And if you DO like baked apples, there's no easier and better way to do them than cored from the top -- but leaving 1/4" of core at the bottom -- with the core space crammed with walnuts and then maple syrup [REAL 100% maple syrup of course, not maple-flavored pancake syrup!] poured in and a little cinnamon sprinkled on top. Set them in 1/4" of water in a 375 degree oven and take them out when they are wrinkled and just beginning to collapse.
Or remove a few sausages from their casings and break them up into bits - saute for a bit, then stuff them into cored apples and pour maple syrup over them. Cook until the apples are soft and the skin is about to fall off them.
Friday, October 17, 2008
On Poaching Fruit by bookseller
...you can poach just about any non-berry fruit (and you can poach berries, too, but you get pie-filling), though depending on what kind of apples you have, they might do better as apple sauce. If you wanted to make apple-pearsauce, that would be delicious, too: Just core and slice the fruit (peeled or not -- if the fruit haven't been sprayed, I tend to leave peels on) and put them in a big pot (nonstick, ideally) with a splash -- really, just a splash -- of water or cider or apple juice or white wine or whatever you have around, and a fistful of sugar (brown would be nice). If you would like to spice things up a bit, you could add two or three whole cloves, a cinnamon stick, a vanilla bean that you have slit in half the long way and scraped the seeds from (into the pot) with the point of a knife (throw the scraped bean in as well), some strips of lemon zest (that's the yellow part of the rind, none of the white pith that lies just beneath), five or six green cardomoms that you have cracked with the flat of a heavy knife or the bottom of a pan, maybe 1/4 teaspoon of powdered ginger (or say 1/3 cup of crystalized ginger -- that would be delicious) or an inch of fresh ginger (sliced but no need to peel). The fancy way to add these spices is to tie them into a square of muslin or cheesecloth, so that you can just pull the spices out when everything is cooked, but that's not really necessary, though if you throw in whole cloves or cardomoms or pieces of vanilla bean, etc., you might want to fish them out before you mash. Anyway, any of those spicing options would be delicious, and you could even combine them -- lemon and cloves and vanilla? Cardomom and ginger?
Put the pot over low heat, covered, for maybe 15 minutes, which should be long enough for the fruit to start giving up its liquid. It will look quite dry at first, and you'll be tempted to add more water/cider, but you really won't need to; the fruit has plenty of liquid of its own. But if you do, it's not a problem; if the sauce winds up with more liquid than you'd like, once the apples/pears are cooked, you can just turn the heat up under the pot and boil away the excess. Anyway, just keep cooking it until the apples/pears are soft enough to mush. Taste it periodically to see if you'd like to add more sugar or maybe a splash of lemon juice. It's enormously forgiving; you can add some sugar now and then more again in 20 minutes, etc. When the fruit is soft, mash it as you'd like. I like my applesauce kinda chunky, so I go at it right in the pot with an old-school potato-masher, but you could chuck everything in the blender (LET IT COOL A LITTLE FIRST) if you want things smooth (you will REALLY want to pull the whole spices/fresh ginger out first, if you go that route). I can't really give you times or amounts of sugar, because different apples and pears break down at very different rates, and require very different amounts of sweetening. Also, how sweet you'd like it is really up to you.
Once it's mashed, let it cool, and then, if you want to booze things up, add whatever appeals -- brandy, Amaretto, a handful of raisins or chopped dried figs that you have soaked till soft in rum. Up to you. It's all good.
Baked apples I have never loved, but poached whole pears are a classic Eastern European dessert, and a lovely thing. For half a dozen pears, I'd make a brew of roughly 2 cups of wine (dry Marsala would be nice -- I'd stay away from dessert wines, and whites rather than reds are traditional, but there's no need to hew to tradition) and 2 cups water, a scant cup of sugar, one or two sticks of cinnamon, a vanilla bean (halved and scraped, as above), and maybe a couple of cloves and/or some lemon or orange zest (peel it off with a vegetable peeler and use a paring knife to scrape off any enormous bits of white stuff; it doesn't matter if the strips you get are big or small, thin or fat). Bring this to a boil in a largeish PAN -- not a pot -- you want something wide enough to accommodate all the pears in one layer. While that's coming to a boil, core the pears FROM THE BOTTOM (leave the stem intact). I like to peel them from the stem end about halfway or two-thirds way down, so they still have some skin on at the bottom. Don't worry how ragged your coring job is; nobody will see it.
Once the brew has come to a boil and all the sugar is dissolved, pop your pears in, turn the heat down quite low (you want a slow simmer) and cover the pot. Let everything simmer for perhaps 20 minutes, turning the pears at the ten-minute mark. At 20 minutes, test the pears with the point of a knife; if everything's tender all the way in, you're done. Take the pears out with, ideally, a slotted spoon (if you use a regular spoon, it ain't the end of the world), turn the heat back up and boil the brew hard, UNCOVERED, for maybe 10 minutes, until it has the consistency of, say, melted jelly (you don't really want the consistency of honey or maple syrup -- that's too thick). Taste it (use a wooden spoon, to avoid burning your lips, and blow on it first). You might want to add a little lemon juice or perhaps some honey, even a slug of Calvados, should you have some lying around, or rum or brandy. Pour in any juice that the pears have given off while sitting on the counter, and stir up the syrup. Let it cool to room temp, pour it all over the pears, cover, and put in the fridge overnight to chill. You can eat them cold or nuked, with whipped cream, creme fraiche, Greek yogurt, with a sprinkle of toasted walnuts, a drizzle of honey. You can take the pears out again, nuke them (I'd opt for medium power) and boil the syrup down again till it really does thicken, and pour that over the pears. With some vanilla ice cream? MAMA! Or hold the ice cream, put the pears on plates standing up with a few toasted nuts scattered around, and you have an elegant dessert that would be at home in Paris or Prague or Poland.
You can also do this in the oven, with the pears standing up in a roasting pan that you cover with tinfoil. If you do that, you can first stuff the pears (where you've cored them) with, oh, some toasted walnuts and butter and brown sugar mixed together, or with dried fruit plumped in brandy, etc. That's very swanky, but frankly, I tend to like the simpler, unstuffed, stove-top method best.
Put the pot over low heat, covered, for maybe 15 minutes, which should be long enough for the fruit to start giving up its liquid. It will look quite dry at first, and you'll be tempted to add more water/cider, but you really won't need to; the fruit has plenty of liquid of its own. But if you do, it's not a problem; if the sauce winds up with more liquid than you'd like, once the apples/pears are cooked, you can just turn the heat up under the pot and boil away the excess. Anyway, just keep cooking it until the apples/pears are soft enough to mush. Taste it periodically to see if you'd like to add more sugar or maybe a splash of lemon juice. It's enormously forgiving; you can add some sugar now and then more again in 20 minutes, etc. When the fruit is soft, mash it as you'd like. I like my applesauce kinda chunky, so I go at it right in the pot with an old-school potato-masher, but you could chuck everything in the blender (LET IT COOL A LITTLE FIRST) if you want things smooth (you will REALLY want to pull the whole spices/fresh ginger out first, if you go that route). I can't really give you times or amounts of sugar, because different apples and pears break down at very different rates, and require very different amounts of sweetening. Also, how sweet you'd like it is really up to you.
Once it's mashed, let it cool, and then, if you want to booze things up, add whatever appeals -- brandy, Amaretto, a handful of raisins or chopped dried figs that you have soaked till soft in rum. Up to you. It's all good.
Baked apples I have never loved, but poached whole pears are a classic Eastern European dessert, and a lovely thing. For half a dozen pears, I'd make a brew of roughly 2 cups of wine (dry Marsala would be nice -- I'd stay away from dessert wines, and whites rather than reds are traditional, but there's no need to hew to tradition) and 2 cups water, a scant cup of sugar, one or two sticks of cinnamon, a vanilla bean (halved and scraped, as above), and maybe a couple of cloves and/or some lemon or orange zest (peel it off with a vegetable peeler and use a paring knife to scrape off any enormous bits of white stuff; it doesn't matter if the strips you get are big or small, thin or fat). Bring this to a boil in a largeish PAN -- not a pot -- you want something wide enough to accommodate all the pears in one layer. While that's coming to a boil, core the pears FROM THE BOTTOM (leave the stem intact). I like to peel them from the stem end about halfway or two-thirds way down, so they still have some skin on at the bottom. Don't worry how ragged your coring job is; nobody will see it.
