Friday, November 06, 2009

Measured Unemployment Tops 10%!

This morning's official government unemployment figure finally topped 10%, coming in at 10.2%.

In pre-market activity, the S&P500 Index futures plummeted. However, at this point, 10:30AM, they have rebounded, then fallen again through yesterday's closing values.

Of course, the usual pundits weighed in on CNBC about how unemployment lags a recovery, blah, blah, blah, blah.

Even Brian Wesbury, usually quite sanguine, was beating a 'glass half full' drum, predicting a peak unemployment number in only two more months.

However, in this morning's Wall Street Journal, Mark Gongloff notes,

"In the eight recessions between World War II and 1982, payrolls bottomed and unemployment peaked, on average, less than one and two months, respectively, after the recessions ended.

Assuming, as most economists do, that the latest recession technically ended in June 2009, this recovery already is looking jobless."

I wrote this post in early September. In it, I suggested that the US economy has changed pretty significantly since that 1982 recession, now almost thirty years ago. I compared this to the difference in the US economy between 1930 and 1960.

To me, the fact that Gongloff reports that the unemployment peaking behavior has been different since the 1982 recession indicates that this phenomenon may just not exist any longer. Businesses are run differently, with much more timely data and inventory control systems. Linkages between manufacturers, distributors and retails are tighter and more seamless.

In any case, Gongloff's point is well taken. He reports that,

"Economists, on average, expect unemployment to peak in February 2010- eight months after the recession's assumed end.

Even that forecast might be optimistic......

At that pace, given the historical relationship between payrolls and GDP, payrolls would fall through the second quarter of 2010, according to University of Wisconsin economist Menzie Chinn. And unemployment typically peaks after payrolls bottom."

One thing is pretty certain. Given the Fed's recent denial of the effects of so much monetary base creation on the inflation rate, this unemployment number will give it an excuse to keep rates around zero.

Some have opined that this will be great for corporate profits. Well, perhaps for banks, in that they can literally get free money and invest it in Treasuries at a positive spread.

But for most companies, rates affect borrowing. If consumer spending isn't healthy, expansion is moot, and so will be borrowing.

Despite the pundit on CNBC who foresees a "business-led recovery," that simply doesn't make sense. Yesterday's reported 10%+ productivity increase means that today's businesses can pump out quite a bit of volume without adding labor.

So much for Say's Law in the modern US economy.

Thursday, November 05, 2009

Charlie Gasparino's New Book "The Sellout"

With his new book, "The Sellout," released on Tuesday and already available on Amazon for about $15, Charlie Gasparino appeared on CNBC nearly non-stop that day.

Harper-Collins' publicity people arranged for a same-day book review in the Wall Street Journal, as well. The review is extremely positive and provides some important details which Gasparino ceaselessly provided in his on-air interviews that day.

Specifically, Gasparino repeated a phrase he coined that went something like this,

'If Wall Street became greedy, as many have charged, it was in response to the federal government's actions in the mortgage markets.'

From many viewings of Gasparino's bullying rants a few years ago in discussions with senior WSJ editor Allan Murray, I have come to have a latent dislike for the man. But I admire his honest and full exposition of how the mortgage-backed financial meltdown truly came to exist. And that is due to explicit, bi-partisan federal government manipulation and coercion of the financial system to make questionable mortgage loans to lower-income borrowers, then securitize those loans as if they were high-quality debt instruments.

Credit goes to Gasparino for mentioning clearly and loudly, in nearly every interview, the name of Massachusetts Democratic Representative and current chair of the House Banking Committee, Barney Frank, as a prime architect of the financial mess which exploded last year.

The Journal review highlights Clinton-era HUD secretaries Henry Cisneros, who resigned under a cloud of bribery charges, and current NY AG Andrew Cuomo, as having unilaterally pushed down the income thresholds for 'low income' borrowers and pushed up the percentages of GSE-sponsored bonds composed of loans to those borrowers to 50% of all their mortgage-backed bond issuances.

It's pretty rich to consider that Cuomo helped kick off this orgy of bad mortgage lending, then has the gall to go after BofA over the Merrill purchase, which was brought about by....bad mortgages backing bonds.

Too bad Cuomo can't, or won't, prosecute himself for being part of this mess. He certainly deserves it.

In a rather arcane note in the Journal review, it mentions Gasparino's very detailed explanation of how the Fed's revised capital standards incented banks to hold more mortgage-backed securities, relative to Treasuries, since the former were given higher weight in the calculation of regulatory capital. To illustrate the impact, the review relates that Lehman's mortgage-backed holdings tripled in only three years, while its Treasury holdings remained flat.

