Friday, June 26, 2009

New Regulations' Effects On US Banking Profitability

This morning's Wall Street Journal featured an article in the Money & Investing section contending that proposed new financial regulations could, by mandating 'plain-vanilla' financial products, such as mortgages and credit cards, result in a reduction in bank profitability.

I think the article's premise is correct. Having worked in one of the nation's large, money-center banks, Chase Manhattan, for years, I can attest to the truth that the more complex, illiquid and/or non-standardized financial products are, the higher their profit margins tend to be.

That's why bond and derivative trading are nice businesses. Without centralized clearing and settlement and/or transparent price quotes, margins stay high. Especially on retail customer transactions.

In product lines like credit cards and mortgages, various fees and the all-important credit card balance-maintaining customers drive the above-bank-average profitability of these businesses.

However, I don't see anything wrong with this particular type of regulatory reform, nor its effects on bank profits.

I've contended for some time that financial services business growth, over time, can't legitimately exceed that of the economy. Financial services is a purely derivative activity. It's done to facilitate other activities, not for its own reward.

Therefore, in order to 'goose' growth and profits, bankers routinely develop new products with extra fees or complexities which allow premium pricing, at least for a while. After seeing how many people failed to understand, or claimed to fail to understand their mortgage documents during the recent mortgage lending problems, it may well be a good idea to mandate simpler, plain 30-year, fixed-rate home loans be available as a default choice for consumers. The same could well be true for credit cards, which also seem prone to misuse and abuse by under- or uneducated consumers.

If these proposed regulations retard bank profit growth or margins, so be it. Better to have a healthier, slower-growing financial services sector with fewer catastrophic losses than what we've seen out of mediocre bank management for the past half-decade.

More "Green Energy" Lies

There's a group named "Repower America" which has been running a series of deceptive ads on cable television for the past few months.

Here's one of them from a few months ago.

They take a craggy-faced actor and dress him up to appear like a real, wizened, concerned old geezer who knows what's right for America, by gosh!

The current ad features the same 'old crag face,' this time alleging that we are borrowing billions to pay for our gasoline. That new ways are necessary, and, of course, the oft-repeated canard that wind and solar power will create lots of new, 'good-paying' jobs.

Of course, what none of these commercials tell you is that the infrastructure expense and effort, not to mention consumer tradeoffs to accept electric cars, are enormous. As I explained, with the help of a Wall Street Journal article, in this recent post, you just cannot feasibly replace locomotion-focused carbon-based energy with a few windmills and solar panels. The author noted,

"The latest data from the U.S. Energy Information Administration show that total solar and wind output for 2008 will likely be about 45,493,000 megawatt-hours. That sounds significant until you consider this number: 4,118,198,000 megawatt-hours. That's the total amount of electricity generated during the rolling 12-month period that ended last November. Solar and wind, in other words, produce about 1.1% of America's total electricity consumption."

The conversion of electricity into oil terms is straightforward: one barrel of oil contains the energy equivalent of 1.64 megawatt-hours of electricity. Thus, 45,493,000 megawatt-hours divided by 1.64 megawatt-hours per barrel of oil equals 27.7 million barrels of oil equivalent from solar and wind for all of 2008.Now divide that 27.7 million barrels by 365 days and you find that solar and wind sources are providing the equivalent of 76,000 barrels of oil per day. America's total primary energy use is about 47.4 million barrels of oil equivalent per day.

Of that 47.4 million barrels of oil equivalent, oil itself has the biggest share -- we consume about 19 million barrels per day. Natural gas is the second-biggest contributor, supplying the equivalent of 11.9 million barrels of oil, while coal provides the equivalent of 11.5 million barrels of oil per day. The balance comes from nuclear power (about 3.8 million barrels per day), and hydropower (about 1.1 million barrels), with smaller contributions coming from wind, solar, geothermal, wood waste, and other sources.

