Plough (before its takeover by Merck), MedImmune’s takeover by AstraZeneca, Abbott Laboratories take over of Advanced Medical Optics.

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Source:
U.S. in Vast Insider Trading Probe
SUSAN PULLIAM, MICHAEL ROTHFELD,JENNY STRASBURG and GREGORY ZUCKERMAN
WSJ, NOVEMBER 20, 2010
http://online.wsj.com/article/SB10001424052748704170404575624831742191288.html

ETF’s Firm Foundations by Matt Hougan
November 20, 2010
Matt Hougan

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Matt Hougan is the President of ETF Analytics and the Global Head of Editorial for IndexUniverse. This is a guest column written by him in response to the recent negative press reports about ETFs.

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Over the past few months, a series of poorly researched “white papers” have criticized exchange-traded funds and raised questions about the soundness of the ETF structure.

These papers—from the Kauffman Foundation, Bogan Associates, and others—center on three main assertions:

1) ETFs are fundamentally flawed and subject to collapse during stressful market conditions.

2) ETFs are a serious threat to market stability and are likely to cause future “flash crashes.”

3) ETFs are driving up the correlation between individual stocks, ruining price discovery in the markets, and thereby threatening capitalism as we know it.

All three assertions are false. They rest on a foundation of flawed logic, simple misunderstandings of ETF structures, and superficial research.

Despite transparent flaws, these arguments have received widespread media attention, from CNBC to the Financial Times. That’s a shame, because even a little bit of research could debunk the claims quickly.

Claim 1: ETFs Are Fundamentally Flawed and Could Collapse

The argument that ETFs could collapse was first advanced by a research outfit named Bogan Associates in a white paper published on September 15, 2010. It centers on the fact that many ETFs have high short interest, often many multiples of the number of shares outstanding.

The Bogan report focused on the SPDR S&P Retail ETF (NYSEArca: XRT), which at the time the report was written had over 500 percent short interest; in other words, each share in XRT had been sold short five times.

That sounds terrifying. How can an ETF have more shares sold short than exist in the first place? But it happens regularly with both stocks and ETFs, and it is both perfectly legal and safe.

Imagine that I own all of the shares of XRT. I want to earn a little extra money, so I lend them to you, for a fee, so that you can sell them short. You sell them to a guy named Bob. XRT has 100 percent short interest.

If Bob then lends them to someone else who sells short, the ETF now has 200 percent short interest. They may then lend the shares to another party, and so on.

Bogan’s particular concern with ETF short interest ties to one of the most important features of the ETF structure: the ability of large shareholders in the ETF to “redeem” shares back to the ETF issuer. If a large institution owns 50,000 shares of a fund like XRT, it can give them back to the ETF issuer and receive in exchange an equal value in the underlying stocks held in the ETF portfolio.

Bogan’s concern is that if even one-fifth of the people who bought XRT from short sellers redeem their shares, the ETF provider will be forced to hand out all the underlying securities in the fund. The fund will then be left holding nothing, and anyone who still has XRT in their portfolio will be left holding worthless paper.

It’s easy to see the concern. So easy, in fact, that the lawyers who designed ETFs put protections in place to guard against this situation. Those protections vary in detail but follow a similar form: When ETFs have high short interest, redeeming shareholders must prove they have clean, unencumbered ownership before a redemption is processed. This language exists in every prospectus I’ve looked at; the team at Bogan Associates either didn’t open a prospectus or was simply engaged in scare tactics.

The Kauffman report, published last week, took this mistaken concept and shoved it one tangled step further. Kauffman’s primary concern was that, during a market crisis, investors might place huge buy orders for an ETF, flooding it with cash. They suggested that the ETF issuer would then have to chase stocks, trying to put that cash to work. If the issuer couldn’t buy the shares, the ETF’s value would be in question.

Read the rest of this entry »

As much as I loathe anecdotal evidence, I was taken aback by the sheer insanity of the retailers this week before Thanksgiving weekend.

Yesterday, I ran a few errands, and it was fairly insane. Black Friday is a full 7 days away, and the parking lots were nothing short of madness.

All the usual caveats apply — NY/LI is not the rest of the country, I live on the tony North Shore, and the Americana (the Miracle Mile in Manhasset) is not representative of the typical retail shopper. (Get a load of the intro to their website, and the list of stores, its utterly absurd.

Barron’s cover story is on that exact subject: Off to the Mall.

Are people seeing a renaissance of shopping, or is this just so much more wishful thinking?

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click for larger cover

Three more lucky ducks join the hit parade, making this the record year of the crisis. (Charts courtesy of Ron Griess, The Chart Store)

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click for larger charts

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Alan Abelson has a few kind words in this week’s Up & Down Wall Street column.

