Here are articles on Finance

Millennials don’t save? Of course not. Neither would you.

Millennials don’t save? Of course not. Neither would you.

Why are millennials broke? Systems. Not choices.

I recently read an online discussion in which Baby Boomers and Gen Xers resoundingly chastised millennials who don’t save enough for retirement. It seems that instead, millennials are struggling with student debt. The crowd was quick to dismiss the problem as irresponsible millennials spending too much for college degrees that pay too little (e.g. Art History).

Really? Millennials (raised by Boomers and Gen Xers, by the way) are an entire generation of people who simply made bad college choices at historically unprecedented levels? Get real. Remember who chooses to attend college and decide on a major: An 18-year-old with no real world experience, who probably knows nothing about modeling lifetime financial implications of their decisions. Expecting them to be able to choose well is naive. Indeed, many Baby Boomers and Gen Xers made really bad choices. But when they were college age, the system was different. A bad choice, financially, wouldn’t—and didn’t—cripple you for life.

The fundamental economics of education and saving have changed.

That was Then

When Gen Xers were growing up, a college education cost a total of about a year and a half’s salary. MIT four-year tuition was $40,000 before books and expenses. A graduating student could get a job that paid a salary in the $30,000 range.

Furthermore, students could get jobs that paid enough to make a serious dent in student expenses. On-campus student jobs paid about $10, and a 1/4-time job would bring in $5,000 a year. That’s enough to pay half of the tuition bill. Today, student jobs still pay about $10. Needless to say, it won’t be covering half of the tuition bill.

To make up the difference, student loans fill the gap. Student loan interest rates were comparable to rates offered in savings accounts, so once a graduate started saving money, their asset base could compound at about the same rate as their student loans, so their net worth could be at least somewhat stable.

Starting salaries generally paid a living wage (enough for rent, food, utilities, a bit of entertainment, and savings), without the need for multiple jobs. And a college degree was a genuine ticket to a better-than-average job.

This is Now

Today, a college education costs closer to 4 years’ starting salary. MIT tuition is about $184,000.

Debt loads can’t be easily reduced by student jobs. No jobs available to students can make much of a dent in the $46,000/year tuition. Student jobs still pay in the $10-$12/hour range.

A starting salary of, say, $50,000 (higher than many are likely to get) isn’t actually enough to live in many cities while paying down student debt. While saying “move somewhere cheap” sounds attractive, the kind of jobs that make use of a college education are often located in big cities that aren’t that cheap.

Student loan interest rates are much higher than you can get in savings accounts, they aren’t dischargeable via bankruptcy. And the college degree that cost all this money is simply needed to get a job at all. Except from a certain class of top-tier schools, it isn’t a ticket to a comparatively higher salary.

Our Choices are as Bad as Millennials’

Everything I’ve read about Baby Boomers and Gen Xers is that we suck at saving money. We may have been living nice lifestyles, but we’re anything but role models when it comes to good lifetime financial decisions. But unlike millennials, we lived in a time where circumstances gave us decent lifestyles despite our bad choices. And our bad choices will, again, fall on the millennials. Our retirement years will make their middle-age a living hell, as they struggle to deal with an aging population that saved nothing and expects to be supported.

Millennials probably aren’t better at long-term financial planning than the rest of us, but they likely aren’t any worse. They were born into a set of circumstances, however, where the road to success that worked for us—a college education—had changed. That road, itself, costs more, benefits less, and creates circumstances that would be just as devastating for any Gen Xer or Baby Boomer.

The Key Business Concepts Missing From The National Debt Debate

In business, if you decide to do a project you scope out the project. You estimate what it will cost, over what time frame it will produce results, and so on. Then you decide how to finance it. There are many, many possibilities: you might finance it by paying for it directly. That’s equity investment. You might borrow to pay for it, which is debt financing. You could also finance it in other ways by having suppliers or customers carry part of the cost. Which option is best depends on many factors, including prevailing interest rates, payback periods, and so on.

