Wednesday, December 31, 2008

ProLogis' Rebound
In late November the industrial property REIT ProLogis (PLD) was on the verge of collapse. Its stock almost reached $2.00. Today its stock is near $14. It's still well off its early September levels, but a nice rebound all the same. A refinancing and a few property sales have helped the stock price. Its 2009 dividend is projected at half of 2008's. Here is a chart for the past three months:

AIG Part Two
Here is the second part of the Post's three-part series on AIG and its role in the Credit Crisis. AIG's collapse really was Spitzer's fault.

Tuesday, December 30, 2008

It's All Eliot Spitzer's Fault
Here is part one of a three-part series from the Washington Post on AIG and the growth of its Financial Products division. This is a fascinating story about the creation and growth of the exotic financial products, built on cheap credit and complex financial models, that lead to AIG's collapse and exacerbated the Credit Crisis. One theme of the article that sticks out to me is the involvement of Hank Greenberg in the Financial Products division, even from its start-up phase. He had the pluse of AIG and its wide range of businesses. When I worked for a subsidiary of AIG (that was nothing more than a pimple on the elephant's ass) the fear of Greenberg was palpable. I am sure that when he was forced out by Eliot Spitzer the oversight of the Finanical Products division became less intense. Greenberg could not have stopped the Credit Crisis, but AIG's fate may have been different.

Monday, December 29, 2008

Madoff's Strategy - As I Understand It
From what I have been able to gather from reading news reports on Bernie Madoff and watching CNBC, it appears that Madoff was managing money based on a strategy using options on an index. He would buy a stock or index, sell a call option and buy a put option. For example, he would:
  • Buy the underlying stock at $100
  • Sell a call option at $105, giving the buyer of the option to purchase the stock if it reached $105
  • Buy a put option at $95, giving Madoff the option to sell the stock if it dropped below $95
What this strategy, known as a collar, did was limit the upside because the stock would get "called" if it reached $105, and protect the downside because if the stock dropped below $95 the put option would be exercised and the stock would be sold at $95 no matter how much below this amount the stock had fallen. The money received for selling the call option should have offset the cost of buying the put option. This collar strategy is generally benign, as it limits gains and losses to the range between the exercise price between the two options. Success is through repetition of the process over many stocks and having the underlying stocks increase in value slowly.

This strategy is marketed to conservative investors. It is usually only successful when markets are rising slowly and orderly (so the stock does not get called away or the put option exercised), which rarely happens. Consistent, long-term returns are hard to achieve because winning positions tend to be offset by losing positions.

A mutual fund group called Kelmoore has run a similar option strategy and has posted poor returns. I remember this fund group from the late 1990s when its funds came out at $10 per share. Financial advisors at the brokerage firm I worked for screamed for these funds because of their alleged safe, solid investment strategy. Over the several years that I followed the funds, shares in various Kelmoore funds dropped to less than $5 per share. Bad returns for a conservative strategy.

I searched for updated data on the Kelmoore funds. I found limited information on a few financial websites. It looks like the Kelmoore funds had some kind of reverse stock split in 2005, and continued their losing ways. The Kelmoore funds were acquired or taken over by another fund company, Dunham, earlier this year and have slipped into obscurity. Here is a chart of one Kelmoore fund's performance:

Ouch. It looks like the original $10 investment has lost nearly 90% of its value. This strategy is also a tax disaster as all gains and income are short-term. So you lose money and get a tax bill.

I don't know how similar this is to what Madoff was doing, but it could not have been that much different, especially since Madoff's bogus black box strategy was a fraud, and his consistent returns a lie. The simple rule is avoid people selling "safe" covered call strategies.

Sunday, December 28, 2008

Madoff Feeder Funds
Here is an article from yesterday's Wall Street Journal. It details the people and organizations that acted as marketing arms for Bernie Madoff. Some of the guys were just salesmen that sold Madoff's false returns. One firm, Tremont, a sponsor of funds-of-funds had $3.3 billion with Madoff. My guess is that it will be hard for Tremont to survive this as it touted its due diligence and diversification while limiting information on the managers it used. Assets will flee Tremont over the next months and quarters.