Once the brew has come to a boil and all the sugar is dissolved, pop your pears in, turn the heat down quite low (you want a slow simmer) and cover the pot. Let everything simmer for perhaps 20 minutes, turning the pears at the ten-minute mark. At 20 minutes, test the pears with the point of a knife; if everything's tender all the way in, you're done. Take the pears out with, ideally, a slotted spoon (if you use a regular spoon, it ain't the end of the world), turn the heat back up and boil the brew hard, UNCOVERED, for maybe 10 minutes, until it has the consistency of, say, melted jelly (you don't really want the consistency of honey or maple syrup -- that's too thick). Taste it (use a wooden spoon, to avoid burning your lips, and blow on it first). You might want to add a little lemon juice or perhaps some honey, even a slug of Calvados, should you have some lying around, or rum or brandy. Pour in any juice that the pears have given off while sitting on the counter, and stir up the syrup. Let it cool to room temp, pour it all over the pears, cover, and put in the fridge overnight to chill. You can eat them cold or nuked, with whipped cream, creme fraiche, Greek yogurt, with a sprinkle of toasted walnuts, a drizzle of honey. You can take the pears out again, nuke them (I'd opt for medium power) and boil the syrup down again till it really does thicken, and pour that over the pears. With some vanilla ice cream? MAMA! Or hold the ice cream, put the pears on plates standing up with a few toasted nuts scattered around, and you have an elegant dessert that would be at home in Paris or Prague or Poland.
You can also do this in the oven, with the pears standing up in a roasting pan that you cover with tinfoil. If you do that, you can first stuff the pears (where you've cored them) with, oh, some toasted walnuts and butter and brown sugar mixed together, or with dried fruit plumped in brandy, etc. That's very swanky, but frankly, I tend to like the simpler, unstuffed, stove-top method best.
Fruit Compote by bookseller
So I had a bunch of fruit -- say half a dozen each plums and white nectarines, plus smallish amounts of raspberries and blueberries, that I had bought in a fit of greed before the Dow collapsed, and that was about to turn up its toes. Plus which it was all somewhat challenged in the delicious department. So -- with the Down now having collapsed -- in a fit of newfound frugality, I decided that rather than pitch the lot, I would poach it, and make compote.
I boiled up a scant cup of sugar (well, for those mindful of my earlier post re lower-carb eating, I used Whey Low, my beloved sugar sub), a cup of fresh orange juice that I had, in a previous fit of frugality, frozen in an ice-cube tray, and three cups of water with a vanilla bean. I sliced the plums and nectarines, tossed them into the brew, and let it all simmer away, covered, for about 10 minutes. Removed the sliced fruit, boiled the brew down to about two cups of syrup, and let everything cool overnight. Once it was cool, I poured the juice that the plums and nectarines had given up overnight into the syrup, and tasted the syrup. It was a beautiful dark pink from the plum-skins and had a very pleasant plum-and-citrus flavor, but it was missing a little...something.
AhhhHA! In the back of the cupboard I had a large mason jar full of creme de cassis that I had made a couple of summers ago from organic black currants, vodka, and Whey Low. I poured in a healthy glug -- maybe a quarter-cup, certainly not more than that -- and stirred it up.
Oh. My. God. Delicious to the tenth power. I mixed the now-cooled plums and nectarines with the raspberries and blueberries, ladled Syrup of the Gods over everything, ladled the remaining cup of SoG into a teeny Tupperware for...for I'm not sure what I'll use it for, but I must avoid the temptation to just suck it down straight, and put both containers in the fridge. I am now counting the minutes until it will have chilled sufficiently to become my lunch, with some Greek yogurt. DAYUM. This is one of the best things I have ever made.
ETA the reason I am so devoted to Whey Low is that it tastes and functions exactly like sugar, but has the calories and carbs of Splenda (which I can't stand). Anyone wanting to make their own Compote of the Gods from the above description could certainly just use sugar with pretty much identical results.
I boiled up a scant cup of sugar (well, for those mindful of my earlier post re lower-carb eating, I used Whey Low, my beloved sugar sub), a cup of fresh orange juice that I had, in a previous fit of frugality, frozen in an ice-cube tray, and three cups of water with a vanilla bean. I sliced the plums and nectarines, tossed them into the brew, and let it all simmer away, covered, for about 10 minutes. Removed the sliced fruit, boiled the brew down to about two cups of syrup, and let everything cool overnight. Once it was cool, I poured the juice that the plums and nectarines had given up overnight into the syrup, and tasted the syrup. It was a beautiful dark pink from the plum-skins and had a very pleasant plum-and-citrus flavor, but it was missing a little...something.
AhhhHA! In the back of the cupboard I had a large mason jar full of creme de cassis that I had made a couple of summers ago from organic black currants, vodka, and Whey Low. I poured in a healthy glug -- maybe a quarter-cup, certainly not more than that -- and stirred it up.
Oh. My. God. Delicious to the tenth power. I mixed the now-cooled plums and nectarines with the raspberries and blueberries, ladled Syrup of the Gods over everything, ladled the remaining cup of SoG into a teeny Tupperware for...for I'm not sure what I'll use it for, but I must avoid the temptation to just suck it down straight, and put both containers in the fridge. I am now counting the minutes until it will have chilled sufficiently to become my lunch, with some Greek yogurt. DAYUM. This is one of the best things I have ever made.
ETA the reason I am so devoted to Whey Low is that it tastes and functions exactly like sugar, but has the calories and carbs of Splenda (which I can't stand). Anyone wanting to make their own Compote of the Gods from the above description could certainly just use sugar with pretty much identical results.
Anatomy of a Crash by bookseller
...leaving aside the repeal of Glass-Steagall, which had separated commercial banking from investment banking -- I think a lot of people who were nominally responsible for this catastrophe had less choice than is superficially apparent. Virtually everyone in the money-industry, from the CEO of Merrill Lynch to Joe Assistant Mortgage Broker in the fourth-largest branch office in Cedar Rapids, is not only compensated but effectively employed based, in very large part, on quarterly numbers. And those numbers are assessed on a comparative basis -- by comparison against the competition. So if a given segment of the market is rising, REGARDLESS of whether you think it's rising for foolish or even fraudulent reasons, you have little choice but to buy into it. If you fail to do so, and that segment -- for at least one more quarter -- continues to "work," your numbers will look like shit relative to your competitors'. Your company's stock price will drop, your compensation will drop, and your job will be in jeopardy. Continue to follow this route for, say, three quarters or a full year, and you'll be out of a job.
No, that isn't the only option. Warren Buffet has built a staggeringly successful investment shop by taking the long view and insisting that the managers of the companies he owns do so as well. However, not only is he arguably the most brilliant investor in the history of capitalism, he is one of the few people in the world of money who don't really have to answer to anybody else. That is, he is so highly regarded that even if Berkshire's number tanked for a year, neither the board nor his stockholders nor even the Wall Street pundits would question him. But he's in a unique position, and it's not fair to demand that others, who lack his protections, assume his risks.
All of which is to say that I see relatively few villains in this God-awful mess, and a lot of people who are looking into an abyss of fear and uncertainty that they had little hand in creating. No, I don't believe that anyone at the executive level should be getting any kind of bonus, since the tradeoff they made when they accepted the insane perks of Wall Street executive-hood is that they bear responsibility for disaster. I'm somewhat less hard-nosed when it comes to the bonuses that are routinely doled out to rank-and-file brokers, traders, etc., since they're paid sort of like waiters -- their hourly salary is relatively sucky, and they count on their bonuses to represent the vast majority of their annual income. By and large, they were just doing what they were told ato do. Plenty of them were smart enough to understand that this was a shell-game, but they were covering their asses and those of their families, and while I'm not throwing a pity-party for them, I have no desire to add my derision to their misery.
