Big Bang, Followed by Broken Glass

Determined to attract masters of the financial universe to London, in the 1980s Margaret Thatcher's Britain unleashed financial markets in what was called the Big Bang. In 1999 the U.S. responded by scrapping provisions of the Glass-Steagall Act that prohibited banks, brokers, investment bankers and insurance companies from cohabiting in the same holding company.

The rest is misery.

Now, reports FT.com, London's Big Bangers think they might need to enact something like … Glass Steagall.

If bond salespeople and brokers should once again be banned from commercial banks here and abroad, could bank investment advisory services make a comeback?

Astor Son's Trial Begins (Finally!)

The trial of Anthony Marshall, accused of looting assets of his mother, Brooke Astor, and fiddling with her will, finally began today, The Times (London) reports.

The trial is expected to last six months and involve some 60 witnesses, including Henry Kissinger. The mainstream media may have a profitable summer after all.

We should have seen it coming . . .

. . . suggests Robert Shiller, in a remembrance of a presentation delivered by Lawrence Summers back in 1989. Summers rather presciently outlined the market psychology that would lead to a bubble, then a crash. He didn't get the date right—he posited 1991—but much of the rest is impressive.

Shiller says we have to take this psychology into account when creating solutions, but he doesn't say what that means. Based upon today's stock market, I'm guessing that having the President decide who will head a car company is not the answer.

Should Fiduciaries Be Cost Conscious?

Like trust officers, writes Jason Zweig in Who Will Guard Your Nest Egg? investment advisers are expected to act out of "fiduciary duty" and put their clients' interests ahead of their own.

Always? Within asset classes, much of the variation in returns seems to relate to expenses:

Let's say you tell your broker that you want to simplify your stock portfolio into an index fund. He then tells you that his firm manages an S&P-500 Index fund that is "suitable' for you. He is under no obligation to tell you that the annual expenses that his firm charges on the fund are 10 times higher than an essentially identical fund from Vanguard. An adviser acting under fiduciary duty would have to disclose the conflict of interest and tell you that cheaper alternatives are available.

Where could this line of thought lead? Are trustees of 401k plans breaching their fiduciary duty if they allow a high-cost insurance or brokerage firm to handle the participants' investments?

•

Be sure to appreciate the Heath Hinegardner illustration, reproduced below, that accompanies Zweig's column. For more of Hinegardner's conceptual illustrations, see his admirable web gallery, TrustHeath.

And now for something completely different

I find this interesting:



It's today's sun. What's interesting is that there are no sunspots. As you may know, the number of sunspots rises and falls on a very regular 11-year cycle. We should have been getting more sunspots last year, but we didn't. NASA reports that its been almost 100 years since the sun has been so spotless, and 2008 was already the most spotless year of the space age.

Two years of spotlessness. So what?

Here's a graph of climate change from a post at PowerLine:




Note the "Little Ice Age" of the 1600s. It coincides with something called the Maunder Minimum, an extended period when, for unexplained reasons, there were no sunspots. We could be entering a new Little Ice Age, based upon the sun's current inactivity. However, scientists are still debating that relationship—the Little Ice Age started before and ended after the Maunder Minimum, but the minimum was its coldest part.

If it seems like the winters are getting colder, it may not be your imagination. Can we hold off on that new carbon tax until we get more data?

Bears Who Buy (Derivatives, That Is)

Andy Kessler's op-ed in The Wall Street Journal adds to my store of knowledge I wish I didn't have to acquire.

You can't just manipulate a $62 trillion market for derivatives. So what did the bears do? They looked and found an asymmetry to exploit in those same credit default swaps. If you bid up the price of swaps, because markets are all linked, the higher likelihood (or at least the perception based on swap prices) of derivative defaults would cause the value of these CDO derivatives* to drop, thus triggering banks and financial companies to write off losses and their stocks to plummet.