Here's another way to consider the 76,000 barrels of oil equivalent per day that come from solar and wind: It's approximately equal to the raw energy output of one average-sized coal mine." "

After you build some windmills, where are the jobs? And won't ending the use of coal, oil and natural gas put tens of thousands of miners, pipeline workers, refinery workers and drillers out of work? Most of which, I'd guess, make more than a mundane job in a factory producing solar panels or windmill parts.

Finally, I didn't borrow any money to fill my gas tank this week. So I don't know where the people who put the words into ol' crag face's mouth get their facts.

Probably, they are using the following specious logic. America sells debt to investors around the globe. America imports many things. One of those things is oil.

Let's just assume, and say, that all that borrowed money via T-bills is used to pay for imported oil.

Simple, huh? Wrong, but simple and, to the uninformed, scary and powerful.

But you could point to anything and say it is the source of our trade flow imbalances. I noted this in my critique of Boone Picken's flawed arguments in this prior post.

"Repower America" makes deceptive ads and claims on so many levels, it's disgusting. Let's hope people see through the lies and misleading inferences in their commercials.

Thursday, June 25, 2009

Robert Reich's Flawed Analysis of Public Healthcare

Robert Reich, former Clinton labor secretary and liberal economics professor, now at UC Berkeley, wrote an extensive defensive of a governmental healthcare option in yesterday's Wall Street Journal entitled "Why We Need a Public Health-Care Plan."

My overall reaction to Reich's poorly-reasoned argument is that, if this is an example of his thinking, I can't understand how he managed to receive an academic appointment, let alone a PhD in his field. His logic is flawed and his reasoning is sloppy.

Essentially, the error Reich commits is to assess the impact of a public health option in the future as if vibrant, profitable private healthcare options were still available, which therefore would be carrying much of the burden of the true cost of healthcare not paid by that same public option.

For example, Reich wrote,

"But before we even get to this point, it's important to recognize that those terrifying CBO cost projections significantly overstate the costs. They did not include potential cost savings from the lynchpin of health-care cost containment: a so-called public option that would give people who don't get health care from their employer the choice of a public insurance plan. Why? For the simple reason that the Senate committees hadn't yet agreed on a public option. Yet without a public option, the other parties that comprise America's non-system of health care -- private insurers, doctors, hospitals, drug companies, and medical suppliers -- have little or no incentive to supply high-quality care at a lower cost than they do now."

Reich's final statement in this passage is simply untrue, and displays his ignorance of how business, as opposed to economics, actually works. Implicit in Reich's statement is an accusation of illegal oligopolistic behavior by private healthcare providers. Even without a public option, each healthcare insurer/provider has a motivation to supply lower-cost care in order to secure a larger market share and, thus, enjoy economies of scale and higher profits for shareholders. With each provider attempting to do this, they all have to keep up with each other in competing for healthcare dollars.

Of course, allowing cross-state-line competition would make this motivation even stronger.

Reich later wrote,

"Critics say the public option is really a Trojan horse for a government takeover of all of health insurance. But nothing could be further from the truth. It's an option. No one has to choose it. Individuals and families will merely be invited to compare costs and outcomes. Presumably they will choose the public plan only if it offers them and their families the best deal -- more and better health care for less."

This is highly disingenuous of Reich. He ignores, or fails to understand, that practitioners of medicine, and drug manufacturers, can only give special discounts to the federal government's "public option" so long as they can make up the profits on the private healthcare plans.

In effect, Reich fails completely to realize that subsidization will occur, in part, as a result of government's coercive behavior with providers of medicine and medical care.

Ask yourself this question. If the government did not, itself, provide a 'public option,' but, instead, issued limited-purpose, government back debt specifically to fund a standalone, independent provider of the 'public option,' licensed to do so by the government, but without coercive legislation or other actions, how many pharmaceutical companies, doctors and hospitals would cut special deals with this firm?

