Saturday, November 14, 2009

Russ Ackoff's Split Personality

I read Russ Ackoff's obituary on Veteran's Day in the Wall Street Journal with great interest. The management guru died at the end of last month, so the notice was a little late.

The Journal's review of Ackoff's professional accomplishments was downright reverent. They discussed Ackoff's legendary "big picture" view, his rule-breaking graduate program at the Wharton School, and, of course, his big life-long meal ticket, the Anheuser-Busch account relationship.

It seemed odd to me that, in three columns spanning half the height of the page, there was absolutely no mention of the two things for which I feel Ackoff was justly famous.

First, he was generally acknowledged as the first practitioner of "management science," in that he ran around corporate America in the 1950s successfully and effectively applying the "80/20" rule.

If that is what various pundits mean by his big picture focus, so be it. But as I heard it explained by some refugees from his original Busch Center at Wharton (more on that in a bit), he got a lot of managers in the early days of the professionalization of the field to address the things that accounted for 80% of their problems or opportunities, and not sweat the 20%.

The other, companion accomplishment, was his co-founding, with C. West Churchman, of the first operations research department at Case Western, then Case Institute of Technology. I actually met and, mercifully briefly, worked with a guy who claimed to hold the very first PhD in OR from that program. And thus, he alleged, the first operations research PhD in the country.

Regardless of that detail, Ackoff's initial signal contribution was in operations research.

I knew several people at the Wharton Applied Research Center, where I worked while completing my MBA, who were escapees from Ackoff's Center. There had been a major philosophical schism, and one of Ackoff's bright young disciples, a former McKinsey consultant named Jim Emshoff, had bolted with a handful of staff and students to found the competing WARC.

One of my close friends and fellow student/employees at the center related the major flaw of what Ackoff's degree program was then called, Social Systems Science.

As Dave put it, after hearing Ackoff wax eloquently on the holy grail of multidisciplinary approaches to business problem-solving, he'd ask how to solve some particular problem.

He related that Russ would then reply that you would use (depending upon the nature of the problem) various existing functional approaches, e.g., stochastic modeling, statistics, EOQ modeling, etc.

Ackoff's big money client, and substantial underwriter of so much of his work, was, indeed, Anheuser-Busch. But at Busch, Ackoff was known mostly for advertising efficiency work. Not some puffed-up 'systems' solution.

And Ackoff's Center's staff and students were, according to the WARC people who had fled the group, known for management approaches and theories which couldn't be very easily implemented.

One has to wonder how ultimately useful and valuable an holistic approach to management, per Ackoff's Center, has been, if, after some 40+ years, it still is largely unknown among major business graduate programs.

Friday, November 13, 2009

The Key Assumption: Michelle Girard On CNBC

In a video which can currently be seen here, RBS senior economist Michelle Girard argued, in an appearance on CNBC this morning, that the US economy is now on the brink of experiencing the sort of sling-shot employment recovery which has been historically characteristic, at least up through the 1982 period.

She referenced the recent 9%+ productivity gain, and historic pickup in monthly employment of the 1982 recovery, as reasons to believe that the economy's unemployment bottom is at hand.

To me, Girard's forecast of 250,000 jobs added monthly next year illustrates the key assumption about our current economic situation.

If today's economy is like that of nearly 30 years ago, then Girard is correct. If it's not, and we are experiencing both a once-in-a-generation mismanagement of the economy, along with a radically different type of economy now than in 1982, then I believe the many other economists and pundits who disagree with Girard, will be correct.

That includes economists like David Malpass, and pundits like Mort Zuckerman.

Much as I'd like to believe Girard, I personally favor the latter two. I just think too much else has gone wrong in our current economic climate to favor a simple historical extrapolation of prior recovery experiences.

As my business partner opined at lunch the other day, we are suffering a loss of confidence stemming from the near decade-long housing bubble which was abetted by the federal government, followed by the Fed's mismanagement of its bursting, and, now, the current administration's overspending, combined with the Fed's monetizing the debt to fund that overspending.

Meanwhile, tax rates are rising, more spending is being planned and passed by Congress, while the sole source of economic activity seems to be Fed liquidity.

All of this leads sensible business people to doubt that there is much in the way of market forces for recovery which are not simply the pass-through effect of Fed liquidity and government stimulus spending.

Thus, I don't see Girard's rosy expectations coming true, because the source of the growth she envisions requires confidence that, in my and others' opinions, does not yet widely exist in the business community.

More Misplaced Hero Worship: Gates & Buffett On CNBC

Count me among the unimpressed.

CNBC's much-touted Columbia Business School appearance of Bill Gates and Warren Buffett, heavily promoted all yesterday and aired last night, is completely uninteresting to me.

