Friday, April 03, 2009

A Lack of Boundaries: Private Sector & Government

I recently sat with my business partner discussing the sad state of corporate management and governance that has led major US corporations to go begging to the federal government for help.

Now, we have new regulations affecting the compensation of employees at any company which accepted or requested TARP funds, completely contrary to the promises, at the time, of then-Treasury Secretary Hank Paulson that Washington would be the most passive of investors.

Further, any expenditures at companies which have accepted or requested government "help" are now scrutinized for the potential of being too "lavish" by a Congress that, itself, has overspent taxpayers' money.

How did we get to this point? Is it the fault of corporate America, or the federal government?

I believe it is the fault of both parties. Neither seems capable of respecting boundaries.

In my opinion, as well as others, such as William McGurn of the Wall Street Journal and even liberal Nobel Economics Laureate Joseph Stiglitz, the bankruptcy option has been avoided far too much in the past twelve months.

Bear Stearns, Lehman, BofA, AIG and Citigroup, upon appealing to the federal government for assistance, should all have been referred to bankruptcy court or the FDIC for closure. GM and Chrysler, too, should be in Chapter 11.

Somehow, corporate executives have come to expect their government to play favorites, pick winners, and temporarily prop up failing companies, rather than admit their own mistakes and close up shop.

By failing to observe the boundaries of responsible corporate behavior, boards of directors and CEOs unwisely opened a Pandora's Box of problems by requesting government financial aid. This left them open to having their operations and decisions overseen and scrutinized by political officials who have used the excuse of looking after taxpayer money in order to move our economy down the road of fascism.

At the same time, government officials, beginning with the Bush administration, and continuing into the current one, have unwisely consented to helping private corporations, rather than declining, and sending them to their fate in the financial markets or bankruptcy courts.

By failing to observe the clear line between private and public spheres of activity, our government officials have compromised our economic system and given into the temptation to begin manipulating companies for political purposes and pet political agendas.

Both government and corporations would have better served our society if they had just said "no."

No requests for handouts and government help. No consent by government to involve itself in any private company rescues.

It's difficult, at this point, to see how and where these mistakes will end. But it's very easy to see how and where they began. Our private and public institutions have failed the US by refusing to adhere to time-tested separations that allow the private sector to take risks and bear the consequences with limited public interference.

Thursday, April 02, 2009

The Key Issue In GM's Debacle

Holman Jenkins wrote a searingly insightful, clear editorial in the Wall Street Journal yesterday.

As usual, he cut to the core of the current mess involving GM by observing,

"Keep that in mind amid reports the administration favors a "quick and surgical" bankruptcy. It's a bluff. The same administration that inserted itself into GM's corporate governance to order the resignation of a CEO is hardly likely to defer to the prescribed legal order for a failing company, namely bankruptcy. Even a "prepackaged" filing runs too much risk of a judge imposing more "sacrifice" on the UAW than the administration is prepared to tolerate.

GM bondholders understand this: They've been intransigent precisely because they calculate the UAW is too important to Democratic electoral politics for Mr. Obama to risk losing control of the reorganization process to a bankruptcy judge." (my bold)

That's the issue in a nutshell. Democrats feel a need to defend the UAW's benefits, as I noted in this post,

"The truth, of course, is that Chapter 11 is crucial to force such negotiations. Gettelfinger is scrambling to hold out for pre-bankruptcy negotiations, because, in bankruptcy, his union will have its benefits and wages slashed unilaterally.

In fact, one Democratic Senator explicitly accused, but not by name, some Republicans and pundits for using Detroit's problems to break the UAW. But the UAW is doing that all on its own. It doesn't need help."

As I wrote in another recent post, I don't like to mix politics and business on this blog. But when politics is the major force behind a business story, it's unavoidable.

Congress, as Jenkins notes in his piece, created some of the problems GM currently faces,

"The Wagner world was given a second lease on life by a peculiar feature of Congress's 1975 fuel economy law. Known as the "two fleets" rule, it effectively forces Detroit to make its cheap small cars in high-wage domestic UAW factories, even if it means losing money on every car. The rule has no fuel-economy function. Its only purpose is to shield the UAW monopoly inside each Detroit auto maker from global labor competition.