Finally, w/r/t the "X's suffering is greater than Y's" sweepstakes, I think it's bogus. What, do we have so little empathy that we need to measure it out in teaspoons? In this world, it is ALWAYS possible to find someone worse off than X. The immigrant families in Los Angeles or London, earlier referred to? The ones who are half an inch away from foodstamps? There are thousands of families in their home villages to whom those immigrant lives look almost unimaginably luxurious. We longed for a ditch.
Yes, I do have something of a dog in this race, in that I spent years interviewing and working with brokers, traders, bankers and money managers, and I liked plenty of them. But one of the Left's great weaknesses is the tendency to deify poverty, such that only a miserable life qualifies as "authentic" and qualifies one for empathy. I think that's a lousy bandwagon to jump on.
...You have spent the past 14 years in one single industry -- it's what you're trained for, it's where all your contacts are, and it's pretty much the only thing you know how to do. You have the usual laundry-list of annual expenditures -- kids' school, retirement fund, helping aging parents, mortgage of your own, etc. And you're going to burn all your bridges and take a job as a substitute math teacher for $27K a year on a matter of principle -- a principle that everyone around you seems to have no trouble denying. Sure, people do that. If they are proven right, they get to be called heroes. Most of the time, they're called schmucks, and their families don't thank them for it. And MOST of the time, they don't do it, because ordinary people are just trying to get by, and principle is expensive.
As for a mechanism of trade's becoming a commodity, I think that's been true of pretty much every mechanism of trade that humanity has ever come up with, from salt and pepper to tea, silver, opium, women, you name it. If you're talking about the ability to fuck with a country's economy by manipulating its currency -- for example, by shorting the dollar (or the pound, which almost bankrupted the UK at one point) -- I think that's an interesting discussion, but I'm not sure what relevance it has to the current crisis.
And the board, whose job -- in theory -- is to advocate for the shareholders, says yes indeedy. So they loosen the guidelines. And they do it again next year and again the year after that, because real estate prices HAVE continued to appreciate -- in fact, they're in a tremendous bull market -- so the risk of default continues to look tiny. Until it doesn't.
And that's how bad loans get written. You see that Bank A up the street is writing a lot more loans than you are, and you know you're going to get shat on, when it comes time to report to the board on how your loan business is doing. You have to figure out a way to swipe some of the mortgage-business from Bank A. So you make it easy ("10-minute credit-check!"), and you make it widely accessible ("No credit? No problem."). Done. And Herman, the stuttering geek whose job it is to run the statistical models that kick out the information that, for example, the historically low rate of default has been based in part on a kind of banking (where you know your banker) that doesn't exist any more and in part on a pool of borrowers that excludes those with lousy credit? Herman is a killjoy. Herman doesn't drink at the Christmas party. You can't fire Herman, because that would look bad, but you sure as hell don't pay him much attention.
ETA oh, and the one guy who says, Hey, we should listen to Herman? The one guy who in fact IS listening to Herman and refusing to write "risky" mortages? His book of business looks crappy compared to his colleagues' (and once again, it's all about comparisons), so he doesn't get promoted, he doesn't get a raise, and he's told that he needs to make next quarter's quota or his job is on the line. And, of course, he's out of work like everybody else when the bank tanks.
Yes and no. Regulation is almost always about fighting yesterday's battle, and capitalism -- and the securities industry in particular -- is all about figuring out the strategy that will work tomorrow.
I wish I could promise to stop pontificating like I was the love-child of Jesus and the Sage of Omaha, but...I can't.
To a very large extent, all the other money managers, at least in the U.S., are subject to constant comparison with "the market," which is shorthand for A)the S&P 500 and B)other money managers who are understood to invest in roughly the same kind of securities. (In other words, managers of equity portfolios, who primarily buy stocks, are compared with other managers of equity portfolios, rather than with managers of portfolios that are focused on bonds, etc.) Suppose you're an investor with $100,000 that you want to put to work, and you want to invest it in stocks. You go looking for a money-manager to handle your investments, and the way you look is by comparing the records of a whole lot of equity funds. Fund A, managed by Manager A, beat the S&P by 2 percentage points in each of the past three quarters. Over those same three quarters, Fund B, managed by Manager B, lagged the S&P by 2 percentage points, because Manager B thought that the tech stocks, which everybody else was buying, were overpriced. However, over the past three quarters "the market" -- meaning all the other investors out there -- had continued to like tech stocks, and had continued to bid up the price of tech stocks. Since Manager B had refused to participate in this strategy, his fund had missed out on the profits in tech stocks, so his "numbers" -- the fund's percentage gain -- look lousy by comparison with his competitors.
Again, you're an investor. Are you going to go with the guy whose numbers look comparatively lousy? Probably not. You may read an article or two claiming that Manager B is prudent and refuses to overpay, but you'll see other articles claiming that Manager B is simply out of touch; globalization/the Internet/the advent of 401-k plans/some other factor has fundamentally changed the nature of investing, and old farts like Manager B are the equivalent of people who insist on making buggy whips in the age of automobiles.
So you don't invest with Manager B. And thousands of other investors don't, either. And thousands of OTHER investors, who had invested with Manager B, look at their gains, and then look at the gains that their neighbors, who sank everything into a combo of Intel and Pets.com, have made over the past year. They sell their shares in Manager B's fund, and buy into the same tech fund that you opted for.
Now it's the end of the year (I'm being generous; it's more likely the end of the quarter). Manager B has to go before the board of directors for his annual review. They say "Not only has your fund lagged all the other stock funds and the S&P 500 Index for the past three quarters, but, as a result of this poor performance, investors have bailed, and you know have only 100 shareholder accounts, compared with 200 last year. As you know, your annual compensation is based on your performance relative to the S&P 500, so you're only going to make half the money you made last year. And since our fund COMPANY makes money based [this is very simplistic] on the number of shareholders we have overall, and since your performance caused us to LOSE shareholders, you are now on probation. You have one quarter to get your fund's performance even with that of the S&P 500.
Now it's the end of the year (I'm being generous; it's more likely the end of the quarter). Manager B has to go before the board of directors for his annual review. They say "Not only has your fund lagged all the other stock funds and the S&P 500 Index for the past three quarters, but, as a result of this poor performance, investors have bailed, and you now have only 100 shareholder accounts, compared with 200 last year. As you know, your annual compensation is based on your performance relative to the S&P 500, so you're only going to make half the money you made last year. And since our fund COMPANY makes money based [this is very simplistic] on the number of shareholders we have overall, and since your performance caused us to LOSE shareholders, you are now on probation. You have one quarter to get your fund's performance even with that of the S&P 500; if you don't, you will be out of a job."
So Manager B does the only thing he can: He starts buying all those overpriced tech stocks that everybody else is buying, because they're the only thing the market seems to like right now.
I have a very clear recollection of meeting with a guy, a fund manager, who was in Manager B's position in about 1999. He was a very conservative investor with a long and impressive record of earning steady profits for his shareholders, with few periods of loss. But his strategy involved buying stocks that he regarded as bargains, so he had refused, for maybe a year at that point, to buy the tech stocks that were the market's darlings. When I interviewed him, he was in the process of packing up his nice corner office and moving to a shitty little space without a window. He was fired about a month later.
Actually, it's a whole lot more complicated than that, in part because the stock prices of the 500 companies in the S&P don't all get "weighted" the same. Suppose you have put together an index of technology stocks. One of them is Microsoft -- it's huge, and if every individual share in every tech company in the index were added up (if you counted each share, one by one), Microsoft would represent a BIG ole percentage of the shares. On the other hand, you have, I dunno, Hairbrushes.com, which somehow managed to squeak its way onto the index. It represents just a tiny portion of the shares in the tech industry. So when you're calculating your average, you give more weight to Microsoft than to Hairbrushes. And there are other complications as well, some of them involving proprietary software, but that's the basics.