The one guy in the article that stood out to me was a Los Angeles financial advisor that formed various partnerships that in turn invested all their assets with Madoff. Here is the outtake:
Mr. Chais charged substantial fees, according to the statement from the Marloma partnership -- 4.5% of clients' assets.
I don't know if this is an upfront fee or annual fee, but if it's an annual fee, the clients in this advisor's partnerships were paying an outrageous level of fees. This advisor raised capital through his partnerships, invested all the capital with Madoff, and then did nothing but collect fees. The ultimate something for nothing - and nothing is what he and his clients have now.

The Madoff scandal is exposing ugly fee arrangements - and who said rich people hated paying fees. Many Madoff investors were paying multiple levels of fees, with both annual fees and performance percentages, for a strategy, if executed without fraud, that by design limits returns. I will explain the basics of how I understand Madoff's strategy in a later post.

Thursday, December 25, 2008

I Was Wrong
My anecdotal evidence of packed malls did not translate to sales. This Wall Street Journal says that retail sales "plummeted" this year.

Update: Sales did not stink at all retailers. Amazon has its best Christmas ever.

Monday, December 22, 2008

Just a Thought
I know from watching CNBC and reading the Wall Street Journal that the economy is in a deep recession, unemployment is soaring and that retail sales are awful. But every store and mall I have been to this Holiday Season has been packed. This may be anecdotal, but I can't see sales being as bad as reports are predicting.

Friday, December 19, 2008

What's the Difference?
I wonder what the difference between the Brent Crude and West Texas Intermediate. I know they are produced in different places, but other than that I am at a loss. The price for the two types of oil is shown on commodity tables and across the CNBC tickers. What is interesting to me is that the two oil prices never seemed to me to diverge more than a dollar, but this is anecdotal from watching CNBC. Today the two have diverged by almost eleven dollars. With oil at $15o a barrel this divergence may not be that significant, but at $33.87 per barrel, the differnce seems significant. Brent is at $44.50, indicating that West Texas crude is 24% cheaper. I don't know why these seemingly similar benchmarks would move so far apart.

Update: Problem solved, and I better undo my arbitrage trade. The West Texas price reflects January futures contracts while the Brent reflects February futures. The February West Texas futures contracts closed at almost $43. This shows the importance of comparing apples to apples.

Thursday, December 18, 2008

Doctor Chutzpah
I just tried to make a doctor's appointment and was told the first available date is in late February. Jeez, I'm glad I am not dying. Doctors' collective arrogance never stops amazing me. The first question in any doctor's office is never how you are feeling, but instead it's about your insurance. Doctors and their staff have no problem keeping you waiting for extended periods - I'd love to send a doctor a bill for the time wasted during business hours sitting in a waiting room or an exam room - but all have draconian policies about missed appointments or arriving late for an appointment. And their billing is a freaking mystery - no posted prices and no negotiation - there must be a class on opaque pricing in medical school. OK, I feel better.
Greed is Good - Until It's Bad
Here is a New York Times article on the outsized bonuses paid on Wall Street over the past few years, with a focus on Merrill Lynch. Executive decisions, in my opinion and experience, are almost always made on how the executive is going to be compensated, not on the business school mantra of shareholder wealth maximization. The past few years will be studied in business schools for years, as decisions based on executive compensation destroyed shareholder wealth.
More Madoff
Bernie Madoff's sons were smart enough not to invest with their father. Here is the post from Talking Points Memo discussing the Madoff foundations' investments.

Wednesday, December 17, 2008

Madoff Comments
The list of victims is staggering. I am still not sure how he stole $50 million, and I think when the dust settles the amount will be much less. I also think that he did not start with a plan to steal money but probably got sideways, made a few false statements to retain assets, and built his scam from there. Once a scam is started it can't be stopped without exposing the entire crime. If Madoff really pulled a Ponzi scheme, I wonder if the people who got paid out in full will have to give all or part of the money back? I suspect they will because the payments were made fraudulently.

Madoff reported year-end 2007 assets of $17 billion. This guy obviously could attract assets. Between trading revenue and management fees this guy could have lived large without the scam. If he had produced legitimate return figures and lost assets because of it, he still would have had significant money because people trusted him.

