Snarky Behavior

Joe the Plumber(s)

October 20, 2008 · Leave a Comment

l this talk about small business and income above $250,000 got me thinking… hey, I used to work for a small business. I wonder how the Presidential candidates’ respective tax plans would effect them?

I realized though, that there really is no “Joe the Plumber” at my old firm.  Before she passed away, the CEO established an “Employee Stock Ownership Plan,” (ESOP) devolving her ownership to the employees.  Individually, the employees should be able to make tax-exempt “contributions” (i.e. purchase shares of stock) without any changes… this policy should remain untouched regardless of who becomes President.

In terms of the firm, and somebody should definitely check me on this, my understanding is that there are significant tax deductions to be had on pre-tax contributions to the fund.  Additionally, both Obama and McCain are proposing to eliminate capital gains taxes on small businesses, so any realized gains in the value of the shares currently held by the firm would also be exempt from taxation.

What about the $250,000 threshold?  Again, I should be checked on this, but my understanding of tax burdens and incentives is that because there are tax-deductions for pre-tax contributions to the ESOP, it would make sense for the firm to pay dividends on the Net Operating Profit (NOP) up to that threshold.  The company is essentially paying down a leveraged loan used to buy-out the previous owner, and both the interest and principal are tax-deductible.  (Lots of deductions here going on here).  So, depending on the structure of the businessess, that seems like an appropriate amount of money to carry forward year-over-year.

So basically, my understanding is that the “Joe the Plumber” model does not apply.  It would if there were a single owner who received all of the after-tax earnings, but since the company is employee-owned, if anything, the Obama tax-plan seems like a better alternative because it encourages the firm to pay-out dividends below the $250,000 threshold.

Note:  I am nowhere near 100% confident this interpretation is correct.

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Self-Reflexivity

October 15, 2008 · 4 Comments

Without getting too specific here, since God knows who reads this:

As a teaching assistant for my stats class, I have been responsible for administering a weekly computer lab.  The professor for the class gives me the assignment, tells me what his expectations are, and sets me free to drop knowledge to a room full of about 25 students.

Again, without getting too specific, I have faced considerable challenges in how to best utilize these two hours.  There are constraints in terms of instructions, objective, pacing, differentiation, skill-level, attention, patience, technology… you name it, I face it.

AGAIN, without getting too specific, I have done my best to organize those two hours in a way that best serves the needs of ALL of the students.  I don’t want anyone leaving lab without having done the exercise, so that’s priority #1.  People work at their own paces based on their tech-level, so I’ve strategized to create step-by-step power-points on how to use the data-analysis program, and helped people on an individual level as they encountered problems.

Some students are very frustrated with a “learning-by-doing” approach because they’re not entirely sure whether their outcomes are correct or not, since I haven’t provided an examplar or group hand-holding session.  Today I listened to them explain their frustrations with my approach, and I could certainly understand their perspective.  I tried to be diplomatic without over-sharing the considerable constraints I felt I faced, just as I’m trying to be diplomatic now as I write this.

Some students were more… constructive… in their feedback than were others.  Other students seemed to complain out of a sense of entitlement; that whatever approach I was using didn’t meet their expectations for learning objectives.  And they weren’t interested in my theory that data analysis programs are hard, and part of the learning of the program is the struggling with it.  “We pay a lot of money to learn, not to struggle,” was the quote I believe.

Obviously I felt some of the criticism was…unjustified… given my constraints, objectives and perspective.  But it made me very self-reflexive.  The students who were particularly harsh demonstrated no empathy for my perspective.  They were critical for the sake of being critical.  I feel as if there were no circumstances under which they would not find something to complain about.

And I’m like this a lot of the time.  A lot of people are like this a lot of the time.

It’s really easy to complain about what’s wrong.  It’s harder to understand why things might be wrong.  It’s hardest to figure out how you can change things.  And it’s damn near impossible to apply this kind of systematic, analytical reasoning in a relatively reasonable time frame.

Step 1 (Anger):  Things are Bad –> Step 2 (Empathy and Understanding):  Why are they Bad?  –> Step 3 (Analysis):  How can I change the things that make things Bad?

Most people are perpetually stuck on Step 1.

Only managers understand Step 2.

I’m voting for Barack Obama because he gets step 3, and he can do this kind of thinking on the spot, all the time.

