Saturday, October 17, 2009

The BofA Ken Lewis Succession Mess

By now, BofA's board must be lamenting the day its CEO, Ken Lewis, agreed to take federal funding. And agreed to buy Countrywide Financial. And agreed to buy Merrill Lynch. And agreed not to tell shareholders of the bonus payouts to Merrill employees prior to the sale's closing.

Now the administration's "pay czar" is refusing to agree to Lewis' compensation.

Isn't this all enough to prove why it's never a good thing for government to get in bed with private, publicly-held companies?

BofA probably should have just taken its lumps from the Countrywide purchase and soldiered on, rejecting federal "help."

It could have done what it liked with the Merrill purchase, including rescinding it for material changes. It could have paid its employees what it liked, and ignored Treasury's coercive behaviors.

Instead, the board has to scramble to replace its CEO, who is girding for an extended legal battle with the New York State. And has to submit its executive compensation to some nitwit in Washington.

Federal money was the root of all of this trouble for BofA.

They should have just said "no."

Friday, October 16, 2009

Mortgage Market Pablum from Barclay's Michelle Meyer

Another wacky segment which I caught yesterday afternoon featured a woman from Barclays named Michelle Meyer. Apparently she was a rising star at...ah..... Lehman. Now she's chief economist at Barclays Capital, having been absorbed along with some other remnants of Dick Fuld's failed investment bank.

The topic of interest to me was one on which I'm planning another post, as well- a return to poor lending standards and the abrogating of current mortgage contracts.

The various talking heads on the segment were discussing rising delinquencies and, ultimately, the foreclosures which will follow. One CNBC reporter noted the story of a realtor who simply stopped paying her family's home's mortgage because their loan is so deeply underwater. This was some nine months ago, so the story went, and she hasn't been contacted by her bank yet, effectively letting the family live mortgage payment-free in their own home.

As the CNBC on-air anchor introduced the topic of mortgage forgiveness and rewrites, she polled the discussion participants regarding how this treatment of investors will affect subsequent mortgage lending in years to come.

Meyer jumped in and missed the entire point with her comment. Instead, she blurted out something about the price bottom having been reached, so it's upwards from here for the market. Nothing in her comment indicated she understood in the least what the anchor's question implied.

I watched this, and Meyer, with curiosity. Meyer appears to be, at most, in her mid-30s. Most of her mortgage-related experience has thus been in one of the most bizarre, unusual markets of all time. Rates near historic lows, negligible down payments and easily-securitized liar loans, option-rate ARMS and other strange residential finance creatures. All in a surreal market of ultra-low rates.

By contrast, my friend and sometimes business partner, B, is a residential finance veteran of some thirty years. He built at least two mortgage businesses on Wall Street, and has consulted with several others. He and I have discussed how he has supervised and managed teams of twenty-something mortgage business personnel who were stymied when confronting recurring problems B had first seen, and solved, decades ago.

It struck me as disappointing that CNBC has sunk to basically having kids on their segments as experts.

Remember when Mary Meeker and Henry Blodgett were the queen and king of internet business analysis? That didn't end so well, did it? If I remember correctly, I think Blodgett signed a consent decree to refrain from being an analyst anymore.

Lehman wasn't exactly a successful, driving force in investment banking during its last incarnation. Color me sceptical (yes, note the blog's title), but the failed bank wouldn't be a place where I'd expect to find the sector's best economic analysis or talent.

Even Bear Stearns had, in its day, Larry Kudlow and David Malpass. Both economists of much greater depth and with longer experience than Meyer.

To appear on air and assure everyone that, despite mortgage loan covenants being torn up by government programs, future housing finance will be unaffected just seems ludicrous to me.

But that's what Meyer seemed to be saying with her rather irrelevant response to the question concerning how investors will now view the safety of mortgage-backed instruments.

Misplaced Hero Worship: Morgan Stanley's John Mack on CNBC

Yesterday afternoon I happened to catch Bill Griffeth's fawning, softball interview with Morgan Stanley retiring CEO John Mack.

