Friday, May 14, 2010

Congress Plans To Ration Consumer Credit

This morning and afternoon, CNBC has had fairly extensive coverage of the new and expanded consumer finance regulations making their way through the Senate and headed for the House.

Among other features, the bill cuts debit card usage fees. The general effects of the bill are for Congress to exercise price controls over consumer credit providers. This will, of course, result in the rationing of credit to consumers.

Imagine lower-income consumers finally getting to the point of affording credit or debit cards, only to discover that they are no longer available to them, on prior terms, due to increased costs of regulation.

Yesterday's Wall Street Journal carried an editorial co-authored by Cliff Asness, founder of hedge fund AQR. His piece called attention to the very many vague and unspecified instances of language in the horribly-written Dodd financial 'reform' bill. Language making it unclear what is illegal and how penalties will be assessed.

Bill Isaacs, the former FDIC head, was on CNBC expressing his hope that more insane and unworkable concepts get added to the bill, thus making it completely incapable of being passed during this session of Congress.

Between the badly-written, so-called 'reforms,' public and legal attacks on investment banks, and, now, new attempts to curtail, proscribe and limit profitability of consumer lending, the recent federal government actions aimed at the financial sector point to less available capital or credit, higher costs of capital, and the effective rationing of credit and capital on non-price bases.

None of which are good things for our nation or its future economic growth.

Starbucks Expands Its "Fighting Brand"- Seattle's Best Coffee

Wednesday's Wall Street Journal called attention to Starbucks' plans to push its lower-priced brand, Seattle's Best Coffee, through various distribution channels. The wholly-owned unit, once a Starbucks competitor, is now headed by Michelle Gass, the parent's CEO's one-time strategy aide.

Essentially, rather than repeat its mistake of the past few years by taking the Starbucks brand down-market, causing temporary sales growth but diluting the brand's image, the company is tapping its lower-priced coffee brand to implement this strategy.

One pundit likens it to the Gap's Old Navy brand, but I'm not so sure that comparison works. After all, style, quality of material and price all serve to differentiate Old Navy, while, in the end, moderate-priced coffee is moderate-priced coffee.

Seattle's Best is to be marketed through franchisees, sales of beans in grocers, and the like. I suppose that, if done successfully, this Starbucks division can earn a respectable return. Perhaps, at first, it will add some growth to the parent's income statement and total return through raw revenue growth.

But, over time, what's the likelihood that a middle-market coffee roaster, competing with Dunkin' Donuts and McDonalds, will somehow break out in the segment and prove to dominate a segment known more for its very lack of distinguished flavor?

More than anything, isn't the plan to push growth at Seattle's Best Coffee an implicit admission by Howard Schultz that the Starbucks brand isn't as capable of delivering profitable growth which will enhance shareholder value and consistent total returns in the near future? That the main Starbucks brand is essentially devoid of significant opportunities for growth, having saturated its markets in recent years?

Thursday, May 13, 2010

GM Wants A New Captive Finance Unit

The headline in yesterday's Wall Street Journal, "GM Looks At Return To Auto Lending," caught me completely off guard when I saw it.

Is Ed Whitacre nuts?

The lead paragraph in the Journal article stated,

"General Motors Co. is weighing an attempt to buy back its old auto-lending arm or start a new finance company in a bid to become more competitive and bolster the company's appeal ahead of an initial public stock offering...."

This is surely among the more wrong-headed, disastrous moves I've read regarding the failed auto maker.

If the 'core competence' notion has any value, this is one stupendously dumb idea. GM has shown over several decades that it couldn't even build attractive, competitively priced gasoline-engine cars.

Its financing arm, GMAC, eventually grew to be its own entity, pursuing profitability through....sigh.....residential finance. Where it went fabulously wrong and lost billions.

True, an equally-naive Cerberus bought into the unit before the implosion. But my point is that finance is, or should be, a related but non-core function for making and selling vehicles.

The temptation has been, in past decades, for US auto makers to cut price through finance terms, making their financing arms the repository of losses while their vehicle operations look healthier.

Granted, the Journal piece went on to note,

"GMAC, which recently renamed itself Ally Financial, made $653 million on its North American automotive operations in 2010's first quarter."

Of course, operational profit on auto lending may, and probably does not address the balance sheet risks for Ally of holding, selling or hedging its portfolio of auto loans.

Like any financial institution which has borrowed in the credit markets, is highly leveraged, and makes loans, Ally and, thus, GM, when it either repurchases part of Ally or starts its own new finance unit, has to manage asset/liability risks.

How is Ally doing on that score right now? If GM owned Ally, and continued its infamous 0% rate financing programs, to which it has seemed to always turn when tempted by slow sales or share erosion, how would it manage borrowing money at positive interest rates and lending it at lower ones?

Sounds to me like yet another recipe for disaster at GM.