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Pessimistic

October 10, 2008 · Leave a Comment

The more I read about this crisis, the more pessimistic I become.  The amount of credit defaults swaps out there is just mind-boggingly ridiculous… an estimated $62 trillion dollars.

The 2008 estimated global GDP is only $65 trillion.

That means we have insurance policies out there looking to collect when various banks and other institutions fail for 95% of our global economy.

I don’t really know enough about this to comment anything meaningful, but it seems really quite scary.  You just can’t pay out on policies when everyone is effected.  That’s not how risk-management works.

It’s like the whole world is flooded, and everyone wants to collect on their flood insurance.

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Palin and the Polls

October 3, 2008 · Leave a Comment

I’m in Iowa at my parents house, and watched the VP debate with my Stepmom.  We watched on Fox News and I was yelling at the television the entire time, incredibly flustered with Palin’s refusal to a.) answer questions and b.) offer specifics.

Most of all though, I was flustered to see how well she was performing.  After watching her interviews with Katie Couric, I was expecting her to get trounced.  Not being able to name a single Supreme Court decision besides Roe v. Wade?  Not being able to recall the name of another US Vice President in history?  Why wasn’t the moderator pressing her on her answers?  Where were the follow-ups?

After the debate, I conceded that Palin “won,” in the sense that she won the expectations game.  The guys on Fox (Kristol, et al.) were creaming their trousers over it.  I complained (loudly) to my Step Mom that a.) these men had no, zero, zilch respect for Sarah Palin (the soft bigotry of low expectations) and that b.) identity politics is going to destroy our democracy in the long run, and it’s hard to be sympathetic to mid-to-low class Americans when things go badly if these are the leaders they’re going to vote for.

But I was INCREDIBLY heartened to see the polls amongst undecideds indicating that Biden had indeed “won” the debate, even though Palin was more “likable.”  It reminded me that even though Palin was the more impressive orator, Biden had the more impressive argument, and in the end, that’s what people cared more about.

It’s good to know that in the aggregate, good ideas triumph over bad ones, and sound sense triumphs over cockamamie.

It’s also important to remember that if/when Obama wins this thing, the educated class doesn’t celebrate this as a triumph of elitists/educated class over philistines/working-class, but simply GOOD IDEAS over BAD ONES.

Remember, in an information age, the logical end of the Republican party is near.  You can’t sustain yourselves on lies.

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Newt Gingrich is an Idiot

October 2, 2008 · Leave a Comment

I haven’t had a chance to follow the back and forth arguments going around right now about possible reforms for this financial crisis, but I can tell you with near certainty that Newt Gingrich’s proposal to suspend mark-to-market accounting practices is just about the dumbest thing I’ve ever heard.

I’m going to really over simplify this for “Dropping Knowledge” purposes:

In accounting, every company is required to file a “balance sheet” to show that its business is in good order.  It’s called a balance sheet because your assets should ALWAYS equal your liabilities.  Any difference between your assets and your liabilities is covered by shareholders (called owner’s equity).

ASSETS = LIABILITIES + OWNER’S EQUITY

If the value of your assets increase over the value of your liabilities, the value of each owner’s share of the company increases correspondingly.

↑ASSETS = LIABILITIES + OWNER’S EQUITY

If your liabilities are greater than your assets, you need to raise more capital by issuing more shares, decreasing the value of each share.

↓ASSETS = LIABILITIES + ↓OWNER’S EQUITY

The overall value of a company — or it’s “market capitalization” — can be calculated by multiplying all of the shares owned (shares outstanding) by the MARKET DETERMINED PRICE PER SHARE.

MARKET CAP = #SHARES OUTSTANDING x PRICE PER SHARE

If the market thinks you stink, the value of your company drops.  It’s pretty simple.

Right now, everybody knows the value of the liabilities.  That’s indisputable.  You owe what you owe.  But nobody knows the value of the assets; or, put more accurately, they know the value depends on the ability of of the underlying mortgages to be paid off.

For the last 18 months, companies have been busy “writing off” losses… basically devaluing their stated assets, so that their balance sheets actually balance.  Every time they recognize a loss, the perceived value of the company falls, the stock value drops, as does the market cap– the owner’s equity and asset values drops in correspondence with one another.

Now, financial institutions require capital to perform day-to-day operations.  Right now, because banks don’t know the value of their assets, they can’t sell them, and they can’t value the assets (or themselves) as a result.  Investors won’t invest, because they don’t believe the write-offs have finished.  And nobody will lend to them, because they’re worried the bank will go under at any moment.  The rating agencies downgrade their credit worthiness, and the cycle exacerbates.

