I recently read "Irrational Exuberance" by Robert J. Shiller. This was the 2005 second edition which added some material about housing prices to the 2000 first edition which was about the stock market. Schiller's thesis in both cases was that prices were high by historical standards making expected future investment returns poor. Unfortunately although Schiller proved to be correct I didn't find this book very interesting.
One problem is that the book is dated. Arguments about whether we are in a stock market or housing bubble are less interesting ten or fifteen years later when we know the answer. There wasn't a lot in this book that was new to me. Another problem is that Shiller sometimes makes his arguments in a somewhat simpleminded way. For example he cites (p. 47-49) the rise of 401(k) plans as a factor increasing demand for stocks. But of course traditional defined benefit pension plans also invested in stocks. So it is not clear that shifting to defined contribution plans makes much difference. As another example Shiller claims (p. 177) that "... the efficient markets theory asserts that all financial prices accurately reflect all public information at all times." But this is the most simplistic form of the theory, a more sophisticated version allows for some imperfections that can only grow to the point where they can be profitably exploited by the smartest best capitalized investors. This deals with Shiller's later objection (p. 179) that without some profitable trades the smart money would not stick around to keep prices in line.
Shiller spends considerable time dealing with the objection that we can't be in a bubble because bubbles are impossible. Apparently this isn't really a strawman as it seems there are reputable economists who believe something like this. Still I find it hard to take this objection seriously and am not that interested in lengthy refutations. In general I thought the book was too long, that the main ideas could have been presented more concisely. I also found some of the advice unconvincing. Schiller is big on hedging as a form of insurance. But insurance generally costs money and may not be worth it.
In summary although Shiller is correct in his major claim that asset prices can get out of line I didn't find this book very compelling and so can't recommend it.
Saturday, June 14, 2014
Monday, June 2, 2014
Mad Men
On May 23, 2014 Elliot Rodger went berserk and killed 6 people before committing suicide. For several reasons the incident received an unusual amount of publicity and various people with axes to grind have attempted to draw lessons from it. However I think the main lesson is just that crazy people sometimes do crazy things.
Most incidents like this are perpetrated by mentally ill people and this case doesn't appear to be an exception. Of course there is some danger of circular reasoning when there is little independent evidence of mental problems prior to a killing spree. However that was not the case here.
I would define mental illness as mental abnormalities which cause problems for the subject. By this standard it was clear to many of the people around him that Rodger was mentally ill. What was not so clear was that he was dangerous. It may also be that his mental illness was not of a common type like paranoid schizophrenia but this does not mean he wasn't mentally ill at all. He was obviously abnormal.
It is a mistake to ascribe too much meaning to the actions of a crazy person. Their erratic random actions will sometimes by pure chance appear carefully planned. This doesn't mean they were. In this case Rodger achieved great notoriety in death but I am unconvinced that was his plan.
Most incidents like this are perpetrated by mentally ill people and this case doesn't appear to be an exception. Of course there is some danger of circular reasoning when there is little independent evidence of mental problems prior to a killing spree. However that was not the case here.
I would define mental illness as mental abnormalities which cause problems for the subject. By this standard it was clear to many of the people around him that Rodger was mentally ill. What was not so clear was that he was dangerous. It may also be that his mental illness was not of a common type like paranoid schizophrenia but this does not mean he wasn't mentally ill at all. He was obviously abnormal.
It is a mistake to ascribe too much meaning to the actions of a crazy person. Their erratic random actions will sometimes by pure chance appear carefully planned. This doesn't mean they were. In this case Rodger achieved great notoriety in death but I am unconvinced that was his plan.
Sunday, June 1, 2014
The Buy Side
I recently read "The Buy Side", a 2013 Wall Street memoir by Turney Duff. Duff tells the story of his Wall Street career which was reasonably successful until he was brought down by abusing drugs. I didn't care for it. Much of the book is devoted to his struggles with drugs (especially cocaine) and I have never found drug fiends particularly sympathetic or interesting.