Are Gates and Buffett wealthy? Yes. Successful? Certainly at times they have been.

Are either a model for the paragon of our society? No.

Or the two people most-qualified to opine on "Keeping America Great?"

That, by the way, is the intended topic of their appearance in a town hall format for CNBC at Columbia.


Neither is an inventor or true entrepreneur.

Buffett went to Columbia, studied under the legendary Ben Graham, and made his mark as an equity investor. Basically, he invested other people's money.
Gates is famous for presiding over Microsoft's growth as a software giant. But his and its origins are a little less auspicious.
But let's see how the companies with which both are associated have fared recently.
Over the past five years, Microsoft and Berkshire Hathaway have had mixed results when compared with the S&P500 Index.
Gates' company has underperformed the index, while Buffett's company has modestly outperformed.
In fact, for the entire period, Microsoft has underperformed the S&P, while Berkshire treaded water for half of the period.
Going back further, to 1985, it's clear that Gates' Microsoft had an incredible streak of wealth creation. There were software publishers before Gates, but his company did a few things differently, and was blessed with fortuitous timing.
For the record, Gates' biggest break came when he managed to hoodwink the original developer and owner of the rights to MS-DOS to sell them to him for a song. Meanwhile, Gates had IBM negotiating with him to provide such an operating system for the IBM PC.
Gates' Microsoft retained the rights to royalties on all the PC clones, which was the source of the firm's incredible gusher of profits in those early years.
Following this, Gates drove his team to create knock-offs of already-existing business tools for text, presentations and spreadsheets, uniting them, uniquely, in the "Office" suite.
But let's be fair. Gates and his people had existing products at which to aim. Remember Lotus 123 and Quattro Pro? How about WordStar, Wordperfect and other early text programs? Harvard Graphics or Persuasion for graphics?
And Microsoft's Windows? Stolen from Apple, who stole it from Xerox's PARC developers.
My point is, Gates did a yeoman's job of building on others' earlier successes, but there is almost nothing important that Microsoft ever pioneered. Especially the infamous web browser.
I'm not a purist. I don't own a Mac, an iPod or an iPhone. Not being a complete Neanderthal, I do own two Shuffles.
Gates' company provided good value in software for the money, except for later versions of the company's operating system. But let's not confuse what Microsoft has historically produced with truly innovative creations. They never have been. Rather, Gates' and Microsoft's strength has always been taking existing software and enhancing it, packaging it with other software, such as Office or Windows, and delivering it at a reasonable price-point.
Buffett is even less accomplished in this vein. Look, the guy had a number of good years early on, but he's never created anything.
There's a big difference between creating wealth and knowing anything about "keeping America great."
If it's only about making money, let's hear from John Paulson or Steve Cohen. Or Michael Steinhardt and Eddie Lampert.
Then there's the venue. Columbia's Business School?
Is there a more cookie-cutter place where students are focused on conformity to the norms they believe will get them a Wall Street job?
Gates didn't even finish college.
As I listened yesterday afternoon to the CNBC anchors extol the greatness of Buffett and Gates, I nearly became sick. Bill Griffeth nearly began to build an altar to the two billionaires.
I think this is all grossly misplaced attention.
If "keeping America great," in a business sense, is the focus, I would have chosen radically different people to interview.
Some of my candidates?
-Bob Metcalfe, inventor of the Ethernet
-Fred Smith, founder of FedEx
-Pierre Omidyar, founder of eBay
-Michael Dell, founder of Dell Computer
-Steve Jobs, co-founder of Apple
These people have all exhibited far more in the way of innovative flair and creativity, successfully, than either Buffett or Gates.
And I wouldn't waste the appearances on MBA students. Instead, I'd open it to a mix of college and graduate school students of all disciplines.
I certainly wouldn't purport to offer, as examples of people who know how to "keep America great," two guys who have created nothing on their own, but are never the less long on willingness to pontificate in a media spotlight.

Thursday, November 12, 2009

More Confusing Financial Rhetoric From Henry Kaufman

One-time Salomon Brothers economist Henry Kaufman wrote a typically-muddled editorial in yesterday's Wall Street Journal entitled "The Real Threat to Fed Independence."

Is it just me, or is Kaufman really getting to the point where he can no longer even focus on his topics anymore, and, thus, contradicts himself, while also wandering somewhat aimlessly among not-always-related topics?

Regarding the title and, thus, putative topic of Kaufman's latest diatribe, I think he's too late. Though omitted from his article, the Humphrey-Hawkins Full Employment Act of 1978 pretty much gutted independence for the average Fed Chairman, as I noted in this post from February of this year. True, Paul Volcker managed to ignore it, as he and it were both newly-minted at about the same time.

Kaufman begins his piece by writing,

"To be sure, the Fed has never been fully independent of the political process, and it shouldn't be. The president appoints the chairman and the governors of the Federal Reserve Board, and Congress must approve these appointments. With the chairman serving a four-year term, presidents at their discretion can change the Fed's leadership. While Fed governors serve a 14-year term, most of them step down well before the end of their terms."

Already, I disagree with him, and side with the venerable Milton Friedman. Find a way to put the growth of the monetary base on autopilot, and save a lot of angst and money for Fed Governors, Chairman and such. Keep the data-collection, operations and related reporting elements. Transfer regulatory oversight to the OCC or the FDIC.

Kaufman goes on to contend,

"So, why should we be concerned that the Fed will become highly politicized now? First, there is the Fed's legacy of its inability to limit past financial excesses. By failing to be an effective guardian of our financial system, it has lost credibility.

During the Greenspan years (1987-2006), the Fed clearly failed to recognize the significance of the many structural changes in the financial markets—such as the rapid growth of securitization and derivatives—on economic and financial behavior and thus for its monetary policy. The Fed also failed to foresee how the 1999 repeal of the Glass-Steagall Act, which had separated commercial from investment banking since 1933, would sharply accelerate financial concentration through mergers and acquisitions and thus contribute to the "too-big-to-fail" phenomenon."

Gee, Henry, why stop at 1987? Didn't the Fed fail to foresee the effects of removing Korean War-era regulations on installment credit, checking accounts, etc.? And, then, in the 1960s, with the despised withholding tax, the creation of the Eurobond market? And so on?

When has the Fed ever gotten ahead of any financial innovation?

But Henry gets to the heart of his argument about two-thirds of the way through his editorial,

"From my perspective, the most important issue confronting the Fed will be its proposals for reforming our financial system, especially the question of what should be done with institutions that are deemed "too big to fail." It is clear from the last few years that these large financial conglomerates have not been an anchor of stability. To the contrary. All of these institutions—including Citigroup and even J.P. Morgan Chase—would have failed if the federal government had not provided enormous amounts for direct and indirect support in key markets.

From what I could gather from a speech given by Fed Chairman Ben Bernanke at a conference sponsored by the Federal Reserve Bank of Boston a few weeks ago, the Fed favors constraining giant institutions to the point where they would become, in effect, financial public utilities. They might be required to increase equity capital and to limit their activities in proprietary trading and other risky activities."

So far, I actually agree with Kaufman. In fact, my good friend and sometime-business partner, B, was the first persion to my knowledge, back in 1996, to coin the phrase "financial utilities" to describe the current crop of super-sized commercial banks- Chase, Citigroup, BofA- minus their riskier activities.

I've written quite a few pieces about this phenomenon, discussing how the government would force divestiture of activities which couldn't reasonably be covered by FDIC protection.

Kaufman continues,

"But under this arrangement, these large institutions nevertheless would still command a vast amount of private-sector credit. And when markets became unstable in the future, other financial institutions would merge in order to come under the government's protective too-big-to-fail umbrella.

If an overwhelming proportion of our financial institutions are deemed too big to fail, monetary restraint would fall heavily on institutions that are not. Pressure would sharply intensify on smaller institutions that mainly service local communities. Further consolidation would result, which in turn would reduce credit-market competition. At the same time, with increasing financial concentration, market volatility would increase.

All of this would narrow the gap between the Federal Reserve and the political arena. Taken to its logical conclusion, our market-based system of credit allocation would be replaced by a socialized financial system, and the Federal Reserve would become part of it."

Here's where Kaufman forgets his prior position. First, he posits something that is far from necessarily true, i.e., that plain vanilla financial utilities will get into trouble with risky loans. Or that other, riskier financial services entities won't be created to offer riskier credit via better risk management.

Then, he magically equates the Fed and the "political arena," but without any explanation of what this means, or how it actually transpires.

But, right now, by the mid-2009, with government-directed mortgage loan forgiveness in Fannie and Freddie portfolios, we already have socialized finance. Congress has been doing this for over a decade.

Where were you while this was happening, Henry?

But if the financial utilities can't do risky activities, how, then, will they get into trouble and come to account for even more banking? Won't the risky activities already be in smaller, newer entities, which won't be rescued?

This is what I mean by Kaufman forgetting his own position just a few paragraphs earlier.

However, the real punchline here is that the phenomenon about which Kaufman warns in the future is already here.

How else do you describe government loan forgiveness in its own portfolios, and coercion of private entities to join a mortgage foreclosure moratorium?

Or allow Fannie and Freddie to become so bloated, but poorly-managed, as to destroy the former, parallel, private conduit systems?

