Monthly Archive for February, 2011

Labor Unions Are Hazardous to Everyone’s Wealth

Posted on February 28, 2011, 9:08 am. Closed

Thanks to Simoleon Sense for pointing out this post from the Empirical Finance Blog that shows how labor unions are hazardous to your financial health.

From the abstract of the research which is the basis of the post:

“We estimate the effect of new unionization on firms’ equity value over the 1961-1999 period using a newly assembled sample of National Labor Relations Board (NLRB) representation elections matched to stock market data. Event-study estimates show an average union effect on the equity value of the firm equivalent to a cost of at least $40,500 per unionized worker. At the same time, point estimates from a regression-discontinuity design—comparing the stock market impact of close union election wins to close losses—are considerably smaller and close to zero. We find a negative relationship between the cumulative abnormal returns and the vote share in support of the union, allowing us to reconcile these seemingly contradictory findings. Using the magnitudes from the analysis, we calibrate a structural “median voter” model of endogenous union determination in order to conduct counterfactual policy simulations of policies that would marginally increase the ease of unionization.”

Essentially, the researchers found that when there is a union victory at a firm, the firm then underperforms its industry benchmark by nearly 10% after the first year.

I guess we can better appreciate why lots of businesses might want to move to right-to-work states.

Subprime Was Subprime, But Prime Turned Out to be Subprime Too

Posted on February 17, 2011, 8:49 pm. Closed

On February 16, the New York State Assembly Standing Committee on Insurance held a hearing on financial guaranty insurance and representations and warranties in securitized debt transactions. Back in 2007 and 2008, many of the monolines like MBIA, Ambac, and Radian got into big trouble insuring RMBS. Underwriting standards were especially egregious on the part of the originators and the banks who did the securitizations essentially committed fraud when they represented and warranted to the monolines conformed to the underwriting standards set out in the insurance agreement.

Joeseph Brown, CEO of MBIA, testified before the Committee and gave a very good background of the financial guarantee industry and “how the fraud, misrepresentations and failures of certain securitization sponsors to honor their representations and warranties on residential mortgage-backed securities that we insured have led to billions of dollars of claims on MBIA’s policies.”

Most interesting to me is this statement (from which I derived the title of this blog post):

These reps and warranties were critical to us, as these criteria were a key determinant of the quality of loans eligible to be included in the loan pool – and consequently, how the pool could be expected to perform. Interestingly, during this same time period, we insured several billion dollars’ worth of subprime mortgage securitizations. We required overcollateralization consistent with subprime loans because the pools were accurately represented to us, and we understood that they posed a higher risk than securitizations of prime loans. Ironically, these subprime transactions have performed with virtually no losses. Our losses have actually come from securitizations of what were represented to us as pools of prime loans – which, as a result, were structured with less overcollateralization. But because the quality of the loans was misrepresented, and they turned out to be anything but prime, the performance of the securitizations has been abysmal.

Thus far, MBIA has paid out over $4.2 billion in claims and the Company expects to recover about $2.2 billion as of September 30, 2010. After reading through the lawsuits filed by MBIA and Assured Guaranty against these banks, I expect both companies to experience continued success in recovering what they have paid out. When over 80%-90% of loans in a securitization breach a rep and warranty, it is just sickening to see banks avoid their contractual obligations.

Suggestions to Managers of Banks

Posted on February 14, 2011, 8:55 pm. Closed

Despite Hugh McCulloch‘s early opposition to the National Banking Act of 1862, Salmon P. Chase selected McCulloch to be the first Comptroller of the Currency in 1863. McCulloch sent a letter to the managers of all national banks on best management practices. The following is an excerpt and you will see that they are just as applicable today as they were 148 years ago:

“Let no loans be made that are not secured beyond a reasonable contingency. Do nothing to foster and encourage speculation. Give facilities only to legitimate and prudent transactions. Make your discounts on as short time as the business of your customers will permit, and insist upon the payment of all paper at maturity, no matter whether you need the money or not. Never renew a note or bill merely because you may not know where to place the money with equal advantage if the paper is paid. In no other way can you properly control your discount line, or make it at all times reliable.

