Friday, January 29, 2010

Bernanke's Renomination As Fed Chair

It doesn't seem very comforting to see Bernanke confirmed by the smallest margin the Senate has ever voted for this position, does it?

Especially when you consider that he's had the job for one term. I guess some Senators felt that changing Fed chairmen was risking someone even worse than Bernanke.

For a guy who seemed so experienced and well-qualified for the job, he sure made a hash of it when the going got tough.

To me, the salient criticism of Bernanke & Co. was conveyed in Anna Kagan Schwartz' interview in the Wall Street Journal in October, 2008. In that interview, she said this, which is in that linked post,

"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."

By that, which she specified elsewhere in the interview, she meant that liquidity wasn't the problem in 2008, but counterparty risk and solvency.

For this alone, I think Bernanke should have been denied another shot at mismanaging our money supply.

I suppose many feel better that even more uncertainty hasn't been injected into the financial system. But the price is to labor under a Fed chief who clearly does not have the confidence of most of Congress, has taken steps that are pretty clearly unconstitutional, including his role in the AIG and Merrill Lynch situations, and confused the nature of the single greatest challenge any Fed chairman has faced, with the probable exceptions of Volcker and Eccles.

Indra Nooyi's Insights On US Consumer Behavior In The Recession

Yesterday morning, PepsiCo CEO Indra Nooyi provided her own very unique perspectives on current consumer behavior and whether the US remains in a recession.

Nooyi began by stating that Pepsi views unemployment statistics differently than most observers, carving up the statistics by type of worker. I only caught two of the categories, which were, not surprisingly, white collar and blue collar workers.

Nooyi discussed visits by blue-collar workers to convenience stores and ATMs. They are visiting less, buying less, withdrawing less cash from ATMs. That was very surprising, as these consumers pay fees for each withdrawal, yet still minimize the amount withdrawn at each ATM visit.

Many of these people, she contended, are now unemployed. Thus the fewer trips to the C-stores and less cash withdrawn.

She left no doubts that a large segment of Pepsi consumers have been hit hard by unemployment, and has not yet rebounded.

Separately, Ms. Nooyi left the impression of being a very savvy, insightful and connected CEO. In a product/market of so many consumers, where there are probably fewer identifiable key, large direct customers, Nooyi's team seems to do a great job of continuing to take the pulse of their markets.

Thursday, January 28, 2010

Larry Ellison Changes Course

You have to admire Oracle CEO Larry Ellison's ability to read trends and adapte his company's strategy as necessary.
In fact, Oracle has been on my equity strategy's selection list four times in the past year. That's a testament to Ellison's ability to keep Oracle consistently growing revenues at high rates while still outperforming the S&P on total return.
Yesterday's Wall Street Journal noted that Ellison had recently changed course and, after eschewing hardware businesses for years, suddenly pounced on the ailing Sun Microsystems. If memory serves, Ellison first tried to buy a key software business that Sun owned, and couldn't get it. Evidently worried that it would fall into a competitor's hands, and seeing his rivals begin integrating software and hardware, Ellison moved to take Sun.
He said, according to the Journal, that,
"Oracle will focus on selling such combination systems to businesses. Mr. Ellison said they will cost less and perform better than systems that use parts from different companies.....he expects systems that combine hardware and software to become a multi-billion dollar market."
One would surmise that Ellison and his executives have foresee a change in economics from having Oracle products flexibly work with various hardware systems to being cheaper by being integrated with just one hardware line.
It takes an open-minded, secure CEO to be able to see changes in trends, acknowledge them and take action to accommodate them.
Not many companies can perform as well Oracle under Ellison's leadership.

The Continuing Blindness In the AIG Matter

Yesterday's Wall Street Journal carried Holman Jenkins' weekly column. This week's topic was Geithner, Goldman and AIG.

Jenkins engaged in some very humorous role play, contending that Geithner didn't really have much leverage over Goldman et. al. He articulated two options: total nuclear annihilation via an AIG-triggered systemic meltdown, or; explicit exchange of political favors for accepting a haircut on AIG positions.

After discussing the two options, Jenkins offered that a simple government guarantee of AIG's positions would have restored order to the market, probably without costing anything. Certainly less than a complete takeover and payouts to counterparties.

I think Jenkins' idea is sound, but he omitted one very credible alternative that Geithner & Co. have never discussed.

That is, a simple carving out of AIG's financial products unit for placement into bankruptcy. Such a move would have isolated the troubled portion of the insurer from the heavily-regulated insurance operations.

