Q&A With Myron Scholes

Here's a short "Crash Course" interview with Nobel Laureate Myron Scholes, conducted by Deborah Solomon.

The guy's got a sense of humor. Who'da thunk it?

Stick A Fork In Me!

The semester is now officially over at Unknown University. I gave my last final Tuesday afternoon (the last slot in finals week). Unfortunately, grades had to be turned in by 4 today (only 48 hours later).

I finished the almost all the grading last night at 3 a.m. (except for the final assigning of grades). So, it looked like the coast was clear.

Unfortunately, nothing is ever easy in the Unknown Household.

This morning, Unknown Elder Son was looking and feeling washed out. So, after a quick trip to the local hospital to have his blood counts taken, it turns out he needed a blood transfusion (not an uncommon thing - anemia is a common side effect of chemo).

Unknown Wife took him in for the transfusion, and I got to attend the faculty meeting with the Unknown Baby in tow (he slept through the entire morning, which is probably the best course of action when on a faculty retreat). After lunch, I left to feed him and drop him off at a neighbor's house for the afternoon, so I could finish the grading.

Now it's off to Six Flags for the weekend. Since the Unknown Sister-In-Law is taking care of the little one for the weekend, it'll be almost like we're a family of four again.

Happy Mother's Day

We're off to a neighboring state to visit my mother for Mother's day. It'll be the first time my side of the family gets to see the Unknown Baby Boy in person.

As for the rest of my life, I have a final exam to write for Tuesday, followed by an executive education class on Wednesday, a Faculty retreat on Thursday, and a trip to Six Flags in Lake George over the weekend (Unknown Older Son is a big Loony Tunes fan, and we wanted to go there before his stem cell transplant in early June).

So, blogging will continue to be light for the next week or so.

Now go tell your Mother (or the mother of your children) how much you appreciate her.

A Good Conference, Followed By More Crazy

I thought I'd put a few impressions of the EFA conference from this past week. While pretty short, it was a very good time: catching up with old friends, making some new ones, getting a lot of work done, and SLEEEEEP!

Because of all the other stuff going on in the Unknown Household, I was only able to get away for a day, so I took an early Friday flight to Baltimore, followed by the train to Washington. I arrived at the conference hotel just before lunch. Between 11:00 Friday and 1:30 Saturday (when I took the hotel shuttle to the airport for my return flight) I

• Had two papers presented (both were presented by coauthors), and received good comments on both. In both cases, the papers were well received by the discussant and the audience.
  
• Met with coauthors on three papers (the two mentioned above and a third one that's also coming along nicely). On two of the papers, we just talked briefly to discuss what needs to be done next to get them out the door. On the third paper, my coauthor and I spent about a hour applying various methods of statistical torture to the data, yielding some pretty nice confessions (oops! - that would be "results").
• Arranged to present a paper at my undergraduate Alma mater in the fall. I know a good number of the faculty, none of which were there back in the dark ages when I was an undergrad. We've been talking about my coming to present some of my work for some time, and it looks like it'll finally happen
• Talked with another potential coauthor about combining some of my data with his methodology.
• Most importantly, I went to bed by 9:30 and (since there was no-one clamoring for a 3 a.m. feeding) slept almost 9 1/2 hours without interruption. Woo Hoo!
  

Just to show that nothing ever changes for long, when I got back, I called the Unknown Wife, and she said it was all right to go to a book store and veg a bit (it's one of my favorite ways to decompress).

Of course, this was followed by a second phone call an hour later telling me that Unknown Son was getting nosebleeds. We called the on-call oncologist and was informed that he was likely low on platelets (they are the clotting factor in the blood, and often get depressed following chemotherapy). So, it was a quick drive home, followed by a trip to the ER, followed by an overnight stay at the hospital so he could get a platelet transfusion (since it was the weekend, we couldn't do it on an outpatient basis.).

He was discharged the next morning, and all's been quiet since.

For now.

Next Semester Should Be Interesting

We're winding down the semester at Unknown University (only one exam to go, and I'm done). So, I was looking ahead to next semester (hey - I was on the train, and had little better to do for an hour and a half), and I realized that it will be the most interesting and varied teaching load I've ever had. Here's the lineup:

• Fixed Income: This is a new prep for me. It's an overview of the Fixed Income field, and is taught with a standard lecture approach. My goal is that students coming our of the class would be comfortable discussing anything they'd be thrown in an interview for an entry-level FI interview. At a minimum, it'll cover everything on the FI section of the CFA Level 1 exam, and about half of the CFA L2 FI material. I approach courses like this in a very structured manner - I give the students in a course like this very explicit guidlines as to what they should be able to explain or calculate (these are similar to the Learning Outcome Statements used in the CFA progtam), and give them a series of problem sets to drive home the material.
  
• Advanced corporate finance: This class is taught primarily using the case method. As a result, I spend as little time lecturing as possible (mostly to give basic background on a topic that might be addressed in a case). It's highly interactive, and while I choose the cases with some major themes in mind, the actual topics discussed in any given class run from pillar to post.
  
