Economists need to follow the accountants lead

A great source for accounting students- Open Tuition.

Artist of the Day- Tsilli Pines

According to Pines, the piece she created for this issue of the magazine, above, titled, "Corporations," isn't just about the way accounting practices are "wacky on such a large scale for so many businesses." To her, "everything, from the way we are trying to make up for personal losses to the way the economy is being propped up, feels like it's being put back together imperfectly

This series is about the topography of money in human consciousness, the constant parade of numbers in everyday life. The figures are at once imaginary and very real. I’m interested in the power numbers have in our lives, and how much they dictate, both psychologically and actually.

Here's the artist on Flick

A meeting of government accountants

ICGFM Blog

Economics Department wants Accountants

The Economics Department at the University of California, Santa Cruz is recruiting for lecturers who can teach at both the lower- and upper-division level. Our most urgent need (currently) is for applicants who can teach accounting courses.

Why are Companies piling up cash

One study shows that the average cash ratio doubled from 1998 to 2004 and the median ratio more than tripled, while debt levels fell. According to S.& P., the total cash held by companies in its industrial index exceeded $600 billion in February, up from about $203 billion in 1998.

René M. Stulz, who holds the Reese chair in banking and monetary economics at the Fisher College of Business at Ohio State University, said research he conducted with two other professors on corporate cash levels since 1980 indicated that growing cash holdings over that period most likely reflected the simple fact that the world became a much riskier place for business.

“Companies responded to those rising risks by saving more,” said Professor Stulz, whose study excluded utilities and financial companies because their cash reserves are monitored by regulators.

An even longer savings trend was spotted by Jason DeSena Trennert, managing partner and chief investment strategist at Strategas Research Partners in New York, who said his own rough examination of corporate balance sheets shows that “cash, as a percent of total assets, is as high as it’s been since the 1960s.”

-Companies Are Piling Up Cash

State budgets and the rising construction costs

Costs have jumped for projects as varied as levee construction in New Orleans, Everglades restoration in Florida and huge sewer system upgrades in Atlanta. The reconstruction of the Interstate 35W bridge in Minneapolis, a $234 million project, has been fast-tracked for completion by December, and state officials say it is too soon to know whether it will come in on budget.

The impact has been felt in different regions at different times, and not every project has been high-profile. In Oregon, high costs have forced the State Department of Transportation to slow the rate at which it upgrades roads and bridges. In Seattle, school building projects were put on a fast track this fall because of fears of cost overruns.

“We escalated our project schedule to get ahead,” said Fred Stephens, director of facilities and construction for Seattle Public Schools.

Nationwide, increasing costs first became a problem for some projects more than two years ago, and in some regions the rate of increase has dropped in the past year. But some regions are tighter than ever, and the pressure from the high costs can be more acute in the context of general revenue declines.

The list of culprits for the increases often depends on the rate of growth and construction in a particular region, with labor costs playing a role along with the rising prices of materials like steel and concrete, and asphalt, fuel and other petroleum-based products.

Experts say high costs are linked to competition from a global development boom, particularly in China and India; the housing boom in the United States; and the rush to rebuild after Hurricane Katrina in 2005 and other recent hurricanes that struck Florida and the Southeast. In the Northwest, public projects have competed with downtown construction surges in Seattle and Portland. Just across the Canadian border, hotels and highways are being built to prepare for the 2010 Winter Olympics in Vancouver.

The costs have added to what has become an increasingly bleak economic forecast for many states and local governments. At least 25 states expect to have budget deficits in 2009, according to the Center on Budget and Policy Priorities, which estimates the combined budget shortfall for 17 of the states at $31 billion or more. Many cities, too, see difficult times ahead as revenues wane and costs increase for wages, pensions and health care...

In San Leandro, a city of 78,000 in the San Francisco Bay Area, Mr. Udemezue said the city could not afford to delay work on the parking garage and retiree center.
“We can’t wait,” he said, “because we don’t know if the prices are going to come down or go up.”

