Why Berkshire Is No Bargain

Whitney Tilson, manager of T2 Partners, tells the WSJ that Berkshire is cheap.  So cheap, in fact, that Berkshire is Tilson's largest position.  I disagree, strongly, with his analysis that Berkshire is cheap.

Warren Buffett works for free.  There are very few people in finance, money management especially, who work for free.  (This is why he pays no taxes, right?  If we all worked for free, and sold stock when we needed cash, we'd pay very low tax rates too, but I digress...)

With great fanfare, Berkshire has hired Weschler and Combs as money managers.  Who knows what they're getting paid right now.  We do know two things for certain:

• They aren't working for free
• Their now spectacular credentials ("Yes, Warren hired me to manage Berkshire's money...") mean that their market price is the lion's share of a hedge fund fee: 2% management fee and 20% performance share.

Over the next 10 years, Berkshire is going to move from one portfolio manager who works for free to any number of portfolio managers who work for something (again, guessing) closer to a 10% - 15% share of their performance.  As I've written here, performance fees paid to venture capitalists, private equity firms and hedge funds amount to extremely valuable options...to the managers, not the investors along for the ride.

Fundamentally, Berkshire's compensation model must shift from altruist investor to commercial fund-of-funds.  Yes, right now Warren Buffett is hiring managers much like a fund-of-funds invests in hedge funds.  This new model may work, but it certainly has far higher embedded costs of operations than the current operation. 

The succession planning challenges faced by the board have become real.  They will have real costs.

Investment Lessons From the Rockies

I've been on vacation in Montana and the Canadian Rockies for a while.  Not where you'd expect investment advice to grow on trees.  However, if you look, you'll find them.  Here are three images of investment advice.

Lesson 1: Know the rules of the game.

You're looking at a five hour traffic jam, merging down to one lane.  As far as the eye can see, no one enters the merging lane.  In the U.S. we'd call that an arbitrage opportunity.  In Canada, that's business as usual.  God help the poor sap who tries to cut the lane.  One driver tried.  Others berated him so badly, he ran, tail between his legs, to the back of the line. 

Lesson 2: Herding is real

I took about eight minutes to shoot this abandoned house.  (My wife and kids won't sit in the car on the side of the road in the middle of nowhere for much longer.)  When I started, the cows didn't care.  Soon, they're all looking at me, and a large crowd is headed my direction.  As a city person, I'm shocked.  My kids were laughing.  However, it reminds you how quickly a crowd of essentially mindless beings can latch on to something entirely irrelevant to their well being and success. 

Lesson 3: Chaos cannot continue forever

I'd imagine the day Avalanche Lake formed, it seemed like the world would end.  A massive avalanche clears the trees from the side of a mountain into an empty valley.  No one (if present) would have imagined the pristine calm that would follow. 

Kelly Campbell, Government Bailouts and Pure Arbitrage

The other day I was so smitten with Kelly Campbell's discussion of mortgages, I investigated his other great advice.  In particular, he gives three reasons CDs stink.  I wish I could say this got me thinking, but it didn't.  I only observed that his three reasons are all the same: Certificate of deposit rates are low, you barely earn anything and they might rise in the future.

That doesn't mean they stink.  So, I went looking for a good example of a CD.  That's when I found the arbitrage.  For this, I owe Kelly thanks.

You and I own Ally Bank (f/k/a GMAC.)  Ally has great commercials.  The Feds took over when the financing arm of the old General Motors went bust.  We both own it as taxpayers, re-branded as Ally.  Unfortunately, I happen to own ever so slightly more due to an investment through my old employer.  I say ever so slightly because the equity owners were diluted so massively by the government bailout.

As owners, we should all be pleased that Ally has filed for an IPO.  Let's hope the bankers do a great job selling the stock.  But, I'm a little concerned about how Ally funds itself.

