May 2000 Newsletter
Issue Five, Volume One

LOTS TO TALK ABOUT

By Mike Gasior

Well, I could not have anticipated the wave of e-mails that last month’s newsletter was going to produce. It seems people either had no opinion about what I had written or they were pretty outspoken with regard to their view. Needless to say, I could quickly spot the people who must have had an accumulation of Internet stocks since they were outwardly agitated with me. I thought you might enjoy some of their comments. Please make note that I have quoted all of these people verbatim, so lay off of me about spelling and punctuation errors. Now on with the commentary.

BULLS MAKE MONEY, BEARS MAKE MONEY, MIKE GETS SLAUGHTERED

Fine. I admit it. I screwed up the quote this time, although I’ll defend myself to the extent that the idea was correct. Nonetheless, you guys seemed to enjoy busting me open on this one. I accept my thirty lashes.

"I couldn't agree more but I always preferred, ‘Bulls make money. Bears make money. Pigs MAKE BACON.’"

"The adage is actually, Bulls make money, Bears make money, Hogs get slaughtered."

"Actually, I had always heard the quote as ‘Bears make money, Bulls make money, Pigs get slaughtered.’"

"Hi Mike, I remembered the expression as ‘Bulls and Bears get fat, but Hogs get slaughtered.’"

So, there seems to be more than one recollection of what the saying actually is. There is no doubt however that I was furthest from the mark. Plus, you guys write much more interestingly than I do.

ACCOUNTING IN THE NEW WORLD

The subject of accounting at Internet companies seemed to strike the deepest nerve with readers. Somehow I was surprised that so many of you were surprised. This whole thing truly borders on crooked and somebody is going to wind up in a hurt locker because of practices occurring in the books of these companies. All I want is for it not to be anyone in my audience. Don’t forget the rule that attorneys always go by in court…..if anyone is going to go to jail, it’s going to be the client, not them. Remember that if you are an accountant or auditor signing off on these companies’ financials.

Here are some of my reader’s thoughts on the matter.

"I have read your report with great interest. as an "old school" accountant and an alumni of pw when the big 8 roamed the world, the ‘new accounting’ techniques are coming home to roost. I know several of the new age CFOs who factor in accounting techniques that definitely would bring the regulators-we will see."

"Hmmm.....I am ashamed of my CPA colleagues for recording revenues and presenting financial statements this way. ‘Revenue recognition’ is not a new concept, it is a core concept in accounting and was taught to me when I first took accounting classes 15 years ago. It says something that the SEC in getting involved more and more in accounting practices. Previously the FASB and the accounting profession as a whole policed itself and did a pretty good job. Unfortunately, that seems to be changing....."

"Another great newsletter!! I enjoy reading them and passing them along (with credit to you of course) to my friends in the company. I especially enjoyed your ripping of the dot coms in this newsletter. Just had dinner Saturday night with a friend of mine who just left her job (a good paying and somewhat secure one at a university) to go with an internet startup. I tried the whole evening to get her to tell me how they book revenues and i'm not quite sure i ever got an answer, but after reading your newsletter, i now have a pretty good idea! I absolutely agree with everything you're saying....glad to know i'm not the only one out there who believes that VALUE does matter."

"As always, I enjoy reading your letters. First of all, I never knew this type of 'accounting' existed - this must be an example of what I have heard referred to as 'Creative Accounting'. Secondly, have you ever thought of publishing your letters in Time, Money, Fortune, etc.? I truly believe that the public is unaware of these events and needs to be informed - before their retirement funds evaporate. Please keep writing these letters. I am not aware of anyone else who is willing to take a stand and inform the public."

"IT’S" A BIG PROBLEM

Okay, I admit it. My grammatical errors can drive lots of people crazy. I took my beatings on this subject too.

"I certainly enjoy your newsletter. But I wish you (or your editor) would learn the difference between ‘it's’ and ‘its’ and use it correctly. Sorry, but it's a pet peeve of mine!"

