Friday, October 29, 2010

GM's Sweetheart Deal From Uncle Sam

I was watching CNBC yesterday afternoon when its automotive reporter, Phil Lebeau, appeared with a breathtaking, special update on the delay of GM's formal unveiling of its much-delayed Volt electric car.

After explaining that the delay is due to all of GM's senior executives being out on a road show to sell their imminent IPO, Lebeau let drop that the company will have repaid about $21B to the government, assuming a successful equity sale.

He then went on to note that the total amount of federal money pumped into the failed car maker is about $50B, but it's not realistic to expect all of that to be recouped.

Really, Phil? Wow, where can I get a deal like that?

Wait...I know....I should have bought a house I couldn't afford, not paid the mortgage, and gotten a mortgage modification!

Silly me.

It's the new culture of debt repudiation. Forget mere excess or conspicuous consumption. We're way beyond that now.

Consider how many other US companies have recently been given roughly $30B of capital, free of charge. No interest, no need to repay it. It's a gift.

Does anyone else think this is crazy and, ultimately seriously damaging to our economic system? Or am I alone in this belief?

On Global Central Economic Planning & Currency Management

University of Chicago finance professor John Cochrane wrote a rather scorching editorial this past Tuesday in the Wall Street Journal entitled Geithner's Global Central Planning. He begins with a simple, scathing assessment of the recent G-20 finance ministers' conference,

"Economists are full of bad ideas. Terrible ideas seem to emerge when the gurus get together to talk about coordinating their bad ideas. Last week's public letter from Treasury Secretary Tim Geithner to the G-20 finance ministers is a great example."

To begin to provide detail, he refers to language in a Geithner proposal emanating from the conference,

"Mr. Geithner starts with a dramatic proposal: "G-20 countries should commit to undertake policies consistent with reducing external imbalances below a specified share of GDP [later reported to be 4%] over the next few years." "

For some perspective as to ill-informed Geithner's idea is, Cochrane provides this classic example,

"Since when is every trade surplus or deficit an "external imbalance" in need of correction? It makes sense for a country that has good investment prospects to import a lot of goods, run trade deficits, and borrow money. Years later, the country puts the resulting products on boats to pay the lenders back. The U.S. borrowed abroad to finance our railroads in the 19th century and ran surpluses when Europe was rebuilding after World War II. Were these "imbalances"?"

Cochrane makes a very good point. How is it that Geithner is so skilled at judging what's an imbalance needing correction, versus a natural trade flow of capital and goods?

Then he considers the very real current situation of the US and China,

"Or consider a country (say, China) with a lot of middle-aged workers who need to save for retirement. It makes perfect sense for them to put stuff on boats and send it to a second country (say, the United States) whose people want to consume the goods. The people in the first country invest their earnings, say, by buying the bonds issued by the second country. And as they retire, they cash in the bonds and buy goods flowing the other way.

Do these and similar stories exactly account for current trade patterns? I don't know. But nobody else does, either. In particular, the army of economists in the basements of the International Monetary Fund (IMF) has no clue exactly how much each country should be saving, or where the best untapped global investment opportunities are around the world—including whether trade patterns are "normal" or "imbalanced." "

Just so. Cochrane continues by turning to Geithner's new idea,

"So what policies would Mr. Geithner have countries undertake to bring economies around the world into his idea of better balance? He says that G-20 "countries running persistent deficits"—that's the U.S.—"should boost national savings by adopting credible medium-term fiscal targets consistent with sustainable debt levels."

So Mr. Geithner knows that trade surpluses in the end come down to saving and investment. And he knows that in the U.S. people are trying to save right now. Our government is undoing their efforts with massive fiscal deficits. Mr. Geithner recognizes that most of the trade "imbalance" comes down to a big fat fiscal imbalance centered in Washington, D.C. But there's the catch. "Medium term" means "not now" and "not long-run entitlements." "Target" means "promises." Even if a target would make a difference, who believes in targets from our government? We don't know what the rate of taxation will be in three months!

