Steven Bradford has links.
Today's WSJ reports that:
Investors are stampeding into initial public offerings at the fastest clip since the financial crisis, fueling a frenzy in the shares of newly listed companies that echoes the technology-stock craze of the late 1990s.
October was the busiest month for U.S.-listed IPOs since 2007, with 33 companies raising more than $12 billion. The coming week is slated to bring a dozen more initial offerings, including Thursday's expected $1.6 billion stock sale by Twitter Inc., the biggest Internet IPO since Facebook Inc.FB -2.10% 's $16 billion sale in May 2012.
As I document in my article How American Corporate and Securities Law Drives Business Offshore, in The American Illness:
During the first half of the last decade, evidence accumulated that the U.S. capital markets were becoming less competitive relative to their major competitors. The evidence reviewed herein confirms that it was not corporate governance as such that was the problem, but rather corporate governance regulation. In particular, attention focused on such issues as the massive growth in corporate and securities litigation risk and the increasing complexity and cost of the U.S. regulatory scheme.
Tentative efforts towards deregulation largely fell by the wayside in the wake of the financial crisis of 2007-2008. Instead, massive new regulations came into being, especially in the Dodd Frank Act. The competitive position of U.S. capital markets, however, continues to decline.
In the article, I explained that how the risk of anti-fraud liability adversely affects the competitiveness of U.S. capital markets and how the federalization of key aspects of corporate governance during the last decade generated significant net regulatory costs adversely affecting those markets. None of these structural problems have been solved. Instead, the current book in IPO volume is happening despite them.
The reasons behind the IPO boom in fact make it look like an IPO bubble:
The rush to buy shares of newly public companies is the latest sign of investors' thirst for assets with potential upside, at a time when relatively safe investments are generating scant income due to tepid economic growth and Federal Reserve policies that have kept a lid on U.S. interest rates. ...
To others, however, the demand is an indication that a rally fueled primarily by abundant liquidity from the Fed, and not by earnings growth and economic expansion, is entering dangerous territory.
"When I hear intelligent investors asking me not which companies are good to invest in, but which IPOs can I get into, it scares the heck of me," said Mark Lamkin, a wealth-management adviser based in Louisville, Ky.
As well it should. Once the Fed starts to curb liquidity, the structural legal problems that beset US capital markets will quickly pop the present IPO bubble.
The one that started it all
We’ve confidentially submitted an S-1 to the SEC for a planned IPO. This Tweet does not constitute an offer of any securities for sale.— Twitter (@twitter) September 12, 2013
Twitter has begun a process that should ultimately lead to an initial public offering (IPO) of shares in the company http://t.co/kqdb2u1dZd— The Economist (@TheEconomist) September 13, 2013
Here's why Twitter filed for a secret IPO http://t.co/dQeQgfjHtd— HuffPostBiz (@HuffPostBiz) September 13, 2013
Last August the Treasury Select Committee published its report Fixing LIBOR: some preliminary findings: see here. The response of the Financial Services Authority was published today: see here (pdf). This contains some interesting points about the FSA's powers in respect of approved persons, and the approved persons regime, which were also recently discussed before the Parliamentary Commission on Banking Standards: see here.
For my take on reforming LIBOR, see Reforming LIBOR: Wheatley versus the Alternatives (January 31, 2013). NYU Journal of Law & Business, Vol. 9, No. 2, 2013; UCLA School of Law, Law-Econ Research Paper No. 13-02. Available at SSRN: http://ssrn.com/abstract=2209970
Hedge fund investor Bill Ackman last appeared in these pages when he announced his big short play at Herbalife, which he claims is a "pyramid scheme." David Benoit is liveblogging Ackman's presentation at the Harbor Investment Conference and reports that Ackman is doubling down on his claims:
Ackman is making a big comparison: says the "FTC missing Herbalife is the equivalent of the SEC missing Madoff."
Cheering for a short seller goes against the American spirit, even if short sellers can usefully warn investors of frauds and hype. Warren Buffett, for one, refuses to short stocks at all. He says he wants to avoid the unlimited losses of a short sale gone bad. But I suspect that Mr. Buffett has another reason. He knows that betting against success would hurt his apple-pie image.
Bull shit. Short selling is capitalism at its finest.
Joseph Schumpeter famously taught that creative destruction was the core of capitalism. The prospect of failure is thus an essential aspect of the capitalist system. It's capitalism's opponents who think failure is something to be prevented. Hence, it's been correctly observed that:
The beauty of the capitalist system is that it allows ... changes/transformations to take place on a natural and gradual basis, unlike “static systems” such as various 20th century communist systems (such static systems tend to fall apart overnight as they were not allowed to evolve over time).
