Saturday, January 24, 2009

Our Resilient Economy: Remembering Nixon's Wage and Price Controls

Last year's ineffective tax rebate checks for how many hundreds of billions of dollars? I can't even recall.

The badly-managed, ill-conceived and ineffective TARP for $350B, with another like sum to follow this year.

Now, a $1T+ 'stimulus' plan to allegedly fix an economic recession. Except the larger part of the economic shrinkage is due to deleveraging, more than recession. And spending doesn't fix recessions, it only adds to government debt.

Still, we've endured worse. Perhaps the very worst, the nadir of America's free-market economy, was the 1971 imposition of wage and price controls by Republican President Richard M. Nixon.

Having defeated the hapless socialist Senator from Minnesota, and sitting VP, Hubert Humphrey, Nixon was viewed as a cold-hearted, paranoid conservative. If any Republican in then-recent memory embodied corporate politics, it was Nixon.

Yet, in what was to become a new paradigm for US Presidents, the ardent cold warrior opened China. And, as conservative, business-supporting President, he crossed over to commandeer the economy though cumbersome wage and price controls. All because inflation rose to the then-scary range of 2-3%. Union demands drove wage increases beyond prior experience.

Just about two years later, on January 11, 1973, Nixon called the whole thing off, ending the two-year travesty.

Later, in the late 1970s, Jimmy Carter almost instituted gasoline rationing. My girlfriend in the early 1980s had worked on the program for Energy Secretary James Schlessinger as a consultant at one of the beltway firms.

Yet, some thirty-five years later, in the mid-2000s, our economy had risen to unbelievable size and prosperity.

Ronald Reagan's tax cuts, Paul Volcker's steady hand at the Fed, and American enterprise combined to usher in the most productive, wealth-producing era in modern American history.

If our economy could withstand the body blows of Nixon's wage and price controls, Carter's energy policy, and even, before both of them, LBJ's inflationary financing of the Vietnam War as he raised taxes, it can also probably survive the current tough times, and those to come.

There's still hope for the US economy not because of, but despite, the planned programs of Congress and the administration.

Friday, January 23, 2009

GE's Weakness & Immelt's Defense

Well, it's GE earnings time again. And time for its inept CEO, Jeff Immelt, to bluster with excuses about his weak leadership of the ailing conglomerate.

I caught some of King Jeffrey I's interview with his own minions on GE-owned CNBC this morning. Salient among Jeff's various excuses was this gem, as closely paraphrased as I can recall,

'We made $4 billion last quarter. I'm not apologizing for that.'

My old boss at Chase Manhattan Bank, Gerry Weiss, then SVP of Corporate Planning, and a longtime GE senior planning officer, used to comment on the inertial earnings power of large companies.

At Chase, he noted, we made enormous profits just by being one of the three largest US commercial banks. In fact, he would frequently say,

"We make money in spite of ourselves."

But that line of reasoning, as Gerry also noted, is inherently flawed. It ignores returns on equity, market value, or even assets. It's a desperate play for the shock and awe of big numbers.
As the nearby 1- and 5-year price charts for GE and the S&P500Index indicate, shareholders have voted, via price, that Immelt's profit numbers are not acceptable. Over the past five years, GE's price has fallen at a faster rate than the S&P. In the past twelve months, GE's earnings have apparently continued to disappoint investors. Just this year, the company's stock price has declined faster than the price of the S&P.

GE had, as of last quarter's report, assets of $829B. On that basis, $4B of quarterly earnings doesn't seem all that awesome, does it?

For Immelt to resort to that is an indicator of just how desperate he is to somehow explain GE's sudden collapse under his mismanagement.

