PeppercomBlog

The State of the Economy

Posted by Milos Sugovic

The IMF said back in April the U.S. was headed for a recession and will take the rest of the world with it. This month, it made sure to remind us of the elephant in the room since it finally got something right. On the other hand, the panel of economists that officially declare a recession, also known as the National Bureau of Economic Research (NBER), are waiting for the kiss of more data to wake up. But the pile of statistics we all are staring at is telling, nonetheless. We’re surely going down, and there’s no doubt the economic and financial fortunes have turned quickly.

Before jumping to conclusions, remember that the NBER defines a recession as “a significant decline in economic activity spread across the economy, lasting more than a few months, normally visible in real GDP, real income, employment, industrial production, and wholesale-retail sales.”

To make sense of the performance and behavior of the animal also known as the macroeconomy, let’s turn to ECON 102 for a second: Macroeconomics is about the aggregate, and indicators such as GDP, unemployment rates, and price indices facilitate the analysis of the whole. The whole is a sum of many legs, which all operate in tandem. Every action produces a reaction. So it’s important because it assists governments and corporations in the development and evaluation of economic policy and business strategy. Without further ado, here’s what we’ve seen thus far:

The wise thing to do

Posted by Matt Purdue

The NYT reported that investors are fleeing due to the unprecedented shakeout of hedge funds. There hasn’t been much good news about hedge funds lately, so there’s not much new here. But it is interesting to see the NYT take the woes of hedge funds to the front page last week. Of course, this being the NYT, the story smacks of proletariat palaver and beats the drum of class warfare without really reporting anything ground-breaking.

After we move past the NYT’s inherent bias, note a couple of things: the average hedge fund is down 17.6 percent this year. But keep in mind that the S&P 500 is down more than 40 percent in the past year. So hedge fund performance is actually pretty good. But funds are suffering because some investors are asking for their money back, choosing to put it in cash equivalents.

Despite the Times’ torches-and-pitchforks approach, institutional investors like pension funds and endowments will continue to use smart hedge funds as investment vehicles. With hedge funds beating stocks by 23 percentage points, it’s the wise thing to do.

Problem is, the Times missed two real stories here:
(1) If Democrats gain control of the White House, expect more hedge fund regulation in 2009.
(2) Hedge fund managers skim 20 percent of fund profits off the top. Did this emphasis on performance spur them to take unnecessary risks -- risks that, because hedge funds are so opaque, were hidden from investors in any way?

The Perfect Scam

Posted by Milos Sugovic

A company is bottling New York City tap water and selling it in stores for $1.50. Is that brilliant or brilliant? Say goodbye to outdated and unsustainable pyramid schemes, and greet the power of imperfect information and stupidity exploitation. 

Tap'd NY’s Craig Zucker (rhymes with “sucker”) founded a bottled water company he promotes as having a "local twist." What’s the local twist you might ask? The city's public water…oh, and the $1.50 price tag.

Bottled water might be the most creative business innovation, and Craig Zucker, with his “honest and local” company, is taking advantage of imperfect information and the negative publicity surrounding the costly importation of foreign bottled water. Consumers have no way of identifying purified water from regular tap water before consuming it, and surely the product would pass any taste test anyway. On top of that, the company is using corporate responsibility to stress its support of local economic growth and development via patriotic consumption. 

Asymmetric information is every economist’s fascination. It leads to sub-optimal, imperfect outcomes and paves the way for superfluous profits. Think about it: the cost of production for this “award-winning” water is miniscule because it equals Zucker’s city water bill plus a filter. The price, on the other hand, is the market rate.  

So next time you reach for the perfectly chilled bottle of Evian Spring Water, make sure you get Tap’d NY instead. After all, it comes with free refills.

“Temporary” Impairments

Posted by Matt Purdue

For those of us following the financial services space closely, particularly in the realm of insurance and/or portfolio valuation, will find the Fitch Ratings news as an interesting eye-opener.

There’s been a lot of controversy over fair-value accounting, particularly over mark-to-market accounting. In principle, mark-to-market requires companies to value assets on their books according to what they would be worth on the open market.  

The problem in today’s economy, however, is that companies hold billions of dollars worth of assets for which there is no market. Yet, they have to record the falling value of these assets as unrealized losses. These losses hurt their performance, and down they go. (Some very smart people have called for the temporary suspension of mark-to-market rules to give companies some breathing room.) 

Recently the SEC and the Financial Accounting Standards Board told companies they can use more management discretion when they value hard-to-value assets. According to Fitch that’s fine. It won’t affect the way they rate the creditworthiness of these companies. But will it help in the long run? Probably not, the ratings agency suggests. 

When Short-Selling Returns...

Today's guest blog entry comes from Scott Krady

Regulators and market experts will be paying close attention to the markets on Thursday as the temporary ban on the short selling of nearly 1000 companies is lifted.  The SEC created the rule - a ban that began on September 22 temporarily halting the practice in which traders borrow shares and sell them in order to take profits. With a short sale, investors sell shares they do not own (essentially borrowing them) and later purchase them at a lower price, anticipating that during the sell/buy interval the price of the stock will drop.  Key behind the SEC’s ban on short selling has been regulators’ concern over rumors and misinformation about companies. In issuing it, the SEC believed it could halt the spread of false information that could potentially drive down a company’s share price when investors short sell a company’s stock.  This practice is illegal. 

One group certain to weigh in on the short selling ban will be hedge funds. Since the ban on short sales began, hedge funds have endured record redemptions, the likes of which even giants such as Citadel Investments are not immune to.  

It’s clear that one certain impact of the ban has been to send many investors to the sidelines. Just look at the trading volume of these companies since the ban was announced: 

Spare Some Change?

Posted by Milos Sugovic 

Don’t fly without cash! I learned that one the hard way this weekend. It was my first flight since the recent oil shock and I ended up watching “Get Smart” without audio. Turns out, charging for headphones is a movie admission fee on flights these days.  

Back in the day, watching a movie on an airplane seemed like a textbook example of a public good. It was non-rival, meaning consumption of the good by one individual did not reduce availability of the good for consumption by other passengers, and non-excludable, meaning that no one could be prevented from using it.  

But airlines found a way to turn a seemingly public good into a private one by making its consumption excludible. How? Continental Airlines, for example, is charging $1 for headphones, and at no surprise, i-Pod headphones were useless aboard the 737. What was once complimentary is now an expense.  

In effect, Continental and others airlines are capturing consumer surplus -- the utility or benefit experienced by a consumer but not reflected in the price of the ticket -- by implementing hidden costs. But that can go only so far.