A victory for the backbenchers

The President seems ticked off chiefly that negotiating with "the leadership" isn't enough, that the backbenchers in each party acted yesterday as if they have minds, and constituents, of their own.

Mr. Bush's address this morning, at 8:45, began as follows: "Yesterday, the House of Representatives voted on a financial rescue plan that had been negotiated by Congressional leaders of both parties and my administration. Unfortunately, the measure was defeated by a narrow margin. I'm disappointed by the outcome, but I assure our citizens and citizens around the world that this is not the end of the legislative process."

It "had been negotiated." It was, you see, a done deal. Then those darned non-leaders got in the way.

Personally, I'm happy for its loss. It represented a lousy deal. The key for any revised plan ought to be a debt-for-equity swap, bringing in the bondholders of the major financial institutions as the holders of equity in the re-organized entities.

This thought is hardly an idiosyncracy of my own. A lot of people are making the debt-for-equity point, but no one within the beltway seems yet to have listened.

Sometimes you can't get things right until you break what is wrong. The backbenchers broke something wrong yesterday. Bully for them.

Asian markets not impressed

One theme of the news coverage this last weekend of the frenetic negotiations in Washington over the details of a Wall Street bail-out plan was this: they had to get a deal n place before the Asian markets opened, Monday morning in Hong Kong and Tokyo, or Sunday evening in Washington. It was crucial to send a message to the investors in those markets.

Upon waking this morning, we can check -- those investors weren't impressed.

The bottom line of today's HK trading, as measured by the Hang Seng index, is a drop of 669.13 points to 18,012.96. In Tokyo, the Nikkei closed 149.55 down at 11,743.61. In Singapore shares fell 32.45 to 2,379.01.

If there had been no deal, the administration and do-something-quick allies would have cited these numbers as proof of how disastrous waiting is.

But there is a deal, so these numbers will of course be spun as proof that the markets need immediate follow-through.

Follow the sun. What's the story with the Euro markets? In Germany, the DAX is down. In France, the CAC-40 is down. In London, the FTSE is down. Gee, this deal doesn't seemed to have worked any market magic after all, has it?

I'm not saying nuttin'....

Dillard's

Barington Capital Group LP and Clinton Group Inc. have joined forces to urge a change in the share structure of Dillard's Inc., a mall-based retailing company.

The two activist investors filed a letter with the SEC last week asking the board of Dillard's to remove its dual share structure, which as things stand keeps in the hands of class B shareholders the right to elect two thirs of the board.

The existing management group owns W.D. Co., which in turn owns about 99.4% of class B shares.

My first thought when hearing of such a situation is that there is something to be said for the principle of "caveat emptor" in the ownership of shares of stock,, though. Anyone who bought any shares in Dillard's should have done the research in advance necessary to understand that the management maintains this sort of lock on control. If they have done that homework, then one would expect the price of class A stock would sell at a discount that reflects the limited significance of the vote that comes with it.

But the first thought is not always the best thought. One might also consider that operationally, same store sales have fallen over the past year. Maybe the management is doing itself as shareholders a service by locking things up so tightly. Maybe a shake-up in control could have effects on the sales numbers.

Anyway, the two hedge funds togerther own 5.67% of that class A stock. Their letter asks for a committee of independent directors to be formed to consider their proposal.

New board for InSite

InSite Vision Inc. is a developer of eye-care related products, based in California and chartered in Delaware.

It held its annual meeting Monday. At that time, shareholders had the opportunity to vote on a chalenge slate -- six nominees for the InSite board put forward by a venture capital firm, PTV Sciences. Six seats constitutes the whole of the board.

Yesterday, in a press release, InSite acknowledged based on prelim figures that PTV appears to have won. "It is time for management and the new Board to focus on the road ahead and work together to transform the company into a successful, multiple-product organization," said the good sports.

PTV has claimed that InSite hasn't delivered on the profit potential of its products, especially in light of its $5.8 million loss in the second quarter of this year.

InSite is perhaps best known for the eye-infection treatment AzaSite, which contains azithromycin. Insite scored something of a coup in early 2007 when it concluded a patent-licensing deal with Pfizer, becoming the licensee of all Pfizer's azithromycin related patents.

Back in those balmy days, the company's stock was selling for $1.50 a share. But investors have a habit of askling, "what have you done for me lately," and the stock has been sliding since last summer. These days it trades around $0.50.

Hence the new board.

US equity prices

There's been an inordinate amount of punditry in recent days linking the rise and fall of US equity prices to the prospects of Wall Street bailout legislation in Congress.

