Regret theory in practice

I am on holiday in Italy until - well - today - when I go to Germany for work.

I rented a car.

Supplemental insurance for the car - which reduces excess from 2000 Euros to zero - was 14 Euro per day (for nine days). The car is automatically insured beyond a 2000 Euro excess.

I did about twenty seconds thinking and elected (against my wife's wishes) not to take supplementary insurance.

The logic:

(a). I pay about $800 a year for a $40,000 car in Australia. It gets driven a lot. That works out at under $3 per day - and it covers considerably more than the supplemental insurance - which makes the supplemental insurance look expensive.

(b). Against this I would be driving about 5x average - somewhat offsetting this - and on the opposite side of the road. Thought of that way the insurance is not massively mis-priced.

I figured there was less than a 10 percent chance of a dingle - but more than a 5% chance. The insurance looked expensive. I am a hedge fund manager and paid to take rational bets. So I declined the insurance.

You guessed it - I had a dingle.

The 2000 Euros is financially irrelevant to me. [It is way less than I risk, personally, every day in the stock market.]

But I am surprisingly, irrationally unhappy about not taking the insurance.

It is widely observed that people (likely including my clients) are irrationally affected by small losses.

But they pay me to be rational. And I insist on being so - but it is harder than it looks.




John

Is anyone other than me rattled by the FIFA arrests?

Soccer (or what most the world calls "football") is barely an American game. None of the FIFA officials arrested are American citizens and none of the alleged crimes involved American citizens.

And yet FIFA officials are subject to American extradition warrants on the basis of American law.

This is from one of the countries that is not a participant in the International Criminal Court and does not like to subject itself to international law.

I have little doubt that FIFA is corrupt. And I don't doubt it deserves to be cleaned up.

But try this scenario. A country (say France) makes it illegal to emit greenhouse gases above a certain quantity in non-compliance with international agreements. US utility executives (who emit huge amounts of greenhouse gas) are travelling in a third country (say Switzerland) and get arrested to be tried in France.

Would you be comfortable?

I would not. But you could reasonably argue that ensuring the planet is not despoiled is more important than cleaning up corruption in football. And you could reasonably argue that emissions in the United States affect France far more than say soccer corruption affects the United States.

This is just anti-democratic. We non-Americans did not vote for the US laws and the US legal system is not responsive to our votes.

But the US system applies to us even when we are not dealing with Americans.

It seems strange to me to explain democracy to Americans - but alas it seems Americans have forgotten the tyranny of foreign laws.




John

Postscript. It seems some of the crimes involved US Citizens and on US soil... but the extraterritorial claim is still made. Some are non US citizens concerning Brazilian tournaments.

Many people commented on extradition treaties requiring the crime be a crime in both jurisdictions... but the arrests took place in a third country - Switzerland - that had tenuous links to the crime.

This editorial is also to the point...

http://www.washingtonpost.com/blogs/monkey-cage/wp/2015/05/27/how-watergate-helps-explain-how-the-u-s-can-prosecute-fifa-officials/?wpisrc=nl_pmpol&wpmm=1

Hanergy: let there be no doubt

Background: Hanergy is a large cap solar cell manufacturer that has been suspended on the Hong Kong market. The biggest shareholder supposedly lost USD14 billion in one day. 

Now that Hanergy has been suspended I can let these out.

I went to visit Hanergy's main factory in China about a six weeks ago. It was almost entirely silent. There was essentially no production of solar cells at all and the accounts that suggest significant production and sales are entirely fraudulent.

There was some evidence that someone was exploring starting production - and I will get to that - but the factory was almost entirely idle.

Here are a few photos.

This is the plant. There were almost no cars despite a vast car park. All gates except one were locked.

There was a single truck being loaded with solar cells - so there was *some* production. However this truck was being loaded when we arrived and still there when we left two hours later. This plant if it had any production at all had it only a trial basis. The accounts that suggest substantial production are false.

This is another photograph of the main drive to the plant. One car was parked. There was no movement.

This I found particularly bizarre. There were solar cells set up around the plant Some of them were set up in triangle-patterns. This is the only place I have ever seen solar cells set up so that they are not orientated towards the sun.