That is, increasing entropy + capitalism system = consistent short-selling opportunities.
If informed investors recognize that a stock is over-valued they perform a valuable service by selling it short and pushing down its stock price. This can both deprive the company of capital and be a signal to other actors in the market that the company might not be as healthy as is generally believed.
In sum, I agree completely with the claim that:
Free speech, an independent spirit, and free markets are key American virtues – and ones that, believe it or not, short sellers exercise every day. They’re a necessary part of the financial markets and are here to stay.
On Thanksgiving Day, I grill-roasted a heritage breed, free range, organic 9 lb turkey from D'Artagnan using apple and hickory wood chips for smoke (one of the best things I ever did was to install a gas line on my back porch so I can run a natural gas grill and patio heater without ever having to worry about running out of propane on a long cook like this one, and hard wood charcoal purists can bite me).
Since it was just Helen and I, we had two drumsticks, one thigh, and one breast left over. A mid-morning snack today revealed that the leftovers had intensified in smokiness. I also had some leftover boiled new potatoes, green beans, and carrots. (The leftover cornbread dressing didn't make it past that midmorning snack). As I pondered tonight's dinner, I immediately thought: hash. So here's how I (mostly) cleaned out my refrigerator.
You definitely want to have your mise en place ready to go before you start cooking, as it goes pretty damned quick.
I heated my trusty All-Clad Master Chef 2 Nonstick 12-Inch Fry Pan over medium-high heat and added a tablespoon of olive oil and a tablespoon of butter. When the oil-butter mix stopped foaming, I added the onions and chili. I hit them with a small pinch of salt. I sauteed them until they had softened and were just beginning to color at the edges. I then added the garlic and cooked it another 30 seconds. Next I added the turkey and stirred it through. Next I added the potatoes, carrots, and a big pinch of the dried parsley. A big pinch of salt and 10 grinds of black pepper (using my Turkish pepper mill) followed. I tossed the hash around in the pan for a while, smoothed it out to an even level, and then pressed it down to let it brown. I spread the green beans and green onions on top of the mix.
While the hash browned, I heated a pat of butter in my Calphalon Nonstick 8-Inch Frying Pan. When the butter stopped foaming, I fried two eggs over easy. I seasoned them with salt, pepper, and a few dashes of Tabasco. As the eggs fried, I stirred the hash to mix in the beans and green onions. I then dished up the hash and topped each plate with one egg. Because I like heat much more than Helen does, I refrained from hitting her serving with the several more dashes of Tabasco to which I subjected mine.
What wine to serve with this hash? Granted, you could make a case for beer, cola, or iced tea being better matches. But I like wine. Specifically, red wine. I wanted something young, fruity, not super tannic, with some smoke being a plus. The 2010 Foxen Tinaquaic Vineyard Syrah worked surprisingly well.
The bouquet suggests black cherry, raspberry, and cola. The palate picks up those elements, but adds smoky bacon, tar, and plums. Grade: B+
As I write this at 9:49 am of the morning after Obama's reelection victory, all of the major stock market indices are down. The Dow Jones is down 2.18% and NASDAQ is down 2.40%. It's easy to score political points with those numbers. The market is clearly spooked by (1) the prospect that continued divided government will make resolving the impasse over the fiscal cliff harder and (2) the likelihood of continued heavy-handed regulatory and enforcement practices by the Obama administration.
But there's something more important going on under the rader screen. US Treasury securities historically have been used as a proxy in finance for the so-called "risk free rate"; i.e., the theoretical rate of return of an investment with no risk of financial loss. Hence, as Matthew Philips observed after S&P downgraded the US' credit rating:
U.S. T-bonds and bills have been a proxy for the risk-free rate for decades. Without a risk-free rate, modern finance essentially falls apart, since it is the building block of most financial models. People use it for determining everything from the value of a company, to the price of an option or a bond.
Of course, the very concept of a risk-free rate has always been relative. It assumes a zero chance of default. If you want to get technical, there isn’t a zero chance of anything really. But ... U.S. treasuries are still the least risky place to put your money in the whole world.
Not anymore, according to today's WSJ:
Treasurys have a new rival for safe-haven status: U.S. companies.
Bonds of Exxon Mobil XOM -3.42% and Johnson & Johnson JNJ -1.10% are trading with yields below those of comparable Treasurys, a sign that investors perceive them as a safer bet. It is a rare phenomenon that some market observers said could be the beginning of a new era for debt markets. It could ultimately mean some companies will borrow at lower rates than the U.S. government.
