Ted Audio Collective Hello everyone.
You're listening to After Hours.
I'm Felix. And I'm Mihir.
It's the two of us.
Mihir, there's something I wanted to ask you for a long time.
As a finance professor, when you think about your personal finances, is that you don't have to think about it much because you feel so in control?
You just know things?
Or is it because it's also the object of your study that maybe you're more ambitious, maybe you're more sophisticated about what you do?
Do you think it plays a bigger or a smaller role in your life, the personal finance stuff?
Yeah, that's a great question.
I don't know if I've ever thought about it because I don't really think about what it would be like not to be a finance professor.
Yes, yes. I think the really interesting thing to me about it is you really want to be disciplined about it.
And you realize how easy it is not to be disciplined.
The foundations of finance are deeply embedded in me, so I think about them a lot.
But then you still realize that when you're making your own personal finance decisions, it's easy to deviate because you're like, well, wait, why not do this kind of crazy thing?
So, the challenge is to stay true to all that.
And that makes it really fun.
So, I think actually this is good, Felix, because I think we got some financy topics.
I got a financy topic.
Do you got a financy topic?
So, I would like to talk about Bed Bath and Beyond, a company that seemed very close to bankruptcy and now we got saved.
I think in a really interesting and unusual way.
And I'm curious to know, does it make sense?
What are the players thinking?
I have more questions than answers on this one.
Okay, God. Well, me too as well.
But let's try it. And then in our ongoing quest to challenge our listeners' affection for us, I thought we could talk about annuities.
We've talked about Fire, which is the financial independence retire early.
We talked about financial regrets.
And actually, annuities are this super interesting product that are kind of related to all those questions.
And so, I'd love to talk a little bit about them and some of the puzzles about annuities.
Fantastic, let's do it.
Excellent. Okay, Felix, Bed Bath and Beyond, one of those great meme stocks.
What do you think is going on?
So, Bed Bath and Beyond is a Home Goods retailer, and it's an older and beloved brand.
It had a really great reputation for so many years.
It started in the early 1970s, and the company did really well.
Reminding me, in some aspects, a little bit of Walmart.
It was a very frugal culture, very careful about both controlling growth, but also controlling costs throughout the organization.
And they became famous for essentially having branded goods at discounted prices.
But then, I think probably the truth is, it wasn't an easy retail environment to begin with, and they missed the transition to e -commerce a little bit.
Probably, the company is also somewhat unlucky in that the kinds of things that they sold, it's really easy to transfer to e -commerce, unlike say, maybe clothing or shoes, where it's a little more complicated.
So, it's a combination of both having missed the train to some extent and then being in the midst of the e -commerce revolution.
So, you would just see sales falling over time, company valuations falling over time.
And then, as you alluded to, it became this meme stock.
All of a sudden, people seemed to love it.
Everybody jumped on the bandwagon, individual investors.
And then, typically for meme stocks, you see this eventual decline.
They had a second mini peak in January.
I think there was some rumor that they might be acquired.
But things really didn't go well overall.
So, in the end, the last couple of weeks, even creditors froze, credit lines.
Everybody expected the company to go into bankruptcy.
They closed stores because they didn't have access to credit.
If you went to some stores, actually, the shelves were sort of empty because they couldn't build inventory anymore.
And then, the most interesting thing happened.
So, Hudson Bay Capital, a hedge fund, along with other investors, worked out this deal to save the company from bankruptcy.
And, of course, the last thing you would ever do is buy equity of a company that goes bankrupt because you're unprotected as an investor.
But that's exactly what they did.
And the way the deal worked was about $200 million or so that they invested in preferred shares.
And it came with an option to convert right away.
And the conversion was very favorable to Hudson Bay Capital.
So, at the time when they closed the deal, they were able to purchase shares at roughly $3.
I think as long as the shares don't trade lower than $0 .70 or so, Hudson Bay Capital and other investors will actually have a guarantee.
It also comes with warrants for an even much larger amount, $800 million, same kind of conversion.
And that's interesting because that's actually a larger number of common shares than even exist today.
It's an interesting trade that reminds me a little bit of what happened with AMC when it was a preferred stock by individual investors.
And I'm curious, what do you make of it?
Does this make sense?
Is it going to save the company?