Once in bankruptcy, AIG's counterparties would no longer have a right to 100% payments for positions. But an orderly disposition could have occurred, again avoiding needless losses to US taxpayers.

It continues to mystify me why only one Journal contributor has ever raised this option. It's the default path for failing companies, and should have been the preferred option for AIG.

Geithner may or may not have been guilty of various malfeasances or neglectful inactions in the AIG situation. But one thing is sure. He and his team were surely guilty of a lack of creativity and perspective on the situation.

Wednesday, January 27, 2010

Apple Joins The eReader Business

Today's much-heralded announcement of the Apple tablet brings Apple into even broader competition with Amazon.
Several weeks ago, I discussed this impending event with a business colleague who has had involvement with other companies entering the electronic book reader business. In a few short years, the niche most recently pioneered by Amazon's Kindle is getting rather crowded.
For example, Barnes & Noble debuted a reader, as has Sony. Now Apple brings its prowess to the category.
A glance at the two nearby price charts for Amazon, Apple & the S&P500 Index for the past 5 years, and then for the companies since Apple's inception, tells an interesting story.
Over the past five years, Amazon's and Apple's equity price moves have been surprisingly coherent. While both suffered somewhat through the last year's market troubles, both delivered performance significantly above that of the S&P. The pattern of the price moves almost leads one to conclude that Amazon now behaves in a quasi-technology issue manner.
Looking at the same three series from the mid-1980s, it's rather shocking to see that, in a much shorter timeframe, Amazon has created more return for its shareholders than has Apple. And, again, looking over the longer term, the recent nearly-identical patterns of the two firms' equities moves is stunning. If I'm not mistaken, Amazon began performing like Apple around the time of the Kindle's introduction.
This morning's Wall Street Journal features articles focusing on Apple's battle with Amazon over pricing of titles and relationships with publishers, as well as, on the technology front, its continuing march into new product areas.
If I were handicapping this race, I'd have to bet on Apple. For several reasons.
First, by controlling the entire business system, including in-house product design, as a software and hardware producer, Apple has more natural advantages over the long term. My colleague and I discussed how likely it will be for Apple to release, in future versions, an iPhone-like tablet, where the phone application becomes a freebie.
Second, Apple cut its teeth on this business model with the iPod, which has consistently outperformed MP3 players. At a stroke, Apple can neutralize Amazon's history with publishers, simply through its contracts for epublication on the tablet.
Third, Apple has a much more visceral brand loyalty than does Amazon. In a product space becoming crowded with entries, the vaunted Apple brand, distribution system, and customer service are all advantages which will bring share to the tablet. By comparison, Amazon is simply a place where you buy books online. And maybe some music, if you don't use an iPod. Perhaps rent or buy videos, as well.
I just don't think Amazon has built strong enough brand identity for what is coming in this product/market space to withstand Apple's assault on the ereader category.
Finally, if Apple only competes on a par with Amazon, it's already won. For Amazon, it's a defensive game of mitigating share loss. Perhaps the tablet will expand the overall market, but with its expected higher price, probably not share that was going to Amazon. For Apple, any sales of tablets and content through its online site are net additions.
The momentum and nature of the competitive situation would seem to favor Apple- again.

Tuesday, January 26, 2010

Bernanke's Troubling Congressional Roadshow

There was considerable buzz yesterday as Fed chairman Ben Bernanke made the rounds of Capitol Hill.

According to Senate Majority Leader Harry Reid, Helicopter Ben promised he'd continue his easy money policy as a quid pro quo for being reappointed to his current job.

As retiring Kentucky Republican Senator Jim Bunning contended this morning on CNBC, Bernanke is engaging in unusual and dangerous behavior.

What are we to make of a Fed chairman publicly prostrating himself for Senate confirmation votes? Where's the outrage from the rest of the Fed now? They certainly rallied to protest the House bill to audit the Fed. They were all up in arms about the sacred independence of the Fed.

How can it possibly remain 'independent' when its chairman grovels before Congress, promising easier monetary policy than the already-zero interest rates?

Worse, what signal does this send to the rest of the investing world? The chairman of the central bank for the world's reserve currency pleading with those who would reappoint him that he'll make monetary policy sufficiently lax to please them?

This way would seem to lie serious danger for the US dollar and very dire long term economic consequences for our country.

Ed Whitacre Anoints Himself GM CEO

You certainly can't fault Ed Whitacre for lacking chutzpah, can you?