The Dow Jones is an older index than the S&P (it was started in the late 19th century, whereas the S&P, IIRC, started up in 1926), it is comprised of only 30 companies at any given time, and those 30 companies tend overwhelmingly to be in manufacturing (hence the Dow Jones INDUSTRIALS Average). The price movement of the Dow is also calculated somewhat differently from that of the S&P -- there's a whole bunch of seriously mind-numbing algorithms involved -- but the principle's the same. Because the Dow is so small, by comparison, and because it is so heavily weighted toward "old economy" companies, it is largely regarded as a has-been in the financial industry, though its moves continue to be reported in the press, more out of habit than anything else.
The bankers present your shares to the market in what's called an Initial Public Offering, usually known as an IPO. Let's say that investors around the country have glommed onto the deliciousnsss of your muffins. Plus, the Surgeon General has just released a report stating that muffins are the healthiest thing one can eat, and that all schoolchildren should eat at least six muffins every day. All of a sudden, they think your company is likely to be more profitable than the investment bank has assumed. They think you are likely to increase profits by, say, 25% a year, rather than the paltry 12% assumed by the bankers. That would make your stock worth -- they think -- quite a bit more than $10 a share, so they offer to pay $12 per share. The guy (ha ha, it's never one guy -- it's another investment bank) who bought at $10 thinks this is a great deal: A 20% profit on his investment (right? He paid $10, but he's getting an extra $2 for each share) in just a few days. So he sells. You're happy, but some woman in North Dakota thinks the shares are worth even more than $12 a pop; she offers $15 for the shares that were just bought at $12. Now the price of Muffin shares is moving up very quickly, and investors around the country, who couldn't care less about muffins, get interested. Clearly, SOMEBODY knows something good about Muffins. So they offer $17, no, $18, no, $21, no $26 apiece for shares of Muffins. Brokers around the world start calling their clients (brokers are the folks who buy the shares for you -- it's like hiring somebody to buy your Springsteen tickets; you give them the dough and they stand in line for you, in exchange for a percentage of the cost of the tickets). The brokers say "Look, everybody likes muffins. Don't you like muffins? I love muffins. And the shares are going up like a rocket. You can't lose." (The equivalent schpiel is "Don't you love Bruce? Everybody loves Bruce. I hear he does a 20-minute version of 'Born to Run,' with EXTRA LYRICS. And I'm telling you, these tickets are selling like hotcakes. If you want to see the concert, you better give me the money, like, NOW.") Anyway, all of a sudden, everybody in the world thinks they HAVE to own shares of Muffins, or they will miss out on the most profitable company in the history of baked goods. Because not only is the company itself going to make money but -- and this is the important part -- at the current price, the shares are UNDERvalued, the company is going to be even more profitable than people think. But they -- other investors -- are going to wise up real quick, meaning thatthe shares bought today at $100 apiece will be sellable tomorrow for, say, $120.
This is known, in investment circles, as The Greater Fool Theory. As in, there's always somebody more idiotic than you are, who can be persuaded to buy your overpriced stock.
A further factoid: Why can't you buy your own stock/Springsteen tickets? Because only people with, uhhh, special ties are allowed on the line, and you don't have the tie. But your broker does. He is also supposed to have special knowledge -- not illegally gained inside knowledge, but the knowledge that comes from extensive study and analysis -- of how likely it is that Bruce will do the extended version of "Born to Run," of whether Stevie Van Zandt has hurt his thumb and will thus not be playing in the Omaha concert, of the fact that Muffins has had a fire at its primary facility and will thus have to cancel 15% of its orders this quarter, etc. He gives you this information, along with his advice as to whether that makes the tickets/shares overpriced at current levels or a good buy, because they are likely to get even pricier. That advice and knowledge -- and this is very much in theory -- is what you pay him for; the standing-in-line, special-tie stuff is just part of the service he provides, splendid fellow that he is.
Now suppose it's two days later, and you have just heard that Van Zandt's thumb is worse than initially believed; he won't be playing Hartford, either. Shit. You LOVE Van Zandt. You don't want the tickets anymore. You call your broker, and ask him to sell them for you (you know, walking up and down the line of people waiting to buy, saying "I got two on the aisle, for less than what you'll pay at the window"). He agrees with you that the Hartford tickets are now less valuable than they were before news got out about the thumb, and he's happy to sell the tickets for you -- in exchange, once again, for a percentage of the sale price. You paid $100 apiece for these tickets/shares, and you're now selling them for $90 apiece -- a 10% loss. But your broker, interestingly, has gotten paid on both transactions.
That's pretty much how the market works. Everybody hears about the Surgeon General's report on muffins, so they are willing to pay even more for the stock, and soon, nobody gives a damn about the muffins at all, they just know that there's some company whose shares are exploding in value, and they want in, at any price.
Then, catastrophe: Lindsay Lohan is on "The Tonight Show," and claims that muffins caused her to gain 20 pounds. All of a sudden, investors start revising their estimates of how much money Muffins is likely to make in the next quarter. Shit. Sales look like they're going to DROP by 20%. Unload those shares immediately! The price of Muffin's shares starts ticking down, back to $100, to $80, to $60. Brokers around the world call their clients, saying "I dunno what...something about some actress...but this is a major sell-off. Dump your Muffin shares right now, or you're going to get an even lower price for them tomorrow."
And that's the crash.
Derivatives: Hugely complicated, but the basics: Suppose there's an index that represents all the baked-goods companies in the U.S. That index -- the average share price of all those bakeries -- is currently priced at $10 per share. But you think that in the next six weeks. the Surgeon General is going to release his Eat Muffins report, with the ancillary suggestion that everybody also consume large numbers of bagels and assorted pastries. That will send the stock price of all those bakeries -- and, thus, the index's average price -- through the roof. So you call your broker and say that you want to buy a contract that will allow you to buy shares of all the companies in the Baked Goods Index, in the same percentage as they are represented in the Index, in SEVEN weeks, at a price equivalent to an average of $11 per share. This contract is a "derivative," because its price and constituents are DERIVED from the attributes of the underlying index. If in fact you're right, and the share price of all those bakeries has shot up, thanks to the SG's report, you will own your shares at an average price of $11, while the Baked Goods Index, by that point, will show an average price of $15. Score!
Of course, the financial-services industry loves to complicate things, in large part because the more complicated a security, the easier it is to sell it without the risk that the buyer will actually read the fine print. So your broker suggests that, rather than buying this simple "futures contract," you buy a contract the value of which will be determined by the difference in average price between the Baked Goods Index and the Regional Banks Index. Or that difference, multiplied by the average daily percentage gain, over the previous 60 days, of the Southeast Asian Debt Index. Or by the gain of the Debt Index OR the average daily gain/loss in the spot price of Sweet Crude Oil, whichever is greater. And to offset any risk, why don't you bet that the average price of Indian energy stocks is going to drop by at least 15% by November 17 -- a bet you can make by buying yet another derivative, this one DERIVED from the attributes of the Indian Energy Index. No such index? No problem. The broker's bank will, effectively, create it for you.
Note, by the way, that you cannot buy or sell shares in an index; the index is just a monitoring tool. You can, however, buy shares in all the companies in the index, in the weightings represented in the index (i.e., of the $100 you're investing, 14.3% -- and I'm totally making these numbers up -- will be invested in Microsoft, 0.04% will be invested in Hairbrushes.com) by buying either an "index fund," which is a mutual fund designed to produce exactly the same gain/loss shown by the index in any given period, or an "Exchange Traded Fund" (usually known as an "ETF"), which works the same way but is purchased differently. And if you're buying a derivative, the securities firm will have created a sort of imaginary index -- no less valid than any other index -- by putting all the Indian energy stocks, say, into an imaginary basket, adding up their prices, calculating the appropriate "weightings," and then calculating the average price of the stuff in the basket. This basket is now the Indian Energy Index.
Ok, done now.
Similarly, it's popular to track the performance of the U.S. market back to 1926, because that's when the S&P 500 started being published (meaning it's relatively easy). But the norms derived from that historical analysis will essentially assume that the economic conditions that prevailed in the 20th century -- in particular, America's economic dominance and a radical disparity between America's industrial productivity and the productivity in pretty much the rest of the world -- will continue to prevail. A statistical analysis that went back to, say, 1840 would most likely throw out very different "norms."
