Monthly Archives: December 2011

a former MF Global CEO is now managing NYC pension investments

December 6, 2011 By in Derivative instruments, Industry Analysis, Investment firms, Portfolio management, Securities regulation, Trading Tags: , , , , , Leave a comment

in the Wall Street Journal

In an odd article at the top of the front page of  the December 1st Greater New York section of the Wall Street Journal, the newspaper heralds NYC’s hiring of Kevin Davis, a former CEO of MF Global, who was replaced there in late 2008.  Mr. Davis has been overseeing commodities investments for the city’s Bureau of Asset Management for about three months.   Lawrence Schloss, himself a former director of MF Global, selected Mr. Davis for the job, saying he has 26 years of experience and was the best candidate to apply.

details

The article goes on to to relate, without analysis or comment, that:

–Mr. Davis is earning a salary of $175,000–which is less than 1% of his compensation during his last full year at MF

–MF Global’s stock lost over 90% of it value during his tenure

–MF was subsequently sued by pension funds for misrepresenting its risk management practices, a case that MF recently settled by paying $90 million.

any significance?

There’s nothing in the article, other than its prominent placement, to indicate that there’s anything amiss with the hire.  And the placement may be more the result of political differences between the city Comptroller and News Corp than of anything else.

Two things strike me, however:

1.  NYC, like many government bodies, seems to be an advocate of the penny-wise-pound-foolish school of investment manager compensation.  A competent commodities person would make many times what the city is offering.  Mr. Davis may have been the only candidate to apply.

2.  The event that ultimately led to Mr. Davis’s demise at MF was discovery of $141 million in losses from unauthorized wheat trading by a broker in MF’s Memphis, Tennessee office.  According to theFinancial Times, the trader wasn’t a “rogue” who evaded management controls; the company’s computer systems weren’t programmed correctly.

Two years later, we’re finding again that MF Global’s computer recordkeeping systems are inadequate.  In fact, the records are in such a shambles that no one has been able to figure out how much customer money is missing from the firm–other than it’s a lot–or where it went.  I doubt Jon Corzine found top-notch recordkeeping systems when he arrived at MF and dismantled them (for what it’s worth, he doesn’t strike me as the kind of guy who would have looked in the first place).  My hunch is that they’ve been inadequate for a long time and that no one investigated properly, or extensively enough, after the 2008 trading losses.  There may well be much more to the MF Global story today than deficient computers.  But I think anyone using the in-house systems should have immediately realized their inadequacies and at least insisted they be fixed.

Macau gambling market results for November 2011: has a slowdown begun? …does it matter?

December 5, 2011 By in Casinos, China, Current Market Thoughts, Entertainment, Hong Kong, Industry Analysis, Recent Market Action, Stock ideas Tags: , , , , , , , , , , , , , , Leave a comment

the Tang report’s conclusion

Macau gaming stocks began a late-August swoon when Karen Tang of Deutsche Bank, an influential securities analyst in the Hong Kong market, published a report on the casino stocks there.  In it, she predicted that a sharp and protracted slowdown in spending by high-rollers in the Macau gambling market would soon begin.  According to Reuters, she said that revenue growth would slow to +34% year on year in October 2011, +32% in November and +20% in December. Growth might shrink to as little as +10% during 2012.

her reasoning?

Affluent Chinese were no longer spending on European-made luxury cars.  She and the DB economics department felt that this was the harbinger of a widespread pullback in consumption by the wealthy.  Finally, they thought, the affluent were succumbing to the Beijing government’s attempts to rein in economic growth on the mainland.

does the argument make sense? 

In my opinion, no.   There’s been no sign of falloff in any other area of Chinese luxury spending.  Maybe the new cars were ugly, or the potential buyers had no garage space left.  I’m not saying that Chinese gamblers aren’t going to spend less in Macau in the coming months.  That could happen.  I’m only observing that I don’t think the luxury car situation is evidence in favor of this conclusion.

I think Ms. Tang would have been better off arguing that the Macau casino stocks were fully priced for the best possible outcome and therefore had no near-term upside.  That would mean that they could only go sideways or down–reason enough to take some profit in the sector.

Nevertheless, the Tang report was enough to drive the sector down very sharply in late August and throughout September.  At one point, some stocks had lost close to half their value before beginning to rebound.  …and then the Europe-related selling began.

what does all this mean for us today?