General Electric CEO Jeff Immelt famously complained that "by spending 25 million bucks in a handful of transactions in an unregulated market" traders in credit default swaps could tank major companies. "I just don't think we should treat credit default swaps as like the Delphic Oracle of any kind," he continued. "It's the most easily manipulated and broadly manipulated market that there is."

*CDOs are derivatives consisting of packages of debts derived from mortgage loans, commercial loans, etc. So we're dealing with derivatives of derivatives of derivatives? I'm too old for this!

The New Mass Affluent

What's that, bro? The over $5 million in investable assets you were so proud of has shrunk to a bit under $3 million? Welcome to the world of the mass affluent, as defined by Bank of America.

Those mere millionaires we mentioned recently really are moving down-market.

The Real Billionaires

Mere millionaires – those with a seven-figure net worth – are less plentiful but still don't feel rich. For the truly deluxe life, one needs a seven-figure income. (Ask any large-cap CEO.)

Is the disparity as great at the ten-figure level? Do mere billionaires envy James Simon, John Paulson, John Arnold and George Soros? That foursome of hedge fund managers, The New York Times reports, enjoyed ten-figure earnings last year.

Lets hope institutions that lost billions take the hedgers' windfalls philosophically. As Gertrude Stein observed, "Money is always there, but the pockets change."

Our “Reset” Economy

GE's Jeffrey Immelt may be no Warren Buffet when it comes to letters to shareholders, but he and his writers do better than most. Excerpts from his current letter:

We are in a recession and, at times like these, it is difficult to predict how bad and for how long. We are running GE to “weather the cycle.” However, I believe we are going through more than a cycle. The global economy, and capitalism, will be “reset” in several important ways.

The interaction between government and business will change forever. In a reset economy, the government will be a regulator; and also an industry policy champion, a financier, and a key partner.

The financial industry will radically restructure. There will be less leverage, fewer competitors, and a fundamental repricing of risk. It will remain an important industry, just different.

There are other resets as well: the diminished role of the automotive industry; a prolonged downturn in housing; a decline in the prominence of alternative investments; and the nature of executive responsibility and compensation.

• • •

I run a global company, but I am a citizen of the U.S. I believe that a popular, thirty-year notion that the U.S. can evolve from being a technology and manufacturing leader to a service leader is just wrong. In the end, this philosophy transformed the financial services industry from one that supported commerce to a complex trading market that operated outside the economy. Real engineering was traded for financial engineering. In the end, our businesses, our government, and many local leaders lost sight of what makes a nation great: a passion for innovation.

To this end, we need an educational system that inspires hard work, discipline, and creative thinking. The ability to innovate must be valued again.

Let's put the budget debate in context

It was only 8 months ago (seems longer, I know) when the Congressional Budget Office confidently predicted that the bank bailout would cost $25 billion.

Here's what the CBO says now about the future budget deficits:



Keep in mind, these are based upon the rosy scenario that we return to nearly 3% annual GDP growth.

Wow.

ADDED: Martin Sullivan, who writes analyses for Tax Notes, is no right-winger. He suggests that March 20, the day the CBO analysis was released, is the official end of the Obama honeymoon (link requires subscription). He concludes:

When we are talking about stimulus spending, even most Republicans will give the administration a pass on large deficits. But it is an entirely different story when it comes to spending after the recession. It is the consensus view -- and it was the administration's view -- that extra efforts for deficit reduction were required after the recession was over.

Now that the CBO has let the cat out of the bag, the president -- if he is going to lead -- must be explicit about how he plans to balance the trade-off between fiscal sustainability and his plans for long-term spending. He cannot simply dismiss the CBO numbers and hope they are wrong.

The other side of the A.I.G. bonus story

This resignation letter should be read by everyone. Kudos to the NYTimes for publishing it.

Born to Behave Badly?

What the leaders of American finance lack in risk-management skills, they seem to make up for in their ability to infuriate the American public. Today's example, from The American Banker:

Despite the Federal Reserve Board's latest attempts to stimulate the housing market, home lenders are keeping rates artificially high to control the volume of refinancing ...