Is it just a brilliant financial move at the expense of individual investors?
How should we think about what just happened?
God, yeah, it is a crazy story.
And it is this ongoing saga of meme stock frenzy just continues to play out.
I'm kind of reminded of this quote, history repeats itself, the first time is tragedy and then is farce.
This is like the farce version.
The whole thing strikes me as vaguely tragic, but this is really the farcical part.
The interesting thing is you would think to yourself, this makes no sense.
As you put it, Felix, you're investing in equity of what is an entity that is highly at risk and whose bonds, by the way, trade on pennies on the dollar.
So the lenders are thinking it's worth nothing and they get paid before the equity holders get paid.
So then you're asking yourself, well, then this is a super stupid thing to do.
And the answer is, yeah, but not if you can effectively take advantage of those retail investors.
And that I think is what this is.
So one of the pieces that's fascinating about them is the turnover, which is the daily trading volume in the stock is enormous.
There are maybe 100 million shares outstanding.
But on a daily basis, sometimes 200 million shares will trade hands, which is crazy.
So that's more than the actual number of shares outstanding are trading.
So you can just imagine there's lots and lots of people trading.
So what does that allow for?
Well, first off, that allows for prices to be volatile because everyone's punting.
And if everyone's punting, there are possibilities for this stock to go up and for the stock to go down.
And that's of course exactly what we've seen.
These fluctuations in a band between $3 and $6 and every day you have no idea what's going to happen next.
That's right. And in those settings where there's like a lot of volatility, the beautiful thing to do is to have an option of some kind because then you can exercise that option at the most opportunistic time.
So they've structured it so that basically they can take advantage of periods of periods where there has been some kind of a low point and it's quickly followed by a high point.
And in those settings, they're able to buy it at a discount to the low point and then immediately sell it out at that potential high point.
And here's the trick.
They think they're going to be able to immediately sell it out because the volumes are so high.
The volumes are like the key piece of this.
Because otherwise, if there wasn't a lot of trading, you wouldn't be able to get out of the position.
There will be no one else on the other side.
Exactly. So there's a part of finance, which is wonderful, which is we fund enterprises that are going to grow and we provide capital and we create value.
And then there's another part of finance, which is greater fool.
Some version of I buy low sell high and then take advantage of someone else's misplaced optimism.
And just to be clear, big chunks of venture capital and private equity are that this is an extreme version of that.
Literally the greater fool theory, which is all I need to do is to make sure there's enough greater fools out there.
And they believe this for just enough time to make it all kind of work up.
And then, oh, by the way, they have these warrants on top and these additional warrants on the actual common stock.
So I don't know Felix, it all to me feels a little bit depressing as this meme stock saga just plays out way longer than it should be.
Am I a hopeless finance romantic when I think there might be an angle to the story that could be good for the company also?
So if the entire capital injection happens, it will be about a billion dollars or so.
That's right. On a much reduced number of stores, that's an okay amount of capital to play with.
Because in 2019, activist investors pressured the company and they brought in a new CEO and the new CEO's direction was essentially a departure from what BitBath and Beyond was all of this time.
So he tried a private label play, the idea being that if you don't have to pay for the brands, you can be even lower cost and in a situation where you have trouble competing with e -commerce, maybe that gives you a second lease on life.
And that backfired dramatically because when the loyal BitBath and Beyond customers went to the store, their first experience was that they didn't see any of the brands that they expected.
The whole point of the store was that you would see brands at an unusual price point.
And then of course, once the brands were gone, essentially sales declined very quickly.
Now that we know that that's not a feasible path forward and the company has a little bit more time and has some capital, can now probably get some credit lines from maybe the old financiers, maybe new relationships also.
So is there a chance we might look back and say ultimately it's safe jobs, safe the brand that people really respected for a very long time?
I think that's a reasonable way to think about the world.
And the reason to think like that is if you think it's a little bit of a death spiral that they're in, which is they can't get inventory because they can't get credit.
And if you can't get inventory, then you can't get customers.
And if you can't get customers, then you can't get credit and then you can't get inventory.
This is the death spiral of retail.
And that's really, really hard.
And if you can arrest that even briefly, then you can potentially reverse it.
The problems at Bed Bath & Beyond have been going on for quite a while.
And I don't think it is a temporary injection that they need.