Clearly, the US federal government designed the systemic incentives and underwriting activities which fed the so-called "greedy" Wall Street financial machine. On this point, Gasparino is quite clear, and does a real service by reminding or, in many case, informing people for the first time just how much of the responsibility for what occurred last spring and fall rests with various federal officials in administrations or the Fed stretching back as long ago as 1995.

Otherwise, you'd be prone to believe the current administration's demonizing of investment and commercial banks as the sole culprits in the recent and continuing financial services debacle.

It's a timely book and, by all the evidence available, a worthwhile read. I'm probably going to buy a copy on Amazon this week.

Wednesday, November 04, 2009

Buffett's Berkshire Buys Burlington Northern

Yesterday's business news was all about Warren Buffett's Berkshire Hathaway buying the 78% of Burlington Northern railroad that it did not already own.

On CNBC, they interrupted regular programming for a long telephone interview with the investor. He said, clearly, that buying the remainder of BNI was a 'long term bet on the US economy.'


Additionally, he cited some statistic involving the ton/miles delivered per single gallon of locomotive diesel fuel, to illustrate that a bet on railroads is a bet on energy efficiency. Several CNBC on-air staffers "oohed" and "aaahed" at the number, as if Buffett were the first to discover this.

Actually, CSX has been using the number for about six months in its very effective television ads against long haul trucking competition.

This morning's Wall Street Journal contained an article noting that Buffett typically doesn't pay premiums in the range of the 30% he offered for BNI. Nearby are price charts for Berkshire-B, BNI, and the S&P500 Index for the past 5 and 29 years.

BNI has outperformed both for the past 5 years, and equalled Berkshire over the longer timeframe.

Wilbur Ross opined on CNBC yesterday that Buffett's move for BNI means it has, and/or promises, performance that will be better than Berkshire, or else he wouldn't be buying it.

As I discussed this last night over coffee with a business colleague, I noted that, once again, as with his purchase of Goldman Sachs and GE convertible instruments, Buffett received treatment about which other investors can only dream.
First, because Berkshire already owned 22% of BNI, Buffett was able to secure a private screening of the recent board presentation. As an effective insider, then, Buffett had special knowledge that you or I don't about the company's recent and prospective performance.

I don't believe such knowledge made the ultimate difference in Buffett's offer, but it does show how and why Buffett can get deals you cannot. And won't be hauled into court, either, for doing them. Like, oh, say a recent Sri Lankan-born hedge fund manager?

More likely, what Buffett achieved for and with his 30% premium was the avoidance of an even higher premium, due to a bidding war for BNI.

Here's why.

As my old mentor from Chase Manhattan Bank taught me, when an asset is a scarce item, with few replacements, it can easily realize a large premium from a bidding war. Back in the day, we saw US Leasing go for a large premium, because it was a rare type of financial company.

BNI has only one similar competitor, Union Pacific. Two smaller ones are CSX and KSU. The four, with the S&P500 Index, appear on the nearby 29-year price chart.
CSX and BNI have outperformed the other two railroads, and the S&P, handsomely. That explains why Buffett isn't buying UP.
It also explains why Buffett doesn't want competition in this bid. If he had approached the BNI management publicly, and/or with an investment bank, he may have had one or more hedge funds quickly raise the price through arbitrage.
But right now is a good time to buy. While liquidity is high, M&A activity hasn't re-ignited yet on a large scale. There probably isn't a single business competitor who is positioned to take BNI without anti-trust issues. And it would take some time for even a few private equity groups to collaborate on a bid for BNI. Plus, they tend to want quicker returns than Buffett will accept.
Again, here is where Buffett gets opportunities others do not. How many investors would sit still for being told that a $44B acquisition is carrying a 30% premium and may not pay off for a decade? Most would redeem at the next quarterly window.
That said, the acquisition makes a lot of sense. BNI is well-positioned to grow via transporting imported goods from the US west coast. It will benefit from increased focus, whether the entire green agenda is ever passed in Congress, on fuel efficiency. Rail beats over the road long haul trucking hands down, and can do inter-modal, too.
Railroads have high barriers to entry. It's unlikely anyone will ever, again, build a freight rail line from scratch in this country. Even with regulatory oversight, rails have good pricing power, and it will probably improve over time, again, due to a bias for mass transportation versus highway usage in the US.
Finally, while Buffett isn't buying BNI at the absolute trough of this past January, it's still way below the trend line of the past few decades. Chances are, as Wilbur Ross noted, BNI's assets will realize a much heftier return with eventual economic growth than will the bulk of Berkshire's other portfolio assets.
Put it all together, and it's a good move by someone who gets opportunities and benefits available to few other investors.
In that sense, it's really less newsworthy, because it's just a one-off deal by someone who gets special favors.

