Deceptive Infographic #1: The Heathcare Vote

The first infographic I want to highlight comes from the otherwise excellent Political Math Blog. The diagram aims to portray the House of Representatives vote split for the recently passed healthcare reform legislation in comparison with the vote splits for other major social reform. It is an interesting diagram because it illustrates how objective information can be displayed in a manner that influences your perception of the data.

In the first three vote blocks, the dividing line between “Yay” and “Nay” is drawn down the middle of the “split” party, indicating that there are party members on both sides of the debate. However, in the final vote block on heathcare reform, the creator of this diagram has specifically arranged the colors such that the Yay/Nay dividing line runs directly between the parties, with the dissenting Democrats hidden off to the right side. This increases the contrast between the parties, and makes the Heathcare Reform vote appear more partisan and divisive than it actually was.

When viewing an infographic (or any seemingly “objective” data), make sure you consider whether or not the designer is trying to “lead” you toward drawing a specific conclusion or feeling a certain way by presenting the data in a certain manner.

Deceptive Infographic #2: Household Income vs. Debt

I originally found the next graphic on Digg, where people were whipping themselves into an outrage about how unfair life is, how capitalism is broken, and how America is headed to hell in a handbasket. Except this graphic is totally flawed (click for a full size version).

The graphic compares the trend in average household income (the green bar) with the trend in total household debt (the red bar), and reaches the “nightmare” conclusion that the latter is quickly outpacing the former. The problem in this graphic is that comparing annual income to total debt is apples to oranges. Suppose I make $50,000 a year and owe $250,000 on my mortgage. Is this necessarily a Bad Thing? No. Here’s why:

This comparison completely neglects the other side of the household balance sheet – assets. You borrowed $250,000 on that mortgage to buy the house, so you also own an asset (the home) worth $250,000 (putting aside the housing crash for a second). You also have likely saved some of your income each year, which is building up as an asset in your bank account. Both of these assets can be liquidated to eliminate the debt. The debt is only dangerous if it is not matched by an asset of equal or greater value.

In addition, the diagram assumes you never use any of the income you earn in the time between each bar (several years) to pay down any of the debt, yet you continue to borrow. If that’s the case, the prison is of your own making. I could go all day, but the bottom line is, this is a completely flawed comparison. Debt is not inherently a Bad Thing. Irresponsible debt (debt that is not counterbalanced by assets) is a Bad Thing.

The lesson here is that you should pay attention to context and the validity of comparisons before drawing conclusions, especially when data visualization is involved.

In Summary

Infographics are incredibly useful for conveying a lot of data at a glace, and draw the eye with bright colors and interesting shapes. Often an infographic is the best way to communicate data to a relatively unsophisticated or novice audience. However, when you come across a flashy data visualization, sure the author didn’t create it to tell a specific story. Always take some time to envision the data behind the chart – would the data table create the same reaction that the infographic elicits?

Update: Here is a great infographic that was sent over to me today by my friend Vanessa – it depicts the magnitude of the recent Deep Water Horizon oil spill that occurred last week in the Gulf of Mexico. It does an excellent job putting the magnitude of the spill in context with other well known spills (Exxon Valdez, Amoco Caldiz) and also illustrating just how much oil was spilled relative to the world’s daily consumption. Check it out. Even better, they make the underlying data available here.

I strongly disagree with this argument, and the general one that just because Chrysler is not public, it is less deserving of a bailout than Ford and GM. You may be surprised at the actual ownership of Ford and GM – the majority of their shares are held by investment houses similar to Cerberus.71% of Ford’s outstanding equity is institutionally owned, and in addition, 40% of its voting rights are controlled by the Ford family. GM is 78% institutionally owned.

Also, why is the public not aghast that Ford and GM cannot raise additional equity from their existing shareholders? If Ford and GM cannot float additional equity on the public market, why should the taxpayer invest? The answer is that none of the Big 3 can raise additional equity because their market cost of capital is astronomical. This is why the government has to step in – neither the private nor public markets are willing to make any sort of further bet on these companies.

In addition, Cerberus has agreed to forfeit any profit it may make on its Chrysler investment if it receives government money. Ford and GM’s public shareholders have clearly made no such promise.

To be clear – I am in no way in favor of a bailout for any of the Big 3. These are sick companies, and they need to die. However, discriminating against Chrysler because they are privately held is really inappropriate.

I was forwarded the following parable, written by David R. Kamerschen, Ph.D. Professor of Economics at the University of Georgia entitled “Barstool Economics”. I think that while it is a bit simplistic, it is definitely timely and interesting.