Or forcibly inject federal capital into banks, then refuse to take selected repayments, requiring some banks to be treated as government-owned financial entities?

None of which actually involves Fed independence. That's a completely different topic, Henry.

Rather than regulatory forces conspiring to bring all financial activity under the Fed's oversight, and then calling this 'socialized' finance, I believe the non-Federal Reserve government entities have done a pretty thorough job socializing finance apart from the Fed, which has contributed to the efforts, as well.

Socialized finance won't be thrust upon the Fed. The Fed has already been moving, with the GSEs, FDIC, Treasury,, in this direction for years.

More Liesman's Follies

CNBC's senior economic dunce Steve Liesman managed to substantially reduce his already-low credibility on matters economic in just a few minutes yesterday morning.

In one feeble attempt to cheer on equity markets and spread economic happy talk, Liesman held up a basketball and a coin. He then compared, I believe, the circumferences of the two objects- or perhaps the volume, it doesn't really matter- in order to focus attention on those currently employed in the US economy.

Laughably, the economic illiterate CNBC staffer tried to dismiss the (at least) 10.2% unemployment rate by claiming that so many Americans are employed that it just seems silly to focus on the comparatively fewer who are not.

This is certainly news to anyone with academic training in economics- which, of course, does not include Liesman.

But that stunt paled in comparison to Liesman's next idiotic utterance.

In a discussion of the amount of TARP funds either repaid or uncommitted, Liesman observed that it was about enough money to "repay the Chinese."

Let's recall that the TARP money was essentially printed and dispensed to rescue a diverse group of US entities with some connection, however tenuous, to banking, which were thought to be in danger of failure.

The misunderstood and largely inappropriately implemented emergency legislation, as demanded by then-Treasury Secretary Paulson, gave the impression that TARP funds were expected to be recovered, and were only a temporary measure.

So, what the CNBC economic idiot is recommending is that we take funds which were to be temporary in nature, the result of running government printing presses extra shifts, and simply buy out Chinese holders of US obligations.

If it weren't so hysterically comical, it would be tragic. How can anyone actually be this dense about economics and be employed by a cable network devoted to business news?

Wednesday, November 11, 2009

Lee Cooperman & Charlie Gasparino

I wanted to write this morning about Charlie Gasparino's interview with Ted Forstmann which appeared in Friday's Wall Street Journal. On the way to doing so, I happened to see Lee Cooperman's appearance on CNBC for a few hours this morning.

The contrast between the two seemed to me to be notable.

Last March, I wrote this post describing the dynamics of Cooperman, Michael Steinhardt and Mario Gabelli in a joint appearance on CNBC.

As I reread my post, I see that Steinhardt was, in retrospect, wrong about being long for the past six months. But simply reading my impressions of that morning quickly bring back my feeling of respect for Steinhardt's careful, measured remarks, the obvious product of much reflection.

In contrast, this morning's appearance by Cooperman was just as lightweight as that of last March. Amazingly, Cooperman carried on about the recession and alleged recovery as if it's no different than any other prior US recession/recovery combination. He rattled off statistics regarding average length of recession, and merrily forecast heady times for equities ahead.

For this reason, I checked back to that March post. It's hard to convey Cooperman's bubbly optimism. More to the point, it's hard to understand it in the face of 10.2% unemployment, a cratering US dollar, and federal debt and deficits of previously unheard of dimensions.

With this background, I turn to Gasparino's recent interview with Forstmann.

Yesterday, I wrote this post discussing hedge fund group owner Mark Spitznagel's recent Journal editorial which heavily cited Ludwig Von Mises' early twentieth-century book and theories. Spitznagel bored in on the folly of government manipulation of capital markets, and the damage which typically, consequentially follows.

In that vein, Gasparino's piece is great reinforcement. He begins with this statement,

"I recently sat down with legendary investor Ted Forstmann to discuss why, on the one-year anniversary of the financial meltdown, the press has largely ignored the role of government in creating the meltdown—and possibly setting the stage for another one—by allowing Wall Street to borrow cheaply and easily during the past three decades."

In that paragraph, Gasparino echoes my own sentiments in yesterday's post. It gives me mixed feelings about not being alone in my concern about this. Glad I'm not alone, unhappy about the observation itself. Gasparino continues,

"Mr. Forstmann knows a thing or two about greedy investment bankers: He's been calling them on the carpet for years, most famously during the 1980s when he fulminated against the excesses of the junk-bond era. He also knows that blaming banking greed alone can't by itself explain the financial tsunami that tore the markets apart last year and left the banking system and the economy in tatters.

The greed merchants needed a co-conspirator, Mr. Forstmann argues, and that co-conspirator is and was the United States government.