“Distribute your loans rather than concentrate them in a few hands. Large loans to a single individual or firm, although some times proper and necessary, are generally injudicious and frequently unsafe. Large borrowers are apt to control the bank, and when this is the relation between a bank and its customers, it is not difficult to decide which in the end will suffer. Every dollar that a bank loans above its capital and surplus, it owes for, and its managers are therefore under the strongest obligations to its creditors, as well as to its stockholders, to keep its discounts constantly under its control.

“Treat your customers liberally, bearing in mind the fact that a bank prospers as its customers prosper, but never permit them to dictate your policy.

“If you doubt the propriety of discounting an offering, give the bank the benefit of the doubt and decline it; never make a discount if you doubt the propriety of doing it. If you have reason to distrust the integrity of a customer, close his account. Never deal with a rascal under the impression that you can prevent him from cheating you. The risk in such cases is greater than the profits.”

The Dark Side of Creativity: Original Thinkers Can Be More Dishonest

Posted on February 12, 2011, 9:19 am. Closed

A recent study by Francesca Gino and Dan Ariely suggests that creativity is a better predictor of unethical behavior than intelligence.

Abstract

Creativity is a common aspiration for individuals, organizations, and societies. Here, however, we test whether creativity increases dishonesty. We propose that a creative personality and creativity primes promote individuals’ motivation to think outside the box and that this increased motivation leads to unethical behavior. In four studies, we show that participants with creative personalities who scored high on a test measuring divergent thinking tended to cheat more (Study 1); that dispositional creativity is a better predictor of unethical behavior than intelligence (Study 2); and that participants who were primed to think creatively were more likely to behave dishonestly because of their creativity motivation (Study 3) and greater ability to justify their dishonest behavior (Study 4). Finally, a field study constructively replicates these effects and demonstrates that individuals who work in more creative positions are also more morally flexible (Study 5). The results provide evidence for an association between creativity and dishonesty, thus highlighting a dark side of creativity.

Alleghany Corporation’s Goals and Philosophy From 1993

Posted on February 11, 2011, 5:22 pm. Closed

As I mentioned in my previous post, F.M. Kirby, former Chairman and CEO of Alleghany Corporation, recently passed away. To honor his life and the success of his company, I have transcribed from the 1993 annual report the section on Alleghany’s goals and philosophy:

Goals

While holding risks to a prudent level, we week to achieve:

  • An average annual compound growth rate of 12 percent in earnings per share, together with a consistently high quality of earnings
  • An average annual long-term return on stockholders’ equity of from 12 to 14 percent after tax

Policy and Philosophy

In pursuit of these goals, Alleghany has adopted a highly decentralized organizational structure with the following characteristics:

  • Small but select parent-company staff, which sets goals for the management of our operating units, ensures that they are provided with incentives to meet these goals, and monitors their progress
  • Operating units that function as quasi-autonomous enterprises
  • An entrepreneurial culture quick to identify and react to opportunities
  • Conservative parent-copmany capital structure, combined with ample, immediately available credit
  • Primary emphasis on long-term goals, and the patience to achieve them
  • Investor relations devoid of promotional activity
  • Candor and clarity in our stockholder communications, together with an open door for investors who wish to learn more about us

Conservatism dominates our financial analyses. We shun investment fads and fashions in favor of investing in basic financial and industrial enterprises that offer long-term value to the investor. We are careful to distinguish between success and bigness, and have frequently taken advantage of opportunities to shrink our capitalization when our common stock has become available on attractive terms. Since 24 percent of our outstanding common stock is beneficially owned by our directors and management, to an extent unusual in corporate America their personal fortunes, as well as those of the company’s public stockholders, depend on the successful outcome of their efforts.

This philosophy is the primary reason why Alleghany has provided such excellent returns for its shareholders.

F.M Kirby II, Former CEO and Chairman of Alleghany (Y), Dies

Posted on February 11, 2011, 11:39 am. Closed

The Citizens Voice has a good obit on F.M. Kirby:

Fred Morgan Kirby II of New Vernon, N.J., the former chairman and CEO of Alleghany Corporation and namesake of the F.M. Kirby Center in Wilkes-Barre, died Tuesday morning in North Carolina at the age of 91.