Wouldn't that new 'public option' firm's attraction for healthcare deliverers be its potential market share? Why would it have any competitive advantage over existing private firms, other than government coercion?

Reich continues his misleading and wrong-headed reasoning in the following passages,

"But, say the critics, the public plan starts off with an unfair advantage because it's likely to have lower administrative costs. That may be true -- Medicare's administrative costs per enrollee are a small fraction of typical private insurance costs -- but here again, why exactly is this unfair? Isn't one of the goals of health-care cost containment to lower administrative costs? If the public option pushes private plans to trim their bureaucracies and become more efficient, that's fine.

Critics complain that a public plan has an inherent advantage over private plans because the public won't have to show profits. But plenty of private plans are already not-for-profit. And if nonprofit plans can offer high-quality health care more cheaply than for-profit plans, why should for-profit plans be coddled? The public plan would merely force profit-making private plans to take whatever steps were necessary to become more competitive. Once again, that's a plus.

Critics charge that the public plan will be subsidized by the government. Here they have their facts wrong. Under every plan that's being discussed on Capitol Hill, subsidies go to individuals and families who need them in order to afford health care, not to a public plan. Individuals and families use the subsidies to shop for the best care they can find. They're free to choose the public plan, but that's only one option. They could take their subsidy and buy a private plan just as easily. Legislation should also make crystal clear that the public plan, for its part, may not dip into general revenues to cover its costs. It must pay for itself. And any government entity that oversees the health-insurance pool or acts as referee in setting ground rules for all plans must not favor the public plan."

This last paragraph is Reich's most egregious error of logic. He points to a sort of portable voucher which he hypothesizes being given to each consumer, with which to purchase healthcare. But he simply omits, and denies the potential for the 'public option' program to additionally run at a loss, charging below-market prices in order to gain share. Were it a standalone firm, the 'public option' purveyor would be charged with anti-competitive pricing behavior. In anti-trust law, it's called "predatory pricing."

The legislation to which Reich refers is hypothetical, and, in the event, will never have real force. The phrase "it must pay for itself" is laughable, and simply reveals Reich, even with his Washington experience, to be hopelessly naive about how the healthcare plan which he champions will really work.

Honestly, if the terms on which Reich insists a public option were actually used, and enforced, there wouldn't be a problem, because the effort would fail miserably. However, you can be sure that none of Reich's provisos will be included in Congressional legislation or, if included, will not be enforced.

Just consider what a mess Congress made of the mortgage markets by failing to oversee Fannie and Freddie. Thanks to Congress, both parties, by the way, private mortgage conduits were elbowed out of business by GSEs which ran amok and ruined a big chunk of our financial system.

Do you want the same type of results in the healthcare sector?

Reich makes another statement near the end of his editorial,

"As a practical matter, the choice people make between private plans and a public one is likely to function as a check on both. Such competition will encourage private plans to do better -- offering more value at less cost. At the same time, it will encourage the public plan to be as flexible as possible. In this way, private and public plans will offer one another benchmarks of what's possible and desirable."

Again, he's off in academic economic dreamland. This is not what will occur.

Instead, a heavily and stealthily-subsidized federal 'public option' will drive private healthcare insurers out of business by underpricing care and risk. When employers realize that they can more cheaply fund their healthcare benefits by buying the public option, private plans will disappear.

Reich simply ignores that almost all US consumers are covered by third-party payer plans, and, thus, don't even make their own decision about who provides their healthcare insurance.

Why did the Journal even print this naive blather? Perhaps to embarrass and reveal Reich for the misinformed, lazy analyst that he obviously is?

Wednesday, June 24, 2009

Comments On The Proposed Financial Regulatory "Reforms"

The current administration's blueprint for extensive financial regulatory "reform" was recently released. It's instructive to note the assumptions which must underlie its format.

Specifically, I refer to two aspects of the changes. First, it provides vast new regulatory powers to two federal institutions- the Federal Reserve and the FDIC- which utterly failed to prevent the recent mortgage-related financial collapses of both firms and the entire US financial system.