Ally offers the usual line-up of deposit products to attract cash.  Remember, banks make money by attracting deposits from savers and lending to borrowers, taking a spread.  Potentially uniquely, Ally attracts deposits by offering five year CDs with an early termination penalty of two months interest.  So, Ally will take your FDIC guaranteed deposit of $250,000, and pay you (today) 2.37% interest, fixed for five years.  However, you can close the account any time you please, only forgoing two months' interest.  That's free money.

What's the problem?  Ally may look like it has a chunk of stable, longer term deposits, when in fact it doesn't.  It has deposits that could be long term, but probably aren't, from people smarter than me who have been engaged in this transaction for a long time.  When short term rates rise, these deposits flee.

So, as Ally shareholders, what should we do?  I for one have just opened my account.  I'll get my too high, riskless return on my cash...and maybe contribute slightly to the fiction of Ally's strong balance sheet, ever so slightly improving the IPO price!

Criminal Financial Planner?

 In this brilliant piece, entitled "Should You Pay Off Your Mortgage or Invest?", Kelly Campbell, a Certified Financial Planner attempts to answer the question.  It's a very hard question to answer, especially depending on a number of particulars for some households.  (I could go on for hours about this for my household...)

Campbell's attempt to answer is so bad, she should be...I don't know, not published by US News and World Report??

Assume a $500k house, $450k mortgage at 5%, real estate returns 5%, other investments return 8%, and you have a 25% tax rate.


Here's her analysis:

Scenario 1: You pay off your mortgage. Since there is no loan, and no investment other than your house, both your investment money and your house value increase at 5 percent (the rate of return on real estate). Your total increase is $25,000.

Scenario 2: You owe $450,000 (90 percent of your home's value). In this scenario, you have a $450,000 note with a 5 percent interest rate. The cost to you is $22,500 per year in interest. But since you are able to deduct the interest on the note, the real cost, assuming a 25 percent total tax rate, is $16,875 per year.

Remember, you will also have the $450,000 that you would have used to pay off your mortgage invested. Assuming the above 8 percent return on investment, this will give you a return of $36,000. Net out what you make and what it costs--$36,000 less $16,875--and you earn a $19,125 return each year.

Brilliant!  If you borrow money to invest, and prices rise, you make more money.  If they don't, you have a problem.  Her closest concession to reality: "It's very important to have investments capable of achieving an 8 percent return..."  Holy cow, that's an understatement!

Should we be surprised?  Probably not.  I am sure Ms. Campbell has many clients asking a very reasonable question: "Why am I giving you money to manage when I could simply pay down my mortgage?"

That's a complicated question that can be very hard to answer.

I guess the easy answer: The Campbell household needs to eat too.

Insider Trading As Art

I cannot tell you how many hedge fund managers will tell you they invest like Warren Buffett.  Making such a claim strikes me as particularly silly.  At best, they invest like Warren Buffett 20 years ago.

Here's a story about why you do not invest like Warren Buffett.


Several years ago, State Farm had to place a massive reinsurance treaty, (that's a contract that pays State Farm after a catastrophic event--insurance for an insurance company,) for the risks of widespread fires following an earthquake in California, for billions of dollars.  The reinsurance brokers told potential counterparties to this contract that Berkshire Hathaway had set the price, and agreed to take a substantial fraction of the risk.  Sounds good, right?  Ajit Jain and Warren Buffett set the price, and you can get in on it too!


But wait!  The contract covered State Farm for something like $4 billion after they lost $2 billion.  And, Berkshire had also provided insurance to State Farm for losing $1 billion after they lost their first $1 billion.  But, no one knew the price paid for that treaty. 

That's when I realized Warren Buffett trades on inside information.  Few people asked anything about the second contract, (called the "lower layer" in reinsurance lingo.)  State Farm could pay Berkshire a fortune on the lower layer to compensate them for setting the price on the massive, higher layer.

At the height of the financial crisis, Buffett bought a preferred equity from Goldman Sachs that he wrote about in his annual shareholder letter.  Sure, he probably thought Goldman stock was cheap and the company could pay its debts.  But, he also knew that with his blessing, the market would have less concern about Goldman, and his actions would contribute to Goldman's success.  Ditto for Swiss Re and General Electric.