"They're always there waiting to hand out free money," he said. "They just throw money at the problem every time Wall Street gets in trouble. It starts out when they have a cold and it builds until the risk-taking leads to cancer."

Mr. Forstmann's point shouldn't be taken lightly. Not by the press, nor by policy makers in Washington. But so far it has been, and the easy money is flowing like never before. Interest rates are close to zero; in effect the Federal Reserve is subsidizing the risk-taking and bond trading that has allowed Goldman Sachs to produce billions in profits and that infamous $16 billion bonus pool (analysts say it could grow to as high as $20 billion). The Treasury has lent banks money, guaranteed Wall Street's debt and declared every firm to be a commercial bank, from Citigroup with close to $1 trillion in U.S. deposits, to Morgan Stanley with close to zero. They are all "too big to fail" and so free to trade as they please—on the taxpayer dime."

All true enough. But Gasparino does a real service to readers, similarly to the theme of his recent book and his comments in support of them, as I noted here. He clearly identifies federal government culpability for the recent financial mess. For example, I wrote,

"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."

Gasparino, in his interview with Forstmann, then provides real value by linking recent events to something so far back that my own brief brush with it was early in my career at Chase Manhattan Bank.

"The conventional wisdom as perpetuated in the media is that these bailout mechanisms are unique, designed to ameliorate a once-in-a-lifetime financial "perfect storm." They are unique, but only in size. A quick look back at the past three decades will demonstrate what Mr. Forstmann meant when he said the government has been ready to hand out free money nearly every time risk-taking led to losses.

The first mortgage market meltdown of the mid-1980s, spurred by the Fed's supply of easy money, was among the most painful market upheavals in the history of the bond market. The pioneers of the mortgage bond market, Lew Ranieri of Salomon Brothers and Larry Fink of First Boston (the same Larry Fink now considered a sage CEO at money management powerhouse BlackRock), lost what were then unheard-of sums of money. (Mr. Fink concedes to losses of over $100 million.)"

I vividly recall attending a mortgage-backed bond conference at which all of the era's mortgage finance luminaries- Fink, Ranieri, Michael Mortara, and, if memory serves, Dexter Sfent (sp?), a name now not even found via Google- spoke. I'll save my own anecdotes for another post, but, suffice to say, my takeaway impression, which I conveyed to my boss, SVP of Corporate Planning, Gerry Weiss, was that these investment banks were taking a haircut for repackaging risk, but doing nothing to reduce it. They were merely spreading it among the many mortgage-backed bonds, sliced up by tranches of time and risk.

So, for taking a hefty underwriting fee, they 'solved' the S&L's problems of underwater mortgages by securitizing them, transferring risk to bond holders while pocketing a fee.

Gasparino continues, with the theme of warning that last year's extreme bailout of the financial services industry was no new thing,

"What happened then was a dry run of what was to come," Mr. Fink recently told me, as he looked back on the market he created, which would eventually lie at the heart of the most recent financial crisis. Wall Street took excessive risk in mortgage bonds amid the easy money supplied by the Fed—and lost. When the crisis began, the Fed under then Chairman Alan Greenspan slashed interest rates—as it would do after Orange County, Calif., declared bankruptcy in 1994 because of bad bets on complex bonds; and again in 1998 when the hedge fund Long-Term Capital Management (LTCM) blew up; and of course in the bond-market crisis of 2007 and 2008. The lower rates each time lessened the pain of the risk-taking gone awry, and opened the door for increased risk down the line.

A similar bomb exploded in 1998, when LTCM blew up. The policy response to the LTCM debacle is instructive; more than anything else it solidified Wall Street's belief that there were little if any real risks to risk-taking. With $5 billion under management, LTCM was deemed too big to fail because, with nearly every major firm copying its money losing trades, much of Wall Street might have failed with it.

That's what the policy makers told us anyway. On Wall Street there's general agreement that the implosion of LTCM would have tanked one of the biggest risk takers in the market, Lehman Brothers, a full decade before its historic bankruptcy filing. Officials at Merrill, including its then-CFO (and future CEO) Stan O'Neal, believed Merrill's risk-taking in esoteric bonds could have led to a similar implosion 10 years before its calamitous merger with Bank of America.

We'll never know if LTCM's demise would have tanked the financial system or simply tanked a couple of firms that bet wrong. But one thing is certain: A valuable lesson in risk-taking was lost. By 2007, the years of excessive risk-taking, aided and abetted by the belief that the government was ready to paper over mistakes, had taken their toll."

It's instructive to stop at this juncture and dwell on Gasparino's last sentence. By the end of 2007, Wall Street firms had benefited from a full 20 years of federal bailouts of their failures to manage risk adequately.