I was just listening to such talk on morning television, along with admonitions that "bailout" isn't the right word. It's a "rescue." Well ... excuse me.

Either way, I'd like to interject some skepticism about that link. The market didn't rise Friday, I submit, because it had decided that the "Paulson plan" will pass and prove wonderful. The market rose Friday because the SEC banned short selling on a wide range of stocks.

If you arbitrarily exclude a certain class of sellers, then you've jiggered the prices in favor of a rise. How complicated a concept is that?

Likewise, I submit, the market didn't fall Monday because the market has suddenly become worried Congress won't pass the bill after all.

More likely, it fell because evidence accumulated over the weekend that the SEC isn't all that serious about the short sale ban, and that it won't last. That, by the way, is very good news and we should welcome Monday's decline as part of the natural equilibrium-seeking process for unjiggered prices.

On the broader point, Gordon Crovitz had a fascinating op-ed piece in yesterday's WSJ, under the headline "Information Haves and Have-Nots."

The money quote. "There are now about half as many Wall Street analysts as in 2000. Former New York Attorney General Eliot Spitzer eviscerated the profession with $1.4 billiuon in settlements and a new mandate for how the industry would be structured, which made the analysts uneconomical....The now-former senior executives at Bear Stearns, Lehman and Merrill must wish they had been able to retain all those star banking analysts."

Another Spitzer legacy that has contributed to our present troubles was his Ahab-like pursuit of Hank Greenberg, effectively kicking him out of the executive suites of the insurance company Greenberg did so much to build -- AIG.

The US government has now effectively nationalized AIG, on the ground in essence that Greenberg's successors couldn't handle the job. Well ... why does he even have successors???

More on IRF, accounting troubles

It was almost a year and a half ago -- April 2007 -- that IRF announced it was investigating accounting irregularities at one of its foreign subsidiaries. It didn't say which one, though the Japan subsidiary seems the best guess.

And the irregularity may have been a form of old-fashioned channel stuffing.

At any rate, this announcement didn't have any very dramatic immediate effect on the stock price.

But what did have an impact a few weeks later (on July 1) was the news that IRF had fired its chief financial officer, Michael P. McGee. The announcement was quite tersely worded. There was none of the common face-saving stuff. The world wasn't told that Mr. McGee had decided to "pursue other opportunities," or to spend more time with his family.

It said he had been "terminated," full stop. Then it praised his replacement, Linda Pahl, for her qualifications.

Deep into that announcement, the company reminded its investors that "an internal investigation of accounting irregularities ... continues." It drew no explciit connection between those irregularities and Mr. McGee.

Mr. Market can add though, and gets to "four" quickly enough when companies lay out the 2 plus the other 2. IRF's stock price entered the month of July 2007 at $37.50. It fell nearly to $30 before that month was out. Though it soon made a partial recovery, this was the start of a continuing slide. A year after Mr. McGee's sudden departure, IRF was selling for $17.50 a sure.

It has come off of those lows since, and largely as a result of, Vishay's interest in an acquisition.

As my readers may rightly infer from the tentative quality of these last two posts, I'm still feeling my way into this company, its history, and the proxy fight. I'll seek to lessen my own ignorance in the weeks to come.

International Rectifier

On Tuesday, Sept. 16, one semiconductor manufacturer filed a proxy statement with the SEC in connection with the nomination of three candidates to the board of another.

Vishay Intertechnology, of Malvern, Pa., is trying to get representatives n the board of International Rectifier, of El Segundo, California. This is part of their larger campaign to buy up their Californian cousin.

In an accompanying statement, Vishay said: "It has been our strong preference to work together with International Rectifier to negotiate a mutually agreeable transaction; however, International Rectifier’s refusal to negotiate with us has left us with no alternative but to present our increased all-cash premium proposal directly to International Rectifier stockholders. We look forward to the delayed 2007 Annual Meeting on October 10, 2008, at which the International Rectifier stockholders, the true owners of the company, will have an opportunity to express their views by electing our three nominees to the International Rectifier Board of Directors."

The incumbent board replies that Vishay's proposed price, $23 per share, "significantly undervalues the future prospects of the Company when compared to the value that we expect our new strategic plan to deliver to our shareholders."

IRF's stock value closed Friday at $20.39. It was below $17 at its nadir this summer.

The underlying problems that make IRF vulnerable involve accounting troubles -- of which I'll have something more to say tomorrow.

The Last Tycoons (2007)

Consider this just a book notice, not a proper review.

The Last Tycoons is an unauthorized history of Lazard Freres & Co., the international banking consultancy that lasted as a privately-held concern for more than 150 years, until finally it was taken public in 2005, transforming itself into Lazard LLC.