Sorry for the mistake everyone. I hope no one was deeply offended by this. And a pet peeve of mine is readers who have enough free time on their hands to scold me about such things. Perhaps thirty more lashes for me??

WE LOVE YOU MIKE!!

Yes, there are actual readers who actually enjoy my ramblings.

"As I was getting ready for work this morning and listening to Ron Ensana on IMUS I said to myself - I wonder what Mr. Gasior has to say about all of this! Great issue of the newsletter. I was at a conference last week and a lunchtime speaker talked about selling the bubble instead of buying the dip ..."

"I am with you Mike. Some of my swine friends would have been lucky to have lost 10% on Friday. Most lost half of their invested funds."

"I really enjoyed your newsletter. May I share it with my graduate auditing students? I think it will spark a lively discussion of the role of the auditor."

"Thank you so much for your superb newsletters. Just keep them coming!"

WE HATE YOU MIKE!!

Oh yes, there are plenty of people aggravated with me as well.

"You are wasting your time sending me this. Send your bearish thoughts to bears not bulls. Long-term the market goes on to set new highs." (Of course it does….when? How long is long term?)

"Newsletter Author: While I appreciate your observations on the market and on accounting issues, I sincerely hope you will CLEAN UP YOUR LANGUAGE, otherwise I will not read the newletter any longer " (Newsletter Author? Don’t I put my name on line four?)

"Take me off of your list. Your comments are useless and annoying. Your ignorance is only exceeded by your poor use of the English language. GO AWAY !" (Yikes.)

"I did take a moment to peruse the newsletter and did not care for the tone of it - self-serving arrogance sprinkled with derogatory remarks is not what I would call informative." (Ouch.)

IF YOU’RE GOING TO WRITE, PLEASE DON’T DRINK

It seems like some people like to send me e-mail after spending some serious time down at the local tavern.

"as someone who regularly comments on C.N.B.C and who lived and traded through the 70s,80s and 90s and who has read economic and political history and founded AIMA i agree with much of which you write. In my experience the most useful comment is time specific and unambiguous you are yet to be time

Specific enough. By the way ,such commentary as opposed to the more qualified comments of others is usually contradicted by the facts ,unless of course your time horizon is infinite ,in which case the power of your point is some what diminished."

"Great Advise, I am however still concerned about the amount of potential panic in this thickle market."

NOW TO THE IMPORTANT MATTERS

There is actually a lot going on this month which I thought timely to discuss with my audience. First, the SEC has decided to postpone the implentation of decimalization. When the NASDAQ originally asked for an extension of the deadline the SEC said pretty firmly that it would not extend the deadline and I thought they would stick to their position. I was wrong.

Also, Alan Greenspan and the Federal Reserve Open Market Committee chose to increase short term interest rates this week by half of a percentage point (50 basis points) and this is going to profoundly impact several areas near and dear to my heart: Derivatives and Mortgage Backed Securities. I think I should issue a few warnings on these subjects this month.

POSTPONING DECIMALIZATION

The decision has been made by the SEC to postpone the implementation of decimalization. Originally the plan was to begin moving equities to decimal based pricing from fraction pricing beginning Monday, July 3, 2000. The initial increment would be five cents per share and that would change to one cent before year-end 2000. I covered the reasons why this change is significant in previous newsletters. You can read those by visiting http://www.afs-seminars.com.

The NASDAQ had asked for an extension citing the dramatic rise in trading volumes, which was putting their membership under tremendous pressure to keep up with settlements and systems demands. Although the New York Stock Exchange had not asked for an extension (and didn’t have to after NASDAQ did) you can be pretty certain that they were pleased to buy some time here since their trading volumes have increased heavily as well.

As is the SEC’s habit, they rejected the request for an extension pretty much out of hand. In recent years whenever there have been changes in regulation which favor investors, the SEC has pretty much pushed them forward irregardless of Wall Street’s opposition. A recent example would be the move to T+3 back in June of 1995. Many broker dealers and custody banks thought the SEC would back off that date but the SEC stood fast and the change took place on schedule.