In the grading guide known as the Pavement Condition Index, zero is not far from a dirt strip and 100 is a fresh new roadway. When Mr. Udemezue began working for San Leandro 16 years ago, the average road ranking in the city was nearly 70. Now it is closer to 60, despite what Mr. Udemezue said were the city’s efforts to keep up maintenance.

Years ago, there was more money in the city’s general revenue stream that could be diverted to help with basic maintenance, which Mr. Udemezue said required about $5 million a year.

That general revenue now goes to other needs, like public safety, and the roads go wanting, with flat revenue from gas taxes and other declines leaving about $1.2 million to maintain roads each year. The $13 million retiree center and the $8 million parking garage have been affected, too, with the city dropping plans to build commercial space beneath the garage and reducing the space for social programs in the center.

Mr. Udemezue and others say they have heard that things may be stabilizing, but they cannot be sure.

-Building Costs Deal Blow to Local Budgets

Idiots Guide to Subprime Crisis

The US sub-prime crisis in graphics, from BBC via CrossingWallStreet

The sniffing accountant

Seinfeld,The Sniffing Accountant- one of my favorite episodes.

My accountant actually did take a big chunk of money from me and use it to buy drugs and the thing that was hardest for me to comprehend about this is the life choice of drug abuse and accounting. But actually it makes sense I mean why would an athlete or a musician take drugs? They have an interesting job but an accountant if ever a job required some hallucinogenic support this is the job. That should be the legal defense, you're in court "You're charged with possession of illegal narcotics" "But you're honor, I'm an accountant." "Bang, case closed. Bailiff give this man back his peyote buttons and tequila back for the drive home. Sorry to bother you sir, terribly sorry."

Watch the entire episode.

A demon of our own design

On Wednesday, one floor trader bought 1,000 barrels, the smallest amount permitted, and sold it immediately for $99.40 at a $600 loss, said Stephen Schork, a former floor trader on the New York Mercantile Exchange and the editor of an oil market newsletter.

"They absolutely overpaid," he told Radio Four's Today Programme.

"He paid $600 for the right to tell his grandchildren that he was the first in the world to buy $100 oil."

Most trading in energy futures has shifted away from the trading floor and takes place on electronic platforms.

-Single trader behind oil record

Who's going to pay the bill for IMF?

The income shortfall for FY 2008 is now projected at about SDR 90 million (US$140 million) compared to an initial projection of about SDR 146 million (US$228 million).
-IMF Executive Board Completes Midyear Review of Fund's FY 2008 Income Position

Is CAPM Dead?

From interview with Eugene Fama;

Region: With Kenneth French, you’ve said that the capital asset pricing model (CAPM) developed by John Lintner and William Sharpe has “fatal problems” in explaining stock market returns because of its reliance on beta [the volatility of an individual stock relative to overall market volatility]. And you’ve found that two other factors are crucial for determining prices. Can you tell us about these factors? Are they inefficiencies, or do they represent hidden risk? And is the CAPM truly dead?

Fama: Let me first tell you what the returns evidence says, and then we can talk about how to interpret it. The returns evidence basically says that if you look at the CAPM market beta, it’s not enough to describe the cross section of average returns.

The CAPM says that all you need to know are these market betas, market sensitivities, in order to fully describe the cross section of average returns. What you find is that other variables contribute to the explanation of average returns above and beyond what you get from beta. Indeed, over the last 50 years, you get very little at all from beta.

The two variables that we’ve focused on are market capitalization (the financial profession calls it size, a misnomer because it’s really market capitalization) and the book-to-market ratio, the ratio of the book value of a common equity to its market value. Now, there’s no magic in that ratio. The ratio of almost anything to price will work as well. These are the two variables.

So, small-cap stocks have higher average returns than large-cap stocks, and stocks with higher ratios of book value to market value have higher returns than low book-to-market stocks. Low book-to-market stocks tend to be growth stocks. High book-to-market stocks tend to be relatively more distressed; they’re what people call value stocks. That’s given rise to what the finance profession—academic as well as applied—calls the size premium and the value premium. The value premium tends to be bigger.

