The Citigroup Anomaly Lives

Summary: Citigroup securities are still violating the law of one price.

Later this week, Citigroup will finally launch its offer to convert some preferred stock into common stock.  That exchange has big implications for the government, which purchased preferred shares through the TARP program; after the exchange, the government will become Citi’s largest shareholder.

The exchange also has big implications for investors.

As I noted two weeks ago, there have been some anomalies in the pricing of Citigroup securities. Those anomalies have gotten smaller, but they are still with us. Citigroup is still violating the law of one price.

The crux of the pricing anomaly is that there are three different ways to invest in Citigroup’s common stock:

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Venture Capital: Follow-Up

Last week, an article in the Wall Street Journal prompted me to post a short piece on the decline in venture capital.  Economist Susan Woodward sent me a helpful note outlining what she sees as the key reasons for this contraction:

The 2000 vintage year is going to be the worst year for venture capital ever.  I believe it will be the first year when venture fails, overall, to return capital to investors. Vast sums of money poured in ($95 billion was invested in portfolio companies that year, versus an average of $25-30 billion per year 2002 and later), and the prices paid were high, and a lot of the stuff funded was dumb.  In a fund’s 10 year life, nearly all of the good stuff has happened by year 6 or 7.  Any company that has not become obviously valuable in that time is very unlikely to do anything good for investors.  Investors know this too. Thus, pretty much all of the year 2000 funds look terrible by now.  Their general partners see that investors are not going to fund another fund for them, so they are making other plans.

(Susan has had a ring-side seat for the rise and decline of venture capital.  Based in Silicon Valley, she’s a Principal at Sand Hill Econometrics, where, among many other things, she has tracked the returns on venture investments.)

A fun parlor game is to try to remember — without using Google, Bing, or Cuil — some of the “dumb” venture deals from that era.  My first two guesses were (“Because pets can’t drive”) and Webvan, but both were already public by 2000.

The Exploding Federal Deficit

Last week, the Congressional Budget Office released it’s latest snapshot on the Federal budget. CBO estimates that the federal budget deficit was $984 billion — just short of a trillion dollars — during the first eight months of the fiscal year (October 2008 through May 2009). During the same period last year, the deficit was “only” $319 billion. Why has the deficit been exploding so rapidly? Lower tax revenues and higher spending (yes, that’s obvious, but keep reading).

Last week, the Congressional Budget Office released its latest snapshot on the Federal budget.  CBO estimates that the federal budget deficit was $984 billion — just short of a trillion dollars — during the first eight months of the fiscal year (October 2008 through May 2009).  During the same period last year, the deficit was “only” $319 billion.

Why has the deficit been exploding so rapidly? Lower tax revenues and higher spending (yes, that’s obvious, but keep reading):

Exploding Deficit

As the chart shows, there have been three basic factors driving up the deficit:

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Google’s Defense

Google will likely face close scrutiny from the Obama administration. Indeed, it is already the subject of at least three separate antitrust reviews. Here are three ways Google will try to defend itself.

As Jeff Horwitz notes in the Washington Post this morning (“Google Says It’s Actually Quite Small“, previously posted on Slate), the search giant will likely face close scrutiny from the Obama administration.  Indeed, Google is already the subject of at least three separate antitrust reviews.

How will Google try to defend itself?

As Horwitz reports, Google will undoubtedly employ two classic defenses:

Defense 1.  Being a monopolist isn’t illegal.  If firms achieve market dominance through “superior skill, foresight, and industry” (as Justice Learned Hand put it decades ago), that’s fine under our system.  We want to reward firms that gain market share by being innovative and delivering value to customers.

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Venture Capital Declining

An article in this morning’s Wall Street Journal documents a decline in venture capitalists.  Both the number of VC firms and their capital under management have declined sharply:

A large number of individual VCs are also departing their firms.  And, the Journal notes:

The actual number of exits might be even higher than the trade group’s figures indicate. Venture-capital funds are typically 10-year investment vehicles. That means even if a venture capitalist no longer actively invests, he or she can remain on a firm’s masthead because they have to wind up their investments in older funds.

The article is worth reading in full for its discussion of the factors — weak economy, reduced investment capital, natural turnover, etc. — that are contributing to the decline in venture activity and the departure of individual VCs.

I don’t know how much this generalizes (readers please chime in) but one VC friend of mine reports two other factors that may be driving him and some other successful VCs from the business:

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Cloudy Jobs Data

Markets greeted this morning’s jobs reports with enthusiasm, as the headline measure of job losses in May — 345,000 — came in significantly lower than expected.  Under normal circumstances, losing more than 300,000 jobs would be bad news.  Of course, these aren’t normal circumstances.

The unemployment rate in May was much less welcome, rising to 9.4% from 8.9% in April.  Part of the increase was due to the labor force expanding — a positive sign — but most was due to an increased number of people being unemployed.

These figures all refer to the headline measure of unemployment (U-3, in the lingo), which focuses on workers who have lost a job and are looking for a new one.  The government also publishes several broader measures of unemployment that account for other ways in which workers may be less employed than they desire.  The broadest of these, known as U-6, adds two groups to the regular measure: those who are marginally attached to the labor force (people who are willing to work and have worked in the past, but aren’t actively looking; this includes discouraged workers) and those who are working part-time even though they want to work full-time.

As shown in the following chart, the U-6 paints a grimmer picture of the U.S. labor market:


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Growing Government Transfers

I’ve received several emails today about a story posted last night by USA Today.  The story points out that government transfers now make up more than one-sixth of American incomes, the highest ever.  Naturally, some observers welcome this development, while others denounce it.

I thought it would be useful to side-step that debate and instead provide some historical context.  To begin, the following chart shows the ratio of government transfers to personal income from January 1959 through April 2009 (the most recent data):

Government Transfers 0 Continue reading “Growing Government Transfers”

Auction the Warrants: Follow-Up

Summary: Readers had some excellent comments on last week’s post about auctioning the TARP warrants.  Here are some updated thoughts. 

Last week I argued that the Treasury should auction off the warrants it received when it made TARP investments in banks.  Specifically, when banks are ready to repay the TARP investment, Treasury should auction the associated warrants to the highest bidder, which might turn out to be a private investor or the bank itself. Among other things, I argued that this approach would enhance the transparency of the process, ensure that taxpayers get a fair return on their investment, and allow banks to preserve needed capital.  A potential win all-around.

In response, readers sent me several very helpful comments that deserve highlighting.

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The Politics of Auctions

Over at Economic Principals, David Warsh has a nice post about how political considerations often limit the use of auctions in solving public policy challenges.

In principle, auctions are a powerful tool for allocating public assets in an efficient and transparent manner.  The FCC has had great success auctioning off portions of the radio spectrum, for example, and the Treasury uses auctions every week to sell the debt necessary to finance our government.  But other uses of auctions — e.g., to allocate landing slots at congested airports or to distribute allowances under a climate cap-and-trade program — face strong opposition from some businesses and some politicians. (ht: Marginal Revolution)