Buffett trading with market power--insider information.  You and I don't do that.  You and I don't even contemplate doing that.  Sure, when I trade my incredibly illiquid insurance stocks I worry about moving the price, but I don't change the prospects of the company.

So, why all the hoopla over David Sokol's trading?  How's the guy in line to be the boss supposed to learn to trade like the boss??!!??

Diversification Deja Vu

I've written before about life settlements.  Generally, I'm a fan of allowing the business.  More recently, I argued that people don't like unseemly parts of their investments when they draw too much attention.  It's really a matter of diversification.

This brings me to the latest controversy over the company Life Partners Holdings Inc., a seller of fractional interest in life insurance policies.  The company has just reduced their return expectations touted to customers, at least partially as a result of pressure from a WSJ story.  I know, this is a shocker: They could not deliver on their promised returns!!  Oh, and they're being investigated by the SEC.

Here's the idea: Think of a life insurance policy as a negative coupon bond with an unknown maturity.  Instead of receiving coupons, you pay coupons.  Instead of getting back your principle at a known future date, you get it back at a random date.  The longer the person lives, the lower your return, because you pay the coupon longer, and you get paid back your principle at a later date.  Variable maturity combined with negative coupons makes these bonds much riskier than typical bonds.  (Of course the upside can be huge if the insured falls short of life expectancy.)

How risky are they?  How many stories have you heard of people with months to live surviving years?  My understanding is that there's excellent medical evidence that the grumpier the old man, the longer he lives. 

The math isn't very difficult.  If you expect someone to die in three years, and they live for four, intuitively you're at least 30% worse off, right?  they lived 33% longer than expected, and you had to pay another year of premium.  (At least there's upside: The insured may live less than three years.)   

Many factors drive life expectancies, and they are just expectancies: Half of all people will live longer than expected. 

Moreover, those that are highly likely to live less than expected probably know this, and won't sell their policies.
Life actuaries will tell you your sample needs thousands of observed deaths to draw credible conclusions.  In other words, you need massive diversification to reduce risk.  Why is that?

In contrast, diversification in the stock market takes relatively few positions.  Twenty or thirty stocks in various sectors get you most of the way there.  A two or three thousand stock portfolio isn't going to deviate much from "the market" or our "expectations."

In it's history, LPHI has only sold 6,400 policies to 27,000 investors.  It seems unlikely many of those 27,000 investors hold even 1000 different lives.  They're undiversified and unrealistic about risk and return.

Frankly,  it doesn't matter if the doctor in Reno, NV who performs all their medical evaluations is any good.  He could be "perfect" at calculating expectancies, and results may be lousy for undiversified investors.  (However, giving him the benefit of the doubt is worse than giving credit rating agencies the benefit of the doubt when you buy mortgage backed securities!)

Think of it this way: Suppose the SEC were investigating an equity index mutual fund.  Rather than holding all 500 S&P stocks like Vanguard, it held 10 or 15.  Would you be surprised at the results when the fund underperformed the index?  (But your friend would still brag at the party that his IRA beat yours!)

ESP and Investing

There's a huge controversy bubbling through the psychology world about ESP.  They New York Times has covered it nicely, both here and here.  A researcher has demonstrated that a group of college students have the ability to predict random appearances of porn on computer screens.  No, I'm not kidding.

Here is a response to the paper. I nominate this paper as the best piece of finance writing I have seen in years.  No, I'm not kidding.

If you took a statistics class in college, you learned this stuff.  You just didn't understand it.  (I got a D in Professor Schervish's intro class...the indignity of this experience only got worse when several years later Lars Hansen, world famous econometrician and my dissertation adviser, found out!)  Remember hypothesis testing?  We reject the null hypothesis that blah blah blah.  Hypothesis tests, those used academics the world over, assume you know nothing about the data before you establish and then test your hypothesis. The test requires different methodology when you know something about the data.