My proprietary research has shown that financial services firms which concentrate on just one, or a few businesses, tend to have higher, more consistent total returns over time. Broadening a firm's business mix, especially when the businesses don't share many fundamental functions, tends to overtax management and promote the lack of attention to the core businesses.

In GM's case, the only link between the two businesses is that the finance arm would be making loans whose collateral was the cars GM made and sold. Aside from that, the real question is whether auto financing, as a standalone business, can generate long term superior returns relative to GM's auto making business.

If so, shouldn't any US investor, who, by definition, as a taxpayer, is already long GM, have the option of buying equity in the finance company that services GM, rather than be forced to own that, too?

TARP Oversight Chief Scold Elizabeth Warren Whines On CNBC This Morning

It was my unfortunate fate to sit through more whining this morning from the head of the Congressional panel looking into the financial crisis, Elizabeth Warren, on CNBC.

Every time I hear this woman talk, my sense that there is nothing she says that is new is reinforced. As well as my sense of how much she doesn't understand about the financial sector.

She began her typical rant by excoriating large US banks for not lending out the TARP money they had been "given." Never mind much has been repaid.

Warren then added the usual pundit's rant about small businesses. Small businesses, she insisted, were being hurt at the expense of larger businesses by the failure of those big, bad banks to lend to the bedrock of the US economy....blah blah blah....small businesses.

Several other guests on the CNBC set countered Warren on two issues. Bob Barbera, chief economist at ITG, noted that small businesses had been disproportionately hurt by the drop in real estate values and, thus, were in no position to borrow any more money. Another guest, perhaps Rich Bernstein, a former Merrill Lynch senior strategist, noted that there wasn't really any real loan demand by small business, just based on economic conditions of late 2008 through late 2009. Further, they were absolutely not hiring anyone.

Nobody on the panel offered another key piece of evidence, i.e., at Fed-induced ultra-low interest rates, how could any bank possibly justify, in hindsight, throwing money given them by the Treasury into risky, low-rate loans to small businesses?

If those banks charged appropriate, higher rates, they would no doubt by garroted by Warren at a later date for daring to profit unfairly on the gift of Federal largess. If they lost money on low-interest loans, they'd be lectured for more foolish lending, just like their original real estate finance excesses.

Warren would have none of the panel's contrary views, insisting she was correct.

Then someone asked if the FCIC was investigating the potential for securitizing small business loans.

I have to say, at this point, I nearly spit out my coffee from shock. What the hell is anyone doing wanting securitization of small business loans when we still are cleaning up the mess from subprime and Alt-A home loans and their securitized offspring?

Warren charged ahead, though, informing everyone that, gosh, small businesses are very unique and require a different kind of lending than simply marking up prime and opening a credit facility for, say, Boeing or Cisco. Only she didn't say it that elegantly. So they are difficult to package up and sell in securities.

Liz Warren is 61 years old, born in 1949, according to her bio. So in 1974-75, when, as a freshmant at Saint Louis University, I was learning the basics of corporate finance in Dr. Fred Yeager's Introduction to Finance 100 course, Warren would have, I guess, been in law school, or already practicing.

Over thirty years ago, I learned in Dr. Yeager's course that conventional business lending was a very qualitative affair. Back then, the standard Brigham & Weston text referred to the "five Cs" of credit: character, capacity to pay, collateral, capital and conditions.

Now, an excited Liz Warren informs CNBC's viewers all about how individualistic is the nature of each small business loan.

Give me a break!

Hundreds of thousands of trained business school graduates working in the financial services sector already know this, Liz. You're only about, what, a few decades late to the party?

Why is it that the head of Congress' vaunted TARP Oversight panel is a liberal lawyer with obviously no practical understanding of finance? How useful are her 'insights' ever going to be? She doesn't even understand how the business works.

To be fair, for all of us, regardless of political persuasion, the challenge of staffing a Congressionally-appointed, outside panel is going to be finding informed but objective members.

The informed experts could well have an industry bias. Financial academics are a potential hybrid which could hold promise, but even some of the more revered theoreticians aren't all that steeped in the reality of fast-moving markets and real instruments, like CDOs.

The more objective candidates from outside the sector, like Warren, simply look clueless and naive. Further, their conclusions are likely to be wrong because they don't fully understand the issues with which they are charged to resolve.

It's hard for me to take seriously anything Warren says from her soapbox perch. When it's an informed comment, which is rare, it's not news. When it's not informed, Warren is just wrong.

Wednesday, May 12, 2010

The FCC Puts US Communications Technology Growth In Jeopardy

Nothing scares off investment capital like uncertainty. Whether measured by higher required rates of return or lower 'certainty equivalents,' uncertainty of return of capital makes projects less attractive.

Thus, the FCC's recent second attempt to regulate the internet is likely to slow or halt growth of that important communications tool and the economic benefits it would otherwise create.