• The Student-Managed Investment Fund class: This class involves a small (10-15 students) managing a real-money portfolio. Most of them come in without experience (other than having take the Investments/Security Analysis course), so they learn the process of security analysis and portfolio management almost from square one).
  

So, the three classes are discinct in their approach: one is a very structured traditiona lecture, one is case-based and taught with what I've heard called the "Soft Socratic Approach", and one is a practicum.

Interestingly, I have 8 students who are taking all three classes. I'm curious to see if they comment on (or even niotice) the different approaches used in the classes.

Hedge Fund Manager Clifford Asness Pushes Back At Obama

One of the hot stories this last week was that the Obama Administration had supposedly pressured and/or threatened hedge fund managers who held Chrysler debt.
ABC News reports:

Thomas Lauria, Global Practice Head of the Financial Restructuring and Insolvency Group at White & Case, told ABC News that [White House financial adviser Steven] Rattner suggested to an official of the boutique investment bank Perella Weinberg Partners that officials of the Obama White House would embarrass the firm for opposing the Obama administration plan, which President Obama announced Thursday, and which requires creditors to accept roughly 29 cents on the dollar for an estimated $6.8 billion owed by Chrysler.

[...]

Lauria said the president's assertion that his clients weren't willing to make any sacrifice is false. The clients were willing to take 50 cents on the dollar from Chrysler for their debt, he said.

President Obama also said of Lauria's clients, "I don't stand with them. I stand with Chrysler's employees and their families and communities. I stand with Chrysler's management, its dealers, and its suppliers. I stand with the millions of Americans who own and want to buy Chrysler cars. I don't stand with those who held out when everybody else is making sacrifices."

Clifford Asness, head of quant fund AQR is not a wallflower. So, he gives a very strong pushback. It's well written, and I agree with the vast majority of it. Enjoy:

Unafraid In Greenwich Connecticut
Clifford S. Asness
Managing and Founding Principal
AQR Capital Management, LLC

The President has just harshly castigated hedge fund managers for being unwilling to take his administration’s bid for their Chrysler bonds. He called them “speculators” who were “refusing to sacrifice like everyone else” and who wanted “to hold out for the prospect of an unjustified taxpayer-funded bailout.”

The responses of hedge fund managers have been, appropriately, outrage, but generally have been anonymous for fear of going on the record against a powerful President (an exception, though still in the form of a “group letter”, was the superb note from “The Committee of Chrysler Non-TARP Lenders” some of the points of which I echo here, and a relatively few firms, like Oppenheimer, that have publicly defended themselves). Furthermore, one by one the managers and banks are said to be caving to the President’s wishes out of justifiable fear.

I run an approximately twenty billion dollar money management firm that offers hedge funds as well as public mutual funds and unhedged traditional investments. My company is not involved in the Chrysler situation, but I am still aghast at the President's comments (of course these are my own views not those of my company). Furthermore, for some reason I was not born with the common sense to keep it to myself, though my title should more accurately be called "Not Afraid Enough" as I am indeed fearful writing this... It’s really a bad idea to speak out. Angering the President is a mistake and, my views will annoy half my clients. I hope my clients will understand that I’m entitled to my voice and to speak it loudly, just as they are in this great country. I hope they will also like that I do not think I have the right to intentionally “sacrifice” their money without their permission.

Here's a shock. When hedge funds, pension funds, mutual funds, and individuals, including very sweet grandmothers, lend their money they expect to get it back. However, they know, or should know, they take the risk of not being paid back. But if such a bad event happens it usually does not result in a complete loss. A firm in bankruptcy still has assets. It’s not always a pretty process. Bankruptcy court is about figuring out how to most fairly divvy up the remaining assets based on who is owed what and whose contracts come first. The process already has built-in partial protections for employees and pensions, and can set lenders' contracts aside in order to help the company survive, all of which are the rules of the game lenders know before they lend. But, without this recovery process nobody would lend to risky borrowers. Essentially, lenders accept less than shareholders (means bonds return less than stocks) in good times only because they get more than shareholders in bad times.

The above is how it works in America, or how it’s supposed to work. The President and his team sought to avoid having Chrysler go through this process, proposing their own plan for re-organizing the company and partially paying off Chrysler’s creditors. Some bond holders thought this plan unfair. Specifically, they thought it unfairly favored the United Auto Workers, and unfairly paid bondholders less than they would get in bankruptcy court. So, they said no to the plan and decided, as is their right, to take their chances in the bankruptcy process. But, as his quotes above show, the President thought they were being unpatriotic or worse.

Let’s be clear, it is the job and obligation of all investment managers, including hedge fund managers, to get their clients the most return they can. They are allowed to be charitable with their own money, and many are spectacularly so, but if they give away their clients’ money to share in the “sacrifice”, they are stealing. Clients of hedge funds include, among others, pension funds of all kinds of workers, unionized and not. The managers have a fiduciary obligation to look after their clients’ money as best they can, not to support the President, nor to oppose him, nor otherwise advance their personal political views. That’s how the system works. If you hired an investment professional and he could preserve more of your money in a financial disaster, but instead he decided to spend it on the UAW so you could “share in the sacrifice”, you would not be happy.

