The Once Invincible

Coach Arsene Wenger (above) should have a happier summer

     This past Monday, Premier League team Arsenal F.C published its financial statements for the first half of the season, posting a profit of about 17.8 million pounds.
     While profits from this period are just half of those from the previous period, Arsenal fans can rejoice in the fact that the reduced income is due to an increase in player investments. Over the past six months, the team brought on the likes of Lukas Podolski, Santi Cazorla, and Olivier Giroud, and the club also announced extending contracts with the talented Jack Wilshire and Theo Walcott.
   Although the increase in spending is and should be considered a good thing for Arsenal as a football team, major problems still exist. The team has failed to win a trophy for seven years, and sit at fifth place in the current Premier League table, one spot away from Champions League qualification. Should Arsenal fail to qualify for the Champions League, the team would suffer a huge hit to television broadcast revenue and home ticket sales, most likely prompting the sale of valuable players. The club's estimated wage bill of 155 million pounds per year would not be sustainable with any less fixtures for the team. Having a losing team with such a high wage bill would also put management under even more scrutiny for signing lackluster players to expensive deals.
    While Arsenal does have its fair share of problems going forward, there still exists hope for the Gunners faithful, The team reported a cash reserve of 123 million pounds with plans of having a strong summer transfer period. A sponsorship deal with Emirates in excess of 100 million pounds will also strengthen the club's finances for several more years.
    Still, fans are growing impatient over a perceived lack of investment in the team. As a Liverpool fan, I had to sit and watch as Xabi Alonso, Mascherano, and Fernando Torres all left Liverpool for greener pastures (maybe not so green for Torres). For Arsenal, the loss of Cesc Febregas, Samir Nasri, and Robin Van Persie has not been balanced out, with management sitting on the cash they made in those deals (each being a historic sum in its own right). After this most recent financial report, the promise has been made to the fans for improvement. Now we will have to wait and see if Arsenal will do what it financially takes to reclaim its place as the Invincibles of England.

-Aureen Sarker (Photo Credit: Arsenal F.C)

Italy’s Political Fallout

After the election that took place on Monday, Italy finds itself in political gridlock. The center-left, led by Pier Luigi Bersani, hold a majority in the lower house while the center-right coalition, led by Silvio Berlusconi, won enough seats in the Senate (117) to deprive the center-left of the majority it needed to govern. Beppe Grillo, a former satirist turned populist-politician, received 25.5% of the popular vote and won 54 seats in the Senate in what is perhaps the clearest demonstration of the dissatisfaction by the Italian people with the electoral system. Mario Monti, the outgoing technocrat that led the government after Berlusconi resigned in the midst of a crisis in 2011, received a lowly 10.5% of the votes for the lower house and 9.1% for the Senate, corroborating the displeasure that the public has for the austerity measures and tax hikes enacted under his government that managed to quell some of the fear ever-present in the marketplace.

SX5E - Euro Stoxx 50 Index (5-day performance)

The effects of such a result were clearly observable in the markets. In the immediate aftermath, the Euro Stoxx 50 Index, a Blue-chip Index containing 50 “Supersector leaders” from 12 European markets, fell sharply after initial projections had the center-left with a majority in both chambers were proven wrong. The FTSE 100 in London closed 1.3% lower and the MIB stock Index in Milan closed 4.9% lower. Even more worryingly, Italian 10-year bond yields rose by about half a percentage point to 4.86%, 62 basis points below the premium commanded by Spanish debt – their narrowest margin in 4 months. Unsurprisingly, the spread on 5-year Italian credit default swaps, or the cost of insuring Italian government debt, rose to 290 basis points from 245 basis points a day earlier. According to Market Watch, this means that it now costs $290,000 annually to insure $10 million of Italian debt against default for five years, versus $245,000 on Monday[1]. The euro fell to $1.3018, its lowest level since January 7.

So what does this mean for the Eurozone? After all, more than 50% of voters cast their ballots unambiguously against the Euro, against further austerity measures, and in favor of increased spending and lower taxes. In the now likely scenario that Bersani finds himself unable to form a coalition that communicates the clear message that Italy is committed to the austerity measures and the euro, then the uncertainty and anxiety that plagued Europe for the most part of 2011 might return. If Italy’s borrowing costs start to rise, a weak government could prevent it from reaping the benefits of a European Central Bank government bond-buying program, which could prove disastrous for the region. With this scenario in mind, European leaders have already started to pile pressure on Italy’s rival parties to form a stable government.

Let’s hope that they do.

-- Andrés Muñoz

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[1] William L. Watts, "Investors Now Fear a Default by Italy more than Spain", Market Watch, http://blogs.marketwatch.com/thetell/2013/02/26/investors-now-fear-a-default-by-italy-more-than-spain/

Greenhill -- M&A Negotiation This Upcoming Thursday!

Resume & Cover Letter Workshop

Come join Finance Society this upcoming Tuesday for a resume and cover letter workshop. Members of our executive board will be teaching you the steps of building the two professional documents. At the end of the workshop you will also have a chance for an one-on-one critique session. Bring a copy of your resume.

Conserving Capital: It All Made Sense Until He Said That EVERYONE Profits

Conserving Capital with Kyle Cameron

It All Made Sense Until He Said That EVERYONE Profits

I have decided to give a central theme to my blog posts for the Finance Society from here on out.  This first post will explore the theme chosen, its centrality to finance, and the chat that inspired the idea. 

