Merrill Lynch Loss Wider Than Expected

From Yahoo...

Merrill Lynch said it was taking a sharper-than-expected writeoff of 7.9 billion dollars for losses in its mortgage activities in the third quarter. Merrill Lynch said the charge was "significantly greater" than the 4.5 billion dollars forecast earlier this month. The investment bank reported a third-quarter net loss from continuing operations of 2.24 billion dollars compared with a net profit of 2.14 billion dollars a year ago. The loss amounts to 2.85 dollars a share, far wide that that the Wall Street consensus forecast for a loss per share of 45 cents.

From TheStreet...

Merrill Lynch stunned Wall Street for the second time this month with the disclosure that it was forced into a $7.9 billion writedown of bad debt tied to risky mortgages and structured paper. The announcement comes three weeks after Merrill surprised investors by estimating that its third quarter would swing to a loss under the weight of $4.5 billion in writedowns on certain securities. Merrill said the writedown increased after the firm took a second look at its valuation of collateralized debt obligations and subprime mortgage backed securities.

Merrill's third-quarter report has to rank among the worst in modern Wall Street history. The firm swung to a loss of $2.24 billion, or $2.85 a share, from continuing operations from a year-ago profit of $3.05 billion, or $3.14 a share. The firm took a $5.9 billion loss on its in-house trading operation. said $6.9 billion of the third-quarter writedown was related to its CDO positions and $1 billion to its subprime holdings. The firm said its net exposure to those securities dropped from second-quarter levels, but it continues to have $15 billion worth of CDO exposure and nearly $6 billion worth of subprime exposure.

What I (and I'm sure others) want to know is how could the loss be SIX TIMES as large as expected just three weeks ago. What kind of risk management do the guys at Merrill Lynch have in place?

[Obsolete] Bear - Citic Swap

Bear Stearns and Citic Securities [a Chinese firm, not to be confused with Citi] will each invest about $1 billion in each other. In return for its investment in Bear Stearns, Citic will receive securities that can be converted into about 6% of Bear Stearns's outstanding shares. As part of the deal, Citic has the right to buy an additional 3.9% of the brokerage's outstanding shares [for that magic 9.9% share]. In return for its investment in Citic, Bear Stearns will receive a 2% stake in the firm. It has the option to buy an additional 5%.

Edited (3/17/2008): Citic Securities has canceled this investment deal with Bear Stearns. "The situation has changed," said Citic Chairman Dan Kong, after Bear's buy-out yesterday by JPMorgan Chase.

Bank of America Earnings Drop 32%

Bank of America reported that third-quarter earnings plummeted 32% because of problems in mortgage and credit markets.

More Recalls

US retail giant Target has become the latest company to recall Chinese-made toys because of safety fears.

Another Chinese product in the United States is under scrutiny. Federal officials ordered a recall of 450,000 Chinese-made tires.

Imagine that. Offshoring production to China (or elsewhere) only results in savings if those other countries cut corners on the safety regulations that are required here in the US. Who could have imagined such a thing? It's not like Economics 101 would suggest that such a thing was likely.

Investment Bank Results

Goldman Sachs earned $2.85 billion, or $6.13 a share, in the three months ended Aug. 31, compared to $1.59 billion, or $3.26 a share, in the third quarter a year ago. Net revenue rose 63% to $12.33 billion from $7.58 billion a year ago.

Bear Stearns reported net income of $171.3 million, or $1.16 a share, for the quarter ended Aug. 31, down from $437.6 million, or $3.02 a share, earned in the same period a year earlier. Net revenue declined 37% to $1.33 billion. Lehman Brothers and Morgan Stanley also reported a profit decline.

In trading (as of 2:40pm today), Lehman Brothers (LEH) is down around 3% and Morgan Stanley (MS) is down around 5%. Goldman Sachs and Bear Stearns are essentially flat. Bear Stearns' troubles had already been priced into its stock since its disastrous bailout of two hedge funds, but I am very surprised that GS has not spiked on the earnings surprise.

Top Ten International Accounting Firms

Ranked by 2007 fiscal year revenue...

PricewaterhouseCoopers International, $25.2B
Deloitte Touche Tohmatsu, $23.1B
Ernst & Young Global, $21.1B
KPMG International, $19.8B
BDO International, $4.7B
Grant Thornton International, $3.5B
RSM International, $3.1B
Praxity, $2.8B
Baker Tilly International, $2.5B
Horwath International, $2.5B

[Updated with 2007 numbers]

Top Ten US Accounting Firms

Ranked by fiscal year 2007 revenue...
1 Deloitte & Touche $9,856,000,000
2 PricewaterhouseCoopers $6,922,000,000
3 Ernst & Young $6,890,000,000
4 KPMG $4,438,000,000
5 RSM McGladrey $1,389,260,000
6 Grant Thornton $939,551,000
7 BDO Seidman $589,000,000
8 CBIZ & Mayer $466,810,000
9 Crowe Group $430,276,000
10 BKD $318,078,000

http://www.wolterskluwer.com/WK/Press/Product+Press+Releases/2007/Sep/pr_19Sep07b.htm

CIT Shuttering Home Lending

CIT Group said it will take a $35 million pre-tax charge in its third quarter associated with its previously announced plans to shutter its home lending business. Its loan collection and customer service activities are unaffected by the announcement.

Men Earn Less Than Fathers at Same Age

In 2004 the median income for a man in his 30s was $35,000. Adjusted for inflation, that's 12% less than what men the same age were making in 1974.

It's time for central banks to stop bailing out markets

The global credit bubble is bursting. This bubble is primarily leverage financing for owning risky assets. The people who were responsible for what happened played with other people's money, marketed arcane financial products with false promises of fat profits, but stuffed their own pockets with big bonuses. Neither these masters of the universe nor their greedy but naïve investors deserve to be bailed out. They deserve what is coming to them. The central banks bear equal responsibility in the current debacle. After 9/11, central banks cut interest rates dramatically and provided the cheap money for this leverage bubble. They must not flood the world with liquidity again to sustain this bubble or create another.

Ameriquest Closing Its Doors

The last assets of its parent ACC were sold to Citi today. This is largely a formality, since the company had ceased origination at the end of last year.

Lousy business model (lending to subprime borrowers) but great Super Bowl commercials.

Earthlink Lays Off Half Its Workforce

EarthLink, one of the few survivors of Atlanta's tech wave of the 1990s, said it will slash its work force nearly in half in an effort to stabilize its business after a string of losses. The company will focus on providing Internet access while cutting 900 jobs -- 562 of them in Atlanta. EarthLink last quarter reported a $16.3 million loss, following losses of $30 million, $24.8 million and $3.2 million in the previous quarters. Perhaps more ominous, revenues stagnated. EarthLink reported revenues of $312 million in the most recent quarter -- a third consecutive quarter of decreasing sales.

The company will close its Orlando FL, Knoxville TN, Harrisburg PA and San Francisco CA offices and substantially reduce its presence in Pasadena CA and Atlanta GA.

Krispy Kreme posts loss

KKD posted a net loss of $27M for the quarter ending 7/29/2007. That comes on the heels of loss of $7.4M and $24.4 in the prior two quarters.

Countrywide

Some interesting discussion on the MarketBeat blog (emphasis mine).

Investors jumped for joy on news of Countrywide Financial’s $2 billion gift, er, investment from Bank of America, which got a nice deal by investing in convertible preferred shares, and gets the platitudes for putting down money to help assuage those worried about the going health of one of the nation’s biggest mortgage lenders. Bank of America gets a $2 billion stake that pays them 7.25% annually in interest, and converts to shares at $18 each.

Rob Cox of Breakingviews.com notes: “If Countrywide’s recent woes are primarily liquidity driven — that is, they are simply a consequence of the bank’s inability to fund itself – then BofA boss Ken Lewis’ investment will prove masterful.” But Doug Kass of Seabreeze Partners Management, who is shorting Countrywide, notes that “the discounted strike price of its non-voting preferred security speaks volumes about Bank of America’s financial and operating concerns facing Countrywide Financial.” After all, the housing shakeout isn’t over, and Countrywide holds nearly $30 billion of option ARM mortgages, where defaults are rising, according to Breakingviews.

John Succo, in Minyanville, agrees, saying the terms of the deal were “struck at egregious terms for CFC,” and it will dilute earnings. It’s hard to know whether to take comfort from CEO Angelo Mozilo’s interview on CNBC, either — within the span of a few minutes he’s blamed the current problems on the Federal Reserve, frightened investors, and worried sell-side analysts (Merrill Lynch in particular). “The problem at Countrywide Financial is that it originated crappy loans — thats how it got into the problem in the first place,” Mr. Kass writes in an email.

Note that Countrywide common shares have fallen 38% in one month, from $34 to $21.

Capital One to close mortgage unit

Capital One Financial said Monday it will cut 1,900 jobs and shutter its wholesale mortgage banking business, a move that comes as lenders continue to struggle in the nation's housing and mortgage markets. Capital One said it will shut down GreenPoint Mortgage and eliminate most of the jobs by the end of year. The company will close 31 GreenPoint locations in 19 states and "cease residential mortgage origination" effective immediately.

HomeBanc Files for Chapter 11 Bankruptcy

HomeBanc today announced that, after careful consideration, its Board of Directors has authorized the Company's management team to seek protection for the Company through the bankruptcy process in order to best preserve the value of the Company's remaining assets. Accordingly, HomeBanc Corp., together with certain of its subsidiaries, has today filed a voluntary petition for relief under Chapter 11 of the U.S. Bankruptcy Code in the U.S. Bankruptcy Court for the District of Delaware. HomeBanc believes that, under the protection of Chapter 11, it will have the time and opportunity that it needs to achieve the best possible value for the creditors and other constituencies of its assets and operations, and to effect an orderly wind down of the Company.

