Robert H. Heath

Supreme Court's Ruling Deals a Blow to Big Media

"And if this technology isn't a violation of copyright laws, what's next?"

I think the situation is more ambiguous than this, which is undoubtedly why the Supreme Court declined to hear the Cablevision case. You can draw a pretty clear line from the Betamax definition of "fair use" to the "networked PVR" proposed by Cablevision.

en.wikipedia.org/wiki/....

If making a copy of a broadcast show is fair use under copyright law, it shouldn't matter whether the copying device is owned by me and located in my house (like a VCR or DVR) or in my brother-in-law's house, or arguably on a Cablevision server.

That said, I don't think we've heard the last of this issue. When I watch a recorded show on my TiVo, there's no explicit economic transaction involved. If Cablevision explicitly charges for the network DVR feature, it does feel like they're "re-broadcasting" for profit. And even if the cost of the feature is bundled into a monthly subscription, the broadcasters will see no distinction between an explicit or implicit charge.

So at the end of the day, network PVR functionality will likely be offered on terms that (at least some) broadcasters reluctantly find acceptable. This may preclude fast-forwarding through ads, forcing viewers to engage in old-fashioned ad avoidance like going to the bathroom, or to the fridge, or another channel for five minutes.

The cost of storage and video compression technology will continue to plummet, making DVR technology in some form a mass market product. As DVRs are quite a bit easier to operate than VCRs, it seems reasonable that in ten years, DVR may achieve near-universal household penetration (in the U.S.) like VCR did before it.

Forward-looking broadcasters may actually prefer to see networked DVR (with limitations) established as an alternative to forestall standalone DVR penetration (without such limitations). Likewise, cable networks with small audiences may gain meaningful viewership through readily available time-shifting.

I think the Supreme Court is wise to duck this case now. Any fine-tuning of Betamax based on the physical architecture of the network and recording devices involved would likely be obsolete before the law profession could sort out its implications.

Moreover, if over-the-air broadcasters -- who currently enjoy "must carry" privileges on cable systems -- move towards negotiated carriage fees as CBS has suggested it might, one can reasonably expect that network PVR rights will be part of that discussion.

During this period of rapid technological and regulatory upheaval, the Supremes are wise to let the market sort this out.

The Unraveling of Newspaper Economics

259326 -

Thanks for your kind comments.

I wrestled with the issue of how to present cause-and-effect regarding bundling and monopoly.

It's certainly easier for bundling to work in the presence of a distribution monopoly and in the extreme case, bundling won't work in a purely competitive and transparent market in which the bundled goods are priced separately and more cheaply. But bundling doesn't require a monopoly to work as a pricing strategy.

As I recall it, bundling can be effective if consumers have heterogeneous demands (you prefer the business news, I like the comics and weekend section) and the firm cannot price discriminate.

In the newspaper industry, it's certainly true that newspapers bundled all manner of content back in the day when most cities had at least two major papers or more.

My diagram suggests a one-way causal relationship, which is a limit of a two-dimensional diagram and perhaps my creativity. In reality, I think all these factors reinforced each other in a "complex" and self-reinforcing relationship.

And yes, "surplus economics" is "profit". I chose the former term to emphasize my belief that even if newspapers could instantaneously transition their businesses to the web, eliminate their newsprint and physical distribution costs and successfully deploy micro-payment and subscription models, it still might not provide the same profit as their old business model because they can no longer expect the economic benefits of bundling third-party content that's readily available (often for free) elsewhere on the web.

Thanks again.

Why We Should Ban Reverse Converts

Felix -

First, a logical point. You can't mock Indiviglio for saying:

"Its usefulness must be clear to someone — otherwise there would be no market demand for the product, and one never would have been sold,"

when you yourself use the same positivist line of reasoning when you assert the contrary based on the same observation:

"The fact is that if these things made sense, they’d be much more popular..."

References:
Indiviglio: business.theatlantic.c...

Salmon: blogs.reuters.com/feli.../

If the debate is whether reverse converts should be banned by some regulator, it's pointless to point to their existence and assert they're popular (not popular enough) therefore they should (should not) exist. This is rhetoric, not logic.

