Investing (aka GameStonk and other gambling events)

Politics & News
6203

There are lots of excellent business books that I can recommend, but one of them is absolutely Smartest Guys in the Room, which covered the Enron story. (Read the book, but don’t see the movie - it sucked.)

The Blockbuster deal is really something, and it’s revealing about the mindset of the people running Enron. I’m doing this from memory, so I’ll probably get the details slightly wrong, but this is the general idea:

The people running Enron, particularly Jeff Skilling and Andy Fastow, were convinced that business ideas were the things that created value. The people who had the ideas were the ones who should be rewarded, and the people who carried out the ideas were just ditch diggers - interchangeable workerbees.

A corollary to this belief is that, if you believe that business ideas were the true value creators, then profits should be recognized when those ideas are created, not when the ditch diggers implement them. So in this case, Enron and Blockbuster team up to conduct a pilot program for Video on Demand. They called this project Project Braveheart. This was a complete nothingburger that Blockbuster never really even officially recognized. But the Enron guys were convinced that this was going to be an enormously valuable technology. (And looking at Netflix, Disney+, et al. now, they were kind of right.)

So in their minds, they had already created the enormously valuable idea, which means that they should be able to recognize the obvious profit of that idea, even though no such profit had happened yet. So they ended up packaging the future cash flows to that project and selling them to CIBC (and very possibly guaranteeing that CIBC wouldn’t lose money, but I’m not positive about that). So that allowed them to recognize about $100 million of profit on a business venture that completely didn’t exist.

Now, if CIBC literally paid them $100 million for this bogus venture, then I guess it’s reasonable to record that as profit. It’s not Enron’s fault that CIBC made a dumbass purchase. But I believe Enron also created a special purpose entity that included the Project Braveheart asset, and marked that Project Braveheart asset to market despite the fact that obviously there was no market for it.

Also fun is the Nigerian barge transaction, which is just completely straightforward fraud. That book is so good that I’m probably going to have to reread it. At least they were using some fairly sophisticated accounting shenanigans to jack up their valuations. These recent businesses like WeWork and AirBNB are just like “let’s write some big, completely unsupported projections in our powerpoint deck”.

I mean, look at this nonsense:
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6204

This one got me laughing pretty hard.

https://twitter.com/parikpatelcfa/status/1338884043237171207?s=21

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Is there anything wrong with mark to market accounting? When it’s coupled with straight up fraud like with Enron, sure, not great. But is there anything intrinsically wrong with the accounting method? @spidercrab, does mark to market accounting tend to lead to fraud?

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It’s a matter of how reliable the market price is IMO. Like, it used to be the case that if a firm like Berkshire Hathaway owned shares of publicly-traded companies, those shares would be on Berkshire’s Balance Sheet at their historical cost. That’s really stupid - it’s very easy to determine the daily market value of publicly-traded stocks, so it’s quite sensible to update the Balance Sheet values to reflect that market value. (Now, there is a question of how to record those unrealized gains or losses on the Income Statement. I preferred the old way of no Income Statement profit or loss until the gains/losses are realized. But current rules say that unrealized gains/losses flow through to Net Income.)

But publicly-observable and verifiable market values are the exception, not the norm. I don’t think that firms should ever be able to record unrealized gains and losses on land they hold, for example, even if they get an appraisal. It’s too easy for firms to just manipulate their Income Statement through optimistic valuations.

And think about a retailer like Walmart. Their entire business is based on the premise that they regularly buy inventory and then quickly resell it for a higher market price. If you took mark-to-market accounting seriously, there’s a strong argument that Walmart should be recognizing revenue on purchased inventory as soon as they acquire it, because they have good evidence that the market value of that inventory is substantially greater than its cost.

Bad!

(All that being said, do I believe that the financial crisis was caused by mark-to-market accounting? No, that’s utter nonsense.)

Oh, and don’t even get me started on the complete bullshit idea that a firm should be able to mark its own debt to market, meaning that a financially-distressed company records huge profits simply because the market value of its own debt is evaporating.

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Wait, that’s even a thing? Like, the liability isn’t discounted. If the firm avoids bankruptcy they have to pay all of it! Someone actually tried to do this?

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Hey man, you’re the one who wants to mark things to market.

