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Greed on Wall Street

道,领导也。一个领导要不断呼唤以及教导其下属。下属的错与过,皆因领导懒惰。

 
 
 
 
 

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24 interesting findings on how Wall Street destroyed itself.

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Greed on Wall Street (Chapter 10 to Chapter 16)  

来自浪里行舟   2011-10-04 14:55:15|  分类: Greed on Wall Street |举报 |字号 订阅

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Chapter 10

Dell ‘s financial statements: re-stated

  Round Rock, Texas, August 16, 2007: Dell today announced that its Audit Committee has completed its independent investigation into certain accounting and financial reporting matters. As a result of accounting errors and irregularities identified in that investigation and in additional reviews conducted by management, the Audit Committee has determined to restate the company’s financial statements relating to fiscal 2003, 2004, 2005 and 2006 (including the interim periods within those years) and the first quarter of fiscal 2007 (collectively the “restatement period”). Dell’s previously issued financial statements for those periods should no longer be relied upon.

Restatement
The restatement of financial statements will correct the accounting errors and irregularities that have been identified through the Audit Committee investigation and by management as a result of its additional reviews. The accounting errors and irregularities that will be corrected are significant because of the combination of the number of issues identified, the qualitative nature of many of the issues, and in some cases, the dollar amounts involved. Many of the adjustments offset each other during the restatement period, and most relate to the timing of the recognition of income and expenses. Consequently, the restatement is expected to have the following effects:

1.                  Net revenue for each annual period is expected to be reduced by less than 1 percent of the previously reported revenue for the period.

2.                  The cumulative change to net income for the restatement period is expected to be a reduction of between $50 million and $150 million (compared to previously reported net income of more than $12 billion for the restatement period), and the cumulative change to earnings per share (EPS) for the restatement period is expected to be a reduction of $0.02 to $0.07 (compared to previously reported EPS of $4.78 over the restatement period). Most of these reductions relate to the timing of net income that would or will be recognized in periods before and after the restatement period.

3.                  The largest percentage changes in quarterly net income and EPS are expected to be in the first quarter of fiscal 2003 and the second quarter of fiscal 2004, each with expected reductions of between 10 percent and 13 percent; the fourth quarter of fiscal 2005, with an expected reduction of approximately 7 percent; and the second quarter of fiscal 2005 and the third and fourth quarters of fiscal 2006, each with an expected increase of approximately 5 percent to 7 percent. Net income and EPS for each of the other quarters are expected to change by 5 percent or less.

4.                  The adjustments are not expected to have a material impact on the current balance sheet. Adjustments to the annual periods are expected to increase total assets by 1 percent or less and increase total liabilities by approximately 1 percent. The opening balance sheet for fiscal 2003 will include a cumulative adjustment to retained earnings reflecting principally the shift of net income from the restatement period into periods prior to fiscal 2003.

5.                  The adjustments are not expected to have a material impact on cash flows during the restatement period and are not expected to have a significant effect on the reported results of future operations.

The investigation raised questions relating to numerous accounting issues, most of which involved adjustments to various reserve and accrued liability accounts. The investigation identified evidence that certain adjustments appear to have been motivated by the objective of attaining financial targets. According to the investigation, these activities typically occurred at the close of a quarter. The investigation found evidence that, in that timeframe, account balances were reviewed, sometimes at the request or with the knowledge of senior executives, with the goal of seeking adjustments so that quarterly performance objectives could be met. The investigation concluded that a number of these adjustments were improper, including the creation and release of accruals and reserves that appear to have been made for the purpose of enhancing internal performance measures or reported results, as well as the transfer of excess accruals from one liability account to another and the use of the excess balances to offset unrelated expenses in later periods. The investigation found that sometimes business unit personnel did not provide complete information to corporate headquarters and, in a number of instances, purposefully incorrect or incomplete information about these activities was provided to internal or external auditors.

The investigation identified evidence that certain adjustments were improper and purposefully incorrect or incomplete information about these activities was provided to internal or external auditors appear to have been motivated by the objective of attaining financial targets for 17 quarters in a row. Why does Dell have to resort to this?

The answer is simple --- To meet the security analysts’ expectations. The security analysts are a group of people who hates deviation - strictly speaking, deviation from their estimates.

Are these security analysts, gods?

Analysis connotes careful study of available facts with the attempt to draw a conclusion. It is part of the scientific method. However, when analyzing securities, we encounter the serious obstacle where investing is not an exact science. The same is true of law and medicine. Nevertheless, analysis is not only useful but indispensable in these professions;  the same should apply in investment and speculation.

The work Benjamin Graham left behind in “Security Analysis” and “The Intelligent Investor”, which laid the path out for all who chose to follow it. Mr. Graham’s definition of common stock investing is:

1.                  The general future of corporation profits

2.                  The differential in quality between one type of company and another

3.                  The influence of interest rates on the dividends or earning returns that he demands

4.                  The extent to which his purchase and sales should be governed by the factor of timing as distinct from price.

On the second point above, he wrote words of caution, “… stocks with good past trends and favorable prospects are worth more than others”.  However, is it not possible that Wall Street carries its partiality too far – in this and in so many other cases?

In summary, the security analysts wanted past trends that were good. So Dell manipulated its quarterly account to show a good trend. The security analysts were happy and therefore helped drive up or maintain Dell’s stock at a high price.  The Dell executives were happy too, because they could cash out their stock options at a high price.

In their minds, “Your money is my money.” A little manipulation is okay.  

Chapter 11

Tremendous growth potential

 Hewlett-Packard had been using this pie chart (shown in Figure 11-1) for more than a decade to tell the investing public that HP is in the most enviable position in the printing industry. Inkjet and LaserJet printing were merely 4% of the print page volume. The pie chart implied that the remaining 96% of the printed pages currently not using their ink is a vast frontier for them to expand their market share. In other words, HP’s printing business growth potential was tremendous.

2011年10月04日 - 老子下凡 - 老子下凡的博客
 

 Figure 11-1: Distribution of printed page volume

 

What HP failed to mention was the cost per page, productivity and lifespan of the printing equipment. For those who are aware of these key determining criteria, they would come to the realization that it is simply not possible for HP deskjet and laserjet printers to encroach the market share currently occupied by the traditional heavy-duty off-set printing equipment.

From the Hewlett-Packard website, one can obtain data page yield and the selling price of ink cartridges. As an example, my experience of using a HP Photosmart C6280 All-in-one inkjet printer which I own is as follows: For monochrome printing, the ink cost alone worked out to be about S$0.043 per page excluding the depreciation cost of the printer.  A printer using the traditional offset printing equipment quoted S$0.05 for the same page.  But this cost already included ink, paper, equipment depreciation, factory rental, labor cost and net profit.

The HP page yield was obtained under the ISO 24711 testing guideline. It is a standard where testing conditions may not reflect every day use. ISO standard page yields therefore should only be used as a starting point for comparison purposes. It should not be used to predict the actual yield one would get from the HP printer and cartridge.  Actual yield will vary depending on the page content and density of printed text. The page density in traditional printing is typically more than double that specified in the ISO standard.

Traditional printing uses paper that is A1 in size (eight A4 pages). The printing speed per page is several times faster than the fastest HP printer. In addition, the A1 paper size alone represents an eight-fold increase in productivity over these printers that print one single sheet of A-4 size paper at a time.

Other post-production processes such as page sequencing, shearing, and binding are much faster in the traditional printing format of an 8-up[7] print-out.  These processes are more efficient and cost much less than the individual-page processing of the output from a HP printer.

Why didn’t HP reveal these other pieces of information[8]? If they had, you would have found it difficult to believe that it was possible for HP to expand into the adjacent market.  This short illustration points out how powerful the veil of misinformation is. 

For more than a decade, HP did not expand its market share significantly from the so-claimed 4%. Yet, all the security analysts on Wall Street hailed this as the best story to write about Hewlett-Packard’s huge potential. The stock price would shoot through the roof one day when the potential is realized.  However, nobody bothered to ask whether this day would ever arrive.

Wall Street loves only the good stories. Good stories sustain share prices, and high share prices are what drive people to buy into a stock. Greater market interest brings revenue to Wall Street.

Does Wall Street care to tell the truth? No!  They are only after your money.


 

Chapter 12

Mergers and Acquisitions

 According to Professors Jeffrey H Dyer of Brigham Young University, Prashant Kale of the University of Michigan and Habir Singh of the Wharton School University of Pennsylvania, in Harvard Business Review (July-August 2004): “Most acquisitions ... fail. A few may succeed, but acquisitions, on average, either destroy or don't add shareholder value.”

CNN financial news September 4, 2001: Hewlett-Packard Co.'s proposed plan to buy rival Compaq Computer Corp. would create a much more formidable competitor in the struggling information technology industry. Aiming to bolster their competitive positions in a sagging market, the two companies agreed on Monday to join forces in a $25 billion merger.

“It makes us a more effective competitor, and an even more effective partner,” Carly Fiorina, HP's CEO, told a news conference in New York Tuesday. “If you don't believe it, watch.”

