Posts tagged: Finance

Show Lin the Money

By , July 16, 2012 1:38 pm

This isn’t a post about Jeremy Lin’s ability. This isn’t a post about the Knicks team composition. This isn’t a post about the somewhat hypocritical comments made by Carmelo Anthony (if he meant that ‘ridiculous’ was Lin signing the offer then let’s not forget he forced the Knicks to gut their team rather than simply sign with them outright in free agency for less money). This post is purely about the game theory of matching Houston’s $25.1M, 3-year contract offer.

Okay, so the easy scenario to look at is what happens if the Knicks don’t match the contract. In this case, you simply do not add salary to your team and you lose Lin for no compensation. Let me rephrase; you lose a 23 year old potential star with extremely high marketability, a player whose in game shenanigans virtually forced a contract resolution between MSG and Time Warner Cable, for nothing. The no compensation thing is an important thing to remember when we get into what happens if you do match the offer.

No one seems to have a problem with the first two years of the contract, which would pay Lin $5M in year 1, and $5.2M in year 2. That’s in line with a back-up quality PG in the league and is clearly something the Knicks would do even if that costs them something on the Luxury Tax side. The biggest issue is the $14.8M balloon payment, the ‘poison pill’ if you will, in the 3rd year of the deal and the Luxury Tax burden associated with the team’s total payroll.

The first thing I want to clear up is that the Luxury Tax is a TEAM payroll burden, so while it is true that this deal will cost the Knicks an addition $15.6M for Lin, it also means that the tax will cost an additional $25.7M for Carmelo, $24.7 for Amar’e, and $15.4 for Chandler above their contract values. The difference between what the Knicks said they would match ($9.8M in the 3rd year) versus this current deal would increase the team payroll + tax from about $179M to roughly $205M. This is mainly because the $5M difference would be taxed at a rate of 425% due to the new CBA agreement.

It’s pretty much a given that the Knicks are committed to being Luxury Tax offenders. Since that will always be true forever into perpetuity, then the value argument of player with respect to their costs should be thrown out. If we do want to make that argument that the Luxury Tax matters, then we should evaluate whether we want a 42 year old Jason Kidd at $6.2M or an injury prone and old Marcus Camby at $8.6M. Neither one of those deals makes sense from an all in cost perspective. Even without Lin’s contract, does anyone out there think Melo and Amar’e are worth $37M+ each? Do you want to pay Steve Novak $5.25M/YR for 15 minutes of shooting 3s?

Now that the Luxury Tax issue is hopefully squared away, the last piece to figure out is that $14.8M third year of his contract. We don’t know what Jeremy Lin will be so let’s examine the two extreme scenarios, Linsanity and Inlinsanity. The Linsanity scenario is that Lin is the legitimate 25 PTS, 9 A, 4 R, 2 S, 50% FG% clutch winning PG we saw in his incredible run. In that case, the Knicks should gladly pay his $14.8 salary as you are looking at an All-Star production level at two-thirds the price. For comparison sake, Deron Williams will be making $21M+ at the end of his Brooklyn Nets contract. Sign him, done deal, Lin for President.

The second scenario, the Inlinsanity one, is where Jeremy Lin is a complete bust. Then you are in the Eddie Curry situation. A bloated contract on the books set to expire that year. There is value in that, as we’ve seen in the past. In fact, it was Eddie Curry’s terrible contract that helped land the Knicks their alleged superstar Carmelo Anthony.  It’s conceivable that you could parlay Lin into at least a 2nd round pick, if not in a sign-and-trade deal for a potential free agent.  Oh, and look which potential small market players would be at the end of their contracts:  2015 – Kevin Love, LaMarcus Aldridge,  Marc Gasol;  2016 – Kevin Durant, Al Horford, Danilo Gallinari, David Lee.

Lin will most likely end up somewhere in the middle of these scenarios.  If he doesn’t gravitate to the worst extreme, then paying an average of $8.3M over three years seems reasonable.  Even as an average PG, there are a few teams in the league that would probably make a deal for him in hopes of a recapturing Linsanity or to capitalize on his marketability.  This was the player that had the 2nd highest jersey sales this year despite only being available half way through the season AND spiked MSG’s stock to the tune of around $100M during his run. Wouldn’t the Clippers love to pair him with Blake Griffin as compensation if the end game is really Chris Paul in a Knicks uniform?

This seems like a no-brainer.  To let Lin walk now means absolutely no compensation for a player that has incredible market appeal.  The worst case scenario for signing him would be the Knicks paying fair value for him for the first two years of this deal and then having an expensive but interesting trade chip in the last year of the deal.  If MSG’s stock is any indication, then it’s time for the Knicks to show him the money.