I find myself unable to disguise my total disgust with CNBC's continued glorification of inept CEOs, including sympathizing over how, in this case, Mack struggled to avoid his firm's demise, while carefully avoiding any question over Mack's responsibility was in leading his firm to that brink of disaster.
In his questioning of Mack, all Griffeth could do was look on in reverence as Mack regaled him with tales of seeking Asian funding to avoid being closed down by the feds.
If you look at the nearby price chart of Morgan Stanley, Goldman Sachs and the S&P500 Index for the past five years, you can see that Mack had spent the better part of his tenure since mid-2005 mismanaging the investment bank onto an index-trailing path.
Much ink has been spilled over Mack's mistakes since his return to the firm at which Sears/Discover Card's Phil Purcell outmaneuvered him after the 1997 merger of the two firms.
If I recall correctly, Mack installed poor risk managers, then had the firm go for broke by diving into trading and underwriting mortgage-backed securities. Then held back in the last nine months while risk taking actually began to pay off again.
In contrast, better-led and -managed rival Goldman Sachs was performing far better even before the crisis of last fall.
So, instead of asking Mack questions about how he managed to lead his firm to the brink of insolvency and possible government takeover or enforced sale to a rival, Griffeth painted Mack as some sort of late-hour hero, beset by forces outside his control, desperately fending off Hank Paulson and Tim Geithner as he rescued Morgan Stanley with funding from new outside investors.
It makes me want to throw up when I see such shallow, gullible, misleading reportage. Much like Wall Street Journal veteran Peter Kann noted in an editorial on which I commented in this post, CNBC is rapidly heading down the road that led to the demise of printed newspapers.
Yesterday's interview of John Mack contained several aspects of that demise, e.g., shallow questions from Griffeth and a biased, flattering treatment of the subject, rather than hard-nosed questions that an intelligent, informed viewer would have posed.
Rather than champion capitalism and free markets, this sort of softball journalism at CNBC contributes to the weakening of our economic system. Griffeth breathlessly spoke about how narrowly Mack avoided Morgan Stanley going out of existence.
Guess what? Few financial service companies from thirty years ago are still around and independent. Poorly run investment banks and brokerages, such as Lehman- twice-, First Boston, Kidder Peabody and Salomon Brothers get taken over. Or perish.
Bill Griffeth needs to get a better sense of the reality of financial markets and the life-and-death cycle of those firms engaged in the rough-and-tumble world of securities underwriting and trading.
If a live televised interview on CNBC of the CEO of one of the less-well run investment banks doesn't feature questions about how Mack could have caused such massive, self-induced damage to Morgan Stanley, what will?

Thursday, October 15, 2009

Holman Jenkins' Rare Mistake

I finally got around to reading Holman Jenkins' interview with Goldman Sachs CEO Lloyd Blankfein in the weekend edition of the Wall Street Journal. The colleague who urged me to read it was correct- it's primarly a public relations piece by Blankfein to try to smooth over the bank's image prior to news that it will be again paying stratospheric bonuses after being rescued by the Fed and Treasury last fall.

Of course, now, Blankfein will have none of that, as conveyed in the interview. Note, for example, these passages,

"Then there's the matter of AIG, source of snarling recriminations even among Goldman's Wall Street brethren. If AIG, a huge player in all kinds of markets, had gone down, the impact on the economy would have been incalculable. Mr. Paulson and Fed Chief Ben Bernanke wouldn't risk it. They reversed course after Lehman and bailed out the insurance giant to a tune that now has reached $180 billion. To this day, charges fly that the AIG bailout was a backdoor bailout of Goldman.

AIG had been a big issuer of guarantees on subprime-backed paper; Goldman had been a big buyer of those guarantees. Nonetheless, when government officials rang up to ask what would be the potential impact of an AIG bankruptcy on Goldman, Mr. Blankfein says his answer was: "negligible." He did not, he says, ask Washington to save AIG: "It never occurred to me, having lived through Lehman Brothers weekend, that there was government money for anything. People wanted to know how we were going to do when AIG went down. I was telling them we were fine."

