Dollars and Jens
Sunday, January 30, 2005
Principal-Protected Funds
Friday's issue of the Journal has an article ($$) on principal-protected funds. It seems the fund companies generally manage the funds and buy insurance on them from other companies; a lot of these insurance contracts agree that the fund will invest 75% or more in bonds, though Merrill Lynch seems to offer more equity-based funds than others.

I would think this would be a great use for index funds; the fund company, the customers, and the insurance company would all know exactly what's being offered. For an S&P index fund, the insurance company in this case would probably become the option markets, and I guess there's less room for a fund company to profit, since it's not hard for an investor to buy an index fund and some SPY puts on one's own. But fund companies could also put together their own index. As long as it's selected by an agreed-on algorithm rather than a fund manager, it should be insurable without agency costs.

Thursday, January 20, 2005
Charlie Bell
The CEO of McDonald's resigned in November, after only a half year on the job, to fight colo-rectal cancer. He died on Monday. In today's Wall Street Journal, there's a full-page ad in memoriam — paid for by Coke.

I thought that was nice. But does it enhance shareholder value? PR isn't my field, but it is often said that Coke is a marketing company, and I'm sure habit and image are big reasons they're able to get the margins they get (though I've tasted enough generic soft drinks to suppose that Coke's trade secrets are worth something). If other people had sentimental visceral reactions, the ad might pay for itself, especially if that reaction is shared by people who have the authority to decide what soft drinks to sell at McDonald's.

Wednesday, January 19, 2005
things go wrong
If you can't take pleasure in human misery, where can you take pleasure?
Fannie Mae on Tuesday slashed its stock dividend in half to raise money to help it comply with new capital requirements imposed on the mortgage finance provider in the wake of an accounting scandal.


The company is facing possible fines or disciplinary action from the SEC and Department of Justice amid an extensive investigation into Fannie's accounts by its regulator, which resulted in a directive to restate earnings and the departure of its chief executive officer, Franklin Raines, and its chief financial officer, Timothy Howard. Fannie has already raised some extra capital by selling $5bn of preferred stock in December but some analysts have estimated its total capital shortfall at $12.5bn.
Fannie Mae's debt-to-equity ratio is in the high double digits, and, while trying to get Congress not to remind investors that the government doesn't guarantee its debt, it has been trying to expand the scope of its business. Pride, it seems, goeth before destruction. Don't feel too bad for Franklin Raines, though; he gets a $111,000 monthly pension.

Some people aspire to such riches; me, I simply aspire never to having stock in a company jump 12% on the announcement of my resignation as its CEO.
Scott Livengood has cut the fat and carbs from his professional life: He resigned from his posts as chief executive, chairman, and president at Krispy Kreme Doughnuts. The company, overshadowed by investor lawsuits, is under a regulatory microscope for its policies on franchise buybacks and earnings forecasts.
By which is meant that he arranged for franchises to be bought, by the company, from friends of his, for much more than they were worth.
Livengood was replaced as CEO by Stephen Cooper, who most recently shepherded the Enron Corp. bankruptcy reorganization.
A specialist in turnarounds, presumably, being better for the shareholders than a specialist in embezzlement.

Tuesday, January 18, 2005
Pensions and So Forth
There's been a fair amount of news about pensions recently. For a start, the Department of Labor wants legislation to shore up the PBGC (Pension Benefits Guarantee Corporation — to traditional, defined-benefit pension plans what the FDIC is to banks), which has recently taken over an unusually large number of underfunded pension plans. One component of the proposal is to increase the premium paid by a healthy plan from $18 per employee per year to $30, and to start indexing it to wage increases.

It seems odd that Congress specifies the premium, rather than instructing the PBGC to charge a premium high enough to keep itself solvent and not substantially higher. It also struck me as odd that the base rate is expressed "per employee" and not, say, "per million dollars liability".

One reason for that might be that pension plans have a fair amount of flexibility in setting their discount rates. I'm a little bit unclear on the specifics of this, but I believe pension plans actually use two discount rates, one for the assets and a different one for the liabilities. If I'm not mistaken, this establishes the pension-accounting community as an opportune target for the war on drugs. Anyway, as I understand things, Labor also wants to set at least one of these discount rates itself based on an index of investment-grade corporate bonds. While I usually oppose centralized decision-making, this would make pension plans easier for investors to compare plans and would make it harder to make an insolvent plan look solvent, and I can't see how the lack of flexibility would harm anyone honest.