Capital conservation has to be the most important topic in finance, and as such deserves a little defining.  Finance poses the question: How do I best allocate assets?  As a subcategory, capital conservation concerns itself with the logical follow-up: How do I avoid poor allocations of assets?  Indeed, capital allocation is what Warren Buffett was referring to in his quote, “The first rule of investing is don't lose money; the second rule is don't forget Rule No. 1”.  However, despite the world famous investor’s reference to capital allocation as the first rule, I would argue that most people – financiers, economists, and other businessmen included – believe finance and investing to be the pursuit of asset allocations producing the largest gains; a cheery view that ignores the often frightening concepts of loss and risk.  This unfortunate view is akin to the gambler who always bets the max and assumes such action will produce the largest gains.     

Upon hearing that I was studying finance, my acquaintance decided that I must be made aware of this business he was involved in that would help save me money.  He began to tell me about Shop.com, a website that he claimed would allow me to save money on the items I normally purchase.  Responding positively to my prodding, he went on to explain that in exchange for the opportunity to purchase this vast array of discounted items, I would need to contribute a small initiation fee in addition to monthly dues.  At this point, his claims have seemed reasonable – in fact, seemingly comparable to my family’s Costco membership.  Like the flip of a switch, however, the conversation turned as he explained how he had made money from selling product himself and networking to find other individuals who would sell products.  I then made the very pointed question, “What percentage of distributors profit from the sale of goods?”  His answer: “100%”.  I will not recount the conversation any further from there, but I did give the acquaintance my contact information and a promise to buy product if he would share his books and prove that he had, in fact, made a profit from his participation in Shop.com. 

I am supremely confident that my acquaintance is exponentially more knowledgeable about his business than myself.  However, I am just as confident that he does not understand capital conservation.  It is highly likely that a significant portion of the  “profits” he has made from product sales, cost savings, and networking to bring in other sellers are illusory.  Such “profits” are surely being destroyed by being tied up in inventory, future purchase commitments, marketing efforts and time, monthly fees, and increased unnecessary purchases.  I hope my acquaintance truly is profiting from Shop.com, but I also know that his mention of everyone profiting from the business is proof of his own complete ignorance of the risks involved.  Even if my acquaintance has profited, his dearth of knowledge around the risk of loss means that he is not conserving his own capital.   

Now ask yourself, are you conserving your capital?  

U.S sues S&P

Last week, the U.S. Justice Department’s legal suit against Standard and Poor’s Rating Services captured much public attention and gave rise to a heated debate. It is by far the first legal case against a rating agency over the cause of the crisis. The government believed that the rating giant should be accounted for its overly optimistic ratings toward mortgage-backed securities and collateralized debt obligations that misled the market and cost investors billions of dollars. Moreover, over the past few years, the government has been investigating whether the firm’s management was involved in intentionally pushing the standards lower for certain kinds of bonds, a misconduct that would potentially bring about a serious disaster for this New York based company.

Indeed, before the housing bubble burst and the crisis began, most MBS’s and CDO’s were given AAA ratings because rating analysts all agreed that the investment was so diverse that it could provide investors a safe net against losses. The government believed that it is this kind of misleadingly high ratings that attracted a huge number of investors into the trap of MBS and CDO investments.

Yet, suing a rating agency for granting certain bonds higher ratings, in some sense, is like accusing a wizard for failing to predict the future, a metaphor that S&P spokespeople have been using repetitively to show their innocence. Furthermore, the rating firm has been emphasizing that this latest crisis is by no means caused by a single financial facility. Instead, it is the result of a combination of complex macro- and micro-economic factors that range from government policies to investor behavior, which as a matter of fact partially affected all rating firms’ credit ratings towards different kinds of equity and bonds.

Whatever the result of this attention-grabbing lawsuit would be, it shows the government’s determination to start seeking the culprits for this passed (or not) financial crisis and to hold them accountable. S&P might just be a beginning.

Ruijia Tan

REO-to-Rental

Housing analysts have been giddy for the past year about the comeback of their industry, whose collapse led to the Great Recession. 2012 ended up being the third worst year for housing ever, but still beat 2011 and 2010. New and existing home sales, housing starts, and prices jumped in 2012; Countless experts expect an even stronger recovery for 2013.

I imagine people are excited because a major housing rebound typically leads to a broader economic recovery. The logic is as more people put equity into their homes, they experience a psychological effect causing them to feel more free to spend disposable income, increasing economic activity - a phenomenon known as the “wealth effect.”
 
Can bullish expectations for housing actually simulate a long-awaited recovery to Main Street? The more I think about it, the clearer it becomes that it’s not being driven by the typical American families who lost their homes in the economic crash. In fact, it’s being fueled by the banks, private equity firms, and hedge funds whose powerful speculation caused that crash in the first place.

Currently, one of the hottest trends in the financial sector is known as “REO-to-rental.” Over the past couple years, hedge funds, private equity firms, and the biggest banks have raised massive amounts of capital to buy distressed or foreclosed single-family homes, in bulk, and at bargain prices.

According to a recent JPMorgan Chase report, the top ten most active REO-to-rental investment firms have already collectively raised enough capital to purchase 15% of all bank-owned homes.  Blackstone is spending over $100 million a week on buying homes.

The strategy involves fixing up, or "rehabbing," distressed houses to rental standard, then renting them out usually for a duration of 3-8 years. By converting distressed properties into strong, steady cash flows for a few years before reselling them, part of this investment strategy essentially entails a macroeconomic bet that prices will significantly appreciate in the nearby future.

Most firms are scooping up properties in the hardest-hit areas, promising high returns from rental revenue streams, usually at least 10% percent annually. It’s the next Wall Street gold rush, with warning signs of a renewed speculative bubble.

-MEHYAR AFKARI

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Finance Society Spring Kickoff