In the same vein that Congress and several administrations allowed the GSEs to pump inappropriate, too-risky, too-low-income mortgages through the US and, ultimately, global financial system, the federal government had also encouraged and abetted private, publicly-held commercial and investment bank excessive risk-taking through 20 years of easy money policy and loss mitigation.

Gasparino concludes,

"With so much easy money, with the government always ready to ease their pain, Wall Street developed new and even more innovative ways to make money through risk-taking. The old mortgage bonds created by Messrs. Fink and Ranieri as simple securitized pools had morphed into the so-called collateralized debt obligations (CDOs), complex structures that allowed Wall Street banks as well as quasi-governmental agencies Fannie Mae and Freddie Mac to securitize ever riskier mortgages.

Likewise, nearly to the minute he was forced to file for bankruptcy, former Lehman CEO Dick Fuld believed the government wouldn't let Lehman die. After all, government largess had always been there in the past.

All of which brings me back to Mr. Fortsmann's comment about policy makers helping turn a cold into cancer. What if the Fed hadn't eased Wall Street's pain in the late 1980s, and again after the 1994 bond-market collapse? What if policy makers in 1998 had allowed the markets to feel the consequences of risk—allowing LTCM to fail, and letting Lehman Brothers and possibly Merrill Lynch die as well?

There would have been pain—lots of it—for Wall Street and even for Main Street, but a lot less than what we're experiencing today. Wall Street would have learned a valuable lesson: There are consequences to risk."

Thus, after reading Gasparino's well-written history, with Forstmann's help, of the last 20+ years of US financial sector excessive risk-taking, with explicit federal government collusion and encouragement, it's difficult to understand how Cooperman can be so cheery about the current real US economic conditions and equity markets.

On one hand, you could say Cooperman is simply following Gasparino's/Forstmann's observations that this recent equity rally, too, will be sustained, and any subsequent damage repaired by easy federal policy.

On the other hand, as I've written in many recent posts, one senses that things are different now. The US is now essentially borrowing from abroad to conduct easy monetary policy. The fact that the US Treasury Secretary had to personally assure the Chinese government with respect to guarantees of GSE-issued debt suggests we no longer can simply inflate our way out of future financial disasters.

It's less a matter of proper US policy conduct, which is unlikely, than it is unaffordable costs of continuing on that past, as measured in rising rates on US debt, the rapidly depreciating US dollar, and potential problems selling more Treasuries into a global market already wary of US monetary and fiscal policies.

Fannie Mae Adopts One of My Ideas

Some time last year or early this year, when large US commercial and investment banks were dropping like flies, and Sheila Bair's FDIC experimented-unsuccessfully- with loan forgiveness at IndyMac bank, I mused to my business partner about a more creative way to mitigate homeless families due to foreclosure. I'm reasonably sure I mentioned it in a post at the time.

If you recall, by that time, the incoming administration announced that banks had better begin a moratorium on mortgage foreclosures. Banks were admonished to go easy on delinquent and defaulted mortgage borrowers, or else. The specter of families tossed to the curb, only to see their homes remain empty, drove Congress and the administration to strong-arm banks to ignore conventional means of handling non-paying home loans.

To me, the solution seemed obvious. Allow defaulting borrowers to remain in their homes, paying a below-monthly mortgage payment rent which was a function of market conditions.

Seems pretty simple, doesn't it? I mean, if the federal government is going to behave coercively toward lenders, why don't they at least do it in a productive fashion?

I surmised, at the time, that the income from a seamless change from defaulted mortgage loan to rental payments would vastly reduce the costs to investors in the mortgages, or the bonds they backed, while also avoiding much real, personal pain and dislocation for the families involved.

Additionally, occupied homes won't be subject to the vandalism that foreclosed, empty homes so often experience.

Now Fannie Mae is announcing a similar plan.

It's about time.

Tuesday, November 10, 2009

Von Mises On Government Intervention In Credit Markets

Yesterday I wrote this politically-oriented post on my companion blog, musing whether or not the Federal Reserve System violates the Constitution. The post was sparked by reading a Wall Street Journal editorial this past weekend by Mark Spitznagel. Spitznagel runs Universa, a California-based hedge fund group which now counts Nassim Taleb as one of its close advisers/employees.

Sometimes it takes a single article focusing on a single phenomenon to make me see that phenomenon in a new, and usually more appropriate light.

In this case, it was Spitznagel's citing Von Mises as having predicted the Great Depression simply by reasoning through how government-forced monetary base creation and rate manipulation inevitably lead to damaging distortions in the capital markets.

It was Spitznagel's description of how government intervention in capital markets, via excessive money and credit creation, which I quoted in that other post, that really illuminated the problem for me.