Blackstone Down To $24.90

It is now down an amazing 29% from its IPO price.

Wells Fargo Jumbo Rate Jumps to 8%

Wells Fargo, one of the nation's biggest mortgage lenders, raised the interest rates on it 30-year, fixed-rate, non-conforming (AKA jumbo) loan to 8 percent last week, up from 6.875 percent. Other lenders are likely to join Wells Fargo.

The reason is apparently the collapse of the secondary mortgage market.

HomeBanc exiting the mortgage business

HomeBanc today announced that it intends to exit the mortgage loan origination business. The Company at present is unable to borrow on its credit facilities and was unable to fund its mortgage loan funding obligations. Accordingly, the Company does not anticipate funding any future mortgage loans and is no longer accepting any mortgage loan applications or funding any mortgage loans previously originated and not yet funded. The Company is seeking the most appropriate course of action to preserve the value of its remaining assets. Kevin Race, HomeBanc's President and CEO, stated, "In light of the extraordinary difficulties that HomeBanc continues to face in the mortgage loan origination market, we feel that it is in the best interests of the Company to exit this business so that we can focus on preserving the value of our investment portfolio assets and loan servicing operations."

HomeBanc also announced that it has reached agreement with Countrywide Financial Corporation whereby Countrywide will acquire certain assets related to HomeBanc's retail loan origination operations, including up to five branches located in Georgia, Florida and North Carolina, and will assume the leases related to those branches. In addition, Countrywide expects to make offers of employment to substantially all of HomeBanc's retail loan originators. Countrywide will pay no cash premium in this transaction and will not acquire any other assets or assume any other liabilities related to HomeBanc. This transaction, which is subject to certain conditions, is expected to close by Friday.

There's that phrase again.

Also, I found this really good website which tracks the mortgage lenders that have imploded recently (112 in the last 15 months). I see tough times ahead for the real estate market.

Bear Stearns President/co-COO Resigns

Bear Stearns President and co-COO Warren Spector resigned, becoming a casualty of a credit risk crisis at the investment bank.

American Home Mortgage Closing

American Home Mortgage Investment Corporation will shutter most of its operations and lay off more than 6250 workers. "Unfortunately, the market conditions in both the secondary mortgage market as well as the national real estate market have deteriorated to the point that we have no realistic alternative," chief executive Michael Strauss said in a statement. The company will maintain 750 employees in its thrift and servicing businesses "as it seeks the most appropriate course of resolution to preserve the value of its remaining assets."

Chrysler Taken Private

Private equity firm Cerberus Capital Management took control of Chrysler Group on Friday in a $7.4 billion deal designed to set the beleaguered 82-year-old automaker on a path to recovery as a private company. Daimler AG will retain a 19.9% interest in the company.

Daimler paid $33 billion for Chrysler in 1998. Now the company is apparently worth $9.2 billion. That's almost $24 billion gone with the wind. In other terms it's a compounded 13% loss every year for nine years, without even counting the losses that Chrysler accumulated over those 9 years. What a bonehead move.

Tyco Spins Off Two Units

On Friday Tyco International spun-off to its shareholders two of its five units -- Tyco Healthcare (which has been renamed Covidien) and Tyco Electronics.

About 500 million Tyco Electronics shares and 500 million Covidien shares will be distributed to Tyco International shareholders. Immediately following the distributions, Tyco International's shareholders will own 100% of the common shares of Covidien and Tyco Electronics.

Tyco International also said that its board approved a one-for-four reverse split which will become effectively immediately following the completion of the dividend distribution. As a result, Tyco International will have about 500 million shares outstanding after the reverse stock split.

Tyco Electronics and Covidien have applied for listing their shares on the New York Stock Exchange and the Bermuda Stock Exchange under the trading symbols "TEL" and "COV" respectively.

Blackstone Down Another 9.8%

Blackstone closed at $29.27 today, down another 9.8% from its $32.44 closing price a week ago. It's dropping even faster than I thought.

Beazer Homes cans chief accounting officer for ethics violations

Beazer Homes, already under a Securities and Exchange Commission informal investigation, has fired Chief Accounting Officer Michael Rand "due to violations of the company's ethics policy stemming from attempts to destroy documents." The move comes four months after the company fired General Counsel Kenneth Gary "for a pattern of personal conduct which includes violations of company policies." In a filing with the SEC, the Atlanta-based homebuilder said Rand's termination followed a briefing by independent legal counsel retained by the company's audit committee, which is conducting an internal investigation of the company's mortgage origination business and related matters. Beazer said it recently became aware of Rand's actions during that investigation.

You have to think that the news in the housing sector is even worse than we think if accounting officers are destroying documents to hide the facts.

Blackstone Down 7.5%

Shares of Blackstone Group fell in their second day of trading as doubts set in about the valuation of the private equity firm. Blackstone shares were down 7.5% to $32.44 on the NYSE.

It could be that Friday was the high point of the market for the foreseeable future. A lot of smart people are wondering about that when the smart money (i.e., Blackstone) starts selling.

Bear Stearns Bails Out Hedge Fund

Bear Stearns said it would provide up to $3.2 billion in financing for a struggling hedge fund it manages, raising concern about other funds that invested in bonds linked to subprime mortgages. The biggest bailout since Wall Street's 1998 rescue of Long-Term Capital Management signaled that the funds' main investments -- a type of bond known as a collateralized debt obligation (CDO) -- may be riskier than previously reckoned. Bear Stearns, the fifth-largest U.S. investment bank, said it would provide secured financing to its High-Grade Structured Credit Strategies Fund so the fund can sell assets in an orderly fashion. Bear also said a second fund (High-Grade Structured Credit Strategies Enhanced Leverage Fund) that took greater risk is still working out a restructuring plan with creditors. The two funds melted down after rising U.S. subprime mortgage defaults earlier this year depressed prices of CDOs, which were essentially repackaged portfolios of subprime home loans and were among the funds' main investments. Bear Stearns' High-Grade Structured Credit Strategies Fund was down about 5% so far this year through the end of April. The High-Grade Structured Credit Strategies Enhanced Leverage Fund, meanwhile, which borrowed more to magnify potential returns and potential risk, was down 23% over the same period.

Another story that provides more of the numbers and paints a much clearer -- and much bleaker -- picture than above...

Merrill Lynch seized $850 million of bonds held as collateral for loans it had made to the funds. Lehman Brothers, JPMorgan Chase and Cantor Fitzgerald also pulled out, leaving Bear Stearns to sort through the wreckage of bad bets on subprime mortgage bonds and collateralized debt obligations. Without assistance from his Wall Street peers, Bear Stearns was forced to salvage the healthier of the two funds, putting $3.2 billion of the firm's capital at risk in the biggest bailout since LTCM. Bear Stearns may dissolve the second fund after more than $600 million of investors' money dwindled to less than $200 million.

First Lucent, Then Agere, And Now Finally Avaya

Avaya announced that it has entered into a definitive merger agreement with Silver Lake, the leading investment firm focused on large-scale investments in technology-driven growth industries, and TPG Capital, a leading private investment partnership, for approximately $8.2 billion or $17.50 (cash!) per common share.

2006 Fortune 500

Top Fifteen by Revenue

1 Wal-Mart Stores $351.1B
2 Exxon Mobil $347.3B
3 General Motors $207.3B
4 Chevron $200.6B
5 ConocoPhillips $172.5B
6 General Electric $168.3B
7 Ford Motor $160.1B
8 Citigroup $146.8B
9 Bank of America $117.0B
10 AIG $113.2B
11 JP Morgan Chase $100.0B
12 Berkshire Hathaway $98.5B
13 Verizon Communications $93.2B
14 Hewlett-Packard $91.7B
15 IBM $91.4B

Top Fifteen by Profit

1 Exxon Mobil $39.5B
2 UAL $22.9B (due to bankruptcy accounting)
3 Citigroup $21.5B
4 Bank of America $21.1B
5 General Electric $20.8B
6 Pfizer $19.3B
7 Chevron $17.1B
8 ConocoPhillips $15.6B
9 JP Morgan Chase $14.4B
10 AIG $14.0B
11 Microsoft $12.6B
12 Altria Group $12.0B
13 Wal-Mart Stores $11.3B
14 Johnson & Johnson $11.1B
15 Berkshire Hathaway $11.0B

Top Fifteen by Market Cap

1 Exxon Mobil $426B
2 General Electric $368B
3 Microsoft $274B
4 Citigroup $256B
5 AT&T $243B
6 Bank of America $231B
7 Procter & Gamble $201B
8 Wal-Mart Stores $198B
9 Pfizer $182B
10 Altria Group $179B
11 AIG $177B
12 Johnson & Johnson $175B
13 JP Morgan Chase $169B
14 Berkshire Hathaway $167B
15 Chevron $159B

You can slice and dice the data anyway you want at
http://money.cnn.com/magazines/fortune/fortune500/2007/

Housing Index

http://www.speculativebubble.com/videos/real-estate-roller-coaster.php

Structured Products

Just got my hands on Structured Products by Satyajit Das. It consists of two volumes, 2600 pages total. Volume 1 covers applications of derivatives, synthetic assets, exotic options, and interest rate and currency structured products. Volume 2 covers equity linked structures, commodity linked structures, credit derivatives and new markets (e.g., inflation, insurance, weather, etc).