The passing of the old ways represented by the public offering inspired this book, by William D. Cohan.

Lazard Freres dates to the 1840s, when brothers (unsurprisingly) named Lazard opened a dry goods store together in New Orleans. Soon thereafter, the discovery of gold in Califdornia lured the brothers out west, and they became engaged in the export of the bullion. From there the gradual move into banking services was natural.

Lazard was involved in many of the highest-profile deals, and public controversies, of the second half of the 20th century. The purchase of The Hartford insurance company by ITT in the early 1970s falls under both of those headings.

Cohan's interest is the period of 35 years roughly beginning with the whole ITT/Dita-Beard controversy, and extending until the IPO of 2005.

I learned a good deal from Cohan about Wall Street during that period, and was struck by new perspectives even on matters I had known.

Perhaps I'll have something more to say about the materials here, and its relevance to the headlines of recent days, when we meet again this coming Sunday.

Three brief items

1. Wow. Wall Street has had an exciting weekend.

Personally, I'm glad Lehman has bit the dust. Somebody had to. These firms and their proprietary traders are in the business of taking risks, and it is in the nature of risk that there be losers.

The "moral hazard" was becoming enormous, even in just the relatively short period since the government avoided a Bear Stearns bankruptcy with a fire sale of that storied brokerage firm to JP Morgan in the spring.

Neither well, nor poorly. JPM stock has lost about 7% of its value since that time. But this is in line with the general market trends in the intervening period, so the acquisition of Bear can't be blamed for that.

Anyway, there had been a lot of talk, the usual talk, about how Lehman again was somebody "too big to fail" and the Federal Reserve or the Treasury or somebody would have to step in and prevent its failure. But nobody has.

As I say, I'm glad. So everybody will be just a little more careful with risky financial instruments in the near future perhaps? So that might not be a terrible thing?

It is sometimes called "creative destruction." Something has to be destroyed as something else is created. What is now being created in the US is a depositor-centered financial world, in which commercial and investment banks are one and the commercial side is the one.

2. CSX opinion.

The second circuit has issued an opinion in the much-watched matter of TCI/CSX.

You can refresh your recollection of the issues here.

I'm disappointed. The 2d circuit didn't even get to what I see as the key issue in the case, the unbundling of votes from economic interest. Instead, it tersely upheld the vote that has been taken and the district court's decisison ONLY INSOFAR as the district court had refused to interfere with that vote.

"We decide that issue alone at this time," the appellate court said. Drats.

3. Crude oil likely to stabilize

Here's some guessing (note that word!).

The fall in the price of crude oil in recent weeks, from its peak of nearly $150 a barrel in mid-July to a current price below $100, has likely gone as far as it is going to go.

The crude oil price run-up this summer seems to have been a South Sea-like speculative mania, and the run-down seems to have been the bursting of that bubble, so now the stuff is back in the grip of the fundamentals.

Given the continuing credit/liquidity crunch, there will be a great deal of temptation to inflate the currency, at least until $110 doesn't mean as much as $90 does now.

Back to real time tomorrow

Take THIS Marty Lipton.

I think Icahn expresses himself quite well.

If all has gone well in my travels, I'm back in the United States right now, but not up to my old blogging self. Want to account for jet lag and all that. So this will be the last of the pre-scheduled entries.

As they say on television: "Not reality. Actuality."

I don't know what that means when used to promote a cable channel, and I don't know why I used it just now, either.

The bearish case on mining stocks

The "Heard on the Street" column of the Wall Street Journal, written in this instance by Arindam Nag, set out the bearish case on mining stocks on August 26.

One intruguing idea in the column is that the rise of specialized ETF funds may have been bad news for such stocks.

"With investors able to invest directly in commodities through exchange-traded funds and other vehicles, they don't have to dig into mining companies themselves to retain long-term exposure to metals."

Okay, but we don't want to be nagged, Arindam.

Cymbal clash. You're a beautiful audience. I can feel the love in this room.

Freedom for Waksal

ImClone founder Sam Waksal walked out of prison last month and took up residence in a halfway house in the Bronx.

Waksal was locked up for insider trading, on a sentence of seven years and three months.

Here's an argument to the conclusion that he should never have been prosecuted from Reason.

Martha Stewart was allegedly one of the individuals whom Waksal tipped off about inside market-moving information. She went to prison herself of court, but on much lighter terms than his.