Newt Gingrich says these liquidity issues rest at the feet of accounting practices requiring the banks to “mark” the price of their assets to their “market” value.  If only they could mark to “economic value”… or historical cost, they lending would continue and the crisis of “chasing a rabbit down the hill” could be averted.

Well, let me put it to you this way, Newt:

If I’m a chicken farmer, and all of my chickens die, I’m out inventory.  Nobody wants to buy my dead chickens.  My company isn’t going to become any more valuable if I’m suddenly allowed to mark my dead chickens at their historical price.

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“Not I,” said the leadership

September 30, 2008 · 2 Comments

There are two basic children’s stories of ideological propaganda that defined the Cold War:

The first is the Communist tale of “The Ant and the Grasshopper.” While perhaps not a great fit with Communist values, the moral of the story is “it is best to prepare for times of necessity,” and the preparations are made by a colony doing equal work to ensure equal provisions.

The second is the Capitalist tale of “The Little Red Hen.” This story highlights the behaviorial economics of the free-rider problem; that is, nobody is willing to exert personal effort that exceeds their derived benefit from that effort, even if collectively, everybody is better off.

Well, right now we have a crisis that requires collective effort to address.  The market fell off 700 points yesterday, and that’s not even a sound indicator of how bad things are due to the SEC ban on short-selling.  The lending markets are absolutely frozen, because we have ZERO political leadership willing to do what’s necessary.

Who will lead this bail-out?

–”Not I,” said the President, who refused to use the bully-pulpit to twist the arms of the House Republicans.  “I’m already unpopular as it is.  I don’t want to do any more damage to the party.”

–”Not I,” said John McCain, who refused to rally his party around a bipartisan effort.  “I don’t really understand the issue, and I’ve staked too much politically on being perceived as decisivie on the politically popular side of this issue, whatever it may end up being.”

–”Not I,” said Barack Obama, who was gaining popularity as the economy tanked.  “I don’t want to introduce presidential politics into delicate negotiations.  This needs to be bi-partisan so we share the political fall-out.  Otherwise I’m staying arms-length away.”

–”Not I,” said the House Republicans, who were getting angry calls about bailing out Wall Street.  “My constituents vote on emotion — we’ve cultivated them that way.  And right now, they’re angry.  I’m not sticking my neck out any further with this administration… I don’t care what the long-term consequences may be.  Let’s wait until after the election.”

–”Not I,” said Nancy Peloisi.  “The Republicans double-crossed us.  After all the concessions we made on a bill we didn’t want, they promised the votes, and didn’t deliver.  I’m not letting our party take ownership on this… it’s way too unpopular.”

So who’s going to be the Little Red Hen here?  Who’s going to say, “Then I’ll do it”?

Isn’t that what leadership is supposed to be?  Or is our politically system that handicapped?

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For My Dad

September 30, 2008 · 3 Comments

My dad (AJ) is a regular reader of my blog now, which is pretty cool.  From what I can tell of all of his high school/college/post-college photos, I’m pretty much on the track of looking exactly like him some day.

He’s had a mustache for as long as I’ve been alive.  I think it’s kind of weird, since he’s not a policeman or anything. I mean, wouldn’t you want to shake things up once in awhile?  Grow a beard or something?  I mean, even Alex Trabek eventually shaved the trademark ’stache.

Anyway, I grew/shaved a mustache today to spot-check my progress.  I think I look too silly when I smile.

Me and Dad

Me and Dad

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Did McCain Grandstand to Crowd Out Palin?

September 25, 2008 · Leave a Comment

That’s the rumor. If you watch Palin with Couric, she was God awful:

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Overheard in the Bronx

September 25, 2008 · Leave a Comment

On my walk home, near Fordham Center, I passed by a group of black men in white robes, “preaching” into a microphone:

[Preacher #1]:  The Bible says that God loves only the chosen people, the Israelites.  The Bible don’t say nothin’ ’bout him lovin’ no other nations!  He don’t love anyone from China!  He don’t love anyone from Japan!  He don’t love anyone from the White Man’s land!

[Preacher #2]:  He values those people as nothin’!  He values them at less than nothin’!  It’s all right here in the Bible!  [Proceeds to read a Psalm].

I walk past.