I think it's a little bit more permanent capital that they need.
Now, this could be capital that will help them arrest that.
And in fact, they can use it to buy inventory.
They can use it to pay off creditors.
They can use it in lots of different ways.
I think you're right.
That's the way it could play out.
It's low probability, but it could play out that way.
And of course, Hudson Pay will characterize themselves as saviors in that outcome.
Good returns and save the company.
Right. But I don't think that's their intent.
If that were their intent, then it would have been structured, I think, quite a bit differently.
But the specifics of the way they're doing it and the reliance on basically exploiting the common shareholders below them who we know are very volatile, that's what makes me think it's not that great.
I mean, the most charitable version, which you just said, which is we're helping the company.
And by the way, we're willing to do it because we're underwritten by, effectively, the retail investors who will do this crazy stuff up and down along the way.
That's right. That's, I think, the most charitable version of it.
The least charitable version of it is they don't really care.
They know there's going to be volatility.
And one of the things about the meme stock thing that I don't think people realize is hedge funds have adopted it in a way.
Yeah. That volatility that the retail investors created that was supposedly handed to the man by taking these hedge funds who are trying to short some stock and make it all run up, it turns out that the hedge funds have co -opted that game and have begun to play that game a little bit themselves.
And so I don't think it's entirely a benevolent strategy.
But we could all look back on this and feel like, oh, yeah, that was kind of cool what ended up happening.
But I don't think that's their intent.
The pattern is definitely visible.
Madre Capital played a very similar role in AMC.
Ultimately, this was just about exploiting meme stock, as opposed to trying to save the company.
But what does it look like relative to bankruptcy?
So say if we think somehow this gives them at least a window to rethink.
I think one of the things that the company has done that is actually quite interesting is the inventory problem that they have.
They tried to concentrate it in that they have a few stores that look like the store you recognize and it's fully stocked.
And so all the inventory goes into a few places.
And you can imagine even a relatively shorter window will allow you to keep these few stores fully stocked, but then also just expand the number of stores.
It's probably still too many stores.
I think they have decided to basically let Canada go, which seems a reasonable decision.
But if they can expand the footprint on some number of stores where they're fully stocked over some time, isn't that preferable to bankruptcy?
I think that's right.
Again, predicated on a good outcome.
Your outcome is a good outcome and that is preferable to bankruptcy.
I think the more likely outcome is bankruptcy down the road.
And what we've done is delay bankruptcy from today till maybe six months from now.
And then the question I want to ask is, is that a good thing or a bad thing?
The way to think that through, I think is a little bit hard, because who cares what happens for six months, if that's all that happens to the operations.
The players here who are worth thinking about that we seldom think about are in fact the lenders.
One of the curious things that happens during a bankruptcy is that the so -called owners who are the equity owners are people who control the assets.
But actually the people who are really owning the company are the lenders because they're underwater.
And so the other angle on this that's fascinating is it's actually weird in bankruptcies because owners have all the wrong incentives because they want to kind of jack up the volatility of a business because it's heads I win, tails you lose.
So why not just shoot for the moon?
And so the other possible outcome here is that they effectively do that, that equity holders get another lease on life, management gets another lease on life and then they shoot for the moon.
And when they shoot for the moon, maybe your story comes about Felix, which is great and everybody wins.
Or maybe they shoot for the moon and they basically destroy a lot of value that the lenders would have gotten if they'd gone bankrupt earlier.
Yeah, that's a hard logic to think through.
But actually in bankruptcies, that's a lot of what's going on is the conflicting objectives of equity holders and debt holders.
And that's kind of what's playing out here as well.
And the delay is also maybe not that meaningful in a job market that is as strong.
You would typically worry about all the people who lose their jobs if ultimately the company doesn't get out of bankruptcy.
But in a market where the jobs are so easy to come by.
That's probably less of a consideration now than it would have been at other times.
I think that's right.
And then the other pieces of it is also there's a lot of real estate leases and there's a lot of inventory that can get reallocated.
And maybe that'll be more valuable today or more valuable later.
I don't know how to think that through.
But if you think we're on the precipice of a recession of sorts, then the longer you wait to have this reckoning, then perhaps the worse it is for the people who are not just the creditors, we talk about them like they're whoever, but you know, you're a supplier to Bed, Bath and Beyond.