Finally, the investment world is full of black-box shops, all of them using super-secret, triple-password-protected, entry-only-with-a-retinal-scan software. If all statistical analysis were based on the same underlying assumptions, you'd expect to see those portfolios show very similar returns (right? if they're all plugging in the same numbers). But they don't. In any given period, some of them will have performed brilliantly, some will have been total dogs, and most will be somewhere in the middle.
I could introduce you to people -- actual money managers, with actual clients -- who are convinced that stock prices are predicted or even determined by everything from sun-spot activity to the phases of the moon to the CEOs' astrological charts to the difference, across a 160-day period, between the spot price of gold, the price at noon EST precisely of U.S. 30-year Treasuries, and...some other factor that I forget. (Boy do I remember interviewing that guy. He claimed that his computer models were "foolproof." When I pointed out that, um, the portfolio that he ran, based on those computer models, had under-performed the market for the previous 11 years, he snapped "The market is wrong!" We didn't get a lot done after that.)
Anyway, point is, all of those guys have extremely elaborate computer models on which they base their investment decisions. And those computer models produce extremely different recommendations, because the assumptions underlying all the computer's calculations are extremely different.
Fala, you asked a question a while ago, and I got so caught up in crafting the perfect analogy involving muffins and Springsteen tickets that I didn't answer. Years ago, when I was just starting out as a financial writer, and was in way over my head -- as in I knew NOTHING -- I asked a colleague, who is now a very big shot at the Wall Street Journal, to recommend a textbook, some basic guide to how the market works. He gave me one of the best pieces of advice I've ever gotten, namely, that instead of trying to slog through some excruciatingly boring textbook, I read some of the true-life financial shenanigans books that were, at that time, all over the bestseller lists. They were written essentially like novels, he said, meaning they had vivid characters and story lines, and so they'd hold my interest while providing me with a whole lot of information.
He was absolutely right. I certainly didn't get anything like a complete guide to the markets from those books, but after reading several of them, I had specific questions to ask, rather than feeling totally clueless. Plus they're terrific reads. The ones I chose -- and that I would recommend to you -- were The Predators' Ball, by Connie Bruck (about the rise and fall of the investment bank Drexel Burnham Lambert, and the junk-bond debacle); Liars' Poker, by Michael Lewis (about the deeply strange world of bond-trading); Den of Thieves, by James B. Stewart (about the insider-trading scandals of the late 80s, in which Giuliani made his name as a prosecutor); and Barbarians at the Gate, by Bryan Borrough and John Helyar (about the takeover of RJR Nabisco -- at the time the largest merger in corporate history -- and the craze for "leveraged buyouts," which will tell you everything you need to know about companies taking on too much debt). Liars' Poker and Barbarians, in particular, are very funny -- Barbarians at the Gate, in fact, was made into a terrific movie for HBO -- but they're all lively and interesting and very well written. True, they're all about 20 years old, and some of the details have changed -- leveraged buyouts, for example, are no longer the flavor of the month on Wall Street -- but the basics remain the same, and you'll learn a lot.
ETA I am also a huge fan of The Equity Culture, by B. Mark Smith, which is considerably more current - I think it came out in about 2003 -- and focuses on the process by which stocks, which for centuries had been owned almost exclusively by the rich, became, in just two or three decades, the go-to investment vehicle for virtually the entire planet. It's not as lively as the other books, and it's definitely The Market 102, but I found it fascinating. And if you've gotten geeky enough to like The Equity Culture, you'll probably also be interested in Against the Gods: The Remarkable Story of Risk, by Peter L. Bernstein (he also has an extremely well done book about the history of gold) and in my most favorite, which is a PBS miniseries (available on DVD) called "Commanding Heights" -- essentially a history of the global economy in the 20th century. I was totally riveted, but that is in large part a mark of just how much of a geek I am.
No, that isn't the only option. Warren Buffet has built a staggeringly successful investment shop by taking the long view and insisting that the managers of the companies he owns do so as well. However, not only is he arguably the most brilliant investor in the history of capitalism, he is one of the few people in the world of money who don't really have to answer to anybody else. That is, he is so highly regarded that even if Berkshire's number tanked for a year, neither the board nor his stockholders nor even the Wall Street pundits would question him. But he's in a unique position, and it's not fair to demand that others, who lack his protections, assume his risks.
All of which is to say that I see relatively few villains in this God-awful mess, and a lot of people who are looking into an abyss of fear and uncertainty that they had little hand in creating. No, I don't believe that anyone at the executive level should be getting any kind of bonus, since the tradeoff they made when they accepted the insane perks of Wall Street executive-hood is that they bear responsibility for disaster. I'm somewhat less hard-nosed when it comes to the bonuses that are routinely doled out to rank-and-file brokers, traders, etc., since they're paid sort of like waiters -- their hourly salary is relatively sucky, and they count on their bonuses to represent the vast majority of their annual income. By and large, they were just doing what they were told ato do. Plenty of them were smart enough to understand that this was a shell-game, but they were covering their asses and those of their families, and while I'm not throwing a pity-party for them, I have no desire to add my derision to their misery.
Finally, w/r/t the "X's suffering is greater than Y's" sweepstakes, I think it's bogus. What, do we have so little empathy that we need to measure it out in teaspoons? In this world, it is ALWAYS possible to find someone worse off than X. The immigrant families in Los Angeles or London, earlier referred to? The ones who are half an inch away from foodstamps? There are thousands of families in their home villages to whom those immigrant lives look almost unimaginably luxurious. We longed for a ditch.
Yes, I do have something of a dog in this race, in that I spent years interviewing and working with brokers, traders, bankers and money managers, and I liked plenty of them. But one of the Left's great weaknesses is the tendency to deify poverty, such that only a miserable life qualifies as "authentic" and qualifies one for empathy. I think that's a lousy bandwagon to jump on.
...You have spent the past 14 years in one single industry -- it's what you're trained for, it's where all your contacts are, and it's pretty much the only thing you know how to do. You have the usual laundry-list of annual expenditures -- kids' school, retirement fund, helping aging parents, mortgage of your own, etc. And you're going to burn all your bridges and take a job as a substitute math teacher for $27K a year on a matter of principle -- a principle that everyone around you seems to have no trouble denying. Sure, people do that. If they are proven right, they get to be called heroes. Most of the time, they're called schmucks, and their families don't thank them for it. And MOST of the time, they don't do it, because ordinary people are just trying to get by, and principle is expensive.
But to do illegal things (like filing fradulent mortgage applications) for years? Sorry, but no.Koko, the percentage of this catastrophe that can actually be traced to illegal activity is minuscule. Everyone, from Bush on down, would be THRILLED to find massive evidence of illegality, because then we could put the Bad Guys on trial and all would once again be for the best in this best of all possible worlds. The vast majority of it was completely legal, in large part because the legal system insofar as it concerns the securities industry, has the tensile strength of a doily, and in part because capitalism, as a system, is all about finding loopholes. Most of the time they call it building a better mousetrap.
Also, we haven't discussed the use of statistics and models, which by their very nature lead to over-leveraging.Statistical models are just a function of what you plug into them. If the assumptions you plug in encourage specific kinds of risk, such as taking on leverage (i.e., borrowing money, in one way or another), then that's the route you'll take. But there's nothing inherently pro-risk about the use of statistical models.
As for a mechanism of trade's becoming a commodity, I think that's been true of pretty much every mechanism of trade that humanity has ever come up with, from salt and pepper to tea, silver, opium, women, you name it. If you're talking about the ability to fuck with a country's economy by manipulating its currency -- for example, by shorting the dollar (or the pound, which almost bankrupted the UK at one point) -- I think that's an interesting discussion, but I'm not sure what relevance it has to the current crisis.
