Archive for May, 2010

The sovereign debt-tritus, waiting to decompose all over your balance sheet

May 7, 2010 3 comments

I’m not really one for horror – so I got an almighty fright when I took a look at a chart from the BIS via the New York Times website, which showed the exposure of the financial institutions of various European countries to each other’s sovereign debt. Are you sitting down? Here we go:

So, we know that British, French, German and Portuguese financial institutions are all especially exposed to a credit event on Greek debt. However, who is exposed to those financial institutions? And who is exposed to those who are exposed?

Nobody knows the answer to those questions. And that, I think you’ll find, goes a long way towards explaining why markets panic – and why all kinds of unexpected correlations start going to 1.


Philosophy for the masses: the ‘sense’ of a proper name

May 5, 2010 Leave a comment

A series of posts for those with a general interest in philosophy, designed to lay out some of the more esoteric issues philosophers have been squabbling about over the years and why they are vexed by them.

One of the many gifts that the German mathematician and logician Gottlob Frege bequeathed to modern philosophy was the distinction between the ‘sense’ and the ‘reference’ of a proper name. Indeed, one of the papers that stands out as paradigmatic of the modern analytical tradition in philosophy is Bertrand Russell’s 1905 paper On Denoting, which took issue with Frege’s treatment of the topic and arguably helped usher in the professionalization of discipline seen in the 20th Century (to mixed results, imho).

In that classic 1892 paper Über Sinn und Bedeutung (On Sense and Reference), Frege distinguished between the referent of a proper name (the object it is the name of) and the ‘sense’, which roughly speaking is the thought one has when one is thinking about the object. For Frege and others following him, there was also a relationship between the sense and the referent – but I am going to leave the question of the determination of reference for another, separate post.

Frege was arguing against a theory of names put forward by John Stuart Mill, which was that the meaning of a name is simply the referent – which has the upshot that two different names for the same object mean the same thing. However, Frege observed, this would mean that all identity statements would be trivial; i.e. that if the names ‘Clark Kent’ and ‘Superman’ name the same object, then ‘Clark Kent is Superman’ means the same as ‘Clark Kent is Clark Kent’ and ‘Superman is Superman’. But this is not true – identity statements can be informative. They shouldn’t, on a correct theory of the meaning of a proper name, come out as tautologies.

So, pulling us in one direction for distinguishing between sense and reference is that identity statements (even if they ‘really are’ tautologies when we think about the reference of the names) don’t seem to be that way on their face. This then leads one to the conclusion that there is some other way of understanding a name on its face, as it were.

One prominent reading of Frege was that he identified the sense of a name with a definite description – for example, ‘Aristotle’ means ‘The teacher of Alexander the Great’. However, as a theory of sense, one of they key drawbacks of this is that then to say ‘Aristotle was the teacher of Alexander the Great’ is in fact to say ‘The teacher of Alexander the Great was the teacher of Alexander the Great’ which is also a tautology. Indeed, if you identify the sense of the name as anything which can be also be said to be of an object (like a description, or indeed any property), then attributing that to the object will come out as a tautology.

This is the central reason why I believe the question of the sense of a proper name – the thought one is having when one uses the name – is so intractable and will prove to be so for years to come. If we deny that the meaning of a proper name is anything but the object, then we have the problem of identity statements being tautologies. However, if instead we think of a name as meaning the object (or a non-specific object) but having certain identifying properties, then attributing those properties to the object becomes a tautology.

Now, it has always seemed to me that the answer to this puzzle is going to have to either lie on the ‘descriptivist’ side – because I can’t even think what it would be to have a thought about a specific object without thinking about that specific object having certain properties… I mean, try thinking about your car or house but without them having the property of being a car or being a house – or in completely changing the way philosophers have treated subject-predicate sentences, like ‘John is bald’ (sorry, John).

It is actually quite amazing/distressing how far you can get in philosophy just by saying  relatively benign things, like “If ‘John is bald’ is true, then there must be an object (John) that has a property (being bald)”. My inner Wittgenstein* suspects that everything starts going wrong when we over-interpret that simple and seemingly innocuous observation, which then goes on to do a whole lot of metaphysical damage. In what I intend to be the next post in this series – the problem of universals – I hope to show how this can happen somewhat spectacularly**.

*And believe me if you thought having inner angels and demons is tough, try having an inner Wittgenstein as well

**Or at least, as spectacularly as anything happens in modern analytic philosophy

Something doesn’t add up about Warren Buffett

May 2, 2010 Leave a comment

WARNING: I have completely changed my view on this topic, and intend to write more on in in he future. Below I suggest you can’t perform a fundamental value analysis on Berkshire stock, when of course you can on all its underlying income streams. I leave it up as a shining example of how applying a useful framework inexpertly (in this case, the distinction between value-investing and speculation) can lead to bad results

A bit of a bold title for a first post, but I was absolutely astounded to find out today that Warren Buffett’s phenomenally successful company Berkshire Hathaway – a single share of which would currently set you back $115,325* – hasn’t paid out a dividend to shareholders since 1967.