It’s easy to get people to have a knee-jerk reaction to the idea of lower taxes, however. So for political reasons, virtually the entire debate has focused on “do we finance our government with taxes (the equivalent of equity) or debt?” That’s been turned into rallying cries about taxes that candidates use to drive elections.

If we were making good decisions, the national debate would be about how we want to spend our money. In 2011, the only large discretionary category is defense at $722 billion(*). If we include mandatory spending, the other large categories are social security, Medicare, unemployment assistance, and health care.

Once we’ve made that decision, we would decide whether it makes sense to fund those measures with equity or with debt. The consequences of debt default would, of course, be included in the financing discussion.

Neither the Democrats nor the Republicans seems much inclined to cut spending. They cut specific items that they’re ideologically opposed to, but they don’t touch the big items listed above. And not even candidates who claim to advocate small government propose slashing the only large discretionary item in the budget, our $722 billion defense budget.

What worries me most, structurally, about debt is that debt has to be repaid with interest. An ever-increasing percentage of our national budget is going to pay interest on debts incurred decades ago, whose benefits have long been played out. If we continue funding things with debt, we’ll be piling up interest payments that could eventually wreck us.

Why do people not like high taxes? Because it brings into stark reality the fact that policy choices have real monetary consequences that we must pay for collectively. We like our highways, and our Medicare, and our defense department. But we don’t like to face up to the cost of those things.

Debt allows us to defer taking responsibility. High taxes forces us to take responsibility immediately. That’s why I favor tax hikes. For the ultra-rich? Certainly; they use far more of our infrastructure than the average person uses (e.g. airports, the justice department, the banking system, etc.), and it’s only fair that they pay their fair share of the common resources they’re using. But for all of us. Taxes force us to make smart choices now, rather than giving us the false luxury of waiting for emergency to push us into harried stupid choices.

And above all, I believe in paying $10 for a $10 expense. When we finance with taxes, that’s what we do. When we finance with debt, we pay $11 or $12, or $20, or $50 for that $10 expense. And I don’t care if you’re conservative or liberal, that’s just plain dumb.

(*) You can see the budget numbers here. Try clicking “hide mandatory spending”: http://www.nytimes.com/interactive/2010/02/01/us/budget.html

Global meltdown: Bush saves the day! (in 40 minutes!)

Meetings! I just love meetings … no, I don’t. I hate meetings. But perhaps that’s just because I’m no good at running them.

According to an MSNBC article today, Bush met with the leaders of 20 countries Saturday night. To quote the article:

“After the almost 40-minute meeting and his six-minute statement, the president left the White House for a nearly two-hour mountain bike ride in the nearby Virginia woods.”

Jeez. I really wish I had his meeting facilitation abilities. At a meeting with 20 world leaders, all of whom are undoubtedly known for their keen wit, brevity, and ability to grasp huge honkin’ financial issues in seconds, it would still take me 10 minutes to do introductions. After all, I like to spend about 30 seconds having each person state their name, the country they lead, and their form of government (“Parliamentary,” “Representative Democracy,” “Puppet Dictatorship,” etc.)

That would leave only 30 minutes for the meeting itself, clearly not enough time to lay out the mess, explain the economic issues and how policy can resolve them, etc. Whatever his other problems, it seems Bush is able to resolve a 20-country, unprecedented global financial meltdown in 40 minutes, just by talking for six minutes… astounding! Perhaps it’s the two-hour bike rides? They send enough oxygen to his head that he can think super-clearly.

This is what passes for world leadership.

We have the most advanced technology in history and the ability to feed every man, woman, and child on the face of the planet. Yet we’re still plagued by poverty, famine, gross wealth inequality, and violence. Our human abilities simply aren’t up to coping with issues of this magnitude. We’ve created systems so complex that even the major player (e.g. Paulson) can’t understand them. And our leaders? They’re as clueless as the rest of us, it seems.

So this whole meeting brings up only one major question: Where can I get a job that lets me take two-hour bike rides while the country—ostensibly my responsibility—melts down around me?