So, why is the rebuttal to the ESP paper great reading?  I for one would prefer to contemplate statistics methodology with visions of erotic images on computer screens to the usual urns filled with black and white balls.  More importantly, the authors carefully and lucidly explain the key methodological issues behind statistical tests that all of us too frequently ignore.

Please, read the paper.  Then, think about it the next time someone tells you they've back-tested their investment strategy, and the results are statistically significant.

The Magic of Diversification Revisited

Yesterday, the Wall Street Journal tells us investors are fighting back against life insurance companies that seek to default on their promises to pay claims from policies originated not for "protecting loved ones", or even "estate planning" but for investor speculation.

In this previous post, I argue that investors should not be restricted from trading life insurance policies on people they don't know. I make three points: First, the fact that you will die at some random point in the future has intrinsic value, and everyone should be able to extract that value, not just wealthy people who can buy their own policies. Second, you and I benefit all the time from the premature deaths of others.  (As a resident of the Garden State, I think our only hope for solvency might be the premature deaths of every state employee pensioner!) Lastly, murder is illegal.  Very few investors are going to kill people to reap the rewards of their investments.


While the article itself says nothing new, the comments from the moderately financially informed public (my interpretation of the WSJ readers) seem to hold life insurance companies, hedge funds and convicted violent criminals in roughly the same regard.  They have only slightly more compassion for the elderly seeking a quick buck.


Their disdain puzzles me.  Investors are trading real risks faced by each of us individually.  Liquid,  efficient markets in genuine risks provide something we all need.  Very few natural buyers exist for the risk that a group of people live longer than expected.  (Here's a possible example: Brookdale Senior Living.  Suppose the cost of filling an empty bed is very high.  Thus, they lose money when resident turnover is high.  That means they lose money when life expectancy falls short.  They could hedge that risk.)

So, why the excitement?  As best I can figure, the controversy arises out of a lack of diversification.  Somewhat stinky smelling investments on their own just smell bad and seem risky.  (Whether it's a hedge fund that engages in life settlement transactions, or an bank that writes a reverse mortgage for your grandmother, they both stink.)

When you mix them together with a whole lot of stuff you see the magic of diversification, where no one stinky investment draws too much attention, and the basket provides the complex, pleasant aroma of great investment decision-making. (In 2004, Berkshire Hathaway "lost" over $200 million by buying life settlement contracts that were extremely attractively priced.  No one called Warren Buffett anything unseemly. See page 65 of the annual report for that explanation!)

[Note: One of my friends who knows I've been actively looking at a particular life settlements transaction raised this issue with me.  I'm therefore putting back in the disclaimer I had in an earlier draft.  So, here it is: I spent much of the past three weeks on due diligence of a life settlement transaction.  I am not completing the transaction.  And, while we're at it, I happen to own equity in The Phoenix Companies, Inc.]

Is Stock Picking Really Dead? Part III

Have you ever watched a game of little kid soccer?  Little kids, not big kids.  Here's a hint from my town.  At this age, the moms are not yet soccer moms.  They still think they're hipsters from Brooklyn.  The dads won't show, out of fear someone will recognize them as a New Jersey resident.

Anyway, in Kiddie Soccer, the ball moves randomly.  The four year old kids move randomly near the ball, but not always.  Kid movements correlate poorly with each other and with the ball.  The average location of the kids tells you the ball's location, roughly.  It certainly tells little about the location of any particular kid.

By age six, the kids all chase the ball well.  The dense pack of furious kickers sticks closely to the ball!  The average location of the kids tells you the precise location of the ball.  Not only that, it tells you pretty well location of each and every kid!  Correlation with each other kid (and the ball) rises.  The ball, more or less, still moves randomly, but even without seeing it, you know where it is.

[Maybe by high school kid movements have lower correlation with each other: They stay in position on the field.  And, ball movements get predictable: running and passing in the right direction to reach the goal.]

Is Stock Picking Really Dead? Part II

In my previous post on this topic, I explained that active stock pickers benefit from significant tailwinds when smaller companies outperform larger ones.  Similarly, recently they've been hurt, or at least not helped by the reverse.

