Saturday, March 24, 2012

The Housing Bubble vs. The Higher Ed Bubble

There are many parallels between the US housing bubble of the 2000s and the US higher education bubble. Let's look at them.

(1) False premise in housing: higher home ownership is a good thing. False premise in education: more people going to college is a good thing. It is not. Too many people go to college. So many, in fact, that there are 17 million college graduates in jobs that do not require college degrees, as of 2010.

(2) False premise in housing: a home is an investment; home values never go down nationally. False premise in education: a degree is an investment that will make you more valuable with higher earnings over a lifetime and lower unemployment rates. This is cannot be statistically proven as there is NO control group (people admitted but not enrolled, with the same test scores as college graduates).

(3) Special class of credit involved in housing:
mortgages are typically non-recourse, government-guaranteed (for the ultimate holder of FNM/FRE paper), non-market based product (30-year, fixed-rate is not a "free market" product). Special class of credit involved in education: student loans are also non-free market products, many given directly by the Dept of Education, covered by the taxpayer, with income-based repayment, artificially low rates, and inability to discharge in a normal bankruptcy

(4) No skin in the game for the originators in housing: the "originate to sell" model of the subprime mortgage brokers meant that they had no risk once the loan was sold regardless of what happened to it. No skin in the game for the originators in education: no university president, no admissions or financial aid officer, nor an Ed Dept bureaucrat will lose a dime if the loans do not perform.

(5) Low underwriting standards in housing: because of the collateral and "long" history of rising RE prices, some people felt that the usual precautions (downpayment, income and credit history) could be relaxed. Low underwriting standards in education: no one is turned down for a student loan, and there is no change in terms for different schools, majors or test scores. One widely-publicized disturbing article describes how for-profit colleges enroll homeless and otherwise vulnerable people to get the grant and loan money.

(6) Extensive subsidies in housing:
not just mortgage interest deductability, think 2nd level: road space demands by single-family housing; utility work (length of pipes and wires required). Extensive subsidies in education: at the individual level, you can start with grants, deductions of various expenses, and loan forbearance. At the institutional level, you have tax-exempt status both for operating budgets and endowments, aggressive/abusive use of eminent domain by private and public institutions, federal and state grants, and many other forms of aid.

(7) Credit product hides the true cost in housing: teaser rates, option ARMs, etc. "innovations" brought low introductory payments. Credit product hides the true cost in education: both via subsidized rates and no repayments until after graduation.

(8) Disconnect between price and productivity in housing:
the price-to-rent ratio almost doubled vs. the normal levels during the bubble. Disconnect between price and productivity in education: student loan balances just hit $1 trillion. Think about it, if education- in its current form- was such a value-added activity, would you be seeing such drastic indebtedness?

(9) Homeownership expansion was a mission: the emblematic Angelo Mozilo, founder/CEO of Countrywide, said in a 2007 Business Week interview "let me just tell you that Countrywide for 40 years has been on a mission to lower the barriers of entry for the American people to have the opportunity of home ownership." Education expansion is a mission: look no further than professional educrat Obama who proclaimed that "It’s time to make education America’s national mission” and that the "country is not producing enough people with college degrees." With friends like these...

The tide is already turning at the margins (as it did with housing): law schools. Law school graduates have caught on that they were taken for a ride, quite possibly with fraudulent promises, so twelve TTTs ("third tier toilets") are getting hit with class action lawsuits. Good luck to the plaintiffs.

Tuesday, March 13, 2012

Book review: Backstage Wall Street by Josh Brown

They say that everyone has one book in them: this is Josh Brown's book. Backstage Wall Street is part autobiography, part financial advice, part a sarcastic, sober assessment of "Wall Street" for individual investors, part history, part financial product details, part uncovering of marketing schemes, part catharsis. The trademarked snarky humor is recognizable throughout the piece: I laughed out several times. Unlike many textbook-ish and stuffy finance investment books, this book is conversational, humble and non-assuming. At the same time, it does not always flow very well from chapter to chapter, in part because of the switch between anecdotes and theory. People looking for a fool-proof "system", a Suze Orman diet vanilla coke read, or a data-heavy CFA curriculum-type handbook will be disappointed. This book might well be the equivalent of Monkey Business, a classic that covers the lives of junior investment bankers with the added bonus of useful advice.

Josh- widely known via his blog The Reformed Broker- had started out in the traditional brokerage world, something virtually unknown to young people: people calling you on the phone to sell you stocks, Bud Fox-style. The high-pressure sales environment, the churn, the conflicts are all described in painful detail. He even lays out the "straightline": a widely used pitch to overcoming objections by the person at the other end of the line. But you would not buy a car designed by the salesman with the gaudy tie, should you buy "advice" from a telemarketer? Probably not in this day and age, hence the industry is on its way out. Josh is now an independent RIA whose interests are much better aligned with those of the clients.