My biggest concern about Bush in 2000 was that every company he’s ever run, he’s run into the ground. That concerns me. Past behavior is, alas, the best predictor of future behavior.

“Shrub,” by Molly Ivins, recounted the messes prior to his being elected. At the time, I imagined he and his policies wouldn’t be the best for the country, but I honestly didn’t believe they could screw up an entire country.

And to be fair, he and his policies only exacerbated structural problems that had been in the works for years. Heck, Clinton’s the one who lowered Fannie Mae mortgage standards allowing the subprime mortgages to start to take hold. And the financially illiterate actually took out the mortgages. And the further financially illiterate (the financial and banking sector, as it turns out) bought the repackaged mortgages.

But at the end of the day, it’s the leader who needs to be seeing farthest. As is common knowledge by now, they didn’t bother to read the report entitled ‘Bin Laden Determined to Attack Inside the United States.’ And even though such minor folks like Warren Buffett have been warning about derivatives for years, their market ideology got well in the way of noticing that the numbers didn’t add up.

There’s not much I can do about it from where I sit. Except vote.

Why the finance industry should accept much more blame for the crisis.

If what we want to do is point fingers, there’s plenty of blame to go around. At the end of the day, though, I hold the creators of the securities as being far more responsible than the home buyers.

Professionals should be held to higher standards

First off, the financial companies are supposedly professionals. That means they understand far more about how all this works. Bluntly, I hold them to a higher standard. If they’re going to take home billions in pay, I expected them to think through their investing decisions and security formation very, very carefully.

The financial community has gone wild in abstracting away risk and reward from underlying securities. And they’ve gotten very, very rich from that. But they’re professionals. If they buy a mortgage-backed security and are surprised that people can default on the mortgage, then they need to take full responsibility for that. Period.

Stocks and bonds and mortgages all represent actual entities in the world who are actually doing stuff. If you remember this, you can make intelligent decisions. Warren Buffett became the richest man in the world by doing this intelligently and sharing with everyone who cares to listen how he does it. When others in the finance community choose to ignore that underlying reality because it’s convenient, I can’t have much sympathy when the house of cards collapses.

(Upcoming crisis: if they buy a credit swap from someone who can’t actually guarantee the underlying loan, then again, they absolutely deserve whatever they get. Especially if they’re the ones who lobbied for non-regulation in the credit swap market!

My solution involves using eminent domain to reclaim every penny and every asset paid to every employee of the i-banks who created, traded, and sold these entities. then the taxpayers pay for the remainder of the bailout. Aren’t you happy I’m not in charge?)

Selling a financial product to numerically illiterate customers is bad business

Second, innumeracy. You can say all you like that it’s the dumb mortgage holders who bought dumb mortgages. And I agree. Only they weren’t dumb; they were simply ignorant. We don’t teach people anything about financial literacy in school. Even when I got my MBA, it took quite a while for the group of very bright (but non mathematical) students in the room to understand how to calculate simple financial concepts like “net present value.”

Most people don’t really understand the math of a variable rate mortgage, and certainly aren’t good enough at budgeting and forecasting future scenarios to realize what is and isn’t a good financial decision.

Again, the mortgage underwriters were professionals. For them to say, “we sold these to people who couldn’t pay, it’s their fault,” is simply absurd.

If you’re in the business of making loans and then carrying those loans on your books, it’s YOUR responsibility to make sure the loans can be paid off! Not because you owe the customers anything, but because Accounting 101 GAAP rules say that you don’t count on an asset’s value unless you’re highly certain it’s going to be worth that much.

If a bank writes a mortgage and chooses to relax its standards under the theory that it can sell the mortgage before the borrower defaults, then the bank is being irresponsible (not to mention implicitly defrauding the folks it sells the mortgage to).