Tuesday, November 03, 2009

Stanley and Black & Decker Merge

One merger and one acquisition are in the business news this morning.

The merger is perhaps the less exciting of the two, but, for me, the more interesting.

I'll make some observations about Warren Buffett's just-breaking news that his Berkshire Hathaway has purchased the rest of railroad Burlington Northern Santa Fe for cash and stock.

Regarding the Stanley-Black & Decker merger, it's a small but interesting validation of Schumpeterian dynamics.

The nearby 2- and 5-year charts of the two companies' equities prices, and the S&P500 Index, show that both have been uninspiring for the period.
Black&Decker, the larger firm, has done far worse than Stanley. Stanley managed to slightly outperform the index over the past 2 years, and stay even with it over 5. In contrast, B&D has trailed over both timeframes, with a far deeper plunge earlier this year.

With the last decade's runup in housing activity, both firms' equities, as displayed in the third chart, rose nicely. Ironically, though, not as robustly as from the mid-1980s to the late 1990s, when the technology bubble collapse affected the entire US economy for a few years. Over this nearly-25 year period, B&D has always been managed less-well, judging by the price movements relative to the S&P. True, these charts don't reflect dividends, but I'm guessing that, at worst, B&D had similar policies to those of Stanley Works.
In any case, B&D has a long history of much bigger equity price swings than Stanley. With the recent collapse in housing activity, it's understandable that now is a good time for B&D's shareholders to get Stanley Works' management running their assets. I don't know of that many cases in which you can see two competitors so differently managed, and one finally throwing in the towel and merging with the other.
With the Craftsman brand still under the struggling Sears umbrella, this certainly seems to clear things up in the competitive marketplace for the newly-merged firm. The CEOs of both are on record as stating they have little competitive overlap, and perhaps that is true. But Both clearly advertise to the homeowner, so you have to wonder.
By simple math, there are only two truly national home tool marketers remaining with this deal- Craftsman and Stanley. And Stanley will be better-positioned for continued new product evolution and development.

Monday, November 02, 2009

The Deepening Mess At Government-Owned GM

Thursday's Wall Street Journal noted that GM is drawing another slug of funding from us taxpayers.

Originally allocated as much as $50B, the new amount, expected to be more than $2.5B, is part of the initial $30.1B loan from the US government arranged at the time of GM's bankruptcy.

According to the Journal article,

"GM officials have been reluctant to give updates on the balance of the escrow funds because it gives only a partial portrait of the company's cash position."

So much for transparency of government and the operations of a large, failed car company you now own.

In the same edition of the paper, another Journal piece reported on how political favoritism is running rampant at GM.

It seems that, although the management is apparently trying, at last, to run things on an economic basis, current government ownership is complicating that.

One story involved a GM car dealer in Spencer, West Virginia. Upon learning his dealership was slated for closure, he appealed directly to one of his state's US Senators, Jay Rockefeller. In due course, Rockefeller brought pressure upon GM's management to reverse the decision.

So much for a taxpayer-funded entity being managed for better results. Instead, we see political favoritism trumping common sense.

Then there is the case of a Montana palladium producer. Learning that GM was sourcing this commodity from South Africa, for a lower price, the mining firm had Montana's two Democratic Senators, Baucus and Tester, pressure GM to relent.

A quote from Tester, revealing his stupidity and the lengths to which he'll bend logic to defend pure political favoritism, is priceless,

"Sen. Tester says he isn't just trying to protect a local mine, but is doing it for GM, too. Reinstating the contract "would be in the best interests of GM," he says. "They are dealing with mines in foreign countries, with all the whims of whatever they may do. This is a matter of stable supply." "

Stable supply. Foreign country whims. Hah!

Hasn't Tester heard of Henry Waxman's cap-and-tax bill?

So we see that GM is now being run- and plundered- according to the pressures brought to bear by states' governmental officials. Now that the company is federal-owned, the businesses with the best connections to powerful governmental officials get the best deals, no matter how uneconomic, with GM.

This is why boundaries between business and government are so sacrosanct. Once government gets involved with running businesses, profit takes a back seat to political cronyism and favoritism.

You're never going to get your $50B+ taxpayer money back from GM- not at this rate.