Mr. Geithner goes on to say that "countries running persistent deficits" should "strengthen export performance," but he doesn't say how, or what other "performance" we should weaken to get it. Is this a code word for export subsidies, devaluation and industrial policy, and a plea that the rest of the world should let us get away with it?

His advice to the other G-20 countries, those "with persistent surpluses," is that they "should undertake structural, fiscal, and exchange rate policies to boost domestic sources of growth and support global demand." In particular, "G-20 emerging market countries with significantly undervalued currencies and adequate precautionary reserves''—have you figured out this means China?—"need to allow their exchange rates to adjust fully over time to levels consistent with economic fundamentals."

He argues for a brave new system, coordinated by the IMF, of international discretionary currency interventions: "G-20 advanced countries will work to ensure against excessive volatility and disorderly movements in exchange rates.""

You can see the problems already, can't you? None of this is reducible to practical, believable policies. And, even if it were, it's economic central planning on a grand, i.e., international scale. Anybody remember how that idea worked out for Russia during the last century?

Without a doubt the funniest passage in Cochrane's piece is also the most sobering in terms of the prospect of economic conflict between the US and China,

"What's the right policy toward China? They put a few trillion dollars worth of stuff on boats and sent it to us in exchange for U.S. government bonds. Those bonds lost a lot of value when the dollar fell relative to the euro and other currencies. Then they put more stuff on boats and took in ever more dubious debt in exchange. We're in the process of devaluing again. The Chinese government's accumulation of U.S. debt represents a tragic investment decision, not a currency-manipulation effort. The right policy is flowers and chocolates, or at least a polite thank-you note."

And we wonder why the Chinese are exploring more diversified baskets of assets into which to trade their depreciating US dollars?

Cochrane sums up Geithner's loopy idea with this concluding passage,

"This is all as fuzzy as it seems. Markets and exchange rates are not always right. But it is a pipe dream that busybodies at the IMF can find "imbalances," properly diagnose "overvalued" exchange rates, then "coordinate" structural, fiscal and exchange rate policies to "facilitate an orderly rebalancing of global demand," especially using "medium-term targets" rather than concrete actions. The German economics minister, Rainer BrĂ¼derle, called this "planned economy thinking." He was being generous. Planners have a clearer idea of what they are doing. "

The scary part for me is that this isn't some private economic white paper circulated among Geithner's staff. This crazy idea is out in public, proposed to the G-20, as if it's actually workable, or even desirable.

Thursday, October 28, 2010

Ray Ozzie's Parting Shot At Microsoft

I haven't yet written about Ray Ozzie's departure from Microsoft. Somehow, I missed the October 19 article in the Wall Street Journal. However, I think it's a watershed event for Microsoft, and not a good one.

The end of the piece states something I think needs to be clear upfront,

"Mr. Ozzie is a legendary technologist in the computer industry, whom Mr. Gates once called "one of the top five programmers in the universe." "

I can't recall all of Ozzie's successes, and don't feel like Googling his bio right now. Suffice to say, he's legendary, and for good reason. Thus, his role as Chief Software Architect should have made a huge difference, in a good way, for Microsoft. Instead, here are added passages from the Journal article,
"According to one person familiar with the situation, Mr. Ozzie decided to quit Microsoft because "he has accomplished what he wanted to accomplish" at the company. His major contribution to Microsoft was in helping it shift the company to focus on cloud computing, in which more computing chores move into data centers rather than being executed on PCs operated by users.

But several current and former Microsoft executives say Mr. Ozzie failed to exert the kind of leadership many of them hoped for after he took over the title of chief software architect from Mr. Gates in 2008. These people noted that Mr. Ozzie did far less public speaking and other similar high-profile duties than Mr. Gates did, especially in his latter years at the company. Those kind of public ambassadorial duties have long played an important role at influencing employees within Microsoft itself, these people said.

