Friday, June 19, 2009

New Financial Regulation May Finally Unwind GE's Pointless Diversification

I've argued in prior posts that GE is an organizational anachronism. It's my belief that current CEO Jeff Immelt is likely to be the company's last.

In past years, I honestly thought there was a chance that a private equity hunting party, composed of several of that breed, would team up to bring GE down, buy and quickly dismember it, unlocking value in the better industrial units, while minimizing the value loss in its financial and media properties.

Now, however, the unwinding may come from a totally unexpected source- regulation. It appears that the newly-proposed financial services regulations will sweep up corporations with significant finance units. Thus, what analysts, irate shareholders and private equity shops could not accomplish, Congress just might- the beginning of GE's dissolution.

From what has been written in the Wall Street Journal, it appears that the GE finance unit's leverage, asset quality, and financial structure might all fail to pass muster, once explicit allocations of the parent are made. The regulatory compliance nightmare may just be enough impetus to cause the company to shove its troublesome financing business out the door via a spin-off.

Funny how that may work, isn't it? After so much braying about the value of diversification, which, by the way, has been empirically disproven for over twenty years, Immelt may be forced to begin dismantling the failed conglomerate that is GE for regulatory reasons, rather than to avoid either being ousted or bought for salvage value.

Thursday, June 18, 2009

Jack Welch & John Bogle On The New Financial Regulators

Stripping away all the bluster and lying premises of the newly-proposed financial regulator scheme, one sees that there is considerably less than meets the eye.

This morning, on CNBC, both John Bogle and Jack Welch trashed the proposals. Bogle, I believe, criticized the idea of centralizing regulation too much. Welch, in my opinion, attacked the plan's most glaring weakness.

It ignores how the current financial mess truly unfolded, conveniently overlooking Congress' own role. Welch explicitly brought this point up, reminding one and all of how Congress fostered the mess by:

-passing CRA legislation mandating that banks lend mortgage money to people who otherwise would have been judged too risky

-pushing Fannie and Freddie to securitize increasing amounts and percentages of subprime mortgages

-foolishly ignoring those GSE's bloating up in a market which would have been better-served by private securitizers with private capital discipline, rather than the implicit, now explicit US government funding guarantee

Further, the FDIC and the Fed have been ostensibly given even more power, when they failed to use what they had to head off the current crisis. Welch and, I believe, Bogle, both noted this.

It's a fact that bank examiners should have halted the subprime and liar loan mortgages several year ago, but failed to do so. They simply failed in that job.

So what is the current administration proposing? To try once more to have the FDIC and Fed attempt to regulate banks. Maybe this time they'll "really" examine banks.

Maybe not.

But it's folly, and, one definition of insanity, to do the same thing over and over, expecting a different result when nothing has changed.

Besides, how much more powerful does the Fed have to be? It's already coerced a bank, BofA, into buying an overpriced broker, Merrill Lynch, then hiding financial problems from shareholders in order to make sure they voted to close the purchase.

It doesn't take a genius to realize that if you don't have a correct, honest analysis of what went wrong, you have little chance, except being tremendously lucky, of fixing the problem so it won't recur.

The unintended consequence of over-regulation by government, whether it be mandating expensive audits for publicly-traded corporations, complying with Sarbanes-Oxley, or expanding the powers of financial regulators, is usually to falsely assure the public that things are safe, when, in fact, fraud and incompetence will still be present.

Wednesday, June 17, 2009

The Daily Show Mocks The New York Times

This video says it all. No deep analysis of economics, changed media consumption behaviors, etc., is really required to 'get' the newspaper sector's problems. Just watch this hilarious, scathing and mocking clip about the NY Times.

Sent to me by a friend, it's a piece from the Daily Show, which I don't watch, lampooning the Old Gray Lady, which I don't read.

Ironic that Stewart sticks it to this liberal publishing icon. I can't figure out why the Times agreed to even allow this story to be done, and collaborated, too. I kept thinking I was watching a comedy sketch, but I believe the Times staffers are real.

Tuesday, June 16, 2009

The Heavy Hand of Government Already Distorts US Economy

Monday's Wall Street Journal features a piece on how recent government interventions into the economy have already skewed terms of competition. The article reports,

"The effects are rippling into nooks of the economy far beyond Wall Street and Detroit's troubled car industry. The massive intervention has shifted the way companies do business in a host of ways -- not all of them intended by the government. Increasingly, companies big and small are competing on the basis of their ability to tap government money. A divide is opening between gets and get-nots.

