Continuous Productivity

Just a Reminder...

Contrary to popular opinion, housing prices will not necessarily rebound:

Moneyball Missed the Reserve Clause?

Great article arguing that although baseball is an inefficient market, it is not a completely free market:

The problem with likening the market for baseball players to an equity market is that the former is not a genuinely free market. The reserve clause binds players to the team that drafted them for the first six years of their career; during this time they cannot become free agents and sell their services to the highest bidder. So the intrinsic value of a highly productive player will rise, but he will not necessarily be paid his market value until he has completed his “indentured servitude” (as Lewis termed it). Thus it is not surprising that while payroll cannot tell us anything about wins, it does a pretty good job of predicting a team’s average age: young players are much cheaper.

To understand how much the reserve clause matters, let’s look at the young talent on the Oakland squad Lewis chronicled. Shortstop Miguel Tejada hit 30 home runs for the low, low price of $290,000 in 2000. Two years later, when he won the American League MVP, he made only $3.5 million (I know, but it’s all relative). His free agent contract, which he signed with the Baltimore Orioles after the 2003 season, was for $72 million over six years. Eric Chavez (whom the A’s actually did sign to a long-term market-value contract in 2004) produced 32 home runs in 2001 for $625,000.

Mark Mulder, Tim Hudson, and Barry Zito, the A’s “big three” pitchers, led the team to the 3rd, 2nd, 1st, and 1st American League ERA ranking, respectively, from 2000 to 2003. In 2001, when the A’s won 101 games, the combined salary of Tejada, Chavez, MVP-runner up and all-star first baseman Jason Giambi, Mulder (21 wins), Hudson (18 wins), and Zito (17 wins) was under $8 million. In the first year after each player’s “indentured servitude” ended, the six made a total of $43 million. The A’s won even though they were poor because they did not have to pay their young players what they were worth.

Giambi, who won the MVP in 2000, epitomizes the economics of baseball. He joined the Yankees as a free agent after the 2001 season. In that first year with his new team, he made more in salary than in the seven years he spent in the A’s organization combined. This turned out to be some deal for Oakland. As the San Francisco Chronicle’s Vlae Kershner recently pointed out, Giambi produced about half of his career home runs and RBIs in an A’s uniform. For that output, the team paid about 9 percent of his career earnings (up to the end of last season).

Just as the A’s could not have afforded to compete without the reserve clause during their “moneyball” run, no small-market team could compete without it today.

Why Athletes Go Broke?

An extremely irritating article that tries to tie in supposed athlete stupidity to the current financial mess:

Ismail played two years in Canada and 10 in the NFL, estimating that he earned $18 million to $20 million in salary alone. He made an abortive NFL comeback attempt in 2006, never getting beyond workouts with the Redskins, and then navigated the reality-TV circuit (Pros vs. Joes, Ty Murray's Celebrity Bull Riding Challenge). Today he does a Cowboys postgame show on Fox Sports Net. As cautionary tales go, Ismail's could've been worse: He has his Notre Dame degree, and he never filed for bankruptcy, had legal trouble or got divorced. Yet he lost several million dollars, he admits, through "total ignorance."

It began in the winter of 1991 when he sank $300,000 into the Rock N' Roll Café, a theme restaurant in New England designed to ride the wave of the Hard Rock Cafe and Planet Hollywood franchises. One of his advisers pitched the idea as "fail-proof, with no downsides," Ismail recalls. He never recouped his money and has no idea what became of the restaurant.

Lesson learned? If only. After that Ismail squandered a fortune funding not only that inspirational movie but also the music label COZ Records ("The guy was a real good talker," says Rocket); a cosmetics procedure whereby oxygen was absorbed into the skin ("We were not prepared for the sharks in the beauty industry"); a plan to create nationwide phone-card dispensers ("When I was in college, phone cards were a big deal"); and, recently, three shops dubbed It's in the Name, where tourists could buy framed calligraphy of names or proverbs of their choice ("The main store opened up in New Orleans, but doggone Hurricane Katrina came two months later"). The shops no longer exist.

You might say Ismail had a run of terrible luck, but the odds were never close to being in his favor. Industry experts estimate that only one in 30 of the highest-caliber private investment deals works out as advertised. "Chronic overallocation into real estate and bad private equity is the Number 1 problem [for athletes] in terms of a financial meltdown," Butowsky says. "And I've never seen more people come to me about raising money for those kinds of deals than athletes."

