Friday, January 28, 2011

Recalling Basic Economics

I had an interesting conversation at my fitness club the other day with an acquaintance who is in the accounting/consulting field. We were discussing the current economic situation, and he asked me, to paraphrase,

'What do you think of the notion being circulated that Bernanke is pursuing QE2 and low rates in order to drive equity market prices up, to make businesses and investors feel better, so to better spark a real economic recovery?'

I replied that, if true, it's a misguided approach. I noted that, for those who recall their basic economics, we're now in a classic Keynesian liquidity trap. Rates aren't driving investment and, if anything, as I've written in some prior posts, are likely to fund marginal, unwise projects, because of the ultra-low rates and their inability to include adequate risk pricing.

We discussed the wasted so-called stimulus spending and added deficits, neither of which have really affected the unemployment rate.

It was then that, in answer to my colleague's question concerning what should have been done, I repeated my belief that banks and other firms, e.g., GM, contrary to auto czar Rattner's contentions, in need of capital should have been allowed to properly enter a formal Chapter 11 process. Profitable operations would have been protected and either spun off or sold. Unprofitable operations would have been liquidated, which is what Citigroup and GM subsequently did. Merging failed banks is no longer a major issue, given FDIC deposit insurance. This myth that large-scale bank failures cripple the economy persist only so long as government and industry officials allow it to perpetuate.

Once you've insured depositors, what's the risk? Loans are transferred or sold. Operations are transferred and merged. Shareholders lose, which is appropriate. Bondholders line up in order of seniority, according to bankruptcy law.

Where's the problem? We're overbanked in the US as it is.

Then I touched on the inequity of government's enforcement of a mortgage foreclosure moratorium. How unfair it has been for existing owners to be given breaks, while equally-deserving buyers at the true, lower market-clearing housing prices are denied the opportunity to do so. Which only delays a true housing recovery.

Anyway, my colleague agreed with my suggestions. But, further, I recalled for both of us some more basic economics, i.e., you can't have recoveries without real recessions. You can't have the release of resources- capital and labor- without the liquidation of failed firms. If firms aren't allowed to fail, resources don't experience the necessary Schumpeterian recycling into new uses.

We can't experience robust economic recoveries without full economic recessions. Despite politically-originated attempts to chop off the downside phases of economic cycles, we can't always be in an expansion. Real capitalistic economies have expansions and contractions.

King Canute couldn't stem the tides, and our government can't rewrite economic laws to eliminate periods of economic contraction.

Disappointment On CNBC This Morning

It was with great disappointment that I learned that Steve Rattner would be a guest host on CNBC this morning.

Here's some information pertaining to Rattner's recent settling of an SEC charge by paying a $6.2MM fine and agreeing to a suspension from activity involving broker/dealers or investment advisers for two years.

Why is CNBC even going near this guy? Is this the best they can do? A guy who has pretty clearly been caught violating SEC regs in a pay-to-play scheme involving pension fund management?

I turned to Fox News for the duration, rather than watch this egotistical guest host. The few words I caught emanating from him were the usual scare stories about how if he hadn't saved GM, the US would have sunk into another Depression and 2-3 million more jobs would have been lost.

Please, spare me this unsubstantiated drivel.

Thursday, January 27, 2011

GE, Morgan Stanley & Sustainable Growth

Recent Wall Street Journal articles reported improved performances for GE and Morgan Stanley. On these bases, pundits are now sending the equities of the firms skyward, as seen in the nearby price chart for the two firms and the S&P500 Index.

GE's revenues for the quarter were up 51% from the year-earlier period. The Journal piece noted that the firm,

"posted its first revenue increase in more than two years and its highest level of new orders since 2007."

Morgan Stanley reported a 35% rise in profits versus the fourth quarter of 2009. However, one observer was quoted as saying,

"They need consistent revenue growth. That's where they've let investors down."

Ah, yes. Consistency.

Well, here's a look at the two firms' price charts, along with the S&P500, over the past five years.

Looks quite a bit different, doesn't it?

Over that period, the Index easily outperformed the two firms.

