Friday, February 26, 2010

More Congressional Ineptitude

Maxine Waters is not the only incompetent House member. Not by a long shot.

Yesterday, as I watched/listened to the so-called health care summit, Fox News cut to an interview by Megyn Kelly with Florida Democratic Representative Debbie Wasserman-Schultz.

It was, to say the least, revealing.

Kelly asked Schultz to explain why Democrats continue to push a 2,300 page health care bill too complex for anyone to fully comprehend, when so many polls indicate that about 55% of voters want a new health care bill to be written from scratch by both parties, together, and something like only 30% of voters want the current proposed legislation.

Schultz replied with a laundry list of items which she claimed voters were for, on an individual basis. Among the items she listed were:

-low insurance premiums or small increases
-no dropping coverage because of sickness
-insurance available for pre-existing conditions
-coverage of all Americans

What Schultz and, for that matter, Kelly, overlooked and ignored, is the flaw inherent in asking interviewees on a questionnaire for multiple, serial responses on attributes of a choice.

Back in the late 1970s, when I attended graduate business school, conjoint analysis was already a fairly mature, well-regarded technique in marketing research. That was over 30 years ago!

What conjoint analysis does is allow respondents to choose, usually in either paired-comparisons or rank ordering tasks, between various sub-optimal combinations of attributes.

In the case of health care, for example, a 'choice' might be low premium increases, but no pre-existing condition coverage and coverage for 90% of Americans.

By working through such choices, respondents reveal their relative values for each attribute. The key is being forced to choose among alternatives combining various levels of the various attributes.

Why isn't Congress commissioning some conjoint analysis-based research to provide members with information on what Americans value most, and least, among the possible, but expensive, attributes of a health care reform bill?

This is the sort of omission that drives me crazy. Sad to say, a look at Schultz's bio tells you a lot. She was a carpetbagging resident in her district when she went to work for a state legislator. She then ran for his vacated seat at the tender age of 26, won it, and served the maximum number of terms. Then she ran for Congress.

So, once again, as in the case of Carolyn Maloney or, for that matter, my old civics teacher, longtime Bob Michel aide and current Secretary of Transportation, Ray LaHood, we have a Representative with no more than perhaps 3-4 years of experience actually working for a living. And those years were quite long ago.

No wonder our elected representatives provide so few modern, easily-available techniques to assist in resolving policy questions. They truly are clueless, because they've spent too much of their adult lives as professional office-holders.

And, again, as I did at the end of my post about Maxine Waters, I want to stress the business implications of this post. Provisions of the current health care bill will cause businesses to dump their employees into government-run plans. This will cause health insurance costs to skyrocket, increasing our national debt and, eventually, raising taxes. This will lead to less job creation and lower economic growth rates.

It's important for all of us to push back ill-advised, stupid legislation and government overreach. It begins by getting rid of lifetime officeholders of all parties, and striving to elect experienced, non-professional candidates for a few terms, so that their goals and those of ordinary citizens who work for a living are aligned.

Thursday, February 25, 2010

"So Dumb, Her Head Must Hurt...."

Years ago, a college friend had a saying about really stupid people. It was,

"He's so dumb, his head must hurt."

This phrase came to mind yesterday morning as I heard and watched California Democratic Representative Maxine Waters question Fed Chairman Ben Bernanke.

Waters distinguished herself with a new low in ineptitude when she began by confusing the discount rate with the Fed Funds Rate. After Bernanke patiently explained the difference, Waters then spent long minutes insisting that mortgage interest rates must remain low, so she wanted Bernanke to guarantee and assure the House Financial Services Committee that market interest rates would not increase due to the increase in the discount rate.

Now, if you visit that link, you'll see a list of the House members on the committee. Because they are not listed in alphabetical order, it's a reasonable guess that they are in order of seniority. Thus, Waters is at least the third-longest serving Democrat on the panel. I know I've heard Waters' idiotic questions and comments on this committee for years.

Don't you think it's fair to expect such a long-serving committee member to know, by now, the difference between the discount window rate and the Fed Funds rate? How about expecting them to know a fair amount about the structure of the US financial system, basic economics, and some international trade economics, as well?

But, no, instead, we get Maxine Waters.

"So dumb, her head must hurt."

Just once, I'd like to, and would pay money to hear a Fed Chairman respond to a question like Waters' as follows,

'Ms. Waters, your question is idiotic. It conveys a total lack of understanding of the workings of the Fed.

How long have you been on this committee, Rep. Waters? Don't you think you owe it to your constituents and all American voters, to actually understand the matters before this committee?

Have you not taken the time, over the years you've been on this panel, to learn about our financial and economic system? Or are you simply overwhelmed by the subject matter?

Mr. Frank, this is ridiculous. I'm casting pearls before swine, here.

Please make sure, in the future, that the members on this committee have passed a basic test of knowledge on the subject matter that the committee oversees.

Until such time as you can assure me that all of your committee members have passed such a test, a test which I will sit with you to create, I will not bother to waste my valuable time sitting for questions from uninformed, stupid Members.

That is all for today. I have work to do.'

This is why so many of us cringe at the prospect of Congress having more and more power over all facets of American life. Congressional members sit on committees, the subjects of which they have absolutely no knowledge.

It's frightening that these people think they can regulate or oversee anything. Few seem to have even held a private sector job recently.

Just imagine you were Ben Bernanke and had to continually explain complex, inexact economic matters to more than 30 Maxine Waters clones.

It's not a political matter, nor a partisan issue. It's about the ability of Americans to conduct business in the face of inept, inexperienced and unqualified federal legislators trying to accrete more power to themselves, while remaining ignorant of how business and economics actually work.

It's enough to make you go insane, isn't it?

Wednesday, February 24, 2010

General Growth Properties' Fall From Grace

I have read, with some dismay, the articles concerning Simon Properties' bid to take over the remains of General Growth Properties.

My own connection with the firm, though brief and passing, goes back to 2000.

At the time, a prominent hedge fund manager and former Salomon Brothers partner offered to assemble a hedge fund around my equity strategy. His anchor investor, as it were, was GGP's then-chairman, Matthew Bucksbaum. At the time, Bucksbaum was a billionaire, thanks to his personal investments in GGP. The firm had been built by his family over decades, then gone public as a REIT, providing substantial, liquid wealth for them.

As part of the process of securing Bucksbaum's investment, the partner assembling the hedge fund asked me to do some analysis of GGP's competitors, and GGP, using the consulting version of my research. It was to be a threefold activity: a chance for Matt Bucksbaum to evaluate me and my work; a good faith provision of free analysis, and; a formal reply to a question Bucksbaum had regarding GGP's valuation relative to his company's peers. Vornado, Simons and Rouse were among the REITs which I analyzed.

It didn't take me long to do the analysis, nor identify a probable cause of GGP's relatively lower valuation, particularly when compared to Vornado. Put simply, GGP had a bad habit of selling properties when they had accrued substantial gains, providing shareholders at those times with extraordinary gains. Thereafter, investors knew such gains would be years in coming.

Consequently, GGP's earnings were more volatile than Vornado's, and its valuation was lower, due to this lack of consistency. I provided some guidance as to how GGP could improve its earnings consistency, and offered to provide additional presentations to the firm's management team.

Bucksbaum understood my analysis, conclusions, and recommendations, though he evidently declined to pursue them further.

However, he agreed to back our hedge fund.

When I read of GGP's sudden spiral toward bankruptcy in the last year or so, it took me back to my meetings with Bucksbaum in the spring of 2000. I can't, of course, estimate how much of GGP's troubles were due to the operating policies which I identified as probably depressing the firm's value to investors. Articles in the Wall Street Journal suggested that, like investment and commercial banks, and many hedge funds, GGP had unwisely used too much short term borrowed funding. Adding to that problem, the firm's COO, Matthew's son, John, had apparently borrowed heavily against family-owned GGP shares. When margin calls came due during the 2008 financial debacle, the firm's and family's fortunes began to rapidly unravel.