Suppose that every day, ten men go out for beer and the bill for all ten comes to $100. If they paid their bill the way we pay our taxes, it would go something like this:

The first four men (the poorest) would pay nothing.
The fifth would pay $1.
The sixth would pay $3.
The seventh would pay $7.
The eighth would pay $12.
The ninth would pay $18.
The tenth man (the richest) would pay $59.

So, that’s what they decided to do.

The ten men drank in the bar every day and seemed quite happy with the arrangement, until on day, the owner threw them a curve. “Since you are all such good customers,” he said, “I’m going to reduce the cost of your daily beer by $20.” Drinks for the ten now cost just $80.

The group still wanted to pay their bill the way we pay our taxes so the first four men were unaffected. They would still drink for free. But what about the other six men – the paying customers? How could they divide the $20 windfall so that everyone would get his ‘fair share?’

They realized that $20 divided by six is $3.33. But if they subtracted that from everybody’s share, then the fifth man and the sixth man would each end up being paid to drink his beer. So, the bar owner suggested that it would be fair to reduce each man’s bill by roughly the same amount, and he proceeded to work out the amounts each should pay.

And so:

The fifth man, like the first four, now paid nothing (100% savings).
The sixth now paid $2 instead of $3 (33% savings).
The seventh now pay $5 instead of $7 (28% savings).
The eighth now paid $9 instead of $12 (25% savings).
The ninth now paid $14 instead of $18 (22% savings).
The tenth now paid $49 instead of $59 (16% savings).

Each of the six was better off than before. And the first four continued to drink for free. But once outside the restaurant, the men began to compare their savings.

“I only got a dollar out of the $20,” declared the sixth man. He pointed to the tenth man – “but he got $10!” “Yeah, that’s right,” exclaimed the fifth man. “I only saved a dollar, too. It’s unfair that he got ten times more than I!”

“That’s true!!” shouted the seventh man. “Why should he get $10 back when I got only two, the wealthy get all the breaks?”

“Wait a minute,” yelled the first four men in unison. “We didn’t get anything at all. The system exploits the poor!”

The nine men surrounded the tenth and beat him up.

The next night the tenth man didn’t show up for drinks, so the nine sat down and had beers without him. But when it came time to pay the bill, they discovered something important. They didn’t have enough money between all of them for even half of the bill!

And that, boys and girls, journalists and college professors, is how our tax system works. The people who pay the highest taxes get the most benefit from a tax reduction. Tax them too much, attack them for being wealthy, and they just may not show up anymore. In fact, they might start drinking overseas where the atmosphere is somewhat friendlier or not reinvest in the community.

Just some food for thought…

But how did we get here? Why are people defaulting on their mortgage payments? And what effect does this have on the markets and economy?

The explanation begins with a description of a special kind of loan employed by many homeowners with less than perfect credit, or those that may be borrowing more than they can afford – an adjustable rate mortgage (ARM). These mortgages often come with a low introductory “teaser rate” that makes the loan seem cheap. However, after a certain period of time, the loan’s interest rate “resets” to a much higher rate (often higher than the borrower can afford to pay).

So why would a borrower agree to an adjustable rate mortgage, knowing that the higher rate is more than they are able to afford? Many times, these loans are made to people with poor credit, and are the only kind of loan they can get. They’ll often take a short-term view and sign the loan, hoping to be able to refinance before the higher interest rate takes effect.

Another major contributing factor has been the United States housing bubble. In 2005, home prices were higher than they’d ever been, and seemed to have nowhere to go but up, having experienced price appreciation of 10% or more in each of the previous 4 years. Real estate was the hot, “sure thing” investment. Home buyers had no problem signing an ARM, because they assumed that as the price of their home continued to rise, they could either refinance or flip the house before the higher interest rates kicked in.

Just one problem – bubbles burst. By 2006, housing prices had peaked. Throughout the year, they corrected downward, and by the end of the year, had experienced double digit declines in some markets.

By this time, all those ARMs signed in 2005 are beginning to “reset” to much higher interest rates – often more than doubling peoples monthly payments. Faced with payments far too high for their budgets, people normally would sell the house and “buyout” the mortgage with the proceeds. However, real estate prices are substantially lower than they were in 2005 – meaning that selling the home would not net nearly enough to cover the amount of the mortgage it was purchased with (at inflated 2005 prices). So, unable to meet their monthly payments, and unable to sell their homes for enough to buyout their mortgages, this leaves the homeowners only one option – default.