On this basis,

"I like the people, I made some management changes and I just felt comfortable with the team,"

Whitacre decided he will be GM's long term CEO. Never mind the board- it's been a useless rubber stamp for decades. Whitacre was appointed by the current administration, so any notionally publicly-held company would be asking for a fight with the thugs in Washington if they were to contest the federal government's wishes.

After all, consider AIG's fate.

So Whitacre crowned himself king of GM.

Unfortunately, Whitacre's experience has been in a sector more or less defined by government intervention- telecommunications. Sure, he cobbled together SBC, now named ATT, from the remnants of various Bell System operating companies and, finally, the remains of the one-time parent company. But as I noted in an earlier post, the most important task in that sector was managing the regulatory environment, and perhaps cost-cutting.

GM needs an entirely different set of skills in its CEO. To sanction Whitacre's self-promotion to CEO is to admit that GM will continue to be a ward of the US taxpayer. The new CEO's most prominent management changes were to bring in two old regulatory affairs specialists who worked for him at SBC.

Does that tell you something? It ought to.

Whitacre sees GM's most important task as managing Washington. Beyond that, I don't think Ed Whitacre has any idea how to run a competitive company, the business of which is to sell big ticket products to consumers.

Anybody stupid enough to still be a voluntary GM shareholder deserves what happens next.

Oh, right. That would be mostly union members, wouldn't it?

Monday, January 25, 2010

Excerpt from Scott Paterson's New Book "The Quants"

The weekend edition of the Wall Street Journal contained a very thought-provoking excerpt of its reporter, Scott Paterson's, new book, "The Quants."

Based on the lengthy piece in the Journal, this is one book that promises to be worth reading.

The review provides a synopsis of some of Paterson's reporting results, primarily from the viewpoint of a secretive quantitative proprietary hedge fund known as the Process Driven Trading group, within Morgan Stanley.

Describing the group, Paterson writes,

"Instead of looking at individual companies and their performance, management and competitors, they use math formulas to make bets on which stocks were going up or down. By the early 2000s, such tech-savvy investors had come to dominate Wall Street, helped by theoretical breakthroughs in the application of mathematics to financial markets, advances that had earned their discoverers several shelves of Nobel Prizes."

Sound familiar?

It should. Paterson's description of Morgan Stanley's PDT group is almost identical to the image and composition of another infamous hedge fund, John Meriwether's Long Term Capital Management. That group, which was largely composed of an exodus of talent from then-independent Salomon Brothers, plus a helping of Nobel Laureates, including Myron Scholes and Robert Merton, attempted to exploit the same sorts of arbitrage opportunities in global securities markets.

LTCM didn't pan out as expected, shutting its doors in bankruptcy after only six years. And causing concern that its failure would bring down global capital markets.

What Paterson's teasing sample reveals is that, well, there really is nothing much new in financial markets.

Back in 1987, the then-experts in trading and risk management were convinced "portfolio insurance" strategies would avoid catastrophic losses. They didn't. Instead, identically-designed risk management systems all dumped the same types of securities amidst a sudden downdraft of equity prices, causing a torrential selloff.

Then again, in 1998, LTCM triggered the same phenomenon. Of course, that time, the underlying hedges were much, much more sophisticated than those of 1987. Back then, the big fad was lightning-fast trading of baskets of S&P components to exploit minute, fleeting price differentials.

By 1998, with tremendous advances in computing power and speed of data communications, LTCM's traders were able to construct far more elaborate, incomprehensible hedges which unwound in almost completely-opaque fashion. Opaque even to their designers.

Now, thanks to Paterson's brief excerpt in Saturday's Journal, we see that the quants were at it again. It's always the same. Bright young 20+ and 30+ year olds who've never seen a market meltdown apply the latest mathematical and physics advances to series of securities market data.

They may have read the fundamental papers on portfolio theory from the 1950s, but probably not. They may be familiar with the pesky, annoying details of minimum assumptions underlying the existence and behavior of liquid securities markets, but probably not.

What they are familiar with is how to take many series of data and extract measures of variance and covariance. Nevermind that what they 'discover' are temporal relationships of abstruse complexity underpinned by then-existing market environments.

To the latest generation of quant trading jockeys, it's all a straightforward application of math to securities markets prices.

The field you never see plumbed nor represented on the hot Wall Street hedge fund trading desks is..... catastrophe theory. The body of work exploring what happens when there are profoundly discontinuous changes in environments which cause rapid and extreme dislocations in outcomes of some system.