Suppose a firm begins its life by issuing $20 million of equity and borrowing $80 million in cash. Its opening Balance Sheet will be:

Assets 100
Liabilities 80
Equity 20

Now the firm announces its plans to manufacture and sell black & white TVs. Debtholders immediately recognize this as a doomed entity and start trading their debt at 25 cents on the dollar, so the market value of the debt is now $20 million. In a mark to market world, your Balance Sheet looks like this:
Assets 100
Liabilities 20
Equity 20

But that doesn’t make sense, because the Balance Sheet is no longer in balance. Assets haven’t changed, Liabilities have been marked down to 20, so the only remaining solution is that equity must have increased to 80. Where did that $60 million increase in equity come from? Well, it came from mark-to-market accounting, which means it must have been a gain, and we should recognize it as such on the Income Statement.

This is how Citigroup recorded a profit in 2009:

Citigroup posted its first profitable quarter in 18 months, in part because of unusually strong trading results. It also made progress in reducing expenses and improving its capital position.

But the long-struggling company also employed several common accounting tactics — gimmicks, critics call them — to increase its reported earnings.

One of the maneuvers, widely used since the financial crisis erupted last spring, involves the way Citigroup accounted for a decline in the value of its own debt, a move known as a credit value adjustment. The strategy added $2.7 billion to the company’s bottom line during the quarter, a figure that dwarfed Citigroup’s reported net income. Here is how it worked:

Citigroup’s debt has lost value in the bond market because of concerns about the company’s financial health. But under accounting rules, Citigroup was allowed to book a one-time gain approximately equivalent to that decline because, in theory, it could buy back its debt cheaply in the open market. Citigroup did not actually do that, however.

“It’s junk income,” said Jack T. Ciesielski, the publisher of an accounting advisory service. “They are making more money from being a lousy credit than from extending loans to good credits.”

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OK, maybe mark to market accounting has some drawbacks

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6210

Futures recovering bigly. Seems like US will be up net over 2 days despite futures being -2.5% at one stage. Greatest ECONOMY on earth!

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I don’t really disagree with you about Tesla and DoorDash being questionable investments at their current prices, but all stocks are valued on theoretical future profits. As they say, past performance is no guarantee of future results. It’s just easier to quantify, so it’s possible to build elaborate quantitative models around historical results with a straight face.

I feel like a crank because of my monomaniacal obsession here, but I am compelled to point out that this is a much bigger deal in ultra-low discount rate environments. If you’re discounting at 10% or 15%, it’s not unreasonable to assume that past performance is going to be basically like future performance during the periods you care about (the next 5-10 years), at least in most cases. But if you’re discount at 2%, you care about earnings 30 years out. If you look at the Dow 30 years ago, it had Eastman Kodak and Sears Roebuck and the American Can Company as components. Things change.

Just mechanically, low discount rates force investors to value earnings from far-future periods about which little is known. (In other words, the “discount rate” on the quality of information we have about what will be happening in 2050 is the same, and our data is poor, but the financial value of money in 2050 is now much higher.) If you want a bubble theory, you can speculate that the absence of concrete information is allowing people’s natural inclination towards speculative frenzy to take over, and that’s probably true to a large extent. But there’s not really an alternative. You can’t just assume that GM’s earnings are going to persist over a 30 year horizon when you know that there’s likely going to be a fundamental change in how cars are built during that period.

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A Random Walk Down Wall Street is one of the books that I would recommend to anyone who is interested in investing or wants to learn more about personal finance.

One of the first things the book covers is two theories of stock valuation, which it calls the firm-foundation theory and the castles-in-the-air theory. The firm-foundation theory is the view that a stock’s price is determined by the current value of a future stream of profits, which is what Bob’s describing.

On the other hand, the castles-in-the-air theory says a stock is worth whatever someone is willing to pay for it (or might be willing to pay for it tomorrow). This is the logic of speculation and bubbles.

It’s helpful to keep in mind that both of these dynamics are determining the price of most stocks at any given point in time.

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6214

100% gamestop portfolio guy has a far bigger brain than the rest of us apparently goddamn

up 25% today

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6215

Where’s my fucking PS5 then???

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I have again decided that purchasing additional shares of Berkshire Hathaway and shorting an equal number of shares of Apple is a risk-free arbitrage opportunity, and have acted accordingly.

Both sides of that arbitrage are currently underwater, but I am confident that the situation will soon be corrected.

I will be taking no questions at this time.

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6217

popped when this guy bought more shares apparently and this

Cohen called for a strategic review to help the company transition from a brick-and-mortar retailer to a technology company.

what could this possibly be

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2804×766 275 KB

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The gamestop electric car of course

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Between this and GME there must be some newly minted millionaires in the WSB community. Shit is crazy

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This recent article includes discussion of both Vanguard and State Street:

Bottom line, probably nothing to worry about. In theory probably pretty hard to screw up a target date fund. :grinning: