Saturday, July 18, 2009

Hank Paulson's Congressional Show Trial

I happened to see several minutes of Hank Paulson's Congressional show trial of last week. Specifically, I heard a Representative, from which party I honestly don't know, lambaste Paulson for having enjoyed a statutorily provided tax deferment on profits earned from premature sale of assets upon being confirmed Treasury Secretary.

Sounding like a mad dog with no common sense whatsoever, this thin, older-looking male Representative repetitively demanded to know how much in taxes Paulson had avoided paying due this provision.

This particular line of 'questioning' was quite far afield from the stated reason Paulson was appearing before the Committee, i.e., to determine whether he and/or Ben Bernanke used undue coercion on BofA CEO Ken Lewis to force him to complete the Merrill Lynch acquisition.

If we are to attract candidates of merit and suitable qualifications and accomplishments to cabinet-level offices, we can't have Congressional members behaving like Grand Inquisitors. Specifically, twisting legitimate actions of government servants to appear as something else- in this case, tax evasion by the rich.

We're all going to be much poorer, economically and otherwise, if our Congress continues to attempt to criminalize every aspect of any administration's behavior with which it disagrees.

Friday, July 17, 2009

Let CIT Die

There has been much handwringing regarding CIT's imminent demise, amidst discussions with the federal government for yet another rescue package.

According to Tuesday's Wall Street Journal, CIT has suffered heavy losses in its lending to small- and medium-sized businesses, but is not really considered a lynch-pin of the overall banking system.

Still, federal administration members worry about the signal that would be sent if a major lender to small business goes bankrupt.

Honestly, how hard is this one to figure out?

CIT has lost money doing its business. It's evidently not very good at making credit risk and/or funding decisions, which are the two most important aspects of a lending business.

If there is sufficient profitability in well-made small business loans, some other firm will enter the market as CIT vacates it with its collapse. Hopefully, doing the business better than has CIT.

But why in God's name would anyone wish to prop ups a badly-run lender that isn't crucial to the nation's financial system?

This is really a no-brainer. The loans which are outstanding will be assumed or bought by some entity. New credit will flow if it's viable and profitable.

If it's not, then these borrowers were not the ones we should want to have receiving loans in the first place.

Things generally work better when you leave market forces to figure them out. The mere fact that the administration has been discussing bailing out CIT tells you they don't really understand the dynamics involved in this matter.

Rather than clear out an incompetent source of business lending, to make room for better ones, administration officials are seriously contemplating aiding idiots who have run their own business into the ground.

This is no way to recover an ailing economy, nor, for the long run, promote efficient economic activity in the US.

Thursday, July 16, 2009

Exxon Blinks On Alternative Energy

In a scene very reminiscent of the 1970s- and isn't much of our political economy these days?- Exxon announced a strategic reversal on alternative energy sources.

Yesterday's Wall Street Journal reported that Exxon is pairing with esteemed biologist J. Craig Venter to research the use of algae to clean greenhouse gases and secrete oil.

Honestly, reading that last part, it sounds like a sci-fi novel.

And maybe- just maybe, if we are lucky- it is.

Because the last time Exxon appeared to abandon its primary business, oil exploration and refining, and jumped into something else, it wasted billions of dollars. According to the Journal article, this time, it seems to be anteing up only $600MM. Truly a pittance for the oil giant.

Some historical context is required to properly understand what's happening here.

Back in the 1970s, when the Clean Air Act Extension and high oil prices put pressure on oil companies, Exxon launched Exxon Enterprises. EE was a holding entity which oversaw startup planning for all sorts of non-oil businesses, including solar energy panels, a fax machine business, and various other electronic office products initiatives. The thinking was to use Exxon's enormous revenues to fund so-called replacement technologies, such as electronic office equipment, to replace oil used in commuting and travel, and solar, to replace depleting and expensive oil.

I consulted to one of the EE businesses as part of the Wharton Applied Research Center when I was a graduate student. In a hilarious activity straight out of Joseph Heller's Catch-22, our mission was to help the management of Exxon Solar Energy to forecast a developing market of sufficient size to secure follow-on budgetary funding to continue the business effort. The furthest thing from our charter was to actually create any product. We were brought in to simply play a paper-shuffling game of justifying the unit's existence to corporate for a few more years. The stories we heard of oil executives jumping ship from the New York headquarters to work out in Florham Park, NJ, were many and rich. Suffice to say, there was a whole lot of ticket-punching going on, but nobody believed in the longevity of the businesses.

As it happened, a year later, I was working at AT&T in Morristown, just a stone's throw from EE. In short order, Lee Raymond, the now-retired CEO of Exxon, was brought in to wind down the whole mess and stanch the incredible losses emanating from Florham Park.

Raymond observed that oil wasn't going away, while Exxon would never amount to much in these new areas. He presided over the selling off or closing of all the EE business efforts.

In truth, EE had served its purpose. During a period of hysteria over high oil prices and Arab control over much of the world's crude, Exxon had successfully deflected some public criticism, and appeared to be spending money on diversification in order to seem to be 'solving' the problems associated with high oil costs.

Once Reagan was in office and the publicity crisis had passed, Raymond, a rising 'go to' guy at the firm, was brought in to restore sanity.

I think that's what's occurring now, too.

