Friday, December 17, 2010

John Cochrane On The Euro & European Bank/Country Bailouts

Back on December 2nd, University of Chicago finance professor John Cochrane wrote a scintillating piece in the Wall Street Journal entitled 'Contagion' and Other Euro Myths.

I appreciate Cochrane's insightful, clear analyses of global economic and financial phenomena, and his recent piece is no exception.

I have long contended that much of the damage of the recent global financial sector crisis was a function of poor balance sheet management, evidenced by over-reliance on short-term borrowing, and Cochrane confirms this. He writes,

"The big culprit in all of this is short-term debt. There would be no crises if governments had issued long-term debt to match long-term plans to repay that debt.

Governments like to roll over short-term debt for exactly the same reasons Bear Stearns and Lehman Brothers did: It looks cheaper- at least until the crisis comes. But buying insurance is always expensive."

Cochrane correctly notes how short-term financing decisions are, in effect, a bet on an ability to rely on markets for continuing pricing and demand. Which is, of course, mistaken. Just like the pricing of mortgage-backed assets during the 2007-08 crisis, sovereign debt becomes problematic when issuers have assumed that markets will always have an appetite for roll-over issuances at affordable prices. In that crisis, you may recall, special-purpose SIVs backed by Citigroup had to be bailed out by the parent when they failed to roll over their short term borrowings due to the unexpected plunge in the assets held in the vehicles.

It's always the same. Funding decisions in low-rate environments veer dangerously short-term in nature, then become problematic as frequent trips to the market make the entity hostage to volatile investor sentiments.

Cochrane makes more excellent points in his piece. He notes that it would be better for Europe's national governments to directly and explicitly bail out their banks, rather than unnecessarily involve the currency union in bailout out an entire country. He further notes that either a blanket, "ironclad guarantee," or clear rejection of any bailout, would calm markets. By choosing the middle path, taking a case-by-case approach, the EU and IMF have magnified investor uncertainty and market volatility.

Finally, Cochrane draws obvious parallels between the European debt crisis and a looming potential one in the US. Specifically, he notes the financial instability of many US states, and the Fed's similarity to European banks in loading up on short-term financing, via QE2. And, similiarly to the ECB, which is buying suspect European sovereign debt, the Fed is buying questionably-valued paper, too.

Cochrane dispels the myth of contagion in Europe, replacing it with sound analysis of the true causes of the debacle, and better alternatives to resolve it.

Thursday, December 16, 2010

The Latest On GE & Its Failed CEO Immelt

The Wall Street Journal featured GE's Tuesday outlook in its Ahead of the Tape column earlier this week.

Paul Glader wrote of the company's failed CEO Jeff Immelt,

"And investors are cautious about his ability to reorient the company given questionable acquisitions in areas such as homeland security, commercial real estate and subprime mortgages during his first 10 years as chief executive."

Isn't it stunning to realize that GE's board has allowed Immelt to destroy shareholder value for so long without lifting a finger to punish or replace Immelt? The nearby price chart for GE and the S&P500 Index since 1960 illustrates how atrociously bad Immelt's performance has been.

He assumed command of the firm from Jack Welch in September, 2001. Simply by observing the distance that GE's blue line was above the index's green one at that time, compared with now, one sees how much of the firm's cumulative value built over 40 years has been eliminated through Immelt's incompetence.

Glader gives a few faint compliments to Immelt in an intervening paragraph, then closes with this cautionary note,

"Still, Mr. Immelt has a long road to travel to convince investors there is more value for them in holding GE's stable of disparate businesses than directly investing in growth markets themselves."

If you read my prior posts concerning Immelt's dismal performance, under that the Immelt label, you'll see how he's already reaped so many tens of millions in cash, plus the usual options, that Immelt really no longer can be assumed to rely on current or future GE compensation for his financial needs. He's now in it mostly to salvage his reputation, if that's even now possible.

Just viewing the magnitude of Immelt's disastrous tenure at GE, and the company's board's complacency, no investor should feel safe owning GE for anything other than a timing play. In my prior posts, I've argued that GE need no longer exist as an entity, being primarily the last of a once-common breed of conglomerates which no longer have a viable financial raison d'etre in a world of ultra-low equity trading costs.

As a long run equity investment, it's been among the worst an investor could choose since Immelt took over as CEO.

Wednesday, December 15, 2010

Going Easy On Citi's Vik Pandit

Last weekend, according to the Wall Street Journal, was the third anniversary of Vikram Pandit's elevation to CEO of the ailing US bank Citigroup.