Microsoft Cuts Workforce, Ends Growth Era

Yesterday's pre-market open announcement by Microsoft that it is cutting 5,000 of its 91,000 employees marks the first time the company has trimmed its workforce.
For some, this is a sign that the firm is no longer a high-growth technology company. For me, though, charts like the one nearby have said it for years, as my prior posts on the company have stated.
For the past five years, Microsoft has been unable to outperform the S&P500Index. Say what you will about employee or revenue growth, the total return simply hasn't provided sufficient, risk-adjusted reasons for holding the equity, versus the index.
One fund manager on CNBC today complained bitterly of the firm's pre-open announcement, and swore never to hold any of Microsoft's equity ever again.
The layoffs were blamed, in part, for the major selloff of the equity market from the opening bell.
I haven't seen Microsoft in my equity portfolios for over a decade. Looks like market perceptions are finally catching up with mine.

Another Blunder At Citigroup

Just when you thought Citigroup couldn't make another blunder, it managed to do just that by naming failed Time Warner ex-CEO Dick Parsons as Chairman.

Talk about going from the frying pan into the fire. As bad as Bob Rubin was for the firm, Parsons may well be worse.

True, Parsons probably won't actively and knowingly mislead the board and the rest of the bank into risky CDOs and other ill-advised business decisions, as Rubin did.

Parsons might, I suppose, simply do nothing. Which, in a way, would be an improvement over Rubin.

But Parsons has no track record of succeeding at anything at Time Warner, where he replaced Gerald 'let's buy AOL' Levin. Nor at Citigroup, either, as a board member.

Citigroup has now managed to shuffle executives over the past year or so in such a way as to have no experienced commercial banker as either chairman or CEO.

Nice job, guys.
The nearby price chart for Citigroup and the S&P500Index shows that the bank's equity has declined by some 60-70% in the past year, while the S&P declined 'only' about 40%.
Does anyone really believe Parsons can do anything to help the situation?

Thursday, January 22, 2009

State Street Bank's Troubles

State Street Bank has now joined the ranks of US commercial banks experiencing problems from asset value declines.

I provided consulting to the bank's then-CEO, Marsh Carter, some years ago, in the company of my mentor and one-time boss, Gerald Weiss. The three of us knew each other well from our days at Chase Manhattan Bank, and Gerry was a more or less permanent, personal consultant to Carter when he ran State Street.

From the work I did for the company in 1997-98, I recall that the bank's primary competitive advantage was, and probably still is, its immense custody function. As a result of bidding a low price to service pension fund custody needs, the company knew where to locate quite a few securities, as well as became the institutional broker for trades from those customer accounts.

With this huge front end asset servicing business, State Street's other, downstream businesses could make money as a result of information about these securities. All perfectly legal.

Among the bank's least-related businesses was its own asset management group. The current CEO, Ron Logue, headed that group back when I consulted with the firm. So it's rather ironic that, now, the Wall Street Journal reported yesterday that Logue cited the asset management business as the source of the bank's current losses.

On Friday, it disclosed- unexpectedly- that it had some $9.1B of unrealized portfolio losses.

I haven't followed State Street very closely since Carter departed. He went on to become chairman of the NYSE in the wake of John Reed's departure. His successor, David Spina, was a somewhat myopic, cost-conscious operations executive who never understood that the key to State Street's long term ability to earn consistently superior returns was the investment in its ability to process more diverse and foreign-sourced assets, in support of its main customer base, US pension and other large asset funds.