More sordid revelations about Madoff will surface over the next few days. The Madofff fraud is going to give the fund-of-funds business a permanent black eye. I never understood the wisdom of these funds with their high fees and low returns.

Tuesday, December 16, 2008

Oil Slick
Here are two articles on the drop in drilling activity. One from yesterday's Wall Street Journal and one from today's New York Times. This logically follows the huge drop in prices. Oil seems to have found a temporary floor near $45 a barrel. Experts are predicting $25 a barrel oil, but these are the same guys who said oil was heading to $200 a barrel. The next set of articles will report the drop in alternative energy investments, but that's not the point of this post.

To me, the key to the oil drilling business over the past four years was buried in the New York Times article:
One reason projects are being shut down so fast is that costs throughout the industry, which had surged in recent years, are still elevated despite the drop in oil prices. Many companies are waiting for those costs to come down before deciding whether to go forward with new projects.
Many investors who thought that oil investment was sound because of high prices did not realize that high operating and drilling expenses offset the high oil revenue. This is why so many oil and gas direct investment programs have had such poor returns in recent years. The 0perating cost of these programs increased as fast as the the price of energy. The only programs that are going to have decent returns were the ones that were able to lock in leases and drilling contracts in the early 2000s and had production with high prices. Programs offered over the past few years that are not in a position to wait until prices rebound - because eventually they will rebound - will have poor returns.

Monday, December 15, 2008

Gold Question
The price of gold has been between $750 and $850 an ounce for a month despite wide scale drops in commodity prices. I don't know whether it is a fear play or a future inflation play. Recently, I find myself looking first to the price of gold and the overnight banking spreads than to the movements in the stock market. Times are strange.

Thursday, December 11, 2008

Auto Crash
The auto bailout crashed and burned this evening, so look out for a wild day on Wall Street tomorrow. It seems strange that the Government gave Wall Street banks $350 billion, with another $350 billion on the way, with little oversight or preconditions, but the Big Three automakers had to go through a weeks long proctology exam to get $14 billion, and still Congress said no. It does not make intuitive sense to me.

The bailout died in the Senate, as the House passed a bailout today. The lead Senator against the bailout was Alabama's Richard Shelby. I don't know much about him, but hearing him talk he does not seem like the brightest light in the Senate, especially on financial matters. He is a career politician, starting his political career nearly forty years ago in 1970. He nearly scuttled the financial bailout earlier in the Fall. Alabama has three large manufacturing plants - Mercedes, Honda and Hyundai - and you can bet these played a large part in his opposition to the bailout.

I am still ambivalent on the idea of an auto industry bailout. Bailing out every troubled industry is an untenable position for the Government. But I am also aware of the wide employment base, especially in the Midwest, dependent on the auto industry. The potential of putting this many people out of work is scary, and the repercussions will be felt throughout the country. No one will buy cars, not even Richard Shelby's Alabama-made Mercedes, Hondas or Hyundais.

Update: Looks like the bailout will happen under the TARP, which is probably where it should have been in the first place. I was harsh on Senator Shelby above, but Senator Corker from Tennessee was key in scuttling the deal. Tennessee, like Alabama, has a large foreign auto manufacturing base. It should be noted that I think it's great that foreign auto firms manufacture here in the United States. It blurs the lines between what is a foreign and domestic auto maker.

Wednesday, December 10, 2008

Layoffs Getting Ridiculous
Here is a Wall Street Journal article announcing that the NFL is laying off 14% of its workforce. The NFL expects the job cuts to result in $50 million in savings. If this is an annual savings, it works out to $333,333 per employee. At that salary, I want to work for the NFL. Last I checked the NFL has a monopoly and long-term TV contracts with every major network, and it even has its own network, so future revenue does not seem in doubt. Ticket prices to an NFL game are so expensive that most people can't afford them anyway, let alone the unemployed, under-employed or those hurt by the recession. Hell, if people in Detroit are still paying to see the Lions, I'd argue that the NFL is more recession-proof than any business in America.

Firms, like the NFL, that are laying off people just because they think the recession may impact them are idiots. Needless layoffs, while theoretically prudent, are going to make the recession a self-fulfilling prophecy. A dip in profitability is not the end of the world, especially for a private club like the NFL.