The nearby price chart of large US banks Citi, Chase, BofA, Wells Fargo and Goldman Sachs illustrates how miserably Pandit's institution has performed under his leadership- if you can use that word.

While all of the banks have been more or less flat for a year, Pandit's Citi plunged far lower during 2008. If you don't blame him, saying he inherited that downdraft, then you certainly can't say he did any better than any other bank since then.

In fact, it would be fair to say he essentially did nothing, and Citi benefited from a sector-wide easing of pressure on share prices.

Remember, if you will, and as I noted in posts at the time, like this one nearly two years ago, that Pandit was very slow on the trigger to change anything at Citi,

"For Vik Pandit, it's too little, too late. As the price chart for Citigroup in yesterday's post illustrated, the bank has lost nearly 80% of its equity price in the past twelve months. Surely, as others have also noted, Pandit would have gotten much more value for his shareholders had he done this early last year, rather than now.

This is precisely the sort of long term damage that results from in-denial, head-in-the-sand approaches to the actual condition of a business. By insisting on keeping Citigroup's unwieldy, difficult-to-effectively-manage business assortment intact, Pandit simply destroyed more shareholder value faster than he would have otherwise.
For this, alone, it should be time for him to go. And what more convenient time for the board, than in tandem with the guy who mistakenly hired Pandit, Bob Rubin."

The Journal, and others, are all saying Pandit has "made it," "survived," etc. Truth is, Pandit was the wrong man for the job, hand-picked by the guy who helped ruin Citigroup, Bob Rubin.

It's far from clear, from the lack of any stories concerning what Pandit ever did during the past three years, that 99 other people couldn't have "achieved," and I use that word very, very loosely, the same results at Citi to date.

It never fails to amaze me that CEOs like Pandit get time and allowances for failure or lackluster performance to which their lieutenants would never be entitled.

Next, we'll be hearing that Jeff Immelt, GE's hapless CEO, will be judged a success because, after nearly a decade of failure to perform for shareholders, he might eke out a one-time outperformance of the S&P.

From my perspective, Pandit is simply another fortunate guy who was given a job in which he hasn't done much, therefore receiving accolades for not having noticeably done more damage. However, of all the banks in that chart, only Goldman Sachs decisively outperformed the S&P for the period. None of the other banks have CEOs who were capable of delivering market-beating performance for their shareholders. But I don't believe I've read that any of those CEOs returned their large compensation packages due to those failures.

Monday, December 13, 2010

A Farm Belt Asset Bubble?

Thursday's Wall Street Journal's lead staff editorial was entitled The Farm Belt Boom.

In yet another piece of a larger inflationary mosaic, the piece detailed the recent dramatic rises in land prices in the US farm belt. For example,

"The Federal Reserve Bank of Chicago reported in November that farmland values across the upper Midwest have jumped 10% since 2009. The year-over-year increases were even more dramatic in some states- 13% in Iowa, 11% in Indiana......Land fever is running rampant."

The Journal editorial credits global crop prices, but also adds this cautionary information,

"But the price surge has been so rapid and so broad across nearly all commodities.....that it can't merely be a function of new demand for specific grains.

This is where monetary policy comes in. As the greenback declines amid easy Fed policy, commodities rise in value. Farmland booms have typically coincided with periods of Fed easing, such as the 1970s and the late 1980s. It's no accident in our view that the latest commodity price surge began this summer when the Fed's talk about another round of quantitative easing began in earnest.

The problem comes if the boom is an artificial, money-fed bubble."

Which echoes my recent post discussing the risks to banks of the low-rate environment,

"One is, obviously, the greater probability of asset bubbles, against which loans may be made, in low-rate environments. We just saw this over the last seven years. Now rates continue to hover at record lows.

The second aspect involves risks versus rates. At ultra-low rates, projects of marginal merit appear to be worthwhile and may be funded. Yet they are precisely the most vulnerable loans, once rates begin to move upwards towards more normal, sustainable levels."

Somewhere, banks are lending to buyers of this expensive farmland. At some point, if and when this commodity price boom softens or turns south, the typical outcomes will obtain, i.e., over leveraged landowners, bankrupt farmers and insolvent banks holding worthless loans on now much-less valuable farmland.

As the Journal piece concludes,

"We hope Fed Chairman Ben Bernanke is right when he says asset bubbles and price spikes in commodities are nothing to worry about. Of course, he said the same thing about housing and oil in the last decade. We're not predicting an imminent bust, but we do hope someone at the Fed is watching prices grow in farm country."
Scary, isn't it? We're not two years on from the financial meltdown caused by an overheated mortgage banking sector, exacerbated by low rates, and the Fed is still biased toward keeping them ultra-low.