Saturday, February 28, 2009
For instance, in Wednesday's Wall Street Journal, James Glassman and William Nolan took about half a page to come to the stunning conclusion that financial services giants took excessive risks about the time they ceased being partnerships, and began to bet other people's money.
Back about five months ago, I wrote this post, in which I observed,
"3. In the 1970s, many of Wall Street's formerly-private investment banks and retail wire houses- First Boston, Morgan Stanley, EF Hutton, to name a few- go public, reaping windfalls and subtly transferring formerly partner-shouldered risks of the firm's positions and businesses to thousands of retail and institutional investors."
And in this post, from July of last year, I observed,
"Only in financial services, the 'wheel' is between publicly- and privately-held concentrations of capital and risk management. Again, viewed from afar over decades, the story of commercial and investment banking for the past forty years has been a gradual selling of transactions, asset and risk management businesses at their 'tops,' as formerly-private banks of both stripes went public, followed by managerial ineptitude, decline in risk management, and excesses in pursuit of growth via more risk."
Or how about this post, from October, 2007, in which I noted,
"In short, it's risk management that brings down large, diversified financial service firms every time. More than anemic growth, excessive growth in one or two businesses inevitably leads to excessive risks, which are typically hidden from the credit and audit functions, as well as senior management. After all, the executives are playing with the firm's money, so it's a win/win or lose/win proposition for them. Either way, their firm takes any losses.
The days of smallish Wall Street partnerships in which risks were well-understood, acknowledged, and managed, because the partners owned the risk, are long gone now. Instead, diversified financial mega-firms such as Merrill and BofA own many business units, in which managers play a risky game to advance their careers.
Thus, the entire complexion of financial service businesses, markets, and the risks inherent in them, have changed irrevocably, as a function of the sector's current organization. That's why you can expect something like the current Merrill writedowns and firings every few years at one or more diversified financial giants."
And, back in August of 2006, in this post, I made the same point for the first time in this blog,
"As capital and capital markets activity began to mushroom unexpectedly in the early 1980s, investment banks scaled up massively to take advantage of the deal/money flow, and not be left behind as market share midgets. Not only did old wire houses end up as public entities, but so did firms like Salomon Brothers. As this type of growth accelerated, senior partners took their one-time windfall and went public, culminating with Goldman some years ago. In the consulting world, the same thing happened with the old "Big 8." Andersen Consulting eventually became the publicly-held Accenture.
Since public companies can't really have private partners, that model went out the window. And with it, the ability of the firms to internally manage through soft periods with their own plentiful capital. So, welcome to the world of management by objectives, or, as the author phrases it, "short-term greedy."
In short, just because something is published as an editorial on the pages of the Journal doesn't mean it's a fresh idea. Some of us working away quietly via daily blogs get to the same ideas much sooner.
Then we come to yesterday's Wall Street Journal. One Peter J. Wallison, of the American Enterprise Institute, waxed for half a page on how to thread the needle of valuation of toxic securities on bank balance sheets.
Funny how I came to a similar conclusion almost exactly a year ago, in this post, when I wrote,
"Why should a firm be forced to keep its balance sheet on a 'breakup' valuation basis? If the firm doesn't plan to sell itself or liquidate, why must every scrap of every asset be current-valued?
What about industry sectors in which substantial investment is required in assets whose value will grow with time, such as cable, mining, or technology? Or commercial banks which legitimately desire to be portfolio lenders to the housing sector, and, thus, are not affected by performing loans whose values are temporarily depressed due to market or credit conditions?
It's one thing to force market valuations on assets which are purposefully traded frequently, such as bond or equity funds. But forcing firms which own significant amounts of assets that are not intended to be liquid seems silly, especially if the 'market' for those assets temporarily dissolves, creating an apparent value of zero."
Since then, I wrote several other pieces arguing for, not a suspension, but a modification of 'mark-to-market' valuation to explicitly consider economic value, as measured by cash flows.
Again, it didn't take an AEI fellow to come up with this notion, either. Anyone with a background in commercial bank treatment of bad loans, reserve accounting, and 'workouts,' is already familiar with the notion of non-market, economic-value approaches to the valuation of instruments on balance sheets.
What does it portend for business idea generation when just a single blogger- me- can lead the Wall Street Journal on editorial topics of such import as these by as much as an entire year? I'm sure there are many other examples of talented business people writing informed, paradigm-breaking pieces well in advance of editorials in major media publications which echo the same ideas.