I have no idea how it came to pass that Logue, an outsider to the bank's core functions, has eventually become CEO. But to read that State Street now has problems involving off-balance sheet conduits and other asset quality issues makes it sound like it began to operate more like Citigroup, and less like the less-risky, fee-based custody and processing bank it has historically been.
As the nearby price chart for State Street and the S&P500 Index shows, the company enjoyed a period of fairly consistent outperformance of the index from 1991 through about 1998. It was at that point that my consulting findings predicted that, if management failed to change some operational parameters, it would see a corresponding decline in its future total returns, relative to the S&P. Only a few days after my final presentation, the bank reported results which triggered a 10% drop in the price of the firm's equity in a single day.
Since that time, State Street's performance has been about the same as the index's. As I expected, Spina's cost focus eventually ended the firm's ability to continue benefiting from its massive market share. I would venture to guess, not having access to internal financial information, that State Street's market shares in key custody segments either eroded, or became less profitable.
Thus, it is understandable that they began to look to unrelated asset management units to make up the shortfall. But, in this area, the bank had no particular competitive advantage.
But in the last decade, it would have been fairly easy for even mediocre asset management by those units to offset the falling custody profitability and provide Logue with his ticket to the top job.
It is, in my opinion, yet another example of how failure to understand and manage a company's core businesses can result in a serious failure due to the attempt to maintain performance in the face of changing business realities. Either State Street's main business began to grow much more slowly, signaling an end to its natural period of consistent market outperformance, or they attempted to harvest the business prematurely. In either case, by using ever-riskier asset management to offset this decline, the once-conservatively managed bank has now joined so many other US commercial banks in requiring Federal money to stave off the effects of serious losses due to badly chosen business actions in the past few years.

Wednesday, January 21, 2009

Fiat Proves My Point On Detroit Bankruptcies

Yesterday's Wall Street Journal reported Fiat's interest in taking a controlling interest in Chrysler.

According to the article, Fiat would begin by taking a 35% position, with the option of increasing to a controlling 55% ownership. Incredibly, Chrysler has fallen so far that all Fiat must do for this position is to cover

"the cost of retooling a Chrysler plant to produce one or more Fiat models to be sold in the U.S."

Thus, my claim, along with others, expressed in this November post, is being shown to be true. Given the opportunity, other auto makers will step in to buy parts of the troubled Detroit-based US auto makers, when they prove attractive for those buyers' own strategies.

Fiat is essentially getting a US base on the cheap. They don't even want to build Chrysler cars, just use the existing plant infrastructure. Then they'll escape foreign-import laws and sell their cars as US-made.

If Congress and the prior administration had simply let GM file Chapter 11, the same sort of market self-cleansing would have occurred. Maybe it still will, but the odds grow longer as Wagoner feels he's successfully elbowed his way to the Federal cash trough.

It's really a shame, because now, during the very week of US political power transfer, Schumpeter's theory of creative destruction is being proven true for the zillionth time.

Chrysler's millstone becomes Fiat's new beginning in the US market. Problem solved!

When, if ever, will politicians, collectively, ever learn that markets do right themselves, and, short of that, forced, arbitrary intrusions by government, and false price-setting always distorts or delays eventual market self-healing?

Another GE-Welch Alum Goes Down: "Rusty" Mike Zafirovsky

Last Thursday's Wall Street Journal reported that the former "Iron" Mike Zafirovsky has put his company, Nortel, in to Chapter 11. Thus becoming, I guess, "Rusty" Mike, and the latest of Jack Welch's spawn to fail in running a company.

Of course, Welch's replacement, Jeff Immelt, has been a complete disaster. Jim McNerney had little to negative effect at 3M, before moving to Boeing and assisting in the Dreamliner snafu.

Bob Nardelli managed to help ruin Home Depot, then jumped out of the frying pan, tens of millions of dollars wealthier for his 'work,' and landed in the fires of Chrysler. No sign yet that Bob has turned that one around, either. I suppose asking for a Federal bailout would qualify as failure, don't you think?

Now we have Mike Zafirovsky. As CEO of Nortel since 2005, he certainly owns the company's current situation. As the nearby price chart for Nortel and the S&P500 Index for the past five years shows, Nortel has been in decline for the bulk of Iron Mike's tenure.
It's now lost nearly all of the value it had when Zafirovsky took over the company.
Like Lucent, it seems the business of developing, manufacturing and selling telephone-based digital processing switching systems just seems to have been the wrong business to be in since the digital revolution.
At least Lucent managed to fall into the arms of Alcatel. No such luck for Nortel, the once-vibrant competitor of Lucent's businesses when they were under the AT&T umbrella so many years ago.
It doesn't seem like any of these companies managed to survive the onslaught of wireless and the digitization of information streams. They might claim to have gone digital with their communications systems, but, somehow, that didn't seem to matter.
As a GE-trained success story, I'd have expected Iron Mike to have either merged or reshaped Nortel before this end befell the company.
Then again, looking at the records of Nardelli and McNerney post-GE, and GE post-Welch, under Immelt, it really doesn't look like any of these guys learned much in their alma mater's famed training program, does it?