Andrew Lo's hypothesis: conclusion

So if we've followed Lo's reasoning set out in yesterday's entry, we have a sense of how different species emerge. Speciation depends upon changes in economic conditions that change the adaptive behaviors into maladaptive ones, and force a re-jiggering. The specifics of the re-jiggering lead to distinct roles, or ecological niches, explaining the distinctions between hedge fund behavior and pensiuon fund behavior.

"The AMH is still under development.... Even at this early stage, though,
it seems clear that an evolutionary framework is able to reconcile many of the apparent contradictions between efficient markets and behavioral exceptions. The former may be viewed as the steady-state limit of a population with constant environmental conditions, and the latter involves specific adaptations of certain
groups that may or may not persist, depending on the particular evolutionary paths that the economy experiences."

Presumably, of a "steady state" stayed steady long enough, the different species might all mongrelize back into one another. In that respect, Lo's speciation is different from Darwin's. But that is a trivial point, because the steady state is only a theoretical "limit," -- change is the reliable reality. Species remain distinct.

One of the implications of the view is: "[I]nvestment strategies will also
wax and wane, performing well in certain environments and performing poorly in other environments. Contrary to the classical EMH in which arbitrage opportunities are competed away, eventually eliminating the profitability of the strategy designed to exploit the arbitrage, the AMH implies that such strategies may decline for a time, and then return to profitability when environmental conditions become more
conducive to such trades."

And that is where I will leave the matter for now.

Andrew Lo's hypothesis

Lo calls his view the "adaptive markets hypothesis." Note the modesty of the term "hypothesis" rather than the more declamatory "theory."

Anyway, the AMH stems from a new interpretation of the fall of Long-Term Capital Management. LTCM's spread positions were "quite rational," Lo writes. They were impossible to maintain, though, because "the forces of irrationality -- investors flocking to safety and liquidity in the aftermath of the Russian default in August 1998 -- were stronger, at least for several months, than the forces of rationality."

That's a rather sharp contrast with the views that, for example, Roger Lowenstein expressed in his book on LTCM.

Anyway,Lo's view is that their "spread positions were quite rational," but that the markets stayed irrational longer than they could stay solvent.

We can understand the actual balance of rationality and irrationality, Lo thinks, if we begin with the idea that there are distinct species within the ecosystem of the market. Each species has its own ecological niche.

When circumstances change, when a shoreline moves or the climate warms up, the old niche may become maladaptive. The deck gets re-shuffled, not immediately but over time.

Likewise, when something happens to change an economic/financial environment, previously rational strategies may become maladaptive.

Lo writes, "Individuals make choices based on past experience and their best guess as to what might be optimal, and they learn by receiving positive or negative
reinforcement from the outcomes. If they receive no such reinforcement, they do not learn. In this fashion, individuals develop heuristics to solve various economic challenges, and as long as those challenges remain stable, the heuristics
will eventually adapt to yield approximately optimal solutions to them."

Each individual's "heuristic," then, or investment strategy, will be path-dependent. It will be what it is because of the history of the crises that individual or institution has experienced. The different species that have their origin in such means include: pension funds; hedge funds, retail investors, and market makers.

I'll finish the thought tomorrow.

Not in real time

I'm traveling, dear reader, so for the next few posts on this website you'll be reading material I prepared weeks ago and scheduled for these dates.

Hope you enjoy it nonetheless.

To dive in, here's a link to a fascinating paper by Andrew Lo, a professor at MIT.

Lo is discussing the efficient market hypothesis, which (a) seems to have a powerful logic to it, but (b) runs into important counter-examples in the world of fact.

Lo believes there is a way to 'save the appearances,' to reconcile theory and fact in the world of financial economics.

For tomorrow's entry, I've summarized Lo's theory as I understand it. You can wait until then, or you can just follow the link, read his paper, and make up your own mind what he's saying and how far it is valid.

Latest Re: The New York Times

The two hedge funds that pressed (successfully) for representation on the board of The New York Times Co. earlier this year are again adding to the size of their stake in that company.

The two funds, Harbinger and Firebrand, indicated in January that they planned to shake up the board by or at the annual meeting in April. This decision put them on a famously glassy uphill slope, though, because nine of the directors of TNYT are elected only through restricted Class B stock. And 89% of the Class B stock is in the possession of the dynastic Ochs-Sulzberger family. Only four directors are on the board as a result of the vote of Class A stockholders, so even if dissidents elected all of those four, the controlling family would remain ... the controlling family.

Nonetheless, beginning in January and iunto March, the Harbinger/Firebrand forces increased their holding of that Class A stock from 5% to nearly 20%. Their operational case was that the Times needed to improve its digital strategy and sell some noncore assets.

They made their point, at least to the extent of getting half the representation available to them -- two of those four seats. They reached this accord in March, and the stockholders' meeting itself was a peaceful one.