Last I read, Matthew Bucksbaum was reduced to being worth only tens of millions. Still more money than most Americans will see at his age. But something like 1% of his peak net worth.

A good lesson in how fleeting business success can sometimes be.

Tuesday, February 23, 2010

Reflections On TARP's Rescue of "The Quants"

I closed this recent review of Scott Patterson's new book, The Quants, with this passage,

"After a bit more reflection, I'm going to write a post discussing, from the viewpoint of Patterson's book, the folly of the TARP, government intervention, and implicit saving of the quant funds by the federal government."

Well, I've reflected, and arrived at some conclusions which work, at least for me.

Before I express them, let me also repost the key failings which Patterson's book revealed among the largest, apparently most market-influential quant hedge funds,

"1. They all exhibit a shallower comprehension for the human behavioral aspects of financial markets than their mentors.

2. With each succeeding generation of acolytes, the belief that pure mathematical and statistical methods can apply, sans contextual understanding, to financial markets grows stronger, and the awareness of key underlying, limiting assumptions grows weaker.

3. Crucial dimensions of risk management for both the hedge funds, and the instruments they often trade, e.g., leverage, collateral, and ability to meet an instrument's, such as a credit derivative swap's obligations, are profoundly separated from the actual trading activities.

4. As such, both senior managers of the firms engaging in these activities, as well as counterparties, bear significant responsibility for having little understanding of the pragmatic aspects of risks which were undertaken by these quantitative traders.

5. Perhaps most ironically, all of the current generation of quantitative traders believed in exceptions to Eugene Fama's general EMH model, yet, in a fallacy of composition, when, together, they exploit commonly-observed inefficiencies, they become the very agents of EMH, obliterating the profitable inefficiencies they so recently observed and on which they traded."

It's my contention that, by inadvisably rescuing Citigroup and Morgan Stanley, the federal government unwisely allowed many investment firms run by flawed managements to survive what should have been their Darwinian, Schumpeterian moment of extinction.

Beginning in late 2007, the fall in values of financially-engineered, structured fixed income products, e.g., CDOs, caused large losses at firms such as Citigroup and Merrill Lynch. As equity in those firms plunged, their managements scoured the globe for new sources of equity. The downward spiral in asset values, in time, during 2008, took down Bear Stearns, Lehman Brothers Holdings, Merrill Lynch, Wachovia, Washington Mutual, while finally approaching making insolvent Goldman Sachs and Morgan Stanley.

I contend that this phenomenon, left unchecked, would have resulted in much more damage to, and possibly the end of quant hedge funds like those, and quite possibly those described in Patterson's book. Specifically, Citadel, AQR, and PDT within a failed Morgan Stanley.


Without government guarantees of major players in markets for instruments which those hedge funds traded and held, the values for those instruments would almost certainly have plummeted, as so much market-making capacity would have been liquidated. Simply put, there'd have been nobody to whom to sell the various swaps, CDOs and other fixed income assets.

Existing on large amounts of short-term financing from banks, as they do, the quant hedge funds would likely have become insolvent, as their losses on assets far exceeded their slim capital ratios.

Suppose the firms which Patterson profiled (with the apparent exception of Simons' Renaissance), and many like them, were to have lost everything and closed?

Would this have been such a bad thing? I think not. Rather, it would have been the most desirable outcome.

As I noted in the five points I restated from my prior, linked post, the managements of many of these funds was, and still is, badly flawed. Their risk management systems are flawed and too simplistic. They use too much leverage for survival during the worst market events. They fail to broadly understand the true impact of the existence of so many of their ilk, together, attempting to exploit presumed market inefficiencies, i.e., that this very act, using so much capital, leads to the return of those market niches to efficient pricing.