Tuesday, January 20, 2009

Regarding The New Revelations About BofA's Purchase of Merrill Lynch

Yesterday's post discussed Citigroup's recent debacle in some detail. Thanks to long mismanagement and the choice of a novice as its latest CEO, the financial giant has become, essentially, a government-owned banking utility.

Now we come to the other, most recent ward of the government, Bank of America.

Back in December, when Merrill Lynch's shareholders voted to sell their firm to BofA, it seemed rather straightforward. True, BofA's Ken Lewis seemed to be missing the chance to step back and drive a harder bargain, with Merrill's continued weakening condition offering him that opportunity.

But, as I noted in this post from late 2007, commercial bank CEOs are notoriously less capable and effective than their (former) investment bank counterparts. Thus, Lewis' forbearance seemed to be just business as usual.

Now, however, from a spate of Wall Street Journal articles last week, we learn that surprise, surprise- Lewis refrained from backing out of the Merrill purchase due to coercion from Federal government officials.

So, once again, we see that the allegedly passive interest which the Federal government bought last year in our large banks is anything but. In BofA's case, Bernanke and Paulson dictated to Lewis that he must penalize his common shareholders in order to satisfy their demands, and conclude the purchase of Merrill Lynch.

But there's plenty of blame and shame to go all around the table of senior officials, government and private sector, in this travesty.

Lewis claimed that Merrill was a feasible purchase, stating even last Friday, according to the Journal,

"We did not expect the significant deteriorate in mid to late December that we saw."

Gosh, Ken. Isn't that what you are paid to do? Correctly anticipate evolving credit and market risks to your assets?

Apparently Lewis and his team either failed to conduct a proper, updated due diligence on Merrill, didn't insert sufficient clauses to provide for Merrill's asset value shrinkage, or simply did not know what they were seeing when they conducted their analysis of Merrill's books and positions.

Regardless of the reason, this blunder certainly must cost Ken Lewis what little credibility he still has with anyone- analysts, employees, investors.

Oh, and, to close the deal, Lewis then required a further $138B of US taxpayer money, from Treasury, to both provide adequate capital so that the resulting combined firm would pass muster on regulatory bases, as well as provide guarantees for losses on suspect Merrill assets.

It looks like we, the taxpayers, pretty much own another large commercial bank. Nationalization continues apace.

Then we come to John Thain. Reading this morning's Wall Street Journal article about his actions, it is nearly impossible to escape the conclusion that Thain knew very well he had misled Lewis into consummating the deal, while all along knowing of the serious, significant deterioration of Merrill's positions.

Thain disingenuously removed himself from New York during a critical week in December to ski in Vail, Colorado. His spokesperson claims Thain was 'working and available,' while others see him as having deliberately distanced himself from the gathering cloud over the transaction.

It's much more understandable why Thain chose not to revisit the transaction's desirability with his own board or shareholders. Per my prior, linked post, once again, an investment banker managed to out negotiate a commercial banker.

Seen from a distance, once again, we see the needless, expensive and private property rights-trampling behavior of government. Rather than have the excess, incompetent capacity represented by Citigroup, Merrill Lynch and BofA removed, their assets sold at market prices, and only healthy institutions left to compete, instead we have them all being propped up, polluting and delaying the process of the markets to cleanse the financial system.