I walked around the enormous plant. Not a truck went by and the only people we saw except at the side were the gardeners. (There were several of them - and we asked them if it ever got any busier. They confirmed it did not.)

However on the side there was a shaded area with some motorbikes parked - which suggest that the plant is not entirely idle. Just almost.

Strangely two white guys walked out of the plant. I think they were Americans trying to sell some technology - maybe sales guys from AMAT - but I am only guessing. I tried to signal for them to come over but they did not.

There has been much press that compares Hanergy to other solar companies and suggests there may be disruptions in the market for panels. Garbage I say. The right comparison is Sino Forest or Longtop Financial Technology.

Hanergy barely existed.




John

Disclosure that will annoy my clients. Despite sitting on these we were not short Hanergy. Too much squeeze risk for my liking.

Follow up from the McDonalds property post

There is no point reading this blog post without reading the prior post (linked here) first...

So many people thought the last blog post was wrong that I need to take it seriously. Several Europeans who claimed direct knowledge of the traffic in that McDonalds in Milan suggested it was profitable.

One person tartly tweeted that my post was from the "Thomas Friedman school of observing something inconsequential and developing an unverifiable explanation".

Here is how I thought about it...

Here is the P&L from McDonalds in 2014.

I am assuming this was a company owned store - and I will not allow any of the generalised SG&A to be billed back to this store.

Company stores had 18.17 billion in revenue and 15.29 billion in direct costs (listed as food and paper, payroll and occupancy etc). This is about an 18 percent margin.

This store was (ignoring Venice*) in the most expensive place to operate in Northern Italy. I roughly knew these numbers and it was almost inconceivable to me that this store isn't 18 percent worse than the average MickeyD's in terms of operating costs or the like.

That suggests the received wisdom about the lack of competitiveness of certain European countries (and the need for an internal devaluation or deflation) is wrong. Staggeringly wrong. Now whilst I am bullish on many European names and I am here looking for prospective investments but I am far from that bullish.

I come from another expensive country (Australia) where cost-competitiveness doesn't look all that good. McDonalds has only closed a few stores - but it has downsized several in high cost areas near me. A small high-cost store seems to be acceptable. A large one, not so much.

The store in the high-cost but highly trafficked Bondi Beach is small. It never looks profitable, but I may be wrong there too.


John

*Venice is a frighteningly expensive special case at least in part because the logistics are difficult.


POST SCRIPT.

An alert reader tells me that this site has a history of concessional rent - and has been the subject of legal action. http://www.reuters.com/article/2012/10/16/us-mcdonalds-milan-idUSBRE89F1BP20121016

Maybe that explains it.

J

McDonalds: property, ego and identity

I have just spent a few days in the modern Middle East cities of Doha and Abu Dhabi. This is the only place I have seen which matches China for just sheer excess of the property market. There are beautiful skyscrapers on what should be worthless land surrounded by barren streets and the odd drip-irrigated palm tree.

It's pretty clear what is going on here. These countries see airlines and skyscrapers as symbols of national importance and they build both without regard to cost.

But all in all it made me think of the superiority of our Western liberal system. We have bubbles of course - but nothing like this.

In Abu Dhabi I saw very beautiful skyscrapers with government employees spread at one employee per 120 square metres. You could play cricket inside the building and nobody would notice. Just empty space.

--

So I get to Milan - and 50 metres from the Duomo I am wondering through a very famous shopping arcade in the early morning. Here is the photo.

 Turn around 180 degrees and this is the view:

Yeah, there it is, Mickey D's (NYSE:MCD).

They can't possibly be making money here - just planting the flag amongst all the Italian restaurants.

This is a statement of ego rather than anything else. It doesn't have the grandiosity of Doha, but then McDonalds is not as rich as Qatar. The ego/motivation is the same.

They would be better off closing this and dedicating the savings to keeping the toilets in the US restaurants clean.

But then property has often been a statement of ego - and US mega-corporates are not immune.





John

PS. If Carl Icahn controlled a big stake in MCD this store would close. Carl often brings some rationality to these things.

ANZAC Day Centenary

I have just returned from the Dawn Service marking the Centenary of the landing of the Australian and New Zealand Army Corps (ANZACs) at Gallipoli (in the then Ottoman Empire and now modern day Turkey).