I am more interested by the business aspects of Wall Street and Duff doesn't offer much insight into them. Duff worked on the "buy side" (hence the title of his book) which meant he was employed by hedge funds to trade their portfolios, buying and selling stocks. Sometimes he was told what trades to make, at other times he had discretion to establish his own positions. In both cases for reasons that are unclear to me (and which Duff makes no attempt to explain) the hedge funds that employed him were willing to pay millions of dollars in inflated commissions. Naturally this made Duff a very popular man with his counterparties on the "sell side" as their incomes were directly tied to how much of his trading Duff chose to do with them. They showed their appreciation by extravagant entertaining which included in Duff's case supplying drugs. Duff proved unable to handle the drugs in the long run perhaps in part because he wasn't really happy with his job even when he was doing well (1.8 million in his best year by his account). Duff ended up in rehab twice when his drug abuse rendered him unable to perform adequately at (or even at times show up for) work. By his account he still had employment possibilities on Wall Street even after his second stint in rehab but chose to try and become a writer instead.
Duff worked for a time for Galleon Group which has since been brought down by an inside trading investigation which led to Galleon's founder, Raj Rajaratnam, being convicted and sentenced to 11 years. Duff didn't like Rajaratnam and depicts him as engaging in a variety of questionable behavior. But fortunately for Duff he had left well before Galleon got in trouble with the law. Duff himself admits to performing acts at work (at Galleon and elsewhere) of dubious legality. At times he is worried that this (or his drug use) is under investigation and will get him arrested but it appears these worries were unfounded (possibly just drug induced paranoia). Duff doesn't appear concerned that his book will cause him legal problems and as a practical matter having left Wall Street he is probably not a high priority for prosecution.
The main point I would take from this book is that there is a lot of extravagance and waste on Wall Street ultimately funded by excessive client fees. Fortunately these fees can often be avoided (or at least substantially reduced) if you are on your guard which I would certainly recommend when dealing with Wall Street.
While this book contained a few points of interest I don't recommend it. It is pretty long and I didn't find it compelling. Michael Lewis's Wall Street memoir "Liar's Poker" is much better and I also liked "A Colossal Failure of Common Sense" more although I didn't recommend it either.
I am more interested by the business aspects of Wall Street and Duff doesn't offer much insight into them. Duff worked on the "buy side" (hence the title of his book) which meant he was employed by hedge funds to trade their portfolios, buying and selling stocks. Sometimes he was told what trades to make, at other times he had discretion to establish his own positions. In both cases for reasons that are unclear to me (and which Duff makes no attempt to explain) the hedge funds that employed him were willing to pay millions of dollars in inflated commissions. Naturally this made Duff a very popular man with his counterparties on the "sell side" as their incomes were directly tied to how much of his trading Duff chose to do with them. They showed their appreciation by extravagant entertaining which included in Duff's case supplying drugs. Duff proved unable to handle the drugs in the long run perhaps in part because he wasn't really happy with his job even when he was doing well (1.8 million in his best year by his account). Duff ended up in rehab twice when his drug abuse rendered him unable to perform adequately at (or even at times show up for) work. By his account he still had employment possibilities on Wall Street even after his second stint in rehab but chose to try and become a writer instead.
Duff worked for a time for Galleon Group which has since been brought down by an inside trading investigation which led to Galleon's founder, Raj Rajaratnam, being convicted and sentenced to 11 years. Duff didn't like Rajaratnam and depicts him as engaging in a variety of questionable behavior. But fortunately for Duff he had left well before Galleon got in trouble with the law. Duff himself admits to performing acts at work (at Galleon and elsewhere) of dubious legality. At times he is worried that this (or his drug use) is under investigation and will get him arrested but it appears these worries were unfounded (possibly just drug induced paranoia). Duff doesn't appear concerned that his book will cause him legal problems and as a practical matter having left Wall Street he is probably not a high priority for prosecution.
The main point I would take from this book is that there is a lot of extravagance and waste on Wall Street ultimately funded by excessive client fees. Fortunately these fees can often be avoided (or at least substantially reduced) if you are on your guard which I would certainly recommend when dealing with Wall Street.
While this book contained a few points of interest I don't recommend it. It is pretty long and I didn't find it compelling. Michael Lewis's Wall Street memoir "Liar's Poker" is much better and I also liked "A Colossal Failure of Common Sense" more although I didn't recommend it either.
Monday, May 19, 2014
Property Tax
Thomas Piketty in an interview for a British think tank suggests property taxes should be assessed based on your equity in a property (value less debt) not on value:
But it is perfectly possible at the national level to transform our traditional forms of property taxation, which are typically proportional and which do not take into account financial assets and financial liabilities, because they were set up in the nineteenth century when most property was real estate property, so they do not take into account financial wealth and liabilities. This can be turned into a progressive tax on net wealth, which basically would be a way to reduce property tax –council tax in the UK – for the vast majority of the population. Typically, if you have a house that is worth £500,000, but you have a mortgage of £490,000, you are not rich – you have a net wealth of £10,000, so you should pay less than someone who has no mortgage or who paid off his or her mortgage many years ago.