And you know, you're kind of wondering if you're going to get paid and those are other businesses.
So that's the sense in which it all feels a little bit unfortunate.
But I would love to be back in six months and celebrate.
Yeah, exactly. We hear annuities.
It's such a wonderful idea.
Yes. We all don't really know how long we're going to live.
And so the idea is paying someone and then the someone will give you a paycheck for the rest of your life.
Fabulous. What could be better?
Yeah. And then they have a really complicated reputation.
So that's exactly right, Felix.
So let's just anchor people's ideas in what they might think about more naturally.
Most people worry about dying.
And that's called mortality risk.
And the reason you worry about dying is because then maybe your family won't be well off.
And so you buy life insurance.
Turns out there's another risk that gets a little bit larger as you get older, which is you worry about how long you're going to live for.
That's called longevity risk.
Now, in this case, the quote unquote bad outcome is you live too long.
And now you might say to yourself, why is that a bad outcome?
And the answer, of course, is well, because you have to then think about your resources.
And if they don't last, that's a problem.
So annuities are a solution to that problem.
You pay an insurance company a big chunk of change and then they offer to give you some kind of a return over time, often until the time that you die.
And so effectively, you're annuitizing your wealth in that way.
And it solves the problem of I don't know how long I'm going to live and I need money coming in for as long as I live.
And the insurance company has a really fabulous opportunity to pay you quite generously because over all the people who have bought an annuity, some of them will die early.
And so you can then redistribute that income.
And so typically, when you compare the rates of annuities to the rates of, say, CDs, you can be a little more generous because not everyone will live much longer than they had expected.
It's kind of a classic pooling idea, right?
And then the market is tiny.
It's just remarkably small.
Nobody does it. Why does nobody want to annuitize?
So there are a couple of answers to that question.
And it kind of goes to topics we've talked a little bit about, like financial regret and fire.
If you think about the fire movement, if you want to retire when you're 40, how do you manage that risk?
Which is you have accumulated so many assets and you're going to live for maybe 50 years longer and you don't know if it's going to be 30 years or 70 years.
And similarly, the financial regrets episode that we talked about.
So why might this be?
So first is, well, there is some annuitization going on with things like Social Security.
So maybe that's enough annuitization to make people feel okay.
Second possibility is there are some forms of annuitization that we don't call annuitization, but they really are.
Like owning a home.
Well, when you own a home, you're basically annuitizing because you've bought housing services until you die.
And Medicare is a little bit like that too.
But the more interesting versions, I think to explain why so few people do this, one is related to just human psychology and our perceptions of how long we can live.
And maybe the other is just about the way the finance industry has developed this industry.
So on the first, it turns out people are remarkably pessimistic about how long they will live, certainly around the ages of 50 or 65.
I have to say, I'm in that group as well.
When I first looked at the tables, this is how old I am.
And then what's the probability of living until 80, 90, 100?
The probabilities were so much higher than I had expected.
I thought there's no chance I'm going to be 100.
And then it turns out, no, that's actually not right.
It's weird, right? You know what average lifespans are, call it 80 plus for men and even more for women.
And conditional on being alive at 50 or 60 or 65, it's even higher.
It's just different.
It's different. But then we think to ourselves, yeah, 75, 80 max.
And it turns out that there's a substantial risk of people living longer.
And of course, especially if you think about today with the demographics, it's getting even bigger.
So that psychology might be a play, which is people just don't think they're going to live that long.
Which, by the way, ties to our financial regret story, which is maybe what's happening is people don't understand that they're going to live that long.
And then guess what?
You have to suffer a decrease in living standards later to do that.
The other possibility, by the way, is all of this is happening in some ways in families.
Maybe there's a couple and you're kind of like pooling across the couple, or I expect my children to take care of me.
Or some version of that maybe is helping to solve this problem.
But the basic facts are pretty hard to reconcile.
And then Felix, the last part is what you referenced, which is, have you actually shopped for an annuity?
I have not. It's bonkers bad out there.
What do I mean by that is, I'm a finance professor and I look at some of this stuff and it's mind numbing.
It's like a deferred variable and a fixed equity annuity.
And the jargon and the terminology is really difficult to piece through.