“Barry Ritholtz of FusionIQ, who’s sparing in his praise of just about anything connected with Wall Street even though (or maybe because) he earns his daily bread analyzing markets and the economy, calls the rescue of GM and its IPO “the most successful bailout of the 2007-2010 era.”

Grumps like us might not view that as all that much praise, but, he explains, the new pared-down GM has clean books, is well capitalized, has been relieved of its crushing debt and enjoys less onerous payroll (employment is down to 209,000, from 324,000 six years ago), pension and health-care obligations (the union now picks up the tab for retirees’ health care).

Fair enough, but obviously the acid test for both the company and its new stockholders will be where GM goes from here. Don’t misunderstand our restrained response to the rapidity and extent of its revival. Back in the dark days of the Great Recession, we voiced our conviction that allowing the company to go up in smoke would cause unimaginable woe to an economy teetering on the edge of the abyss. So we’re only too happy to second Barry’s positive view of GM in its new incarnation.

Our wariness springs from the fact that this lame recovery is still notably fragile, the consumer still wary and pinched. And the things that make him so—the lack of jobs and the sorry condition of housing—stubbornly refuse to fade away. All of which stacks up as a rather formidable speed bump for GM and its fellow auto makers in the road ahead.

Keep in mind, the purpose of the GM complement was to point out how absurd the bank bailouts have been.

I have no real opinion on where GM’s stock goes, but I can firmly state that had the banks gone through the same process, they would be much healthier today than they are. So too would the entire US economy.

A quote in Abelson’s column, for some reason, never ceases to thrill me . . .

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Source:
Off the Scrap Heap
ALAN ABELSON
Barron’s NOVEMBER 20, 2010
http://online.barrons.com/article/SB50001424052970204076004575616694011909442.html

Watch the full episode. See more Mark Twain Prize.

The Economist asks: “Fifty years after the dawn of empirical financial economics, is anyone the wiser?”

My short answer: “Only the people who understand both the data and its limitations, and not get lost in the illusion of precision.”

Markets are driven by myriad factors, most of which are readily quantifiable. But the small number of inputs that do not lend themselves to easy modeling is how certain empiricists get themselves into trouble. They believe their models accurately account for the real world, when they do not.

One would imagine that the parade of Black Swan events that keep upending their models would convince these economists otherwise, but you would be surprised at how foolishly stubborn these folks are.

The EMH proponents, the VAR analysts, the “stocks for the long run” folks — the grim reality of their performance has not dissuaded them from their beliefs. This has Yale Professor Robert Shiller concerned:

“[Shiller] worries that academic departments are “creating idiot savants, who get a sense of authority from work that contains lots of data”. To have seen the financial crisis coming, he argues, it would have been better to “go back to old-fashioned readings of history, studying institutions and laws. We should have talked to grandpa.”

Shiller puts his finger on the right pressure point. The factors ignored by the quants were the underlying changes in laws and regulations. That allowed banks to run wild, something the pure quants were not prepared to detect and act upon. The radical deregulation of the past 3 decades was the equivalent of dark matter, undetectable by Newtonian physics — or quant trading funds.

Shiller describes many modern economists and market observers as idiot-savants; truth be told, when using that phrase he is only half right.

Here is the Economist:

IT ALL began with a phone call, from a banker at Merrill Lynch who wanted to know how investors in shares had performed relative to investors in other assets. I don’t know, but if you gave me $50,000 I could find out, replied Jim Lorie, a dean at the University of Chicago’s business school, in so many words. The banker, Louis Engel, soon agreed to stump up the cash, and more. The result, in 1960, was the launch of the university’s Centre for Research in Security Prices. Half a century later CRSP (pronounced “crisp”) data are everywhere. They provide the foundation of at least one-third of all empirical research in finance over the past 40 years, according to a presentation at a symposium held this month. They probably influenced much of the rest. Whether that is an entirely good thing has become a matter of debate among economists since the financial crisis.

It is an interesting article worth perusing . . .

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Source:
Data birth
Economist Nov 18th 2010
http://www.economist.com/node/17519706?story_id=17519706

Steve Winwood kicks off the ‘Can’t Find My Way Home’ Worldwide Cover Contest

The acoustic version of this is outstanding:

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UPDATE: Here is the contest winner:

(Thanks Pure-Water!)

Have a quick look at yesterday’s post: Wedbush: Cheap as a Fox.

There was a robust discussion in comments — and the general take that resonated with me was summed up thusly: Being judicious about expenses is one thing, but being ultra cheap can be counter-productive and myopic when you figure in the opportunity costs.