Under the terms of a deal,
HP (HWP: down $4.33 to $18.88) has agreed to acquire all of Compaq's (CPQ: down $1.30 to $11.05) outstanding shares through a stock swap, creating a new company that would have sales of $87.4 billion and earnings of about $3.9 billion.

The deal, which the companies expect to be completed in the first half of 2002, will put the new company second behind
IBM in the computer hardware business worldwide. It also would move the combined company, which would retain the HP name, ahead of Dell Computer as the leading supplier of personal computers -- a position Dell took from Compaq earlier this year.

Fiorina -- who has faced a lot of criticism recently amid plummeting sales and profits -- will be CEO of the newly formed company. Michael Capellas, Compaq's CEO, will be president and chief operating officer.

Executives from both companies -- which compete in areas such as PCs, servers and storage systems as well as handheld computers -- said that by joining forces they will be able to better compete against rivals. Those rivals include Dell in the PC market as well as IBM and
Sun Microsystems in the server and storage products market.

Merrill Lynch analyst Tom Kraemer said Tuesday that the merger could do a lot to improve both companies' ability to compete. But he noted that it will face some challenges, both in getting approval from regulators as well as integrating their operations should it receive such approval.

“This move makes HP look much more like IBM and, in our opinion, makes strategic sense,” Kraemer told clients in a research note Tuesday.

“Both HP and Compaq have been pursuing several common strategies: Becoming more services-centric, Wintel in the enterprise, storage as a technology growth engine, and moving to an overall solution sell,” Kraemer said. “There will obviously be regulatory and enormous execution hurdles, but, with the addition of Compaq, HP should be better positioned to move forward on every one of these fronts.”

Lee Schlesinger wrote in Talk Back on March 15, 2002: In 1989, HP was one of the leaders in the RISC workstation market, competing against equally strong Apollo and Sun Microsystems. HP acquired Apollo, but failed to take advantage of its engineers or its technology. A year after the merger, HP had gained no market share; but instead helped reduce the competition for Sun, which went on to dominate the space.

At the time, Digital Equipment Corp. was a smaller workstation player, but its bread and butter product was the VAX/VMS minicomputer. As PCs and networking continued to gain momentum through the '90s, Digital steadily slid, and eventually, in 1998, turned to Compaq to salvage an afterlife. Compaq proved it didn't know what to do with the company it bought any better than HP knew what to do with Apollo.

Digital's most exciting technology, the Alpha chip, was allowed to die on the vine. Eventually even the VAX was retired. Compaq was unable to convert Digital's loyal customer base to Compaq clients. Many former digital customers fled, upset with Compaq for what they perceived as the evisceration of a company they had done business with for many years.

Compaq's record for merging the operations of acquired companies is poor. In 1995, Compaq bought networking vendors Thomas-Conrad and NetWorth. The company was never able to develop a networking products line. In 1997 Compaq bought Microcom and let its remote access hardware and software products virtually disappear. That same year Compaq acquired Tandem, which, true to the fault-tolerant nature of its product line, remains in business.

Of course, in this proposed marriage, Compaq would be acquired, and HP the surviving entity. HP's record is a bit more difficult to assess, as its acquisitions have been smaller companies with names like Indigo, Open Skies, Bluestone, NuView, and Trinagy. It's been a long time since the company tried to swallow a meal as big as Compaq.

Until the merger was proposed by the companies' chief executives, HP and Compaq viewed each other as rivals. Despite the claims of the two leaders, HP's and Compaq's product lines are more competitive than complementary. Both have large stakes in client, server, and handheld computers. In a merged company, some of those product lines will disappear, and if the past is any guide, the combined company will not retain the combined market share.

Charles Cooper of ZDNet News wrote March 20, 2002: Back in the days when I covered sports for a living, the old-timers were fond of instructing press-box newbies never to root for one team over the other. Their advice: Always root for the better story.

And so, if we can trust the accuracy of Hewlett-Packard's unofficial proclamation of victory over the opponents of the Compaq acquisition, the better "story" indeed has won.

Why? Depending on management's skill, the story will evolve in one of two ways:

Scenario A:After three years, the digerati have crowned Carly Fiorina as one of the greatest corporate leaders in modern times. Because many in this fickle flock of big thinkers earlier questioned her acumen--if not her sanity--after the announcement of the Compaq deal, the bestowal of the honor is that much sweeter. But Fiorina has stuck to her vision, creating a smoothly running mega-power that has ultimately squashed pesky Michael Dell and caused Sam Palmisano to order a major overhaul at IBM.