Right now the SEC has asked market participants for their input through answering a list of questions regarding how they would like to see the change take place. From the tone of the letter’s questions it seems as though the SEC has chosen September 4, 2000, as the new date to begin the changeover to decimalization. What the SEC seems to be leaning toward is a phasing in of the change which would lead to thousands of stocks trading in decimals, while thousands of others would remain in fractions.

Speaking for the securities industry, the SIA has posted their letter to the SEC on their website, which can be visited at http://www.sia.com, that outlines their suggestions. The SIA feels that having thousands of stocks priced one way, while thousands of others are priced differently would be too confusing for the public. For what it’s worth, I would have to agree with their thought process.

The SIA’s recommendation is for there to be a small group of stocks priced in decimals starting in September as a study group. Their suggested number is 30 stocks. This would be followed by a gradual phase-in with all stocks being quoted in decimals by March of 2001. Of course, this is only the suggestion of one group. I promise to keep you abreast of any decisions from the SEC.

WATCH THOSE MORTGAGE BACKED SECURITIES

In this rising interest rate environment there will be a host of problems for investors in Mortgage Backed products and I felt it necessary to at least warn you of some of these potential issues.

--Extending Durations

As interest rates continue to rise, the prepayment speeds on Mortgage Backed Securities will slow. This will cause the duration and weighted average lives of them to extend. The resulting problem may be some pretty serious asset/liability mismatches at some insurance and pension companies. It may also cause some serious damage to the net asset values of some bond mutual funds. Let’s remember some simple and basic facts. When rates rise, bond prices fall. The longer the duration of your bonds, the more affected they are by rates. Right now your Mortgage Backed securities durations are getting longer by the day. The summary is that they will be dropping in market value much more precipitously than your standard bond.

--Mortgage Backed Derivatives

More than anything else, some of the derivative products created with MBS will cause the most damage to investors, just like they did back in 1994 when Orange County and so many others got their asses shot off. Here are all the questions you need to remember:

"Do we own any PO’s (principal only) securities?"

"Do we own any inverse floaters?"

If the answer to either question is "yes", be prepared for some serious market value fluctuations. If they’ve been used in a proper portfolio strategy, this will be no big deal and you will be just fine. If they haven’t been, then you should be expecting to hear from Mike Wallace sometime soon.

ANOTHER DERIVATIVE DISASTER PERIOD??

The last time we went through a series of interest rate increases of this proportion was back in 1994. Are you going to make me list these for you?? Orange County. Proctor & Gamble. Dell Computer. Gibson Greeting Cards. State of Wisconsin. State of West Virginia. The Palm Beach County Sheriff’s Department. And many, many, many others. What did all of these have in common? All had taken speculative positions that rates would stay constant, or better still, go down. Some of the positions were spectacular in size. Some of them were unbeknownst to the investors who had taken them. But the only thing necessary to flush them all out was this steady rise in short term rates.

Well here we go again. Rates are rising once again and if there are any investors with a position that favor falling rates we will see some disasters. Hopefully there were plenty of lessons learned from the last go around back in 1994. Then of course, you also know my opinion of the human learning curve.

LOOSE ENDS

I am going to be in New York City hosting the Mortgage Backed Securities Seminar on June 5th and 6th and the Private Placements Seminar on June 7th. These two topics have been very timely of late and there is still room in both programs for enrollment. I will also be in Atlanta on June 12th and 13th for the Mortgage Backed Securities Seminar in Buckhead.

The decisions are just about final for the Bermuda Seminar series to be held in November. Watch for details in next month’s newsletter, or you can call my office for details at (860) 347-6568.

As always I appreciate your comments, both good and bad. Keep those cards and letters coming.

Next month I hope to re-visit the topics of T+1 and decimalization for a quick update and, of course, any timely news that may come up in the meantime.

If you would like to add anyone to the distribution list, or change the e-mail address where you receive this newsletter, you can also accomplish this at the Website at http://www.afs-seminars.com.

Copyright 2000, Michael Gasior. All Rights Reserved.

PREVIOUS | NEXT