For now, just a handful of relatively short-term bonds yield less than comparable Treasury bonds. But some market observers said some fundamental changes in the financial health of U.S. companies relative to the government, including the fact that some corporations are more highly rated than Uncle Sam, suggest it could become a longer-lasting trend.
This is what four years Obamanomics has brought us: An historic reversal of the assumption that US treasury securities were so safe as to be essentially risk free. And the astonishing fact that the markets perceive some corporations to be less risky than the United States government.
One wonders what four more years will bring?
With Bernanke's easy money policy slashing rates on fixed income investments to essentially nil on a risk-adjusted basis, those of staring at retirement in a decade or two are hunting for returns anywhere we can find them. Unfortunately, if The Economist's Buttonwod columnist is correct, the prospects are dim:
ONE key reason why I have been pessimistic about the outlook for the US stockmarket is based on the use of the Shiller price-earnings ratio. ... The Shiller version tries to eliminate the effect of the economic cycle on valuations; without it, stock markets look expensive when earnings collapse in recessions and look cheap when earnings are high in booms. So it averages earnings over 10 years, and adjust them for inflation; at the moment, the p/e is 21.5, well above the historical mean.
So what? The noted quant, Cliff Asness, head of fund management group AQR, published a third quarter commentary in which he looked at future equity returns when the Shiller p/e was at current levels. The average 10 year real return was just 0.9%.
In addition to the individuals whose savings are at risk, there is also very bad news for taxpayers in public pension profligate states like Illinois or California:
That is extremely important for pension funds, particularly those in the US which assume a ludicrously high (nominal) return of 8% going forward. As I have pointed out in the past, this is way too high but allows them to stint on their contributions (not to mention this is wrong in theory, as well as practice. Liabilities are a debt, and should be discounted by bond yields).
Some people argue that the 30-year returns pension funds have achieved justify an 8% assumption. But this is fundamentally misguided. Back in 1982, Treasury bonds yielded 10.5% and US equities 6.2%. Investors benefited from the high level of running yield as well as capital gains as valuations improved to current levels. That simply cannot happen again. Treasury bonds now yield 1.7% and the dividend yield is 2.2%. Absent some unexpected surge in profits (which are already vlose to an all-time high as a proportion of GDP), the most likely outcome from here is low real returns. Whether you are an employee in a 401(k) plan or an employer running a final salary scheme, you need to put more money aside to generate a given pension.
Buttonwood notes some shocking facts:
As Deutsche Bank points out in its long-term asset return study, the longest series of bond yield data is for the Netherlands dating back all the way to 1517. In June, those yields reached a record low. Not just any old record, then, but a 500-year nadir. In America, yields go back only to 1790 but they too have been at all-time lows.
In other words, the developed world's central banks have (a) failed to stimulate the economy and (b) created an environment in which saving essentially is pointless because returns have been so low for so long. Maybe it's time to try some new central bankers and some new ideas.
I've noted many times over the years that short selling has many pro-social aspects, while being unfairly blamed for problems whose root causes lie elsewhere. A new paper brings to our attention an important additional prosocial benefit of short selling:
We hypothesize that short-selling has a disciplining role vis-à-vis the managers forcing them to reduce earning manipulation. Using firm-level short-selling data over the sample period of 2002 to 2009 across 33 countries, we document a significantly negative relationship between lending supply and activism in the short sell market and earnings manipulation. Additional tests using ETF ownership as an instrument or based on market-wide short-selling restrictions further confirm that short selling potential strongly discourages earnings manipulation. Meanwhile, the impact is more pronounced for firms with weaker corporate governance. Collectively, our findings suggest that short selling provides an external governance mechanism to discipline managerial incentives.Massa, Massimo, Zhang, Bohui and Zhang, Hong, The Invisible Hand of Short-Selling: Does Short-Selling Discipline Earnings Manipulation? (August 5, 2012). Available at SSRN: http://ssrn.com/abstract=2124464
Earnings manipulation is an important source of agency costs in public corporations. By constraining management's ability to do so, short selling thus provides an important market check on potentially destructive misconduct. Which, once again, calls into question the wisdom of restricting it.
I have been reading with great interest Frank Partnoy's new book, Wait: The Art and Science of Delay, which argues that: "Even as technology exerts new pressures to speed up our lives, it turns out that the choices we make––unconsciously and consciously, in time frames varying from milliseconds to years––benefit profoundly from delay. As this winning and provocative book reveals, taking control of time and slowing down our responses yields better results in almost every arena of life … even when time seems to be of the essence."
