Doing Nothing Can Be Very Smart
Posted by Eddy Elfenbein on April 6th, 2009 at 11:11 am

Here’s an interesting note on the Dow Jones Industrial Average (^DJI). Periodically, the gate keepers of the index add or delete stocks to keep things fresh. But if they had simply left the index alone, it would have done far better.
Since 1930, nine of the 30 stocks are still left. Twenty have been bought out or merged and only Bethlehem Steel has gone bust. The index would have finished 2008 at 14,600 instead of 8776. On top of that, the Dow’s weird weighting by price instead of market value also would have hurt you.
I don’t have the numbers on this but my guess is that a lot of the untouched Dow’s gain is due to one stock, IBM (IBM). The company was removed from the index in 1939 and put back in 1979. In those 40 years, IBM gained an astounding 22,000%.
Warren Buffett once said, “Lethargy bordering on sloth remains the cornerstone of our investment style.” Now you can see why.

Shorting Reason
Posted by Eddy Elfenbein on April 5th, 2009 at 10:46 pm

Richard Posner has a good review of Animal Spirits by George Akerlof and Robert Shiller. Here’s a snippet:

As one reads this book, one has the sense that deep down Akerlof and Shiller believe that being rational is the same as being right. That is a mistake. It prevents them from entertaining the possibility that what has now plunged the world into depression is a cascade of mistakes by rational businessmen, government officials, academic economists, consumers, and homebuyers, operating in an unexpectedly fragile economic environment, and that what is retarding recovery is not the “unreasoning fear” of which Franklin Roosevelt famously spoke but the rational fears–the reasoning fear, to use Roosevelt’s idiom–of businesspeople, consumers, and officials who confront economic uncertainties for which no one had prepared them.

I’ve often been critical of Robert Shiller’s work because I think he places too much emphasis on the short comings of investors. It’s true that folks often get carried away with things especially when prices get moving.
The truth is that many times it has been “different this time” or we did “enter a new era.” The speculation usually comes after a major change has taken place. Asset prices don’t easily confirm to a simple morality tale of people getting greedy and overpaying for stuff. If you scratch the surface, you’ll see that there are many concrete reasons (and government policies) that caused the animal spirits.
Just to give one example is that bubbles can often be confirmed by popular memes. The Nifty Fifty craze of the early 1970s specifically focused on companies that fostered social harmony (Xerox, McDonalds, Coke, Polaroid, Disney) which was a natural inclination after the turbulent 1960s.
The bubble of the 1990s seems to have been aided by the growth of the dubious first-mover-advantage theme. I remember being told countless times how some dot-com stock was “just like QWERTY.”
The story was that once a company became an industry standard, it would be the winner that took all. There was even a magazine called the Industry Standard. In 2000, the magazine sold more advertising than any magazine in America.
It didn’t last.

Creditors Need to Take Some Risk
Posted by Eddy Elfenbein on April 4th, 2009 at 11:28 pm

Tyler Cowen has a good op-ed in the NYT pointing out a key factor in the bailouts—the true recipients are the creditors and that might cause future problems:

What the banking system needs is creditors who monitor risk and cut their exposure when that risk is too high. Unlike regulators, creditors and counterparties know the details of a deal and have their own money on the line.
But in both the bailouts and in the new proposals, the government is effectively neutralizing creditors as a force for financial safety. This suggests a scary possibility — that the next regulatory regime could end up even worse than the last.
The more closely a financial institution is regulated, the more it will be assumed that its creditors enjoy federal protection. We may be creating a class of institutions whose borrowing is, in effect, guaranteed by the government.

Weekend Poll
Posted by Eddy Elfenbein on April 3rd, 2009 at 8:00 pm

Update: This question comes from the work of Daniel Kahneman and Amos Tversky, though I changed the amounts in order to experiment.
By pure rules of expected return, people should to take the 50-50 bet for $3000. Although that’s what most folks said, there’s still a significant percentage that chose the guaranteed $1,000. Incidentally, I don’t blame anyone for taking the $1,000. It really comes down to each individual’s risk tolerance.