Update: I just saw this article on Here is a quote from Barry Diller:
"The idea of a company that's earning money, not losing money, that's not, let's say, 'industrially endangered,' to have just cutbacks so they can earn another $12 million or $20 million or $40 million in a year where no one's counting is really a horrible act when you think about it on every level," said Diller, who's been known to lay off workers from time to time. "First of all, it's certainly not necessary. It's doing it at the worst time. It's throwing people out to a larger, what is inevitably a larger, unemployment heap for frankly no good reason."
I guess I am not the only one who thinks needless layoffs are stupid.

Tuesday, December 09, 2008

Stupid Is As Stupid Does
Readers of this blog know my opinion of the brain power at AIG. Here is some proof from a Wall Street Journal article:

American International Group Inc. owes Wall Street's biggest firms about $10 billion for speculative trades that have soured, according to people familiar with the matter, underscoring the challenges the insurer faces as it seeks to recover under a U.S. government rescue plan.

The details of the trades go beyond what AIG has explained to investors about the nature of its risk-taking operations, which led to the firm's near-collapse in September. In the past, AIG has said that its trades involved helping financial institutions and counterparties insure their securities holdings. The speculative trades, engineered by the insurer's financial-products unit, represent the first sign that AIG may have been gambling with its own capital.

And here is the dilemma:
The fresh $10 billion bill is particularly challenging because the terms of the current $150 billion rescue package for AIG don't cover those debts. The structure of the soured deals raises questions about how the insurer will raise the funds to pay the debts. The Federal Reserve, which lent AIG billions of dollars to stay afloat, has no immediate plans to help AIG pay off the speculative trades.

The $10 billion in other IOUs stems from market wagers that weren't contracts to protect securities held by banks or other investors against default. Rather, they are from AIG's exposures to speculative investments, which were essentially bets on the performance of bundles of derivatives linked to subprime mortgages, commercial real-estate bonds and corporate bonds.

These bets aren't covered by the pool to buy troubled securities, and many of these bets have lost value during the past few weeks, triggering more collateral calls from its counterparties.
And dumber:
Some of AIG's speculative bets were tied to a group of collateralized debt obligations named "Abacus," created by Goldman Sachs. The Abacus deals were investment portfolios designed to track the values of derivatives linked to billions of dollars in residential mortgage debt. In what amounted to a side bet on the value of these holdings, AIG agreed to pay Goldman if the mortgage debt declined in value and would receive money if it rose.
It is not surprising that AIG came out on the short end of a trade with Goldman Sachs.

Monday, December 08, 2008

Anecdotal Aspirations
In my opinion, there is a strong correlation between this year's economic collapse and sky-high energy and commodity prices earlier in the year. The recession was pegged as starting in December 2007, just as oil started its massive upward lunge. Now that oil has collapsed and is trading near $45 a barrel and gas prices are near $1.75 a gallon, this is going to ease pressure on the economy. While I don't think low oil prices are permanent, I do believe they will be stimulative in the short-term.

Sunday, December 07, 2008

Depressing Article
Here is an article on trouble at Extended StayAmerica. Lightstone's April 2007 acquisition of Extended Stay was one of the last highly leveraged real estate deals before the Credit Crisis began in August 2007. Extended Stay has not defaulted yet, and according to the article, any action is a month or two off. Here are some interesting quotes from the article:
One wrinkle in negotiations is that Extended Stay isn't likely to file for bankruptcy protection, because of provisions common in commercial mortgage-backed securities deals that would expose more properties of its founder, David Lichtenstein. A more likely path is for Mr. Lichtenstein to turn Extended Stay directly over to lenders or to swap enough equity for debt to give bondholders control of the company.
Here is more cherry news:

During the real-estate lending boom, Wall Street originated $600 billion of commercial mortgage-backed securities. The default rate on commercial mortgage debt has remained near historic lows, even while residential-related debt suffered a severe downturn.

But that is now beginning to change, sending new shock waves into much-battered banks, private-equity funds and other financial institutions that participate in the $1 trillion commercial real-estate debt market. Hotel landlords typically are the first to feel the pain in a downturn because hotels have the shortest leases in real estate -- one night at a time.