Second point: You're spot on that these securities are complex and misunderstood as evidenced by the comment streams on the relevant blogs which tend to conflate naked-put and covered call positions.

Third, the best piece on this topic is by Mike over on Rortybomb at

rortybomb.wordpress.co.../

Anybody who's writing on this subject should be thinking, "I wish I'd written that article." If you're not, you probably still don't fully understand the topic. Re-read Mike's article.

He makes a compelling case why an investor should be skeptical of these products as indeed any investor should be especially skeptical of any product that combines multiple embedded securities. One should always ask the question, why is it more efficient to buy these securities bundled together when I could buy them separately?

But as I read his post, I believe his conclusion is that these sorts of products should meet a very high threshold of disclosure, not that they should be banned outright. If the disclosure requirement is such that an investor that actually reads it would always decline to invest, so be it. But that's an argument for transparency, not prohibition.

Fourth, arguments based on the ex post returns of a security don't carry any weight (which is the fundamental weakness of the original WSJ article). You can find any number of investments that lost 30% of their value last year, for example almost any publicly listed stock around the world. Should we, therefore, ban retail investment in individual stocks? Of course not. A security should be evaluated by its ex ante expected return and risk characteristics, and I would like to meet the regulator who's smarter than the market in this regard AND willing to work for $125,000 per year at the SEC.

Finally, I am sympathetic to the argument that the specific risks of these securities were not well understood by the investors who bought them or the brokers who sold them. So you have a point that something marketed as *bond* which contained an embedded naked put is arguably misleading, perhaps bordering on false advertising. To stretch Elizabeth Warren's analogy too far, it's a bit like marketing a propane torch as a toaster because they're both capable of browning a slice of bread.

But I still come out for better disclosure as opposed to an outright ban by a paternalistic regulator. The vast majority of investors failed to accurately assess the odds of a 30% decline in global equity markets (not to mention most commodity markets and high-yield bonds). If they had, market values never would've reached the levels from which they fell. If you want a regulator to police the quality of investment opportunities (as opposed to the quality of disclosure) you need to articulate a method for systematically identifying regulators who are smarter than the market.

The Reverse-Convert Scam

It's a shame the WSJ article wasn't better researched and written.

It's too easy to do a drive-by shooting of a financial product by finding a few photogenic "victims" after it's fallen in value by 30%. You could write the same article about an S&P index fund if you could find an investor who will declare no one told him the market could go down 30% in a year.

That said, it's hard to find much good to say about a reverse convert, which was undoubtedly marketed to retail investors who didn't understand it by brokers who probably understood it less (other than the 2-3% upfront fee part).

As you say, the product is essentially a loan to the issuing bank married to a deep (so it seemed) out-of-the-money short put position on a unrelated stock. How any investor benefits by marrying these two unrelated investments is a bit of a mystery.

I suspect the brokers sold it as an "enhanced yield" security whose downside risk was that you'd be buying blue-chip equities at attractive prices... a bit like parking your cash in Treasuries while waiting for the market to trade down to your limit buy order on YHOO. But of course the "enhanced yield" was really just a combination of the risk premium on the unsecured loan to the issuing institution, plus (some portion of) the premium received for writing the puts. If you really wanted a fixed income investment while rolling over out-of-the-money short put positions, why not just buy the Treasuries and sell the puts directly?

So call me cynic on this particular product.

I can, however, imagine a clever and benign financial engineer observing that deep out-of-the-money options are relatively expensive due to the "volatility smile". (Implied volatility of options increases as the strike price moves farther away from the underlying stock price, so if you graph implied volatility as a function of strike price, the graph forms a "smile" with the trough near the current stock price).

So this benign banker has a thesis that rolling over deep out-of-the-money puts can generate consistent cash flow as the seller collects the option premium and lets the puts expire unexercised. Now, he knows that your average doctor or dentist is not going to be talked into an aggressive out-of-the-money option selling program per se, but if it's repackaged as an enhanced yield debt security, he'll snap it up.