Rex Tillerson is no fool. I loved the Journals reference to Tillerson's snide remark about alternative energy, i.e., that he expected to be driven to his funeral in a car powered by gasoline or diesel fuel. And he will be.

But, for now, it's once again time to show public humility at being in the oil business.

Who better with whom to partner than noted scientist Venter, on a project that sounds like something out of pure science fiction.

Imagine- an algae that consumes greenhouse gases and spews out usable energy. Can it get any wilder, more perfect, or safe?

I can just see Tillerson and other senior Exxon execs around a conference room table one-upping each other on what the alternative energy project should have as its aim, and roaring with laughter at the final result.

How many years will it be before any real progress is made on this wild-algae chase? Well, Daniel Nocera's work on fuel cells has consumed about a decade, and he figures he has at least half that time, again, to go before perfecting his work.

Who knows how long Exxon can manage to make this tilt at an enormous windmill take? Most likely, long enough to see a return of either the Oval Office or at least one chamber of Congress to Republican control.

In the meantime, this far-fetched, impossible-sounding quest will soldier on, consuming a trickle of Exxon profits, while reaping huge publicity gains.

Don't ever underestimate Exxon management.

Wednesday, July 15, 2009

The Dial-a-Mattress Case

Yesterday's post discussed Goldman Sach's recent blowout earnings announcement. For what it's worth, a Wall Street Journal column on the back page of today's Money & Investing Section echoed my own note of caution regarding Goldman as a bellwether. More on that in a later post.

Going from the sublime to the ridiculous, yesterday's Journal featured a piece which my business partner and I thought had vanished. It was a rather in-depth story on the bankruptcy filing of New York-based Dial-a-Mattress.

As successful and 'together' as Goldman's management team has always been, Dial-a-Mattress' was home-grown and sort of 'seat of the pants.'

Founder Napoleon Barragan got his idea from a local business that once sold steaks over the phone, and began a similar one for bedding in 1976. After some twenty-five years of solid and profitable growth, the company's downfall began in 2001, according to Barragan. Specifically, the article notes,

"Mr. Barragan said two major changes in his business were largely to blame: an expansion into bricks-and-mortar sales and a culture clash brought on by new management."

In effect, the business cratered due to totally controllable mistakes, not market or consumer trends.

In brief, the Journal piece describes Dial-a-Mattress' haphazard, inept expansion into physical stores right after the 9/11 economic pullback. It's clear from the article that the company stumbled its way into this strategy, mistakenly opening stores in literally "low rent" areas to which people would not drive to shop.

Unbelievably, Barragan states that the company never did standard store-based profitability analysis which could have caught the losses early on and perhaps mitigated the damage.

Around the same time, Barragan hired a fairly large number of new senior executives, thus diluting the culture with which Dial-a-Mattress had succeeded for years. In a scenario straight out of some made-for-television movie about rich, inept businessmen, the new hires ignored the operating processes which had accounted for much of the firm's nimbleness, and, instead, devoted much time and energy to infighting.

Apparently, according to the Journal's piece, nobody bothered to analyze profit margins by channel, store, or any other basis. Thus, rising sales were seen as validation of new strategies, including a successful move to internet-based sales, while profits languished, then fell.

The final chapter is that the firm's competitor, Sleepy's, is purchasing the phone and online portion of the business, as well as hiring Barragan at $500,000/year.

As I read this story, I was struck by how difficult building and maintaining a successful business is. And how often successful companies fail for the most basic, fundamental reasons.

In Goldman's case, it was forced to become a commercial bank, and take federal funding, not so much for its own mistakes, but for the tenuousness of the financial system in which it operated. The mere hint of counterparty failures sent Goldman to the brink. Though it seemed never to skate so close to failure as Bear Stearns did, the same forces were about to bear down on the formerly premier investment bank.

In the case of Dial-a-Mattress, the business model was simpler. Yet the mistakes which sank the firm were simpler, too. And, unlike Goldman's, totally under management's control.

How fleeting is business success. How many ways there are for it to go "poof."

No matter how smart, or uneducated the management at the helm.

I guess, as I read this post, one has to ask the unrelated question,

'Was it fair for Goldman's mistakes in operating in an environment in which it was so vulnerable to counterparty and funding risk to be assumed by the federal government, thus saving the firm and most of its employees, while Napoleon Barragan's mistakes led to his firm's failure?'

Tuesday, July 14, 2009

Goldman's Earnings Announcement

Yesterday's 2.5% rise in the S&P500 has been attributed to Meredith Whitney's 'buy' rating on Goldman Sachs, just in advance of its earnings announcement.

Various superlatives have been used to describe the firm's quarterly earnings. And, coming on the heels of the prior 6 months of financial sector turmoil, in which Goldman had to give up being an investment bank, and become a commercial bank, the performance is somewhat surprising.

Then again, much of the gains were from trading- an old Goldman strength. And it's not clear how the Fed will continue to oversee and/or allow Goldman's current mix of business.

Frankly, I think the investor reaction which propelled the S&P to such a daily gain is misplaced. It's asking a lot to pin hopes on just one, and arguably the best bank's results.

Furthermore, it's not just Goldman's quarterly performance, but, allegedly, Whitney's stamp of approval with a 'buy' rating on the firm.

It's troubling when any single analyst has this type of power over companies with their recommendations. Additionally, while Goldman may be poised to continue its superior performance, that, in my opinion, is precisely why it is not a bellwether for either the sector or the economy in general.