But those bad mortgages? Where did they come from? Some was speculation, some was misfortune, but I think a lot of it was fradulent. Some of it rests on the borrower (e.g., overstating self-declared income), but some of it comes from brokers encouraging people to do the same.Ok, you have an environment in which everyone wants to buy a house, in part because interest rates are at historically low levels, and in part because everything around you -- advertising, etc. -- is touting the delights of home-ownership. You're the head of a bank. You go to your board and say, Look, we're getting tons of requests for mortgages, and our guidelines say that we can only grant mortgages to people whose annual incomes exceed their future payments by X%. That means we have to turn down a whole lot of these people -- and, by extension, the money we would make in interest on their loans. We all know -- because it's received wisdom -- that real estate always appreciates and is therefore a safe investment, so why don't we change our guidelines, and allow our brokers to write mortgages for people whose incomes only exceed payments by Y% instead of X%? That way, we'd be able to write a lot more loans. Plus, the borrowers who fall into the "riskier" camp? We can charge them more in interest, to pay us for taking on the risk, so we'll make even more money per loan. Sure, the potential for default goes up, but default rates in the U.S., for the past 50 years, have been minuscule, so the additional risk isn't really significant. And we'd be making more money for the shareholders. Whadya say?
And the board, whose job -- in theory -- is to advocate for the shareholders, says yes indeedy. So they loosen the guidelines. And they do it again next year and again the year after that, because real estate prices HAVE continued to appreciate -- in fact, they're in a tremendous bull market -- so the risk of default continues to look tiny. Until it doesn't.
And that's how bad loans get written. You see that Bank A up the street is writing a lot more loans than you are, and you know you're going to get shat on, when it comes time to report to the board on how your loan business is doing. You have to figure out a way to swipe some of the mortgage-business from Bank A. So you make it easy ("10-minute credit-check!"), and you make it widely accessible ("No credit? No problem."). Done. And Herman, the stuttering geek whose job it is to run the statistical models that kick out the information that, for example, the historically low rate of default has been based in part on a kind of banking (where you know your banker) that doesn't exist any more and in part on a pool of borrowers that excludes those with lousy credit? Herman is a killjoy. Herman doesn't drink at the Christmas party. You can't fire Herman, because that would look bad, but you sure as hell don't pay him much attention.
ETA oh, and the one guy who says, Hey, we should listen to Herman? The one guy who in fact IS listening to Herman and refusing to write "risky" mortages? His book of business looks crappy compared to his colleagues' (and once again, it's all about comparisons), so he doesn't get promoted, he doesn't get a raise, and he's told that he needs to make next quarter's quota or his job is on the line. And, of course, he's out of work like everybody else when the bank tanks.
Yes and no. Regulation is almost always about fighting yesterday's battle, and capitalism -- and the securities industry in particular -- is all about figuring out the strategy that will work tomorrow.
I wish I could promise to stop pontificating like I was the love-child of Jesus and the Sage of Omaha, but...I can't.
you mentioned Warren Buffet and his unique place in the financial world, in that he's pretty much the only one out there who takes the long view re: investments/companies. Why is he the only one who does this?He's hardly the only money manager who takes a long view. But he is in a unique position in that even if his long view is at odds with what the market is dictating, and his portfolio therefore posts profits, in a given quarter or even a given year, that are substantially below the market average (much less the profits of other investment companies -- which is what Berkshire Hathaway is, effectively), he is unlikely to be "punished" by having shareholders sell Berkshire Hathaway stock, or by having the board of directors call for his dismissal.
To a very large extent, all the other money managers, at least in the U.S., are subject to constant comparison with "the market," which is shorthand for A)the S&P 500 and B)other money managers who are understood to invest in roughly the same kind of securities. (In other words, managers of equity portfolios, who primarily buy stocks, are compared with other managers of equity portfolios, rather than with managers of portfolios that are focused on bonds, etc.) Suppose you're an investor with $100,000 that you want to put to work, and you want to invest it in stocks. You go looking for a money-manager to handle your investments, and the way you look is by comparing the records of a whole lot of equity funds. Fund A, managed by Manager A, beat the S&P by 2 percentage points in each of the past three quarters. Over those same three quarters, Fund B, managed by Manager B, lagged the S&P by 2 percentage points, because Manager B thought that the tech stocks, which everybody else was buying, were overpriced. However, over the past three quarters "the market" -- meaning all the other investors out there -- had continued to like tech stocks, and had continued to bid up the price of tech stocks. Since Manager B had refused to participate in this strategy, his fund had missed out on the profits in tech stocks, so his "numbers" -- the fund's percentage gain -- look lousy by comparison with his competitors.
Again, you're an investor. Are you going to go with the guy whose numbers look comparatively lousy? Probably not. You may read an article or two claiming that Manager B is prudent and refuses to overpay, but you'll see other articles claiming that Manager B is simply out of touch; globalization/the Internet/the advent of 401-k plans/some other factor has fundamentally changed the nature of investing, and old farts like Manager B are the equivalent of people who insist on making buggy whips in the age of automobiles.
So you don't invest with Manager B. And thousands of other investors don't, either. And thousands of OTHER investors, who had invested with Manager B, look at their gains, and then look at the gains that their neighbors, who sank everything into a combo of Intel and Pets.com, have made over the past year. They sell their shares in Manager B's fund, and buy into the same tech fund that you opted for.
Now it's the end of the year (I'm being generous; it's more likely the end of the quarter). Manager B has to go before the board of directors for his annual review. They say "Not only has your fund lagged all the other stock funds and the S&P 500 Index for the past three quarters, but, as a result of this poor performance, investors have bailed, and you know have only 100 shareholder accounts, compared with 200 last year. As you know, your annual compensation is based on your performance relative to the S&P 500, so you're only going to make half the money you made last year. And since our fund COMPANY makes money based [this is very simplistic] on the number of shareholders we have overall, and since your performance caused us to LOSE shareholders, you are now on probation. You have one quarter to get your fund's performance even with that of the S&P 500.
Now it's the end of the year (I'm being generous; it's more likely the end of the quarter). Manager B has to go before the board of directors for his annual review. They say "Not only has your fund lagged all the other stock funds and the S&P 500 Index for the past three quarters, but, as a result of this poor performance, investors have bailed, and you now have only 100 shareholder accounts, compared with 200 last year. As you know, your annual compensation is based on your performance relative to the S&P 500, so you're only going to make half the money you made last year. And since our fund COMPANY makes money based [this is very simplistic] on the number of shareholders we have overall, and since your performance caused us to LOSE shareholders, you are now on probation. You have one quarter to get your fund's performance even with that of the S&P 500; if you don't, you will be out of a job."
So Manager B does the only thing he can: He starts buying all those overpriced tech stocks that everybody else is buying, because they're the only thing the market seems to like right now.
I have a very clear recollection of meeting with a guy, a fund manager, who was in Manager B's position in about 1999. He was a very conservative investor with a long and impressive record of earning steady profits for his shareholders, with few periods of loss. But his strategy involved buying stocks that he regarded as bargains, so he had refused, for maybe a year at that point, to buy the tech stocks that were the market's darlings. When I interviewed him, he was in the process of packing up his nice corner office and moving to a shitty little space without a window. He was fired about a month later.
I don't altogether buy the comparisons with the dotcom bubble.You make a good point, Mol, and I agree that it's not an apples/apples comparison. The similarity, of course, is in the bubble aspect; people become convinced that a given kind of investment -- and it really doesn't matter whether it's tulip bulbs or tech stocks or real estate or mortgage swaps -- is not only a no-lose proposition but a guaranteed money-spinner, so they pile into that field, with increasingly little attention paid to whether the underlying stuff they're buying -- shares in a particular company, Florida beachfront >property -- is worth the price they're paying and can reasonably be expected -- by SOME measure of reasonableness -- to appreciate in value. At the end of the cycle, prices of these investments have become completely divorced from the value of the underlying STUFF. And yeah, to second Zolly's point, one of the results of the inevitable crash is that a lot of the second- and third-tier players (and some of the unlucky first-tier) get put out of business, with the result that the pool of potential investments in this arena -- the property developers, for instance, or the mortgage brokers, or the tech companies -- is, overall, of a much higher quality. But it's a damn painful way of getting to that point.