This makes little sense for US property taxes on owner occupied housing as I will explain. Piketty is correct that someone with a mortgage on their house is less well off than someone who owns their house free and clear. However this is already taken into account in the US tax code through the mortgage interest deduction in the federal income tax code. Although this deduction is often cited as a loophole it has always made sense to me. But I don't think it makes sense to provide a second reduction in your taxes for having a mortgage. In fairness to Piketty many countries don't have a mortgage interest deduction in their income tax code in which case his equity argument above has more force. But in those cases a simpler fix is to add a mortgage interest deduction.
I had previously though the real loophole regarding taxes and owner occupied housing was that the imputed rent on an owner occupied house is not included in income. But while thinking about this it occurred to me that property tax is roughly equivalent to an income tax on imputed rent. (This idea is not original to me but I had not encountered it before.) So besides the practical problems in trying to assess and tax imputed rent as income there is a theoretical case for excluding it as well. Of course if property taxes are a surrogate for income tax on imputed rental income they should ignore mortgage debt as this doesn't affect the imputed rental income you are receiving by living in your house.
A complication in thinking about tax breaks on owner occupied housing is that any benefits tend to be reflected in selling prices and hence make less difference to new buyers than might be expected.
But it is perfectly possible at the national level to transform our traditional forms of property taxation, which are typically proportional and which do not take into account financial assets and financial liabilities, because they were set up in the nineteenth century when most property was real estate property, so they do not take into account financial wealth and liabilities. This can be turned into a progressive tax on net wealth, which basically would be a way to reduce property tax –council tax in the UK – for the vast majority of the population. Typically, if you have a house that is worth £500,000, but you have a mortgage of £490,000, you are not rich – you have a net wealth of £10,000, so you should pay less than someone who has no mortgage or who paid off his or her mortgage many years ago.
This makes little sense for US property taxes on owner occupied housing as I will explain. Piketty is correct that someone with a mortgage on their house is less well off than someone who owns their house free and clear. However this is already taken into account in the US tax code through the mortgage interest deduction in the federal income tax code. Although this deduction is often cited as a loophole it has always made sense to me. But I don't think it makes sense to provide a second reduction in your taxes for having a mortgage. In fairness to Piketty many countries don't have a mortgage interest deduction in their income tax code in which case his equity argument above has more force. But in those cases a simpler fix is to add a mortgage interest deduction.
I had previously though the real loophole regarding taxes and owner occupied housing was that the imputed rent on an owner occupied house is not included in income. But while thinking about this it occurred to me that property tax is roughly equivalent to an income tax on imputed rent. (This idea is not original to me but I had not encountered it before.) So besides the practical problems in trying to assess and tax imputed rent as income there is a theoretical case for excluding it as well. Of course if property taxes are a surrogate for income tax on imputed rental income they should ignore mortgage debt as this doesn't affect the imputed rental income you are receiving by living in your house.
A complication in thinking about tax breaks on owner occupied housing is that any benefits tend to be reflected in selling prices and hence make less difference to new buyers than might be expected.
Saturday, May 17, 2014
FiveThirtyEight
Nate Silver launched a new version of his FiveThirtyEight website on ESPN a couple of months ago. I liked the previous versions (most recently associated with the New York Times) which mostly covered the horse race aspect of national politics but find the new site a disappointment. In my view the problem is the new site doesn't make enough predictions. Making (and explaining) predictions is useful because it encourages you to develop models that focus on what's important. And it has the commercial advantage of driving traffic as people check back to see how the predictions are changing. During the Presidential election campaign I would check the FiveThirtyEight website regularly to get the Silver's latest odds.
It would have been straightforward to extend FiveThirtyEights politics coverage model to sports. The four major US team sports (baseball, basketball, football and hockey) crown a champion every year. So each year you have the equivalent of a Presidential election campaign. And FiveThirtyEight could offer regularly updated estimates of the chances of each team advancing to each level on the way to the championship. Along with the predictions FiveThirtyEight could have posts explaining the models used to generate them. I would find this interesting just as I found the analogous politics coverage interesting. And from a commercial point of view more people care about sports than politics.