If you want to be mad at someone, how about being mad at the Knicks front office for breaking some of the most basic rules of negotiation. If they had half a brain, they would have waited for Lin to sign something (potentially the lower offer) rather than say they’d match it and give Houston and Lin the opportunity to ramp it up. Be mad that they waited to wrap up their most valuable free agent and during that time threw money at Steve Novak, Jason Kidd, and Marcus Camby to the tune of $10M. And be mad they panicked and acquired Raymond Felton, a player that was vastly worse than Lin last year. I don’t care much about the comparison but rather the absolutes that show Lin ranked 3rd in points per play on ISOs, 3rd in FG% shooting off the dribble, and was in the top 1/3 in the league on defensive points per play.


Hide Your Kids, Hide Your Wife, Hide Your 401K

By , April 13, 2011 7:43 am

My buddy Justin posted an interesting chart recently about the correlation between quantitative easing (what the blue shirt crew calls QE, QE2, and possibly QE3) and commodity prices (notice the gas pump recently?). It reminded me of a posting I drafted to write in January, right smack in the middle of the Fed’s 2nd massive infusion of dollar dollar bills ya’ll into the ‘economy’. Now that QE3 appears to be on the horizon, I guess I should get this out and desperately hope that this will be my last opportunity to write on this subject. Here’s the chart:

What this chart is showing is that the huge rally in commodity prices (basically the things you buy to physically keep your body alive such as grains, veggies, meats, etc. and some things that make life easier like oil) have coincided with the Fed’s purchase of treasuries.  This is also one of the main reasons behind the rally we’ve seen in the stock market, and if you don’t believe me, try plotting your stock portfolio in nearly any other currency besides dollar bills.  It won’t be so pretty.

So what does this really mean to you?  Well for one, it means for anyone who was not heavily invested in the stock market (at least 40% – 50% of your assets), you’ve likely seen a huge DECREASE in your spending power.  Basically you can’t buy as much stuff as you used to be able to, primarily because the prices of those items have risen dramatically.  So while you are earning the same wage, it actually costs you a lot more to live now then it did before the Fed spending (see below).

Now what’s even worse is that since this Fed action is on the currency value, it doesn’t just effect what we earn today.  It effects EVERYTHING we’ve ever earned in our lifetime!  That includes your savings accounts, your 401Ks, grandma’s $5 birthday checks … anything that’s denominated in American greenbacks is worth 25 – 30% less due to quantitative easing.  So again I wonder why so many Americans were vehemently opposed to a 3% tax increase on FUTURE income for the uber-wealthy (whose lifestyles will not be affected) yet aren’t so worried about these rounds of QE’ezing that have effectively removed 25% of their ENTIRE net worth (not to mention future earnings as well).

Sadly, while a lot of us could use the extra dough to stay relatively comfortable a bit longer and wait out this economy, it’s really the poorest people in this country and the rest of the world that are facing a real struggle for survival.  A developer I work with noted that for the first time in India’s history, a luxury (a beer), a convenience (a liter of gas), and a necessity (an onion) had all cost the same.  Again, the people that have to bear the burden are often the ones that are least fit to do so.  And last I checked, it wasn’t them who leveraged bad mortgage loans, committed massive financial fraud, borrowed trillions in TARP money, exploited corporate tax loopholes, and paid themselves millions in bonuses.  Just saying.

Revised Lyrics:
Bernake’s climbin’ in your pockets
He’s snatchin’ your accounts up
Tryna rape em so ya’ll need to
Hide your cash, hide your bills
Hide your cash, hide your bills
Hide your cash, hide your bills
And hide your 401K
Cuz they’re rapin errbody out here

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How Can Fix The Banking Industry

By , February 12, 2010 2:18 am

So you are unemployed, with no job prospects in sight and a healthy mortgage and family to worry about.  You are not alone as a staggering 17% of Americans are currently out of work (sorry, U.S. Bureau of Labor Statistics, this is a more realistic vision of the jobless rate, not the 10% that you are ‘reporting’ and will subsequently adjust a year from now when no one is paying attention).  Here’s’s spin on the real unemployment rate in America:

Now while many Americans are finding it hard to earn a wage, there is a strange thing going on with the employed folks at our country’s largest banks.  They are getting bonuses, and not in a figurative sense of ‘hey, you have the bonus of keeping your job although your performance was a bit spotty abysmal over the past few years.’  No, they are paying themselves cold hard cash partly financed by the federal (read as American tax payer dollars) bank bail-out program.  Now I understand that a few of these banks have begun to repay their financial debt to the country, but the ‘lifestyle debt’ of long-term unemployment, mortgage foreclosures, small business bankruptcies, and retirement saving losses that these banks helped create are nowhere close to being recovered.  To turn a blind eye to anything beyond the reach of their balance sheets is just another example of the lack of fiscal and moral responsibility so prevalent in modern day banking.