Mr. Ozzie also clashed with other executives at the company, particularly Steven Sinofsky, now the president of Microsoft's Windows division, these people added. Mr. Ozzie appeared to lose a key battle with Mr. Sinofsky two years ago when control of Live Mesh, a data synchronization technology developed by Mr. Ozzie's team, shifted to the Windows organization at the company.

About a year ago, oversight of another initiative Mr. Ozzie was involved in, its Windows Azure cloud computing technology, moved to the server and tools business run by the division's president, Bob Muglia.

Mr. Ballmer in his email said that the role of chief software architect was "unique" at Microsoft and he won't fill the position after Mr. Ozzie's departure. A Microsoft spokeswoman declined to make Mr. Ozzie available for an interview or comment beyond the email."

Given Microsoft's lost decade of total return performance, as contrasted with Ozzie's accomplishments, I think one would tend to discount Microsoft's version and give Ozzie the benefit of the doubt for what went wrong at Microsoft.

It sounds believable that the internal squabbles at the firm derailed much of what Ozzie had hoped to do. One can only guess at what was lost by giving Live Mesh and Azure to company functionaries. After all, you have to recall that the crew that Ozzie found at Microsoft when he arrived in 2005 is responsible for the firm's total return performance since then. The first nearby chart shows that, when compared to the S&P500 Index, the technology giant comes up, at  best, about the same.

The next chart shows the same two series for a much longer timeframe. In that chart, you can discern that Microsoft has actually lost value over the past decade. More so than the index.

So I wouldn't put a lot of blame for what didn't work on Ozzie. I suspect it's more like a software wizard being sucked into the large, slow-moving blob that has become Microsoft.

His warnings to the firm, as he left, sound on target to me. What I heard on CNBC the other day was that Ozzie predicted that millions of new future users will access the internet and software via cell phones and tablets, while Microsoft, clinging to PC and server operating systems, will lose out on controlling and profiting from that future growth.

Reviewing Ozzie's track record, versus Ballmer's, this isn't a very hard call to make in favor of the former.

Wednesday, October 27, 2010

Tyler Mathisen's Stupidity Is Showing On CNBC Today

Tyler Mathisen managed to demonstrate his incredibly stupidity and failure to grasp the difference between trading and investing this afternoon on CNBC.

It's about 1:40PM as I write this, and Ol' Ty just made a monkey out of himself.

Beginning an on-site report from a conference in Boston, he sputtered, to paraphrase,

'With all these sophisticated, fast trading algorithms, a staid old mutual fund doesn't stand a chance!'

For a guy who has ostensibly been reporting on financial markets for years, Ol' Ty really showed his lack of knowledge in that statement.

One thing which needs to be understood is that no matter how fast and complex the methods that trading desks use will become, they don't have appreciable effects on investments which are not fast-trading strategies.

It's not to say that buy-and-hold for years still works. But failure to buy an equity at the same price as some institutional trader, and paying a few cents more, won't matter much over months.

Of course, if you're Ol' Ty, and work for a network, CNBC, which insists on characterizing every investment decision with the nearly-trademarked phrase,

"So, what's the trade?!"

you wouldn't realize this.

It's bad enough that Ol' Ty can no longer distinguish between institutional trading and retail investing. It's worse when his ignorance and stupidity cause retail investors to misunderstand the markets and panic.

Good job, Ty. Looks like you've earned your money today.

Will Auto Makers Really Lead A Jobs Recovery?

I happened to catch my old friend, auto journalist Paul Ingrassia, on CNBC yesterday afternoon. He was debating, with several other pundits, including Bob Lutz, the role of Detroit's auto makers in sparking a US economic recovery.

From what I gathered, Paul was arguing that the best chance the economy has of creating jobs is for the three US-based auto makers to grow smartly in the years ahead. Essentially, he and the other guests, including, I think, an economist or two, some industry analyst, and the irrepressible Lutz, all agreed that we must pin our hopes for economic rescue on the auto sector.


