No Little People?

Where have all the small IPOs gone?

One of the unfortunate side-effects of the financial crisis has been the consolidation of the financial sector, especially brokerage firms. When Merrill Lynch, Bear Stearns, or National City got in trouble, they were merged into Bank of America, JP Morgan, and PNC. Other firms, like Lehman Brothers, just went away. The too-big-to-fail banks became even bigger.

This has had an impact on the initial public offering (IPO) market. Everyone loves to discuss mega-IPOs like Facebook, which raised $14 billion, or Dunkin Donuts, which raised $400 million. In order to have an impact on their earnings, the big banks compete to manage these big IPOs. This creates huge demand for huge deals, with potential for huge stumbles, like Facebook.

But these high-profile companies don’t really need brokerage firms to manage their public offerings. Everyone knew about Facebook and Dunkin Donuts. They could have gone public via an auction process, as Google did in 2004. They raised $1.7 billion cutting out much of Wall Street—a record at the time. But it’s small firms that need the expertise and exposure that major dealers can provide.

Some very famous firms started small: Intel raised only $7 million in its IPO; Microsoft raised $30 million. These firms didn’t need the cash, but they did need the liquidity. They needed to be public companies so they could use their own stock to compensate employees and make acquisitions. And they needed advisors to help them tell their stories to the institutional investors who can make or break a small IPO.

But there is little virtue in being small today. With mega-firms competing for mega-IPOs, at least in finance today, small is not beautiful.

Douglas R. Tengdin, CFA
Chief Investment Officer
Hit reply if you have any questions—I read them all!

Follow me on Twitter @GlobalMarketUpd

direct: 603-252-6509
reception: 603-224-1350

www.chartertrust.com • www.moneybasicsradio.com • www.globalmarketupdate.net

New Kid on the Block

The British Prime Minister just selected the head of Canada’s central bank to run the 314 year-old Bank of England. What does it mean?

Mark Carney is a 47 year-old Harvard undergrad, Oxford Ph.D. (in Economics) who spent 13 years managing sovereign credit risk for Goldman Sachs before serving as a Deputy Governor, and later Governor, of the Bank of Canada, beginning in 2003. He served the Bank of Canada well, lowering rates in March of 2008—rightly judging that the leveraged sub-prime loan crisis in the US would trigger global financial contagion. Later he made a conditional commitment to keep rates low for at least a year—boosting confidence. He later raised rates, in 2010, moving back towards a more normal stance.

The Bank of Canada didn’t undertake quantitative easing, and hasn’t dramatically expanded its balance sheet. It didn’t need to. Rising oil prices have stimulated Canada’s economy far more than low interest rates. The country is the 5th largest oil producer in the world, producing 3.6 million barrels per day and exporting about a third of that. At $80 / barrel, that’s $40 billion of stimulus a year.

Carney will find the UK economy far different: 40% larger than Canada’s, far more diversified, with a much larger public sector and stubbornly slow growth. Indeed, England is just emerging from a double-dip recession. It also has a weak banking sector and several “too big to fail” institutions. Canada is notable for the lack of drama from its banking sector during the crisis.

Carney has the reputation of an insightful economist who is willing to experiment. If he succeeds in reigning in the banks and finding innovative ways to stimulate the British economy, maybe we can lend-lease him back here when Bernanke’s term is up.

Douglas R. Tengdin, CFA
Chief Investment Officer
Hit reply if you have any questions—I read them all!

Follow me on Twitter @GlobalMarketUpd

direct: 603-252-6509
reception: 603-224-1350

www.chartertrust.com • www.moneybasicsradio.com • www.globalmarketupdate.net

Short-Term Memories

Remember Auction Rate Preferred notes? These investments seemed to offer something for nothing. Their interest rate would float at a spread above LIBOR and be reset weekly. If investors wanted their money back, there were supposedly a host of other investors ready to purchase the securities at their next auction.