A similar factor bet, (fancy term for "investment style that can be explained by something simple",) applies to fundamental valuation.  There are a class of investors who call themselves "value investors".  What the heck is a "no value investor"?  No such thing.  That's why I'm comfortable calling most investors value investors without hiring Pew to work the phones for me.

Value means different things to different investors.  Ratios of letters really matter to value investors: P/E, P/B, EV/FCF, P/EBITDA, the list goes on.  Each of these measures is highly correlated with all of the others.  The differences aren't necessarily rounding error, but they are similar.

Fundamentally, the equity value of a company depends on what remains after the company pays off its debts, dividends out all its earnings, and liquidates at the end of time.  So, you value the future earnings stream. You want to buy that future earnings stream on the cheap.  You also want to know those earnings exist, that they aren't in the imagination of management.

Is Stock Picking Really Dead?

In this Wall Street Journal article, picked up by Yahoo!, various pundits and portfolio managers indicate that stock selection has died.  Macro investing now rules the world of finance.  Here's one of my favorite paragraphs:

Some data suggest that stock pickers are having a harder time outperforming the market. Each year between 1995 and 2007, for example, on average, 50% of mutual funds focusing on large, fast-growth companies beat the Russell 1000 Growth Index, a benchmark for that category, according to Morningstar Inc. Over the past year, only about 24% of those funds beat that index.

Gotta love that.  The folks who evaluate mutual funds for a living, (who don't even include all the funds that go out of business,) say managers who pick amongst large market capitalization "growth" stocks are as good as a coin flip when times are good.  Lately, they look much worse.  So, what's the problem, and should we attribute this to the death of stock picking? 

(Remember, John Bogle, the founder of Vanguard, will always remind you mutual funds are not on average able to beat the market.  On average, they are the market, and they have to pay fees to themselves and their brokers.)

Mutual Fund Fees...Where To Begin??

John Bogle, the grand daddy of mutual fund indexing wrote a very nice Op-Ed piece the other day.  If you know who he is, there's really nothing new in the piece: Management fees directly impact (negatively) the performance of mutual funds, and even Morningstar now confesses that fees better predict performance than their own star system.

Today, Neil Hennessy of the Hennessy family of mutual funds writes in response that Bogle is wrong.  There's a shocker.  The guy who founded the only not-for-profit mutual fund company says fees are bad and the guy running the for profit says he's wrong.  That's a good starting point, but there's more.

Hennessy's first point of insight is that rhetorical device known as the "irrelevant analogy":

We have all learned the lesson that cheaper is not always better. Would you choose the doctor with the cheapest rates and highest number of patients, who then has a larger base to spread costs among?

(Frankly, the medical analogy is pretty good for investing: You're buying a product you have no ability to evaluate.  I've faced many blank stares from friends telling me about their "great doctor" and I ask them for data to prove their doctor is great...but that's a different topic...)

Next Hennessy turns to a laundry list of other expenses investors face.  He's right.  You pay all kinds of expenses you shouldn't.  He misses half of them.  The problem is: Bogle isn't wrong!  Low expenses predict performance.

I'd bet low management fees predict low "other expenses".  What do I mean?  You can bet Vanguard's board fees are lower than Hennessy's.  I'd also bet Vanguard's liability insurance costs less.  Ditto lawyers.  Why?  Vanguard manages mutual funds for the benefit of mutual fund shareholders, not mutual fund managers.  Seems pretty logical that if you manage the fund to benefit the shareholders, then your expenses of covering your own conflicted backside drop.

Hennessy's last argument stands tall as one of my favorites.  Only performance matters, and reported performance takes out fees, so who cares?  Again, he misses the point: Performance isn't predictable, but fees are.

Bad Investment Advice

I try at all cost to avoid giving investment advice.  This applies doubly to my family members.  In August of 2007 I gave my family investment advice.  I told them the banking system was going to fall apart, and they should immediately take their money out of all money market funds and make sure they didn't have over FDIC limits in any bank accounts.  The uniform response: You are out of your mind and wrong.  My email dated August 15, 2007 apologized for annoying them.  I promised not to give anyone investment advice again.