Are these people crazy?

Autos are pretty much commodities. Sure, one or two models are special and command price premiums. But, generally speaking, as evidenced in China, entry into the auto sector is pretty easy. Auto makers are, in fact, auto designers and assemblers. It's not like River Rouge in 1920 anymore.

Plus, last time I looked, most economist bow to the Small Business God for job-creating growth. Ford, GM and Chrysler, wounded as they are, aren't small businesses. Except maybe in the 'small-minded' sense.

So how do you resolve this paradox? Three poorly-run large, old-industry companies, two of which should have died a few years ago, are going to magically lift America out of its recession? And magically create millions of jobs?

Sure, an uptick of auto sales gives these three companies their share. They hire a few people, and, indirectly, their orders for parts and materials spark hiring at their suppliers. I get it.

But that's nowhere near the number of jobs lost, plus population growth, since the official beginning of the recession in late 2007, is it?

Don't we usually hope and expect job growth from smaller, newer, more innovative firms than the erstwhile Big Three? Something more related to new applications of technology? Perhaps more in the vein of the next Google, Genentech, etc?

I respect Paul Ingrassia immensely for his knowledge of the inner workings of the auto industry. But I must confess, I missed the part where he became a respected macroeconomist by correctly explaining and predicting hiring in a large, complex economy as it exits a recession. And I guess I missed Bob Lutz having those credentials, too.

Tuesday, October 26, 2010

Joseph Stiglitz On Quantitative Easing 2

Nobel Laureate and Columbia University liberal economist Joseph Stiglitz wrote a fairly scathing editorial concerning QE2. He begins his piece thus,

"The Federal Reserve, having done so much to create the problems in which the economy is now mired, having mistakenly thought that even after the housing bubble burst the problems were contained, and having underestimated the severity of the problem, now wants to make a contribution to preventing the economy from sinking into a Japanese-style malaise. How? As Chairman Ben Bernanke announced last week, through large-scale purchases of U.S. Treasurys—called quantitative easing, or QE."

Stiglitz then lists three problems he sees with QE2:

"The problem is that, with interest rates already near zero, there is little the Fed can do to restart the economy—and doing the wrong thing can do considerable damage. In 2001, (then) record-low interest rates didn't reignite investment in plant and equipment. They did, however, replace the tech bubble with an even more dangerous housing bubble. We are now dealing with the legacy of that bubble, with excess capacity in real estate and excess leverage in households.

Yet even if the banks were willing and able to lend, lending to SMEs is typically collateral-based, and the value of the most common form of collateral, real estate, has fallen 30% to 40%. No wonder then that credit availability is so constrained. But QE in the form of buying U.S. Treasurys is not likely to affect this much. It will have some effect in lowering mortgage rates, and lower mortgage rates will put a little more money into people's pockets. Higher real-estate prices may also allow some SMEs to borrow more. But these effects, though positive, are likely to be small—so small as to make a barely perceptible difference in America's persistent unemployment.

There is another downside risk: QE may not even succeed in lowering interest rates, or lowering them very much. Given the magnitude of excess capacity, there is little risk of inflation today. But if the inflation hawks come to believe that the risk of future inflation is real, then they'll believe that short-term interest rates will rise. This will mean that long-term interest rates, even now, may actually rise, in spite of the massive Fed intervention, because long-term interest rates are based on expectations of future short-term interest rates.

QE poses a third risk: The bursting of the bond market bubble that the Fed is seeking to develop—the sequel to the tech and housing bubbles—will clearly have adverse effects on the economy, as we should have learned by now."

Stiglitz seems quite complete in his cataloging the problems with QE2 will do. It can't really ignite economic growth, due to the so-called liquidity trap. It won't help the small- and medium-sized US businesses (SMEs), which have more need than large firms for financing. And it may cause a bubble in one of the last unbubbled parts of the financial sector- fixed income. And, he notes, it continues the international currency devaluation competition which can easily hurt the US more than it helps us.

