From fianancial advise to next financial crisis

This is a comprehensible example what the fiscal cliff could affect investor, according to Bloomberg: an investor who sells $100 of stock with a cost basis of $20 in 2012 would see proceeds -- after long-term capital gain taxes -- of $88. Next year, if Congress doesn’t act, earnings from the sale would drop to $80.96 if rates rise to 23.8 percent. That means the stock price would need to rise at least 9 percent for an investor to be better off selling in 2013. Furthermore, assets that generate long-term capital gains aren’t confined to stocks. Owners of real estate and business organized as S corporations, partnerships and limited liability companies and stock options can get capital gains treatment when they sell.

Further, “We have a number of people contemplating selling their businesses,” said Jere Doyle, senior wealth strategist at New York-based BNY Mellon Wealth Management. “They’re trying to jam it through before year-end to take advantage of the capital gains rates.”

Would you sell your $100 stock or company because of the $7 dollar more tax and the $100 would go to $120? Obviously, these financial advisors recommended so. On their stand point, it is true that you can certainly save a few bucks when so many IF's come true:

• IF congress doesn't act
• IF congress doesn't act enough
• IF economical recovery can drive return higher
• IF you can find $100 but not $98 to sell it now 
• IF the $7 dollars is the only affect on investment (do you mind?)
• IF inflation reaches 5%, would that offset the $7?
• IF interest rates hike, what happen?
• many more ...

These are always ridiculous advise often put on TV, newspapers, seminars. Tax smart, tax planning, tax this and tax that, the theme financial advisors propose to clients. The message is to sell.

Hopefully people listen with great deal of reservation. Indeed, I think the problem should be better answered by economists instead of financial advisors when coming to tax preparation. Think about these questions:

• How budget deficit was created?
• How budge deficit was/is handled?
• Is the $7 less earnings the only thing would happen?
• Is the deficit problem the unique problem to us? 
• More important, would the budget deficit become budget crisis or dollar crisis?

These are serious questions attempted to be answered in the book, Profiting from the World's Economic Crisis, by Bud Conrad. Conrad is the chief economist at Casey Research and a futures trader according to the book biography. He holds an MBA and electrical engineering degree.  The book has a theme of the demise of the US dollar and tries to point to alternatives to the dollar. The conclusion is drawn from the deficit history, lessons from the Great Depression, Germany hyperinflation and Japan's stagnation, and many others. Eventually the book leads to conclusion of the demise of dollar and investment protection. This is a serious work the author tries to answer, much like books before 2008 crisis people tried to find out the next burst bubble.

However, like advise from financial advisors, not recommend losing analytical sense while reading. For example, unlike Conrad proposed, gold may not be an valid inflation and alternative to the US dollar. Why? Because, our economy scale is much bigger than all gold reserve can gauge. Currencies aren't back by gold reserves in central banks. Currency balance has been developed in creative ways to tackle financial crisis around the world. No one had heard what central bank swap lines is before. It reached to a peak in 2008, trying to maintain easy availability of the US dollar by influential central banks. The outcome is stronger US dollar. Thus, the US dollar is not only affected by domestic economical condition but also globally.

With disagreement, the book is still a good read, especially supporting documents, charts, and references are from serious authorities. Arguably the book may be better categorized as a trading book instead of an economical book, but some models and conclusion are worth going over in the next few posts.

Why Vikram Pandit exited Citi?

Citi CEO Pandit stepped down after strong disagreement with the board. That was a surprise to many outsiders and insiders that he along with his senior lieutenant picked a time that Citi had seemingly stabilized and turned around. However, it may be the best outcome for everyone that should come early than later.

Pandit took over the post when Citi was thought almost down the pipe. He had been in charge of Morgan Stanley's investment banking arm. He supported electronic trading and encouraged quantitative analysis. Some of his previous subordinates now have become big name hedge fund managers specializing on quantitative trading, e.g., Peter Muller at PDT hedge fund. Pandit himself became a Citi citizen when his co-founded hedge fund was acquired by Citi. He holds a B.S. and M.S. degree in Electrical Engineering from Columbia University, and an M.B.A. and Ph.D in Finance from Columbia Business School. Some said he is too brainy to run a giant bank. What this refers to is his experience is too academic to run such a big bank.

His co-founded 2006 hedge fund, Old Lane didn't go well after Pandit took the top job. Mr. Pandit was named Citigroup’s chief in late 2007, but the hedge fund continued to underperform. After making a paltry 3 percent return in 2007, Old Lane began to lose money in 2008. Investors, in need of cash, asked for billions back from the fund. Unable to keep the firm afloat, the bank decided to close the hedge fund in the summer of 2008.

This background is the main attacking point to Pandit. Compared to BofA's seemingly endless cuts to please investors, Citi did little in core banking business other than enforcing their trading and wealth management business. Indeed there have been troubles for Citi; failed pressure test to raise dividend, and Pandit's pay vote by shareholders. But none of these is comparable to Pandit's strong opponents in regulatory bodies. Sheila Bair of FIDC openly said that Citigroup has lacked "a clear strategic direction and focus" under Pandit in a CNBC interview, and said shareholders have been unhappy. Bair wanted the government to fire Pandit after the taxpayer bailouts and government guarantees. Geithner disagreed, and Pandit kept his job. This time Pandit eventually thinks his mission is complete and decides to step down.

Under the new CEO, Citi is assumed to be focusing on better balance sheets and shareholder satisfaction, i.e., dividend increase. Hence the market welcome the change with shock. On the other hand, there is no doubt that Pandit can find another top job, maybe in hedge funds. Have managed banks in Citi's size is a unique experience for any. The government is happy to get this big bank on their track too. So this is a win-win-win outcome.