So the issue then is, Are these risk factors or market inefficiencies? One group of people says they’re market inefficiencies—particularly the value premium. The behaviorists tend to say the value premium is a market inefficiency. Their story is: The market overreacts to good and bad past times. It doesn’t understand that things tend to mean revert. So growth companies that have done very well tend to be overpriced, and value companies that have done poorly tend to be underpriced, and then the market realizes this and corrects it. And this story says, basically, that people are dumb; they never learn. So every generation of growth stocks and value stocks goes through the same sort of cycle.

That’s not too appealing to an economist—the idea that people never learn about these things—but that is the behavioral story. And initially they said these are arbitrage opportunities because if you go long value stocks and short growth stocks, you get something with a variance close to zero.

But French and I pointed out that if you do that, you get something with a variance very close to the market variance, not zero. It’s quite a risky strategy. And the premium is about the size of the market premium. So it looks and smells like a risk premium. And we developed a three-factor model with a size premium in addition, basically the difference between the returns on small stocks and big stocks.

So, our model has three factors. Every asset pricing model says you need the market in there. Then they differ on how many other things you need. The CAPM says you only need the market. We basically say a minimum of two other factors seem to be necessary. And these two do a pretty good job.

There’s still a third explanation, which is not based on overreaction. It says that people just don’t like small stocks and value stocks. There’s some amount of utility that people get from the nature of the stocks that they hold. So they like big stocks and they like growth stocks, and they’re willing to hold them even though they have lower average returns.

Now you can’t have an arbitrage opportunity there because then there’d be a sure profit. But the fact that they look like risk factors can sustain that story. You can’t tell the difference between that story and a risk story.

Related;
New book: Sharpe's 'Investors and Markets'
The Asset Pricing and Portfolio Choice Simulator

Perry Mehrling, Fischer Black, and Finance
Asset Prices and Portfolio Choice


Books:
Draft chapters of William Sharpe's Investors and Markets: Portfolio Choices, Asset Prices and Invetment Advice

Fama's two books are online; Foundations of Finance, 1976; The Theory of Finance, with Merton Miller, 1972

British Humor on the Credit Crunch

Hilarious!

via Naked Capitalism

Op-ed on Indian Financial Sector Reform

Confusion worse confounded?

Whither Indian financial reform? An answer to that question remains elusive. After a decade, debate about reform has revived with the Tarapore-2 and M-IFC Reports. But it is bizarre and personal. A visiting Martian would think that it involves only dichotomies; i.e. between: (a) going fast vs. going slow; (b) pitting the careful/conservative vs. the brash, aggressive, over-ambitious; (c) impugning 'young', inexperienced, critics vs. eulogising practitioners wedded to past paradigms; (d) old heterodoxies, apparently durable vs. new orthodoxies, allegedly crumbling; (e) Big Bangs vs. small splutters, neither understood; (f) a fiscally incontinent GoI vs. a blameless RBI burdened with cleaning up everyone else�s mess; (g) impossible trinities vs. monetary magicians who reconcile the irreconcilable through sleight-of -control; (h) institutional infallibility vs. the all-too-fallible who argue that regulators may have no intellectual clothes on � if they did, they would not be arguing the way they are; or (j) theoretical market-fundos vs. experienced control-commandos. And so on.

Read This

The Evolution of an Investor by Michael Lewis

Blaine Lourd got rich picking stocks. but then he realized that everything he thought he knew about the markets was wrong. And he's not alone.

Nassim Nicholas Talem- You Tube Interview for the Day

A practitioner of uncertainty

God's Business Fact of the Day

The Evangelical Christian Credit Union in Brea, Calif., a pioneer in lending to churches and a proxy for this market shift, has seen its loan portfolio grow to $2.7 billion, from just $60 million in the early 1990s, said Mark A. Johnson, its executive vice president. Where bankers were once reluctant to lend to churches, the credit union now shares a market with some of the nation’s largest banks.