[Preacher #1]:  The White Man think the Bible is talkin’ ’bout him!  But God only loves the chosen people, the Israelites!  And who are the Israelites?  The twelve tribes!  And there ain’t no White tribe!  There is the so called “Negro” tribe, the Puerto Rican tribe, the Dominican tribe, the Mexican tribe…” there ain’t no tribe for Arabs!  There ain’t no tribe for Asians!  There ain’t no tribe for the White Man!

…you learn something new everyday!

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Dropping Knowledge: Financial Crisis

September 23, 2008 · 2 Comments

I’ve had a few requests for a “Dropping Knowledge” post so I’d like to share my understanding of “Black September” vis a vis my class on International Capital Markets.

A lot of the conversations you read about the crisis pick up at a point where you really need some fundamental background knowledge to understand what’s going on, so I’ll start from the beginning:

Have you ever heard someone say that financial markets “exist to efficiently allocate capital?”  Well that’s true… some people and entities have immediate needs for money (we’ll call them borrowers), and other people and entities have excess savings which they’d like to invest to earn a return (we’ll call them investors).

Borrowers look to borrow a lump sum of money up front in return for the promise to pay installments over the long-haul (basically an IOU, or “receivable”).  The IOU carries with it a small fee – an interest rate – for which the borrower agrees to pay over-time in exchange for the lump-sum up front.  The interest rate is determined by many things, the most important of which is determined by the borrower’s perceived ability to pay back the installments (or credit risk).  The higher the borrower’s credit risk, the higher the interest rate offered to them will be.  Obviously, the borrower would prefer to pay the lowest interest rate available to her.

On the flip side, Investors are looking to lend their money and capture the highest “return” on each dollar they lend.  Investors have a lot of opportunities available to them in terms of how they lend their money (to companies in the forms of equity/stocks, to individuals or groups of individuals, to government), but they typically have a preference for the highest available return at the lowest available risk of losing their investment.

Investment banks exist to find and research investment opportunities (i.e. finding borrowers in need of money, such as start-up companies, municipal governments installing a light-rail system, firms expanding their productive enterprise– “The Buy Side”), packing them up in some form (stock, bonds and securities), and selling them to investors (”The Sell Side”).  They make a hefty commission on this, because it involves a lot of work, and long hours.  In a global economy, money never sleeps! (i.e. there’s always an overnight demand for money or liquidity, and investors typically give their money over to managers to put it to use at all times).

Investment banks compete with each other in terms of the price and quality of the investment opportunities they make available to their customers.  Some investment banks (like JPMorgan, Bank of America) are also commerical deposit banks, meaning they have a broad deposit base from people like you and me who have checking and savings accounts with small amounts of money in them.  Other investment banks (like Lehman Brothers and Goldman Sachs) are “stand-alone,” meaning their only deposit base (i.e. “cash on hand”) comes from private investors (personal equity) and fund-managers (mutual, pension, hedge, or otherwise).

One of the many “packages” investment banks sell to investors are called securities.  Securities basically take a bunch (say 100 or so) of the individual IOUs from borrowers and package them together into a single “vehicle.”  The intuition behind a security is that it pools the risk of default of each individual IOU, so that collectively, the “vehicle”  has an overall expected return and performs with low rates of volatility.  That is, if a few people can’t pay back the IOU, that’s still OK, as long as everyone else still pays on time.

In terms of the current crisis, you had a situation where the IOUs “backing” these securities were American home mortgages.  People were borrowing money from small banks or places like CountryWide in exchange for IOUs to pay back both principal and interest over a period of 30 years or so.  Historically, preferred individual borrowers (i.e. people with good to great credit ratings) could borrow from banks at an interest rate called “Prime.”  The prime-rate is typically set variably 3% above the rate at which the banks themselves lend to each other over-night (the federal funds rate).  People with poor to fair credit ratings were required to pay “prime plus” some percentage amount, and also to place a large down-payment as collateral against their mortgage loan to off-set their risk of default.

Now, in the late 1990s and early 2000s, the American housing-market was booming; especially in places like Florida, Michigan, California and Arizona.  The boom was partly driven by consumer demand, but it was also driven by inflated prices caused by loose lending practices.

