The Long Shot
Posted by Eddy Elfenbein on March 20th, 2008 at 7:47 am

Matthew Yglesias comments on the absurdity of John Meriwether blowing up, yet again. He includes this parable:

Imagine I find a kind of gambling machine somewhere that works kinda sorta like an enormous roulette wheel. It has 100,000 possible outcomes, and on 99,999 of those outcomes it pays off at a 1:1 ratio. But on the 100,000th outcome, you lose at a 1:300,000 ratio. Obviously, placing a bet on that machine would be foolish.

Not to me.
I’d lay down $1,000, let it roll for 20 spins and walk away a billionaire.
Addendum: Or there’s a very remote chance that I’d go in the roulette business. I’d be cool with either outcome.

The Return of Volatility
Posted by Eddy Elfenbein on March 20th, 2008 at 7:42 am

According to a recent report by S&P, market volatility is at a 70-year high. I think that’s merely going by 1% daily changes. Other measurements indicate that volatility has indeed risen, but it’s more accurate to say that volatility has returned to normal from an unusually calm period.
The VIX still hasn’t reached the heights of 1998 to 2002. The index has closed above 30 for a few times recently, but it did it fairly regularly a few years ago.
I think the effect of volatility on equity returns is not very strong. The current VIX seems to have an effect on the dispersion of returns, but not the direction.

How NCAA Tournament Seeds Have Fared
Posted by Eddy Elfenbein on March 19th, 2008 at 7:45 pm

The Chicago Tribune looks at how the NCAA tournament seeds have fared since 1985. I love the idea of a big tournament that invites a huge number of teams. It seems the most democratic, but there are some gaps in justice. For example, the #8 or #9 seed is really screwed because they always must play a #1 in the second round. Only 12 #8 or #9 teams have made it past the second round.
On the other hand, #12 is a pretty good seed. Those teams have a losing, but respectable record against the #5 seeds. A total of 14 number #12 seeds have made it past the second round.
My guess is that the seeds increase linearly while quality increases geometrically. The difference between a #12 and a #5 is probably about the same as a #1 and a #3.
If we wanted to be hard-headed, we could really make it a 12-team tournament and the results would be almost the exact same. Twenty of the 23 winners have been #1, #2 or #3 teams. Of course, that would ruin a lot of the fun.
I’ve noticed that no matter what happens, the media talks about how the first weekend was a “Cinderella Weekend.” But going by history, there’s nothing that surprising by having at least one #14 beat a #3, or having a #2 or #3 lose in the second round.
It’s fun to root for the Cinderella teams (we have a couple of local teams ranked in the double-digits), but history says that the odds are against them.

“Mama – just killed my fund”
Posted by Eddy Elfenbein on March 19th, 2008 at 4:57 pm

Sung to the tune of ‘Bohemian Rhapsody‘ by Queen

Is this the real price?
Is this just fantasy?
Financial landslide
No escape from reality
Open your eyes
And look at your buys and see.
I’m now a poor boy (poor boy)
High-yielding casualty
Because I bought it high, watched it blow
Rating high, value low
Any way the Fed goes
Doesn’t really matter to me, to me
Mama – just killed my fund
Quoted CDO’s instead
Pulled the trigger, now it’s dead
Mama – I had just begun
These CDO’s have blown it all away
Mama – oooh-hoo-ooo
I still wanna buy
I sometimes wish I’d never left Goldman at all.
(guitar solo)
~~~
I see a little silhouette of a Fed
Bernanke! Bernanke! Can you save the whole market?
Monolines and munis – very very frightening me!
Super senior, super senior
Super senior CDO – magnifico
I’m long of subprime, nobody loves me
He’s long of subprime CDO fantasy
Spare the margin call you monstrous PB!
Easy come easy go, will you let me go?
Peloton! No – we will not let you go – let him go
Peloton! We will not let you go
(let him go !)
Peloton! We will not let you go – let me go
Will not let you go
let me go (never) Never let you go – let me go Never let me go – ooo
No, no, no, no, No, NO, NO ! –
Oh mama mia, mama mia, mama mia let me go
S&P had the devil put aside
for me
For me, for me, for me
~~~
So you think you can fund me and spit in my eye?
And then margin call me and leave me to die Oh PB – can’t do this to me
Just gotta get out – just gotta get right outta here
Ooh yeah, ooh yeah
No price really matters
No liquidity
Nothing really matters – no price really matters to me
Any way the Fed goes…..

(Hat Tip: Ritholtz)

The Three-Month T-Bill Now Yields 0.5%
Posted by Eddy Elfenbein on March 19th, 2008 at 2:29 pm

I don’t know what to say. If you invest one million dollars, that works out to a yearly gain of $5,000.
The government can now rent $70,000 a day for the grand total of $1.

A Couple of Bookies
Posted by Eddy Elfenbein on March 19th, 2008 at 1:06 pm

In the movie Trading Places, the Duke brothers explain to Eddie Murphy the essence of their investment business. Murphy shoots back, “You two sound like a couple of bookies to me.”
He’s right; fundamentally, it’s the same idea. Now Bloomberg has a story about one Wall Street’s firm’s growing interest in gambling. Cantor Fitzgerald has a Cantor Gaming unit that’s involved in sports books.
Bloomberg writes:

The firm is seeking Nevada state approval for field tests of a handheld device for playing digital card games and roulette in a casino’s public spaces, such as pools and nightclubs. Officials of closely held Cantor Fitzgerald say it could eventually be used anywhere.