-Megachurches Add Local Economy to Their Mission

Discuss- the lessons of marketing to other businesses.

Readings for the Day

Western Union Empire Moves Migrant Cash Home

Is the Bond Market the Best Predictor of the Outcome of a War?--Posner

Iraqi Bonds and the Effects of the Surge-Becker

Business Bankruptcy Filings

Krugman on Obama on Social Security

Interpreting the Fed

Publication Bias and the Death Penalty

Freddie Mac--victim, villain, or savior?

Applications of Benford's Law

Tim Harford;

Benford’s Law does not apply to every set of numbers - for example, it does not apply to post codes or national insurance numbers, which are assigned by bureaucratic processes. But all sorts of “natural” processes should produce Benford data. And since the units in which many quantities are measured are arbitrary (grams or ounces, miles or millimetres, dollars or yen) then converting to a different unit of measurement preserves Benford’s law.

As an example, think about an economy that is growing from an initial value of $10bn. It must grow by 100 per cent before the first digit changes, to $20bn. Then it need only grow by 50 per cent to reach the next digit at $30bn, which is likely to happen more quickly. To grow from $90bn to $100bn requires just over 10 per cent growth; but then to change the first digit back to two, at $200bn, requires that the stock grow by 100 per cent again. That sort of story suggests why Benford data may be common, although quite why Benford’s Law holds so widely is not yet settled.

Regardless, the pattern is a useful test of the plausibility of data. In the early 1970s, Hal Varian, now chief economist at Google, argued that if economic data satisfied Benford’s Law on the way into an economic model but not on the way out, it was worth taking a second look at the model itself.

And Mark Nigrini, an accountancy professor, found fame in the 1990s by using Benford’s Law to discover accounting scams, frauds and tax dodges, such as inventing invoices that were just under some threshold for managerial approval.

John Nye and Charles Moul, two economists at Washington University in St Louis, have now checked some basic macroeconomic statistics using Benford’s Law. They find that OECD statistics fit the law quite well, suggesting that GDP data should follow Benford. But African GDP data do not fit. It is not possible to say whether the anomaly is due to fraud or underfunded statistical offices. But it is a reminder that some data should come with a health warning.

The Bond Market and Iraq

PRESIDENT BUSH’S surge of troops in Iraq has done little to resolve the political debate over the Iraq war. But global financial markets have been monitoring the war for months, and with remarkable consistency, they have concluded that the long-term prospects for a stable Iraq are very bleak.

That is the picture that emerges from a study by Michael Greenstone, an economics professor at the Massachusetts Institute of Technology, titled, “Is the ‘Surge’ Working? Some New Facts,” which has been circulating as a working paper in academic circles.

Professor Greenstone started by reviewing basic statistics on the Iraqi economy and on the battle for security within Iraq since February. This data provided a murky view, at best.

He found that civilian deaths in Iraq had fallen substantially in recent months. At the same time, though, he found little change in the rate of American and Iraqi military fatalities, while the recruitment of members of the new Iraqi security forces declined sharply. On the industrial side, crude oil production fell as much as 20 percent, but there was evidence of a slight improvement in the availability of electricity.

Sifting through these facts was time-consuming, but it provided little real guidance on the state of affairs in Iraq.

It wasn’t until Professor Greenstone began examining the financial markets’ pricing of Iraqi government debt that he had his eureka moment. It was immediately clear that the bond market — which, historically, has often been an early indicator of the demise of a political system — was pessimistic about the Iraqi government’s chances for survival.

First, some background on the Iraqi bonds. After the United States helped Iraq renegotiate its leftover debt from the Saddam Hussein era, the Iraqi government issued about $3 billion of new bonds in January 2006. These dollar-denominated bonds pay 2.9 percent twice a year and mature in 2028, paying the face value of $100.

To say the least, the market for these bonds is not robust: as of last week, a bond with a face value of $100 was trading at around $60. Professor Greenstone calculated that, from the markets’ standpoint, the implied default risk over the life of the bond was about 80 percent.