From my own background in statistics, I can assure you that the sorts of statistical methods most commonly applied by quants tend to require assumptions of continuity in pricing inputs and behaviors.

Precisely the conditions which send prices moving discontinuously are what tend to be unquantifiable. Especially when those conditions are triggered and amplified by a few dozen hedge funds operating similarly-based quant trading systems.

I've written about this before in posts under the 'Risk Management' label.

What happened in 2007-08 was, it appears, nothing more than the latest version of the application of the most current mathematical methods to series of securities prices which are, in reality, not naturally-occurring forces of nature, but the varying outcomes of human behaviors.

It's telling that, at the end of Paterson's excerpt, Peter Muller, head of PDT, has only two options: hold or fold/sell. He opts to sell.

That's another common element of quant strategies. They assume plentiful capital, or some sort of calm, VAR-based orderly loss of position values which allows a methodical unwinding of desk positions. But that's not what happens in a market meltdown.

Instead, position values melt away and erode capital, triggering risk alarms, margin calls and the need to sell positions in order to conform to capital requirements.

Ah, those pesky day-to-day operating assumptions and details.

If only....if only.....

By now, anyone my age or older, or even a decade younger, should understand that simply because hedge funds are run by people with names like Cliff Asness or Peter Muller, or John Meriweither, with pedigrees from Goldman Sachs, Morgan Stanley or Salomon Brothers, hardly means they will survive the test of a market collapse.

Sure, they'll no doubt do very well in a reasonably calm, or even frothy upward-moving market. Or a prolonged, gradual market decline.

But the sort of market conditions which are the specialty of Nassim Taleb, the market composed of sudden shear forces, seems to cripple these quant hedging strategies every time. Every decade, in fact.

No, there really doesn't seem to be much new in financial markets when it comes to advanced risk management, complex hedging strategies and quant models. They work really well- until they don't. Then they fail spectacularly, in concert, and turn ordinary market downturns into market panics.

Sunday, January 24, 2010

Regarding Bernanke's Reappointment

How the winds have changed in just a few short weeks!

I have, on my desk, a Wall Street Journal editorial from the weekend edition of 9-10 January by Judy Shelton. In it, she lampoons the Fed chairman for admitting in a recent speech only,

"the timing of the housing bubble does not rule out some contribution from monetary policy."

Apparently Bernanke still won't face up to the fact that government forces were responsible for the first steps leading to the recent financial sector turmoil. First Greenspan kept interest rates too low for too long. Coupled with that, Congress, through the CRA and misguided direction to Fannie Mae and Freddie Mac, encouraged, as well as demanded, that mortgage loans be made to unqualified home buyers.

Yes, with that stage set, commercial, investment and mortgage banks were too aggressive in their pursuit of profits through residential home financing. But they simply joined the party that the Fed and Congress had started.

Now that the voting public is angry at the federal government for having rescued banks which should have been allowed to fail, Bernanke's reappointment carries more risk than it did only a few months ago.

Personally, I believe that Bernanke responded incorrectly to the developing financial sector debacle as far back as the late summer of 2007. With post-1929 securities markets and banking reforms in place, including deposit insurance, bank insolvency is no longer something to be papered over. Furthermore, there was little sign that monetary liquidity had ever truly dried up in 2007 or 2008.

What worried federal officials was the solvency of Bear Stearns, Lehman, AIG, Morgan Stanley, Goldman Sachs and Citigroup, not the overall liquidity in the US.

Additionally, at a time of administration and Congressional overreach in several legislative areas, the Fed is now seen as having behaved in an unconstitutional manner in the AIG case. And its rush, with Treasury, to force-feed federal funding to large banks which could have safely been put into receivership to thin out the sector's overcapacity, is now seen as favoring large business and financial interests at the literal expense of taxpayers.

This has suddenly become very unpopular. Especially in the wake of the election to the US Senate of Republican Scott Brown last Tuesday.

For once, I'm with Larry Kudlow, of CNBC, in thinking that John Taylor would be a good replacement for helicopter Ben. Rather than avoid a depression, our recent challenges have been how to productively and effectively shed excess financial sector capacity without having monetary policy become either overly restrictive, or overly stimulative.

I personally think Bernanke is damaged goods now. He pulled the wrong levers during the recent financial crisis, helped things spin out of control, only to have to apply too much force to rein them back in, while apparently engaging in some illegal behavior by coercing BankofAmerica to close its purchase of Merrill Lynch.

Regardless of its effect on the equity markets, I am actually pleased to see that Bernanke's reconfirmation for Fed chairman is now a long shot.