It makes sense for them to be involved in this. Basically, their business is math. I believe that I once read that the entire field of statistics has always been driven by gambling.

“It’s all about processing,” said Lee Amaitis, 57, head of Cantor Gaming, from London. “All you’re doing is math. If you have an engine that can drive random generating results, you can process bets.”

Up In Smoke
Posted by Eddy Elfenbein on March 19th, 2008 at 11:40 am

WSJ, November 1, 2007

Attendees say Mr. Cayne has sometimes smoked marijuana at the end of the day during bridge tournaments. He also has used pot in more private settings, according to people who say they witnessed him doing so or participated with him.

AP, March 18, 2008

Dow Rises 420 Points

Re: “Bear Stearns is fine.”
Posted by Eddy Elfenbein on March 19th, 2008 at 8:20 am

There’s some controversy surrounding Jim Cramer’s “Bear Stearns is fine” comment from last Tuesday. Cramer has said that he was referring to Bear Stearns as a depository institution, not as an investment. He claims that he was telling the questioner that his money was safe at Bear Stearns’ money management arm. Cramer also says that he called Bear’s stock “worthless “on Friday.
Mick Weinstein at Seeking Alpha, whom I respect greatly, agrees with Cramer. I’m sorry but it doesn’t wash with me. Let me say that I think it’s very possible that that what’s Cramer intended. But, to a reasonable person, there’s no reason to see it that way.
Mad Money is a show dedicated to Cramer’s discussion of stocks. That’s the appeal. Only a few times have I heard him discuss larger money management issues. Plus, there was a stock chart of BSC up on the screen. That strongly implies to an average person that he meant the shares.
If he was referring to Bear’s deposits, Cramer didn’t mention basic facts, like you should immediately speak with your broker, or check up on the firm’s deposit insurance. Anyone who has spent five minutes studying for a Series 7 knows about SIPC. At no point did Cramer make an effort to clear up would could be confusing. Plus, he goes the extra step of saying that “Bear Stearns is not in trouble.”
In today’s WSJ, James Stewart writes that “Bear Stearns didn’t have a retail brokerage operation and didn’t cater to individual investors.” The firm did (and I suppose, does) have a small retail operation but that’s only for high net worth individuals. I looked at Bear’s website and they don’t even have an office here in Washington, DC. Once any trouble hit, I would think that those brokers informed their clients as soon as possible. In high-net worth money management, clients aren’t typically kept in the dark.

Raise the Price
Posted by Eddy Elfenbein on March 19th, 2008 at 8:08 am

I really don’t see how Bear shareholders will approve the $2 deal. Apparently, I’m not alone. The stock is currently at $6 and it went as high as $8 yesterday.
Part of that the buying is being driven by BSC creditors (hedge funds, mainly) who don’t mind taking a small equity loss in exchange for a big debt gain—they just want the deal done. No one knows how much equity Bear truly has, but there’s around $300 billion of Bear Stearns bonds out there. If the whole mess goes to a bankruptcy court, then the stock holders go to the back of the line.
Of course, the debtor’s strategy could backfire if the price goes too high and JPM gets cold feet. Still, I doubt that would happen. As always, one shouldn’t fight the Fed.
I would say that the most likely outcome is that JP Morgan will sweeten the offer. To add some context, it’s really not that much for them. The company’s market value has already increased by $20 billion this week. The offer for Bear will cost them $236 million. What’s the big deal if they double or even triple it? Plus, it could win them some goodwill. Dimon is a very smart guy, and it might be a shrewd move to get out in front of what could become very unpleasant. If I were him, I’d meet with Joe Lewis, Legg Mason and other major BSC holders. He’s already won big. He can afford to be magnanimous.
On top of that, let’s not forget that JPM owns a gigantic call contract of whenever-$2s, and there’s also the building deal. Plus, it’s not unreasonable for the U.S. credit market to recover over the next few weeks. That could be a huge boon for BSC’s debt. To quote Michael Scott, it’s win-win-win. In fact, taxpayers could win as well.
I think we ought to move beyond the question of whether the Fed should be involved in—what I’ll call—a quasi-bailout. Instead, let’s look at the deal that was made, and it makes JPM look Putin-esque. The WSJ reminds us that it’s not uncommon for the government to make money off bailouts:

During the 1995 peso crisis, the Clinton administration offered Mexico $20 billion in loans, with the country’s oil revenues as security. The International Monetary Fund offered another $18 billion. Critics condemned the loans as a bailout. In the end, Mexico didn’t require the entire amount, and the country’s finances recovered. The U.S. ended up making a profit on the interest payments.
The government also turned a profit from the Air Transportation Stabilization Board, an entity set up after the Sept. 11 attacks to support the airline industry. The board ultimately provided a total of $1.56 billion in loan guarantees to six carriers. The government earned just under $350 million from fees and stock sales, according to the Treasury Department.

Last year, the Fed made a profit of $34 billion. It’s very possible that the central bank could make money on whatever they’ll get from Bear’s book. I still don’t understand who gets what. This seems to be a classic case of we don’t know what we don’t know. Perhaps the best move for the Fed is to hold the bonds to maturity.

Has Bill Miller Lost His Magic
Posted by Eddy Elfenbein on March 19th, 2008 at 7:42 am

Legg Mason Value Trust (LMVTX) has badly lagged the market since the beginning of 2006. It has only gotten worse recently.