Are large financial institutions of all stripes doomed to a decade of scorn, mistrust and populist regulation? If so, could community banks and small investment-advisory firms reap benefits?

Revenge of the Madoff Victims

In The New Yorker, Woody Allen imagines two Madoff victims who lose their lives after losing their money and return reincarnated as…lobsters!

The pair are captured and end up tanked in a New York restaurant. Who walks in and selects the pair for his dinner? Madoff, of course:

Moscowitz and Silverman, their ire reaching cosmic dimensions, rocked the tank to and fro until it toppled off its table, smashing its glass walls and flooding the hexagonal-tile floor. Heads turned as the alarmed captain looked on in stunned disbelief. Bent on vengeance, the two lobsters scuttled swiftly after Madoff. They reached his table in an instant, and Silverman went for his ankle. Moscowitz, summoning the strength of a madman, leaped from the floor and with one giant pincer took firm hold of Madoff’s nose.

We have about a dozen lobster boats in the harbor at the moment. How cool to think one of them sent Moscowitz and Silverman on their mission.

David Swensen and the Yale Model

David Swenson, manager of the Yale endowment, is probably one of JLM's favorite investment managers—here's a recent example. Now Conde Nast Portfolio has run an interesting profile of Swenson, and a discussion of what happens when all the endowments try to simultaneously follow the Swenson investment philosophy—you get today's market meltdowns, for example.

It has long been observed that if one had the magic secret to investment success, sharing the secret publicly would necessarily destroy the magic, as everyone tried to follow the formula. The article hints that Swenson deliberately did not follow his own rules, he deliberately built a cash reserve, which he is now going to use to buy up assets from other endowments being unloaded at distress prices.

Perhaps his sharing of his brand of investment magic, which seemed to be against his own self interest, was Swenson's way of legally manipulating the markets?

When the Yale endowment reach $10 billion, Nobel laureate James Tobin wrote a limerick for Swenson called “Son of Sven”:

A young Viking, a badger called Dave
Determined poor Eli to save
First he’d be
A PhD
And then make those markets behave.

One can't argue with success.

Jonathan Clements is doing well

JLM and I always enjoyed the personal finance writing of Jonathan Clements in The Wall Street Journal. About a year ago he jumped to Citibank, as JLM reported. What's that job pay? More than $250,000, so Clements reports he will be hit by the 90% tax on bonuses.

Clements points out that many people with salaries way below the cap could be hit by the 90% tax based upon a spouse's income, or investment earnings. Good point. He also says that some people defer much of their bonus into a 401(k) plan, and that has already happened for the January payments (which would be hit by the new tax). Apparently the 401(k) tax deferral does not extend to this 90% bonus tax. Wow. So those people will be required to come up with 90% of their deferral to keep the 401(k) contribution, or ask for a premature distribution. Super idea!

The Clements plan for avoiding the problem is to take an unpaid sabbatical, beginning about October, to keep his non-bonus income below the magic $250,000 level. He'll have to curtail spending to make this work. As he says, good for him, not so good for the economy.

I suspect cooler heads will prevail this week.

Another look at J. P. Morgan

Last October JLM blogged about a piece on J. P. Morgan's role in quelling the panic of 1907, written by Jean Strouse and published in the Washington Post. Strouse has another piece in today's New York Times, jumping off from Warren Buffett's observation that the economy has fallen off a cliff.

Somehow the story of Morgan's nerve never gets old. I had to chuckle when I read the following:

His power in 1907 derived not from the size of his own fortune but from the trust placed in him by investors, other bankers and international statesman. After Morgan died in 1913, the newspapers reported his net worth as about $80 million — roughly $1.7 billion in today’s dollars. John D. Rockefeller, already worth a billion in 1913 dollars, is said to have read the figure, shaken his head, and remarked, “And to think he wasn’t even a rich man.”