You wouldn't have noticed, but a legislative accident two years ago almost stripped away the two fleets rule. A couple of Republican senators from the South took the lead in crafting the Senate's new fuel economy bill, and built it to please Nissan, which had railed against two fleets for its own reasons.

In the final bill, to no one's surprise, two fleets was quietly restored by Rep. John Dingell and Illinois Sen. Obama (among others) as a political favor to the United Auto Workers.

The UAW's Mr. Gettelfinger had testified, coyly, during Congressional hearings that failing to renew two fleets might cost 17,000 auto workers jobs building small cars. He didn't say that two fleets is in fact the fulcrum by which, for the past 30 years, the UAW has been able to defeat globalization.

He didn't say two fleets was the sine qua non for the past generation of the UAW's power to suck the Big Three dry."

As I noted in today's prior post, undue governmental meddling in the private sector, including choosing winners and losers among companies, unions or sectors, is expensive and ultimately disastrous for taxpayers.

Government fostered the GM mess, although the company's own management stood by silently as it happened. We'd all be better off had the Bush administration simply told GM to file Chapter 11, if necessary, because our government is not in the business of picking winners and losers among sectors, companies or unions.

The Unseen Costs of Government Intervention in Businesses

Yesterday morning, I heard Alabama's Republican Senator and ranking member of the Senate Banking Committee, Richard Shelby, say on CNBC, in reference to the auto maker bailouts, to paraphrase,

'I hope GM succeeds.'

Frankly, I was horrified. It's bad enough that both the Bush and Obama administrations allowed GM and Cerebrus/Chrysler to avoid bankruptcy court via Chapter 11.

But to hear a conservative Republican express a desired outcome for a specific company was very disappointing.

In my opinion, the sentiment which Senator Shelby should have expressed was,

"As a member of Congress, I cannot, of course, express preference for one competitive US company to the detriment of another. To indicate that I, rather than the market, possess a desire for any US company to have a specific outcome is improper.

Rather, I wish that GM receive and experience what our markets, both consumer and financial, judge appropriate for the company.

If that means survival now, on its own resources, and success in the future, so be it. If, instead, it means the firm cannot continue operations, and must file for Chapter 11 bankruptcy, again, so be it."

It is simply wrong for our federal government to engage in such massive intervention as to be lending private-sector companies money, in hopes of avoiding their demise.

How can our government possible know, better than the natural forces of our markets, that the best use of, for example, some building in Flint, Michigan, is as a GM plant, rather than the new home of some entrepreneur's business?

What if the fall in rental price of that former plant is the key to allowing some new business to flourish, employing workers and having better growth prospects than GM?

In the same way as the administration's hamhanded approach to mortgage foreclosure relief is frustrating attempts by new aspirants to homeownership, about which I wrote here recently, the distressing attempts by our government to "pick winners" in the private sector is mistakenly substituting governmental preference for that of our consumer and capital markets.

Isn't this what the Soviet Union tried, and ultimately found to be inefficient, unworkable and a failure for most of the 20th century?

Who among us truly believes that our federal government is more skilled than consumers and investors in the selection of those business which ought to survive and prosper?

By propping up GM and refusing to allow it, if necessary, to enter Chapter 11 proceedings, our government- both Congress and the administration- is merely delaying the inevitable market-clearing dissolution of failing and failed companies, the recycling of their resources a la Schumpeter's observations of eighty years ago, and the freeing up of labor to be employed in new ventures.

Government isn't the right institution to select our economy's winners and losers. For that, we have a process which we have trusted for most of our country's life- our freely-operating, private capital and consumer markets.

Wednesday, April 01, 2009

The Troubling Loss of Fed Independence

Back in mid-March, economist Judy Shelton wrote an editorial in the Wall Street Journal entitled, "Is Inflation Baked Into the Budget Plan?"
I'll write about the main focus of her article in another post. For today, though, I'd like to quote this passage from Ms. Shelton's piece,
"The notion that monetary policy might be in cahoots with fiscal policy is sure to elicit howls of protest all the way from the Treasury to the Federal Reserve -- about a mile's distance. But no one can seriously suggest that the Fed has not been politicized beyond all pretenses toward independence. The Fed has become a key player in the government's efforts to deal with the credit crisis, purchasing hundreds of billions in mortgage-backed securities guaranteed by federal agencies and taking them onto its own balance sheet. Last month the Fed issued a joint statement with Treasury that they stood ready to inject more capital into banks "to provide a cushion against larger-than-expected future losses." And according to yesterday's surprise announcement, the Fed now plans to buy up long-term Treasury bonds -- an act of fiscal incest -- while taking another $1 trillion or so onto its balance sheet to boost consumer spending.