The important point is that anyone who owns one of these Iraqi bonds has to decide each day whether the Iraqi government is likely to be functional enough to make its debt payments, or will default along the way. All else being equal, if the surge policy is effective, it ought to be raising the market price of these bonds.

Bondholders “aren’t politically motivated,” Professor Greenstone said. “They don’t have to rationalize their previous statements or justify their votes from years past. All they care about is whether there will be a functioning Iraq in the future such that they will receive their payments.” At a certain price, most securities will find a buyer, and there are still buyers for Iraqi bonds. But the price they are willing to pay is very low.

Of course, it’s worth asking whether bond traders know anything more about Iraq than the pundits do. It’s impossible to say with certainty, but the collective wisdom of financial markets has proved remarkably adept at evaluating events and predicting the future, even the turning points of war.

During the American Civil War, for example, when Confederate forces lost at Gettysburg, Confederate cotton bonds traded in England dropped by about 14 percent. During World War II, German government bonds fell 7 percent when the Russians started their counterattack at Stalingrad in 1942, and French government bonds rose 16 percent after the Allied invasion at Normandy in 1944. Many such examples of the prescience of financial markets have been documented by economic historians.

Comparing the yields on Iraqi bonds from the start of the surge in February to late August, Professor Greenstone calculated that the bondholders implicitly raised the chances of an Iraqi bond default by 40 percent. Over that period, Iraqi bond prices fell about 14 percent — as much as the Confederate cotton bonds fell after the battle of Gettysburg.

Professor Greenstone is quick to acknowledge that the bond evidence does not necessarily imply anything about the surge as a military tactic. The American troop buildup might be giving the Iraqi government a reprieve, but over the long term, most bondholders seem to have concluded, it’s a lost cause.

In an interview, Professor Greenstone used a medical analogy to describe the possibility that the surge might be defined as successful, but would still result in the demise of the Iraqi government. “It might be a heart surgery that failed so the patient is dying,” he said, “or a heart surgery that succeeded but during the operation they found a deadly liver cancer so the patient is dying. Either way, though, the guy is dying.”

HE also knows that the late-summer turmoil in global bond markets because of the subprime housing problems and the ensuing credit crisis could complicate his analysis. But he points to two important pieces of evidence suggesting that the overall problems in the credit markets did not cause the Iraqi bond meltdown.

First, the Iraqi bonds were already falling before the subprime crisis began, and at no point did they ever rise above their pre-surge levels. So even if you do not attribute the entire 40 percent increase in the chance of default to the surge, there is certainly no evidence that it reduced the odds.

Second, and more important, while the bond-market turmoil affected all kinds of debt, the plunge in the value of Iraqi bonds has been much worse. Professor Greenstone’s data shows that Iraqi bonds have fallen not just in comparison with safe United States Treasuries but also when compared with those of nearby Qatar, and with a broad range of risky emerging-market bonds.

In the market, people vote with their money, and the vote is not going well for the new Iraq. Politicians in the United States may be divided over whether the surge has raised the chances of political reconciliation in Iraq. But the bond market has already made its message clear: don’t bet on it.

-In the Bond Market, a Bleak Prognosis for Iraq

Related: Programs and Data Used to Produce the paper

Quote of the Day- Everyone's a Hedge Fund

"We make money from hedging and building cars. The difference is that hedge funds don't make cars the last time I checked."- Porsche

Source; Share options put Porsche on a faster path to profit

Porsche yesterday revealed it earned three times as much money from trading derivatives as it did from selling cars, prompting accusations it was acting more like a hedge fund.

The German luxury sports car maker said €3.6bn ($5.2bn) of its €5.86bn pre-tax profit in the year to July was from share options.

Stripping out the €521m it made from revaluing its 31 per cent stake in Volkswagen, which it controls, and €702m from its share of VW's profits, it made at most just €1.05bn from its "core" carmaking business.

"It does look like a hedge fund," said Stephen Cheetham, an analyst at Sanford Bernstein.

Another London-based analyst said: "It is a hedge fund investing in just one stock."