Patriotic Moments in Bank Brokerage

Wachovia ordered to pay $1M for demoting reservist:

... Michael Serricchio, 35, was a financial adviser for Prudential Securities in Stamford when he became one of the first National Guard members and reservists activated after the terrorist attacks. Wachovia acquired Prudential's brokerage division before Serricchio returned in 2003.***

Wachovia offered him a reduced position four months after he returned and told him he would have to rebuild his client base, which a jury determined in June violated a rule requiring employers to maintain positions for serviceman called away on active duty.

Judge Janet Bond Arterton of U.S. District Court in New Haven ruled Serricchio should receive about $800,000 in back pay, interest and damages. Wachovia also must pay Serricchio's court costs and fees, which his attorneys estimated to be more than $500,000.

"Even after the jury ruled in our favor, Wachovia took the position that they didn't do anything wrong, that they didn't owe him a penny in back pay," said Serricchio's attorney, David Golub.

"We are considering our options, including a possible appeal," said a Wachovia spokesman.

The Next Successful Wealth Managers

In his Wealth Report, Robert Frank comments on estimates that $1 trillion in investment wealth moved out of banks (broadly speaking) that disappointed their clients or simply died.

In whose hands will much of this investable wealth end up, assuming it doesn't stay in home safes?

[T]he real question isn’t so much who gets the money but who gets the business model. The wealth-management industry is in turmoil as it tries to figure out how to win back client trust and guide them through a drastically different investment landscape–one in which municipal bonds are the new hedge funds.***

The winners will be the firms that are committed to independent advice, deliver on the services they promise and (this is the most important) actually understand the products they are selling to their clients.

That "most important" requirement is interesting. It can be met in two ways.

1. The David Swensen way: Yale's endowment seems to have flourished (until the current fiscal year) thanks to rigorous, sophisticated analysis of varied and complex asset classes and those who manage such assets. If you have the brains, the team and the resources needed to understand almost any investment, you can invest in almost anything.

2. The Warren Buffett way: He missed the tech boom of the 1990s because he didn't understand tech and didn't want to try. He also missed the dot.com bust. If you limit your choices to investments you can understand, you're not blindsided by investments you didn't understand.

Will both models coexist? Which will prove sexier to market?

AIG: Unintended Consequences

A giant insurance company decides to go into a new form of "insurance" that requires no reserves of capital, gets burned, then contracts with several hundred employees to pay them retention bonuses if they will stick around to clean up the mess.

Who could have guessed that this chain of events would boost the local economy in and around Fairfield County, Connecticut? More demand for bodyguards…security services…alarm systems!

Yet that is the likely result, judging from this New York Times story. Death threats and vicious condemnation by locals are being rained upon the hapless AIG threesome we previously mentioned, as well as others. If the names of recipients of bonus bounty at Merrill Lynch are publicized, the Times notes, they too may need to up their security spending.

A financial headline this morning indicated that a certain firm was revamping its platforms, hoping to resume full production of financial products, this time in a more "transparent" manner. If the populist backlash against derivatives and those who loved them continues, is it really going to be that simple?

Followup on the Sun-IBM merger

Here's some interesting background from AppleInsider related to the Sun-IBM merger talks and the effect they could have on Apple. I did not realize that before Steve Jobs sold the NextStep operating system to Apple, where it would become the foundation of OS X, he had already sold it once to IBM for $10 million and later to Sun for $11 million. That is some salesmanship.

The article concludes that the merger could be beneficial to Apple:

A merger of IBM and Sun would result in an even tighter relationship with Apple, and could even create a market for licensing Mac OS X Server on enterprise hardware and supporting that software using a services team that Apple lacks the resources to quickly assemble from scratch.

Sometimes $43 Million Isn't Enough

The post-nup gives her $43 million, but the divorcing wife of United Technologies chairman George David figures she needs more than $53,000 a week to get by.

Don't we all.

Whoops! Not Just "London Loonies"

Commenting on a previous post, I termed the bonus babies at AIG's Financial Products Division "London loonies." Incorrect, or at least incomplete, according to The Stamford Advocate:

[Three Connecticut residents] were identified by the New York Post as recipients of the highly criticized bonuses.