The article goes on to imply that the supposed higher rates of failure for athlete financial investments is that they are trying to hit a homerun:

Hunter, who in November 2007 signed a five-year, $90 million contract, has been able to absorb the loss. But innumerable other athletes have not been so lucky. Former (and perhaps future) NFL quarterback Michael Vick filed for Chapter 11 bankruptcy last July and recently put his mansion in suburban Atlanta on the market. That's partly because he is unable to repay about $6 million in bank loans that he put toward a car-rental franchise in Indiana, real estate in Canada and a wine shop in Georgia. "It's always so predictable," Butowsky says. "Everyone wants to be the next Magic Johnson."

But Johnson is the rare, luminous exception of tangibility gone right. In 1994 he started a chain of inner-city movie theaters and diligently built a business empire. Today Magic Johnson Enterprises includes partnerships with Starbucks, 24 Hour Fitness, Aetna and Best Buy, and its capital management division has invested over a billion dollars in urban communities.

And that's the theme of the entire article. The basic premise being that athlete's are too stupid to handle their own money and piss it all away due to the stupidity. I find this premise annoying for a couple of reasons:

1. The rate of failure for athletes in ventures is no higher, I'd bet, than the general rate of failure for all ventures. In fact, private equity pros (the funds that invest in everything from startup Google to bankrupt Newspapers) don't hit at a higher rate than athletes.

2. I know many "educated" professionals from healthcare, technology, and finance that have lost money on everything from real estate, to private equity, to even public markets and bonds. Does that make those guys idiots as well?

The purpose of this article is, basically, to paint athletes with the brush that they are stupid and the few that are successful are geniuses. It's no different, I suppose, than the majority of articles in the Financial Times profiling business luminaries that made money when the rest of the world was losing it.

There are some valid points about divorce and wasting money on tangible toys. But, again, this is no different than the 30-year old banker that makes a couple million bucks, gets divorced, and pisses away his fortune. The case of excess capital dissolving is common across all industries and types of people. The last decade is an example of excess capital (credit-driven, but still excess) that led to massively wrong investments and stupid decisions.

The author could have made a broader point that making money with new ventures and investments is hard. It's a rare skill with a whole lot of luck, and most of the world just can't do it. Instead, we have another "stupid" athlete article.

Geitner Plan Explained

One of the best explanations of the government involvement in attempting to stabilize the economy:

Q: What is the Geithner Plan?

A: The Geithner Plan is a trillion-dollar operation by which the U.S. acts as the world's largest hedge fund investor, committing its money to funds to buy up risky and distressed but probably fundamentally undervalued assets and, as patient capital, holding them either until maturity or until markets recover so that risk discounts are normal and it can sell them off--in either case at an immense profit.

Q: What if markets never recover, the assets are not fundamentally undervalued, and even when held to maturity the government doesn't make back its money?

A: Then we have worse things to worry about than government losses on TARP-program money--for we are then in a world in which the only things that have value are bottled water, sewing needles, and ammunition.

Q: Where does the trillion dollars come from?

A: $150 billion comes from the TARP in the form of equity, $820 billion from the FDIC in the form of debt, and $30 billion from the hedge fund and pension fund managers who will be hired to make the investments and run the program's operations.

Q: Why is the government making hedge and pension fund managers kick in $30 billion?

A: So that they have skin in the game, and so do not take excessive risks with the taxpayers' money because their own money is on the line as well.

Q: Why then should hedge and pension fund managers agree to run this?

A: Because they stand to make a fortune when markets recover or when the acquired toxic assets are held to maturity: they make the full equity returns on their $30 billion invested--which is leveraged up to $1 trillion with government money.

Q: Why isn't this just a massive giveaway to yet another set of financiers?

A: The private managers put in $30 billion, but the Treasury puts in $150 billion--and so has 5/6 of the equity. When the private managers make $1, the Treasury makes $5. If we were investing in a normal hedge fund, we would have to pay the managers 2% of the capital and 20% of the profits every year; the Treasury is only paying 0% of the capital value and 17% of the profits every year.

Q: Why do we think that the government will get value from its hiring these hedge and pension fund managers to operate this program?