How is it that yesterday, Monday, November 9, 2009, we witnessed a 2%+ rise in the major US equity indices simply because the G20 finance ministers announced over the weekend that they will continue to hold rates at absurdly, unsustainably low levels, while continuing to spend borrowed or printed money on stimulus programs?

Did we not struggle through immense financial and, now, non-financial economic pain, beginning in mid-late 2007, precisely because Alan Greenspan cut and held rates at unsustainably low levels beginning post-9/11, 2001? And Ben Bernanke responded to the 2007 softness in mortgage-backed bonds by cutting rates again?

Viewed more clinically, as Spitznagel does, from the distance, through time, of Von Mises' work of the early 1900s, it's easy to see that any significant government intervention in capital/credit markets only distorts investors' and savers' intentions, causing havoc.

In this post, from last October, I discussed Anna Kagan Schwartz' interview in the Wall Street Journal. She, too, decried the Fed's creation of excess liquidity, arguing that the only issue was which banks were solvent, which was easily solved by closing the insolvent ones! Simple, and non-capital market distorting.

Alan Reynolds wrote a brilliant analytical piece in the Journal back in September, on which I commented in this post. In part, I observed, in answer to the question Reynolds posed in his piece as to why recessions became longer and more severe with increased government intervention,

"Why do you suppose this is true? What is it about large-scale government intervention that causes recessions to be longer and deeper?

I would guess it is two factors.

The first is the distorting effect of government, which is to say, political meddling with price, demand and supply signals in an otherwise-free market for goods and services. Reading Amity Schlaes' excellent history of FDR's economic failure, "The Forgotten Man," brings home how destabilizing and distorting massive government economic intervention is. Investors hold back, worried about the shifting rules governing the context of their investments. Which industries will government punish or radically regulate next?

The second is the nature of recession-based government legislation. Typically, it involves two things- printing or borrowing large amounts of money on the citizens' behalf, and creating or enriching transfer payment schemes.

The first action leads to higher taxes, crowding-out of private investment, and higher interest rates down the road. None of which are necessarily healthy for the private sector, or a country, as a whole.

The second action slowly, inexorably overlays a drag on economic activity, as new claims on behalf of non-producers are made and collected by big government. This saps savings in order to transfer wealth to those who consume without creating value in the economy. This additional marginal tax, in the form of items like FICA, predictably depress marginal economic activity across many income levels.

These transfer payment schemes are rarely reduced or eliminated, so, over time, you probably have an accretion of this economic drag on productive private sector activity."

Without knowing it, my first point was echoing Von Mises' own theory and observations.

Since my primary research inspiration and influence for over a decade has been Joseph Schumpeter, another, perhaps more well-known member of the Austrian group of distinguished, turn-of-the-century economists, I'm very open to learning more about Von Mises. I ordered the book to which Spitznagel refers for my business partner and myself just after reading his editorial.

As I noted at the beginning of this piece, reading Spitznagel's laser-like citation and description of Von Mises' explanation of the dangers and bad outcomes that result from significant government intervention in credit and capital markets caused me to stop and view the past decade of US monetary policy in horror.

Right now we are seeing more distortion in capital markets from wrongheaded Fed policy. After having induced, with the collaboration of bad federal Congressional and administration policies since 1996, bad mortgage lending with low rates since 2001, the Fed has returned to the same economy- and credit-wrecking interest rate policies which caused our problems in the first place.

As I noted in that political blog post yesterday, both William McChesney Martin and Paul Volcker, the only Fed chairman who are truly revered, earned that reverence by persevering in raising rates in the face of intense criticism. Both put the US economy on track for a long period of prosperity, until it was undone by lesser chairmen.

Who believes that today's zero Fed funds rate and excessive US deficit spending can possibly be healthy for the US economy? Spitznagel reminds us that Von Mises warned of such irresponsible forcing of savers' and investors' hands. Holding rates so low and creating so much credit necessarily leads to bubbles and lending to unworthy business projects. The only outcome is loss and more economic pain.

How can Bernanke be so blind as to fail to understand that he is now repeating what his predecessor did, with likely the same result in the not too distant future?

Monday, November 09, 2009

NBC/Universal: The Failure of Jack Welch's Strategy

This morning's brief mention on CNBC that a valuation has been mutually agreed upon by Comcast and GE for the latter's NBC/Universal unit brought back to mind my plan to write this post.
A few weeks ago, while discussing the negotiations to sell NBC, I mentioned to a colleague that, while much delayed, this was yet another black eye for once-stellar ex-GE CEO Jack Welch.