A behavioral finance adherent might see this as a framing issue, coaxing an investor into an investment that may have had attractive ex ante risk-return characteristics (even if ex post, they were not). A complete cynic will see it as borderline fraudulent marketing. As is usually the case, the real truth probably lies somewhere in between.

A more interesting article would've explored whether the investors were actually receiving a market return for the lending risk and put-writing program, or whether the sponsoring bank was getting a great deal.

Finally, it would have been interesting if Mr. Light had investigated the benefit to the issuing bank of creating a universe of "natural" sellers of out-of-the-money puts. Selling the other side of that trade as portfolio insurance has probably been pretty good business lately.

Gary Gorton Explains the Financial Crisis

Nicely written article.

Overconfidence and the Financial Crisis

As always, Gladwell provides a memorable descriptive observation, but an empty normative prescription.

What does it mean to "rein in" the expertise on Wall Street? And which "experts" should we hire to do it? And how shall we protect ourselves from their "acting like experts".

To paraphrase from the movie Spinal Tap, there's a fine line between "simple" and "simplistic".

How the CDS Market Makes Restructurings More Difficult

Alan Young's comment heads down the right path.

If the amount of debt "insured" by credit default swaps exactly equals the face value of debt outstanding, there is a compelling market solution to the problem Felix highlights. Namely, the "insurer" buys the debt from the insured party at par (even if they are currently trading at 20 cents on the dollar) then uses his legal standing as creditor to effect the workout that yields 45 cents on the dollar. The insured party is made whole, and the insurer who agreed to bear the risk of owning the bonds has his proper place at the restructuring discussion.

The problem arises when the face amount of CDS exposure dwarfs the actual debt outstanding. With 10x the face value of debt trading in the swaps market and bid:ask spreads of, let's say, 20x30 cents on the dollar, you can picture scenarios where speculators might want to buy the bonds with the intention to be obstructionist in a workout discussion to accelerate a defined event-of-default and payment under CDS hedges.

In this simplistic but, I think, representative example, the "true" resolution value of the bonds may be linked to the swap position of the bondholder. And so the value of the swaps (simplistically, par minus the market value of the bonds) is also linked to some characteristics of the bondholder/swap-holder. And just like that, when it matters most, the pricing model for the swaps includes some very important endogenous variables, which are essentially unforecastable.

Here's One U.S. Real Estate Market that Looks Healthy

Let's look at Campo's hypothesis.

Here's a graph of the year-over-year Case-Shiller Sales Pair counts by month for the Washington DC area. The Pair Counts represent the number of re-sales of homes previously tracked by the Case-Shiller index. (I've used the data for home sales only, these exclude condo sales.)

www.scribd.com/doc/143...

There is some evidence of a spike in DC area home sales in the month of January following a presidential election relative to the prevailing trend, but the effect is hardly universal. In '89 and '93, corresponding to the elder Bush's election and the first Clinton administration respectively, we see a clear spike. The transition to the second Clinton administration in '97 demonstrated no clear spike, and that's not terribly surprising.

Interestingly, Bush the younger's inauguration does not reveal a spike, perhaps lending credence to those who think his administration was largely populated by Beltway insiders and some of his father's re-treads.

The '05 spike for Bush's second term is probably related to the housing bubble reaching its zenith rather than a re-population of the administration.

And finally, there is a "relative spike" in '09 corresponding to Obama, but the Y-o-Y change is still flat.

Conclusion: Administration changes MAY have a measurable impact on short term housing sales in the DC area.

Keep in mind that Washington DC is not Northern Virginia, and the Case-Shiller Pair Counts do not include all sales, only repeat sales in their database. Also, this data is for home sales only; it excludes condo sales.

Source data is available here:

www2.standardandpoors....

Too Many or Too Few Narratives?

I think the reality is that the administration is b) [hopeful, but not sufficiently] "confident that markets are irrationally depressed and think the government should push prices to fundamentals through the world's largest risk-arb operation," but also realize that c) "... we have no choice because the banks have us by the plums."