Such flawed management needs to be weeded out and extinguished. That's the free market way. Short term success may exist, but, longer term, those business models incapable of weathering occasional storms must perish. Otherwise, capital is inefficiently allocated.

Instead of adding to the chances of future long term stabilization of financial markets, our government's rash, incorrect actions in 2008 have only served to prolong the lives of hedge funds which are managed using flawed models, techniques and assumptions.

As hedge funds, these entities were to only take investments from 'sophisticated' investors. So their failure shouldn't bother us. And if, among those so-called, self-identified sophisticated investors, were entities holding, say, pension assets of unions or the endowments of non-profits, well, that's just too bad.

Sooner or later, those institutions need to face the consequences of dabbling in financial markets in which they do not truly have expertise. We, the rest of society, can't save these institutions from themselves forever without substantial costs to the rest of our society.

Finally, the unintended, or, perhaps more frighteningly, intended consequences of the TARP and related Fed actions of 2008, were to have saved some wealthy investors, at a cost to the rest, and definitionally poorer elements of US society. That's just wrong.

After reading Patterson's book, think about whether you really believe that families with an AGI of under $200,000 should be taxed to pay for the rescue of people like Weinstein, Asness, Griffin and Muller.

Monday, February 22, 2010

Geithner: A Legend In His Own Mind

This morning on CNBC there was mention made of tax cheat and Treasury Secretary Tim Geithner's interview in Vanity Fair.

Two details of the interview came to light.

First, Geithner contemplated an alleged offer to run Citigroup. When I heard that, I burst out laughing, nearly spilling my coffee.

Here's a guy who has been taken to the cleaners by private sector parties, as described here and here.

So what would make anyone, especially Geithner, think he's up to the task of running the horribly-organized mess that is Citigroup?

How incredibly arrogant of Geithner. All anyone has been able to show so far is that Geithner might be a second-rate financial system's plumber, of sorts. Certainly nowhere near up to running a large US bank, much less a deeply-troubled one.

The other incredible admission from the Vanity Fair article is that Geithner now blames his tax cheating on.....TurboTax.

Right. Like you or I could do this and get to be Treasury Secretary. Never mind even just getting amnesty.

If you can stop laughing at this pathetic display of poor judgement on Geithner's part, consider what a whining excuse-maker he is. Nothing is ever Timmy's fault.

Outmaneuvered by Goldman? Had to do it- not his fault. Cheated on his taxes? Not his fault- blame the software.

This guy has to go.

The Municipal Defaults & Bankruptcies Begin

Thursday's Wall Street Journal detailed some of the evolving defaults among municipalities, including Harrisburg, Pennsylvania, and Vallejo, California.

The Harrisburg Chapter 9 filing caught my eye because only a few weeks ago, a friend mentioned that some waste treatment facility bonds he owns mysteriously missed their recent interest payments. Sure enough, it was Harrisburg.

I wrote posts here and here recently describing this scenario, as predicted by Meredith Whitney and David Rosenberg. Two passages from those posts were,

"Meredith Whitney predicted that the effects of these problems will hit home next spring, when tax receipts come due, and fail to provide expected revenues for these many struggling governmental entities.

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."

And, as if on cue, the Journal article highlighted the now-occurring problems.

At the end of the piece, a Harrisburg government official noted that they can't really raise taxes, or people will simply move to cheaper suburbs surrounding the city.

Funny how both municipalities and cities/counties have this problem. Their runaway spending over the past few decades can't now be fixed by simply raising taxes.

Truly, the more profligate, poorly managed state and local governments are now suffering the consequences of their mistakes.

And that is looking to be a non-trivial add-up in the general analysis of overall US economic health.

And, no, simply sending newly-printed greenbacks from Washington to pay these debts won't make them "go away." It will simply federalize the mismanagement of various states and local municipalities. Something unlikely to be accepted by Congressional members from non-affected parts of the country.