Scenario B: Walter Hewlett was right about this idea turning out to be dumber than a sack of hammers. Things have gone from bad to worse, and Fiorina has been pegged as the second coming of the Emperor Nero after word has leaked of an obscenely huge compensation package. Investors go ape as they watch the HP-Compaq integration descend into disaster, and they call for Fiorina's head on a pike. All the while, wiseacres in the peanut gallery endlessly revel in her public humiliation as she slowly twists in the wind.

The truth is that both sides in this overwrought feud have been running a lot of jive about a post-merger world.

Even the most dyed-in-the-wool supporters acknowledge that Fiorina is sticking her neck out. This is a huge gamble, and the odds against a flawless integration are long. Plus, the critics are absolutely right when they point out that big tech mergers often flop. Remember the forgettable pairing of Sperry and Burroughs to create Unisys? More recently, Compaq purchased Digital Equipment in a deal that once looked great on paper but failed in practice. The cliche about the devil being in the details contains much truth.

But the deal's opponents blew it when they underplayed the risk of doing nothing in a fast-changing tech market. Resurrecting the legend of Bill Hewlett and Dave Packard, they essentially argued it was preferable to stand pat than to ‘slash and burn’. The best they could offer was a proposal to spin off the printing business sometime in the future. The smarter shareholders knew that was a losing hand. The "HP Way" may once have worked wonders, but the company employs 36,000 people in businesses that lose money. Better to bet on Fiorina and hope the shake-up bears fruit, rather than to wait around for the inevitable rot to take hold.

The only common ground between Hewlett and Fiorina is that they both envision a stronger future for HP. But the paths they propose to take to this Promised Land were miles apart.

Fiorina is going to sink or swim on the strength of her ideas about how to reconstitute HP for the 21st century. There's no place for phony olive branches or mollifying her opponents by adopting halfway measures. That means being ruthless. That means not looking back.

A formal tally showed that Hewlett-Packard shareholders voted narrowly to approve a merger with Compaq Computer, but opponents refused to concede defeat. According to a complete, but preliminary, tally by Delaware-based IVS Associates, shareholders approved the deal by a margin of 45 million votes out of some 1.6 billion votes cast. HP received 837.9 million votes, or 51.4 percent of votes cast, while opponents of the merger garnered 792.6 million votes, or 48.6 percent. That is a slim victory margin of 2.8%. The final vote count is a blow to Walter Hewlett, son of HP's co-founder, Bill Hewlett, who was not re-nominated to HP's board of directors.

Throughout the entire episode, nobody ever asked, “Who initiated the merger?” Was it Carly Fiorina? Or Michael Capellas? The answer is, No. It was the investment bankers on Wall Street. 

The investment bankers received a big fat commission of several percentage points on the combined value of the merger and acquisition of the two companies that were matched successfully. In the merger of HP and Compaq, valued at US$25 billion, you can imagine the obscene amount of money that goes into the hands of the investment bankers.

In some mergers, the deals could only be brokered through a cash injection, in part or in full, to pay the acquired party.  Where do the billions of dollars in cash come from?  Once again, the investment bankers arrange for funding and in the process, make huge profits in two ways.

Firstly, the big fat commission from the merger and acquisition project.

Secondly, the interest spread of such a bridging loan is usually several percentage points above LIBOR. However, the merger of HP and Compaq was through a stock swap by HP when acquiring Compaq.

Investment bankers know very well that for a merger and acquisition deal to go through, it largely depends on the sheer determination of the two CEO’s to persistently overcome all odds and any resistance. The episode of the merger of HP and Compaq demonstrated this fact.

How did they enlist the support of the two CEO’s? In this episode, Carly Fiorina was offered US$70 million and Michael Capellas, US$50 million.

Did the HP-Compaq merger really bring positive value to the combined entity? The net profit of the combined PC and server division of HP has been way behind Dell Computer until today. That means the shareholders did not gain anything but on the losing end. Thousands of employees from the combined entity were handed pink slips.

There is a question that nobody ever asked.  How in the world do investment bankers know how to run a business and make the combined entity stronger?

Certainly, the answer is, “They are not in the business of running the merged business operations.” The post-merger problems are for the incumbent CEO to iron out.

Who is laughing all the way to the banks? It is the investment bankers who initiated the deal. In their mind, their only thoughts were: “Your money is my money”.


 

Chapter 13

The unspoken expectations among security analysts

 Wall Street is a place where you cannot stop the music. The music must go on even though it is well past midnight.

But what kinds of music do they play? It is the sad or happy kind?

Many a times, an audience loves happy music. Occasionally, sad music was played for a good change of taste or atmosphere. Here is a case of sad music that did not turn out to be too sad. The security analysts had mauled the share price of Volvo Group very badly because it was expecting extremely poor financial results for its fourth quarter.