The field startups don't do well

Startups do everything from health care to semi-conductor to services, almost everything. Even though success rate is low, some startups eventually excel in their field and grow. The book The Startup Game: Inside the Partnership between Venture Capitalists and Entrepreneurs, cracks the relationship between VC and entrepreneurs, essentially is investor and founding partners. Yahoo, Google, Facebook, Intel, a long list of startups now are world wide brand names. One field, however, hasn't have widely had success so far. This field is investing.

There are many hedge funds that are startups such as one or two people shop. They do as much as they can from analysis, trading, and recruiting investors. Outsourcing the rest they can't like legal issues to other firms. Investors invest in these startups from many reasons. Barton Biggs' book tells numerous stories on this. Many can't survive at their early start. Biggs didn't explain why they failed. Of course, he did compare the hedging fund business to high tech startup either. A recently most successful startup hedge fund probably is John Paulson's in 2008 who captured the financial crisis. 

The reason may lie on the field where startups root. So far for the past fifty or sixty years, capitalism systems were based on three tenets. First, the economic growth, measured in GPD. Second, consumption of resources to satisfy end users was the most important outcome of all economical activities. Finally and more recently, wealth accumulation was realized through short-term changes in asset values rather than through products and services. In other words, it is through capital manipulation. High tech startups pick the first route as they try to make goods to the public. Input to these startups is capital and outcome is product. All of these results in a huge amount of disposable income that exceeds pure consumption needs. That is where the last way finds its market. The trend is apparently shifting to capital regeneration. However the unique feature of this approach is that it is singularity, i.e., money in and money out. There are no diversified products and services. This may be the most important nature of this business and also pre-defined as a hard business to run. People used to say that during California's Gold Rush age, the ones who eventually last to the end weren't those trying to buy tools to dig gold but the ones who sold tools. So intuitive and philosophical.

A risky business

Investing needs to keep pace with current news and economy conditions. Thus in addition to media, often investors would go to seminars, listen to iPod/iTune, or even call in to talk to financial advisers. Questions can be very specific to certain investment they have and seek very clear answers from the advisers. Action on the advice or not is unknown but the message does deliver to other audiences. However, sometimes or most of times message isn't well returned. There is no reason to blame only the host for this. But it is still very interesting to see how these two sides react.

Here is one example for iTune. One caller left a message to the host stating that he called in the program a while ago when company XYZ was at  $70ish/sh. He wanted to know if he should sell it because he bought it at $40ish. The host recommended that he could keep it as a long term investment as the finance was strong. But now it is less than $20/sh. What can he do? Obviously, the advice was dead wrong. This sort of conversation may have happened thousands of times for the host. He simply explained plain fact that why XYZ is at $20 now and no reason to sell it for deep loss. No argument. No apologies either. But why he didn't apologize? There may be a few reasons such as there is no solid evidence that the trade occurred. Maybe some hoax. Also, without actually committed to the caller, he had no responsibility at all. Still, listeners may believe the caller.

This may be a vague case as vague relationship between them. But in some other cases, the host doesn't seem convincing. Here is another example. There was a seminar held by JP Morgan. The presenter tried to reason bond funds are over-priced and deem for correction when the FED raises interest rates. At the same time, junk bonds may deserve better opportunity. He listed different yield curves before and after the 2008 crisis to show how crazy the situation was. It seems convincing but suddenly he made a quick turn and said he diversified his managing portfolio by investing in a less liquid real estate investment. Immediately, the hard proved better opportunity seemed not valid because otherwise why need to diversify? There seems a credibility issue.

Many such cases reflect that money managing business is very risky, in personal reputation sense. Of course, we still will go to such events to absorb information, but with analytical mind.

The 101 Index

Highway 101 segment through the Bay Area becomes  over-crowded again. An hour commute often turns into more two hours. People call the level of traffic congestion the 101 Index. This often means the economy is booming.

On the other hand, San Francisco office rents is reported had risen to an average of $33.27 per square foot in the second quarter, up 6.4% from the previous year, according to real-estate research firm Reis Inc. That outpaced all other major U.S. metro areas, says Reis senior economist Ryan Severino. The city ranks third behind New York City and Washington, D.C., based on prices alone. Meanwhile, San Francisco office vacancy rates fell to 13.8% in the second quarter, from 14.8% during the year-ago quarter and 15.5% in the second quarter of 2010.

All good signs, isn't it? For some yes, for some no. The ones who would say may be social networking IPO investors. The Wall Street Journal reports that Facebook employees have lost millions of dollars on paper profit, same as their IPO investors. The tone is sympathetic, maybe because of the amount of fortune lost. However, readers argued that 90% startups would fail. Venture capitalists have to make up the failed 90% from the 10% that can go to IPOs. The 90% maybe dreams from some entrepreneurs or wealthy individuals and unrealistic. When they structure entities to achieve the goals, the onset is already risky. There is no sure bet.

Many further argue that old economy participants like doctors or workers work whole life to pay off houses, children education, etc, but the young workers at the social networking startups now talk about lost millions in a couple months on stocks. Is this fair? Tangible and intangible asset comparison has never been clear here. The most important factor is early investor return expectation. Because of low success ratio at venture capital investments, whenever there is some sort of return, they have to drive it very hard so that they can recycle capital. Overpriced IPO prices and over-issued shares are two apparent ways. There are always bigger fools to pay the bill.

Social networking companies aren't soon be out of tide. They may remain for a while. However, investing in these companies is a different story. The sell side is always on call for action.