Actually, can anyone recommend a book that explains some of these things to me? I am not sure I know what Dow/Jones is, or NASDAQ, or how the stock market works, or what derivatives are, or mutual funds, or commodities, or hedge funds, or what the various financial institutions do (or did do before they failed or got taken over by the government), etc.Fala, the Dow Jones Industrials Average, like the Standard & Poors 500, is an "index" of stock prices. To create an index, you -- and boy oh boy is this an over-simplified explanation -- pick a bunch of stocks that, for one reason or another, you think are representative of either the economy as a whole or a particular segment of the economy (there are secondary indices, carved out of the S&P, that cover just telecom, for example, or just financial-services companies, like banks and insurance companies). Once you have your group (and for the S&P 500 there are, surprise, 500 companies on the list), you add up their stock prices and derive the average. The next day, you add them up again and again derive the average. The difference between the two averages is the amount of money that the index is said to have gained or lost from one day to the next. It's typically expressed as a percentage, as in "The S&P is down 2% since Monday."
Actually, it's a whole lot more complicated than that, in part because the stock prices of the 500 companies in the S&P don't all get "weighted" the same. Suppose you have put together an index of technology stocks. One of them is Microsoft -- it's huge, and if every individual share in every tech company in the index were added up (if you counted each share, one by one), Microsoft would represent a BIG ole percentage of the shares. On the other hand, you have, I dunno, Hairbrushes.com, which somehow managed to squeak its way onto the index. It represents just a tiny portion of the shares in the tech industry. So when you're calculating your average, you give more weight to Microsoft than to Hairbrushes. And there are other complications as well, some of them involving proprietary software, but that's the basics.
The Dow Jones is an older index than the S&P (it was started in the late 19th century, whereas the S&P, IIRC, started up in 1926), it is comprised of only 30 companies at any given time, and those 30 companies tend overwhelmingly to be in manufacturing (hence the Dow Jones INDUSTRIALS Average). The price movement of the Dow is also calculated somewhat differently from that of the S&P -- there's a whole bunch of seriously mind-numbing algorithms involved -- but the principle's the same. Because the Dow is so small, by comparison, and because it is so heavily weighted toward "old economy" companies, it is largely regarded as a has-been in the financial industry, though its moves continue to be reported in the press, more out of habit than anything else.
I am not sure I know what Dow/Jones is, or NASDAQ, or how the stock market works, or what derivatives are, or mutual funds, or commodities, or hedge funds, or what the various financial institutions do (or did do before they failed or got taken over by the government), etc.The stock market...oy. Ok, you own a company, Muffins R Us. Your muffins are really popular, but your bakery facilities are very small, and you can't produce enough muffins to meet demand. You could sell a lot more muffins if you could afford to buy or rent more bakery space, but you don't have the money. So you "take the company public," which means that you go to an investment bank, and have them calculate the "value" of the company. (At its most basic, this calculation is done by multiplying Muffin's annual sales OR annual profits -- depends on the industry, and on whether you actually have profits -- by some number that the bankers basically pick out of their back teeth.) Say they value your company at $5 million. You only need $500,000 for your expansion, so you decide to sell 10% of your company to the public, at an initial price of $10 per share. That means that, in the future, of any profits your company makes, you keep 90%, but the shareholders get the rest.
The bankers present your shares to the market in what's called an Initial Public Offering, usually known as an IPO. Let's say that investors around the country have glommed onto the deliciousnsss of your muffins. Plus, the Surgeon General has just released a report stating that muffins are the healthiest thing one can eat, and that all schoolchildren should eat at least six muffins every day. All of a sudden, they think your company is likely to be more profitable than the investment bank has assumed. They think you are likely to increase profits by, say, 25% a year, rather than the paltry 12% assumed by the bankers. That would make your stock worth -- they think -- quite a bit more than $10 a share, so they offer to pay $12 per share. The guy (ha ha, it's never one guy -- it's another investment bank) who bought at $10 thinks this is a great deal: A 20% profit on his investment (right? He paid $10, but he's getting an extra $2 for each share) in just a few days. So he sells. You're happy, but some woman in North Dakota thinks the shares are worth even more than $12 a pop; she offers $15 for the shares that were just bought at $12. Now the price of Muffin shares is moving up very quickly, and investors around the country, who couldn't care less about muffins, get interested. Clearly, SOMEBODY knows something good about Muffins. So they offer $17, no, $18, no, $21, no $26 apiece for shares of Muffins. Brokers around the world start calling their clients (brokers are the folks who buy the shares for you -- it's like hiring somebody to buy your Springsteen tickets; you give them the dough and they stand in line for you, in exchange for a percentage of the cost of the tickets). The brokers say "Look, everybody likes muffins. Don't you like muffins? I love muffins. And the shares are going up like a rocket. You can't lose." (The equivalent schpiel is "Don't you love Bruce? Everybody loves Bruce. I hear he does a 20-minute version of 'Born to Run,' with EXTRA LYRICS. And I'm telling you, these tickets are selling like hotcakes. If you want to see the concert, you better give me the money, like, NOW.") Anyway, all of a sudden, everybody in the world thinks they HAVE to own shares of Muffins, or they will miss out on the most profitable company in the history of baked goods. Because not only is the company itself going to make money but -- and this is the important part -- at the current price, the shares are UNDERvalued, the company is going to be even more profitable than people think. But they -- other investors -- are going to wise up real quick, meaning thatthe shares bought today at $100 apiece will be sellable tomorrow for, say, $120.
This is known, in investment circles, as The Greater Fool Theory. As in, there's always somebody more idiotic than you are, who can be persuaded to buy your overpriced stock.
A further factoid: Why can't you buy your own stock/Springsteen tickets? Because only people with, uhhh, special ties are allowed on the line, and you don't have the tie. But your broker does. He is also supposed to have special knowledge -- not illegally gained inside knowledge, but the knowledge that comes from extensive study and analysis -- of how likely it is that Bruce will do the extended version of "Born to Run," of whether Stevie Van Zandt has hurt his thumb and will thus not be playing in the Omaha concert, of the fact that Muffins has had a fire at its primary facility and will thus have to cancel 15% of its orders this quarter, etc. He gives you this information, along with his advice as to whether that makes the tickets/shares overpriced at current levels or a good buy, because they are likely to get even pricier. That advice and knowledge -- and this is very much in theory -- is what you pay him for; the standing-in-line, special-tie stuff is just part of the service he provides, splendid fellow that he is.
Now suppose it's two days later, and you have just heard that Van Zandt's thumb is worse than initially believed; he won't be playing Hartford, either. Shit. You LOVE Van Zandt. You don't want the tickets anymore. You call your broker, and ask him to sell them for you (you know, walking up and down the line of people waiting to buy, saying "I got two on the aisle, for less than what you'll pay at the window"). He agrees with you that the Hartford tickets are now less valuable than they were before news got out about the thumb, and he's happy to sell the tickets for you -- in exchange, once again, for a percentage of the sale price. You paid $100 apiece for these tickets/shares, and you're now selling them for $90 apiece -- a 10% loss. But your broker, interestingly, has gotten paid on both transactions.
That's pretty much how the market works. Everybody hears about the Surgeon General's report on muffins, so they are willing to pay even more for the stock, and soon, nobody gives a damn about the muffins at all, they just know that there's some company whose shares are exploding in value, and they want in, at any price.
Then, catastrophe: Lindsay Lohan is on "The Tonight Show," and claims that muffins caused her to gain 20 pounds. All of a sudden, investors start revising their estimates of how much money Muffins is likely to make in the next quarter. Shit. Sales look like they're going to DROP by 20%. Unload those shares immediately! The price of Muffin's shares starts ticking down, back to $100, to $80, to $60. Brokers around the world call their clients, saying "I dunno what...something about some actress...but this is a major sell-off. Dump your Muffin shares right now, or you're going to get an even lower price for them tomorrow."
And that's the crash.