One of my professors, Zvi Bodie, who is known for his risk-aversion, has written an article for next month's Milkin Institute Review in which he argues that pension funds should be required to invest entirely in investment-grade bonds. It's an interesting idea, which would clear up the key question of what to do about downside risk in the plan assets. Currently, companies that sponsor plans keep most of this risk, with the PBGC as insurance. Plans could be required to buy put options, or, equivalently, required to put a certain portion of investment assets in safe bonds and allowed to buy calls with the rest. The PBGC insurance acts like a put option, but the premiums aren't thought out, or even related to the level of risk inherent in a plan's assets.

In other news, the Governor of California has suggested that the defined-benefit plan run by CalPERS in behalf of state employees be phased out in favor of 401(k)s. Which is the way the world is going. The employee gets all of the downside risk, but gets to decide how much to take (by investing in stock funds or bond funds or some of each).

The President and the Congress are, of course, going to spend a lot of the next year on a key plank in Bush's "Ownership Society", the diversion of some Social Security payments into private accounts. I generally support this, but I support some restrictions, again because of downside risk. If people are allowed to squander their social security accounts, I think the government is likely to bail them out, and I don't think the taxpayer ought to bear a participant's downside risk. So I'd like to see mutual fund companies offer mututal funds with floors, with unusually large management fees to include the cost of the put option. I don't know precisely how these would be structured. I don't envision guaranteeing a minimum return on a daily basis, for example, but on a yearly or multi-year basis; I don't want the fund companies to go under if the market takes a crash; and there are moral hazard issues with respect to the performance of the fund managers. But I think something like this could be worked out.

The price of milk and market failure
The obscure cheese exchange opens with the blare of a siren each trading day at 10:45 a.m. and closes about 15 minutes later. Some days there are no trades. But the low-tech methods and limited trading don't reflect the huge influence of the exchange. The dairy industry uses the quotes for the price of cheese on the exchange to set raw milk prices, in much the same way the financial industry uses benchmarks like the prime rate to set interest rates for everything from home equity loans to credit cards.


It's a strategy that has made [Dairy Farmers of America] the dominant buyer of cheese at the Mercantile Exchange, conducting more than half of all purchases, according to several sources who track the exchange. The cooperative now buys hundreds of truckloads of cheddar cheese at the Merc each year, timing its purchases for maximum impact on the cheese price.
Onerous registration required.

I'm not entirely satisfied of this, but I'm not actually sure that this strategy, conducted consistently, would have a long-term effect on the prices; obviously if markets were efficient this would be the case, but the problem here is that they aren't. It doesn't seem to me that this is going to artificially restrict supply or increase demand (much); it feels to me as though, over a period of time, whatever other reactive forces are at play in determining the market will pull prices down.

This doesn't mean this shouldn't be fixed; insofar as the strategy is not conducted consistently, it's clearly screwing with the information discovery process, and I'm sure there are efficiencies to be gained from improving that — not least, the energy and waste put into the — ultimately unsuccessful, I posit — rent-seeking.

Tuesday, January 11, 2005
Do companies give enough to charity?
These figures pale in comparison to the profit generated by U.S. companies: oil giant ExxonMobil, for one, made $17 billion in the first nine months of 2004. That's leading some in philanthropy to question whether more can be done.
I certainly wouldn't think the right amount would be on the same order of magnitude as profits, though I would expect both to correlate with the general size of the company.

There are tax reasons for companies to contribute money to charity, rather than simply distributing the money for shareholders to contribute as they would like. (Hence Berkshire Hathaway's now defunct program allowing class A shareholders to designate charities to which contributions would be made.) There may also be genuine economies or business benefits, as is often the case when a company contributes its own product. At some companies, though, corporate charity has included large bequests to the alma mater of the CEO; unless an unusual number of the company's shareholders had an interest in that particular school, this is probably closer to embezzlement than it is to actual charity.

I don't imagine many shareholders of most companies give nothing to charity, nor that they object to charitable giving in general, but, tax benefits aside, there's little call for much of that to be done on their behalf, instead of giving them the choice as to where to put the money themselves.

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