Yahoo news wrote on February 7, 2008: STOCKHOLM (AFP) - - Swedish truck maker Volvo Group on Friday reported a net loss in the fourth quarter in the face of crumbling demand, which it said would remain weak through the first half of 2009.

But company shares shot up by 16 percent as the performance was seen as less damaging than had been feared and the group's solid financial position provided welcome news.

Volvo recorded a net loss of 1.348 billion kronor (128 million euros, 163 million dollars) in the final three months of 2008 against net profit in fourth quarter 2007 of 4.0 billion kronor.

Fourth quarter sales fell 9.0 percent to 76.95 billion kronor.

For the full year 2008 Volvo suffered a 33 percent plunge in net earnings to 10.01 billion kronor from sales that rose 6.0 percent to 303.66 billion kronor.

Volvo's main division, Volvo Trucks, which manufactures lorries under the brands Volvo, Renault and Mack, delivered 251,150 vehicles last year, up 6.0 percent over 2007. But deliveries fell 22 percent in the fourth quarter.

Orders plunged by 47 percent in the full-year and by a whopping 82 percent in the last three months of the year.

Volvo shares closed up 16 percent at 40.60 kronor on the Stockholm exchange.

“The report was much better than feared,” analyst Michael Andersson of Finnish bank Evli told AFP.

“We know now that the economic environment is weak. But in that environment the company is still strong.... Cash flow was positive... which was quite unexpected and which leaves it in a very strong financial position.”

Meanwhile, Albert Alexis, analyst at Natixis bank, said "everything was not negative" and welcomed Volvo's decision to pay a dividend of 2.0 kronor, down from 5.50 kronor in 2007.

Here is a piece of good music and no one is allowed to say anything bad about it.

[9]Citigroup is the largest player in the $350 billion SIV market, managing seven of these off-balance sheet vehicles that hold a combined $80 billion in assets. SIVs issue short-term debt to investors such as money-market funds while buying mortgage-backed securities and other assets that carry a higher yield.

“Citigroup is confident that its SIV accounting is proper and in accordance with all applicable rules and regulations,” said Christina Pretto, a bank spokeswoman.

The SEC's review of Citigroup is in the early stages, people familiar with it said. The result could range from no action to a referral to the agency's enforcement division. The SEC is also taking a broad look at how brokerage firms valued assets tied to high-risk mortgages and whether they were timely in their disclosure of losses to investors, people familiar with the matter say.

“I don't think Citigroup is broken,” said Ted Wolff, an executive at Solaris Asset Management, a New York investment manager that has more than $1.5 billion in assets and would consider buying the stock if it gets somewhat cheaper. "The real issue is what's on the balance sheet."

The security analysts stopped short of writing the following message.

Looking at Citigroup balance for year 2007, its total shareholders’ equity was US$113.598 billion. Its net tangible assets are valued at US$49.707 billion after deducting goodwill of US$41.204 billion and Intangible assets of US$22.687 billion.

If the US$80 billions SIV’s were to be halved in value, Citigroup’s net tangible assets will be totally wiped out. But why were there SIVs in the first place?

The security analyst who dares to bring up this question would be fired immediately. This is because, on Wall Street, no one is allowed to destroy value. A plunging stock price will wipe out billions of dollars of value in each of their portfolios. That is a definite, no, no.


 

Chapter 14

The rise and fall of Harvard University’s endowment fund

            HARVARD GAZETTE ARCHIVES wrote on September 19, 2006: Harvard endowment posts solid positive return.

Harvard University's endowment earned a 16.7 percent return during the year ending June 30, 2006, bringing the endowment's overall value to $29.2 billion.

The continued strong returns reinforce the endowment's critical support for Harvard's academic programs and mission. In the 2006 fiscal year, endowment dollars provided almost a third of Harvard's operating budget, or over $930 million.

In addition to significantly outpacing the University's total return target, the fiscal 2006 performance compares favorably to other large institutions. Specifically, the endowment outperformed the median large institutional fund, measured by the Trust Universe Comparison Service (TUCS), by 5.9 percentage points (16.7 percent versus 10.8 percent). According to preliminary numbers, Harvard's performance was also slightly above the median return of the 25 largest University endowments.

The 16.7 percent return for the last fiscal year brings the endowment's annualized 10-year performance to 15.2 percent, beating the 8.7 percent turned in by the TUCS median large fund. The 5-year annualized return recorded by HMC is 13.5 percent, well ahead of the 6.7 percent registered by the TUCS median. In commenting on the drivers of return, El-Erian, who was named Harvard Management Company president and CEO in October 2005 and took over in February 2006, noted that, "increased internationalization in the context of a broadly diversified asset allocation was a decided positive."