Friday, February 27, 2009
It's rare that the Wall Street Journal's editorial page carries two completely erroneously-reasoned, ill-logical and, frankly, bone-headed pieces in the same day. But yesterday was such a day.
The two editorials to which I refer, of course, are "Are Executives Paid Too Much?" by Judith Samuelson and Lynn Stout, and "We Cannot Delay Health-Care Reform" by Senators Max Baucus and Teddy Kennedy. I'll deal with the first piece in this post, and the second in a later one.
In order to make the most focused, germane comments possible, I'll intersperse my remarks between the italicized text from Samuelson's and Stout's article.
"Our economy didn't get into this mess because executives were paid too much. Rather, they were paid too much for doing the wrong things."
This is true. I have long held, going back to the early 1990s, well over fifteen years ago, as a result of my proprietary equity research, that senior executives should be granted incentive compensation as a function of a five-year-lagged difference between their firm's total return and the S&P500 Index. Thus, Samuelson and Stout are observing nothing new whatsoever.
"In the summer of 2006, well before most economists had any inkling of the calamity that was about to unfold, the Aspen Institute brought together a diverse mix of high-level business leaders, investment bankers, governance experts, pension fund managers, and union representatives. When you put successful people with such disparate and conflicting backgrounds and loyalties together in the same room, the result can be a shouting match. But the members of the newly formed Aspen Corporate Values Strategy Group found they shared an unprecedented consensus: Short-term thinking had become endemic in business and investment, and it posed a grave threat to the U.S. economy."
I wonder what a "governance expert" is? Who is s/he? What are such a person's credentials? This seems like another one of those loony "institutes" cooked up by so-called experts on the outside, with no prior, inside experience actually doing any of that about which they opine.
Honestly, the term "Aspen Corporate Values" seems a contradiction in terms to begin with. The entire name of the group seems an amalgam of feel-good, sound-good business terms with no discernible meaning.
"This collective myopia had many causes. One cause, the Aspen Group concluded, was the demands of the very shareholders who are now suffering most from the stock market's collapse. It is extremely difficult for an outside investor to gauge whether a company is making sound, long-term investments by training employees, improving customer service, or developing promising new products. By comparison, it's easy to see whether the stock price went up today. As a result, institutional and individual investors alike became preoccupied with quarterly earnings forecasts and short-term share price changes, and were quick to challenge the management of any bank or corporation that failed to "maximize shareholder value."
The authors are wrong in their basic contentions, as expressed in this paragraph.
It is precisely the company's total return that is the sum total and expression of whether the company is "making sound, long-term investments by training employees, improving customer service, or developing promising new products," as such activities add comparative value for that enterprise.
To denigrate the maximization of shareholder value per se is wrong. Short-term maximization, yes. Again, I wrote about this in a Directorship piece over fifteen years ago. But long term, consistently superior total returns is the hallmark of corporate success. Samuelson and Stout mention this basic, simple and rather obvious concept nowhere in their piece.
"Meanwhile, inside the firm, executives were being encouraged to adopt a similarly short-term focus through the widespread use of stock options. The value of a stock option depends entirely on the market price of the company's stock on the date the option is exercised. As a result, managers were incentivized to focus their efforts not on planning for the long term, but instead on making sure that share price was as high as possible on their option exercise date (usually only a year or two in the future), through whatever means possible.
Executives eager to maximize the value of stock options began adopting massive stock-buyback programs that drained much-needed capital out of firms; jumping into risky "proprietary trading" strategies with credit default swaps and other derivatives; cutting payroll and research-and-development budgets; and even resorting to outright accounting fraud, as Enron's options-fueled and stock-price obsessed executives did."
The authors mix too many examples from vastly differing sectors, and attempt to give the impression all are alike. They are not. Rather than provide credible evidence, the authors simply advertise their lack of understanding of business.
And, for the record, next time, ladies, use the correct, pre-existing English language term, "incented," rather than the made-up, goofy-sounding "incentivized."
Did "massive stock-buyback programs" drain "much-needed capital out of firms?" Perhaps not. When managers believe that their firm's equity is undervalued, it is a reasonable use of resources to buy some of that equity back, then reissue it when investors realize the intrinsically higher value later on. Of course, if an inept management is, in fact, destroying value, then buying back stock hastens the proper result- withdrawal of capital from an ailing firm.
Samuelson and Stout miss this fact entirely, railing instead at any withdrawal of capital from any enterprise. In effect, the authors of the editorial seem to claim omniscience, implying that any cost-cutting of R&D budgets, staff, or mitigation of risk with reasonable employment of hedges via derivatives, are wrong on their face.