The “2nd tier” buyers can also be smart about what they’re buying

The 2nd-tier people buying that mortgage from the bank are buying an asset they don’t understand. They’re free to ask for a payment guarantee from the bank to accompany the mortgage. They didn’t, and are then surprised that the default rates were higher. (These people clearly missed the whole Junk Bond crisis that had all these same elements.) If I have to buy insurance on my house in case there’s a fire, then the 2nd-tier buyers should also be smart enough to demand the bank guarantee the default rate that they claim their mortgages will produce. Or if the banks won’t do that, then the 2nd-tier buyers should at least look at the mortgages to make sure they’re as high-quality as the bank believes them to be.

Rating agencies don’t exempt finance professionals from due diligence

“But the rating agencies…” you begin to cry. Screw the rating agencies, people. If a buyer of a mortgage-backed security decides to trust a rating agency’s evaluation of a security that everyone admits is hard to value, then again, you’re consciously deciding to allow your business’s integrity to reside in the hands of the rating agency.

You could take a random statistically valid sample of mortgages and hire a bunch of interns to re-run credit and income checks to make sure the mortgages are sound. You could further ask whether you believe the borrowers can still repay after rates increase. It’s called “due diligence” but it requires admitting that there’s a physical reality that might get in the way of your free money-printing machine. It also requires doing legwork in the physical world, which the finance people were understandably loathe to do.

It wasn’t the consumers who came up with the idea that these mortgages were affordable

And lastly, the marketing of these mortgages were designed to persuade people to take them out. Well, it worked. And for banks and lenders to be shocked that their marketing worked, and then further shocked that their own lax standards put them in a position where their borrowers couldn’t repay is just hubris beyond belief.

So yeah, many consumers should have made better decisions. But they’re not professionals, they’re not financially literate, and they’re being subjected to $100,000,000 of marketing and sales tactics.

The mortgage writers and derivative creators are financially literate professionals who chose to ignore their own historical underwriting standards and sell mortgages that couldn’t be repaid. They then took these bad mortgages, repackaged and resold them to other institutions that didn’t bother to do real due diligence.

To me, the case is clear: if I have to blame someone, I’ll blame the industry of “professionals” who ignored the financial realities of their customers, invested in bad quality securities, eschewed due diligence, and generally took the profits when times were good and are now trying to shove away responsibility for their own decisions now that times are bad.

Greenspan? Rapidly approaching status of “bad joke” in my mind.

According to a New York Times article about Greenspan and his policies today, Greenspan is defending his stance on derivatives (he was pro-derivatives) by saying the whole imploding economy is because of people acting in bad faith in the markets, but the deregulated derivatives approach was somehow still “right.”

Mr. Greenspan is apparently living in a world without people. I’ve been aware of Wall Street and its tendancy to, er, stretch the boundaries of good and bad faith since Greenspan took office. In case he didn’t notice, we had a Savings and Loan Crisis, a Junk Bond collapse, Long-Term Capital Management’s collapse, the Internet bubble popping, then a wave of corporate scandals that even took down Arthur Andersen. Where was he during this 20-year march of greed that he could champion deregulation under the belief that people wouldn’t be greedy and would act in good faith without regulation to impose penalties when they didn’t?

How could he cling to a theory that depended, oh-by-the-way, on the naive belief that people would do the “right” thing even though the instruments let them become unbelievably wealthy by doing the wrong (but legal) thing?

I just don’t get it. And I find myself repeating it over and over in stunned disbelief. He actually believed that Wall Street would police itself, after having presided over several TRILLION dollars worth of corruption and greed with several successive financial instrument “advancements.”

I’m so very, very glad that the man is no longer making policy. Of course, having the head of an investment bank now in the position doesn’t exactly fill me with confidence. Goldman has a good reputation, but at this point, I’m not at all sure that anyone steeped in the financial industry culture for 20+ years has the objectivity to know whether the system is fundamentally broken (they have a vested interest in believing it’s not), or whether it simply requires some trillion-dollar tweaks to put it back in order.

Investors warn against eliminating guidance… especially if they have no talent.