Annual endowment performance is not measured just by gains or losses in value, but also by how investments perform against benchmarks in different investment classes. In fiscal 2006, Harvard's endowment beat benchmarks in 9 of 11 individual asset classes. Emerging markets posted the year's highest total return while commodities achieved the best performance relative to benchmark. In aggregate, HMC out-performed its composite benchmark by 3.7 percentage points, translating into $0.9 billion of incremental value added for the endowment.

“Philanthropy Today – A summary of what matters the most to most non-profit world” wrote on January 30, 2009: Harvard's Endowment Losses "Tip of the Iceberg"

Harvard’s endowment losses of $8-billion “might be only the tip of the iceberg of illiquid investments,” writes Edward Jay Epstein, a journalist and author, in a column for online magazine, The Big Money.

Harvard’s money managers, writes Mr. Epstein, pursued an aggressive, non-traditional strategy that included hedge funds and other illiquid investments that made the money more difficult to recover once the economy collapsed.

“As late as June 2008, the fund kept almost no reserve of cash or Treasury bills and allocated a mere 6 percent of its money to fixed-interest bonds. It also borrowed more than $1-billion to amplify the returns on its less conventional investments. So by the time the bubble burst in the fall of 2008, only a small fraction of the endowment-fund investment was even under the jurisdiction of the SEC,” he writes.

Daniel Gross Posted Monday, Nov. 17, 2008: Harvard's Investment Errors. That's where America's greatest university is investing its endowment?

Shouldn't Harvard have seen the credit catastrophe coming?

The recent market turmoil portends hard times for even the wealthiest universities. Last week, Harvard President Drew Gilpin Faust told stakeholders that, with the research service Moody's projecting "a 30 percent decline in the value of college and university endowments in the current fiscal year," Harvard needs "to be prepared to absorb unprecedented endowment losses and plan for a period of greater financial constraint."

If any investor could have avoided the credit catastrophe, it should have been Harvard. Harvard, the ultimate long-term investor (it's been compounding assets for more than 350 years), sports the nation's leading business school and counts a host of financial geniuses among its many distinguished alumni. But judging by one snapshot of a portion of Harvard's gigantic endowment, Harvard's recent financial performance is less than impressive.

The Harvard Management Company has the enviable but challenging task of managing Harvard's mammoth endowment. As of June 30, 2008, HMC managed more than $45 billion, the vast majority of its endowment assets. (Here's HMC's annual report and data on its impressive recent performance.) HMC parcels out big chunks of the endowment to outside managers — hedge funds, private-equity firms, asset managers of all stripes and its staff manage a large chunk itself.

Ross Kerber, a Boston Globe Staff wrote on February 7, 2009: Seventy percent of Harvard's money is run by outside managers such as Convexity Capital Management, the Boston firm started by one time Harvard endowment chief Jack Meyer.

RODERICK BOYD, Staff Reporter of the Sun wrote on January 12, 2005: Harvard stunned by the defection of fund manager. Harvard University's immense endowment took a body blow yesterday when its longtime president, Jack Meyer, announced that he is starting his own money-management firm and taking his top four managers with him. In his nearly 15-year run as head of Harvard Management Company, Mr. Meyer helped the endowment earn large returns and explode in size, to $22.6 billion from $4.7 billion.

As to why he was leaving this year, Mr. Meyer said it had little to do with the compensation scrutiny. “It's been a great 15 years,” he said. “I felt it was time to explore a new challenge to see what I could do.”

People who have studied Mr. Meyer and his team's performance are certain that it played some role in his decision. “His performance was epic and he was a true pioneer in the endowment area,” a managing director at Commonfund, Jud Koss, said. Commonfund, based in Wilton, Connecticut, manages more than $30 billion for the endowments of hundreds of universities.

Until the seventy percent of Harvard's money run by outside managers such as Convexity Capital Management, the Boston firm started by one time Harvard endowment chief, Jack Meyer is properly accounted for, you’ll never know Jack Meyer’s performance was epic or pure fabrication of lies.

If Harvard does not take good care of its money, of course, Jack Meyer will take it for granted that “Your money is my money”.


 

Chapter 15

Oil price shot up to US$147 per barrel

 Hedge funds run on the greater fool theory. They believe the price that they are buying right now is already sky-high. But it really doesn’t matter. Because there will be another greater fool who will bid it up to even greater heights.

However, very few people recognized that the biggest fools among all are the investors who pump billions of dollars into the hands of the hedge fund managers.

Just take a look at how the hedge fund managers bid up the oil price from a low of US$60 per barrel in Jan 2007 to US$147 per barrel in July 2008.