You'd think that such massive tomes, covering such an encyclopedic list of topics, contain a wealth of knowledge. You'd be wrong. The explanations are at such a basic level that they are essentially useless to anybody with even an elementary understanding of structured products. And to top it off, the material is incredibly dated (even though the third "revised" edition was published in 2006). For example, the author dedicates pages to employee stock option plans and how they are not reflected in the financial statements, with references to articles written in the 1990s. He appears completely unaware that IASB and FASB both now require employee stock options to be accounted for in company's financial statements.

A total waste of money.

WHD Problem 5.9

Calculate the theta, gamma, vega and rho for European call and put options.

Note: I have assumed a non-dividend stock.

Θ = ∂Π/∂t

Θ_c = - ½S₀N'(d₁)σ/√T - rKe^-rTN(d₂)

Θ_p = - ½S₀N'(d₁)σ/√T + rKe^-rTN(-d₂)

Γ = ∂₂Π/∂S₂

Γ_c = Γ_p = N'(d₁)/S₀σ√T

v = ∂Π/∂σ

v_c = v_p = S₀N'(d₁)√T

ρ = ∂Π/∂r

ρ_c = KTN(d₂)e^-rT

ρ_p = -KTN(-d₂)e^-rT

Transforming the Black-Scholes equation into the Heat equation

(∂V/∂t) + ½ σ² S² (∂²V/∂S²) + r S (∂V/∂S) - rV = 0

First substitution: u = V e^-rt

V = u e^rt

(∂u/∂t) = (∂V/∂t) e^-rt - V r e^-rt

(∂u/∂t) + V r e^-rt = (∂V/∂t) e^-rt

(∂V/∂t) = e^rt (∂u/∂t) + V r = e^rt (∂u/∂t) + r u e^rt

(∂u/∂S) = e^-rt (∂V/∂S)

(∂V/∂S) = e^rt (∂u/∂S)

(∂²V/∂S²) = e^rt (∂²u/∂S²)

And the equation changes to...

e^rt (∂u/∂t) + r u e^rt + ½ σ² S² e^rt (∂²u/∂S²) + r S e^rt (∂u/∂S) - r e^rt u = 0

(∂u/∂t) + ½ σ² S² (∂²u/∂S²) + r S (∂u/∂S) = 0

Second substitution: S = e^x

x = ln S

(∂S/∂x) = e^x
(∂x/∂S) = 1 / S

(∂u/∂x) = (∂u/∂S) (∂S/∂x) = (∂u/∂S) e^x = S (∂u/∂S)

S² (∂²u/∂S²) = S² ∂/∂S (∂u/∂S)

= S² (∂x/∂S) ∂/∂x (∂u/∂S)

= S² (1/S) ∂/∂x (1/S ∂u/∂x)

= S [ 1/S ∂²u/∂x² + ∂u/∂x ∂/∂x (1/S) ]

= ∂²u/∂x² + S (∂u/∂x) (-1/S² ∂S/∂x)

= ∂²u/∂x² - (1/S) e^x (∂u/∂x)

= ∂²u/∂x² - ∂u/∂x

And the equation changes to...

(∂u/∂t) + ½ σ² (∂²u/∂x² - ∂u/∂x) + r (∂u/∂x) = 0

(∂u/∂t) + ½ σ² ∂²u/∂x² + (r - ½σ²) ∂u/∂x = 0

Third substitution: z = x - (r - ½σ²)t to cancel the first derivative term, and t' = - t to conform to the usual sign convention.

(∂u/∂t) = (∂u/∂z)(∂z/∂t) + (∂u/∂t')(∂t'/∂t) = (∂u/∂z)[-(r - ½σ²)] + (∂u/∂t')(-1)

∂u/∂x = ∂u/∂z

∂²u/∂x² = ∂²u/∂z²
And the equation changes to (dropping the ' on the t variable) ...

- (∂u/∂t) - (r - ½σ²) (∂u/∂z) + ½σ² (∂²u/∂z²) + (r - ½σ²) (∂u/∂z) = 0

- (∂u/∂t) + ½σ² (∂²u/∂z²) = 0

And finally, voila, we have the heat equation...

∂u/∂t = ½σ² (∂²u/∂z²)

WHD Problem 3.6b

Find the most general solution of the Black-Scholes equation that has the special form V=A(t)B(S).

(∂V/∂t) + ½ σ² S² (∂²V/∂S²) + r S (∂V/∂S) - rV = 0

V = A(t) B(s)

(∂V/∂t) = B (dA/dt)

(∂V/∂S) = A (dB/dS)

(∂²V/∂S²) = A (d²B/dS²)

B (dA/dt) + ½ σ² S² A (d²B/dS²) + r S A (dB/dS) - r A B = 0

(1/A) (dA/dt) + ½ σ² S² (1/B) (d²B/dS²) + r S (1/B) (dB/dS) - r = 0

½ σ² S² (1/B) (d²B/dS²) + r S (1/B) (dB/dS) - r = - (1/A) (dA/dt)

Since the left-hand side depends only on S and the right-hand side depends only on t, the only way the equality can hold is if both sides are equal to a constant K.

- (1/A) (dA/dt) = K

A(t) = c e^-Kt

½ σ² S² (1/B) (d²B/dS²) + r S (1/B) (dB/dS) - r = K

½ σ² S² (d²B/dS²) + r S (dB/dS) - (r + K) B = 0

S² (d²B/dS²) + (2r/σ²) S (dB/dS) - (2/σ²) (r+K) B = 0

This equation proceeds as in the previous exercise.

λ² + (2r/σ² -1)λ + (-2/σ²)(r+K) = 0

λ = { (1 - 2r/σ²) ± [ (2r/σ² - 1)² + (8/σ²)(r+K) ]^½ } / 2

λ = { (1 - 2r/σ²) ± [ (2r/σ² - 1)² + (8/σ²)(r+K) ]^½ } / 2

λ = { (1 - 2r/σ²) ± [ (2r/σ² + 1)² + (8K/σ²) ]^½ } / 2

There are three cases depending on the roots: two real roots, one real root, two complex roots. And to be explicit, we should note that the case of two real roots can come about either with a real value of K (which leaves the form of A(t) above unchanged) or with a complex value of K (which would require rewriting A as we'll see in a minute).

Case 1: λ₁ and λ₂ are distinct real roots.

B(S) = c₁ S^λ₁ + c₂ S^λ₂

V(S,t) = (c₁ S^λ₁ + c₂ S^λ₂) e^-Kt

Case 1A: K = 0
(Special scenario under case 1)

This reduces to the special case where there is no time dependence V = B(S)

V = c₁ S + c₂ S ^(-2r/σ2)

Case 2: λ₁ = λ₂ = λ is the only real root.

B(S) = S^λ (c₁ + c₂ ln S)

V(S,t) = S^λ (c₁ + c₂ ln S) e^-Kt

Case 3: λ₁ = a+ib and λ₂ = a-ib are complex roots (with K real).

B(S) = S^a [ c₁ cos (b ln S) + c₂ sin (b ln S) ]

V(S,t) = S^a [ c₁ cos (b ln S) + c₂ sin (b ln S) ] e^-Kt

Case 3A: λ₁ = a+ib and λ₂ = a-ib are complex roots (with complex K = c + id).
(This is not strictly separate from case 3; it's simply a matter of expanding e^-Kt for complex K.)

B(S) = S^a [ c₁ cos (b ln S) + c₂ sin (b ln S) ]

V(S,t) = S^a [ c₁ cos (b ln S) + c₂ sin (b ln S) ] e^-ct (cos dt - i sin dt)

Note that all of these solutions (except Case 1A) have too many degrees of freedom, due to the freedom of choice in choosing K. Normally boundary conditions would restrict the universe of valid values for K, but the problem as stated did not provide any such conditions.

WHD Problem 3.6a

Find the most general solution of the Black-Scholes equation that has the special form V=V(S).

(∂V/∂t) + ½ σ² S² (∂²V/∂S²) + r S (∂V/∂S) - rV = 0

Substituting V=V(S) reduces the partial differential equation to an ordinary differential equation.

S² (d²V/dS²) + (2r/σ²) S (dV/dS) - (2r/σ²) V = 0

This is an Euler differential equation x²y'' + axy' - by = 0, the solutions of which can be found with the aid of the characteristic equation.

λ² + (a-1)λ + b = 0

λ² + (2r/σ² -1)λ + (-2r/σ²) = 0

Applying the quadratic equation, one obtains (after a bit of algebra) two roots

λ = 1 and λ = (-2r/σ²)

Using these roots, we determine that the most general solution of the Euler equation is
V(S) = c₁ S + c₂ S ^(-2r/σ2)

WHD Problem 2.5

There are n assets S_i,...,S_n satisfying the following stochastic differential equations dS_i = σ_i S_i dX_i + μ_i S_i dt, for i = 1, ..., n

The Wiener processes dX _i satisfy E[dX_i] = 0 and E[dX_i²] = dt, as usual, but the asset price changes are correlated with E[dX_idX_j] = ρ_ijdt where -1 ≤ ρ_ij ≤ 1.

Derive Ito's Lemma for a function f(S_i,...,S_n) of the n assets.

Actually, I already know most or all of the content of The Mathematics of Financial Derivatives; I am reading it as a review in preparation for more advanced materials I am hoping to get to in the near future.

This exercise is pretty trivial, mostly a matter of keeping track of all the variables.

The Taylor series expansion is
df = (∂f/∂t)dt + Σ(∂f/∂S_i)dS_i + ½Σ(∂²f/∂S_i∂S_j)dS_idS_j

dS_idS_j = (σ_i S_i dX_i + μ_i S_i dt)(σ_j Sj dXj + μj Sj dt) = σ_i σ_j S_i Sj dX_i dXj = ρ_ij σ_i σ_j S_i Sj dt
dropping all higher order terms and then substituting in the correlation assumption.

