Friday, November 27, 2009

Mort Zuckerman On "Too Big To Fail"

Mort Zuckerman wrote a good editorial in Wednesday's Wall Street Journal addressing the "too big to fail" phenomenon in US banking.

He lays out the situation that fostered super-sized financial institutions in the beginning of his piece,

"It is also true that the wisdom that led to the Glass-Steagall Act, which separated commercial banks from investment banking during the Great Depression, was discarded. In 1999, President Bill Clinton and Congress revoked the act, thereby accelerating financial consolidation through mergers and acquisitions. So we got huge firms whose failure would bring down the whole house of cards. The too-big-to-fail phenomenon led to bailouts with taxpayer money, provoking a deep-seated public anger that has been further aggravated by the recent pile of executive bonuses.
The too-big-to-fail firms, in short, lie at the heart of the current crisis. Some are now even bigger, in part because the government had to sponsor and support several mergers that made them larger. The presumption was that big meant diversified and sophisticated and, therefore, less risky. That presumption proved false.

The dangers posed by a too-big-to-fail financial firm surely must be dealt with by new legislation, and one change needed is that the price large banks pay for the privilege of size should be significantly increased. If they benefit from explicit or implicit protection from the government, they should not be able to ride free on the backs of taxpayers.

Their risk of failure should be reduced one of two ways: by increasing capital requirements or by providing the option for the banks to be smaller or less systemic. This can be done either by narrowing what businesses they can be in or by making them less interconnected. In the worst-case scenario, the final backstop has to be bankruptcy or dissolution through a series of well-ordered procedures that do not imperil the whole economy or adversely affect our market-based system of credit."

I think Zuckerman is correct. His recommendation echoes that of my friend B, who first, among people I know, or what I have read, first predicted the rise of financial utilities in a conversation with me in 1996. That is, the driving force has to be to refuse implicit government deposit guarantees to large, risk-taking financial service firms.

Since really large banks have to be in many businesses, there should be some sort of firewalls between any government-insured businesses, and the riskier ones, or, at such sizes, government insurance should simply be priced for the added risk.

What puzzled me, though, was Zuckerman's contentions regarding such large financial institutions,

"Moreover, it must be remembered that the size of many of our financial institutions, despite its role in bringing on the crisis, has also greatly benefited the U.S. economy. Size, for example, enables our big financial firms to compete against others in Europe and Asia.

The too-big-to-fail institutions operate around the world, participating with similarly large financial partners to execute diverse and large transactions. They offer a full range of products and services, from loan underwriting and risk management to local lines of credit, providing financing to states and municipalities as well as firms of all sizes.

Should we fragment and constrain the system and cap the size of banks, it would undoubtedly limit the competitive level of service, breadth of products, and speed of execution. Clients could turn to foreign banks that don't face the same restrictions. Ill-judged reform could undermine one of the most important ingredients of American global power: our financial know-how, intellectual firepower, and size."

I must say that I emphatically disagree with Zuckerman on this point. He may have been correct in the 1960s and 1970s. But certainly by the 1980s, when I was at Chase Manhattan Bank, the evolution of deep, broad global financial markets had pretty much negated the advantages of banks with global reach, offsetting the declining advantages with the headaches of managing such sprawling, multi-business entities.

How does Zuckerman explain the rise of standalone mortgage banking, M&A and credit card companies in the 1980s?

Further, those very financial utilities were the ones which required such expensive cleanup and, in the case of Citigroup, Wachovia and WaMu, went bust.

If these financial titans created such value, how did they manage to self-destruct? That's a rhetorical question. The answers are, they were either too complex to safely and profitably manage, or didn't really provide extra benefits, or both. And I think it's "both."

The capital markets and technology of the past two decades have given smaller financial firms with better people advantages over the Citigroups, Chases and Goldman Sachs.' The new breed of excellent financial service firms are, once more, privately held, i.e., the better hedge funds and private equity shops.

For some reason, many people, including Mr. Zuckerman, behave as if the latter don't exist, and only focus on publicly-held financial institutions. But the mere fact that such successful hedge funds and private equity shops exist ought to be evidence to intelligent observers that the financial utilities simply aren't so valuable and uniquely important, after all. The really good people already left those cattle pens for the greener, more flexible fields of privately-held financial companies.