The business world is not that simple, but, evidently, Samuelson and Stout are, in their own mindset.
"The system was perfectly designed to produce the results we have now. To get different results, we need a different system.
To get business back on track, the Aspen Group concluded, it is essential to focus on not just one but three strategies: designing new corporate performance metrics, changing the nature of investor communications, and reforming compensation structures.
Starting with metrics, we need new ways to measure long-run corporate performance, rather than simply relying on stock price. In terms of investor communications, companies need to ensure corporate officers and directors communicate with shareholders not about next quarter's expected profits, but about next year's and even next decade's."
The authors begin this passage correctly. A change is required, and it is the change about which I wrote for my Directorship article over a decade ago. It's simple and requires no new measures, just the extension of the measurement of existing ones over more years, and subtracting the free ride of the S&P500's effect on corporate total return over five-year periods, in arrears.
The idea that any corporate officer can speak with clarity and credibility concerning expected profits over a year in the future is ludicrous. A decade? What are these women smoking? The only thing that would arise from such practices is frivolous shareholder lawsuits.
Oh, wait. I get it. Lynn Stout is a professor of corporate and securities law at UCLA. Makes sense. Demand that business executives make more litigation-producing earnings forecasts. Great business for law school grads, eh?
Only a lawyer out of touch with real business could write that and believe it has any relationship to the modern, fast-paced world of global business. Company fortunes can change in just a few years, due to competitive actions half a world away.
"Finally, and perhaps most importantly, companies must change the ways they reward not only CEOs and midlevel executives, but also institutional portfolio managers at hedge funds, mutual funds, and pension funds. Executives and managers should be rewarded for the actions and decisions within their control, not general market movements. Incentive-based pay should be based on long-term metrics, not one year's profits. Top executives who receive equity-based compensation should be prohibited from using derivatives and other hedging techniques to offload the risk that goes along with equity compensation, and instead be required to continue holding a significant portion of their equity for a period beyond their tenure."
Huh? You're going to forbid an executive from hedging stock options? I seriously doubt that is legal. And, anyway, all that will happen is that they will find a way, or some smart trust attorneys (wow, there are those smart lawyers again) will find it for them, to have an unrelated trust or a family relation hold the hedged position.
And how in the world can you not compensate "institutional portfolio managers at hedge funds, mutual funds and pension funds" based on their correct bets on market index movements? Not everyone invests directly in equities. Or even equity options. Some managers simply buy and sell indices and their options.
Mutual fund managers rarely, if ever, are paid incentive compensation by customers. Perhaps by the firm's managment, but not the customers directly. Hedge and pension fund managers, if they have 2/20 compensation, typically have their "20" subject to a high water mark, i.e., they can't get incentive compensation when the value of the fund declines, until the fund value rises above the prior highest value. Some funds even have escrows which hold back the 20% incentive fees for a year or more, so the manager doesn't even receive that money if short results are reversed. Samuelson and Stout once again display their naivete about that which they write so emphatically.
It's clear Samuelson and Stout aren't living in the real world of business and finance. Perhaps too much time in that Rocky Mountain air?
"So long as our metrics, disclosures and compensation systems encourage executives and institutional fund managers to look only a year or two ahead, we have to expect that that is what they'll continue to do. It's time for a long-term investment in promoting long-term business thinking."
Well, their conclusion is correct. But, as I noted in my first remarks to their opening paragraphs, this is not a new idea by a long shot. Their overall goal is fine, but their details are all wrong. And completely lacking in common sense, real world applicability, and credibility.
I wonder how this piece of bad reasoning ever made it onto the Journal's editorial pages.
Thursday, February 26, 2009
Last night, my business partner and I ran into an old friend, while playing squash, who works for Citigroup. Given the bank's problems, and his position in one of the planning groups, he'd been scarce for months.
Suppressing jokes about offering to buy coffee with a few shares of Citigroup stock, we asked him how things are on the inside. There wasn't that much he could say. Other than the allowable teasing about becoming a government employee, it was just a sad situation.
Drawing back from the personal anecdote, I recall a few articles in the Wall Street Journal cataloguing Vik Pandit's recent travails trying to get some direction from his new, largest shareholder. Geithner's evidently been reduced to cryptic, late night phone calls to Pandit, vaguely urging that 'something' be done soon.