The truth of that statement made me recall an incident from earlier in my career, where I worked in the research department of a Sell Side firm. I was employed for a perfectly fine shop with a few billion under management and about 1,000 employees. The CEO was a nice guy, but a cheap sunuvabitch. He was formerly of Bear Stearns (from decades prior), where he must have caught that cheapness bug.

It manifested itself in all manners of counter-productive ways. There were lots of little monetary annoyances, and it affected their recruitment and retention of talent. Bonuses were insultingly punk — that’s why I ultimately left. Mind you, this was during a relative boom period, and not during a recession or crisis.

But here’s what I recall most about where being notoriously cheap hurt them: Like many Wall Street firms, they had an override system in place for recruiting. I brought in a new department — a sharp group of distressed asset buyers. They were wildly profitable for many years (though they did get hurt in the 2008 collapse).

Getting paid on it was always a headache — constantly a day late and a dollar short. “They aren’t profitible yet, the start up costs are big” was the common cry. All the other excuses were similarly annoying, but when senior execs were taking home millions, it was utterly unacceptable. I asked around the more senior guys, and the most common answer was SOP: Standard Operating Procedure.

The cheapness was almost a running gag — but it had a pernicious impact. When employees sense that the firm is not a two way street, that “favors” only run one way, it leaves an impression. The takeaway message was don’t bother recruiting, ’cause you won’t get paid on it.

Mind you, all of this was early in my ramp up in the media. Soon after this event occurred, I was getting lots of inquiries from many people who were either seeing me on Kudlow or hearing me on Bloomberg radio or reading quotes in the WSJ. Big institutional sales traders and RIA/Brokers — nice books, lots of AUM, large trailing 12s. (That’s street speak for big producers).

Whenever I got one of these inquiries, I could not have been nicer. I was nothing if not honest to a fault with the inquiries:

“Hey these are really nice guys but truth be told, they are super cheap motherfuckers. Terrific guys to have a beer with, but tight-assed as all shit. Money isn’t everything, and if you want a great home with nice guys, this is a great place. But I would be lying if I did not tell you the bonuses suck. I am happy to introduce you to them, but you can do much better comp-wise elsewhere. Do you know Joe XXXX at XXX ?“

I kept a running total of how many of them I simply sent elsewhere. Following the lack of payment on the departmental recruitment, I tracked about $25M in gross annual revenues that had reached out to me. We would never have signed all of them, but even a fraction of that was a lot of revenue. I got no money for steering this cash flow to other firms that paid nice bonuses. I’m sure the new hire and his boss must have thought ‘I was swell,’ but that was not my motivation. I was going to be damned if I was going to generate one excess dollar in revenue for the owners and not get compensated for it.

The crap bonus during our biggest year ever was the last straw. Truth be told, that was the beginning of the end — and I couldn’t bring new guys in if in my mind I knew had a foot out the door. I left the first day in January, and never looked back.

This one comment summed it up:

“Being in the tech industry, I am of the view that the “cheap as a fox” approach to running a company is ultimately inferior to providing your workers with the proper tools and resources they need to perform at a high level. I’ve found that people/companies who have a cheap approach towards infrastructure/operating expenses also tend to be cheap when it comes to acquiring the best people, which in technology (and I suspect in other fields), is ultimately a losing game.”

Its hard to find fault in that analysis.

But I wonder: How many employees behave similarly? How much money is management leaving on the table because of how cheap they are with their employees? Not just new talent, but new ideas, costs savings, innovations, new business lines? I am an unusually vindictive prick, or is that pretty normal human response?

I wonder how many start ups have been formed because people said “Up yours” to their former employers?

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UPDATE  November 20, 2010 4:52pm

Postscript: One of the people who traded with this division as a counter-party emails me:

Hey B

Do you recall the conversation we had at Bobby Vans about XXXXXX and his group back in 2006? You laid out for me why they were going to blow up — too much leverage, too much RMBS exposure too much structured junk. You scared me out of some of my positions, and for a few months, I cursed you for it (then I had the best P&L on the desk for a year).

I asked you if you were going to warn XXXXX about the group’s exposure, and I recall your exact words: “I never got paid one dollar on this group or any of their transactions, so my ex-firm and I have no fiduciary relationship about this. That is lawyer speak for ‘They can go fuck themselves.’ ”

I still trade with them occasionally. In case you don’t know, the group left the firm some time ago, after racking up 100s of millions in losses. I would wager they gave back the past decade’s profits and then some.

It cost them a whole lot more than mere missed commissions and assets. It definitely left a mark.

-snip-

Heh heh — that quote does sound like me

A little Karma goes a long way  . . .