Mr. Blankfein points to what he calls a fundamental aspect of Goldman culture—its risk-management discipline. AIG had been regarded on Wall Street as a gold-plated client, not just a "Street" counterparty. But Goldman had nonetheless taken the usual step of requiring AIG to post collateral nightly against any deterioration in the market value of the guaranteed assets.

Mr. Blankfein placed some of the phone calls himself. "AIG was being beastly, difficult to deal with, not responding well to our calls for collateral. And I called them up and fought with them, and it was always because they were disagreeing with our 'marks.' They never said, and I never had reason to suspect, 'We're illiquid. We don't have the money.' It never occurred to me."

Goldman, in its rigor, reinsured any shortfall with other counterparties, who were also required to post collateral nightly. "We had one day of exposure with them. It doesn't mean I can't lose $300 million if they don't pay because that's how much a market can move in a day, but basically I'm not worried about it."

These estimates, of course, have a theoretical element. The underlying assets would certainly have collapsed even further in value if Wall Street firms and AIG began dropping like nine-pins. We'll never know. In the event, AIG was rescued—though that now meant that taxpayer money, in a sense, was being shipped to Goldman to meet AIG's collateral obligations.

Some say today the government should have spurned Goldman's collateral demands. Some say it should even have forced Goldman to settle the outstanding positions at a discount.

Realistically, though, AIG faced hundreds of counterparties; and short of bankruptcy, which Washington had ruled out for AIG, no obvious formula presented itself for rewriting thousands of AIG contracts without risking the market panic Washington was trying to forestall. For its part, Goldman would have been on thin ice with its own shareholders if it had voluntarily relinquished valuable contract rights to make nice with Washington."

There's just one problem with that last paragraph. Mr. Jenkins is wrong.

In an article that appeared in the Wall Street Journal within a few months of the financial sector meltdown of last fall, one astute observer noted that there was, in fact, an existing process by which AIG's numerous counterparties could have been fairly and equally treated.

That option, of course, was bankruptcy. And it's rather curious to me that Jenkins glosses over this with a simple "Washington had ruled (that) out for AIG."

As that editorial writer noted several months ago in the Journal, putting AIG's swaps through bankruptcy, quickly, would have resulted in all counterparties taking a known, equal percentage haircut on the value of their positions. This is no different than learning that the value of your swap declined for some market reason. Swaps gain, and lose value all the time.

The source really is somewhat immaterial.

I'm surprised Jenkins gave Blankfein, Goldman and Washington all passes on this rather monumental corruption of capitalism.

AIG's takeover by the federal government is precisely the sort of unnecessary appropriation of private property, followed by draconian, confusing Congressional and administration rules impositions, that begs for more use of bankruptcy and less entanglement of Washington with private enterprise.

What We Haven't Learned From The Reagan Recovery

Yesterday's Wall Street Journal featured an editorial by economist Judy Shelton entitled "The Message of Dollar Disdain."

Quite by accident, since I had yet to turn to that page, I had a discussion with a business colleague over lunch about the same topic that Shelton mentioned at the end of her piece. I had told my friend about this recent post, based upon another Journal editorial, as well as a cross-post from my political blog featuring two video clips of Steve Wynn on fiscal policy. Both concerned the impact of proposed, costly social programs on a federal debt already bloated by roughly six decades of deficit spending.

Ms. Shelton wrote,

"Sadly, due to our fiscal quagmire, the Federal Reserve may be forced to raise interest rates as a sop to attract foreign capital even if it hurts our domestic economy. Unfortunately, that's the price of having already succumbed to symbiotic fiscal and monetary policy. If we could forge a genuine commitment to private-sector economic growth by reducing taxes, and at the same time significantly cut future spending, it might be possible to turn things around. Under President Reagan in the 1980s, Fed Chairman Paul Volcker slashed inflation and strengthened the dollar by dramatically tightening credit. Though it was a painful process, the economy ultimately boomed."

I mused to my friend about the same scenario. That is, I suggested that, if the long term effect of the weak dollar is, as David Malpass wrote in yet another Journal editorial, a fate much like Britain, the "hollowing out" of the US economy, then the solution is to raise interest rates on US Treasuries. Combined with more prudent fiscal policy, a la Wynn's observation that 'no government spending ever increased its country's standard of living,' in the form of restrained/reduced spending and lower taxes, genuine private economic activity would be resuscitated.