Now, I'm breaking the promise.  Here comes investment advice.  The WSJ asked (presumably) highly paid financial advisers a simple question: A recent high school or college grad has to good fortune of $10,000 to invest.  What single mutual fund or ETF should they buy?  I'll summarize the results in three answers: small cap equities, non-US equities or very long term target date funds.

The answer should be "I refuse to answer this question without more information, otherwise I'm as useful as a one legged punter in the NFL."  The attitude that someone can or will even try to answer that question reflects everything wrong with investment advice. Circumstances matter.  Hugely.

Why do they answer?  I guess they think being quoted in the WSJ will enhance the value of their business.  That way they can give bad advice to more people. 

So, where's the investment advice?  Several thoughts occur to me.  Employed?  Does your employer have a 401(k) match?  Then "invest" the $10k on rent and food so you can save more efficiently.  Not employed? "Invest" in a money market fund because you can't take the risk of anything else.  Trust fund from grandma? Buy something very risky that will entertain you and matter if you win, since you won't care if you lose.

Government Sponsored Leveraged Equity Bets...On College??

I've explained before why I think 529 Plans should go away.  They only benefit the very wealthy, and probably they feed the ever increasing costs of college education. 

Melissa Bean of Illinois, has introduced HR5030, which seeks to allow the use of 529 Plan assets to cover student loan interest payments.  From her website:

"With one daughter in college and another to follow, I keenly understand the financial challenges parents face to fund college education,” Bean said. “This bill allows those who’ve saved in 529 accounts and played by the rules to allow their investments to recover before using them to finance those costs."

This bill reflects a fundamental misunderstanding of just about every aspect of finance, from investing through tax.

Let's make this very simple.  Bean bought a risky portfolio to save, tax free, for her daughters' college costs.  This portfolio went south. 

H.R. 5030 would allow her to use the risky plan assets to finance student loan debt, not just direct educational expense.  If she were a Goldman instead of a Bean, we'd call this proprietary trading. 

She believes she can invest her 529 Plan assets in such a way as to earn a spread above the borrowing rate on student loans.  That's a bold assumption.

We could just stop there.  Why should the government encourage more leveraged risky bets than they already encourage? 

The New Standard For Investing? Are You Kidding?

George Soros and Andrew Ross Sorkin share a common passion: They both appear deeply concerned about socially beneficial investing.  As Soros states, "Whether or not Goldman is guilty, the transaction in question clearly had no social benefit."  Similarly, Sorkin writes, "What purpose does a synthetic C.D.O., which contains no actual mortgage bonds, serve for the capital markets, and for society?"  I am highly confident both Soros and Sorkin have made investments with dubious social benefit in the eyes of most people.

Let's consider these statements.  We pretty clearly see that consenting adults, so-called "sophisticated investors" chose to enter into the transactions in question.  (Side note: If you ever have the pleasure of being called a sophisticated investor, that very likely means the person telling you such confidently believes your check will clear.)  So, in the moment, the individuals best suited to judge the merits of the decision believed they were making a good decision.  By construction, a good decision must benefit them.  So, who's to judge after the fact?

But more importantly, who should be the judge of whether a potential investment has merit for society?  We "allow" all kinds of investments with far less ambiguous merit.  Cigarette manufacturing and sales, for example.  Should Congress decide which investments merit capital because they meet someone's view of socially beneficial?  That's an interesting contrast to the recent Supreme Court decision striking down a ban on animal cruelty videos.

Making financial regulations and investment decisions based on standards of "social benefits" risks too much in a free society. 

[Oh, and those investments of dubious social value?  Here's a guess: Soros engages in high frequency equity trading, and Sorkin at some time in his career has owned Philip Morris stock in a mutual fund.]