But it didn’t work out that way. When the financial crisis hit, a lot of the auctions failed. Short-term notes became long-term loans. Bonds that were as good as cash suddenly traded at a deep discount.

Borrowers were unhappy, too. Their weekly-reset cash-like interest rates suddenly went to penalty levels four or five percent above the benchmark. That was bad. but it got worse: many of these credits were municipalities that had swapped their floating rate liabilities into fixed rate exposure. These “pay-fixed, receive-floating” interest rate swaps were now bleeding cash, even as the towns needed to pay more to their bondholders.

So we had angry bondholders and angry borrowers. Naturally, they sued the brokers who set up this process. At first the brokers claimed that failed auctions hadn’t happened before, so they couldn’t be held responsible. Only they had: in 1990, Citibank and some small utilities got into trouble when their preferred auctions failed. The brokers should have known better.

So many brokers bought the discounted bonds back at par, bailing the investors out. Swap counterparties also settled for pennies on the dollar, as cash-strapped municipalities cancelled swap contracts. This “sure thing” backfired for everyone involved.

Some of the lawsuits are finally being adjudicated, and it isn’t going well for the dealers. This disastrous product was sold to unwary investors because many were reaching for yield, which often ends in tears. While this particular chapter remains closed, today’s yield-hungry investors should be on the watch for products like these. Let’s not forget the foolishness of the past, lest we repeat these kinds of mistakes in the future. We don’t need any more tears.

Douglas R. Tengdin, CFA
Chief Investment Officer
Hit reply if you have any questions—I read them all!

Follow me on Twitter @GlobalMarketUpd

direct: 603-252-6509
reception: 603-224-1350

www.chartertrust.com • www.moneybasicsradio.com • www.globalmarketupdate.net

Another Black Swan?

Another Black Swan? – Is the world a fragile place?

That’s what Nassim Taleb thinks. The former best-selling author and hedge fund manager has written a book in which he divides the world’s structures into three categories—the fragile, the robust, and the anti-fragile. Fragile items are those that are getting along, but break down in times of stress. Robust items can stand up to shocks and stresses without changing. Anti-fragile systems get stronger and more creative when they face new challenges. Continue reading Another Black Swan?

Giving Thanks

So what do you have to be thankful for?

I thought about this question and a lot of things stand out:

First, I’m thankful that the election is over. As a proud resident of a “battleground” state, my land-line phone rang nonstop during this election season. I’m thankful that our family can eat a meal in peace.

I’m thankful that New Hampshire has no major-league sports teams: so we don’t have team-owners threatening to move their franchise if we don’t build them a new stadium. Miami Marlins fans just had to watch owner Jeffrey Loria trade away proven players for unknown prospects after they built a $515 million stadium in 2008, complete with 37,000 seats and a retractable roof. Taxpayers are on the hook for this white elephant, even though the team finished 12 games below .500 last year.

I’m thankful that Apple and Samsung both have killer smart-phones. Competition is what makes things better for consumers. Competition means I can buy jeans for less than $10 and a snack-wrap for $1.40. Competition means computers just get smaller, lighter, and cheaper. Are you listening, guys? It’s your innovation, not your lawsuits, that’s changing the world.

I’m thankful that amidst cheaper energy, a stronger housing market, and low inflation and interest rates, the economy is growing. A growing economy provides opportunities for young and old alike, to better themselves, to be what they want to be, and to earn a living while doing it.

Most of all I’m thankful that the turkey’s in the oven, my kids are coming home, and the holidays are giving me a few days to reflect on what’s really important.

Happy Thanksgiving, from Charter Trust.

Douglas R. Tengdin, CFA
Chief Investment Officer
Hit reply if you have any questions—I read them all!

Follow me on Twitter @GlobalMarketUpd

direct: 603-252-6509
reception: 603-224-1350

www.chartertrust.com • www.moneybasicsradio.com • www.globalmarketupdate.net

Down the Drain?

Sometimes the end isn’t the end.