***

The three Connecticut men work for AIG's Financial Products division in Wilton. That group entangled its parent company in a massive web of credit default swaps -- a kind of insurance policy covering debt -- that put AIG on the hook for billions of dollars when mortgage securities and other investments went bad.

***

Finding supporters of the titans of AIG Financial Products' division is hard. Finding anybody Wednesday to talk about [the three] in their neighborhoods proved impossible.

No one answered the door at any of their homes, well-appointed, large colonials with clapboard exteriors and manicured lawns.

Can Investment Management Be Overpriced?

If investment managers give exactly the same advice to a number of clients, can they charge some clients a higher percentage fee than they charge to other clients?

That's the question, more or less, in the case of Jones v. Harris Associates. As investment managers – aka "advisers" – to certain mutual funds, Harris charged individual investors a higher percentage than it charged institutions such as pension funds.

Did Harris have a fiduciary duty to treat individual investors fairly? A federal appeals court didn't think so. Now the Supreme Court will explore the question.

Popular Delusions and Perpetual Madness

This morning visited the Gutenberg Project to seek out the truest book about people and money ever written, Charles Mackay's "Popular Delusions and the Madness of Crowds." The Project is trying out a new format, EPUB. The beta version seems to work pretty well with Adobe Digital Editions, though copying text is iffy. "Popular Delusions" is said to remind us that human nature and human greed never change. That's not necessarily so. Investor foolishness may actually be on the increase. Consider the following, from Mackay's description of all the little stock bubbles that popped up in London's Exchange Alley at the time of the South Sea Bubble:

But the most absurd and preposterous of all, and which showed, more completely than any other, the utter madness of the people, was one, started by an unknown adventurer, entitled "company for carrying on an undertaking of great advantage, but nobody to know what it is." Were not the fact stated by scores of credible witnesses, it would be impossible to believe that any person could have been duped by such a project. The man of genius who essayed this bold and successful inroad upon public credulity, merely stated in his prospectus that the required capital was half a million, in five thousand shares of 100 pounds each, deposit 2 pounds per share. Each subscriber, paying his deposit, would be entitled to 100 pounds per annum per share. How this immense profit was to be obtained, he did not condescend to inform them at that time, but promised, that in a month full particulars should be duly announced, and a call made for the remaining 98 pounds of the subscription. Next morning, at nine o'clock, this great man opened an office in Cornhill. Crowds of people beset his door, and when he shut up at three o'clock, he found that no less than one thousand shares had been subscribed for, and the deposits paid. He was thus, in five hours, the winner of 2,000 pounds. He was philosopher enough to be contented with his venture, and set off the same evening for the Continent. He was never heard of again.

Writing in 1841, Mackay assumed his readers would recognize that investing in "blind pools," as such ventures came to be known on Wall Street, was the height of folly. Today? Blind pools known as hedge funds attract presumably sophisticated investors, pension funds and endowments. In recent years they sold particularly well as Madoff funds. "In the present state of civilization," Mackay wrote, "society has often shown itself very prone to run a career of folly…. Melancholy as all these delusions were in their ultimate results, their history is most amusing." Excuse us if we don't laugh, Mr. Mackay. We're too deep in melancholy.

Hedge funds clipped

The number of hedge funds shrank by about 15 percent last year.

Sun for sale?

Remember when Sun Microsystems was going to buy Apple computer? That was before Steve Jobs returned to Apple and discovered the immense power of the lower case i (iMac, iPod, iTunes, iPhoto, iEtc.) . That 1996 deal fell apart, if I remember correctly, because Sun didn't think Apple was worth the price management and shareholders were asking.

How quickly fortunes turn. I.B.M. Said to Be in Talks to Buy Sun for $7 Billion reports the New York Times.

Another Madoff question

There are lots of unanswered tax questions, according to the Tax Notes writeup on reactions to Rev. Proc. 2009-20 and Rev. Rul. 2009-09,the Madoff/ponzi scheme relief rulings announced yesterday. Here's one I should have thought of earlier:

Taxpayer made a gift to child of a $2 million interest in the Madoff fund. Taxapayer used up his unified credit to avoid gift tax, but did file a gift tax return. Does he get his unified credit back now? Does it depend upon how long ago he made the gift?