Let’s quickly review a few side issues.

The President's attempted diktat takes money from bondholders and gives it to a labor union that delivers money and votes for him. Why is he not calling on his party to "sacrifice" some campaign contributions, and votes, for the greater good? Shaking down lenders for the benefit of political donors is recycled corruption and abuse of power.

Let’s also mention only in passing the irony of this same President begging hedge funds to borrow more to purchase other troubled securities. That he expects them to do so when he has already shown what happens if they ask for their money to be repaid fairly would be amusing if not so dangerous. That hedge funds might not participate in these programs because of fear of getting sucked into some toxic demagoguery that ends in arbitrary punishment for trying to work with the Treasury is distressing. Some useful programs, like those designed to help finance consumer loans, won't work because of this irresponsible hectoring.

Last but not least, the President screaming that the hedge funds are looking for an unjustified taxpayer-funded bailout is the big lie writ large. Find me a hedge fund that has been bailed out. Find me a hedge fund, even a failed one, that has asked for one. In fact, it was only because hedge funds have not taken government funds that they could stand up to this bullying. The TARP recipients had no choice but to go along. The hedge funds were singled out only because
they are unpopular, not because they behaved any differently from any other ethical manager of other people's money. The President’s comments here are backwards and libelous. Yet, somehow I don’t think the hedge funds will be following ACORN’s lead and trucking in a bunch of paid professional protestors soon. Hedge funds really need a community organizer.

This is America. We have a free enterprise system that has worked spectacularly for us for two hundred plus years. When it fails it fixes itself. Most importantly, it is not an owned lackey of the oval office to be scolded for disobedience by the President.

I am ready for my “personalized” tax rate now.

HT: Zero Hedge.

It touches on a couple of very interesting points that are fertile grounds for class discussion:

• the fiduciary role of hedge funds - would it be correct for them to "back off" on their demands, or is their sole allegiance to their investors?
  
• how the bankruptcy process could change as a result of introducing non-economic (i.e. political) considerations into the process). You could ask the question as to whether it is appropriate for the government as bargaining agent to elevate the junior claims of the unions above the claim of the bondholders
  
• the "unintended" effects of government intervention. In particular, a rational hedge fund manager might be much less willing to purchase securities in troubled firms if they thought they might end up being involved in bargaining with the government. This could result in lower liquidity, more mispricing, and higher costs of capital for these firms

As a colleague of mine says, we live in interesting times.

Using "Yes! 50 Scientifically Proven Ways to Be Persuasive" In The Classroom

I recently started reading Goldstein, Martin, and Cialdini's "Yes!: 50 Scientifically Proven Ways to Be Persuasive." It could easily be described as "Freakonomics for Social Psychology". It's a fun, easy, and very informative read, with each chapter only about 1500-2000 words long, and highlighting one persuasion technique. So, you can knock out a chapter in 10 minutes or so.

It's a very interesting introduction to the social psychology literature on persuasion - it lists all the underlying research in the appendix.

In addition to learning some interesting things, I've also gotten some great ideas to use in my classes. I'll be discussing these over the next few weeks, starting with

Chapters 1 & 2: "The Bandwagon effect"
One way to increase compliance with a request is to mention that a lot of other people have done the same thing. In these chapters, the authors mention a study where they tried to see if they could increase the percentage of people staying in a hotel who reused towels at least once during their stay. Their solution was simple. The hotels who do this typically put a little card in the hotel room touting the benefits of reusing towels. All they did was add a line to the extent that the majority of people who stay in hotels do in fact reuse their towels at least once during their stay. This dramatically increased the percentage of people who chose to reuse.

In a related study, they added another line stating that XX% of the people who stayed in this room reused towels. This increased compliance even more.

Chapter 3: "What common mistake causes messages to self-destruct?"
The bandwagon effect can also cause messages to backfire. In one study, they seeded the Petrified Forest with fake pieces of petrified wood, and then posted signs stating that "many past visitors have removed the petrified wood from the park, changing the natural state of the petrified forest", accompanied by a picture of several visitors to taking pieces of wood. These signs actually increased the incidences of the behavior they were intended to stop.

Here are the applications to my classes: First off, to use the bandwagon effect in my case course, I'm going to state figures (made up, of course) at the beginning of class as to the average amount of time past students in that class have spent preparing each week. I'm also going to tell my classes that the average evaluation for the professors in the college ranges from 4.2 to 4.8 on a 5 point scale (I know, it's inflated, but it might be interesting to see what happens if I state that several times during the semester). If I really want to use the bandwagon effect, I'll mention that evaluations in THAT particular class have been a bit higher.

As for avoiding the "self-destruct" part of the bandwagon effect, I plan on spending less time talking about how many students are absent. If I need to mention it, I'll focus on the flip side that 94% of the students in this class make the vast majority of classes, and commend them on that fact.

More to come later. It's a great book, and inexpensive, too (the paperback is less than $20).