Well, the November Macau gambling market results were posted on the website of the Macau Gaming Inspection and Coordination Bureau on the afternoon of December 1st.  Here they are:

Monthly Gross Revenue from Games of Fortune in 2011 and 2010
Monthly Gross Revenue Accumulated Gross Revenue
2011 2010 Variance 2011 2010 Variance
Jan 18,571 13,937 +33.2% 18,571 13,937 +33.2%
Feb 19,863 13,445 +47.7% 38,434 27,383 +40.4%
Mar 20,087 13,569 +48.0% 58,521 40,951 +42.9%
Apr 20,507 14,186 +44.6% 79,028 55,137 +43.3%
May 24,306 17,075 +42.4% 103,334 72,211 +43.1%
Jun 20,792 13,642 +52.4% 124,126 85,853 +44.6%
Jul 24,212 16,310 +48.4% 148,337 102,163 +45.2%
Aug 24,769 15,773 +57.0% 173,106 117,935 +46.8%
Sept 21,244 15,302 +38.8% 194,350 133,237 +45.9%
Oct 26,851 18,869 +42.3% 221,200 152,106 +45.4%
Nov 23,058 17,354 +32.9% 244,258 169,460 +44.1%

Source: Macau DICJ

As you can see from the bold figures, after being wildly wrong about October growth prospects, Ms. Tang seems to have predicted the November results reasonably accurately.

Is there any significance to the November prediction?  My guess is that there isn’t much meaning for the stock market, even if this turns out to be more than a lucky guess.  For one thing, the stocks are much cheaper today than they were when the original report came out.  For another, Beijing has just publicly signaled that it is reversing its money policy to favor GDP growth.  So stocks should now be beginning to discount a reacceleration of the gambling business in Macau–not a slowdown.

It will be interesting to see how the Hong Kong market evaluates this situation.  My hunch is that the mid-November lows will hold, but that the market will want to see at least the December market results before becoming more bullish.

the November 2011 Empoyment Situation report: upward revisions show a healing economy

December 4, 2011 By in economics, employment, Employment Situation report, Portfolio management, Strategy Tags: , , , , , , , , , Leave a comment

the report

Before the opening of equity trading in New York on Friday December 2nd, the Bureau of Labor Statistics released its monthly Employment Situation report for November.  The results:

–the establishment survey (of large companies and government agencies) showed that the economy added 120,000 jobs last month;

–the household survey (of 60,000 workers) indicated that the unemployment rate had dropped from 9% of the workforce to 8.6% .

As has been the case for over a year, the job additions are the result of stronger private sector performance— +140,000 jobs –and government sector weakness— -20,000 jobs — as states and municipalities continue to bring their spending back in line with revenues after years of excess.

the revisions

September figures underwent their second, and final, revision.  The initial report two months ago showed a gain of +103,000 jobs (+137,000 in the private sector, -34,000 in the public).  The October ES report revised that up to +158,000 (+191,000 private sector jobs, -33,000 public sector).  The current report revises the figures up again, to +210,000 (+220,000 in the private sector, -10,000 in the public).

October numbers were initially reported as +80,000 jobs (+104,000 private, -24,000 public).  The November ES report also revises October up, to +100,000 jobs (+117,000 private, -17,000 public).

Adding the initial November job gains to the most recent revisions for the prior two months indicates that the US economy has 200,000 more citizens working than we thought a month ago.

Over the past three months the economy has added about a half-million jobs .

economists’ reaction

Comments in the media by professional economists were, to my mind, surprisingly downbeat.

I can see three reasons for this:

–the quirky ADP employment report, which came out on Wednesday, showed the economy added +206,000 private sector jobs last month.  By contrast, the official figure of +140,000 looks a bit tepid.

–the 8.6% unemployment rate isn’t as positive as it seems.  Recent graduates looking for their first jobs aren’t counted as unemployed, nor are “discouraged” workers who have lost their jobs but quit looking for new ones.  Maybe this isn’t ideal. but it’s the way the unemployment rate calculation is designed.  The current drop in the unemployment rate appears mostly due to changes in non-counted groups.

–the monthly job gains need to be 200,000+ to begin to bring the unemployment rate down.

I think economists’ bearishness is overdone.   Today’s US economy is in a lot better shape than it was a year ago.  The private sector numbers are improving, and are at the point where enough new jobs are being created as here are new graduates coming into the workforce.  For some time, companies have been reporting shortages of workers in certain areas. And the most recent BLS report on job openings indicates there are still about three million private sector jobs as yet unfilled.

It could be a lot worse.

stock market reaction

It may sound a little too simple, but I think the stock market is coming to the conclusion that after six months all the money that’s going to be made by being bearish has already been made.