Liquid Assets? You've Been Hitting the Bottle A Little Too Hard

Today must be a light news day because too much attention has been paid to this ridiculous study of wine price appreciation.  The authors claim investing in wine beats investing in stocks, and aids in diversification of investors' portfolios, reducing risk and increasing returns.  I appreciate a good wine.  I even appreciate a good study.  This paper falls in neither category.  Put this back with the Maneschevitz and Tarot cards.

They examine several years of wine auction trades on a subset of relatively more actively traded wines that one might construe as something investable.

Panic Investing And Profiting From Disaster

Not long after Passover, it's nice to see the James Altucher in the WSJ attempting to help people profit from a nice list of several plagues.  I'm a fan of contemplating disaster.  Most friends think I spend too much time on the topic.  This piece stinks like rotting corpses after the death of the first born.

The first fundamental problem: Free insurance rarely exists.  Making money when something out of the ordinary happens, especially bad things, typically requires losing money when things don't go wrong.  Why?  I've written more about this here, but the basic idea follows because you want to insure against the vary same things others want to insure against, which means (a) you want someone else to hold risk you don't like and they probably don't like it either, and (b) your insurance requires your counter-party tie up capital waiting for the event. 

Second fundamental problem: He suggests public equity market hedges for all his risks.  Public equity markets, all prognostications aside, operate pretty darn efficiently.  This means two things: First, often equity prices reflect expected economic growth, in the broadest sense.  Second, equity prices reflect a risk premium, or how much investors will pay for a dollar of future earnings potential.  Neither of these factors really change in response to the ills of Altucher's world. Acute disasters don't matter in the long run.  Big, long run disaster expectations efficiently work their way into prices.

With those two warnings, let's look at his suggestions....

86 The 529

A story in the Education section of the Journal discusses pre-paid tuition plans, a special case of 529 college savings plans. (For those without children and therefore not up on the details of college funding, these plans allow savers to invest tax free, as long as the proceeds go toward college tuition.) It turns out most investors in pre-paid tuition plans didn't read the fine print: Counterparty credit risk. They turned their cash over to state controlled entities that blew their money, and can't make good on their commitments.  There's a shock.

Add incompetent state oversight to the list of bad management, lousy investment options and absurd add-on fees.

Jimmy Stewart Cared, But Why Should You?

I have a confession: I've made it this far in my life without ever seeing It's a Wonderful Life.  I consider this an accomplishment for someone who studied economics.  You cannot imagine how many lecturers reference a single scene of an old film.  All I know is that Jimmy Stewart has the teller window slammed on him at the bank.  He apparently didn't like that.

Most people reading this wouldn't particularly care if their bank failed.  Your deposits fall below FDIC insurance limits, so you won't lose anything.  I know several people who have experienced failure in their primary banking relationships, and they barely noticed.  Most bank failures since FDIC, luckily, have not hurt any depositors.

Bank failures more likely strike blows at companies. Imagine some very large deposits. Microsoft's cash to make payroll on January 31st, for example.  At some point, it must sit in a reasonably small number of places.  Not in $250,000 slices.  Microsoft has no interest in taking risk with their payroll, for even an instant, when someone else, (shareholders of a bank) reap the rewards.  Or, maybe they do break it magically into $250,000 slices.  That has a cost.  Microsoft shouldn't have to bear that cost, or the risk.

Of course he saw it coming...

I'm am completely sick of hearing he saw it coming...nothing about this individual in particular bothers me, but we hear this refrain all too frequently after outlier events.  Making proclamations that unlikely disasters will happen is easy because, well, talk is cheap.

Making piles of money (John Paulson, anyone?) doesn't even prove the point, but it's a step in the right direction.  At least he placed the bet.  Betting that disasters will happen when the bets are cheap takes skill to price, luck to get right, and errors don't come cheap.

The problem remains, however.  If we're talking about rare events, we can't see enough to differentiate luck from skill.  How long do we need to watch an investor to see if he can accurately predict one in fifty year events?  In financial markets, were correlations run very high, the answer, sadly, is a long, long time.

Where does that leave the academic in the SEC?  Sadly, I suspect ignored, with no authority, and a somewhat bigger audience than I have...but he won't be as entertaining!