Having watched Congress rebuff 'net neutrality' earlier this year, the FCC is trying again by unilaterally declaring that the internet may be regulated under the 1996 Telecommunications Act.

Noting the year of that act, one already realizes that the Act came just at the dawn of the internet's rapid growth in the late 1990s. The notorious "dot com" bubble.

So, not only did the Act not even foresee developments only a few years hence, but, now, over ten years later, it is most assuredly out of date, drafted, as it was, with the intent of regulating telephony.

Having worked for ATT years ago, in the early years of my business career, I can attest that the last ten years of growth of internet-related services is beyond all comparison to growth in telephony for the last thirty. Once telephony went to wireless, the rest of the changes were of magnitude, more than type.

Other than that, companies like Verizon have only introduced innovation by expanding outside of voice communications to look more like cable companies.

The FCC's unilateral power play is sure to have very negative consequences for one vibrant sector of the US economy.

Think of how many new initiatives, perhaps along the lines of Facebook, Google, or the thousands of apps for iPhones, will now be choked off by uncertain returns to capital as the FCC clouds the business operating environment for such services.

It's bad enough that our government uses taxpayer money to prop up old, antiquated and unproductive sectors like auto manufacture. To now turn to the other end of the spectrum and move to limit growth in new economic sectors will surely lead to a moribund US economy in the not too distant future.

Tuesday, May 11, 2010

Rick Santelli v. Paul Kanjorski

If you enjoy Rick Santelli, here's a clip of the exchange between him and this morning's CNBC guest host Rep. Paul Kanjorski, about whom I wrote here earlier today. Once again, thanks to a reader's search, this time for the video of the exchange, I was alerted to go find it.

In my earlier post, I wrote, in part,

"And, as I'm writing this, Kanjorski is lampooning voters who blame CRAs, Fannie and Freddie for causing much of the recent mortgage-backed financial meltdown. That, alone, should tell you that Kanjorski is living in an alternative universe where Congress has never done anything to damage our financial system."

This exchange occurred right after I wrote that.....

More Reflections On The ECB Greek Bailout

The big news in US equity markets this week continues to be the weekend announcement of the ECB bailout of Greece and, prospectively, Spain and Portugal.

The US pre-market open S&P futures were down to 1141 at one point this morning, from yesterday's close of nearly 1160. As of 10AM, the S&P index is around 1154, still down slightly.

Already, before the open of the US equity markets, pundits were warning of the potential risks and negative consequences, for equities, of the ECB's bailout.

One, of course, is that the Euro isn't a reserve currency. Thus, the relatively benign effects, so far, on the dollar, of the late-2008 massive printing and borrowing of dollars, may not accrue to the Euro or the Eurozone economies.

Second, the austerity measures called for in the bailout will probably result in real economic slowing for the Eurozone economies. That isn't good for short term GDP growth and, by extension, will affect those companies doing much business there.

Third, there's some non-trivial political uncertainty accompanying the ECB actions. The British still don't know the shape of their new government, in the wake of Brown's defeat. And Angela Merkel's party lost an important state election, which will result in her party's loss of control of Germany's upper legislative chamber. Simply put, it's too early to tell if most Germans really approve of using their economic strength and savings to pay off the debts of their relatively less hard-working and less prudent Greek Euro-neighbors.

And Spain is still to come.

All of which means that, after the predictable one-day jump in equities, the longer-term consequences of the ECB action may be quite different.

According to my measures, equity market volatility has not yet abated, and returns are by no means assuredly back to a long, steady march upwards. Seeing just what sort of market dynamics predominate in the days and weeks ahead is still unclear.

Who's Minding Our Markets?

This morning, CNBC's morning program is still beating a loud drum regarding the sudden drop in equity prices on Thursday afternoon. To facilitate the process, they invited Pennsylvania Democrat Representative Paul Kanjorski to be a guest host. Kanjorski is a member of the House Financial Services Committee, thus, his attraction for CNBC. Talk about one hand washing the other......

It's ironic for CNBC to have Kanjorski guest host to discuss Thursday's alleged trading scandal, because Kanjorski is actually a scandal-tainted legislator, himself. I found this out due to an accident a month or so ago. At the time, I had written a post on one of my blogs involving Kanjorski. Reading through my Sitemeter details of visits, I found that one reader had found my post from a search for 'Kanjorski scandal.'

Sure enough, Kanjorski, a Representative since 1984, has a big earmarking scandal in his past apparently involving using millions of dollars of federal money to enrich his family. Wasn't Kanjorski's regionally-close, Pennsylvania Democratic House colleague John Murtha, also known for excessive, often self-serving earmarks, too? Must be something in the water up in Northeast Pennsylvania.

Anyway, knowing this makes Kanjorski's earnest-looking, solemn attitude regarding finding and punishing equity market traders and 'insiders' much more of a joke. After all, it seems Kanjorski is a veteran 'insider' himself.