Yeah. And so the interesting thing to me about this industry is usually the financial industry is pretty good at taking a product and then driving it home, like mutual funds.
Yeah. They just made mutual funds into a huge industry over the last 40 years.
Somehow they haven't figured out how to do that with this product.
Yeah. Instead of simplifying it and making it accessible, they've complexified it to like the nth degree and made it completely inaccessible.
So that's the other piece I think that's going on.
One mistake that strikes me as almost inexplicable is that there are products that are called annuities, but they're more on the wealth building side.
Yes, exactly. Where you give up some of the upside of financial markets and then they insure you against a big moves in the stock market.
Yes. These products I think are so different from the problem we just talked about, but for some inexplicable reason, we call both of them annuities.
And then of course we have to be much more specific.
And so that's how you get to the 182 word description of what that financial product actually is.
Right. So that to me from a marketing perspective, I totally don't get.
And then I think a second concern is the commissions.
Yes. At least traditionally commissions were just sky high.
It looked like there was an opportunity to redistribute some of the benefits of annuities to the people who live the longest.
Right. But of course the option is always that actually all of that is just generating a nice profit for the insurance company.
There's no guarantee that the redistribution that is possible in theory will actually benefit those who have purchased annuities.
And I think both of these coupled with sales tactics really have undermined the reputation of a product that could be so helpful to so many families.
Yeah, I think you're spot on on both those points, Felix.
And I think they're connected.
So the first point is really important, which is in many countries, the insurance industry has been taken over kind of by the investment management industry.
So there is an insurance component to these products.
Think about term life or think about annuity.
Yeah. I'm ensuring against the risk I die or I'm ensuring against the risk I live too long.
But then they bundle it with a whole bunch of investment products.
Yeah. So that's whole life and that's all these other things where you bundle it with investment management and then they're like, oh yeah, give us your capital and we'll invest it in this funky way.
And then that'll deliver superior returns or similarly with annuities died.
And that's where you get to your second point, which is then the fees come in because that becomes a way to actually hide a lot of fees basically because the returns are uncertain and then you load it with fees.
And then by the way, you're also making the whole purchase a lot more complex because what you're buying in reality with a lot of deferred annuities is some combination of a bond portfolio with some derivatives mixed in and like a whole bunch of funkiness.
And then you're like, what have I bought?
And unfortunately, I think it's an effort to in a very low rate environment juice returns.
And then it's also an effort in a way to kind of masquerade a lot of fees.
I just wish there was a world in which the insurance providers would provide insurance as opposed to bundling it with so much investment management because that's effectively swamping these other kinds of needs, which actually people have that are real.
Yeah. At the same time, we are at a point now where many more people think about annuities.
Part of that has to do with changes in the stock market, obviously, that all of a sudden, if you saw you could retire in a year or two, things might look very different for you.
And so you need to postpone, which interestingly, if you postpone getting social security, that, of course, has an annuity aspect also.
It's like an annuity, in fact.
Yeah. But the other change that I think is important is that it used to be very difficult to buy annuities out of your 401k.
And now, as a result of a change in rules, many more people will have an option to do this.
So given where we are with the stock and the bomb markets and given these new opportunities that come with 401k accounts, is it something that people should look into?
Is it something where this is such a complicated decision that the best thing you can do is ask your financial advisor, what's the right approach?
Yeah, it's complicated.
In addition to the things you just mentioned, I'll just mention one more in terms of developments that might make us want to think about it a lot more, which is, as interest rates rise, then it's also conceivably quite a bit more interesting.
And then finally, inflation is back.
And so if you are worried about that risk, which is, wait a second, I'm not going to be making income, and I may be living longer, and inflation might be around.
That's a really tough set of circumstances.
So the short answer is, I think annuities actually do make a ton of sense.
And they should be some fraction of your portfolio.
It's really worth thinking about doing.
And in particular, the ones that offer you inflation protection, I think are really interesting, because that's the real risk, that you retire when you're 60 or 65 or 50, and it's 30 years later, and inflation is a lot higher, and you want protection from that risk.
Now, Social Security is somewhat indexed for inflation, maybe your house is helping with that.
But the reality is, that is the big risk that we have not thought a lot about in the last 30 years.
So my instincts are, it's time to revisit this.