The problem- with or without brokers calling you- is that most people are bad individual investors, and make suboptimal choices. This is similar to the issues faced with the wider retirement system: the decline of the defined benefit plans has "empowered" individuals with 401(k)s, and, for the most part, the experiment has not been a success. Josh lays out in detail the pricey marketing machinations employed by mutual funds and the brokers that sell them, and how the mutuals are getting replaced by ETFs. Josh also discusses the often grotesque ascent of the discount online brokerages, and the double-edged sword they are for non-professionals. He also covers the "research" controversy from the dot-com boom to the big settlement, and the general disservice it has been providing.

The most important takeaway from the book for an individual investor is what to avoid: I won't spoil it for you, and some segments of this chapter have been featured here and there online. The list is a compendium of products and pitches designed to exploit every human weakness there is- greed, fear, desire to belong, desire for safety- with a plethora of products, systems and promises.

Almost any investor can learn something from the book so I recommend it.

Full disclosure: I bought my own full-priced Kindle edition copy of the book. I have not been asked to review it. I have interacted with Josh Brown dozens of times on twitter, via email and once over the phone, and I genuinely like and respect the guy. I think there should be more people like him in the blogosphere, the MSM and the real world. I also think that the book's full title is grammatically incorrect: "Knowing WhoM To Trust, WhoM To Run From, And How To Maximize Your Investments"

Saturday, March 10, 2012

Buffett's Fangirls Leave Something Out

Just like many others, I follow "The Oracle's" every step. I read his letters. I follow various SOTP analyses on BRK, and how much it is "worth". My first ever investment book was Buffettology.

But I am tired of Buffett, and his fangirls across the mainstream media, twitter and the blogosphere: the famous investor has become just an oligarch mouthpiece for the current administration on controversial policies, while hogging one bailout after another, and skipping on taxes himself. Buffett is also getting a huge pass from the fawning MSM on his abject mishandling of the long-awaited succession, including nepotism, lack of foresight and non-disclosure.

Here is what gets skipped over by the drooling anchors across various channels:

(1) Buffett has been a very successful investor in the PAST. He has not generated any alpha in the last 10 years, which happens to coincide nicely with the greatly increased MSM attention and the switch in investing strategy (see next paragraph). To be fair, at his size, he probably can't.

(2) Buffett no longer invests the way that made him famous. One of my fave blogs, Can Turtles Fly, describes the three stages very well: classic value, classic Buffett (until the 1990's) and large conglomerate/institutional (since then). The Buffett approach to investing today is very, very different from what he used to do. Again, size plays a role. But if you hold BRK, you need to be aware of both the lack of alpha and the "new" Buffett approach.

(3) Buffett- in the early years- was a huge beneficiary of tax breaks, but now that he has his, he does not mind asking everyone else to pay up. Jeff Matthews explains more here.

(4) Buffett was a polygamist, as explained in his big bio. Unlike the inbred weirdos along the AZ-UT border, he got away with it in the court of public opinion. (for the record, I fully support freedom of relationships between consenting adults)

(5) Buffett is a true oligarch who has been benefiting extensively from various bailout programs over the last few years:

- Investments in GS, BAC, USB and WFC: the banks have been among the biggest government program beneficiaries. The absolute travesty of having AIG pay out 100 cents on the dollar on the CDS contracts that GS held with taxpayer money sure helped Uncle Warren (and Uncle Lloyd, of course). And do not buy "we did not need the bailout" line: one a couple of names in the industry fail, everyone is suspect. The optics of Buffett calling Obama and two days later doing the BAC deal are really bad, regardless of whether they were connected

- Investment in GE: one of the biggest pigs in corporate America, GE blew up, and was saved by the taxpayer to the tune of $140 BILLION. GE keeps getting taxpayer funding for things like locomotives and "green things" while, at the same time, promising purchases of Obamamobiles. Don't forget that GE got tax refunds despite making billions in profits.

- Investment in AXP: the securitization markets froze so AXP was allowed to issue FDIC-backed debt (read, guaranteed by you and me).

- Investments in a large number of insurers: the entire industry benefited from TARP in 2009; again, it does not really matter if WB took money directly if many players in the industry did (Prudential, The Hartford, Principal...)

- Investments in the housing complex:
it is not just the banks that benefit from the $2 trillion in housing bailouts. Buffett owns Clayton Homes, Benjamin Moore paints, Shaw Industries carpets, Acme Brick, several furniture names.

- Investment in Coca-Cola:
KO spends billions on HFCS, and the taxpayer spends billions every year to subsidize HFCS...

- Obviously, any company will try to maximize every benefit but I see pattern here with the major holdings.

(6) Buffett has grossly mismanaged the succession plans. This is becoming more of a concern as cognitive abilities- on average- do decline with age. If it were a private company, sure, do whatever you want. But you have shareholders, and, yet, you appoint your son to be Chairman, mismanage the situation with the multiyear heir-apparent David Sokol, and, in the latest letter, don't reveal any details on the putative successor/s outside of the two value investors who got little fiefdoms to run and prove themselves. What other public company CEO can get away with such antics? Where is the board?

(7) And, while Buffett is quite public about other people paying their taxes, his own NetJets is being sued by the government over taxes... No irony here at all.