This is Australia and New Zealand's remembrance day for all war dead.

There are no survivors left from that war - and the ranks of Second World War veterans are thinning. But the Trust is doing an admirable job of keeping the memory alive and relevant - and Martin Place was packed at 4 AM for the service.

Wreaths were placed by representatives of all our Armed Services and our Allies and also by the Turkish Consul - but compared to my Anzac Day of a few years ago it felt a stilted affair.

A few years ago I went with Alice - a then elderly war-widow - and I wrote it up for the blog. Alice is no longer with us - but to keep the memory alive I will repeat the post.

===

ANZAC Day 2009 Post

The original ANZACs were the Australian and New Zealand Army Corps.  They landed on 25 April 1915 at Galipoli in the Dardenelles for what was to become a protracted and punishing military defeat.

Australians (and New Zealanders) still commemorate Anzac Day as their national day of remembrance and with numerous dawn services, remembrance parades followed by war stories, stories about the (great) grandkids and drinking with your mates.  It’s a day that is both sombre and joyous, reverential and light-hearted.  We remember our dead in a peculiarly Australian fashion.  

Today I was privileged to go to the ceremony with Alice.  Alice looked after me as a child and I return the favour in her old age.

Alice served as a nurse in the Second World War.  Her first husband served in Palestine, Tobruk and possibly El Alamein – but paid with his life at the true battle for Australia – at Kokoda.  (The reason I am not sure he fought at El Alamein is timeline.  He may have been at El Alamein and he was certainly in Egypt but the main battle was fought at El Alamein in late 1942 and the Kokoda battles were already happening by then.)  

Alice’s family sacrifice did not end there – her second husband had what I suspect were continued psychological problems after New Guinea.  Alice’s son (Richard) served in Vietnam.  (It is possible however that Alice's second husband fought at El Alamein - and she confuses which battles they fought in.)  

I pushed Alice in her wheelchair at the Legacy War Widows Service in Sydney.  The ranks of World War II War Widows are getting thinner – and Alice may have been amongst the oldest.  She is the youngest (and one of only two surviving) of more than a dozen children.  Being the youngest of many her father was not young when she was born – and – possibly uniquely – she was wearing her father’s Boer War medals.  The medals proudly were issued under Queen Victoria and Edward VII and showed their heads – reminding us that Australia has always fought under the auspices of the British Crown.

The ceremony was short and moving – and whilst I was pushing a wheelchair I did not feel that I belonged in the march.  Other people had sacrificed much and I was a beneficiary not a victim.  Still many tears were shed.

It was about an hour till the main march went through.  Richard disappeared to march with his Vietnam buddies.  I was left chatting with a bunch of mostly spritely women in their 80s whose husbands had died when they were 18-20.  Most did not remarry though one did and the second husband died in the Korean War.

Their husbands mostly died in campaigns against the Japanese after fighting the Germans.  The woman who sat next to me told me her husband served on HMAS Australia and was killed by a kamikaze at the Battle of the Coral Sea.  I was surprised as I did not know that kamikazes had been used as early as the Battle of the Coral Sea (1942).  Moreover it did not gel with her age as she was 18 married and pregnant when the war ended (1945) so it was unlikely that he was killed in 1942.  But HMAS Australia was the victim of a kamikaze – possibly the first kamikaze and there were many dead.  The date of that attack (January 1945) matched the age of her child.  Not to quibble.  She bought up a very well adjusted child as a very young widow – and she never remarried.  It does talk however to how inaccurate memory is – even of very important things.  Her mixed up memory matched Alice's doubt about which husband (if any) fought at El Alamein.  

The march itself was charming, lighthearted, sad and poignant.  And most of those things all at once.

It was led by a group of horses in full nineteenth century military regalia.  After a decent interval came a man with a wheelie bin and a shovel who – to cheers from the crowd – cleaned up the horse dung.

Then came a riderless horse called Galant in lieu of any surviving veterans from the Boer War.  Another riderless horse represented the First World War which was dated 1914-1918.  Flags representing all Australian divisions that fought in that war were carried by serving military officers.