Second, it calls for a super-regulator to oversee systemic issues and be the locus of ultimate regulatory authority.

It doesn't take a genius to realize how badly flawed these assumptions are.

In the real world, why would you give more power to an institution that just failed at its existing mandate with its current personnel? Rational people would investigate why the organization failed. Was it staff, training, processes, procedures, leadership, or something else?

Was that 'something else' perhaps an outside authority or player? Perhaps named 'Congress?'

Whatever the cause, it has to be discovered, and a specific remedy suggested to reform the existing regulatory body.

Regarding the hope that a single super-cop on the financial beat will somehow permanently eliminate all future financial disasters, it's a pretty naive one.

Only this morning, a former FDIC chairman laughed at the idea, noting that competing regulatory agencies are more likely to discover problems than a single, unchallenged one.

I'd go further. There is, or ought to be, already, between the Fed, FDIC, OTC and other agencies, sufficient information on US financial institutions to provide other, perhaps new regulatory authorities with data to observe and analyze.

Just because the Fed collects bank data does not mean you want to fuzz up and confuse its mission and focus. Only naive and inexperienced systems designers would equate collecting data with necessarily using it as a regulator.

Why not consider, socialize and then organize generally-agreed regulatory panels or organizations which use data from the existing institutions, but each take a particular perspective on oversight, e.g., institutional risk, leverage, counterparty risk, systemic risk, etc.

Ideally, the Fed should focus on managing the nation's money supply. The FDIC should focus on quickly closing ailing banks.

The information the two existing institutions collect could be used by other, new, when necessary, purpose-driven regulators who could then apply specific tools to the data already collected. This would avoid needless blurring of institutional focii, overburdening of staff, and preserve a diversified, multiplicity of observers of various financial system risks and potential problems.

But it's highly unlikely that anything as simple and blunt as just anointing one agency as super-regulator will solve anything. Or prevent a repeat, in a different area, of the mortgage finance-sourced financial problems of recent years.

Tuesday, June 23, 2009

Jack Welch University

Yesterday's Wall Street Journal featured Jack Welch's investment in an online business school and MBA in its Marketplace section.

The former GE CEO has bought a 12% share of the former Myers University, now renamed Chancellor University System, for "more than $2 million."

Welch and his latest wife, whom he married after having an affair with her while married to his prior wife, will both be involved in the venture. Welch's current wife, Suzy, was the editor of the Harvard Business Review until 2002, when her affair with then-married Welch brought about her resignation.

Another figure from Welch's past, Noel Tichy, his adoring biographer and one-time head of GE's Crotonville management center, is to be the online school's new Dean. Tichy was a relatively non-descript management professor in Michigan until he fell into the GE gravy train a few decades ago. The best break he ever had- until now, I suppose.

So, now Welch is going to lend his name to an MBA program and apparently transfer his vast knowledge of how to manage businesses successfully to thousands of MBA students via the internet.

Here's my question.

If Welch has value as an educator, shouldn't we see it in the performance of the company which he led for nearly 30 years, GE? Shouldn't his business and educational acumen have left a team of deeply-talented, well-educated (by Welch) managers to continue Welch's performance at GE?

However, that's not what actually occurred. No, instead, as I've noted in my numerous (labelled) posts about GE and Immelt, and the nearby price chart of GE and the S&P500 Index displays, the company's performance headed into the toilet as soon as Immelt, Welch's hand-picked successor, took the reins in September of 2001.

In fact, Immelt has managed to destroy all the premium, above-equity-index value his predecessor built over several decades Now, you'd have been about as well off owning the S&P since 1963 as you would have been buying and holding GE until the present.

You have to ask yourself, if this is the result of Welch's personally-trained and selected team at GE after his departure, just how effective is the vaunted "Jack Welch way?"