Pandit is reported to be begging for a chance to fix the unwieldy financial conglomerate, despite its continued slide since the waning days of Chuck Prince's misguided leadership in 2007.
The more I ponder the status of the large US commercial banks, the more I'm taken back to the Journal interview with Anna Schwartz in October of last year, about which I wrote in this post. It's becoming increasingly clear that she is correct.
Better for the FDIC, Federal Reserve, and OTC to have enlarged the capacity to close insolvent banks, transfer deposits to other banks, writedown the bad loans and sell them back into the market.
Like it or not, the way in which our financial system functions, allowing banks to accumulate bad loans results in taxpayers eating those losses. This is why government oversight of lending practices is so critical. When a bank is closed, we can't expect another bank to buy bad assets at face value, when they are clearly impaired.
I believe it's past time for us to lose our attachment to specific organizations and put badly-managed, bankrupt firms to death.
Those outside the financial services sector may not realize it, but commercial banking became a commodity business long ago. Aside from their names, there's not much difference between large banks. Why keep a Citigroup, but close a WaMu or Wachovia?
I remain convinced that Schwartz is correct in observing that the key to repairing the health of the US commercial banking sector is to close insolvent banks. If there is more demand for banking than there is capacity, new capital will flow into the sector, either through existing, healthy banks, new banks, or banking units created by private equity firms.
Geithner's fuzzy private-public asset holding trust doesn't, on the face of it, get the job done. It simply continues to dance around the issue, unaddressed since late 2007, of modifying mark-to-market to allow for economic valuation, if it is higher than a non-existent market price, and taking losses.
Until this is done, capital won't flow into existing banks. And until the federal gorilla stops lumbering through the sector in a haphazard fashion, capital won't flow into the sector at all.
Wednesday, February 25, 2009
That's pretty much how I viewed his remarks. Others may, and will differ.
But as I worked on various items throughout the morning and afternoon, I kept hearing Bernanke solidly endorsing whatever new, half-baked financial rescue scheme is coming out of the administration.
My mind went back to Bernanke's testimony only last year, when Democrats were querying him on the need to cut spending. At the time, anxious to clip a Republican administration's wings and raise taxes, Congressional Democrats were nearly tripping over themselves to ask Bernanke to agree with them that deficits should be closed.
Now, in the wake of a $1T spending bill, Ben was silent on the matter. As were his Congressional inquisitors.
Instead, it was all about propping up famously-named US banks, rather than let them go through the natural process of insolvency, closure and seizure by the FDIC, and the next steps that all failed banks experience.
For example, where was Bernanke's defense of his own staff's bank examinations? Why defer to some new 'stress test' by Geithner's people, when the Fed was presumably stress testing and examining federally-chartered banks all along?
How could Geithner's purportedly "new" idea add anything that hasn't already been, or should have been done?
If anything, following in the footsteps of Volcker and Greenspan, Bernanke seems to cut a decidedly smaller, less confident and powerful figure. With a Congress controlled by the same party as the President who would renominate him in 2010, it's no surprise that Bernanke is appearing as eager and compliant as possible with anything the administration wants to do.
Nationalize a bank, but not call it that? Fine by Ben.
Spend a trillion dollars, but say you'll also cut the deficit? Totally believable, says Ben.
Keep interest rates low and demand more lending by already-crippled banks? Done, says Ben.
I suspect we are in for a very, very dangerous next few years, due to the recent, more acutely-politicized nature of Bernanke's position at the Fed.
Tuesday, February 24, 2009
"Online video is cutting into television, albeit slowly.
People are watching more video than ever on every type of screen -- television, the Internet and mobile devices -- according to a report on the nation's viewing habits to be released Monday by Nielsen Co.
Nielsen found that during the fourth quarter of 2008 the number of users and the time spent watching each of the three screen media rose from the previous quarter. "If people like video, they like it wherever they can get it," said Susan Whiting, vice chair of Nielsen.
The biggest jumps came in the number of viewers watching video on mobile devices and "time shifted" television, that is, programming viewed with a digital-video recorder. Each rose about 9% in the fourth quarter from the third quarter. Roughly 11 million people used mobile viewing and 74 million people watched DVR programming. Internet video users increased 2.3% to 123 million people.
In both time spent and number of viewers, Internet video grew at a rate twice that of television. Michael Vorhaus, president of consulting firm Frank N. Magid Associates, points to the growth as a threat to traditional television viewing. "It's not going to go away and it's not going to get better," he said.