The Jobless Rate Continues to Grow
Posted by Eddy Elfenbein on April 3rd, 2009 at 10:53 am

I don’t have much to add about today’s awful jobs report. Let me say a few minor things. The official rate was reported as 8.5%. Technically, it was 8.543% which was only about 10,000 jobs away from 8.6%. At the present rate, that’s less than half-a-day’s job cuts. Over the last six months, the unemployment rate has ticked up 0.1% about every week.
Over the last nine years, the unadjusted adult population has grown by 23.3 million. The civilian labor force has grown by just 11.6 million which means that less than half of the increase in population is participating in the jobs market. The number of employed has grown by just 4.2 million. So even the increase that is participating in the job market, only 36% have jobs (bear in mind, I’m talking about the net increase).

Cause Please Meet Effect
Posted by Eddy Elfenbein on April 3rd, 2009 at 9:58 am

February 23, 2004

Greenspan says ARMs might be better deal

May 16, 2007:

Pimco hires Greenspan as consultant

April 4, 2009

PIMCO Distressed Mortgage Fund Down 34%

(HT: Joe W.)

Mark-to-Market Is More Realistic
Posted by Eddy Elfenbein on April 3rd, 2009 at 9:27 am

In honor of yesterday’s decision from FASB, we at Crossing Wall Street would like to review our legacy assets which include; three unicorns, eight hobbits (non-union), a half dozen minotaurs, two mermaids, a couple of CHUDs, several tic-tacs, true love and a smurf.

Forbes and the Flat Tax
Posted by Eddy Elfenbein on April 2nd, 2009 at 3:00 pm

Now at his new perch at Reuters, Felix Salmon tweaks Steve Forbes for the news that Forbes magazine is cutting salaries by 10% for everything over $100,000:

This is taxing the rich! It’s class warfare! Why should those employees earning a six-figure salary be singled out for pay cuts? If you cut their pay, don’t you know that you’re going to reduce their incentive to work hard, and also the incentive for lower-earning employees to aspire to their position? And these are the most productive members of the firm! You’re punishing success! You should be giving the higher-paid employees a pay rise, instead — that will surely boost corporate revenues!
Come on Steve, walk the walk. If the rich can’t be treated equally with the poorer at Forbes, where is the hope for them in this world?

I know he’s joking, but two things. Obviously, a cut in salary isn’t a tax. There’s a major difference between dealing with a private employer and government taxes. With the government, you have no choice.
Secondly, what Forbes is doing isn’t running away from the flat tax — it’s exactly how his flat tax works. Forbes has called for a 17% flat tax on income only above a specific level (that’s changed over the years). You may not like his principles, but in this care Forbes is walking the walk.

What Caused Oil to Boom?
Posted by Eddy Elfenbein on April 2nd, 2009 at 1:29 pm

A few months ago, I criticized the absurd 60 Minutes story which blamed speculators for the rise in oil prices. I said the story was “wretched, incoherent and it engages in the worst form of scapegoating.”
As is often the case, conspiracy theories sell. If you have a high tolerance for imbeciles, check out some of the comments when Seeking Alpha posted my piece.
Now James Hamilton has looked into the behavior of the oil boom and bust and he comes to the conclusion that oil was impacted by…are you ready…supply and demand.

But while the question of the possible contribution of speculators and the Fed is a very interesting one, it should not distract us from the broader fact: some degree of significant oil price appreciation during 2007-08 was an inevitable consequence of booming demand and stagnant production.

(Via: Kedrosky.)

S&P 500 Total Return Index
Posted by Eddy Elfenbein on April 2nd, 2009 at 1:13 pm

Even if we include dividends, the S&P 500 has lost money over the last 11 years.

And that’s not even adjusting for inflation. Ugh!