So the Fed is involved up to its neck in this blueprint for the future. Does anyone doubt that former Treasury Secretary Larry Summers, who heads the White House's Economic Council, is slated to be the next Fed chairman?"
The picture accompanying this post ought to give everybody pause. Surely former Fed Chairman William McChesney Martin is spinning in his grave.
I recall in my youth the general awareness that then-Fed Chairman Artie Burns was easily bullied into flooding the economy with liquidity in advance of Johnson's and Nixon's re-elections. That was a very bad time for the US dollar.
Seeing helicopter Ben at the same table with members of the current administration, especially the Treasury Secretary, gives me chills.
As Ms. Shelton wrote in the rest of her editorial, the current stimulus package and operating budget of the US government all but guarantee inflation coming soon. Rather than offset such huge doses of Treasury- and Congressionally-provided liquidity, the Fed is abetting them by purchasing US debt and other, private debt, thus adding to the flood of dollars in the global economy.
We just might come to a point where we'd fondly wish for the inflation rates of the Carter era.

Tuesday, March 31, 2009

Current Myths About Fund Management & Rebounds

This weekend's Wall Street Journal profiled a Texas fund manager, Donald Hodges, amidst the recent ruin of his investment strategy. It highlights a common myth that several friends have expressed to me lately. Simply stated, the belief is,

'I know the market, and my funds, fell sharply last year. But, eventually, the funds I own will come back...won't they? The market will surely regain its losses in time, so my funds will, too. Right?'

Not necessarily.

The article begins,

"For many years, Donald Hodges ran one of the top-rated stock-focused mutual funds in the country. He also has lost money for his investors over the past decade.

A $10,000 investment in Hodges Fund made 10 years ago would be worth around $9,015 today, compared with $7,720 if it was invested in the Standard & Poor's 500-stock index. Years of stellar performance were wiped out by a 49.5% plunge in 2008, a much steeper fall than the S&P, and a 11% drop so far this year."

From various pieces of information in the piece, it's clear that Hodges is a qualitative, seat-of-the-pants type manager. He doesn't seem to employ any tools to assess whether he should be long, or short in regard to equities. The article continued,

"He has become more cautious in his new stock picks, leery about buying until he is sure they are unlikely to blow up.

The "go-anywhere" Hodges Fund -- Donald Hodges invests in both value and growth issues, and ranges from small- to large-market capitalizations -- was founded in 1992 and rose to $750 million in assets by early last year. But now it is one-third that size, thanks to the brutal decline and outflows of around $31 million for the first two months of this year.

In the first half of 2008, even as the broad market fell, Hodges Fund held up relatively better because it had few financials. In the summer, Mr. Hodges took time off for an investors' cruise to Asia. He received a daily update on the fund portfolios via faxes and emails.

But after the collapse of Lehman Brothers Holdings Inc. in September, several of his fund holdings were hit hard. Mr. Hodges figured it was a buying opportunity -- a strategy that had worked well for him coming out of the 1982 and 1987 market slumps."

I found this to be just amazing. And very indicative of subjective equity managers. Without well-reasoned, defensible metrics, Hodges just felt that the fall of last year looked a lot like prior equity markets, so he started buying.

"He bought some cheap shares that he thought would hold up. One was Cal-Maine Foods Inc., a large producer and distributor of eggs. Wrong move. That stock has dropped 42% since September.

"You have to be somewhat forgiving of yourself, and realize that over a period of time you've done well," Mr. Hodges says. "And that day will return again." "

That last statement is so desperate. How can Hodges possibly know if his subjective approach will ever work again?

I have friends who, from the other side of the table, fervently want to believe the same thing. They have holdings in a disparate collection of equity mutual funds which have just been crushed in the past twelve months. They want to believe that, in concert with a hoped-for return to an S&P of 1400, their own funds will also rise.

They just don't realize how unrealistic such a hope is. Like Hodges, many of these other qualitative managers are now at sea in a very different market. We are experiencing the largest deleveraging of the past several decades, if not since the 1930s, as well as a serious recession. How anyone with a purely subjective method for selecting equities would know what to do in these conditions is beyond me.