2011年10月04日 - 老子下凡 - 老子下凡的博客
 

From a historical height of US$147 per barrel, it plummeted down to slightly above US$40 in January 2009 to February 9, 2009 (as of the date of writing).

2011年10月04日 - 老子下凡 - 老子下凡的博客
 

Did anybody ask, “Did the oil consumption change drastically over the 2 year-period when the oil price rocketed almost two and a half times and now back down to 2/3 of the price level when this wide gyration occurred?”

Take a look at the world oil consumption over the last 25 years since year 1982. There was a rise of 25 million barrels a day from slightly less than 60 million barrel daily in year 1982 to about 85 million barrels daily in 2007. But the rise in oil consumption from year 2006 to 2008 has been minimal.

2011年10月04日 - 老子下凡 - 老子下凡的博客
 

The answer is very clear. The insignificant increased oil demand over the last 2 years is not a cause of the rapid rise in oil price. What caused it then?

John bean wrote on June 11, 2008: So much hedge fund money was chasing a finite amount of oil futures that the hedge funds have piled in and many are making vast returns and are seeing the bet as a sure way to make up some of the losses incurred in recent months. So they will do everything they can to push the price up. 

When the oil price crashed who are the losers?

First we have to understand how the hedge fund managers are being rewarded. Most funds charge a fixed annual management fee of around 1.5 per cent of the fund held by the hedge fund manager.

Next, for every dollar the hedge fund manager made out of the fund, 40 cents go to the hedge fund managers as performance bonus. The balance 60 cents go to the investors as his returns for taking a bet on the hedge fund.

What happened was when the oil price went up, billions of dollars were made. 40 per cent of the gains went to the hedge fund managers as performance bonus paid out in cash. The investors were very happy to keep the 60 per cent paper gain.

When the oil price crashed, the investors were the suckees who absorbed the full brunt of the losses. The hedge fund managers will not make a cent of performance bonus on the huge losses. But neither do they have to guarantee the investors the losses. What they have pocketed in the previous years of huge paper gains were in solid cash. What the investors made in paper gain for the last few years were gone into thin air and in addition, has to bear the huge losses as a result of the oil price turned south.

Who made the hedge fund managers and paid them billions of cash in performance bonus? The investors did. Who are the suckees who lost their pants? It is the same pool of investors.

Really, the hedge fund managers are in the most enviable position. Win, I pocket the performance bonus. Lose, you suck it all up.

What do you think the hedge fund managers were thinking when they were handed billions of dollars of funds? In their mind, they say, “Your money is my money; mine is mine”.

They will bet the dollars on the riskiest bet to gain the maximum returns only if they bet correctly. However, if they were to bet wrongly, they have nothing to lose. 

How are the hedge funds doing?

According to Bloomberg, Harvard's unloading of their stakes in private-equity funds is flooding the market, driving down prices for the world’s best- known buyout firms:

Investors led by Harvard University, which manages the largest U.S. endowment at $36.9 billion, may increase so-called secondary sales of private-equity funds to more than $100 billion during the next year, overwhelming available pools of capital. Interests in funds managed by KKR & Co., Madison Dearborn LLC and Terra Firma Capital Partners Ltd. all are being offered at discounts of at least 50 percent, according to people familiar with the sales.

Crippled financial firms such as American International Group Inc. and bankrupt Lehman Brothers Holdings Inc. are joining strapped endowments such as the ones at Columbia University in New York and Duke University in Durham, North Carolina, in trying to sell private-equity stakes. A deepening global recession that is crimping the value of buyout firms’ holdings is forcing further price cuts in a market where buyers already are scarce.

“There’s a huge supply-demand imbalance,” said David De Weese, a general partner at Paul Capital Partners in New York, which manages $6.6 billion. As much as 10 percent of the world’s $1.2 trillion of private-equity interests may change hands next year in the so-called secondary market, up from an average turnover of about 1 percent, De Weese said.

Listen to me carefully: the bloodbath in hedge funds, private equity, and real estate funds is far from over. In fact, it is only going to get worse in 2009, especially for illiquid private markets.

The hedge fund industry endures its worst year in almost two decades because of stock-price declines and a credit freeze that started with rising defaults on subprime mortgages in the U.S. The market slump forced money managers to sell assets to meet $40 billion of investor redemptions in October 2008 alone, according to Chicago-based Hedge Fund Research Inc.

But most hedge funds continue to struggle. According to executive from Man Group, the largest hedge fund investor, up to a fifth of managers in the $1.6 trillion hedge fund industry are at risk of going out of business in the next two years.