Finally, Mr. Zuckerman ends his piece with lavish praise for helicopter Ben and his Fed,

"The central bank may have fumbled a bit in the evolution of the bubble economy. But once the crisis hit, it was the Fed, under Chairman Ben Bernanke, whose innovative, imaginative response to the crisis literally saved the financial world.

Should Congress undermine the Fed, we could face a world-wide collapse of confidence in the dollar that would inevitably lead to higher interest rates. Congress is always playing the blame game, but it would be irresponsible to undermine the Fed and its capacity to handle the new financial world that we will all be living in."

Again, I respectfully disagree. I continue to believe that Anna Kagan Schwartz was correct in diagnosing last year's financial panic as one of solvency, not liquidity. Because so many bondholders were rescued, real consequences for the failure to appropriately measure risk were never felt. Instead, global interest rates have fallen back to levels which engendered the crisis in the first place.

Were insolvent banks simply closed and merged, the system would have automatically stabilized. The US, and, for that matter, the globe, was over-banked. The reason such financial junk as mortgage-backed CDOs were pumped out is that profit margins on conventional financial instruments were so thin, due too excess capacity and competition. Fewer, more solvent remaining financial institutions would have been a better result, with any legitimate needs for financial services being filled by the remaining institutions, both publicly- and privately-held.

The only thing that would have truly vanished was excessive leverage. Instead, the Fed replaced that with publicly-supplied leverage, and we are suffering the consequence of that now- a suspect economic "recovery."

Mr. Zuckerman then, in my opinion, reasons incorrectly, opining that an undermined Fed would lead to higher interest rates. That's the reverse of what most believe, i.e., that a Congressionally-compromised Fed would be forced to hold rates too low in perpetuity.

But we already have that, as David Rosenberg recently noted. Bernanke, in his quest for renomination, opened the monetary floodgates, and we have zero interest rates and an unprecedented rise in the monetary base as a consequence.

How much worse could it get under another regime?

In sum, I believe Mr. Zuckerman, whose editorials I generally find well-reasoned and sensible, only got this partially right. He is correct to call for risk-based pricing of any sort of government-provided insurance to financial institutions, particularly large ones. But his estimation of the value of financial utilities, and the correctness of the Fed's actions last year, are, I believe, widely off the mark.

Wednesday, November 25, 2009

Why Old Media Is Failing: Sloppy Journalism From Time Magazine

Check out this video from this morning's CNBC Squawkbox program.

First, the Fortune managing editor contradicts their own company's press release and embargoed pre-publication article text, saying greed wasn't the main force behind their so-called "Decade from Hell."

Michelle Caruso Cabrera reads from the text she has, provided by Time, that the article says it was "greed." Not so, says the managing editor.

The managing editor's glib analysis of the last decade is simply laughable. Not to mention that, according to him, the decade's experiences for the US were its own fault. Katrina and the 9/11 attacks don't seem to fit, so they basically redefine them.

Finally, the article says it was the "worst peacetime decade," but, then Andy Serwer, the Fortune managing editor contradicts that, saying it wasn't a peacetime decade after all. But it wasn't a wartime decade, either.

Then he says, well,

"Is that semantics? It's a battle. It's a horrible battle. But it's not a wartime decade."

So much for the 9/11 attacks opening the decade's War on Terror. According to TimeWarner, your country hasn't been engaged in a war at all. It's just, you know, "a battle."

I'm guessing neither managing editor has immediate family in the military who has served in either Iraq or Afghanistan.

However, that's a relative sideshow to the main impression this clip left me with when I saw it live this morning.

Here's a major old media publishing company supplying two managing editors for an interview, and they can't even agree with their own magazine's article's main point. Then they rather baldfacedly deny it's been a decade in which the US has been at war.

No wonder old media companies, including TimeWarner, are failing. With "reporting" like this, who would buy their product?