The article also states that commercial real estate value have dropped 15% to 20%, but doesn't give sprecifics. The article ends on this note:

Troubles also have surfaced at Lightstone's Prime Retail division, which owns roughly 30 malls and shopping centers in the U.S. and Puerto Rico. Lightstone has sought to turn over at least six of its malls to lenders after falling behind on debt payments.

Debt-laden landlords of all types of property are beginning to struggle staying current on their mortgages as rents fall and vacancies rise. New York City office space that had been renting for $120 a square foot is now being dumped on the sublease market for about half of that amount.

Thursday, December 04, 2008

CNL Goes Skiing
CNL Lifestyle Properties REIT just bought three ski resorts, Crested Butte in Colorado, Okemo Mountain Resort in Vermont and Mount Sunapee Ski Resort in New Hampshire. It will pay $132 million for the three properites, using $82 million in cash and the balance in seller financing. I guess this explains the drawdown of Lifestyle's $100 million line of credit last month.
More Housing Help
Fed Chairman, Ben Bernanke, made a speech this morning saying more help for homeowners is needed. Hopefully, it's not too late in the game, but the Treasury and Fed have now determined that stopping foreclosures and the downward spiral in home prices is necessary to get the economy stabilized. I agree that housing is at the root of the economy's problems. Lower mortgage rates will not only help the housing market but also the overall economy by increasing disposable income for those that are able to refinance at low rates. Taking this further, low mortgage rates when combined with new low energy prices could provide a strong economic stimulus.

Wednesday, December 03, 2008

Developers Diversified and Inland
In early 2007, Developers Diversified (DDR) acquired the Inland Retail REIT. I think DDR paid about $14 per share for the Inland REIT. It was $12.50 in cash and the balance in DDR stock. I just saw this evening that DDR is trading at $4.80 per share. It was trading in the mid-$30s in September and has a 52-week high of over $47. In late November it hit a low of $1.73. I hope most of the Inland REIT investors took the cash and put it somewhere safe. The realist in me says that a large chunk probably went to Inland American REIT.
LandAmerica Bankruptcy
This is a disaster. LandAmerica, in capacity as a 1031 accomodator, had $400 million of short-term 1031 exchange money in illiquid auction-rate securities. Because the auction-rate securities became illiquid, it could not meet is accomodator obligations, which lead to the bankruptcy filing. Most of the money was in co-mingled accounts. Investors now have to go through the bankruptcy courts to attempt to get their money back.
New Paradigm Skepticism
I get a smirk when I hear talk of new paradigms in investing. Fundamentals don't change, business cycles and asset valuations change. Yesterday's Wall Street Journal had an article on Goldman Sachs' Whitehall real estate funds and their losses. While the article did not state that real estate was going to experience a new paradigm, I got the sense that the article was implying that real estate investing had changed. It has not. Real estate investing has always been a function of two things - income and debt. I know the old saying - location, location, location - but even a property in a good location needs quality tenants paying consistent rent, which will allow an investor to get a favorable mortgage. Credit is tight today and many tenants are feeling the impact of the recession. But credit will return and the business cycle will improve. This will make real estate investments attractive again. I would not bet against Goldman Sachs. When someone talks of new investment paradigms its time to start buying or selling, which ever is opposite of the so called new paradigm.
Makes Sense
Treasury is thinking of using Freddie Mac and Fannie Mae to bring down mortgage rates. This idea seems smart to spark the housing market, and maybe should have been considered earlier. I know the government did not control Freddie and Fannie until September, but it could have exerted some pressure to get the rates down.

Monday, December 01, 2008

Captain Renault Strikes Again
News that the economy has been in recession since December 2007 caused the Dow to drop nearly 700 points. This should not be a surprise to anyone who has watched the markets and read economic data this year. I am more surprised that data does reflect the recession starting in the summer of 2007. The market needs to look forward not backward.
Ten-Year Well Below Three Percent
The markets are off to a bad start this morning. The ten-year Treasury, which dipped below 3% on Friday, is now solidly below 3%. It is trading at 3.81% about a half-hour into the trading day.