I think that is a conservative estimate. Even J.P. Morgan's once-hot Highbridge is going cold. Highbridge Capital Management helped its owner, J.P. Morgan Chase & Co., become one of the biggest hedge-fund managers in the world. But like many prized assets roiled by this year's markets, Highbridge has shrunk considerably, and now many investors want out.

Investors have asked to withdraw 36% of the assets from the firm's flagship multi-strategy fund, the firm's biggest. The exodus, combined with investment losses, could reduce the once-$15 billion fund to $6 billion, according to people familiar with the fund.

The decline means J.P. Morgan will miss out on hundreds of millions of dollars in fees that Highbridge contributes.

The big party in alternative investments is over. The bells are ringing from Harvard to all over the world. And now pension funds are waking up to the stark reality that this huge financial mess isn't going to go away any time soon.


Chapter 16

Wall Street is blind to financial manipulations

 What differentiates between a genius and an idiot is how he looks at things. In Wall Street, a genius tends to see whatever things that happen in the security industry as “Your money is my money; mine is mine”. Everyone in Wall Street masterfully structured his or her performance bonus to short term gains; be it running an investment fund or an organization. Of course, the other most important element called investment risk is always thrown out of the window simply because they think it won’t occur in the near term.

Let’s play on the good music. The near term is long after I have retired from my current position. Why worry? I will make as much money as I can by gunning for the highest gains and in total defiance of the looming risks staring at me. Gains are my money. Losses are the investors ’or shareholders’ money. Who cares if the risks were to bankrupt the company?

What kind of geniuses does Harvard Business School produce?

Let’s take a close scrutiny of the course content for the Harvard Business School corporate financial engineering program, Course Number 1426.

Early sessions in the course provide students with an introduction to options and option pricing, using textbook readings, notes, exercises, and cases. We will build on the concepts developed in Finance2. (We will also cover, although in less detail, simple bonds, forward, future and swap contracts.)

The remainder of the course draws upon the analytic tools and intuition developed to examine recent securities or risk management strategies in which firms have successfully or unsuccessfully attempted to use modern financial technology.

The major modules of the course include (1) understanding financial engineering used to support marketing and production programs, signal information, structure incentives, tap different investor clienteles, minimize bankruptcy costs, and address tax and accounting concerns; and (2) using derivatives to manage corporate financial risks, specifically the control of equity, interest rate, and commodity price exposures.

The applications section of the course will use a combination of cases, notes, readings, and prospectuses. The applications are drawn from a variety of different industries and the instruments studied are both domestic and global in nature.

There is a greater emphasis on equity derivatives, with lesser emphasis on fixed income and commodity derivative products. Students interested in foreign exchange issues should consider International Managerial Finance or other offerings.

Students will be required to write a paper and may work in small teams. The papers should examine an application of financial engineering in a managerial setting and must be approved in advance. Students may also be asked to present their findings to their classmates.

The excesses of Wall Street as described from chapter 1 to 15 are the great students of this corporate financial engineering program. In the author’s opinion, this program is more aptly called, financial manipulation. Why do I say so?

Over a short term period of time of several years or possibly up to a decade or two, the accounts are manipulated using all the techniques taught in most universities’ financial engineering programs all over the United States of America.

When they are applied recklessly with no regards to risk, such applications are doubtlessly used to manipulate the accounts to produce excelling short term gains.  

Since what Wall Street wants is good music, such manipulations are deemed good for the market. Anything that ups the share price is deemed good. It will turn a deaf ear to the sad music hoping that it will die down quickly and be replaced by good music.

Wall Street never learns. It only remembers, “Your money is my money; mine is mine”.



[1] This article was an extract from TODAY, a daily tabloid in Singapore dated October 30, 2008.

[2] A Singapore government owned bank. It is the biggest of the 3 local banks in Singapore.

[3] In order to understand the concept of ‘The veil of misinformation’, please read “7 Deadly Management Behaviors – CEO Edition” by the same author.

[4] Whoever reads this book as political prose is an incorrigible felon who has lost his sense of humanity.

[5] Please read ‘Chapter 1: The veil of misinformation’ of the book titled: “7 Deadly Management Behaviors – CEO edition”, in order to understand the concept behind this theory.

[6] Managing Editor of ClusterStock. Prior to joining ClusterStock, John served as editor in chief of DealBreaker.com, a Wall Street online tabloid. He has contributed to New York magazine, The New York Sun, The New York Times, Time Out New York, The Wall Street Journal and other publications. He has been a frequent guest on CNBC.

[7] Printing eight sheets of A4 sized images in one pass.

[8] This is pure information manipulation with a sole aim of misleading the public. What else can it be?

[9] Please refer to the full story in the chapter, “Off-balance sheet transaction at Citigroup”.

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