Holman Jenkins On GE's Sale of NBC/Universal

Last week's Holman Jenkins column in the Wall Street Journal has been laying on my floor, waiting for this post. In that piece, entitled "The Economics of Jay Leno," Jenkins weighs in on GE's attempt to dump its entertainment unit onto Brian Roberts' Comcast.

Jenkins begins,

"As Mr. Leno explained in a candid interview with trade bible Broadcasting & Cable: "If you are making buggy whips and no one is buying buggies anymore, do you keep making buggy whips? I don't know. This is an economic decision."

In Jack Welch's day, an employee perhaps would not have expounded so freely. Otherwise, however, GE is behaving like what it's always been, an unsentimental owner of a business that it no longer likes and doesn't know how to fix.

Yet, truth be told, Comcast's shareholders don't want the job of fixing NBC either. Only the controlling Roberts family does—and then because the alternative may be having no great future as a prominent American business family. Ergo, a deal merging "content" and "distribution" seems inevitable, even though the track record of such deals is unpropitious."

No kidding. As I've written in some prior posts, combining content and distribution has been a disastrous strategy in media. Think AOLTimeWarner.

Then there's this little nugget, about which I've been writing for a few years,

"This would be a merger, after all, of two businesses that seem headed toward some combination of the fates of newspapers, music CDs and the old wireline telephone business. Customers want the product for free. Comcast's lifeblood, the $100-a-month cable bill and the $50-a-month broadband bill, increasingly look like duplicative expenses. And so on.

True, the number of households that have actually dropped their cable subscriptions in favor of subsisting on TV streamed or downloaded from the Internet is not yet large. But for the Roberts family and its Comcast property, their worst fears lurk just around the corner—being reduced to a "dumb pipe," subject to commodity pricing while somebody else (Google) makes all the money.

Yet an escape route is vexingly hard to envision. Time Warner and Comcast have been talking up plans to make their respective cable lineups available by computer—as long as you keep paying your cable bill. This is a stopgap, especially appealing to anyone who owns two homes but wants to pay only one cable bill. Never mind, too, that hundreds of shows are already available online for free, via Web sites operated by none other than Comcast and the TV networks themselves."

Despite a consultant friend of mine lecturing me several years ago on how wrong I was to believe internet-based video content viewing would cripple cable distributors in the near future, now even Jenkins sees it as just about here. And financially important, too.

As an alternative, Jenkins focuses on the one thing that cable can control and use to its advantage,

"Set-top data, when married with demographic information and purchasing histories, has long been touted as the foundation of a new kind and a better kind of advertising—personalized, less annoying, capable of commanding higher rates from marketers who lament that half their ad budgets are wasted (i.e., selling cat food to dog lovers), but they don't know which half.

For Comcast and other signal deliverers, then, the long-term trick may be inveigling households into keeping the set-top box at the center of their entertainment lives. Maybe the box will be offered free in the future with your broadband subscription. Maybe it will be offered free regardless of who supplies your broadband. The set-top box will morph into your personal "media computer," a gift from a programming aggregator, as long as you agree to surrender large amounts of personal data about your viewing, surfing and purchasing habits."

This is a good insight on Jenkins' part. But it doesn't really mean that NBC/Universal is of special value to Comcast. It simply means any cable provider, even sans content, can sell the viewing habit data. So much for the GE deal as adding value in this scenario.

Jenkins closes with this observation,

"Bottom line, since a deal seems nearly certain to happen: Would a savvy media investor wish the Roberts family luck in their gamble? Absolutely. Would such an investor care to come along for the ride? Maybe not so much."

Which is pretty much my own conclusion, as I noted in this post early last month, when the talks came to light. As for the followup post, this is it, spurred by Jenkins' similar treatment of the other, non-GE side of the deal.

I've written several posts recently, found under the "GE" label, remarking on the failure of the original RCA purchase which brought NBC to GE. And its more recent mismanagement, despite Immelt's protestations of the entertainment unit being a core business for the failing, diversified conglomerate.

But, as I briefly noted in those posts, while Comcast may be the only reasonable buyer, that never meant it was a good idea for the cable systems owner.

More likely, this is one business which might be best spun off to GE shareholders, to avoid more damage to any existing US corporation. If the content housed in the unit has any real value, wouldn't it make more sense to let it be realized independently by the group's management as a pure play? Then some other content outfit, if it desired that talent, could separately make a bid and enrich those remaining shareholders.