So finally we obtain
df = [ (∂f/∂t) + Σ μ_i S_i (∂f/∂S_i) + ½ Σ ρ_ij σ_i σ_j S_i Sj (∂²f/∂S_i∂S_j) ] dt + Σ σ_i S_i (∂f/∂S_i) dX_i

Here we go...

Senator Charles Schumer and other members of the Senate Banking Committee said the federal government should spend "hundreds of millions of dollars'' to bail out subprime mortgage borrowers facing foreclosure. Non-profit groups would distribute the money to help homeowners refinance loans they can't repay, Democratic Senators Schumer of New York, Robert Menendez of New Jersey and Sherrod Brown of Ohio.

So, let me get this straight those of us who did the RESPONSIBLE thing and did not buy more house than we could afford (while watching prices skyrocket out of our reach due to these irresponsible buyers) are now being asked to bend over and take it once more as our tax money goes to subsidize those who did buy more house than they could afford? Why?

And I'm tired of hearing that folks didn't understand what they were getting as a mortgage. Everyone understands adjustable interest. And everyone understands whether or not a payment is more than they can afford. And last of all everyone should understand the consequences of lying about his/her income on a mortgage application. I don't have any sympathy.

These folks took a risk. If it had worked out for them, the profit was all for them. They weren't planning to share it with me. It didn't work out, so I have to share the loss? WTF?

Job Cuts at Citigroup

Citigroup will eliminate about 17,000 jobs as part of a companywide restructuring to reduce costs and improve profit. Overall, the cuts amount to about 5% of the bank's 327,000-strong work force. Citigroup said its plans include "shrinking the size of corporate centers," several of which are in New York. It also expects to move some 9,500 jobs to lower-cost locations. Still, the elimination of the jobs won't reduce the bank's work force, but merely slow its growth, Citi executives said.

Ravings Brands Selling Moe's Southwestern Grill

Moe's Southwest Grill, the crown jewel of Atlanta-based parent Raving Brands, is being sold to Focus Brands, the Atlanta-based owner of Carvel Ice Cream, Schlotzsky's, Cinnabon and international stores of Seattle's Best Coffee. The announcement Wednesday comes on the heels of a lawsuit by franchisees, who among other things said the chain's management was secretly considering a sale. Raving Brands founder Martin Sprock denied that claim as recently as last week.

BearingPoint

The Company's continuing failure to timely file certain required periodic reports with the SEC imposes significant risks to the Company's business, including the possible loss of business, delisting from the New York Stock Exchange and defaults under the Company's credit facility. The Company has identified material weaknesses in its internal control over financial reporting, which could materially and adversely affect its business and financial condition. The Company's current cash resources might not be sufficient to meet its expected near-term cash needs, especially to fund intra-quarter operating cash requirements and non-recurring cash requirements (e.g., to settle lawsuits).

Apparently, BearingPoint didn't file its annual reports for fiscal 2004 and 2005 on time, nor will it file its 2006 report on time. It also has failed to file quarterly reports on time for the past six quarters in a row.

MBA Salaries

Came across the following in the WSJ...

The following business schools reported the highest average annual base salaries for full-time graduates, according to "The Wall Street Journal Guide to the Top Business Schools 2006".

Stanford University: $100,400

Harvard University: $99,848

Massachusetts Institute of Technology: $94,131

University of Pennsylvania: $92,986

Dartmouth College: $91,900

Northwestern University: $91,390

New Century Cuts Over Half Its Workforce

New Century Financial will immediately cut 3200 jobs (54% percent of its workforce) as part of its Chapter 11 bankruptcy reorganization. The company also said it agreed to sell its servicing assets and platform to Carrington Capital Management for $139 million, subject to bankruptcy approval. Separately, New Century said CIT Group and Greenwich Capital Financial Products have agreed to provide up to $150 million of debtor-in-possession financing to keep the company in business as it reorganizes.

LSI Swallowed Agere Today

Agere (a spin-off from Lucent) was acquired by LSI, effective today. The purchase price was 2.16 shares of LCI ($22.55) for each Agere share.

The Mebert Hoax

I've always been fascinated by this ultimate example of Dilbert-ism in the real world, but the story due to age (it happened back in 1997) has been getting more difficult to find on the internet. So I've taken a minute to document the story here for posterity.

Here's the story as originall written in the San Jose Mercury News...

My goal is to see if a group of executives will allow somebody who has very few credentials, except for good hair, to come into their meeting and get them to write a mission statement which is so impossibly complicated that it has no real content.--Scott Adams, Oct. 8, 1997, 9:30 a.m.

Two hours later, management consultant Ray Mébert strides through the doors of Logitech International's headquarters in Fremont. Few employees give a second glance at the short, mustached man in a gray suit as he weaves through a maze of cubicles to a conference room in which almost a dozen senior executives have been assembled.

In a memo distributed to a selected group of Logitech's vice presidents and senior managers, Pierluigi Zappacosta, the company's co-founder and vice chairman, described Mébert as a man with ''special talents as a facilitator'' and ''a very original thinker'' who has collaborated with big-name consultants.

It's not as if Logitech, the world's largest manufacturer of computer mice and related devices, is in a slump. In Silicon Valley, the 3,000-employee company is considered a strong innovator. But in this fast-paced industry, survival depends in large part on aggressively finding new business opportunities, which is why the gifted Mébert has been summoned. His charge, in the words of Zappacosta's memo, is to help ''crisply define the goals'' of the New Ventures Group. Translation: It's time for that most dreaded of corporate exercises, rewriting the mission statement.

Mébert (the French pronunciation, please!) carries nothing but a thin manila folder with documents summarizing Logitech's business goals--which he has studiously avoided reading. ''I try not to become too familiar with the companies I'm consulting for,'' Mébert explains. ''I find that, otherwise, generic solutions might not fit as well.''

If the size of his entourage is a yardstick, Mébert clearly is a success. Does Michael Porter, the celebrated authority on competitive business strategy, arrive with a photographer, a videotaping crew and a personal assistant named Sheena Diamond? Noting all the electronic gear, one exec is heard to mutter, ''Wow, he's got to be expensive.''

Mébert quickly confirms his stature in the management consulting universe. ''I did the Harvard MBA thing, and then I went to Procter & Gamble where I worked on the Taste Bright Project,'' Mébert says. Taste Bright, he explains, was a top-secret effort his team worked on for years, to boost soap sales by cashing in on not only the olfactory but also the gustatory sense.

"There actually are some people who admitted in focus groups that they would sometimes taste soap. We found that to get repeat business it was necessary to actually improve the smell as well as the taste of the soap,'' Mébert says. Zappacosta nods empathetically at such a difficult assignment. There follow serious nods--and a few chuckles--around the table.

Mébert continues with his credentials: He did a stint at Fortune Computer (one of the valley's legendary business failures), then founded Ray Mébert Associates. Apple immediately recruited him to strategize on its much ballyhooed--now beleaguered--handheld computer, the Newton.

These less-than-proud consulting experiences do not raise an eyebrow. Then again, as any loyal reader of ''Dilbert'' can tell you, consultants play by their own rules. To quote that management guru Dogbert, ''Consultants don't need much experience in an industry in order to be experts. They learn quickly. If your 26-year-old consultant drives past the Egghead software outlet on the way to an assignment, that would qualify as experience in the software industry.'' Mébert, it seems, adheres strictly to the Dogbert doctrine.

If the Logitech execs were to look closely, they would notice a few signs that Mébert is not exactly who he says. Strands of sandy blond hair peek from under his thick brown locks. His mustache is a little too symmetrical. Not bad, though, given the hasty transformation Mébert underwent two hours earlier at his home in Danville. It's also home to Mébert's alter ego, ''Dilbert'' creator Scott Adams.

And here's a couple of interviews Scott Adams gave about the incident shortly afterwards.

I got a call from Tia O'Brien [an independent reporter on assignment] for the San Jose Mercury News. She wanted to do a story that was going to be interesting and different. We brainstormed and came up with the idea that I'd put on a disguise, go to a corporation as a consultant, and see if I could fool people into thinking that I was a high-paid consultant when, in fact, I was just full of crap. Zappacosta thought it would be a fun idea. So we set up the scam. Tia acted as my assistant, and Pierluigi was the only one who was in on it in a room full of business executives at Logitech. For over one hour I took them through an exercise on how to rebuild their mission statement. I actually convinced them that the one they had was woefully inadequate. That's part of the humor of it - all mission statements are quite useless. So to tell them the one they had wasn't doing the job should have raised a red flag to begin with. But people in corporations are so used to two things: First, absurdity - so nothing seems too unusual. And second, there is not enough payoff to rock the boat. It was much easier for everyone to listen to what I had to say than to jump on me at the first sight of absurdity. Certainly everyone in the room had at least a moment where they said, "Man, I'm wasting my time!" But I made sure I always skated just below the level at which somebody would call my bluff and would think it was worth taking the chance of calling me a fraud. I had them thinking, "What if it just turns out that he's just eccentric but the best consultant in the world?"

See that picture to the left there, by the light switch? Where I'm peering from behind Dilbert? I have a big mustache and fake brown hair on? I was outfitted by a makeup artist and I went into Logitech as a famous consultant. I was brought in by the founder of the company, who was in on it, and he was in on the joke, and a reporter for the San Jose Mercury News, a freelancer who was working there, set it up with me. They had their senior management there and I gave a whole presentation and reworked their mission statement with them. They thought I was there to give them a better mission statement. But, my stated goal was to give them the worst mission statement ever written, convince them it was good, and get them to agree to put it to music. I succeeded in all that. They agreed to put it to music and I didn't actually have them put it to music. But I got volunteers, and people volunteered. It was the worst mission statement ever written. Every person in that meeting was way above average in intelligence and not one bit more gullible than anybody else on Earth. Completely normal gullibility.