Extending the coverage model to areas other than sports is a bit harder as you don't have the same campaign analogs. And often the data isn't as good. Still there are plenty of things you could try to predict. How will stock prices, federal tax receipts, oil prices etc. evolve over time? It should be possible to find a variety of things about which interesting predictions could be made.
But instead of systematically developing models and using them to attempt to predict things that people care about FiveThirtyEight has too many posts like this one on how Americans like their steaks cooked. The internet is full of random data like this and it is unclear why we are expected to find it of particular interest.
So to sum up, in my opinion the new FiveThrityEight has changed for the worse.
It would have been straightforward to extend FiveThirtyEights politics coverage model to sports. The four major US team sports (baseball, basketball, football and hockey) crown a champion every year. So each year you have the equivalent of a Presidential election campaign. And FiveThirtyEight could offer regularly updated estimates of the chances of each team advancing to each level on the way to the championship. Along with the predictions FiveThirtyEight could have posts explaining the models used to generate them. I would find this interesting just as I found the analogous politics coverage interesting. And from a commercial point of view more people care about sports than politics.
Extending the coverage model to areas other than sports is a bit harder as you don't have the same campaign analogs. And often the data isn't as good. Still there are plenty of things you could try to predict. How will stock prices, federal tax receipts, oil prices etc. evolve over time? It should be possible to find a variety of things about which interesting predictions could be made.
But instead of systematically developing models and using them to attempt to predict things that people care about FiveThirtyEight has too many posts like this one on how Americans like their steaks cooked. The internet is full of random data like this and it is unclear why we are expected to find it of particular interest.
So to sum up, in my opinion the new FiveThrityEight has changed for the worse.
Sunday, May 11, 2014
Target
Target's CEO, Gregg Steinhafel, recently resigned under pressure. Megan McArdle doesn't approve. I find her arguments unconvincing. First while Steinhafel was not directly responsible for the data breach as CEO he bears a general responsibility for everything that happens at Target. It was his job to see that Target's data systems were staffed by competent people and that they were given sufficient resources to keep Target's systems secure. Second the data breach is not Target's only problem. Their expansion into Canada has not been successful to date hampered by what appear to be multiple failures to execute. Again this is the general responsibility of the CEO even if some of his underlings were more directly responsible. And there may be additional non-public issues. For example the board may have lost confidence that Steinhafel was giving them accurate reports. Naturally it is difficult for an outsider to evaluate Steinhafel's performance. Perhaps he has just been unlucky. But as a Target shareholder I am not going the second guess the board's apparent decision that a change at the top was needed.
Of course changing the CEO is a drastic move which shouldn't be undertaken lightly. It suggests the board thinks Target is facing serious problems. So it is not surprising the stock dropped on the news that Steinhafel was out. As I noted back in January I had kind of lost faith in this stock pick. I considered selling but didn't pull the trigger. Perhaps I should have but at this point I think I will wait and see a bit. Which is my natural inclination anyway.
Of course changing the CEO is a drastic move which shouldn't be undertaken lightly. It suggests the board thinks Target is facing serious problems. So it is not surprising the stock dropped on the news that Steinhafel was out. As I noted back in January I had kind of lost faith in this stock pick. I considered selling but didn't pull the trigger. Perhaps I should have but at this point I think I will wait and see a bit. Which is my natural inclination anyway.
Tuesday, May 6, 2014
Annual Funding Notice
Last week I received the Annual Funding Notice for the IBM Personal Pension Plan (which is paying me a pension). Rather than require companies to adequately fund their pension plans Congress instead makes them send all participants annually a report on their plan's financial status. This is pretty pointless as most people won't get much from the disclosure. Pension accounting is inherently complicated and to make matters worse current rules are full of loopholes which can make a plan appear to be in better shape than it actually is. So the report is pretty opaque. And even if your plan is currently in good shape the weak regulations mean it may not stay in good shape. So I expect most people pay little attention to this notice and just hope for the best.
This year I actually tried to understand the report. Although the IBM plan is relatively easy to evaluate because it was frozen some years ago (which means participants are no longer accruing benefits) this proved rather difficult. Besides the notice for this year (2013) I looked at prior year notices, the 2013 IBM annual report and documents on the Department of Labor website for 2012 (the documents for 2013 aren't available yet). As best I can tell the only numbers in the notice worth paying attention to are in the "Fair Market Value of Assets" section. For IBM this says:
As of December 31, 2013, the fair market value of the Plan's assets was $53,953,692,333. On this same date, the Plan's liabilities were $47,920,350,174.