Historic moment?

NYTimes.com has published a letter from reader Paulette Altmaier.. These portions resonated with me:

"President Obama may not realize it yet, but his Katrina moment has arrived.

"This is a defining moment for his presidency, and how he responds will determine the trajectory of his term. He needs to deal with the excesses within the financial industry with the same toughness and conviction that President Ronald Reagan brought to bear during the air traffic controllers’ strike. To date, he is sorely wanting."

Altmaier goes on to identify herself as an Obama voter, ands calls for deeds, not words.

Are the AIG bonuses a tipping point? They certainly make the government look hapless at the moment. What about the fact that AIG has really just been a conduit for billion-dollar payments to foreign banks and Goldman Sachs?

Market Bottom?

If Warren Buffett can't always predict stock market moves, we shouldn't try. Still, hope springs eternal. Contrarians have to love Equities dead as long-term asset.

U.S. advertising down 2.6% in 2008

says Nielsen :: Media Business. That's less that I expected. More:

Ad spending in b-to-b magazines fell 9.7%. Ad expenditures in other print categories were hit hard, too, with steep declines at national magazines (-7.6%), national newspapers (-9.6%), local newspapers (-10.2%) and local Sunday supplements (-11.0%).

Even Internet display advertising fell 6.4%. Cable TV ads were up, the only bright spot.

However, history suggests that those who advertise through tough economic times are more likely to survive them.

IRS Takes Pity on Madoff Victims

Some Madoff victims may be able to deduct most of their losses and carry unused deductions back as far as five years or forward as far as twenty years, according to this NY Times dispatch:

Under the plan, which has been reviewed by the Congressional offices, the I.R.S. will allow investors who are not suing Mr. Madoff to claim a theft-loss deduction equal to 95 percent of their investments, minus any withdrawals, reinvested gains and payouts from the Securities Investor Protection Corporation, the government-chartered fund set up to help protect investors of failed brokerage firms.

Investors who are suing Mr. Madoff, and who thus may have some prospect of recovery, can claim a deduction equal to 75 percent of their investments.

The I.R.S. is also relaxing the rules on how far back the losses can be carried. Current theft loss rules typically allow loss to be carried back 2 years and forward 20 years, but under the plan, the I.R.S. will allow losses to be carried back 5 years as well as forward 20 years.

A Swindler With Class

Paul Greenwood is alleged to have defrauded investors of a half-billion dollars. Lunch money, by Madoff standards. But keeping up appearances counts for something. Greenwood showed up in court wearing a bow tie.

Who says traditional values are dead?

Be an Enthusiastic Investor!

From a Yale Alumni Magazine interview with David Swensen, Yale's star endowment manager:

One of the great ironies is that if you had talked to the average investor 18 months ago, he or she would have thought it was a pretty good idea to buy stocks. In recent months, the same investors despair about their portfolio and are fearful about putting money into the equity market.

That's 180 degrees wrong. They should have been cautious 18 months ago, when prices were much higher than they are now. They should be enthusiastic today.

Undelivered Billions: Is Some Yours?

From The Wall Street Journal:

[N]early $33 billion in unclaimed property [sits] in state governments' coffers.

These are sums that businesses were required to turn over to the states after no activity or contact with the owner after a period of a year or more.

Items can include dividend or payroll checks that haven't been cashed, refunds, trust distributions, unredeemed money orders, insurance payments or refunds, annuities, certificates of deposit, customer overpayments and the contents of safe-deposit boxes.

Some state tax revenues crashed last quarter

So saysTaxProf Blog reporting on a study by the Nelson Rockefeller Institute of Government. Curiously, New York was not among the top ten losers, but Connecticut came in number 9, down 8.5%, and New Hampshire, down 11.6%, was number 7.