There was no horse and no other representation for Australia’s (minor) involvement in the Russian Civil War (1919).  Australia played a very small role in that war – and there were few Australian dead – but the parade did not honour them.  The Australians fought in British units – though – according to this minor history at the Australian War Memorial web site Australia did send naval ships for reconnaissance.  

After a decent interval came a formal precession led by Professor Marie Bashir.  Marie Bashir is the Governor of New South Wales – and hence the representative of Her Majesty the Queen of Australia.  Governor Bashir is I think 78 years old – but my spritely war-widow companions thought she looked young and fantastic.  

Then came a large number of divisions of Second World War veterans.  Some were carried in taxis, some in military vehicles, some in wheel chairs – but most marched.  A few dropped out of the march to flirt with the war widows which I found hilarious and the widows found flattering.  Many saluted as they went past us.

The women tended to look a little better than the men (which is not atypical amongst 85 year olds).  Most colourful were the women who served in field hospitals who were dressed to the nines and all wearing gleaming (and elegant) white gloves.  Interspersed were marching bands mostly provided by various high schools including my high school.  My old high school (Sydney High) is an academically selective school with a history of taking the upwardly mobile children of the latest generation of immigrants.  In the days that Jim Wolfenson went there it was full of Jews and other children of Eastern European refugees.  It now is the children of Indians and Middle Eastern Muslims as well as South East Asians.  The band filled me with hope for Australia – and the racial mix of the students in it differed dramatically from the all-white Second World War returned soldiers.  

The troops went past largely in order of the campaigns they fought.  Most of the campaigns I knew Australians were involved in – but there were groups that fought with Americans and other services (usually in specialised roles) that I did not know about.  One example were the Polar Bears – a naval group covering arctic supply lines.  

There were contingents from Korea, the Malaya Emergency and extensive Vietnam Veterans.  There were small groups from the first Gulf War, East Timor, Iraq and Afghanistan.  

Finally there were groups representing allies we fought with in various wars.  There were for instance a small group of Dutch soldiers who were assigned to Australian Divisions after Dunkirk.  There were Americans (mostly from Vietnam), Ghurkhas and other assorted South Asians.  The largest group were Vietnamese who fought for the South and later settled in Australia as refugees.

To me though one of the most moving parts of the whole parade happened by fluke.  We tried to find a bathroom for Alice – and a woman who worked for Legacy led us to a disabled toilet.  Legacy is a charity for families of war dead – and it was Legacy who had organised the War Widows special ceremony.  They have a group for the children of war dead – and – for the first time – she had organised them a place in the parade.  They were led by a military truck and in the back was their oldest member – a son of a soldier who died in the Great War – and their youngest member – a son of a soldier who died in Afghanistan.  I would not have understood the significance of that baby had I not met the organiser.  

And whilst I am sad for the child – if I judge it by the children of the war widows I sat with then the boy will turn out OK, and in sixty five years he will still be honouring his father’s sacrifice.

John

PS.  I have to repeat one of the comments.

My mother was raised in an orphanage in Brisbane run by Legacy. As far as I know, she doesn't go to A.N.Z.A.C. Day parades, but does go to the Dawn Service. The "Legacy Kids"/orphans have their own get-togethers. Every August for the past 26 years, the orphans have a re-union on the birthday of the woman who ran the orphanage. She was a Legacy employee who had lost her husband on the Kokoda Track. One of her brothers was a Rat of Tobrook (9th Division) and El Alemein veteran, who later lost an arm at Milne Bay in Papua New Guinea. Another of her brothers is buried in France, killed while flying for the RAF. After her husband died, she lost her only child. She later gave back by running the orphanage for Legacy. She touched hundreds of orphan's lives. They never forgot her. She was also my Godmother.

My Grandfather was killed in Sydney during WWII while serving in the Australian Army. My mother has never visited his grave - its just too painful, even after all these years. My father has an uncle buried in northern France, a casualty of WWI's Battle of the Somme. No one from our family has ever visited his grave to pay our respects. There are many families like ours in Australia with similar stories to tell.

Lest We Forget.

PPS.  I have been a little perplexed by the stories told by the War Widows.  They are sometimes embellished, sometimes the stories are compressed.  I gather Alice's first husband fought with the 7th division.  He could not have fought at El Alamein as he would have been in New Guinea by that time.  Here is a history from the 7th's website.  Almost all of what Alice told me (and the medals she wore) are consistent with this history - though she mixes her two husband's campaigns up.  