This is identical to Treasury's mid-September position when TARP purchases were intended to help clear the market for "temporarily" troubled assets, without any real details on how the price discovery process was going to simultaneously protect taxpayers' investments AND shore up the banks' balance sheets.

On this particular point, it's hard to find any distinction between the Bush and Obama policies.

Another Reason Why Inflation Is a Good Idea

Ditto on ding's comment... "targeted inflation" is technically an oxymoron. Inflation is general rise in prices and therefore doesn't change the relative cost of things.

In fact, I think you could make an argument that inflation is a bad thing if you're concerned about the environment since the prices of input factors that go into a product's cost explicitly increase whereas the "price" of externalities that are not explicitly measured (unless by legislation, enlightened self-interest or some other motive) do not appear to change, making the "green" trade-off appear relatively more costly.

Economic Risks Were a Result of Bad Assumptions, Not Bad Intentions

Good article... I expect the flamethrowers to come out for this one.

Surely there were lower-level traders who knew -- or at least suspected -- that a number of their trades were likely to blow up. And most of them probably knew that their internal capital charges were too low for the risks they were taking. Most probably thought they were being exceedingly clever by selling off the "junk" tranches in mortgage securities and keeping only the "super safe" AAA-rated pieces, which booked a spread profit vs. the low capital charge.

But I agree that higher-ups were less blinded by greed than by some combination of ignorance and complacency. The complexity of CDO-squareds and CDO-cubeds make it difficult even today to unravel their true values, so it's understandable that a busy CEO had to defer to his trading desk's (and risk managers') views on value. Moreover, there's a corollary to the old question "If you're so smart, why aren't you rich" that creeps into Wall St's mentality during boom times. Specifically, people start to think, "If he's so rich, he must be smart." As a consequence, rich guy's opinions tend to carry more weight and recent success inevitably leads to greater influence and overconfidence.

At the end of the day, Jimmy Cayne of Bear Stearns, Dick Fuld of Lehman Brothers, Stan O'Neal of Merrill Lynch and Chuck Prince of Citigroup are not poor by any normal yardstick. So yes, in a way they profited from the eventually fatal plunge into levered mortgages. But they are much, much poorer than they would've been if they'd said two (or three or four) years ago, "Stop, I'm not comfortable with this leverage... we'll concede some market share so I can sleep at night."

Even if you accept the caricature that they were motivated by pure greed, they all made a very bad trade. That, in a phrase, is forecast error.

Why I'm Short Selling Goldman Sachs

The investment case presented here is no more compelling than a coin flip.

Keep in mind GS will be reporting earnings soon and has made no pre-announcements. With GS, that usually means a positive surprise. With Treasury backstopping AIG, who in turn is using the money to post collateral on stock-lending arrangements and CDS exposures, GS is a major beneficiary. In down markets, GS and Morgan Stanley tend to win an increasing percentage of advisory business... little in the way of announced deals so far, but I'm sure GS is getting more than its share of mandates. Goldman's traders are pretty good, and volatility gives them more opportunities to exploit. There's been plenty of volatility this quarter.

Also, remember, GS sold stock to Warren Buffet and institutional investors in the $110 - $120 range late last year. With the stock pushing $100, and a little bump up from a good earnings report, GS might sell more stock, pay back TARP funds and become the only competitor not hamstrung by meddling Senators and Congressman.

I would expect the stock to go up, not down, if they pull this off.

Dow in Cautious Mode

Setting aside the ad hominem attacks, what you get when you buy Dow stock is:

The value of Dow's several operations (including the soon to be acquired ROH operations),

PLUS Dow's (and ROH's) investments in unconsolidated affiliates,

MINUS Dow's $9.5 billion of existing debt,

MINUS the $13 billion of soon to be incurred acquisition debt,

MINUS the $3.0 billion of preferred shares to be issued to Paulson & Co and the Hass family

PLUS the cash on DOW's and ROH's balance sheet. ($2.8 billion from DOW and $0.3 from ROH)

Adding it all up, what you get is the value of the DOW plus the ROH assets that exceeds $22.5 billion in <span style="font-style:ital... forma</span> net debt (defined as debt + preferred - cash).