But, back to the issue. Kanjorski has been spewing all manner of hot air this morning, no doubt to make ideal campaign sound bites and video clips. Particularly, he went to great lengths to extol the current financial market regulatory personnel as just the best "in 25 years." Really. Honestly.

No matter that a Democratic administration staffed those agencies. And Democratically-controlled committees are taking a 'hands off' approach with Mary Shapiro in the wake of the incident.

And, as I'm writing this, Kanjorski is lampooning voters who blame CRAs, Fannie and Freddie for causing much of the recent mortgage-backed financial meltdown. That, alone, should tell you that Kanjorski is living in an alternative universe where Congress has never done anything to damage our financial system.

By now, though, it's pretty clear what happened on Thursday. The NYSE used its human specialists to engage a trading slowdown. Claiming that a two minute pause in trading does not constitute 'stepping away' from the market, the NYSE chief and his colleagues and defenders all claim they were merely bringing 'order' to markets run amok from too much electronics.

When the NYSE's specialists essentially took a hike on selected equities, the order flow immediately went to the NASDAQ, which, because of the NYSE's absence, had to order match in a less-liquid market. With more sell orders than buy orders, the 'real,' instant market prices fell.

I really don't think what happened is much more complicated than that.

You can conjure up all manner of conspiracy theories, but, in reality, it does seem to be a case of the regulatory authorities allowing for one exchange to engage equity-specific trading halts, while allowing another exchange to trade through.

What do you think will happen in cases where this differential treatment of individual equities occurs? In down markets, prices will gap down. If Thursday had been an up day, prices would have been skipping up discontinuously, and buyers would have complained about missing bids and being filled at what they considered to be ridiculously high prices.

The truth is, the definition of a "market" involves several dimensions. No one buyer or seller can set prices. Prices must be continuous. Price discovery has to be ubiquitous.

If any of these tenets are violated, it's not a 'market' anymore. Therefore, 'market' orders aren't really going to have their desired effect.

Funny how it's become pretty obvious that the cause of Thursday's ultra-sharp sell-off is a regulatory mistake of keeping exchanges in step with each other. But, because it was a regulatory lapse, the party in power is looking elsewhere for someone to blame.

Monday, May 10, 2010

The ECB Bailout

The business media airwaves are still filled with arguments about the cause of the Thursday elevator-shaft ride of US equity markets late in the afternoon.

No real news there. This morning's CNBC "debate" with the usual regulatory suspects, including Ned Reilly, Elizabeth Nowicki and Jacob Frenkel, got nowhere. Ms. Nowicki was decidedly more informed and credible on this topic than the last one on which I saw her opine on CNBC.

Together, though, the various pundits shed no real new light on the existing gulf between the NYSE human, stock-specific 'circuit breakers,' and the NASDAQ's lack of human intervention. It doesn't take a genius to realize that if one exchange, with most of the liquidity, takes "breaks" at its own discretion, while other markets trade on, then discontinuities are going to occur. Nobody has yet provided justification for breaking those NASDAQ trades. And there are none. If you elected to trade during a market downdraft, you should get that for which you asked. The arbitrary trade-breaking after the fact is unconscionable. No matter that the NYSE, which caused the problem, is finger-pointing at the NASDAQ for breaking trades.

At this point, you can assail Congress and the SEC for allowing this situation to even occur.

But the real news is the spectacular rebound of the S&P, up to 1155 in pre-trading futures at 9:20, on the strength of the ECB bailout of the Euro and all the potential Eurozone countries requiring help.

The US equities market will no doubt open on an upward tear for the morning.

Of course, the longer term consequences of the ECB $1T bailout fund is much more sobering, and hardly cause for this bounce.

First, the ECB isn't the Fed. Europe's economy isn't the same as the US economy.

Just where is the value to be found underpinning this sudden materialization of one trillion Euros?

Sure, we hear that there will be Euro-quantitative easing, just like in the US in late 2008. Greek bonds are trading up and spreads are down.

Everyone feels that the bottom has been put in, once again, by a financial regulatory authority.


Where is all this money actually coming from? Is it real, or just a printed, time-shifted value play by sovereign governments, and their agents, to cover sovereign shortfalls for a few years?

By the way, in case you hadn't noticed, between the IMF and the Fed's own promise to join the party on quantitative easing, this means the US sovereign balance sheet, already stuffed with subprime mortgages and other financial toxic waste, is going to get some more.

Funny, weren't we just debating how overstretched the US balance sheet is? How much debt we'e created and excess money we've printed?

Maybe investor confidence has returned relative to last Thursday and Friday, which, together, accounted for a loss of 4.7% on the S&P.

Can it last?

Already this morning, before the open, many pundits were looking to today's close and warning of a false rally and more equity declines ahead.