Think about this for a second.

Buffett is famous not only for being an incredibly skilled allocator of capital, but for his philosophy of investing for expected future returns rather than on speculation. You find a company whose future returns are undervalued, buy that company and hold it. Maybe you’ll have to rejig it a little to get those expected future returns, but as I recall Buffett saying himself on the BBC special he was the subject of last year: he bought a company once that required turning around and making some tough decisions, and it wasn’t much fun. So he made sure he never had to do it again.

Would Warren Buffett invest in Berkshire Hathaway, if he was following his own philosophy? I can hardly see how. What is the value of owning an expensive piece of stock unless you expect it to pay dividends, or unless you plan to sell it at a higher price in the future? The former is nonsensical if the dividends are zero, and the latter goes entirely against the letter (let alone the spirit!) of Buffett’s investment philosophy.

Consider the following, from in 2004:

A shareholder asked what it would take for Berkshire to change its longstanding opposition to paying a dividend or conducting share repurchases. Buffett used the question to teach a mini-clinic on corporate finance, pointing out that the managers of a company have a fiduciary duty to put the company’s cash to optimal use…

Later, Buffett made a striking observation. Imagine that Berkshire decided that it could no longer wisely invest its $30 billion-plus worth of cash and decided to distribute all that cash to shareholders in a special dividend. Buffett himself, as the largest shareholder, would get more than $7 billion.

Then, he pointed out, he would have to try to find good investment opportunities to put all that money to work for his own account. “I would be in competition with Berkshire’s shareholders, and I don’t think that would be good for them,” Buffett said.”

This response doesn’t make any sense, because the whole point of a fiduciary duty is that management act in the interest of the shareholders. But I can’t see what the interest of the shareholders is here, unless it is simply to increase the share price (and Lord knows that in many cases such a policy can have terrible consequences for shareholders). They never actually get any of the money!

And furthermore, the shareholders might not want to use the dividends to find good investment opportunities. Maybe – and this might come as a shock to the famously frugal Buffett – they might want to spend the money. Money doesn’t just exist for its own sake – it is a medium of exchange. It exists so we can get stuff. Why on earth would anyone invest except to have more money to spend?

Something doesn’t add up. I’m not going so far as to brand one of the richest men in the world a hypocrite.. or maybe I am, I’m not sure. The annual shareholder meeting for Berkshire Hathaway is often referred to as ‘Woodstock for Capitalists’. And that’s the only possible rational reason you could have for owning stock in Berkshire Hathaway – to be part of an elite club that get to go hang with a bunch of cool kids every year (or, at least, with a bunch of kids who all think another kid is really cool). Perhaps this is the way that Berkshire shareholders see themselves. We can test this hypothesis. If it is the case – as I strongly suspect – that one gets as much benefit from holding one share as any other number if we think about it as a private club, then we should expect almost all the shareholders to own one share. If this is correct, anyone who has more than one share is either  a) incompetent at calculating the value of a simple investment (in this case, the marginal utility of a second share in Berkshire Hathaway) or b) engaging in speculation. Either way, they can hardly be said to be following the philosophy of the man they so admire. And Buffett’s justifications about not paying a dividend strike me as if it is supposed to be something more than an elite club.

Almost like its supposed to be a publicly traded business or something.

*UPDATE (3/5/10): This price reflects the ‘Class A’ shares – there are also ‘Class B’ shares which have 1/150th of the claim of Class A.

However, what this serves is to prove the point that Berkshire Hathaway stock holders are engaged in speculation. Class B shares trade at pretty much exactly 1/150th of the price of Class A shares, therefore the value is (unsurprisingly) based on the claim to the company, rather than the right to go to the meeting and be part of the club (which is exactly the same for both Class A and Class B). It remains, then, an utter mystery to me how one can consistently adhere to Buffett’s value-investing philosophy and be a Berkshire Hathaway shareholder.

To drive home this point once and for all: value-investing is based on the idea of a so-called ‘fundamental analysis’ – and essentially if the fundamental analysis churns out a number that is greater than the current market price, then you buy. But if Berkshire never pays dividends (and it never has while Buffett has been running it full time), you can’t carry out a fundamental analysis. Even the price-earnings ratio for Berkshire is pretty high already (about 22), despite the fact as a stockholder you get to see no more of those earnings than I do.

Pure speculation…