The 7th Division left Australia in October 1940 for the Middle East.  Over the next two months, the 7th was concentrated in Palestine.  It was slotted for a move to Greece to help in the defence against Axis invasion, but instead moved into defensive positions in the Western Desert.  Parts of the Division under the command of Maj General Allen crossed into Syria and fought a hard won victory in the campaign against the Vichy French .  18th Brigade excelled itself as part of the defence of Tobruk.   With Japanese invasion of Australia imminent, the Division was recalled home.  Elements of the Division (2/3rd Machine Gun Battalion, 2/2 Pioneer Battalion, 2/2 CCS,2/6 Fld Pk Coy and 105 Gen Tpt Coy)were diverted to Java. They fought a defensive campaign against overwhelming Japanese odds and were only forced to surrender after an early capitulation by the Dutch forces there.

The Division moved to New Guinea and established headquarters in Port Moresby.  The timely arrival of the Division in New Guinea helped to halt the Japanese advance..  21st Brigade fought a bitter campaign of attrition on the Kokoda Track,until replaced by 25th Brigade who slowly forced the Japanese northwards.  18th Brigade and other Australian units inflicted the first decisive defeat of the Japanese on land in World War 11 at Milne Bay and then at Buna and Sanananda in January 1943.   21st Brigade and the militia 39tth Battalion won a costly victory at Gona in December 1942.    George Vasey took over command of the Division in October 1942, until his death in a plane crash in 1945.  Major General Milford then took over command until the end of the war.    In 1943, the Division was airlifted from Port Moresby to Nadzab in the Markham Valley.  After an advance on Lae, the Markham and Ramu Valleys were soon swept clear of Japanese troops.  A bloody campaign in the mountains of the Finisterre Ranges followed. 

Navinder Singh Sarao: Our spoofing hero

This is a comment on the story rampant in the press about a British Man causing the US "flash crash". If you are not familiar this is as good a background as needed.

It took me a while to get my head around just how ludicrous the assertion that a kid (Navinder Singh Sarao) trading a few thousand e-mini contracts caused the "flash crash" was. He did this every day for a few hundred days - and almost every day there was no flash crash. Then there was a flash crash - so ergo - a kid in his basement caused it.

He did this by "spoofing" which is an illegal form of market manipulation. If you need a summary beyond what I give here Matt Levine provides a fairly good summary.

Spoofing

Spoofing - so what is it? Its placing a bunch of (say) sell orders a little above market and a smaller buy order a little below market.

What then happens is that "front running computers" see the multitude of sell orders and assume they are real. They then decide to sell some to get in front of some real selling. The real buy order gets executed.

Now our spoofer is long. They will want to sell at some stage - so they reverse the process. They place a lot of buy orders a little below market and a smaller sell order they want executed - and the front running computer crosses the spread.

The spoofer thus earns the spread, they do this repeatedly and the loser is front running computers. All these trades are placed for mere milliseconds so spoofing is one computer ripping another computer off. Real people don't get fooled by spoofers because the spoofed trades are around for milliseconds.

Making spoofing illegal thus increases the profits of front running computers - meaning more front running computers.

Now alas when I buy a real order in market I have to pay my due to the front running computers - which comes at a real cost to me - a real investor - and to my clients. This is a real cost to real investment in the capital market.

I would prefer the front running computers go away - and the best way for that to happen is to allow spoofing. Spoofing makes the world unsafe for front-running high frequency traders.

--

So what have the regulators done. They have arrested a kid who is spoofing the market with a few thousand e-mini contracts and hence taken money from the front-running computers whose real goal is to rip you (real investors) off. They have made the world safe for the conventional high-frequency traders at a real cost to the investing public.

They were helped out by an industry whistle-blower.

In other words they did it with the help of an industry participant: someone who runs the front-running computers designed to rip-you off.

The Department of Justice has been played into bringing the full force of the US legal system onto an irrelevant trader - just to make the world safer for the real rip-off merchants.

And their case looks plain silly.