Such a move would, of course, sink various marginal business activity. But it would set off a chain reaction of virtuous consequences.

Banks would cut their lending to more viable projects which would clear hurdle rates of perhaps 3-5%, plus risk premium.

New capital would flow into the US to earn decent rates on fairly low-risk Treasuries.

That capital would flow to new business activity.

Money kept by taxpayers, instead of taken and spent by government, as well as not used to pay interest on higher deficits, would also seek investment returns, resulting in greater available capital for business activity.

As Ms. Shelton points out, this is precisely what occurred under the Reagan-Volcker regime.

The essential starting point is a commitment to the future, rather than the protection of past mistakes. In a word, an economy dedicated to Schumpeterian dynamics.

From this viewpoint, the mid-late Bush and certainly current administration's actions are exactly backwards. Rather than protecting existing, failed investments and propping up their value with taxpayer funds and borrowed capital from abroad, the more robust economic path would have been to let companies like GM, Chrysler, AIG, Goldman Sachs and Citigroup fail.

As Anna Schwartz noted in an interview she gave to the Journal last fall, on which I posted here. In that interview were the following passages,

"Ms. Schwartz won't say so, but this is the dirty little secret that led Secretary Paulson to shift from buying bank assets to recapitalizing them directly, as the Treasury did this week. But in doing so, he's shifted from trying to save the banking system to trying to save banks. These are not, Ms. Schwartz argues, the same thing. In fact, by keeping otherwise insolvent banks afloat, the Federal Reserve and the Treasury have actually prolonged the crisis. "They should not be recapitalizing firms that should be shut down.

But perhaps this is actually Mr. Bernanke's biggest problem. Today's crisis isn't a replay of the problem in the 1930s, but our central bankers have responded by using the tools they should have used then. They are fighting the last war. The result, she argues, has been failure. "I don't see that they've achieved what they should have been trying to achieve. So my verdict on this present Fed leadership is that they have not really done their job." "

Ms. Schwartz noted that liquidity was never the issue last fall, or even two years ago, when Helicopter Ben began reducing rates in a panic. Rather, she observed, the problem has been guessing which institutions were still actually solvent, as asset values spiraled downwards.

Monetary and fiscal policy which seek to protect past actions of private capital investors, at the expense of future ones, are doomed to stultify and cement an economy in the past.

Ms. Shelton's focus, while slightly different than that of Malpass or Lawrence Kadish, is never the less chilling. Whereas Malpass focused on exchange rate consequences, and Kadish on mounting interest and rates on the national debt, Shelton concentrated her analysis on the companion measure of US debt/GDP. On that measure, she notes, we will have vaulted, on the basis of current government estimates, from 23rd last year to 7th in 2011. The result? Ms. Shelton writes,

"The U.S. is thus slated to enter the ranks of those countries—Zimbabwe, Japan, Lebanon, Singapore, Jamaica, Italy—with the highest government debt-to-GDP ratio (which measures the debt burden against a nation's capacity to generate sufficient wealth to repay its creditors)."

Economic loss brings pain somewhere in an economy. Schumpeter's genius was to identify that this is the natural order of a healthy, growing capitalist economic system. Our policymakers cannot allow themselves to be unduly affected by the plight of those in the rearward areas of economic decay.

Transfer payments for employees of yesterday's now-faded economic titans is one thing. Actually rushing to preserve those enterprises with taxpayer funds is quite another. Or, worse, with borrowed funds from abroad.

When you assemble the views of the recent Journal economics editorialists- Malpass, Kadish and Shelton- you get a truly chilling picture of US monetary and fiscal policy gone mad.

Perhaps for the same reason so few of us seem to recall the economic horrors of the Carter years, for which Reagan's and Volcker's solutions were so effective, few also realize the danger we are in today.

Or that there is a fairly simple, if painful, way out now, as well.