With potential buyers lining up, Bankruptcy Judge Robert Drain sent the baker’s union and management back to the negotiating table. The union thought that management’s threat to go to liquidation was a bluff, that there were would be a white knight behind them to rescue the company if they just held out long enough. But when they began to make liquidation plans in earnest, the union may have had second thoughts. So the Judge is giving them one last chance.

If they can’t come to terms, there are at least three potential buyers. Grupo Bimbo (No, I am not making that name up) is based out of Mexico and is the world’s largest bread-baking company. They own Entenmann’s, Thomas’s English Muffins, and a host of Latin American brands. Flowers Foods used to make Mrs. Smith’s Pies and Keebler’s Cookies, but now produces Roman Meal, Sunbeam, and the Nature’s Own brands. Finally, there’s a private equity firm, Sun Partners, which claims that they could assemble a better deal for the union than Hostess, and still be cash flow positive in year one: that by investing in new technology, they could see a positive impact on the product, the people, and the profitability.

The Hostess brand is iconic. For all the jokes about Twinkies surviving a nuclear holocaust, people buy them by the millions because they like having a sweet, light snack. In spite of all the faddish lo-carb, no-fat, zero-sugar diets, people indulge because, hey, it’s easy. But having a popular product is one thing. Producing, distributing, and selling it profitably is another.

There are all kinds of reasons for unions not to trust management. But if the money’s not there, it’s not there. If this team can’t save the Twinkie, they really are Ding-dongs.

Douglas R. Tengdin, CFA
Chief Investment Officer
Hit reply if you have any questions—I read them all!

Follow me on Twitter @GlobalMarketUpd

direct: 603-252-6509
reception: 603-224-1350

www.chartertrust.com • www.moneybasicsradio.com • www.globalmarketupdate.net

Twinkie-Town

Should you stock up on Ding-dongs?

On Friday Hostess Brands’ baker’s union rejected a proposed set of wage and pension cuts, forcing management to move from a Chapter 11 bankruptcy reorganization to a Chapter 7 liquidation. Consumers went out and immediately stocked up on the four major food groups: fruit pies, Twinkies, Ho-hos, and Wonder Bread. But they needn’t worry: the iconic brands will be purchased by someone, and will be produced somewhere. But it’s unlikely that the new owners will hire the same workers from the same union at the same or better wages.

Instead, whoever buys these brands will likely set up new plants in new locations with new contracts. There are a lot of states where unemployment is over 10% with a lot of people looking for work. Twinkies aren’t going to just disappear. Rather, they will be in short supply for a few weeks, and once new distribution channels are established, they’ll be back on the shelves.

What happens to the workers is another story. It’s not just an issue of greedy unions and inept management, as some on the right or left would have you believe. Hostess actually entered bankruptcy back in 2004 and was there until 2009. But they came out at perhaps the worst possible time: just after the longest and deepest economic slump since World War II—not exactly propitious for a snack-food company.

And in addition to poor timing and high wages, the company had an antiquated distribution system and a relatively long inventory cycle. Cash-flow was a problem. A new company with new contracts and new management should be able to create value from a well-established brand.

But some people will lose out. Herein lies the paradox of creative destruction: society cannot reap the rewards of competition without suffering the slings and arrows of fortune. That’s why we have a safety-net: to cushion the blow to individuals and families, while everyone adjusts to continual change.

Douglas R. Tengdin, CFA
Chief Investment Officer
Hit reply if you have any questions—I read them all!

Follow me on Twitter @GlobalMarketUpd

direct: 603-252-6509
reception: 603-224-1350

www.chartertrust.com • www.moneybasicsradio.com • www.globalmarketupdate.net

Syrian Rebels

Arabs, and Persians, and Turks.

That’s the key to understanding what’s going on in Syria. The country has 22 million residents has been ruled by the Assad family for over 40 years. From the rise of Islam in the 7th century until the World War 1, the country has been ruled by the Arab, Persian, and Turkish empires, successively, with brief periods under Crusaders and Mongols.