For the first time in the Nielsen study, people ages 18-24 spent nearly the same amount of time -- roughly five hours -- watching Internet video each month as they did watching DVR programs. Other age brackets watched half as much or less Internet video than they did DVR video."
It reinforces why cable executives are so worried. Clearly, the tide is shifting more rapidly to DVR and internet. But since so much video is now being viewed straight from the internet, it's quite possible that the cable companies have already lost the entire younger, under-30 generation.
Monday, February 23, 2009
Thanks to my acquisition of a TiVo unit, which connects wirelessly with my computer network, I wrote,
"My TiVo accesses NetFlix through a wireless adapter which gives it access to my home computer network. While I can't program NetFlix choices on the TiVo controller, TiVo can access my NetFlix account on its own to retrieve my selections.
Thus, it would seem only a matter of time before TiVo provides a feature on its own website that would let me either type in my preferred websites, or simply import my web browser bookmarks, so that I can access this menu on my television screen via TiVo's content menu.
Once I can do this, TiVo would let me watch various programming websites, such as HuLu, as well as NBC's own content, delayed, on its website.
As I discussed this with my business partner Sunday morning, I remarked that, once TiVo does this, I am just one step away from cancelling my cable television service.
The only missing content would be my two primary news channels, CNBC and Fox. Once I could stream these, I'd be ready to cut the cable connection, slicing my monthly content delivery bill in half."
I've been writing about this eventuality for several years, and it would seem that it is finally within sight for an average American internet user and cable television subscriber.
Imagine my surprise, then, when I read an article in last week's Wall Street Journal revealing that US cable systems are in talks with content providers about restricting the latter's distribution of said content, for free, on the internet, on pain of losing some of the revenues they receive from the carriers.
Cable systems like Comcast, Cablevision, et.al., are not stupid. They see the future, and it looks like what happened to the music industry.
So they plan to provide extra internet-accessible content to those who retain their cable television subscriptions, thus, hopefully, saving the vulnerable half of their revenue streams.
I have been reflecting on this approach for the past few days, and I don't think it is a universal solution for the cable system companies.
Back in August of 2006, I wrote this post, in which I mused,
"I don't know what the arrangements are for the provision of, say, ABC's Lost or Desperate Housewives. But it would seem reasonable that production contracts for serial programming is going to change. Before, it was just about syndication rights and royalties. Now, a good production company with a hot property can air it initially via a network, then go solo after the brand has been built. Or, perhaps they'll just go directly to a YouTube or other online video content concentrator site.
Then again, perhaps a really good production shop will simply secure its own financing via the capital markets. Maybe they'll sign a long-term distribution agreement with YouTube to provide basic cashflow while they develop properties for the online market. The possibilities seem truly too many to contemplate just yet."
I still think that scenario can occur. It boils down to branding, doesn't it?
Someone like Larry David, Jerry Seinfeld, or Dick Wolf can probably secure financing, run a few pilot videos on YouTube or another popular site, and then invite viewers to screen a new series directly from their website, going to a paying basis after one viewing from that address.
My point is, while new, unknown content providers may still have to approach networks, cable or broadcast, and be handled by the cable television systems, established artists would not seem to have this problem.
Whether they be actors, writers, directors or producers, veteran talent would seem to be able to marshal other necessary talent, funding, and equipment, in order to create and market their new content directly to viewers' televisions over the internet.
They might go directly to TiVo, as a distributor, among other outlets, for preferred, easy access.
The move by cable companies, of which the Journal article wrote, is surely a clever step, if not a bit late in the game. It will keep a number of viewers connected to video content via their cable television subscriptions.
But I do not think it's a long term, nor necessarily foolproof solution. It seems to me that the Schumpeterian winds of change have already begun blowing at gale force through this sector. As the Journal piece noted,
"Some critics say it might be too late to put the online-video genie back in the subscription bottle. A growing number of people are growing accustomed to watching TV shows online, without paying. About 136 million people watched online video content in January, up 16% from the same period in 2008, according to Nielsen Online."
That would not seem to bode well for cable systems, no matter what they try to do to block this trend. But, they can always ask the music industry executives about this sort of trend. Their experience may hold more parallels than cable industry executives dare to imagine.
Sunday, February 22, 2009
Mr. Immelt, 53 years old, earned $3.3 million in salary in 2008 and hasn't received a raise since 2005. He's also receiving a $2 million equity award.
That's a 61% decline from his compensation in 2007 of $13.81 million, which included salary, the $5.8 million bonus and equity award."