Wednesday, October 14, 2009

Design As An Essential Business Element

Last Friday's Wall Street Journal's book review section contained a nearly-hidden piece of interest. The book is entitled, "Change By Design," by Tim Brown. Mr. Brown is the CEO of IDEO, a design consultancy.

As early as perhaps four years ago, I began to take a stronger interest in the MFA degree than an MBA. There was, I believe, even an HBR article extolling the value of a Master of Fine Arts degree for its integration of design as an inherent value-adding component of products.

It is very much along this line that Mr. Brown's book is reviewed. Rather than treat product design as an afterthought, it is, with the aid of firms like IDEO, being used in the early stages of concept and product design to add features and functionality.

The review mentions a technique used by IDEO which is a direct implementation of a very old (c1975) marketing concept called Tauber's Problem Inventory Analysis. The consultancy shot video of a mock patient entering an ER facility to identify problems confronting the patient not currently addressed.

Often, breakthrough products and services are identified by this type of analysis where focus groups fail. Perhaps the most famous example of such a difference in approach is that of air travel.

It's a commonly-held tenet that air travel could never have been produced by focus groups, because it was a solution that simply did not yet exist in any form. But, as a problem analysis, the characteristics of air travel as a solution could easily be seen to fit various business problems.

As with many good management practices, the irony and disappointment is that they are the exception, rather than the norm. Otherwise, Mr. Brown wouldn't need to write a book about it, would he?

But, then, it's these type of exceptions that drive some companies to deliver consistently-superior total return performance, while most do not.

Tuesday, October 13, 2009

Steve Wynn On The Stimulus, Jobs & Tax Policy

I wrote this post on my companion blog today. Because of some of the political overtones and asides in Wynn's remarks, I originally put it in a political context.

But, on reviewing the clips, I think it deserves to be cross-posted here, as well.

Interest Expense of the US National Debt

I read a piece in the Wall Street Journal yesterday by Lawrence Kadish that left me stunned.

Kadish uses CBO and Bureau of the Public Debt figures to sketch out a horrifying scenario.

At the end of last month, the US national indebtedness stood at nearly $12 trillion. Interest expense for this year on that amount will be $383B.

Kadish then uses CBO figures to derive this year's estimated personal income tax payments as around $904B. Dividing the interest expense for this year into personal income taxes, he derives the shocking rate of more roughly 40%.

True, one could use the estimated $2 trillion government receipts for 2009 instead, making the figure a more palatable 19%. But, in reality, taxes are always and ultimately borne by people. Institutions merely collect taxes indirectly for governments.

Kadish goes on to note that the US government has run deficits constantly, except for those few years of the elusive "peace dividend" following the USSR's breakup, for decades. So, predicting to the mean, or prior behavior, it probably will try to do so going forward, as well.

Now, due in part to the recent financial meltdown and global flooding of liquidity by central banks, interest rates on Treasuries are currently around 3%. But in the Carter years, it was as high as 15%.

Now add in OMB's projections of deficits amounting to some $9 trillion over the next decade, meaning a near-doubling.

You can see the awful mathematical conclusion, can't you? If rates move up, as they most certainly will as liquidity is drained globally, and too many dollars require ever-higher rates on US Treasuries, the current nearly $400B interest tab could easily swell by a factor of at least 5- twice for the larger debt level, and 2.5 times for the interest rate effect.

Will US per capita income rise by five-fold in a decade? Unlikely. Unless you mean purely through inflation. Real incomes certainly will not. If the US economy grew at a steady 3.5% each year and it was all due to productivity, meaning the entire gain went to increase personal incomes, they would only grow by about 40%.

Kadish goes on to state,

"Eventually, most of what we spend on Social Security, Medicare, education national defense and much more may have to come from new borrowing, if such funding can be obtained."

The options, Kadish writes, will become default or hyperinflation.

In prior decades, when our debt was widely held by western powers and investors, our appetite for social programs hadn't reached its current level. Longer ago, the US dollar was a prized, stable store of value in the post-WWII era.

Now, the world's major growth economies are no longer friends, e.g., China, Brazil, India. They won't necessarily even do us the favor of lending in dollars. If so, it will be at exorbitant rates.