Tuesday, November 24, 2009

Kelly Evans' Observations on Consumer Spending

Following an insightful piece only a few days ago, on which I commented here, Wall Street Journal writer Kelly Evans provided another thought-provoking "Ahead Of The Tape" column this morning.

Evans noted the difference between soft measures of consumer sentiment and positive growth, albeit anemic, in recent consumer spending. She writes,

"The Commerce Department is expected to report on Wednesday a 0.6% inflation-adjusted gain in consumer spending for October over September, following spending growth of about 3% annualized in the third quarter."

As have Doug Dachille and David Rosenberg, Evans credits government spending, citing "tax rebates and extended jobless benefits with helping to boost incomes- and spending. As a result, U.S. inflation-adjusted disposable income has risen slightly since the recession began."

She quotes a Normura Securities economist as saying,

"The key question is what kind of consumer do we have in the middle of next year" when most of the government programs have run their course, Mr. Pandl says, "There will be a reckoning at some point."

A reckoning, indeed. Alan Reynolds has noted that Keynesian-style interventions have merely deepened and prolonged economic recessions. With the federal government's stream of such programs in the past eleven months, including a $787B stimulus bill, continuing extensions of jobless benefits, "cash for clunkers," "cash for caulkers," and more, one can only wonder how badly the so-called "recovery" will become once all of this non-private sector spending ends, and we are left with real demand from real consumers' real incomes.

David Rosenberg On CNBC This Morning: 3Q GDP Revisions

This morning's CNBC Squawkbox program featured former Merrill Lynch economist David Rosenberg as guest host.

I was particularly impressed with his sensible and cogent explanations for his gloomy economic forecast. And his easy manner of deflecting CNBC's senior economic buffoon, Steve Liesman.

Rosenberg calmly noted how, for both 2Q and 3Q GDP results, once government spending and credits were stripped out, the private sector has been flat all year. This morning's 3Q restatement of GDP met expectations of its being trimmed from 3.5% to 2.8%.

While I'm not privy to it, references were made to an 11-page forecast Rosenberg published earlier this month. Liesman contended it was so dire as to make him want to get guns for all the co-anchors on CNBC's morning show to facilitate their suicides.

In my opinion, only one firearm would be necessary, and Liesman wouldn't have had to bother anyone else about it, either.

However, back on topic, when Liesman accused Rosenberg of forecasting a 'never ending recession,' the latter replied with an astute comparison to the Great Depression. Specifically, Rosenberg noted that there were a number of recessions, with small, brief 'recoveries,' within the decade-long depression, that were only ended by WWII.

Rosenberg then derided the notion of a recovery when state and local government tax revenues are down 11% from last year, which was, itself, a weak year for tax receipts. He wondered how you could describe the current US economic situation as strong or normal and recovering, when most of the GDP growth is essentially from government spending of borrowed money, and the state and local governments are in extreme shortfall.

I found Rosenberg's assessment actually comforting, in that he offered credible evidence and a reasoned contrast to what he described as a rush to confirm a recovery by every other economist.

In a particularly acrimonious exchange, Rosenberg was constantly interrupted when attempting to reply to a question regarding Warren Buffett's recent purchase of BNI. Despite the co-anchors' talking over his answer, Rosenberg noted BNI''s price being secularly depressed, and Buffett's reliance on the ability of a regulated utility with efficient performance to ride out a not very robust near term economic situation.

Another exchange of interest involved former Fed member Rick Mishkin, Rosenberg and Rick Santelli, regarding Ron Paul's amendment to allow Congress to conduct 'audits' of the Fed. Mishkin, of course, argued the Fed party line, i.e., that this amendment, more than any other in history, seeks to undermine the Fed's authority. That Congress would politicize interest rates and seek to keep them low indefinitely, intimidating any Fed chairman who chose to obstruct that policy.

Rosenberg, with Santelli's support, noted how dismal the Fed's record on interest rates has been, especially right now. How the Fed has politicized itself by monetizing Treasury's debt, so much so as to have simply begun purchasing privately-issued mortgage-backed securities.