When homeowners default on their loans, banks do the only thing they can to recover their money – seize the property pledged as collateral (the home). However, this does not solve the problem. Now the bank is stuck with a home that is a.) very illiquid, and b.) still not worth enough to cover the amount of the loan. So, the bank does the only thing it can – sells the house at auction, usually for a price far lower than what it is worth, in order to recover some of its money. This has the side effect of increasing the supply of houses on the market, which further depresses home prices, creating a vicious cycle.

Though banks have lost millions of dollars in the above manner, it pales in comparison to the billions lost in mortgage backed securities. What is a mortgage backed security? Once a bank has made thousands of mortgage loans, they often package up all the loans together and sell them to investors as bonds. Initially, everyone on Wall Street thought that these bonds were very safe investments (AAA rated, the highest possible) with very little risk of default. After all, home prices were on the rise, and the banks could always seize the valuable real estate collateral if people defaulted. Investors bought these mortgage backed securities by the billions of dollars. Soon however, the forces detailed above began to take effect. Real estate prices began to fall, and homeowners began to default in larger than expected numbers. Quickly, these mortgage backed securities didn’t look quite so safe any more.

As uncertainty about borrowers ability to repay spread across Wall Street, ratings agencies began to downgrade groups of mortgage backed securities (to AA or even lower) – officially indicating that they were now perceived as more risky by the investment community. On Wall Street, when all other things are unchanged, a safe investment is preferred to a risky one. Thus, the newly downgraded mortgage bonds suddenly fetched much less on the open market. Overnight, a bank that thought it was holding $100 billion in safe assets found that those same assets could only be sold for $75 billion – if they could find a buyer at all. As fears spread about just how risky these mortgage bonds might actually be, no investors wanted to touch them until the risks became clear. Because of this, the market for mortgage bonds dried up rapidly, casting the true value of the bonds into even further doubt – after all, if you can’t find a buyer for something, is it really worth anything at all?

So, in summary:

• The real estate bubble is bursting
• Homeowners across the country are stuck with mortgages they cannot afford
• Many are losing their homes as they cannot make their payments
• Banks have lost billions of dollars through defaults and writedowns on mortgage backed securities

I hope I’ve done a decent job of laying out the reasons behind the current crisis, as well as explaining to the uninitiated how they interacted to cause a large amount of pain for homeowners, mortgage lenders, and investors. Next time, I’ll stray from the purely objective and give my opinions on the predicament of homeowners (they’re getting what they deserve), as well as my thoughts on the proposed “bailout” plans by the leading presidential candidates (unfair, economically unsound, and socialist). Stay tuned.

Offer price: $500
Pages ad would be placed on: 6
Duration of Agreement: Forever

Bloggers, let me ask you – does that sound like something I should agree to? On one hand, you might say it’s pretty good for a personal blog I write in my free time. However, once we break down the numbers, we’ll see that it’s not.

My reasoning hinges on understanding two financial concepts – opportunity cost and net present value of a perpetuity. I’ve linked those terms to explanatory articles – make sure to have a basic grasp on the two terms before we move forward.

While the $500 sounds pretty good, we can use net present value math to convert the one time payment of $500 in today’s dollars to its equivalent amount in yearly payments, every year, forever. Because we’re working the formula backward, I will use $500 as the net present value (what I would be paid today), and solve for the equivalent yearly payment amount. I will use 4% as the risk free rate, which is just slightly below the return on a US Treasury Bond.

Net Present Value = Yearly Payment Amount / Risk Free Rate of Return
NPV = P / R
$500 = P / 0.05
$500 * 0.05 = P
P = $25 per year
Because the original $500 was for advertisments on 6 pages, divide the final number by 6:
$25 / 6 = $4.17 per page per year

So it turns out that the $500 offer is really equivalent to only $4.17 per ad per year! And not only is that rate extremely low, I’m locked into it forever! It doesn’t seem like nearly as good a deal anymore does it?

Things start looking even worse when we consider the opportunity cost of taking the offer. If I agree to place new ads on my pages, they will replace the Google Adsense ads that exist there now. This means that I would forego the revenue I would normally receive from those ads. That lost revenue is my opportunity cost.

The Adsense banner ads at the bottom of each post don’t do particularly well, but, for estimation purposes, they return about $10/year. This is obviously higher on more popular posts and lower on less popular ones, but $10 is a good average. So, by accepting this new advertising offer, I will be earning $4.17 per page per year from the new ads. However, I will also be foregoing $10 per page per year from Adsense. This means that I will actually be losing $5.83 per page, per year, FOREVER if I accept the offer!

So it turns out what looked like a good deal from the beginning is actually not such a good deal after all. Bloggers – as you consider ways to monetize your blog, be very careful to weigh your alternatives and consider your opportunity costs. Also remember – forever is a long time to be locked into anything, especially a contract that could be costing you money!