But, as my business partner constantly reminds me, people like stories. Stories with happy endings, no matter how fictive they may be.

So investors cling to shares of mutual funds they have held for years, despite the fact that while, in an average year, 25% of mutual funds can beat the S&P, it is typically a different 25% each year. Public mutual fund managers are notoriously inconsistent in their results.

Will Hodges ever return to his prior portfolio returns? Who knows? Frankly, it's doubtful. As it is, the Journal piece notes that Hodges' fund was Lipper's best 5-year fund in that category for three years. That's a pretty narrow timeframe of outperformance, isn't it?

Multiply the Hodges story a few thousand times, and you have a pretty good picture of the equity management sector right now.

That is, failed managers, taken by surprise, desperately clinging to hope that they can reproduce whatever short period of market outperformance they once exhibited during the last few decades' largely up market on the back of expanding private leverage.

Monday, March 30, 2009

Rick Wagoner's Ouster

I've written my share, or more, of posts criticizing GM's recently-ousted CEO, Rick Wagoner.

And I don't like to mix politics with business on this blog.

But this weekend's firing of GM CEO Wagoner by the head of one of the firm's creditor's, the US federal government, breaks new ground. So I believe it needs to be addressed.

The accompanying price chart for GM and the S&P500 Index since 1962 paints a very sobering picture for the auto maker. In non-deflated dollars, the company's stock price peaked in 2000, but, in real terms, obviously much, much earlier.

Since Wagoner's assumption of the CEO title, GM's market value has headed straight downhill.

I've railed for years against GM's horrible senior management and ineffectual board of directors. I have argued for years that Wagoner should go.

But not because the president of the US, which is not even the largest creditor of the company, says so.

However, even Wagoner's dismissal by a minor creditor, is not the most troubling news related to GM today.

No, that would be the US president's contentions, as expressed in his remarks about GM this morning. It's evidently too recent to find a YouTube clip of the appearance, so my text will have to suffice.

Disturbingly, the president of our country unilaterally declared that:

-GM is too old and important to fail.
-Management is to blame, but workers are not.
-Federal money will be spent to save/create auto jobs in the communities affected by GM's troubles.
-GM will not be put through a normal Chapter 11 bankruptcy.
-After being 'fixed,' GM will rise to success once again.

No mention was made of the UAW's role in this through its exorbitant demands. Nor was Ron Gettelfinger's resignation as head of the UAW demanded by our government.

Further, our president, oddly for an attorney, provided evidence of his ignorance of what a Chapter 11 filing entails. He claimed that such a filing would result in dissolution of GM and the sale of its operations, which would also shut down.

This is simply false.

So now we have an ultimate government taking. At least with AIG, the federal government became the owner of the firm, albeit at gunpoint, and has since called the shots.

At GM, it's not an owner, but a relatively minor creditor. And should have no particular stake in the outcome of the firm. Markets are supposed to do that.

Instead, we have a near-Rooseveltian step by government into the restructuring of the auto sector. Chrysler was judged unworthy of further investment, unless it completes its pending merger with Fiat. GM has been deemed worthy of saving, but, obviously, because of the UAW jobs involved.

And those jobs, and the contracts under which they exist, will not be subject to a court-appointed bankruptcy trustee. No, the government has charged management alone with guilt in GM's failures.

The nature and extent of the federal government seizure of control of GM, using a comparatively small operating loan as the basis for its thuggery, is disturbing.

But perhaps this could have been avoided if, as I wrote half-jokingly, this post were true. Had Armando Codina been replaced by a competent board member, along with most of the rest of GM's board, perhaps this act of government seizure could have been avoided.

My business partner and I have discussed my strong belief in the necessary of death of corporations which cease to serve shareholders well. It is, admittedly, a very robust version of Schumpeterian dynamics. But this latest act in the melodrama that is GM proves my point.

Far better for the private sector to look after its own interests, shutting weak, ailing firms, than to await politically-motivated government meddling.

GM could have gone quietly, with some parts sold, others closed. Now, it's going to be forced to continue life as a money-losing "green" car maker, taking orders from Washington.

Truly, a far more ignominious end for the once-proud and profitable car maker.