Frank's book thus immediately sprang to mind when I read an article in today's WSJ about the increasingly probable collapse of stock trader Knight Capital management:
As Knight Capital Group reels from damage inflicted by a computer-trading malfunction, the episode highlights a risk that had previously garnered little attention: Ever-faster stock trading and complicated markets are putting greater strains on the ability of brokerage firms to manage their financial risks.
Many of the fears originate from within the industry. "We have created a situation that is beyond our ability to control," said Thomas Peterffy, founder of Interactive Brokers Group and a pioneer in electronic trading. "These problems will continue if we don't slow things down." ...
"Speed and risk management have an inverse relationship," says Kevin Cronin, director of global stock trading at InvescoLtd., which manages $647 billion. He notes that Knight's computer error only had a fleeting impact on the prices of 150 stocks out of the entire market and still badly hurt a "great participant" in the market. "To me, it highlights…that there is too much focus on speed."
Too much focus on speed. Continuing problems if high frequency trading isn't slowed down. Well, guess what? That's precisely the point Frank makes in Chapter 3 of Wait, in which he takes up "High-Frequency Trading, Fast and Slow."
In it, Frank points out that 70% of US stock transactions now involve high-frequency trading by computer programs rather than people. He tells the story of how trading firm UNX lost money as its trades got faster and then made money once they slowed down the rate at which their computers traded. From it, as well as both rigorous studies and compelling anecdotes, he concluded that computerized trading works best when the computer program is designed "not necessarily to be first, but to be just right." In contrast, when the programs are designed to be first, you can all to easily get a cascading effect as multiple high-frequency trading computers trading across multiple markets begin affecting one another's programmed decision making. The result can be a flash crash, such as the one he describes that took place in 2010 when Waddell & Reed's computerized high-frequency trading in so-called "E-mini" futures contracts briefly tanked the entire stock market.
Partnoy is no radical reformer. He correctly acknowledges that high-frequency trading has positive benefits, improving liquidity and reducing volatility.
Instead, Partnoy wants the system to optimize delay rather than trying to minimize it. To be able to speed up when appropriate, but also to slow down when appropriate. To prove his point, he reviews how successful high-frequency trading firms are training their employees to think strategically, not just quickly.
One wonders how much the folks at Knight Capital would have benefited if they had rad Partnoy's book and implemented his suggestions? I suspect quite a lot.
The Knight Capital mess is already attracting attention from regulators. Presciently, Partnoy has advice for them as well. He proposes that "instead of trying to keep up with the markets, regulators could help them slow down by introducing explicit pauses." In addition to obvious proposals, like the circuit breakers stock markets already use to slow trading when market decline rapidly, Partnoy has a clever out-of-the-box idea: "force [traders] to take a lunch break."
Partnoy's unique status as a legal scholar derives in large part from the fact that he has life experience few other law professor can match. For example, he worked as a trader in Morgan Stanley's Tokyo office in the 1990s. In Wait, he reminisces about "the positive impact of the required ninety-minute lunch break." He relates that "the pause in trading led to more rational thinking about the trading day."
The thought of the SEC trying to design a mandatory lunch break rule amuses. And Partnoy explicitly acknowledges the enormous political opposition such a proposal would face. Yet, it is precisely this sort of out-of-the-box thinking that lends Wait so much value.
If we can get really smart traders and regulators thinking outside the box about how to optimize delay--rather than minimizing it--we might have fewer Knight Capital cases. And we might delay the day that a Knight Capital-like case cascades into a disaster that manages to take down the entire market.
Getting more of the right people reading Wait would be a good place to start.
Once again, the Presbyterian Church (USA) is considering divesting from certain companies that do business with the Israeli government. As I explained the last time the church went down this road, it's a bad, anti-semitic idea:
Let's start with a basic question: Will the PC(USA)'s decision "work"? In other words, do divestment campaigns tend to achieve their proponent's goals? The clear answer from the empirical literature is "no."
A London Business School Institute of Finance and Accounting working paper called "The Effect Of Socially Activist Investment Policies On The Financial Markets: Evidence From The South African Boycott concluded:
"We find that the announcement of legislative/shareholder pressure of voluntary divestment from South Africa had little discernible effect either on the valuation of banks and corporations with South African operations or on the South African financial markets. There is weak evidence that institutional shareholdings increased when corporations divested. In sum, despite the public significance of the boycott and the multitude of divesting companies, financial markets seem to have perceived the boycott to be merely a 'sideshow.'"