He concludes with a brief restatement of his argument,

"The upside of QE is limited. The money simply won't go to where it's needed, and the wealth effects are too small. The downside is a risk of global volatility, a currency war, and a global financial market that is increasingly fragmented and distorted. If the U.S. wins the battle of competitive devaluation, it may prove to be a pyrrhic victory, as our gains come at the expense of others—including those to whom we hope to export."

I think his last point is extremely valid and largely ignored by the US Treasury and the Fed. Yet it's the one which anyone with a sense of economic history knows contributed greatly to the US economic damage during the Great Depression.

We'd better hope Stiglitz is wrong, but I doubt he is.

Monday, October 25, 2010

Pawn Stars, American Pickers & Efficient Markets

Back in May of this year, I wrote a post concerning a popular History Channel program, Pawn Stars. I find the program to be a great exposition of business model implemented by owners who grasp the model and typically stick to it.

Expanding on the historical theme of vintage items, the History Channel added a program called American Pickers. The two stars of that program are Iowa-based friends of middle-age who drive across America seeking vintage collectibles which they 'pick,' to resell through their shop.

Whereas the pawn brokers are essentially deal-takers, due to the nature of their walk-in business, the pickers are deal-makers who typically offer a price, and certainly negotiate.

Having watched a fair number of episodes in both series, I've come to wonder how long the American Pickers can sustain their program and their business model. Here's why.

The pawn brokers have their customers freely offer goods, usually because they want money for the items, and either don't want to, or can't pursue a narrower, more specialized market segment in which to maximize the value of their wares. Time and again, people bring valuable, vintage firearms or curios, only to be talked into values which are half of what Rick and his crew allege they will get for the item, after it ties up their working capital for months.

Every time I hear that line, I think to myself, if it were me, I'd be heading over to a specialty dealer, if I hadn't done that in the first place. Whenever the weapons experts makes an appearance to authentic some rifle, pistol or knife, I wonder why the seller hadn't just gone to directly that expert's shop? Well, obviously, those who do aren't on Pawn Stars. But it's surprising to me how much money is probably left on the table by naive sellers.

Still, everybody understands that the pawn brokers want a 50% margin, although they might not understand the pawn shop's ultimate sale price, of which they may receive half, will be lower than more specialized buyers.

The American Pickers, however, seem to be playing a more dangerous game. They cajole and push old collectors into parting with items on a largely unsolicited basis. Sometimes they are invited to visit and buy items, but, typically, they are pressing themselves on people who've collected massive amounts of what most people would call junk, begging to buy some of the items.

Quite often, they will drive a good bargain, as illustrated by the end-of-show tallies of the prices they paid for various antiques, and what they believe to be the market price they can realize. Sometimes they have markups of as much as 200%!

Now, if you are a collector who's been visited by the American Pickers, won't you want to watch the program to see yourself? Then, won't you become a little irritated when you see the pickers post so many items with margins in excess of 50%?

How likely is it that the pickers from Iowa can make it through three seasons without either losing their sources, or watching their margins shrink below 50%?

Would you sit still for these guys to manhandle you over various vintage items after you saw them publicly exclaim how they bought something really valuable off of you at some embarrassingly low price?

I think Pawn Stars is pretty entertaining and, due to the nature of its customer base, has at least a few more seasons to run. Its History Channel derivative series, American Restoration, starring the guy who does most of their vintage vending machine and similar merchandise restoration, will also likely have a non-toxic effect on his own business model. That guy, again, has a willing, walk-in clientele eager to realize value.

But the efficient markets being openly created and publicised by the pickers strike me as likely to undermine their own business model, and soon.

One only has to look to the markets for financial instruments to see how a little pricing information, made public, tends to rapidly collapse margins, as well as spawn competitors. All of which tends to ruin what was once a quiet, dark, smaller but more lucrative market in whatever items now become so publicly priced.