Based on the company's performance under those whom he groomed and chose, I wouldn't be writing checks to Chancellor for either of my children just yet. Or maybe ever.

I've always given Welch credit for his very adept handling of the mess of a company Reg Jones handed off to him in the early 1980s. He coped with inflation, high interest rates and misleading accounting values. Welch's instinctive concentration on businesses in which GE could be among the top three in share and were growing was the right move.

However, as I pointed out to him in a private meeting in the mid-1990s, his performance margin over the equities indices pretty much ended by then. Subsequent events in GE's power business proved Welch wrong in his predictions to me that it was poised to take off. My own advice, that the industrial units, being valued differently than growth businesses, were needlessly weighing on the financial and media properties, proved to be correct.

Further, in the latter years of Welch's tenure, GE's performance rested, I contend, more on Welch's persona and a sort of 'pixie dust' in the eyes of analysts, than on Welch's hard-nosed leadership and management.

After all, how much about GE could really have changed by late 2001, when, under Immelt, the firm's reported performances were savaged by analysts, reserves were called into question, and accounting practices were criticized?

I think you have to see GE's performance subsequent to Welch's departure as an early read on his effectiveness as a manager and teacher, and give him an "F" (hey- that's his middle initial, isn't it!). Hardly an endorsement of Jack's way, is it?

Yes, straight from the gut- Jack's lasting impact on his own chosen few hasn't been very pretty to see.

Granted, though, Professor Jack sounds a helluva lot better than Neutron Jack, doesn't it?

Monday, June 22, 2009

Perspectives On Economic Opportunities, Skills, and Jobs

I had a discussion with a business colleague recently on the topic of how "jobs" are perceived by many non-business people, most often state and federal governmental officials.

For example, we often hear of governors or presidents taking credit for "creating jobs." Or state officials will talk about how many "jobs" are in their state, or leaving their state.

If you think about the references to "jobs" abstractly, these politicians talk as if the term refers to a stock of tangible items to be apportioned out to people.

But that's not what a "job" is at all. I contend these linguistic uses belie a totally incorrect viewpoint and understanding of what a "job" really is.

Here's how I view the context and meaning of a "job."

In a society, people have various skills. Some people also have ideas for developing products and services to sell to other people.

While we all want to have an economy that creates sufficient jobs for the people in our society, jobs are a function of business and economic activity, not the other way around.

For example, long ago, farming and various industrial activities required some number of workers. As time went by and technological advances occurred, the number of "jobs" required to produce a ton of steel, or an acre of wheat, fell. But new "jobs" arose to build the machine tools and farming equipment that saved labor in the older, once labor-intensive sectors.

Economic growth via new businesses and expansion of older ones leads to a need for more workers, thus creating "jobs."

Anything a government does to either stifle business growth, or move it elsewhere, causes "jobs" to move and, thus, be lost to the geography over which that government presides as society's political entity.

If the people in an area don't have the skills to do the work required by a new or expanded existing business, there won't be any new "jobs" there. There might be a need for more workers, but without qualified people, the jobs will appear elsewhere.

Thus the growth of technology firms around Boston in the 1980s, and in Silicon Valley for several decades. Until taxes and other expenses drove firms to add new "jobs" in Oregon, Washington, New Mexico, and even overseas.

Jobs are not a fixed or necessarily growing economic good, able to be traded, 'created' or 'saved' by government.

And economic development and business advancement can cause some 'jobs,' or, really skills, to be no longer necessary. Jobs aren't a static concept or body of things to be simply taxed and relied upon by governments.

They are the by-products of business processes and expansion. Treat business badly, cause it to contract or die, and you remove the production needs which lead to "jobs."

Perhaps my colleague best illustrated the point when he engaged in light discussion with a doctor recently.

His doctor asked what my colleague did for a living and, on hearing he is self-employed with several ventures, observed that "at least you can't be laid off."

"No," my colleague replied, "but I can go bankrupt and lose my businesses."