In nearly any other industry, these poorly operated business would be purged in typical capitalist fashion during down business cycles; survival of the fittest, Darwinism in industry.  The main reason these industry Dodos survived was because the government had to intervene and lend mega amounts of money to them.  They were so big, and supported so many consumers and industries, that letting them fail would cause massive devastation to our economy (and the world’s economies).  In fact, 15 of the top 21 recipients of bailout funds were banks or bank subsidiaries whose survival has been contingent purely on their size rather than their abilities to operate, a fact ignored when decisions were made to pay out bonuses this year.

Being “Too Big To Fail” creates an imbalanced risk/reward structure because it allows banks to engage in short-term highly profitable businesses (CMOs, proprietary trading, hedge funds) with limited consideration for the additional risk (thanks to 3rd party capital rescue), which tends to be a long-term compounding problem that grows unfettered over many years.  It essentially allows them to share the risks over a larger capital base (theirs plus the American tax payer) during crisis, yet distribute profits accumulated from their activity that leads to the crisis to themselves (through short-term incentive structures like year-end bonuses on annual financial performance).

So what can you do (and how can help) so that this does not happen again?  Well, it’s pretty simple, fire your (big) bank.  Firing your bank is basically saying “I will not allow you to get so big that you can act irresponsibly because you are not worried about going bankrupt.”  To do this, all you need to do is move your savings accounts to a smaller, more responsible bank.  This exponentially reduces the size of a big bank, because your deposits are significantly leveraged in the modern day banking system (see the section called “Effects on Money Supply“).  Moving $1,000 dollars out of your large bank could potentially reduce the bank’s asset size by $9,000, so a lot if these jabs to shift the deposit base can amount to a staggering change. allows customers the opportunity to do this in their “Ways to Save” section.  Mint could take this a step forward by giving higher visibility to responsible banks or discouraging consumers (think “Didn’t Screw the Economy” rating) from moving accounts to bailout banks.  They could even flat out not allow irresponsible banks on their site, a move that would certainly be damaging to new customer acquisition for these banks.  With information that is publicly available, along with the data they are collecting consumers relationships with banks, they could create a banking watchdog system that brings the same transparency to the banking industry as they have brought to personal finance.  These types of ideas, although not necessarily beneficial in the short-term, could provide a larger pool of financially healthy individuals transacting in more stable and responsible banking industry.

So are you going to move your accounts to smaller, more responsible banks?  Would you like to see companies like Mint impact the banking industry for the better?  Chime in on the comments section if it suits you … or don’t.  I’ll be checking in to see if you did or didn’t while QAing Jeff’s latest build of Wixity.  Fun.

What is Risk?

By , June 9, 2009 10:20 am

What is risk?  When a lot of us hear this word, we automatically think that it has something to do with something bad happening.  What is risk management?  When a lot of us hear this phrase, we automatically think of “Along Came Polly.”  Risk and risk management almost always equates to incredibly awful downsides whether it be in our drive to work (car crashes), our retirement accounts (stock market crashes), or our health (heart crashes).

When we consider risk this way, we are putting unfair weight on the downside of what risk really is.  Risk is really the measure of the unexpected, and the unexpected can work in our favor as well as against us.  That means that even a crazy unexpected positive outcome, like winning the lottery, is also as much of a reality of risk as a plane crash (on island which travels through time for all the LOST fans out there).  Risk is saying that there is a range of outcomes that could happen and we don’t have a clue about what the hell is going to happen in the future.  The wider that range of outcomes, both good and bad, the more risky something is.

Peter L. Berstein, author of Against the Gods: The Remarkable Story of Risk, explains it pretty well.  He says by definition risk is a measure of the unknown, and because of that it is silly to presume and act as if we know what the future holds.  Risk management really is understanding that the future is uncertain, and preparing ourselves and our institutions to deal with the times when things are different from our expectations:

I was particularly intrigued by his comments about using optionality models in corporations as a way to value the option of waiting as an alternative strategy to acting, primarily when making decisions that you can not go back and change.  This is putting a value on the new information you can gain through the passage of time, simply by sitting back and waiting.  Most people, especially in the start-up space, say there is no time for waiting, release early and release often, iterate iterate iterate.  But what if the cost of this far out weighs the value of waiting?