Private Equity Firm To Go Public

Blackstone Group is preparing to become the first major private equity firm to go public. The $4 billion IPO values Blackstone at $40 billion. But investors can only buy into Blackstone's management company, not the companies it owns, and they'll have limited voting rights. Blackstone's partners will remain in control, said Martin Mayer at the Brookings Institution.

[Thanks to CP for bringing this to my attention.]

45% of first-time buyers put $0 down

According to the National Association of Realtors 45% of first-time buyers nationwide put no money down.

That's up from 42% the last time I posted the statistic back in March 2005.

Federal Reserve advisory group warns foreclosures to get worse

Members of a Federal Reserve advisory panel on Thursday warned of a rising tide of US mortgage foreclosures in the coming year, as subprime borrowers in particular are expected to feel the sting. Members of the Fed's Consumer Advisory Council said the number of foreclosures in 2007 is expected to exceed the roughly 1.2 million from 2006. "Foreclosures are at a historic high, and they're going to get higher," said Alan White, a supervisory attorney with Community Legal Services, adding that subprime loans represented about 50% of last year's foreclosures. "It's getting to a point where it's no longer an anecdotal problem, but it relates to the nature of the product," White said, referring to the proliferation of subprime mortgage products.

Collapse of Arthur Andersen LLP

To those who think that the destruction of Arthur Andersen was an over-reaction, keep in mind that we are not just talking about Enron. Arthur Andersen over its last few years also signed off on the extremely dirty books of Sunbeam, Waste Management, Global Crossing, Qwest, and (most appaling of all) WorldCom. This was clearly not just a few bad apples but a systemic cancer within a company that not that long ago was held up as the paragon of auditing ethics.

Staff:

Of course, the jewel of the crown was Arthur Andersen's tax practice, with its approximately 500 US partners, which was won by Deloitte Touche Tohmatsu in April 2002.

The other big ticket item in the collapse of Arthur Andersen LLP was that Robert Half International established the firm Protiviti by hiring more than 700 professionals from the risk consulting practice including more than 50 partners.

The rest of the firm was carved up like a Thanksgiving turkey...

Ernst & Young Acquires Arthur Andersen's Chesapeake Office - 350 employees including 39 partners.

Ernst & Young Acquires Pittsburgh Offce - 87 employees including 8 partners.

Ernst & Young Acquires Louisville Office - 45 employees including 3 partners.

Ernst & Young acquired the Financial and Commodities Risk Consulting and Financial Services practices of Arthur Andersen's Chicago office - 65 employees including 12 partners

Ernst & Young hired 78 Andersen staffers in Miami, Fort Lauderdale and West Palm Beach.

Ernst & Young acquired Ann Arbor, Grand Rapids and Toledo offices - 159 employees including 14 partners

Ernst & Young hires approximately 100 Arthur Andersen professionals including 6 partners from Andersen's Los Angeles, Denver, Phoenix, and San Diego practices.

Deloitte & Touche acquired about 950 staffers from the Chicago office, far more than any other Big Four firm.

Deloitte & Touche acquired 225 employees from the Milwaukee office

Deloitte & Touche acquired 50 employees from the Las Vegas office

Deloitte & Touche acquired the Minneapolis office - 229 employees including 16 partners

From the Atlanta office, Deloitte & Touche hired 359 employees including 39 partners, and Ernst & Young hired 51 employees including 5 partners

The Boston office was divided up between the Big Four - Ernst & Young signed up 15 partners, PricewaterhouseCoopers 5 partners, Deloitte & Touche 11 partners and KPMG 4 partners

KPMG picked up more than 200 employees and partners from the Seattle office

Grant Thornton picked up 50 employees including 6 partners from the New York office

Grant Thornton got 161 employees including 19 partners in Charlotte, Greensboro and Columbia

Grant Thornton buys Tulsa office with 35 employees

Huron Consulting Group was formed by 35 Andersen professionals, mostly from the financial consulting practice, in Chicago.

Keep in mind that this entire process was started in April and was completed by July. I did not think a company with 28,000 US employees (85,000 globally) could collapse in four months. If anybody has information on offices that are not listed here, I'd like to hear from you. In particular, I am interested in learning what happened to the rest of the NYC office.

Clients:

This list is entirely too long to reproduce in this blog since Arthur Andersen had almost 2500 clients. In this case, I will rely on internet links and hope they do not die on me.

http://www.accountingweb.com/cgi-bin/item.cgi?id=74745
http://www.forbes.com/2002/03/13/0313andersen.html
http://www.forbes.com/2002/06/28/0627andersen.html

Collapse of Andersen Worldwide

Defections of Andersen's global affiliates
I would normally provide this information via a link, but I wanted the actual text documented here in case the link dies because this information is becoming increasingly difficult to find on the web.

Argentina 4/16/02 Plans to merge with Ernst & Young
Australia 3/28/02 Announces plans to merge with Ernst & Young
Baltic States 4/15/02 Announces plans to merge with Ernst & Young
Belgium 4/23/02 Announces plans to merge with Deloitte Touche Tohmatsu
Brazil 4/9/02 Announces plans to merge with Deloitte Touche Tohmatsu
Bulgaria 4/24/02 Announces plans to merge with Ernst & Young
Canada 4/12/02 Announces deal to merge with Deloitte Touche Tohmatsu
Chile 4/9/02 Announces plans to merge with Ernst & Young
China 3/22/02 Announces plans to merge with PricewaterhouseCoopers
Colombia 4/23/02 Announces plans to merge with Deloitte Touche Tohmatsu
Croatia 4/24/02 Announces plans to merge with Ernst & Young
Czech Republic 4/24/02 Announces plans to merge with Ernst & Young
France 4/16/02 Plans to merge with Ernst & Young
Germany 4/24/02 Plans to merge with Ernst & Young
Holland 4/24/02 Announces plans to merge with Deloitte Touche Tohmatsu
Hong Kong 3/22/02 Announces plans to merge with PricewaterhouseCoopers
Hungary 4/24/02 Announces plans to merge with Ernst & Young
India 5/4/02 Announces plans to merge with Ernst & Young
Indonesia 4/14/02 Announces plans to merge with Ernst & Young
Italy 4/23/02 Announces plans to merge with Deloitte Touche Tohmatsu
Japan 3/28/02 Announces plans to merge with KPMG
Mexico 4/9/02 Announces plans to merge with Deloitte Touche Tohmatsu
Middle East 4/22/02 Announces plans to merge with PricewaterhouseCoopers
Netherlands 4/22/02 Announces plans to merge with Deloitte Touche Tohmatsu
New Zealand 3/28/02 Announces plans to merge with Ernst & Young
Norway 4/9/02 Announces plans to merge with Ernst & Young
Phillipines 4/24/02 Announces plans to merge with Ernst & Young
Poland 4/9/02 Announces plans to merge with Ernst & Young
Portugal 4/9/02 Announces plans to merge with Deloitte Touche Tohmatsu
Romania 4/24/02 Announces plans to merge with Ernst & Young
Russia 3/22/02 Announces plans to merge with Ernst & Young
Singapore 4/3/02 Announces plans to merge with Ernst & Young
Slovakia 4/24/02 Announces plans to merge with Ernst & Young
Slovenia 4/24/02 Announces plans to merge with Ernst & Young
South Africa 4/11/02 Announces plans to merge with KPMG
Spain 4/3/02 Announces plans to merge with Deloitte Touche Tohmatsu
Sweden 4/22/02 Announces plans to merge with Deloitte Touche Tohmatsu
Switzerland 4/17/02 Announces plans to merge with Ernst & Young
Taiwan 4/11/02 Plans to merge with Deloitte,Touche Tohmatsu
Thailand 4/3/02 Reaffirms plans to merge with KPMG
United Kingdom 4/10/02 Announces plans to merge with Deloitte Touche Tohmatsu
Vietnam 5/10/02 In discussions to merge with KPMG

http://www.accountingweb.com/cgi-bin/item.cgi?id=76820

What it would take to bring down another big accounting firm

The key to survival [of a Big Four firm] lies in the willingness of the partners to stay committed and at their desks — something that the Andersen partners did not possess, as proved by the two-week period in 2002 during which they bailed out en masse and thus smashed the firm beyond recovery.

A study done for McCreevy calculates that the partners of a European firm would bolt in numbers large enough to be destabilizing rather than be forced to finance a litigation payment that extracted a profit reduction of 15% to 20% over three to four years. Applying those assumptions to the Big Four's latest reported US revenues of $4.7 billion to $8.7 billion, the US firms would confront partner flight and possible failure at liability levels as small as $450 million to $1.8 billion. Those amounts are modest to the point of insignificance against the size of this decade's financial debacles — examples ranging from the $20 billion hole in the balance sheet of Parmalat to Enron's $67 billion bankruptcy.

Response to Comment

Any comments on how Unions caused problems in high costs? Japanese companies who have factories in America with no Unions seem to have a very good profit margin. I think Chrysler's workers did themselves and the company in. Any thoughts on comparing this to some airlines troubles? (Eastern, PanAm)

No question that the problems of GM, Ford and Chrysler are due to overly high compensation and benefits demanded by the union. For example, in 2005, GM’s US other postretirement employee benefits expense, consisting of retiree health care and life insurance, increased to $5.3 billion (that's HALF of GM's $10.6 billion loss right there).