I used to feel the way Mishkin does. Until, that is, I watched Alan Greenspan over-inflate the stable economy Paul Volcker bequeathed to him. Compounded by an additional flood of unnecessary liquidity by Bernanke, the recent decade of Fed performance is hardly grounds on which to argue for more independence. Rosenberg is not far wrong arguing that Congress certainly couldn't do much worse for the dollar or inflation.

Finally, when criticized for having missed the recent equity market rally since March, Rosenberg responded astutely with the notion of risk-adjusted returns. He conjectured that those equity managers who rode the recent rally to good returns, and will probably attract more money as a consequence, have little understanding of the real risks they are now running. He also tied the judgement of many economists that the US economy is in recovery to their citing of the equity markets, rather than fundamental economic growth statistics.

In effect, Rosenberg once again drew the comparison to the 1930s, wherein there were several equity rallies amidst the worst general slump in equity prices in thirty years.

Rosenberg's calm, reasoned assertions provided me with reinforcement for my own view that the US economy is not, in terms of the private sector, anywhere near a robust "recovery," nor remotely free from the serious effects of a weak dollar and coming inflation due to the Fed's misguided liquidity policies.

Monday, November 23, 2009

Dell's Non-Existent Turnaround Becomes Visible At Last

My last two posts concerning Dell, here and here, detailed my belief that, despite the founder's return in January of 2007 as CEO, the company is still doomed.

The nearby 5-year price chart of Dell, Hewlett Packard and the S&P500 Index confirms this. Dell's recent equity price rise is about the same as the index's, after having fallen much further since Michael Dell returned.
Even since early January, HP's equity price has risen, while Dell's has fallen.

Dell's recent quarterly earnings report provides more bad news. Its profit dropped 54%, while the rest of the technology sector has been on fire.

Its sales also fell, by 15%. That should be the real worrisome trend. My proprietary research has shown that growth firms are so-noted chiefly by consistent revenue growth, relative to the market. Dell is now going south.

Rival HP reported higher profits in this quarter than the year-ago period, amidst revived demand.

According to an analyst cited in the Wall Street Journal article about Dell last Friday, Dell's gross margin has dropped by half a percentage point, as prices fall while component costs rise.
Schumpeterian dynamics continue to bedevil the aging direct-purchase computer maker. Michael Dell has returned, executives have been shuffled, and Perot Systems has been bought, all to no avail.
Dell's golden age continues to recede further into the past, while the current management team burns through more money and continues to provide no compelling reason for shareholders to remain and see their equity investment underperform an inexpensive S&P index fund.

Home Sales & Economic Growth

Kelly Evans wrote an interesting little piece in this morning's Wall Street Journal's Ahead of the Tape column in the Money & Investing section.

Not being a practicing economist, I do not claim to be totally conversant in every government data series. However, I pay attention to those who are.

Evans noted that sales of existing homes don't really have a strong connection to economic growth. Besides currently being skewed by the government cash-for-home buyers program, like other economic indicators which have been likewise distorted, she notes that the exchange of ownership of existing homes doesn't really create significant economic value.

However, new home sales do. Thus the title of her piece, "For a Better Reading, Try New-Home Sales."

She writes,

"Construction feeds directly into the calculation of U.S. gross domestic product, while sales directly influence GDP only through brokers' fees and commissions.

And amid a glut of excess inventory and an expanding foreclosure pipeline, the signal from new homes right now is much more cautious.

Last week, the Commerce Department said that new-home construction sank 10.6% in October to an annualized rate of 529,000 units, the lowest level since April."

Doesn't sound very promising, does it? But, wait, it gets worse,

"....sales of new homes have stalled in recent months at an annualized pace of about 400,000 units; forecasters expect that pace slowed to 395,000 units when Commerce reports October figures Wednesday.

In a short trading week crammed with data ahead of the Thanksgiving holiday, Monday's existing-home-sales report likely will grab the market's attention.

But Wednesday's read on new-home sales probably will be a more-telling indicator of what is in store for the economy."

Now that I'm clued in to the importance of this number, I'll be watching.