His life reflected the words on his family’s coat of arms: “Facta Non Verba,” meaning “deeds, not words,” according to records and remembrances of friends and colleagues.…

During his nearly 39 years as chairman ending in 2006, Alleghany stock delivered a cumulative return to shareholders of 23,903 percent, compared to 5,215 percent for the S&P 500, according to a release by the National Football Foundation, of which he was an emeritus board member.

Alleghany Corporation (Y) has been an extremely well-run company and remains a large holding of mine.

James Grant Interview on Munis, Rates, and Risk

Posted on February 7, 2011, 11:15 pm. Closed

Bloomberg interview of James Grant on munis, rates, and risk.

Ensco plc (ESV) to Acquire Pride International, Inc. (PDE)

Posted on February 7, 2011, 8:30 am. Closed

Ensco plc to Acquire Pride International, Inc.

Ensco plc (NYSE: ESV) and Pride International, Inc. (NYSE: PDE) jointly announced today that they have entered into a definitive merger agreement under which Ensco will combine with Pride in a cash and stock transaction valued at $41.60 per share based on Ensco’s closing share price on 4 February 2011. The implied offer price represents a premium of 21% to Pride’s closing share price as of the same date and a premium of 25% to the one month volume weighted average closing price of Pride. The definitive merger agreement was unanimously approved by each company’s board of directors.
Under the terms of the merger agreement, Pride stockholders will receive 0.4778 newly-issued shares of Ensco plus $15.60 in cash for each share of Pride common stock. Upon closing, and reflecting the issuance of new Ensco shares, Pride stockholders collectively will own approximately 38% of Ensco’s outstanding shares.
Ensco expects the combined company to realize annual pre-tax expense synergies of at least $50 million for full year 2012 and beyond. The combination is projected by Ensco management to be immediately accretive to Ensco’s earnings and cash flow per share before synergies.
The transaction will create the second largest offshore driller in the world with 74 rigs spanning all of the strategic, high-growth markets around the globe. The combined company will have 21 ultra-deepwater and deepwater rigs, forming the second largest/youngest fleet able to drill in water depths of 4,500’ or greater. In addition, the combined company will have more active jackup rigs than any other driller. Mid-water rigs will represent 8% of the combined fleet.
Based on the closing price of each company’s shares on 4 February 2011, the estimated enterprise value of the combined company is $16 billion. The total estimated revenue backlog for the combined company is approximately $10 billion.

More Proof the Average Retail Investor Doesn’t Know What They’re Doing

Posted on February 6, 2011, 8:38 pm. Closed

Jason Zweig had an article in this past weekend’s WSJ on preferred stocks. I don’t really care about the theme of the article, but there was one example in there worth noting:

Preferred stock also can be “called away” if the issuer wants to retire it. That caught Stan Aten, a printing-company employee in Dallas, by surprise last year when some of his preferred shares of real-estate operator Public Storage, for which he had paid $25.74, were redeemed by the company at $24.50. Mr. Aten, who had bought a few months earlier, lost about $135. He still buys preferreds, but more carefully. “I should have read the prospectus and realized they had the right to do that,” he says.

Yes. He should have read the prospectus. That’s just a basic thing to do. I think this is just more anecdotal proof that the average retail investor does not know what they’re doing when it comes to investing their own money. These individuals would be much better served by giving investment authority to a registered independent advisor or sticking with mutual funds run by managers with a value investing philosophy and with a lot of skin in the game.

The Galleries

Posted on February 5, 2011, 2:52 pm. Closed

“‘The galleries are full of critics. They play no ball. They fight no fights. They make no mistakes because they attempt nothing. Down in the arena are the doers. They make mistakes because they try many things. The man who makes no mistakes lacks boldness and the spirit of adventure. He is the one who never tries anything. He is the break in the wheel of progress. And yet it cannot be truly said he makes no mistakes, because his biggest mistake is the very fact that he tries nothing, does nothing, except criticize those who do things.”

Gen. David M. Shoup,
Former Commandant, US Marine Corps,
Medal of Honor, Tarawa, November 1943