However, it is too easy just to blame the unions. Past management (and here I mean as far back as the 50s) is also to blame in that it was far too easy to promise benefits that would be paid years later rather than wages that would have to be paid on the spot.

I agree that Japanese companies that have factories in the US with no unions indeed have a very good profit margin. Furthermore, it's worth noting that GM and Ford operations abroad are also much more profitable than their US operations. I've previously commented that if Ford could just make their US segment disappear they'd be in top-notch financial shape. This is the reason why I don't think GM would ever buy Chrysler. Folks who know a lot more about cars than me observe that the two companies' vehicle portfolios don't mesh well. And they are right. However, from a financial point of view it just wouldn't work out. GM has more than its fair share of "Detroit troubles" and has no business trying to take on Chrysler's very similar problems.

Your comment in comparing the automakers to airlines is quite insightful. Heavily unionized industries are all collapsing due to the unsustainable wage/benefit promises extracted from management by the unions. Steel, airlines, automakers. They're all going down for the same reasons.

GM rumored to be in talks to buy Chrysler

I have of course been following the many reports of problems at the Chrysler unit of DaimlerChrysler including all the discussion about how the "merger of equals" was falling apart and Daimler was looking at "strategic opportunities" (translation: divestiture) for Chrysler. However, this story BLEW ME AWAY:

General Motors is in talks to buy the Chrysler Group in its entirety, Automotive News reported Friday, citing unnamed sources in Germany and the United States.

MMC selling Putnam

Power Financial, the owner of the biggest mutual fund company in Canada, agreed yesterday to buy Putnam Investments, based in Boston, from Marsh & McLennan for $3.9 billion in cash. Power Financial is buying Putnam, which managed $192 billion as of December 31, through its Great-West Lifeco insurance unit. Marsh, which has owned Putnam since 1970, put the company up for sale in September after assets fell 60% in five years because of below- average returns and fallout from a fund-trading scandal.

Bad News for Venezuela

Venezuelan President Hugo Chavez moves yesterday toward creating what he calls "21st Century Socialism" by vowing to nationalize Venezuela's biggest telecommunications and electricity companies, throw out its commercial code and strip its central bank of all remaining traces of its autonomy take his country straight towards communism.

Chavez vowed to nationalize both the country's largest publicly traded private company, Compania Nacional de Telefonos de Venezuela (CANTV) - owned by US-based Verizon Communications - and Electricidad de Caracas - owned by US-based AES. The choice of two US-owned companies won't be missed elsewhere in Latin America, where Chavez has struggled to persuade nations to follow his lead and not Washington's.

Consolidating his power politically, he also unveiled plans to join his coalition of center and leftist parties into a single party controlled by him called the United Venezuelan Socialist Party, a move seen as leading the country down the road to a single-party state.

[Source: WSJ]

Regulator Seeks Legal Action Against Fannie Mae Ex-Officials

The Office of Federal Housing Enterprise Oversight yesterday filed suit against three former Fannie Mae top executives to recover more than $115 million in pay they received because the company's earnings were misstated. The complaint alleges the three executives "improperly manipulated earnings to maximize their bonuses." The three executives maintain they have done nothing wrong and plan to fight. (In 2003, OFHEO filed similar charges against former top officials of Freddie Mac.)

Milton Friedman, R.I.P.

http://www.ajc.com/business/content/shared-gen/ap/Finance_General/Obit_Friedman.html

Home prices plunge by most in 35 years

The Commerce Department reported that the median price for a new home sold in September was $217,100, a decline of 9.7% from September 2005.

New Ford CEO

CNN Money...

Ford Motor Company surprised the auto industry by tapping senior Boeing executive Alan Mulally as its new CEO, succeeding current CEO Bill Ford, who will stay on as chairman.

ABC News...

When Bill Ford decided that his family's company needed more leadership than he could offer, he started looking for someone who had successfully fixed a large but troubled manufacturing company. He wasn't sure there was such a person, but as he asked around in and out of the auto industry, one name kept popping up: Alan Mulally, EVP of The Boeing Company [and President and CEO of Boeing Commercial Airplanes]. [...] Mulally was widely praised for being a key architect of the resurgence of Boeing's commercial airplanes unit over the past couple of years.

Ford - August was a bad month

Toyota Surpasses Ford

Toyota Motor surpassed struggling Ford Motor in July to rank as the second-biggest-selling auto company in the United States, behind General Motors, sales figures showed. Toyota's victory over Ford was slim, just 487 vehicles. Toyota sold 241,826, up 16.2%, while Ford's sales dropped 32% to 241,339. Three months ago, Toyota passed DaimlerChrysler to rank as the third-biggest company in terms of American sales.

Note: The story has a huge error. It says that Toyota's sales in July gave it 16.2% of the American market compared with 15.9% for Ford. That is absolutely not correct; the margin of 487 vehicles represents a gap of 0.03% not 0.3%.

Ford Cuts Production

If you’re a major automobile manufacturer and you are struggling to sell all the cars you make, what do you do? Do you try new incentives, aggressive marketing, or actually making cars people want? If you’re Ford, you don’t do any of that. Instead, you just make fewer cars. Ford has cut production levels of their vehicles in the fourth quarter of this year by 21% compared to last year. It means that Ford will make 3.048 million vehicles in North America in 2006, that represents a drop of 9% from last year.

Rubin Resigns Board

Robert Rubin has resigned from the board of Ford Motor Company, citing a potential conflict of interest with his duties as a member of the chairman’s office at Citigroup. One analyst said the move may be a sign that the Ford family will need financing for an alliance with another company or to take the struggling automaker private. Another said Citigroup may also advise Ford or a buyer on the sale of the company’s credit arm. In a letter dated Thursday to Ford Chairman and Chief Executive William Ford, Rubin said he needed to step down as the board begins a review of the automaker’s strategic options.

Haven't we already been down this path?

AT&T Launches Its Cable Foray With TV Service

The new AT&T made its new television service available to thousands of San Antonio consumers, kicking off a battle against cable rivals that could result in lower prices for TV, Internet and phone services.

With prices starting at $59 a month, AT&T's initial packages are roughly on par with those of cable, but the phone company says it offers more services for that price, including faster channel surfing, three set-top boxes, an interactive program guide and digital video recorder. Until this week AT&T offered its TV service to only a few hundred consumers in San Antonio. The wider rollout in that area is the precursor to offering the service in 15 to 20 markets by year's end. Eventually the service will be available to 19 million homes. For consumers, increased competition could mean better TV deals, especially if they buy the service packaged with phone or Internet service. Time Warner, AT&T's main cable competitor in San Antonio, says it has no plans to change its prices.

Analysts predict cable companies will lower the cost of their service if they see AT&T begin to win over their customers. Still, other experts say AT&T's television service may consistently be priced a bit higher than cable TV because the very few customers for the nascent service drive up its programming costs. "It'll hasten the advent of bundling as the way to get the best price for a consumer, but is it going to be transformative to your cable bill? Probably not," said Craig Moffett, an analyst with Sanford Bernstein. AT&T's pricing for San Antonio is similar to that of its main cable competitor for the most part but cable offers more general channels and more features such as high-definition television.

AT&T's midrange plan for its TV service, which it calls U-Verse, offers 150 channels plus 31 premium movie channels such as Starz, Showtime and Encore for $79 a month. AT&T's marketing materials promote TV bundled with high-speed Internet, and customers who sign up for both are eligible to receive both services for $10 to $25 a month for the first three months of service, depending on which package they choose. Next month AT&T plans to launch Homezone, which will combine satellite TV from EchoStar with videos and movies from the Internet, according to people familiar with the new offering.

Foreclosure rates up

The foreclosure rate national average is 1.1%, with the following states having above average rates.

Georgia 3.1%
Colorado 2.9%
Indiana 2.4%
Nevada 2.3%
Michigan 2.2%
Texas 2.0%
Ohio 1.9%
Tennessee 1.9%
Utah 1.9%
Florida 1.6%
New Jersey 1.3%
Oklahoma 1.3%
Arkansas 1.3%
Arizona 1.1%
Illinois 1.1%

Delinquency rates up

The national average is 4.41%, so states in white have delinquency rates at or below the national average.

Laborers International Union leaving AFL-CIO

The Laborers International Union of North America announced that it will be leaving the AFL-CIO as of June 1. The union represents about 700,000 workers in the construction industry and is already part of the Change to Win coalition, which has attracted a number of breakaway unions that cite the AFL-CIO's heavy emphasis on electoral politics and not enough emphasis on attracting more people to the labor movement.

Burger King IPO

Burger King's long-awaited IPO (there's a 2000 BusinessWeek story talking about it) has finally arrived. Today's IPO consisted of 25 million shares priced at $17, which represents a 19% stake in the company.

Wachovia to acquire Golden West

Wachovia (#4 commercial bank in terms of assets, #5 in terms of revenue) agreed to buy California thrift Golden West Financial (the #2 Savings & Loan) for $25.5 billion, a 15% premium. Wachovia says the purchase will help the bank expand in affluent, fast-growing markets in the West. Golden West is an adjustable-rate mortgage specialist but will also give Wachovia 285 new branches, including 123 in California and 26 in Texas.

Shares of Wachovia fell fell 6.7%, the biggest decline since October 2002. Investors worried that Wachovia may have overpaid for Golden West, amid signs of weakness in the mortgage industry as interest rates rise. Wachovia also said the purchase will cut earnings per share by 11 cents in 2007 and seven cents in 2008.