As I noted in my post from October of last year, reviewing the Journal's interview with Anna Kagan Schwartz,

"Ms. Schwartz won't say so, but this is the dirty little secret that led Secretary Paulson to shift from buying bank assets to recapitalizing them directly, as the Treasury did this week. But in doing so, he's shifted from trying to save the banking system to trying to save banks. These are not, Ms. Schwartz argues, the same thing. In fact, by keeping otherwise insolvent banks afloat, the Federal Reserve and the Treasury have actually prolonged the crisis. "They should not be recapitalizing firms that should be shut down."

Rather, "firms that made wrong decisions should fail," she says bluntly. "You shouldn't rescue them. And once that's established as a principle, I think the market recognizes that it makes sense. Everything works much better when wrong decisions are punished and good decisions make you rich." The trouble is, "that's not the way the world has been going in recent years." Instead, we've been hearing for most of the past year about "systemic risk" -- the notion that allowing one firm to fail will cause a cascade that will take down otherwise healthy companies in its wake. "

I think this past week has more than validated Ms. Schwartz' judgment. We're in for either a very long return to a market-oriented financial system of credit provision, or a very short journey to a fully-nationalized system of core credit provision.

Monday, January 19, 2009

CitiGroup Becomes Our First (or Third?) US National(ized) Bank

Last week's events concerning Citigroup and Bank of America are surely historic and momentous.

Let's consider Citigroup's situation first. Citi was the first of the large banks to be given the sweetheart deal of US government investment beyond the initial TARP funds, with the government taking losses above some maximum level.

Friday's Wall Street Journal reported that,

"The rescue didn't shake Mr. Pandit's confidence in his strategy. He framed the chaotic week as a reflection of the overall financial industry, not Citigroup. "He had a spring in his step," said a Wall Street veteran who met with Mr. Pandit on Nov. 25. "You could not tell that he is a CEO that's under pressure." "

Maybe he wasn't. Pandit never seemed to really, seriously embrace the reality of the crippled institution he had been allowed to lead.

Yet, only a few months later, we see Citi dismantling itself with a rapidity only those like me and other observers of the long-ailing bank for years, have previously advocated.

Pandit, the bank's CEO of only a little more than a year, has suddenly reversed course on the subject of preserving Sandy Weill's treasured financial supermarket, both by shedding the brokerage unit via a joint venture with Morgan Stanley, and the creation of a 'bad bank,' to free what's left to become, again, Citibank.

What caused the sudden change of mind? Vik's newest, large governmental shareholder used some muscle, indicating that the cookie jar of bailout money was closed until and unless Citi finally did something to resolve its mess of an operating structure and business mix.

According to the Journal article,

"By mid-December, Mr. Pandit and his team realized the company was heading for a big fourth-quarter loss, according to people familiar with the matter. Over the course of a week of meetings, it dawned on them that they needed to at least symbolically break with Mr. Pandit's past insistence on preserving Citigroup's business model, these people said."


But let's be clear about what has transpired. After years of flattened returns under Rubin, Weill and Prince, nobody thought to actually fix Citigroup by undoing Weill's tangled business conglomeration.

No, instead of letting market forces, via its mediocre total return performance, push it into either divestiture, or a merger with a healthier bank, the federal government first bought preferred equity in it. Then gave it even more money, and backstopped some of its potential losses.

Then the Feds began to exert the sort of influence that they promised only last fall that they would not, in fact, use.

If you had any doubts about Citigroup, or the other large commercial banks effectively being nationalized, this should dismiss them. Taxpayers, via the Treasury, now own the real market value of Citigroup. It's basically our bank.

So our government is now calling the shots. How long before my various posts on the evolving nationalization of our commercial banking sector are realized?

The Journal article ends with the incredible observation,

"As word of the looming fourth-quarter loss surfaced earlier this month, Citigroup's shares tumbled to their November lows. Colleagues said Mr. Pandit remained in high spirits, pressing his lieutenants to remain focused on their work."

Maybe Vik should change his name to Chance Gardener, the equally-clueless and improbable protagonist of Jerry Kozinski's "Being There."