Jobs aren't just things which you "get" and "keep." They stem from a business' need for work to be done and skills involved in doing that work. If there's a fit with local people, at a price both can afford, then a "job" may be created for that work at that time at that price.

But speaking of jobs in some totally abstract manner, as if they are a constant stock of income-yielding positions to which all Americans, in the aggregate, are entitled, is simply a gross misunderstanding of how business works.

Sunday, June 21, 2009

Starbuck's Reconsiders The Details

In yet another chapter in Starbuck's continuing struggles to recapture its former luster, the chain is now planning a significant change in what would seem to be a trivial activity. After what has apparently been intensive study of how and when coffees are brewed in the roaster's many stores, management has decided to focus on having fresher pots of coffee always available.

The Wall Street Journal reported, in a recent article,

"Instead of grinding coffee only in the morning, baristas will grind beans each time a new pot is brewed. Timers will buzz to signal when it's time to make a new batch, according to internal Starbucks documents reviewed by The Wall Street Journal.

The changes are part of the Seattle-based company's effort to reinvigorate the "Starbucks experience" in the face of competition from less-expensive rivals such as McDonald's Corp. and 7-Eleven Inc. With Starbucks' changes, customers will be able to hear the whir of grinders and smell the aroma of fresh coffee all day.

Two years ago, Howard Schultz, then chairman of the company, wrote a memo to executives blaming the chain's excessive focus on growth and efficiency for cheapening the coffee-shop experience he long had championed. Mr. Schultz wrote that an earlier switch to preground coffee had taken the "romance and theatre" out of a trip to Starbucks.

"We achieved fresh-roasted bagged coffee, but at what cost? The loss of aroma -- perhaps the most powerful nonverbal signal we had in our stores," he wrote.

Currently, baristas decide when to brew fresh batches "based on multiple signals ranging from demand (quantity), to expiration and timing," the new documents say, explaining that the revamped process "reduces this complexity by eliminating many of these signals."

The documents say that currently, "by using dedicated [containers] to brew coffee, our customers may experience a coffee outage 14 minutes out of every hour, or 23% of the time! This coffee outage occurs for seven minutes during every batch, making brewed coffee unavailable to our customers." As a result, customers can be forced to wait, choose another type of coffee or leave the store empty handed. "To solve the brewed-coffee outage problem, we must change the way we brew coffee," the documents say.

Some baristas said the extra grinding and brewing might slow service and turn off customers with added noise.

But demonstrating to customers that coffee is ground and brewed on the spot could help Starbucks maintain its premium position, especially as rivals tout less-expensive alternatives."

What struck me about Schultz' approach and concerns is that it probably won't attract coffee drinkers the chain hasn't already won over long ago. I'm not a big Starbuck's fan, personally, but I visit their stores with/for my daughters on occasion. The same people are generally in the one we most often frequent.

I honestly don't think more freshly-ground or -brewed coffee aroma will bring (back) Dunkin' Donuts' and McDonalds' coffee drinkers. It's a segmentation issue, and Starbucks long ago sewed up the segment that celebrates expensive coffee and the coffee houses in which one may linger to drink it.

Finally, in these times of government intervention into financial services, auto production and healthcare, I find it instructive how detailed and minute are Schultz' and Starbucks' managers' focus on their business.

Look again at how deeply and precisely the firm's management had studied a specific part of their operation with an eye to customer motivations and need satisfactions.

No governmental civil servant is going to do that. Yet, that's what it takes to succeed in business. Focus on customer wants and needs. Diligent, constant, detailed review of your own business' offerings, strategies, and operations.

Is Schultz right in changing the Starbucks' stores' coffee brewing? I don't know, but I doubt it. Still, he and his managers feel it's an important change to make in order to revive growth, profitability and equity value for the firm.

I just don't see that sort of combination of analytical rigor and imagination from any government hacks trying to oversee, restructure or operate significant portions of the US economy.