But now these powers are vying for control of Syria again. The Arabs of Saudi Arabia, the Persians of Iran, and Turkey are all interested in what happens to Syria, both because of its modest oil production and because of its strategic position near Israel. The capital city of Damascus, with 1.7 million residents, is also a holy city in Islam.

Since shortly after the Arab Spring, Syria has been in a civil war, with perhaps 50 people thousand killed and up 350 thousand refugees. The larger world powers have left the stage: Europe is broke and has no desire for empire; Russia can’t project its former Soviet-era strength; China is too risk-averse to get involved; and the US is out of the picture.

So with the global policemen abandoning the beat, the neighborhood has been left to the strongest families to determine who’s in charge. And the three Islamic peoples representing three different modes of governance are deeply interested in how the civil war is resolved: Saudi Arabia a Sunni Arab monarchy; Iran and Shiite Persian theocracy; and Turkey a secular Islamic state with an independent military. All three had been empires in their own right, and all three have allies in Syria.

So don’t expect this to end quickly or easily. Even if Assad falls, the rebels are likely to fight bitterly among themselves.

Douglas R. Tengdin, CFA
Chief Investment Officer
Hit reply if you have any questions—I read them all!

Follow me on Twitter @GlobalMarketUpd

direct: 603-252-6509
reception: 603-224-1350

www.chartertrust.com • www.moneybasicsradio.com • www.globalmarketupdate.net

Debt and Taxes

Can we forgive our way back to prosperity?

Imagine this: you’re underwater on your mortgage and out of a job. You’ve been struggling to make payments on your home, but you’re not sure you can make it. You’re considering a short-sale and other options. Then you get a notice from a group called “Rolling Jubilee” that they have purchased your mortgage and forgiven it. You’d be delirious, right?

Well, maybe. Because that lovely act—debt forgiveness—is a taxable event. That is, forgiving a $200 thousand mortgage creates taxable income of $200 thousand. This group solicits tax-free donations, buys troubled debt at a discount, and forgives the loans. They maintain that they’re not making any money from the debt cancellation, so they don’t need to file any paperwork. But the IRS may have a different take.

Because when a bank takes a loss a loan, they deduct that loss as a business expense. Any subsequent recovery is income. It makes no difference whether that recovery is earned by a hedge fund speculating or by a homeowner who is unexpectedly mortgage-free. Debt forgiveness is income. Otherwise we could have our employers make “loans” to us every paycheck and then “forgive” the loans. Cute, but wrong.

But you’d happily exchange a $200 thousand debt to a bank for a $56 thousand debt to the IRS, right? Again, maybe. The IRS has a lot more collection muscle than Bank of America. And tax obligations typically survive the bankruptcy process.

Which brings up my final point: we already have a perfectly fine debt-forgiveness process. It’s called bankruptcy. It’s legal, orderly, and doesn’t create new tax obligations. Well-meaning but misinformed folks like Rolling Jubilee need to do their homework. Because the Devil—or in this case, the IRS—is in the details.

Douglas R. Tengdin, CFA
Chief Investment Officer
Hit reply if you have any questions—I read them all!

Follow me on Twitter @GlobalMarketUpd

direct: 603-252-6509
reception: 603-224-1350

www.chartertrust.com • www.moneybasicsradio.com • www.globalmarketupdate.net

Un-Lockeing the Morality of Markets

Un-Lockeing the Morality of Markets

John Locke is usually remembered as a source for the Declaration of Independence. But in a small pamphlet written in 1660 he also displays a keen sense of economic justice.

In 17th-century Europe the price of wheat would vary by town. What was available in one city might be scarce in another. Locke noted two towns—one where the price was five shillings a bushel, and another where the price was 20 shillings, where there practically a famine. If it costs me the same to transport the grain to either town, which should I ship to and what should I charge? Continue reading Un-Lockeing the Morality of Markets