The key points here are that the valuation date is at year's end (as opposed to 1/1/2013 or earlier elsewhere in the notice) so is relatively recent. The assets are valued at fair market value which is fairly straightforward as opposed to elsewhere in the notice where a bogus accounting value can be used (although IBM does not do this) based on what the assets would have been worth if the plan had achieved its expected rate of return. Valuing the plan liabilities is a bit less straightforward as you have to figure the present value of future obligations which requires choosing a discount rate. This should be determined by looking at the current yields of safe bonds which is not that complicated. However elsewhere in the notice an artificially high discount rate is used which makes the plan liabilities look smaller than they really are. This artificially high rate is a recent loophole created by Congress to allow companies to reduce their contributions to their pension plans while pretending they are adequately funded. The notice for 2012 in the Fair Market Value section using a realistic (or at least more realistic) discount rate valued the plan liabilities at $52,939,309,074 (at 12/31/2012) while the artificially low discount rate used elsewhere in the 2013 notice gave a plan liability value of $40,044,112,196 (at 1/1/2013) which illustrates the magnitude of the loophole. The actual discount rates used in the Fair Market Value section are not stated in the notice. The IBM annual report lists discount rates of 4.5% and 3.6% for year end 2013 and 2012 respectively which may be the rates being used. As best I can tell the present value of future plan administrative costs aren't included in plan liabilities which means they are understated a bit. Still the IBM plan appears to be in reasonable shape. And since it is frozen it less dependent on regular additional funding from IBM than active plans.
IBM assumes an 8% annual return on its US pension fund investments. This is too high in the current environment but doesn't affect the above liability numbers as IBM (as a private company) is not allowed to discount plan liabilities using this rate. In contrast public entity pension plans can and do discount their liabilities using their assumed rate of return (which is typically in the 7% to 8% range) thus grossly understating their actual liabilities. IBM's assumed rate does affect IBM's reported earnings.
This year I actually tried to understand the report. Although the IBM plan is relatively easy to evaluate because it was frozen some years ago (which means participants are no longer accruing benefits) this proved rather difficult. Besides the notice for this year (2013) I looked at prior year notices, the 2013 IBM annual report and documents on the Department of Labor website for 2012 (the documents for 2013 aren't available yet). As best I can tell the only numbers in the notice worth paying attention to are in the "Fair Market Value of Assets" section. For IBM this says:
As of December 31, 2013, the fair market value of the Plan's assets was $53,953,692,333. On this same date, the Plan's liabilities were $47,920,350,174.
The key points here are that the valuation date is at year's end (as opposed to 1/1/2013 or earlier elsewhere in the notice) so is relatively recent. The assets are valued at fair market value which is fairly straightforward as opposed to elsewhere in the notice where a bogus accounting value can be used (although IBM does not do this) based on what the assets would have been worth if the plan had achieved its expected rate of return. Valuing the plan liabilities is a bit less straightforward as you have to figure the present value of future obligations which requires choosing a discount rate. This should be determined by looking at the current yields of safe bonds which is not that complicated. However elsewhere in the notice an artificially high discount rate is used which makes the plan liabilities look smaller than they really are. This artificially high rate is a recent loophole created by Congress to allow companies to reduce their contributions to their pension plans while pretending they are adequately funded. The notice for 2012 in the Fair Market Value section using a realistic (or at least more realistic) discount rate valued the plan liabilities at $52,939,309,074 (at 12/31/2012) while the artificially low discount rate used elsewhere in the 2013 notice gave a plan liability value of $40,044,112,196 (at 1/1/2013) which illustrates the magnitude of the loophole. The actual discount rates used in the Fair Market Value section are not stated in the notice. The IBM annual report lists discount rates of 4.5% and 3.6% for year end 2013 and 2012 respectively which may be the rates being used. As best I can tell the present value of future plan administrative costs aren't included in plan liabilities which means they are understated a bit. Still the IBM plan appears to be in reasonable shape. And since it is frozen it less dependent on regular additional funding from IBM than active plans.
IBM assumes an 8% annual return on its US pension fund investments. This is too high in the current environment but doesn't affect the above liability numbers as IBM (as a private company) is not allowed to discount plan liabilities using this rate. In contrast public entity pension plans can and do discount their liabilities using their assumed rate of return (which is typically in the 7% to 8% range) thus grossly understating their actual liabilities. IBM's assumed rate does affect IBM's reported earnings.
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