Investors say it’s a bad idea for companies to stop giving quarterly guidance. I think investors are just flat-out wrong. Quarterly guidance certainly distorts management decision-making, so we know it’s bad for the companies. It’s good for investors because it relieves them of the burden of having to research the companies they invest in, and really understand the businesses and their industries.

To that, I say “pfshaw!” Warren Buffett became the second richest man in the world investing. Read anything he’s written, and he stresses again and again that one can learn a lot about a company from talking to suppliers, customers, and competitors. You can learn about management’s past investing and management track record by reading old annual reports (not quarterly reports, but annual reports). With the internet, all that should be even easier than when Buffett did it.

Investors cry that “oh! oh! without quarterly guidance, fraud will creep in.” Give me a break, people. Enron filed quarterly reports. If no one’s taking the time to understand the companies and the industries, then they’re not going to notice the irregularities in the quarterly reports. And if they do take the time to do a good job, then they won’t need quarterly reports.

In short, let’s eliminate guidance and let businesses make some decisions without worrying about quarterly earnings. Let the investors do some work and be true investors, not simple, short-term gamblers on quarterly reports.

Is Google stock overvalued? How would we know?

A friend wrote: “… and I thought Google was overvalued at $150!” She was implying that it must not have been overvalued, since it’s currently selling for so much more. I decided to whip out my amateur finance knowledge and see if she was right.

Disclaimer: I am not a finance jock. My understanding of valuation models is limited to my experience as an investor in startup companies, my MBA finance courses, and my having read all of Berkshire Hathaway’s annual reports, and whatever other writing I can get my hands on from Warren Buffett. (Especially Buffetology by Mary Buffett and David Clark.)

My friend was likely right. Google probably was overpriced at $150. “Overpriced” means its actual value is less than it’s selling price.

Share price isn’t the same as value. Google’s price may be above $150, but its intrinsic value may be lower or higher. Price says nothing about intrinsic value, though the value investing theory goes that over the long term, price will eventually gravitate to intrinsic value. I told my friend, “you can kick yourself for not having speculated, but don’t assume that your instincts were wrong.”


P/E (price-to-earnings) analysis: Google is currently at $377, with a P/E of 63. That means it will take 63 years for Google to earn back the price of the share you buy. A P/E of 18 is more reasonable (Walmart is at 17, for instance, Microsoft at 18). If Google falls to a realistic valuation (as it’s certain to do over 63 years), this would be about $101/share (377 / 63 * 18 = $107), which is less than the $150 my friend mentioned.

Warren Buffet “bond coupon” valuation: Google produced its historic high $5.68 of fully diluted earnings per share this year. So you are buying a share that produces $5.68 each year. A perfectly safe investment (a T-bill) returns 5.12% a year, so to get $5.68 in earnings from a T-bill, you could buy $111 in T-bills and generate a risk-free $5.68/year.

So paying more than $111 for a Share of Google is a poorer choice than buying a T-bill, unless you think Google will do far better than $5.68/year over time. Note that because Google is riskier than a T-bill, you should actually expect it to cost less than the T-bill, to compensate you for the risk.

Will Google do better than $5.68/year over time? With 215,000,000 outstanding shares, they need to add $215MM to the bottom line to increase earnings per share $1. That’s a big number. So I’m not holding my breath. But let’s assume they can do it…

So let’s look at a third valuation, where we do assume Google will increase its EPS every year.

NPV valuation: Google’s earnings grew 13% last year. A discounted cash flow assuming $5.68/year of earnings, growing 13%/year for 15 years produces a valuation of $141 per share, still below $150. (And that’s assuming sustained 13% growth in earnings, a tough feat. Also assumed: 5.12% T-bill discount rate, and rates have been rising recently…)

CONCLUSION: Google probably is overpriced at $150, relative to its intrinsic value. Due to branding, hype, and general investor irrationality around tech stocks, it’s likely to sell at far more than intrinsic vaule for a long time.

INVESTOR IMPLICATION: Buying Google at current price levels is speculation, not investing. (At least, not value investing.)

– Stever