A: They do get 17% of the equity return. 17% of the return on equity on a $1 trillion portfolio that is leveraged 5-1 is incentive.

Q: So the Treasury is doing this to make money?

A: No: making money is a sidelight. The Treasury is doing this to reduce unemployment.

Q: How does having the U.S. government invest $1 trillion in the world's largest hedge fund operations reduce unemployment?

A: At the moment, those businesses that ought to be expanding and hiring cannot profitably expand and hire because the terms on which they can finance expansion are so lousy. The terms on which they can finance expansion are so lazy because existing financial asset prices are so low. Existing financial asset prices are so low because risk and information discounts have soared. Risk and information discounts have collapsed because the supply of assets is high and the tolerance of financial intermediaries for holding assets that are risky or that might have information-revelation problems are low.

Q: So?

A: So if we are going to boost asset prices to levels at which those firms that ought to be expanding can get finance, we are going to have to shrink the supply of risky assets that our private-sector financial intermediaries have to hold. The government buys up $1 trillion of financial assets, and lo and behold the private sector has to hold $1 trillion less of risky and information-impacted assets. Their price goes up. Supply and demand.

Q: And firms that ought to be expanding can then get financing on good terms again, and so they hire, and unemployment drops?

A: No. Our guess is that we would need to take $4 trillion out of the market and off the supply that private financial intermediaries must hold in order to move financial asset prices to where they need to be in order to unfreeze credit markets, and make it profitable for those businesses that should be hiring and expanding to actually hire and expand.

Q: Oh.

A: But all is not lost. This is not all the administration is doing. This plan consumes $150 billion of second-tranche TARP money and leverages it to take $1 trillion in risky assets off the private sector's books. And the Federal Reserve is taking an additional $1 trillion of risky debt off the private sector's books and replacing it with cash through its program of quantitative easing. And there is the fiscal boost program. And there is a potential second-round stimulus in September. And there is still $200 billion more left in the TARP to be used in other ways.

Think of it this way: the Fed's and the Treasury's announcements in the past week are what we think will be half of what we need to do the job. And if it turns out that we are right, more programs and plans will be on the way.

Q: This sounds very different from the headline of the Andrews, Dash, and Bowley article in the New York Times this morning: "Toxic Asset Plan Foresees Big Subsidies for Investors."

A: You are surprised, after the past decade, to see a New York Times story with a misleading headline?

Q: No.

A: The plan I have just described to you is the plan that was described to Andrews, Dash, and Bowley. They write of "coax[ing] investors to form partnerships with the government" and "taxpayers... would pay for the bulk of the purchases..."--that's the $30 billion from the private managers and the $150 billion from the TARP that makes up the equity tranche of the program. They write of "the Federal Deposit Insurance Corporation will set up special-purpose investment partnerships and lend about 85 percent of the money..."--that's the debt slice of the program. They write that "the government will provide the overwhelming bulk of the money — possibly more than 95 percent..."--that is true, but they don't say that the government gets 80% of the equity profits and what it is owed the FDIC on the debt tranche. That what Andrews, Dash, and Bowley say sounds different is a big problem: they did not explain the plan very well. Deborah Solomon in the Wall Street Journal does, I think, much better. David Cho in tomorrow morning's Washington Post is in the middle.

Context

This is spectacular. I'm fascinated by human alarmist attitudes just because the news media tells them to be alarmist:

He Plans to Start a Hedgefund

All you have to do in life is take massive risks, fail miserably with other people's money, and ask for more money:

The fall of Boaz Weinstein, once one of Wall Street's hottest traders, speaks volumes about why financial firms still are reeling from the shattered global markets.

As a chess master, poker and blackjack devotee and top trader at Deutsche Bank AG, Mr. Weinstein made big bets using complex financial instruments, generating large returns for the bank and about $40 million in annual pay for himself. But in 2008 the group he ran saddled the bank with $1.8 billion in losses, erasing more than two years of trading gains.

The funny thing is, I have no doubt that he will be able to raise a substantial fund:

Last month, Deutsche Bank shut down Mr. Weinstein's operation and wound down many of his positions. He left the bank this week, with plans to start a hedge fund.

So, who really is to blame in these situations? The person that takes the money that others actively give him, or the people that continue to give him that money? The answer is obvious.