Yes, the future of the Eurozone is still a big issue.  But recent developments suggest that the outlines of a resolution are being sketched out now–and that the end result may not be nearly as bad as the consensus has been expecting.

So, I think the stock market is starting to look for reasons to be bullish.  The November ES report isn’t by itself a sufficient reason to be bullish, but it’s another confirming indicator.  My guess is that despite the negative tone I detect in economists’ and market commentators’ recent remarks Wall Street will continue to move higher.

 

 

 

 

the SEC, Citigroup and moral hazard

December 1, 2011 By in Banks, Derivative instruments, Industry Analysis, Investment firms, moral hazard, securities markets, Securities regulation, short selling, Where are the customers' yachts? Tags: , , , , , , , Leave a comment

This is an update and elaboration on my November 11th post about Judge Jed S. Rakoff, the SEC and Citigroup.

moral hazard

Moral hazard in finance is the situation where the existence of an agreement to share risks causes one of the parties to act in an extra-risky manner, to the detriment of the other.   In a sense, the willingness of the party who ultimately gets injured to enter into the agreement causes, or at least allows, the bad behavior by the other to occur.  He inadvertently sets up a situation where the bad behavior is rewarded, not punished.

examples

–Systematically important banks have been able to take very big proprietary trading risks, knowing that they are “too big to fail” and will ultimately be bailed out by the government if their risky bets don’t pan out.  The rewards of such risk-taking go as bonuses to the bankers; the cost of bets gone bad is borne by the general public.

–One of the reasons Germany is so hesitant to bail out Greece is that doing so rewards the latter country’s reckless borrowing behavior over the past decadeand shifts the costs of cleaning up the resulting economic mess onto the citizens of the rest of the EU.

the Rakoff case and moral hazard

Judge Rakoff has just rejected a proposed settlement of a case involving Citigroup and the SEC, on what appear to me to be similar moral hazard grounds.

The settlement involves Citi’s creation and sale of $1 billion in securities ultimately tied to a pool of sub-prime mortgages selected by the bank.  Citi neglected to tell the buyers of the securities that it wasn’t simply an agent.  It was making a $500 million bet that the securities would decline in value sharply–which they subsequently did.  Investors who bought the securities from Citi lost $700 million.

I don’t know precisely how much money Citi made on this transaction.  But I think I can make a good guess.  To make up rough numbers, collecting a 2% fee for creating and selling the issue would bring in $20 million or so.  A 70% gain on its negative bet on the issue would yield $350 million.  If so, the much more compelling reason for creating the issue would be to design it to fail and then short it.  In any event, let’s say Citi cleared $370 million before paying its employees who thought up and executed the total deal.

The proposed settlement?

–fines and penalties totaling $285 million

–Citi doesn’t admit or deny guilt, which means

——the settlement doesn’t create any evidence to support a lawsuit by the investors who lost money, and

——the settlement doesn’t trigger the sanctions against future illegal conduct that are contained in prior settlements with the SEC.

–only low-level Citi employees are reprimanded.

Assume the SEC allegations are all true.

If so, what a deal for Citi!  The SEC “punishment” is that the bank keeps $85 million in profits and gets a slap on the wrist.  Who wouldn’t agree?

What would make this moral hazard is that this is is the worst case outcome for Citi.

And, if you figure that the SEC looks at one suspicious deal out of ten, the situation is even less favorable for investors.  The decision whether to create another issue like this one is a layup.

Would it be so easy if Citi stood a chance of losing money?  …or of triggering clauses in prior settlements prohibiting illegal behavior?

What about the legal team that decided what he minimum disclosure in sales materials should be?  Would they have insisted that Citi must reveal its proprietary trading position in those materials if fines were larger, or if they could be held professionally liable for the information’s exclusion?

What if the Citi executives that okayed everything risked being barred from the securities business for a period of time–would they have acted in the way they did?

grandstanding?

I don’t think critics are correct that Judge Rakoff is trying to raise his public profile by insisting that the SEC either obtain a better settlement or go to trial with its case.  Others are saying that the SEC takes settlements like this because it doesn’t have the legal skill to get anything better.  But these are ad hominem arguments  –like saying the parties are wearing ill-fitting clothes, they’re distracting, but irrelevant.

But it is true that this case comes at a time of growing public anger that bank executives are showing few ill effects from the devastating economic damage they helped cause.

It will be interesting to see what new settlement the SEC and Citi come up with.

Stay tuned.