You see, as investment banks diversified their securities, they found that the mortgage-backed security “vehicles” were performing at a very attractive rate with an extremely low risk of default.  In fact, the agencies responsible for rating the risk of securities had given these vehicles AAA-ratings, which in financial terms means “money good” or “just as safe as a US treasury-note.”  Every investor wanted these security assets as a fundamental part of their investment portfolio.  And investment banks were buying individual mortgages off of the Country Wides of the world like crazy, so that they could turn around, package them up and sell them off to meet investor demand.  At a VERY handsome profit, by the way.

(Side note:  it is at this point where AIG becomes involved.  AIG agreed to insure each one of these assets at a tiny, tiny premium.  They were, after-all, rated AAA.  That’s how a company with market value of $150 billion drops to $5 billion in the span of a year).

(Second side note:  This is where the shit really hits the fan.  Once the institutional investors (i.e. banks, funds, etc.) realized how well these investments were performing, they started borrowing money themselves in order to purchase the securities, and at astonishing rates.  Some funds were “leveraged” at ratios as high as 30:1, meaning for every $30 borrowed, they only had $1 on hand to back it up.  This creates a dangerous situation of musical chairs… once the music stops, the scientific term is “absolute shit storm.”)

Meanwhile, the Country Wides and other small banks were in a bind:  as intermediaries, they could not possibly find traditional mortgages fast enough to sell on to the Investment Banks.  But the Investment Banks were telling them “risk is fine.  We’ll diversify (i.e. pool and mix) the risk.  You just get us the mortages.”

And so the banks started to loosen up their lending practices.  Prime rate went out the window (enter: Sub-Prime lending).  Mortgages were offered without down-payment.  Then without proof of any assets.  Then without any proof of any job or income (NINJA loans – No Income No Job or Assets). When you offer to lend money to someone without running a credit check or requiring them to have any equity-stake whatsover in their home… you can pretty much guarantee that their risk of default is 100%, no matter how low you make the interest payment.

Simply put:  banks preditorily lent money to people to purchase homes that they could not afford.

Why would they do this?  Why would anyone with any sense take an investors money and give it to a borrower, when they knew with near-certainty that the borrower would/could never afford the payments?

Well, for one thing, they were relying on “finely tuned instruments” to monitor the performance of the securities.  Even when some people defaulted, the banks assumed the asset of the house, and could turn around and sell it at the current market price, for a profit.  It was win-win.

Until it became lose-lose, around August 2007.  Times thirty.

Once the housing market bubble bursts, those security vehicles stop performing so well.  And it’s a downward cycle (hence:  “toxic” assets).  If someone defaults on their mortgage, the bank now has to assume and sell the home.  If the bottom of the housing market has fallen out, the banks sells the home for a HUGE loss (which translates to a small drop in the value of the asset it is partially-backing).  Suddenly the supply of available housing vastly exceeds demand.  Everyone is trying to get out of the house they couldn’t afford in the first place.  Consumer spending drops, because everyone’s trying to pay down their house.  The economy tanks.  People get laid off, and can’t afford to pay their mortgages.  And the cycle exacerbates.

The thing is, on Wall Street, nearly everybody has these assets on their books.  As the value of these assets drop, so do the value of their companies, and so does the value of their stock.  Investors see where the economy is headed, and so they withdraw their funds, or stop buying the securities the Investment Banks are trying to sell (er… get rid of).  Who’s going to buy toxic assets?  Nobody knows the values of these assets. There is literally no market for them.  Lehman Brothers, Bear Sterns and Merryl Lynch were scrambling to get rid of them, but they finally had to admit that they just couldn’t do it.  The money was gone.  The wealth was destroyed.

Well, scratch that last part.  Part of the wealth COULD be recouped, but it would require financial backing from someone bigger than Lehman Brothers or Bear Stearns.  In fact, it would require the financial backing of the US Treasury.  If the US taxpayers buy the assets from these companies, then the banks have the required liquidity to perform their normal operations, without having to worry about the perfomance of the toxic assets.  Now they have a fixed interest rate to pay-back the Treasury, which is easier to manage around.

Bernake’s hope is that over-time, that the $700 billion dollars “worth” (I use that word in quotations since nobody knows the “worth” of the assets due to the absence of a market) will be a wise investment.  How?  Well, if the underlying mortgages start getting paid off (i.e. the housing market swings back upward)… that’s how.  The stronger our economy performs in terms of quality job and wealth creation, the greater the return on those assets.

Of course, there’s just as large of a risk that those assets severely underperform, and our economy goes into a recession, if not a depression.  And then as tax-payers, we’re out $700 billion.

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