Note: If you want to learn more about present value and the time value of money, checkout this powerpoint from the University of California, Santa Barbara.

Another Note: I’m not writing this blog for the money. Anything I take in goes first to cover hosting, and whatever is left over I loan out to budding entrepreneurs in the developing world using Kiva.org. It’s a way to give back to the entrepreneurial community that brings a lot of personal enjoyment for me. You should all check out Kiva, it’s very cool.

• DealBreaker – Set this one as your homepage. Updated between 5 and 10 times daily, DealBreaker brings you the real news with hilarious commentary. A perfect blend of humor and fact.
• The Leveraged Sellout – Written anonymously, this blog is a scathing, sarcastic critique of the Wall Street culture and the people who exemplify it. A favorite around the office.
• Banker’s Ball – Another New York lifestyle blog written for the banking audience. Occasionally runs some great articles, but only updated once a week or so.
• iBanking Oasis – More of a forum and less of a blog, the homepage stories are selected daily from threads started by visitors. The discussions are enlightening, but often laced with a bit too much machismo. Still a great resource.
• The All Nighter – A satirical look at investment banking from a junior perspective. Funny articles that any I-Banker can relate to.
• Under the Counter – This blog focuses on the people that run Wall Street and make tons more money than I ever will. Also sometimes strays to macroeconomic topics.
• Going Private – The tagline says it best: “The sardonic memoirs of a private equity professional”. This blog covers all things PE, with the occasional extremely insightful post on industry trends and our perceptions of the market.
• Living the Dream – Another humorous take on Investment Banking, unfortunately less frequently updated than some of the others on this list. The post on the 5 stages of banking is a classic.
• An Investment Banker’s Take on Life – I became a fan of this one after the author ran a series of five posts detailing the history of investment banking, starting even before John Pierpont Morgan’s arrival in New York City in 1857. He’s now begun a similar series on Private Equity that is equally interesting.
• The Stalwart – This one reads like an online version of the Journal or The Economist, though slightly less formal. Some interesting articles, and not always centered on business.
• Trader Mike – The list wouldn’t be complete without a trading blog. Not much humor here, just an interesting look at the market as well as individual stocks. Also gets into some trading strategy, and is definitely not too complex for a beginner. A solid, educational read for those wanting to learn about trading.

That’s all I have for now, I hope I’ve been able to add a few links to your bookmarks/RSS readers. Now you tell me: Have I missed any? Share your own favorite links in the comments.

Specifically, my ~70 hour weeks are spent making pitch books, models, doing equity research, and developing value added ideas for our clients. Almost every day I deal with a new company, a new deal, a new industry segment. I’m learning a lot, not just about the sectors we deal with, but about investment banking in general. So I’m creating a “Finance and Economics” category here on the blog, where I will post general tips, lessons learned, and my own distilled experience.

I’ll do my best to post regularly, both for my own benefit and everyone else’s. Hopefully this category can become a reference for college students wondering what investment banking is like.

1.) Be accomplishment-driven not responsibilities-driven
Eliminate phrases like “duties included” and “responsible for” from your resume. Most employers can easily infer from a job title the basic responsibilities you had. Instead of listing them, describe how you applied your personal skills on the job – your work ethic, ingenuity, etc. These are the skills that translate across jobs, and that employers are looking for.

2.) Focus on describing skills demonstrated, not activities done
When writing about your past experiences, try to focus on the skills you demonstrated at that job, rather than just describing what you did there.

3.) Use powerful verbs
Don’t start sentences with “I”. Rather, begin with an action verb such as “managed” or “coordinated”. The noun is unnecessary, clearly you’re describing yourself!

4.) Justify your text, don’t use left align
Justified text looks better on the page, because it fills up the entire line. It will also help your resume stand out from everyone else’s with left aligned text.

5.) Use a standard font, but not Times New Roman
Another tip to make your resume stand out in the pile. Don’t be temped to use any curly or outrageous fonts. Pick something businesslike and relatively plain, such as Georgia, Arial, or Trebuchet.

6.) Send your resume in PDF format, not MS Word
When sending your resume electronically, make sure you save your resume as a PDF file. The best advantage to you when using PDF is that you ensure your formatting remains intact. Spacing, fonts, emphasis, margins, everything is preserved when you convert to PDF. No matter what, your resume displays the way you want it to. The only exception to sending in PDF is when a company specifically requests a resume in a certain format (usually because they plan to process it electronically).

I hope these tips are useful to all the job/internship seekers out there, especially college students who may not have written a resume before.