With DOW's equity market cap at $6 billion as I write this, the market is essentially saying that DOW+ROH's operating businesses (and nonconsolidated affiiates) are worth $28.5 billion in total.

That's not the same thing as saying DOW shareholders are getting all DOW's business (ex Dow Ag) for "free".

On Mar 12 08:33 AM J-Lo wrote:

> you are the idiot... His comment was not referred to actually purchasing
> the whole company, but rather that the market cap (value of the whole
> company as relates to the current stock price) is relatively the
> same as what analysts say the actual value of Dow Ag is. So in essence,
> when you purchase Dow stock, you are purchasing a share in Dow Ag,
> but getting the rest for free.
>
>
>
>

Dow Chemical / Rohm & Haas Rhetoric Takes a Turn

I have to say these last few "ROH is caving..." posts are a near perfect example of the selective filtering investors engage in to justify a previously formed and strongly held opinion.

Todd - I encourage you to go back and read your posts with a critical eye. You write:

"Less than a month ago Dow Chemical (DOW) was begging Rohm & Haas (ROH) to come to the bargaining table. Now, after a new agreement with their lenders and some chiding from the judge, they are essentially telling Rohm, 'give us the deal we want or we'll see you in court'..."

"Notice the change? Dow has taken Rohm's arguments off the table..."

It would take a diviner of bird entrails or a cold war Kremlinologist to find any new information in the Sunday press release by Dow. But you seem to have found (as in earlier posts) evidence that ROH was caving. The reality is that ROH's comments on the matter have largely been "A deal's a deal" or "no comment". This is not the PR behavior of a company that's making concessions when they are in control of a negotiation.

ROH has had the upper hand in this negotiation from the start and Dow's available arguments in court have been the equivalent of a "Hail Mary" pass with one second left on the clock.

You seized upon the "60,000 jobs lost" argument, without (so it would seem) considering the absurdity of that claim as I indicated in this earlier response to one of your posts.

seekingalpha.com/user/...

See also Highwater 888 here:

seekingalpha.com/user/...

Finally, this comment from 'the surfer' explains very well why ROH had no incentive to cave on the $78 takeover price:

seekingalpha.com/user/...

At the end of the day, DOW's "What about all the lost jobs?" argument was based on the assumption that the original deal would leave them over-leveraged and vulnerable. But no judge was going to accept that argument without asking the question, "So how might you reduce the leverage?" And so we saw DOW lower its dividend for the first time in its history. That was pretty objective evidence that DOW was preparing to close the deal. And the news slipped out that DOW was shopping its AgroSciences business to raise cash. That was pretty objective evidence that DOW was preparing to close the deal. And DOW was accruing the ticking fee on the ROH deal... more objective evidence. And DOW was negotiating with its lenders to extend its bridge lines... more objective evidence.

(Here I find it ironic that you saw this renegotiation as essentially a "bad faith" ploy on DOW's part to install a credit downgrade trigger in the new loan terms, which would trip if the ROH deal closed, which would -- I'm not sure what you were thinking -- give DOW a financing out? No judge would tolerate a walk-away argument based upon DOW's affirmative attempt to sabotage it's own credit facilities, especially when the bridge lines were in place and the deal was fully financed on the ORIGINAL CLOSING DATE, which DOW breached.)

At the end of the day, it looks like the judge did a masterly job here. He pushed the parties to a renegotiation, he probably gave them some private instructions about his tolerance for certain arguments; and DOW was led to take actions that drove its stock price down to levels where the Haas family and John Paulson were willing to take some DOW paper in lieu of cash. Leverage problem solved; sanctity of private contract upheld.

While I'm sure he expressed some concern for the fate of 60,000 employees at DOW, I'm equally sure that the possibility of diluting DOW's existing shareholders was not going to be a factor in any equitable balancing of the various interests at play here.

On to the next deal...

Dow, Rohm Are Talking Again - Some Thoughts

I think you're right... it looks as if this isn't going to trial.