Now, though, the truce may be at an end. Harbinger/Firebrand are buying again.

Meanwhile, what's been happening to the stock price (NYSE: NYT)?

I've included the one-year chart above. The Harbinger challenge was presumably inspired (or at least rendered affordable!) in the first place by the long slide in stock prive at the end of 2007 and through the opening days of 2008 -- from above $21 last September to close to $14.

Once the hedgers made their intentions known, and of course once they started their own buying, the price rose, so that it was back above $20 at the time of the settlement announcement.

Zig-zags notwithstanding, it stayed in that area until early May, they returned to its downward course. The price is now below where it was in January. It closed yesterday at $13.12.

How does that stack up with the market indexes? Not well. The Dow Jones has lost 13% of its value over the last year, but NYT has lost 40% of its.

Anyone who still owns Class A stock is a hardy soul. Or, perhaps, (remembering yesterday's analysis) an institution obeying a mandate or instituting a hedge.

Therein lies another part of this tale. Perhaps some significant portion of the 80% of Class A stock that the two hedge funds don't owned is now owned by counter-parties of theirs, hedging swaps agreements. For in addition to their outright purchases, a recent story in the Wall Street Journal tells me that the funds have "effectively gained economic exposure to an additional 1.7 million Class A shares."

Simple arithmetic tells me that it costs more than 22 million to buy 1.7 million shares at $13.12 each. The "unnamed counterparty" in the story is by definition betting on a decline in price, but it would presumably have bought some shares itself to hedge that risk, and it would have that much voting power.

This is of course the TCI/CSX issue again. Wonder when the 2d circuit will weigh in?

And the world goes round and round.

Institutional Investing

Some heavy wonkish numbers today.

The Conference Board, the non-profit organization best known for putting out the consumer confidence index, has put out a report on institutional investment in US corporations.

It says that over the last two decades institutions have consistently increased their holdings in the largest 1,000 US corporations. Twenty years ago, those corporations were 46.6% institutionally owned. By 2000, the figure was 61.4%. Now, it is up to 76.4%.

Institutional investors include pension funds, hedge or mutual funds, insurance companies, banks and foundations.

Of those variants, that with the most weight to throw around in the US capital markets and corporate suites is: the pension fund. Within that category, state and local pension funds have grown more rapidly than others.

This is important because the state and local funds are more inclined to activism -- and, for that matter, to litigation.

Further, it isn't just the growth of such funds that gives them more weight to throw around. Their internal allocation decisions are moving in the direction of equity. They've increased their share of equity markets from 2.9 percent in 1980 to 10 percent in 2006.

Carolyn Brancato, one of the authors of the report, said in a release: "As the more activist state and local pension funds not only grow in assets but also increase their equity base, they have more stock to vote at annual meetings and in proxy contests."

Meanwhile, in international news ... the U.S. pension funds have historically put very little of their assets into equities outside this country's borders. This amount has grown of late, though. The report says that the largest 25 internationally invested U.S. pension funds now (as of 2007, the latest available figures) allocate 15.3% of their assets that way. It was only 13.5% two years before.

Napster faces proxy contest

Napster ... there's a name redolent of history.

In the speeded-up cyberspatial sense of the word "history" of course.

It began in 1999 as a cool idea in the head of Shawn Fanning. Fanning was 18 years old at the time, and I understand the term "napster" itself was first his hair-related nickname.

He sparked an intense debate over peer-to-peer networks and intellectual property, and redefined the market for music.

Ah, those were the days. Unfortunately, that Napster shut down in July 2001as the result of a court order. The company now known as Napster was formally Roxio Inc., having purchased the original firm's brand and logos at a bankruptcy auction.

Roxio/Napster launched its service, Napster 2.0 in October 2003.

The reborn company's stock price hit a high of $10 in December 2004. But for the subsequent three and a half year, it's been skidding. In early July of this year it was selling for less than $1.25 a share. It has since rebounded a bit. Not much.

Hence, the dissatisfaction of many of its investors, and the present proxy contest. The demands? This from a filing.

"We believe the current classified board structure, the board’s continued support of its poison pill takeover defense, the dilution of shareholder ownership through restricted stock grants for 'performance' and the new 'change of control' severance package awarded to the CEO/chairman have misaligned the interests of the board from those of stockholders. In fact, we believe Napster’s generous senior executive compensation practices overall have created incentives for management NOT to sell the company. It is time for stockholders to exercise owner oversight and force entrenched directors to step aside by casting your vote with us."


Now THERE's a song they've taken from their peers.