Derivatives: Hugely complicated, but the basics: Suppose there's an index that represents all the baked-goods companies in the U.S. That index -- the average share price of all those bakeries -- is currently priced at $10 per share. But you think that in the next six weeks. the Surgeon General is going to release his Eat Muffins report, with the ancillary suggestion that everybody also consume large numbers of bagels and assorted pastries. That will send the stock price of all those bakeries -- and, thus, the index's average price -- through the roof. So you call your broker and say that you want to buy a contract that will allow you to buy shares of all the companies in the Baked Goods Index, in the same percentage as they are represented in the Index, in SEVEN weeks, at a price equivalent to an average of $11 per share. This contract is a "derivative," because its price and constituents are DERIVED from the attributes of the underlying index. If in fact you're right, and the share price of all those bakeries has shot up, thanks to the SG's report, you will own your shares at an average price of $11, while the Baked Goods Index, by that point, will show an average price of $15. Score!
Of course, the financial-services industry loves to complicate things, in large part because the more complicated a security, the easier it is to sell it without the risk that the buyer will actually read the fine print. So your broker suggests that, rather than buying this simple "futures contract," you buy a contract the value of which will be determined by the difference in average price between the Baked Goods Index and the Regional Banks Index. Or that difference, multiplied by the average daily percentage gain, over the previous 60 days, of the Southeast Asian Debt Index. Or by the gain of the Debt Index OR the average daily gain/loss in the spot price of Sweet Crude Oil, whichever is greater. And to offset any risk, why don't you bet that the average price of Indian energy stocks is going to drop by at least 15% by November 17 -- a bet you can make by buying yet another derivative, this one DERIVED from the attributes of the Indian Energy Index. No such index? No problem. The broker's bank will, effectively, create it for you.
Note, by the way, that you cannot buy or sell shares in an index; the index is just a monitoring tool. You can, however, buy shares in all the companies in the index, in the weightings represented in the index (i.e., of the $100 you're investing, 14.3% -- and I'm totally making these numbers up -- will be invested in Microsoft, 0.04% will be invested in Hairbrushes.com) by buying either an "index fund," which is a mutual fund designed to produce exactly the same gain/loss shown by the index in any given period, or an "Exchange Traded Fund" (usually known as an "ETF"), which works the same way but is purchased differently. And if you're buying a derivative, the securities firm will have created a sort of imaginary index -- no less valid than any other index -- by putting all the Indian energy stocks, say, into an imaginary basket, adding up their prices, calculating the appropriate "weightings," and then calculating the average price of the stuff in the basket. This basket is now the Indian Energy Index.
Ok, done now.
And, Bookseller, Buffett doesn't use models!Sure he does, he just doesn't run a black-box shop (a portfolio where the buy/sell decisions are based entirely on statistically driven recommendations). In fact, the shareholder letter he sent out following the attacks of 9/11 talked specifically about Berkshire's failure to "model" correctly. The company -- Warren Buffet runs Berkshire Hathaway, which is nominally an insurance firm that also owns a lot of ancillary businesses -- had built computer scenarios showing what would happen if Berkshire got hit with a lot of fire-damage claims, with a lot of casualty claims, with a lot of life-insurance claims, etc., and they had taken steps to offset the risk involved in any of these scenarios. But they had neglected to plug in the possibility of the company's getting hit with ALL of those claims at the same time, all stemming from a single incident.
Seriously, it isn't a question of plugging in the right numbers. First there are the statistics used - which are usually based on a normal distributionSure it is. "Normal" depends on the time-period you select, and on the market you select, among other factors. For example, there is a widespread and statistically validated belief in the U.S. that over time, stocks rise in value. But as a friend once pointed out to me, depending on how you define "time," this is really true only of the U.S. market. If you live in a country that has been bombed to hell -- 1940s Germany, for example -- or where the insurgents in the hills have succeeded in their plan to nationalize all the major industries, your shares aren't going to be worth spit for a long, LONG time, and maybe never.
Similarly, it's popular to track the performance of the U.S. market back to 1926, because that's when the S&P 500 started being published (meaning it's relatively easy). But the norms derived from that historical analysis will essentially assume that the economic conditions that prevailed in the 20th century -- in particular, America's economic dominance and a radical disparity between America's industrial productivity and the productivity in pretty much the rest of the world -- will continue to prevail. A statistical analysis that went back to, say, 1840 would most likely throw out very different "norms."
Finally, the investment world is full of black-box shops, all of them using super-secret, triple-password-protected, entry-only-with-a-retinal-scan software. If all statistical analysis were based on the same underlying assumptions, you'd expect to see those portfolios show very similar returns (right? if they're all plugging in the same numbers). But they don't. In any given period, some of them will have performed brilliantly, some will have been total dogs, and most will be somewhere in the middle.
I could introduce you to people -- actual money managers, with actual clients -- who are convinced that stock prices are predicted or even determined by everything from sun-spot activity to the phases of the moon to the CEOs' astrological charts to the difference, across a 160-day period, between the spot price of gold, the price at noon EST precisely of U.S. 30-year Treasuries, and...some other factor that I forget. (Boy do I remember interviewing that guy. He claimed that his computer models were "foolproof." When I pointed out that, um, the portfolio that he ran, based on those computer models, had under-performed the market for the previous 11 years, he snapped "The market is wrong!" We didn't get a lot done after that.)
Anyway, point is, all of those guys have extremely elaborate computer models on which they base their investment decisions. And those computer models produce extremely different recommendations, because the assumptions underlying all the computer's calculations are extremely different.
Fala, you asked a question a while ago, and I got so caught up in crafting the perfect analogy involving muffins and Springsteen tickets that I didn't answer. Years ago, when I was just starting out as a financial writer, and was in way over my head -- as in I knew NOTHING -- I asked a colleague, who is now a very big shot at the Wall Street Journal, to recommend a textbook, some basic guide to how the market works. He gave me one of the best pieces of advice I've ever gotten, namely, that instead of trying to slog through some excruciatingly boring textbook, I read some of the true-life financial shenanigans books that were, at that time, all over the bestseller lists. They were written essentially like novels, he said, meaning they had vivid characters and story lines, and so they'd hold my interest while providing me with a whole lot of information.
He was absolutely right. I certainly didn't get anything like a complete guide to the markets from those books, but after reading several of them, I had specific questions to ask, rather than feeling totally clueless. Plus they're terrific reads. The ones I chose -- and that I would recommend to you -- were The Predators' Ball, by Connie Bruck (about the rise and fall of the investment bank Drexel Burnham Lambert, and the junk-bond debacle); Liars' Poker, by Michael Lewis (about the deeply strange world of bond-trading); Den of Thieves, by James B. Stewart (about the insider-trading scandals of the late 80s, in which Giuliani made his name as a prosecutor); and Barbarians at the Gate, by Bryan Borrough and John Helyar (about the takeover of RJR Nabisco -- at the time the largest merger in corporate history -- and the craze for "leveraged buyouts," which will tell you everything you need to know about companies taking on too much debt). Liars' Poker and Barbarians, in particular, are very funny -- Barbarians at the Gate, in fact, was made into a terrific movie for HBO -- but they're all lively and interesting and very well written. True, they're all about 20 years old, and some of the details have changed -- leveraged buyouts, for example, are no longer the flavor of the month on Wall Street -- but the basics remain the same, and you'll learn a lot.
ETA I am also a huge fan of The Equity Culture, by B. Mark Smith, which is considerably more current - I think it came out in about 2003 -- and focuses on the process by which stocks, which for centuries had been owned almost exclusively by the rich, became, in just two or three decades, the go-to investment vehicle for virtually the entire planet. It's not as lively as the other books, and it's definitely The Market 102, but I found it fascinating. And if you've gotten geeky enough to like The Equity Culture, you'll probably also be interested in Against the Gods: The Remarkable Story of Risk, by Peter L. Bernstein (he also has an extremely well done book about the history of gold) and in my most favorite, which is a PBS miniseries (available on DVD) called "Commanding Heights" -- essentially a history of the global economy in the 20th century. I was totally riveted, but that is in large part a mark of just how much of a geek I am.
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