Stories:
Wachovia CEO defends surprise Golden West deal
Wachovia to Acquire Golden West Bank for $26 Billion
Wachovia sees deal as fortification
Wachovia acquires Golden West

GM to sell Isuzu stake

GM said it will sell its 7.9% stake in Isuzu Motors for $300 million, unraveling a 35-year equity alliance to raise much-needed cash to revive its ailing business. In the widely expected move, Japanese trading houses Mitsubishi and Itochu will each take a 3.5% stake and Mizuho Corporate Bank (a unit of Mizuho Financial Group) will buy the remaining 0.9%.

Burger King CEO Resigns

Burger King Chairman and CEO Greg Brenneman resigned today.

John Chidsey, the company's president and CFO, will immediately take over as Burger King's CEO. He's the company's ninth CEO in 11 years.

Brian Swette, a current independent director, will serve as non-executive chairman. SVP and Treasurer Ben Wells will fill Chidsey's spot as CFO.

More Bad News from GM and Delphi

Delphi
Officials of Delphi's two largest unions (UAW and IUE-CWA) rejected the company's latest proposed wage and benefit cuts. Officials of both unions said there was nothing in the proposal to even warrant taking it to union members for a vote. The proposal included a pay cut from $27 to $22 an hour in July 2006 and to $16.50 an hour in September 2007. The proposal also included new, larger health care premiums. As a result of the rejection, Delphi is likely to file Friday in bankruptcy court to void labor agreements covering over 33,000 union members.

GM
General Motors laid off 500 salaried employees at facilities across the country. The layoffs are the first wave of job eliminations in a program aimed at reducing the number of salaried and contract workers 7%.

Housing Banks May Be Forced To Cut Dividends

The Federal Housing Finance Board proposed rules this month that would require the banks to retain more of their earnings as capital to build up a bigger cushion against potential losses. The move comes in the wake of embarrassing stumbles by some of the 12 regional home-loan banks. The proposed rule probably will force most of the home-loan banks to slash their dividends, a big source of income for many of the more than 8100 commercial banks, thrifts, credit unions and insurers that own the banks. The proposal may also discourage the home-loan banks from purchasing mortgage loans made by their members, drying up a small but important source of housing finance and marginally increasing mortgage costs for consumers.

Source: WSJ

Lucent and Alcatel Merging

Lucent and Alcatel announced that they were in talks to effect a "merger of equals."

Here are some financial publications' take on the merger:
http://www.businessweek.com/technology/content/mar2006/tc20060324_429614.htm
http://www.forbes.com/2006/03/24/lucent-alcatel-merger-0324markets03.html

Google Settles Suit

Google agreed to pay $90 million in legal fees and advertising credits to settle a lawsuit filed against it and other Internet companies last year alleging that the companies knowingly overcharged for online advertisements and conspired to continue doing so.

As of this writing, the stock is at $347.76, down 1.73%.

Source: Wall Street Journal

GOOG

Google had a couple of good days Thursday and Friday of last week, but it's been beat up pretty bad this week. After a 2.9% drop today, it is trading at $353.88, down over 25% from its high of $475.11 in January.

AT&T-BellSouth Merger

Two of my four predictions in February 2005 (#1, #2) after the SBC-ATT merger was announced has already come true, as MCI was swallowed up by Verizon.

Now, it looks like a third one is being confirmed as BellSouth gets swallowed up too, by the new AT&T.

The short story:

• AT&T is offering 1.325 shares for each share of BellSouth, which amounts to a 17.9% premium, $37.09 a share at Friday's AT&T closing price, or $67 billion for all outstanding shares. AT&T will also take on BellSouth's debt of $22 billion, putting the total price of the deal at $89 billion. (Compare that with the paltry $16 billion SBC paid for the old AT&T.)
• Current BellSouth shareholders will own 38% of the new company.
• AT&T will own all of Cingular Wireless after the deal. (Will they change the name of the company to AT&T Wireless?)
• About 10,000 jobs will be eliminated after the merger. This is in addition to the job cuts already announced after the SBC-AT&T deal.
• Although the boards of both companies have already approved the deal, there could be regulatory hurdles due to the size of the combined company. (It would constitute a very large portion of the Ma Bell of olden days.)

Google sell-off

Google CFO George Reyes today said advertising revenue growth is bound to slow, sparking a sell-off in their stock. Google shares dropped as much 13%, or more than $50 in heavy trading, before recovering to close down $27.76 at around $362.62, a decline of 7.1%.

Wait a second. Google points out the obvious fact that a $6 billion dollar company is not going to grow 90% this year, and this causes a 7% plunge in the stock price. Sounds like a case of inflated expectations to me.

Burger King IPO

Number-two fast-food chain Burger King filed documents for an initial public offering. Its stock-market debut is likely within six months. Shooting for maximum proceeds of $400 million, the IPO - which touts the fast-food chain's turnaround tale - would top the $391 million raised by Domino's Pizza in 2004. Burger King, which owns or franchises 11,141 restaurants in 67 countries, holds a 12% share of the fast-food-restaurant category, which is expected to grow by 4.2% over the next five years. Burger King's share is less than half of #1 McDonald's and just microscopically ahead of #3 Wendy's, which has been making steady progress to overtake Burger King in the last few years.

Founded in 1954, Burger King has amazingly enough never been a public company. It was sold by its founders to Pillsbury in 1967. Pillsbury was then acquired by Grand Met PLC in 1988, which in turn merged with Guiness in 1991 to form Diageo. "As a result, Burger King Corporation became a small, non-core subsidiary of a large conglomerate, making it difficult for the brand to prosper," the company said in an IPO document.

From 1989 to 2002, the company ran through eight CEOs before being acquired by private-equity firms Texas Pacific and Bain Capital Partners for about $1.5 billion. Since then, the company says, it's been "focused on turning a great brand into a great business." It boasts of its seven consecutive quarters of same-store-sales growth and a rise of 11% in average per-restaurant sales over the past two fiscal years. In the six months ended December 31, Burger King reported net income of $49 million on revenue of $1.02 billion(*).

In its third fiscal quarter, now underway, Burger King said it'll record an expense of $367 million for a cash dividend paid to shareholders, prominently including Texas Pacific and Bain. The company also agreed to pay a one-time $30 million fee to terminate its management agreement with the private-equity firms upon completion of the IPO. Meanwhile, the strong stock-market debut of Chipotle - a spinoff of Burger King archrival McDonald's - and the hefty $2.43 billion price fetched by the private sale of Dunkin' Donuts provide evidence of strong investor interest in fast-food-chain operators.

Source: CBS MarketWatch, Chicago Tribune

(*) Note: I have seen many websites (including WikiPedia) that advertise Burger King's revenue as $11 billion a year. That figure is not correct. That is the total sales at Burger King restaurants whether company owned or franchised, not the revenues of Burger King Corporation.

More Trouble at the AFL-CIO

Two of the nation's biggest construction unions - the Laborers International Union of North America and the International Union of Operating Engineers - announced they are leaving the Building and Construction Trades Department of the AFL-CIO and may soon leave the AFL-CIO altogether. The two unions plan to create a rival building trades group, the National Construction Alliance. Joining the alliance will be the bricklayers, iron workers, and the Teamsters. Together, the alliance will have 1.5 million members. Leaders of the Laborers and Operating Engineers called the AFL-CIO Building Trade Department bureaucratic and out of touch with the new realities of the labor market.

Source: The Wall Street Journal

More on Google

A follow-up on my previous post...

Google has a superb balance sheet:

• $10.3 billion in assets, with an incredible $8 billion of that in cash and marketable securities, and very little in bogus goodwill
• almost no debt, resulting in stockholder equity of $9.4 billion

They also had a very good income statement in 2005:

• Revenue of $6.14 billion, an increase of 92.5% over last year's $3.19 billion
• Net income of $1.47 billion even with coming in under expectations

However, it is trading at $381.50 (down a further 3.7% from yesterday's price as of the time I'm posting this). That's 76x earnings. Does anyone really expect that Google is going to double in revenue and income again next year as it did from 03 to 04 to 05? Price seems a little bit high to me, although let me stress that I am NOT expecting a dotcom-like meltdown since this is a company with a clearly proven business model.

Google's Problems not all tax-related

Taxes were a problem for Google's fourth-quarter earnings, but not as much as investors may have been led to believe. Google's fourth-quarter net income of $1.54 a share, excluding items, missed expectations by 22 cents. (In response, Google shares dropped 12% in after-hours trading Tuesday, 7% Wednesday and 1.4% yesterday.) Google executives stressed that most of the earnings shortfall was attributable to the company having a higher U.S. tax bill than anticipated.

But a closer look at Google's results show that only half of the earnings shortfall - 11 cents a share - may be related to taxes. Google had to record more taxes than expected in the fourth quarter because more of its expenses were allocated to its international operations than it had expected, compared with its U.S. operations. That, in turn, raised U.S. pretax profit as a proportion of Google's total, and a greater percentage of Google's profit was taxed at a higher domestic tax rate. The company's effective tax rate for the fourth quarter was 41.8%; the rate for the full year was 31.6%, compared with Google's projection of about 30%.

Google recorded about $2.14 billion in pretax profit for the year. Applying Google's prior estimate of a 30% effective tax rate to that gets a tax bill of $642.6 million. Google had an actual tax of $676.3 million, the upshot being that the company paid $33.7 million more in taxes than it expected, a figure all attributable to the fourth quarter. However, this equates to only 11 cents a share, using Google's diluted share count of about 304 million. Scott Devitt, an analyst with Stifel Nicolaus, uses different numbers to arrive at a similar conclusion and says the company is off base in blaming most or all of its shortfall on the tax issue. The analyst, who has a "sell" rating on Google shares, stresses that whatever the particular reason for the shortfall, the stock is vulnerable to the market's ever-rising expectations.