Another paper, "The Stock Market Impact of Social Pressure: The South African Divestment Case," from the Quarterly Review of Economics and Finance in fact found:
"Using the South African divestment case, this study tests the hypothesis that social pressure affects stock returns. Both short-run (3-, 11-, and 77-day periods) and long-run (13-month periods) tests of stock returns surrounding U.S. corporate announcements of decisions to stay or leave South Africa were performed. Tests of the impact of institutional portfolio managers to divest stocks of U.S. firms staying in South Africa were also performed. Results indicate there was a negative wealth impact of social pressure: stock prices of firms announcing plans to stay in South Africa fared better relative to stock prices of firms announcing plans to leave."
In sum, divestment may make activists feel all warm and fuzzy, but the evidence is that (1) it has no significant effect on the target of the divestment campaign but (2) likely does harm the activists' portfolios.
As the Manhattan Institute's James Copland explained, these results are entirely consistent with financial theory:
"Unlike a boycott in a traditional goods market, the sale of a stock or bond in a financial market in sufficient volume to affect its price makes it more attractive to a buyer who doesn't care about the divester's social cause. These buyers will bid the price back up to its equilibrium level, the risk-adjusted net present value of expected free cash flows from the instrument. So whereas a goods boycott can be effective under certain conditions, a stock divestiture never can unless there is insufficient liquidity on the other side, a highly dubious condition in our financial market. The Presbyterian Church may have $7 billion in financial assets, but that's hardly a sufficient sum to control financial market pricing."
If the PC(USA) mavens who passed this proposal were simply dealing with their own investments, who could gainsay their right to shoot their portfolios in the foot? Apparently, however, the plan encompasses divesting the retirement funds of Presbyterian pastors and workers invested in denominational pension plans. As such, their decision illustrates a perennial problem of institutional investment; namely, Quis cusotdiet ipsos custodies.
Like the vast majority of large institutional investors, the PC(USA)'s pension plans manage the pooled savings of small individual investors. From a governance perspective, there is little to distinguish such institutions from corporations. Plan investors have no more control over the election of company trustees than do shareholders over the election of corporate directors. Nor do the holders of such shares have greater access to information about their holdings, or ability to monitor those who manage their holdings, than do corporate shareholders. Worse yet, although an individual investor can always abide by the Wall Street Rule with respect to corporate stock (it's easier to switch than fight), he cannot do so anywhere nearly as easily with respect to investments such as these denominational pension plans.
Managers of pension plans are fiduciaries of the beneficiaries of those plans. When they pursue a social agenda nearly certain to result in poorer performance, they are disserving their beneficiaries. The activists at the PC(USA) may have gotten a warm and fuzzy feeling from taking a slap at Israel, but in doing so they injured Jewish-Christian relations, besmirched the one functioning democracy in the Middle East, and stabbed their own people in the back. All for the sake of a gesture that experience teaches will be fruitless.
As for whether the divestmenbt proposal is anti-semitic, I use a standard proposed by Jay Lefkowitz:
A more nuanced standard, and one that properly recognizes that legitimate criticism of Israel is perfectly appropriate, was articulated last year by Natan Sharansky. A member of the Israeli cabinet who for years had been a prisoner of conscience in the Soviet gulag, Mr. Sharansky defined one current expression of anti- Semitism by three features: the application of double standards to Israel, the demonization of Israel and the delegitimization of Israel.
Applying it back in 2004 to the last time the PC(USA) got into the divestment game, Lefkowitz made a persuasive case that the Presbyterian divestment plan was anti-Semitic:
The recent action by the Presbyterian Church sadly satisfies Mr. Sharansky's test. The church has singled out Israel, alone among all the nations of the world, for divestment. It has demonized Israel's treatment of the Palestinians, and it has delegitimized Israel's right to self- defense.
The church is not calling for divestment of its $7 billion portfolio from China, despite China's denial of the most basic political and religious rights and its particularly harsh treatment of followers of Falun Gong. It is not condemning Russia, even though Russia's policies in Chechnya are by any human-rights standard atrocious. It is not even calling for economic sanctions against Syria or Iran, whose human-rights records for their own people are egregious and whose Jewish citizens are denied the basic civil rights and liberties afforded to all Israelis, including its Arab citizens, some of whom even serve in the Knesset.
Nothing's changed in the meanwhile tochange that conclusion. If the PC(USA) in its finite wisdom (that's not a typo--as a colective, the PC(USA)'s wisdom is not just finite, it is minuscule) decides to go forward, it will once again be committing anti-semitism, bad economics and politics, and a breach of fiducary duty simultaneously. That's quite a hat trick.