Kadish's final point is to cite Steve Forbes as saying that the national debt is one issue which will motivate US voters to take action on Washington's profligacy.

I believe that. But on the way there, it's going to get very scary.

Imagine explaining to the average taxpayer that his annual tax liability is nearly half-consumed for just interest on our borrowing to pay for our lush social programs. And we're adding more, by the way.

And that, in a few more years, that figure will be easily more than half. So Washington will continue to try to borrow abroad to pay for promises it is increasingly unlikely to be able to keep to all parties- citizens, investors, and other countries.

Perhaps this is why I'm finding less to write about in the corporate world these days than in the world of Washington-centric business and financial dealings.

Monday, October 12, 2009

Brian Wesbury's Punt In Today's Wall Street Journal

Brian Wesbury wrote an almost schizophrenic economic editorial in today's edition of the Wall Street Journal, entitled "The Economic Recovery Is Well Underway." It's curious to me that he has been absent from the usual venues on which I've either seen or read him for about a year. For example, these posts, here and here, date from August and December of last year.

Wesbury states early in his editorial,

"Many fear a W-shaped economy, otherwise known as a double-dip recession. These fears are overblown. The only double-dip recession of recent decades happened in the early 1980s, when the country was in the grip of "stagflation" and the Federal Reserve ran a roller-coaster monetary policy."

I won't go into all the details Wesbury presents, but simply note his high points. First, he notes that the equity market's recovery dates from about the point at which 'mark to market' valuation was suspended/modified, thus setting a floor under many financial instrument and, by extension, financial entity valuations.

He argues that housing, manufacturing, consumer spending, imports and exports are all of their recession lows. Yes, he writes, even consumer spending, excluding automobiles, is up at a 3.9% annual rate. Wesbury converts all of the quarterly or less rates into annualized rates, so the numbers are pretty compelling, if only on that basis.

On the job losses front, Wesbury cites conventional wisdom that jobs data are always lagging recessionary indicators, but he takes heart that the monthly losses have declined from the 700,000 range early in the year to just below 200,000 recently.

As others have claimed, Wesbury, too, now believes that inventory rebuilding will bring about private sector economic growth and job creation.

So far, Wesbury has kept to conventional economic data and indicators, and on these bases, he's now an optimist. It seems odd to me that he is now completely silent on the hyper-inflation which so consumed him only last December. In fact, the editorial notes, after attributing the piece to Wesbury, that he will soon have a book published entitled "It's Not as Bad as You Think: Why Capitalism Trumps Fear and the Economy Will Thrive."

Perhaps the book has consumed Wesbury's time and efforts for most of the past twelve months.

However, he then turns schizophrenic in the editorial, writing,

"The two factors that could undermine growth in the long run are bad government policy combined with global competition."

He then cites something I mentioned to a colleague recently, i.e., most of the S&P500 have significant sales and operations outside the US. Just because their revenues and profits might benefit from global growth doesn't mean jobs will be created in the US. Wesbury then goes on to note the rise in the minimum wage, a possible temporary job creation tax credit, and probable higher tax rates as bad for the US economic recovery.

He concludes his piece with this passage,

"There is no free lunch. If you take a look at the U.S. economy since 1960, the larger the government share of GDP, the higher the unemployment rate. In other words, when it comes to jobs, government spending has a multiplier of less than one- government spending destroys jobs.

Whether or not this recovery continues depends on the course of government policy. If the U.S. passes a costly bill to nationalize the health-care system, a new tax system to reduce carbon emissions, and higher marginal income tax rates, a European sclerosis will settle in with permanently higher unemployment rates. This will not happen because capitalism failed, but because government gave up on it prematurely."

I am left feeling that Wesbury is trying to have it both ways. He forecasts a recovery on existing economic data, but clearly hedges by citing pending administration and Congressional plans to do all the things about which he warns in his last paragraph. I understand why he does this, and he is attempting to convey what he sees now.

That is, an economy that could be recovering, albeit slowly from a fairly deep drop in economic activity. Combined with federal fiscal policies that could cripple the once-vibrant US economy.

It's hardly a prescription for confidence in either fundamental economic performance or the equity markets for the next few months.