Source: Wall Street Journal

Response to Comment

The problem is, that everyone has been saying the end of real estate boom is near for 3 or so years from now. Eventually the predictors of doom will be proven right.

Yes, but there's one additional thing to consider. In 1996 the "predictors of doom" were saying that the market was overvalued and prices would crash. They were not proven correct until 2000, but when the market did hit bottom in 2002 prices were in fact lower than in 1996. So it's not just a matter of time, but an actual price consideration.

Note that the real-estate bubble will not burst a-la the dot com stock bubble.

I agree it will never be as bad as the dot com stock bubble. The reason for the difference is clear - unlike stocks, homes are physical assets.

I think prices will only stagnate or wane slowly over the years...

Here I disagree. Current prices are sustainable only because of very low interest rates and absurdly generous financing options. I see prices dropping as much as 20% in a relatively short period.

Chipotle IPO

Investors piled into the initial public offering of Chipotle Mexican Grill today. After the 7.9-million-share offering priced at $22 a share, Chipotle shares doubled to close at $44, after reaching as high as $48.28. Chipotle sold 6.1 million shares in the deal, raising about $134 million, while its parent, McDonald's, sold 1.8 million shares. After the offering, McDonald's will have an 88% voting interest in Chipotle and a 69% economic interest.

Chipotle debut marked the biggest opening-day gain for a U.S. IPO since late 2000 and the biggest opening-day percentage gain on the New York Stock Exchange since Martha Stewart Living Omnimedia went public in 1999. Investors are excited about the chain's growth potential as its CEO, Steven Ells, said he plans to use the bulk of the proceeds from the IPO to open 80 to 90 stores this year. Part will be used to pay down a $30 million line of credit with Chipotle's parent.

At $44, shares of Chipotle are trading at roughly 80 times earnings.

Disney acquiring Pixar

Disney agreed today to buy Pixar in a stock deal valued at $7.5 billion based on Disney's closing price of $26. They expect the deal to close this summer.

Disney is offering 2.3 shares of its stock for each Pixar share. That's a 3.8% premium on Pixar's closing price of $57.57, which already is up 8% since January 3 on investor anticipation of a deal. There's no collar on the agreement, which means the value will rise or fall with Disney's stock price. Disney is issuing new stock but says it will buy back shares to return to the current float in 2007.

This deal will make Jobs, who owns about half of Pixar, Disney's #1 shareholder with 6.6%. He will join the Disney board.

Chipotle IPO

Chipotle Mexican Grill, a fast-growing 489-store U.S. restaurant chain and pioneer in the "fast- casual" dining segment, is being spun off by parent corporation McDonald's. In a filing with the SEC, Chipotle raised its forecast price range to $18 to $20. That raises the expected value of the 7.9-million-share offer to $150.1 million, based on the midpoint of the forecast. The shares are expected to price on Wednesday evening and make their market debut on the New York Stock Exchange under the symbol "CMG" on Thursday. Chipotle aims to use the proceeds of the offering to drive an aggressive growth plan to fund restaurant openings and to pay back debt to McDonald's. It plans to open 80 to 90 new stores this year.

Happy New Year?

One of the most important lessons you can ever learn about markets is also one of the easiest to forget: Just because prices are more reasonable than they were doesn't mean they're reasonable.

[...]

No one wants to hear that. It's almost irresistible to believe that after all we investors have endured--the hellish bear market, the recession, the scandals--we've emerged from the crucible sadder but wiser, finally willing to face the truth about stock values. But it isn't so. The amazing reality is that we haven't learned our lesson even yet.

Two Books on AT&T

End of the Line: The Rise and Fall of AT&T by Leslie Cauley
Grade: C

I managed to finish this book because the story is captivating, but the book definitely is not. The analysis is superficial, and Cauley clearly runs out of new things to say so she ends up repeating the same things over and over and over again. As one example, she mentions AT&T strong balance sheet (pre-Armstrong) a half dozen times, and even gets it wrong - on one page, she says AT&T long-term debt was $126 billion; elsewhere she says $12 billion. Her description of the personalities involved is likewise superficial and repetitive. She mentions Armstrongs "Big Blue way of looking at things" at least a dozen times (I am not exaggerating). There's even a entire discussion (regarding negotiations with Time Warner Cable) that is given in its entirety twice (pp. 189 and 190).

Another serious complaint is that the language of the book is inappropriately informal for the subject matter, even downright vulgar in a couple of places. Her very poor writing style just adds to the book's generally sloppy impression. This impression is not aided by the careless errors that pepper the book (e.g., referring to Microsoft as a cable giant). Didn't anybody edit this thing before it hit the shelves?

Most annoying of all is the approach of following parallel lines to that fateful summer of 2000, then backing up to follow another line of thought. It seems to be an attempt to highten the drama, but it fails miserably. A chronological order would have made the story much more interesting as well as making it much easier for the reader to figure out what went wrong with AT&T and maybe learn something from the book. But perhpas this is just as well since Cauley's research would not have been up to this task.

I bought this book expecting some new insights, but there was nothing in here one wouldn't already know from reading the Wall Street Journal as the collapse was happening. Cauley simply did not do any homework or dig beneath the surface in the least. Overall, a very weak effort.


Tough Calls: AT&T and the Hard Lessons Learned from the Telecom Wars by Dick Martin
Grade: D-

The back cover says that this book is "an up-front seat for the roller coaster ride" and a "look at how a great company tumbled" that will give us a "tour of AT&T's wild ride" and "chart the dissolution of an American icon." Not one of those comments is even remotely warranted.

I was expecting to find interesting insider discussions of important questions like:

• Did AT&T make any mistakes during the "trivestiture" in January 1996 (akin to giving away the wireless licenses to the RBOCs in the 1984 breakup)? Martin doesn't say, beyond talking about the PR fallout of the layoffs. These layoffs were only a side issue of the broader business strategy; communication mistakes surrounding them hardly merits mentioning at all.
• Was pursuing cable the right strategy for Armstrong to implement? Probably, but Martin doesn't weigh in on this.
• Did AT&T overpay for MediaOne? Of course, but again Martin is silent.
• Did AT&T further compound its cable problem by putting poor executives (first Hindery and then Somers) in charge of broadband? Not a peep.
• How should AT&T have handled the $2 billion @Home acquisition? Silence.
• Were all these problems unavoidable due to AT&T's pre-1996 succession planning problems? The only aspect of this question that Martin bothers to discuss is the PR fiasco surrounding Walter's departure. As if that were the most important aspect of AT&T's succession problems. He strikes me as having an exaggerated sense of his importance to the organization.

AT&T was a corporate icon for 130 years and had 4 million stockholders. Surely there were "hard lessons learned" as the subtitle claims, lessons that are valuable in the broader context of the modern corporation. However, from reading this book you would get the impression that AT&T's only mistakes were in communications. Martin gives us an incredibly myopic view of just the PR efforts related to AT&T's various missteps. Outside the PR business, who cares? Nobody! This could (indeed should) have been the business book with the broadest appeal in a decade. Instead we got a book that only PR people could stomach. It was so monumentally boring it literally put me to sleep more than once. I bought this book to read about AT&T; if I cared about Martin's actions I would have bought his biography instead.

Despite naming the first chapter "Don't dance to the music of your own buzz" it seems that Martin has done exactly that. His book is the ultimate example of form over substance, confusing the need to address important business questions facing AT&T with the buzz surrounding him and the mostly irrelevant matter of how the answers were communicated. Whether the answers were the right ones or not, Martin is unwilling (or more likely, unable) to say. If this book is an example of the caliber of executive thinking at the level of Executive Vice President at AT&T no wonder the company sank so far so fast.

Google Buys 5% of AOL

Google will invest $1 billion for a 5% stake in Time Warner's America Online unit. Google will become the only shareholder in AOL other than Time Warner. Google also will have "certain customary minority shareholder rights, including those associated with any future sale or public offering of AOL," the companies said in a statement.

Two thoughts come to mind:

(1) The writing is on the wall. Time Warner is slowly laying the groundword for a spin-off of AOL. It looks like it's 5% down, 95% to go.

(2) This values the whole of AOL at $20 billion. Interesting, very interesting! At its peak in December 1999, AOL had a market cap of $210 billion. Ouch!

Pepsico Market Cap Exceeds Coca-Cola's

Today, for the first time in history PepsiCo's market cap ($98.4 billion) closed above Coca-Cola's market cap ($97.9 billion). Symbolic? Yes. Meaningful? That depends on whom you ask.

Source: AJC

Nikkei breaks 15,000

The Nikkei finished up 258.35 points at 15,130.50, its highest close since Dec. 13, 2000. Yesterday ir briefly rose to 15,013.24, climbing above 15,000 for the first time since Dec. 14, 2000.

I ran across the most interesting graph of the Nikkei (see page 1). It overlays the period 1982-1992 for the Nikkei against the period 1992-2002 for the S&P500. The similarity is uncanny. However, there seems to have been a divergence after 2002 with the S&P recovering after 2002 while the Nikkei remained in a 12-year funk in the period 1992-2004.

While I don't think we will return to the returns that people came to expect from the S&P, I also don't think we are headed for a prolonged slump like the Nikkei experienced. A big reason for the Nikkei's decline was the Japanese practice of cross-holding where two companies doing business together would cement the relationship by buying large chunks of each other's stock. At the peak in 1990 more than half of the Nikkei's market cap was cross-held. As the slump began, companies began dumping their cross-holdings exacerbating the market decline. By the time the market hit bottom, less than 20% of the Nikkei's market cap was cross-held. This much healthier number is probably part of the reason that the Nikkei has been able to stabilize and start climbing again.