As for the kid - Navinder Singh Sarao - he isn't a criminal. He is a hero. He is the sort of guy who makes the market safe for ordinary investors.

Here is to hoping the English judge treats the extradition request with the contempt it deserves.




John

Post script: This post caused some debate in our office. Two objections were raised.

(a). There may be some real investors who use algorithms to "just get the trade done". There is an algorithm like that available on interactive brokers. A "just get it done" algorithm may also front-run a spoofer.

(b). If you allow spoofing you would wind up with enormous quantities of it. It would get to the point where maybe 99.9 percent of offers in the market - especially ones just outside the money - would be spoofs. This could be solved with a very small fee - reflecting costs - for placing an order. The fee would probably need to be less than 1c per $100,000.

Neither of these objections however undo the main argument which is

(a). Spoofing makes profits at the expense of front-running computers.

(b). It thus will reduce the number of front-running computers.

(c). Front running computers make profits at the expense of real investors including our clients.

(d). Therefore spoofing helps my clients and I like it.

Navinder Singh Sarao really is a hero.




J

PPS.Navinder Singh Sarao is a kid because he operates out of his mum's basement. He was really in his 30s - but that is still a lot younger than me.

One more Bank of the Internet advertisement

This one needs no explanation at all:

It says: "New draft pick wants to buy a luxury home. BOFI Federal Bank can do that".





John

Another Bank of the Internet advertisement

These advertisements are pitched at mortgage brokers and they have lots of jargon. But this advert is priceless...

It says "Professional fighter wants to buy an estate with a mixed martial arts studio and needs an asset depletion income qualification loan. BOFI Federal Bank can do that."

So what is an "asset depletion loan"?

Here is a fairly standard explanation from a the Chicago Tribune:

Asset depletion. Some high-net-worth borrowers don't show enough adjusted gross income on their tax returns to qualify. With an asset depletion loan, the lender factors the borrower's liquid assets into the income calculation. The asset amount, less the down payment, is amortized over 30 years or until the borrower reaches age 85, whichever comes first, just as if the money were spent during that time.

So the fighter here does not have enough verified income to qualify - and in this context BOFI are happy to impute an income to the forthcoming mixed martial arts studio.

Good luck with that. I am not sure how good the secondary market is in failed mixed martial arts studios.





John

So what exactly do you get with Bank of the Internet stock?

There are only three banks in America who have

(a) a market capitalisation greater than $1 billion.
(b) a price to tangible book greater than three, and
(c) a price to historic earnings greater than twenty.

These are the most expensive banks in America. The raw data set is here (courtesy Capital IQ).

When you pay absolute top-dollar for a bank stock you need to be getting something special - either a better franchise, better management or the like. There has to be something that sets your bank apart from the run-of-the-mill franchises.

Otherwise - dear shareholders - your investment lies somewhere in the range between mere overpayment and being outright ripped off.

Bank of the Internet (NASDAQ:BOFI) is one of the three highest priced banks in America.

There is a "story" about what you are getting - a high growth ultra-low cost internet franchise.

But this blog post is not about the "story" - its about the reality. The reality is you are getting a 2005-style jumbo mortgage lender (with other odd high risk loans) funded primarily by high cost brokered deposit.

These are some examples from BofI's correspondent websites to explain what the really do. This one describes BofI as home for "portfolio Niche Jumbo Lending".

The money quote: "The majority of our loans are approved with either a credit or collateral exception".

In other words this is an exception lender. The exceptions are to their stated underwriting standards.

And because it lends by exception you are critically dependent on who is approving the exception loans.

Chasing through LinkedIn and other sources it appears that many of the people who approve the exceptions are from IndyMac and Thornburg Mortgage - both bankrupt jumbo mortgage lenders.

Whatever: here are a few more adverts for BofI Federal Bank - these are adverts distributed to mortgage brokers:

For those who don't read the pictures it says "Self employed artist wants to buy a studio in New York. BOFI Federal Bank can do that."

The pic is of an exceptional artist. He throws pain and there is none on his clothes. And there is more in this advert:

If you are a self-employed artist I guess they offer you an "exception".

Indeed they make a thing of it. Exception lending is - to quote the advert - an "art". And following LinkedIn we can see the artists come from IndyMac and Thornburg Mortgage...





John