Say your company is launching a new product, and you have to decide how to spend a $1 million dollar budget to advertise it’s awesomeness to the world.  Your marketing division comes to you with a proposal allocating dollars to buying Google Ad Words, a full-page ad in your industry’s top trade magazine, and a viral video campaign.  In passing they mention that the behavioral study of your existing customer base is going well, and the results should be ready in three six nine months, in time for the industry trade show.

We usually get a lot of information about how search engine marketing has the highest brand recall and  video has the best consumer retention rate and the top ten sites that have the exact demographic that we are targeting.  However this information doesn’t guarantee success; the future is completely unknown and its outcomes could range from the greatest advertising campaign of all time to the the most colossal failure destined to be top business school study material (Advertising Mismanagement:  A Case on (Insert Your Company Name Here).  But what is the value of waiting for more information to launch our advertising campaign, specifically our behavioral study?  What if spending $50,000 to finish up the study tells us exactly who to target, and we only need to spend $500,000 to reach them?  Wouldn’t that trade-off be awesome information to have?  This is possible by modeling the value of waiting to act on future information!  This would certainly help in trying to avoid “being too early,” something that venture capital firms often express concerns about.

So we know understand that risk is more than just danger, and really a representation of ranges (positive and negative) of what an outcome can be.  Risk management is really preparing ourselves for the range of outcomes that could happen, and better risk management would also involve valuing what a “wait and see” approach would be.  We do not know what the future holds, so it’s okay to make mistakes, and the sooner we realize that we can’t do anything about uncertainty (that’s not to say we can’t do anything to mitigate the impact of adverse situations), then the sooner we can be happy as a hippo.

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Whatchu talkin’ about Warren

By , May 8, 2009 1:19 pm

Berkshire Hathaway had their annual shareholders’ meeting last Saturday (May 2), and Warren Buffett and Charlie Munger totally hated on “higher-order” mathematics used in finance.    Come on guys, what did little ol’ math do to you?  Math and modern portfolio theory were picked on by these investment gurus more than Arnold was picked on by the Gooch! Don’t worry math, I got your back.

The truth of the matter is while Mr. Buffet and Mr. Munger are right about Wall Street’s reliance on complex math, the real blame should be focused on the consultants and investment managers who hawked these models as the end-all, be-all, best thing since sliced bread.  This is one case where it is totally fine to shoot the messenger in the face, however, we shouldn’t abandon using math to help us make better decisions.  We just need to find a better translator, because the message has some very valuable insights.

The reason why we build financial models, or really any models, is to keep track of numerous and complex relationships, something that is very difficult to do in our heads.  The world does not move in simple, predictable ways and the real value in modeling frameworks is to find the best representation of how the world actually behaves.  Sometimes a simple relationship just doesn’t make sense; Mr. Buffet would surely agree that modeling investment growth as a simple linear change is not nearly a good as modeling it as an exponential change (there are a number of high school curriculum that consider this “higher math”).

The key is to fully understand and make transparent that as we increase complexities in models, we increase the number of things that can go wrong, and therefore decrease our certainty of performance.  Think back to our first calculator, which for a lot of us often doubled as our first watch (wicked).  Simple, easy, and reliable.  Now add in a 2.66Ghz Intel Processor, 8GB RAM, 320GB of Storage, and a super-fly, aluminum cased, glow in the dark keyboard.  We have a kick-ass laptop that let’s us do all sorts of things a whole lot better, but it’s not surprising that its average lifespan is somewhere around 2 – 4 years.  And when it goes, we lose everything (yes, even that awesome illegally downloaded music collection that was the envy of our less tech savvy and risk adverse friends).  The funny thing is that Casio can still multiply two five-digit numbers, even after 20+ years!  But that doesn’t make it better.

Unfortunately, the certainty of performance only really bothers us in the worst of times, like when our computers crash and the stock market collapses.  Now, just like backing up our hard-drives, there are ways that we can create more security around financial modeling.  A few things that come to mind are good stress testing frameworks (if your models can’t do this easily for you, then be very cautious with its results), putting good translators (i.e., people who get how the model works AND understand its limitations) in front of decision makers early and often, and moving to a risk-based incentive compensation model (a discussion for another time).

Modeling frameworks are very useful, but they shouldn’t be used as a reason to stop thinking about what we are doing.  The human element in analyzing data can never be replaced by a pure modeling framework.  We shouldn’t site blantent disregard of rational thought by high-paid consultants and star investment analysts as failures in mathematical modeling.  Because remember, when you point your finger at your model, there are three fingers pointing back at you … wait for it  …. wait for it … okay, you got it, cool.

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