Because my boss at Chase Manhattan at the time, Gerry Weiss, was an ex-GE senior planning executive, I remember very well the hoopla surrounding the news that morning of GE's acquisition of RCA in 1986. In actuality, all GE kept was NBC's video operations, selling off all the rest of RCA's operations and/or licensing others to manufacture products using the RCA brand.

Welch's main corporate development guy, Michael Carpenter, a former consultant, was credited with the idea, and Welch crowed incessantly at the time about how great a purchase NBC was.

Now, 23 years later, only months after Welch's successor, Immelt, once more declared how integral NBC/Universal is to the struggling diversified conglomerate, it's on its way out of the company, soon to become part of Comcast.
The first nearby price chart for GE and the S&P500 Index clearly shows that, for a period covering over 30 years, GE's performance, relative to the Index, reached its zenith just at about the time Immelt took over from Welch. Since then, the relative value of GE has plummeted, and all of the performance premium of 30 years has been lost.
Even in the past six months, when, ostensibly, firms which took TARP money have been rebounding, GE has underperformed the Index by about 50%, rising only around 10% to the S&P's nearly 20% return.
Where's the juice provided by the NBC acquisition? Or are we to believe that the rest of GE was and is so anemic that it's only this bad because of NBC?
In any case, how have things changed such that NBC has lost whatever magical synergistic effect it once had on and with the rest of GE?
They haven't. From reading available material concerning the acquisition, it seems clear that Welch viewed GE more like a closed-ended investment fund, and less as an operating entity that had to actually make some organic sense. Back in April of last year, I wrote this post comparing a non-diversified conglomerate, United Technologies, to GE. The performance difference is notable, and it hasn't been in GE's favor.
At the time of GE's NBC acquisition, there was horror among the latter's ranks, as those employees viewed themselves as privileged, delivering news and entertainment, neither of which could or should be 'managed' by accountants and financial types. Much of the ink spilled over the acquisition and its aftermath was about GE reining in NBC's expenses, and nothing regarding any sort of synergies with the rest of the company. It was largely a financially-oriented move by Welch to shore up the cashflows of GE's maturing industrial business portfolio.
Thus, nearly a quarter of a century later, NBC still doesn't provide anything to GE beyond a purely financial performance, which has been waning. After the initial feeding frenzy in which ABC went to Capital Cities and CBS went to Viacom, as GE bought NBC, traditional network media slumped in an internet age.
It's a sobering end to what began with such fanfare. Back in 1986, Jack Welch still had 15 years to go as CEO of GE, and analysts believed most anything Chairman Jack said. Mike Carpenter was still a rising star, having yet to preside over the purchase and implosion of Kidder, Peabody as a unit of GE Capital, from the infamous Joe Jett government bond trading scandal.
Media at the time blessed the GE acquisition of NBC as bold, large-scale, "big picture" thinking. They overlooked the fact that, even back then, brokerage costs had pretty much obviated the original benefits of the 1960s-era US diversified conglomerate. Investors would have been better-served by an RCA breakup with NBC available as a separate equity. Instead, it simply moved from one shell to another, never really seen clearly on its own, nor managed for long term shareholder wealth creation.
So much time has passed that all of the current analysts' and media attention is on the valuation of NBC/Universal and, only occasionally, Immelt's recent change of mind about the unit's vital importance to GE.
Nobody is asking why, if NBC is suddenly not integral to GE's future, any of GE's businesses have to be housed under a corporate umbrella? Or why GE exists at all anymore?
Even more remote are questions involving whether the NBC acquisition was ever justified? Whether this does not detract even more from a growing sense that Welch's vaunted management style and performance were really more a personality cult and less transferable skills, or even effective as a standalone approach.
After all, as I've written in numerous posts on this blog, none of Welch's spawn from GE have gone on to replicate their old boss' GE performance. And GE, itself, has become a performance disaster under Welch's hand-picked successor, Jeff Immelt, sinking to the point of taking government handouts to survive the debt crisis of 2008.
1986 was a long time ago. Many analysts from that era are retired, and the tenor of those times is long forgotten. But revisiting the event of GE's acquisition of NBC is important, if only in fulfillment of the time-honored saying reminding us that those who don't learn from history are doomed to repeat it.
From a sufficiently long perspective of time, it is clear that NBC was never the magical acquisition Welch imagined. If it was the reason for a spurt of market outperformance in Welch's latter years, then it should have been spun off or sold at its peak, rather than be ridden down in value to its current situation.
Either the acquisition, or its management and disposal, were flawed. And there's no telling how much management distraction NBC caused during its years in the GE corporate portfolio.
I think that, by all accounts, GE's acquisition of NBC was a mistake at the outset, was a drain on GE's management, and was ill-managed in terms of timing the firm's exit from the unit as its value deteriorated in the rapidly-changing media environment of the internet and digital era.