Thanks to federal loans, Cabela's Inc. didn't have to slash credit to its customers. But Genworth Financial Inc., a big insurer, failed to get bailout money, and has raised capital in other ways, such as cutting its dividend. Still other firms hope to gain an edge by steering clear of the government. UMB Financial Corp., a bank in Kansas City, Mo., is going after new customers by boasting that it hasn't taken any bailout money.

Government spending as a share of the economy has climbed to levels not seen since World War II. The geyser of money has turned Washington into an essential destination for more and more businesses. Spending on lobbying is up, as are luxury hotel bookings in the capital."

These last two sentences should send a chill through every reader. Competition is officially becoming a matter of who can curry more favor with Congress and the administration, as both wade ever more deeply into the private sectors of the economy.

It doesn't take a genius to realize that efficiency will now be taking a back seat to politics on a growing basis. Which reinforces Art Laffer's contention that prospects for the US economy going forward are likely to be very bleak.

Monday, June 15, 2009

Art Laffer Again On the Coming Hyper-Inflation

Last October, shortly before the November election, economist Art Laffer wrote a blistering piece in the Wall Street Journal, on which I wrote this post.

Before knowing of the extensive governmental intervention into autos and, planned, into healthcare, Laffer wrote,

"If you don't believe me, just watch how Congress and Barney Frank run the banks. If you thought they did a bad job running the post office, Amtrak, Fannie Mae, Freddie Mac and the military, just wait till you see what they'll do with Wall Street.

Whenever people make decisions when they are panicked, the consequences are rarely pretty. We are now witnessing the end of prosperity."

In last Wednesday's Journal, Laffer was even more bleak. He wrote,

"Here we stand more than a year into a grave economic crisis with a projected budget deficit of 13% of GDP. That's more than twice the size of the next largest deficit since World War II. And this projected deficit is the culmination of a year when the federal government, at taxpayers' expense, acquired enormous stakes in the banking, auto, mortgage, health-care and insurance industries.

With the crisis, the ill-conceived government reactions, and the ensuing economic downturn, the unfunded liabilities of federal programs -- such as Social Security, civil-service and military pensions, the Pension Benefit Guarantee Corporation, Medicare and Medicaid -- are over the $100 trillion mark. With U.S. GDP and federal tax receipts at about $14 trillion and $2.4 trillion respectively, such a debt all but guarantees higher interest rates, massive tax increases, and partial default on government promises.

But as bad as the fiscal picture is, panic-driven monetary policies portend to have even more dire consequences. We can expect rapidly rising prices and much, much higher interest rates over the next four or five years, and a concomitant deleterious impact on output and employment not unlike the late 1970s.
The percentage increase in the monetary base is the largest increase in the past 50 years by a factor of 10 (see chart nearby). It is so far outside the realm of our prior experiential base that historical comparisons are rendered difficult if not meaningless. The currency-in-circulation component of the monetary base -- which prior to the expansion had comprised 95% of the monetary base -- has risen by a little less than 10%, while bank reserves have increased almost 20-fold. Now the currency-in-circulation component of the monetary base is a smidgen less than 50% of the monetary base. Yikes!

Alas, I doubt very much that the Fed will do what is necessary to guard against future inflation and higher interest rates. If the Fed were to reduce the monetary base by $1 trillion, it would need to sell a net $1 trillion in bonds. This would put the Fed in direct competition with Treasury's planned issuance of about $2 trillion worth of bonds over the coming 12 months. Failed auctions would become the norm and bond prices would tumble, reflecting a massive oversupply of government bonds.

In addition, a rapid contraction of the monetary base as I propose would cause a contraction in bank lending, or at best limited expansion. This is exactly what happened in 2000 and 2001 when the Fed contracted the monetary base the last time. The economy quickly dipped into recession. While the short-term pain of a deepened recession is quite sharp, the long-term consequences of double-digit inflation are devastating. For Fed Chairman Ben Bernanke it's a Hobson's choice. For me the issue is how to protect assets for my grandchildren."

Laffer's a pretty smart guy. His insights into the likely hyper-inflation dovetail neatly with his October piece. It's hard to see how inflation won't be coming barrelling into the US economy soon. Those who keep saying they are more worried about deflation seem to have forgotten the Carter years.
Given the expanded monetary base, how on earth will inflation not roar ahead, with so many dollars shoved into international portfolios?
Frankly, I'm at a loss as to understand how the equity markets can have risen some 30% in two months or so, with these numbers available for all to see.