And actually, if you keep your eye, not on how do I get a higher return, but you keep your eye on, how do I basically insure myself against the risks I face, and the risks I really worry about, then I think it's a great thing.
The one piece of advice that I have seen that makes a lot of intuitive sense to me is to start with the income that you will get from Social Security.
And you know that's inflation index.
So that's great. And then think about, what are the financial obligations that I will always have that will not go away?
Maybe it's a car payment, maybe it's a mortgage that you have.
Just sum up everything where you know over a long period of time, even if your tastes change, if maybe your health is no longer so great, those are just fixed expenses that you will always have.
And then check whether there is a difference between the expected Social Security payments and those fixed obligations.
And that's maybe where annuities can play a really useful role because they provide certainty for a fraction of your finances where you have at least a semi reasonable way to predict what they're going to be.
To think through living too long is a hard thing to think through.
What does the world look like if I'm alive and I'm 85 or 90?
Just trying to socialize these ideas, not necessarily with an independent financial advisor, but just with your siblings or with your friends or your loved ones or whoever you have.
With your finance professor, maybe.
There you go. And you know, by the way, the other piece of this is we have a lot more households led by single people.
And then a lot of the risks that we used to pool inside families are no longer getting pooled inside families.
They're the fastest growing demographic around.
And that is something that you really want to think through and get help and talk to each other about how you want to manage that risk as you get older because it's a real risk.
Now, I have one last question for you, me here.
Is this the kind of episode where we need one of these disclaimers where someone in a very low voice will speak very quickly and make a million excuses by acting on what we just said is your responsibility that has nothing to do with the people who appear?
I was thinking we might need a disclaimer like this is the most financy, wonky episode ever.
I think that's the disclaimer we might need.
Helix, recommendations.
Don't tell me it's like a deferred variable annuity from Nationwide or something.
And I'll earn the generous commission for everyone that is sold here.
I wanted to recommend a book by Jennifer Nown called Bodies of Light.
I have to say a little bit of hesitation if I should recommend it or not because it's heartbreaking.
It's the story of a person who grows up in the foster system in Australia.
And her life is just incredibly hard.
It's full of disappointments.
It's full of difficulties.
It has all the challenges of building meaningful relationships if you're pushed from one place to another.
I think the way I got to recommending it is even though it's such a tragic book to read, there's something about the resilience of the main person and this ability to find joy and satisfaction and meaning under the most improbable circumstances that you ask.
Is it a sad book to read?
Yes, it's a really sad book to read.
And does it make you somehow hopeful at one and the same time?
And that's also true.
Oh my God, that sounds fantastic.
Sarah mentioned this book, Educated, which also I loved by Tara Westover.
It sounds a little bit related.
That sounds great. Yeah, I think the two are related with one another.
What do you have me here?
So I love when two artists who you would never put together collaborate on something.
And I was reminded of my affection for these projects recently because one of those collaborators on one of my favorite collaborations passed away and that's Bert Bacharach.
So Bert Bacharach was this songwriter from the 70s and 80s.
And it was kind of poppy stuff, beautiful, beautiful songs.
He collaborated with another one of my favorite artists, who's Elvis Costello in the late 1990s.
I remember. So Elvis Costello, you might remember, is like a new wave, punky guy from the UK, came out in the mid 70s.
And they released an album together called Painted from Memory, which is just the most beautiful album ever.
I love it. In part because it's two people who have come from such different backgrounds collaborating and they turned into a great friendship.
So Bert Bacharach passed away last week and Elvis Costello is in fact on tour in New York doing an incredible set of shows.
And I will just say I listened to that album Painted from Memory for the first time, kind of at a difficult time in my life.
And the album is quite melancholy.
But if you are going through a difficult time, that album Painted from Memory by Bert Bacharach and Elvis Costello is just a gem.
So given his recent passing, I'm going to recommend Painted from Memory.
Wonderful. Yeah, it's such a great album.
These unusual collaborations, they're always interesting.
I was reminded of Tony Bennett's collaboration with Lady Gaga, which is also one of these combinations you never did.
Like what is it about the two?
And then they create something that is quite interesting and Painted from Memory through as well.
It's really fun when that happens.
Wonderful. Excellent.
This was it for today.
Thank you everyone for listening.
This was After Hours from the TED Audio Collective.
Thank you.