What do you suppose are the chances that both firms have suddenly changed the character of their enterprises? That they will continue to consistently report such revenue and income changes in the year ahead?

My guess is that the 51% GE sales growth is a one-time event. Morgan Stanley was lauded as having outperformed Goldman Sachs for the period, but one wonders how likely that will be in the next year.

Elsewhere, some pundits are calling for GE's Immelt to step down from his CEO job if he is to lead the government's new jobs creation initiative. They note that Immelt misled the firm to require a multi-billion dollar capital infusion from the federal government, suggesting he's not exactly a managerial icon.

A Wall Street Journal lead staff editorial on Wednesday charitably excused his mismanagement of the GE Capital unit for seven years, from 2001-08. The piece firmly placed the outsized reliance of the industrial conglomerate on outgoing CEO Jack Welch, but failed to properly hold Immelt accountable for continuing to rely on financial services revenues and incomes to prop up the troubled firm.

Consistency is a curious quality, because you can observe it over time. It isn't created instantaneously. Thus, recent performances notwithstanding, I doubt either Morgan Stanley or GE has suddenly changed its striped and become a new company in the past quarter, or even 12 months.

Wednesday, January 26, 2011

CNBC's Incomplete Economics Lesson

Monday's Wall Street Journal contained a front page headline regarding global commodity inflation. This evidently spurred CNBC to do some in-depth contrarian segments alleging that commodity inflation won't really be all that bad.

Tasked with this effort was the network's under-equipped economic's report Steve Liesman. Using a single commodity, wheat, and a single product, bread, the hapless reporter attempted to track the effects on bread prices for a given increase in wheat prices. Further, he confided that he'd checked with a Harvard economist who told him that component cost increases were more likely to be passed along in highly competitive product markets.

Funny thing was, nowhere did the economically untrained Liesman utter the words inelastic or elastic. As in demand.

Most economists would differentiate the inflationary impacts of component costs according to the demand elasticity of the good. Goods with highly inelastic demands will tend to accommodate price increases without offsetting declines in volume, while goods with elastic demands will not.

But, of course, Liesman, not having an economics background, didn't bother with the fundamental analyses taught in basic economics courses.

What occurred to me was to ask questions like:

-Which commodities are components of food products with what shares of dollar volume of US food spending?
-Which of those products tend to have inelastic demands? Elastic demands?
-What would this mix of inflating commodities' share of consumer food spending by products, and the relevant demand elasticities, suggest for the average food price inflation that US consumers may expect in the year ahead?

None of that was forthcoming from Liesman. Just a pithy little example of wheat and bread costs, without a word concerning demand elasticities. Yet another reason to only listen for news on CNBC, and skip the network's home-grown economic 'analysis.'

Tuesday, January 25, 2011

Airlines Bid To Reverse Commoditization

Holman Jenkins, Jr., wrote a very good piece this past weekend in the Wall Street Journal concerning airlines' use of the internet to try to reverse the commoditization of their service.

In particular, he points out how American, Bob Crandall's old airline, withdrew its listings from some online intermediators, including Orbitz and Expedia. Southwest and Jet Blue have blocked access by intermediaries to their ticketing, as well. Six other airlines are working with AA to establish Open Axis to wrest control of ticketing and related extras back from the brokers.

Jenkins notes,

"Too, the carriers have shrewdly held back most of their ancillary goodies, allowing them to be sold only at their own websites, ticket kiosks or on the plane itself. Because the booking networks fear they will become irrelevant if they can't display the optional services along with basic fares and schedules, airlines see a ripe moment to negotiate a new business model with the online ticket sellers.

The bottom line for travelers, though, is not nearly as profound as some make out. The shopping experience is likely to change a bit, with more targeted freebies, upgrades and "upsells" aimed at individual passengers by airlines hoping to nourish customer loyalty. But the idea (or hope) that airlines will now be able to mint anticompetitive fares is unrealistic."

Fair enough, no homonym pun intended. But Jenkins misses the larger picture, which is simply the only swing of the strategic relationship control pendulum back towards airlines in decades. Crandall said, at the end of this career with AA, that, given a choice, he'd prefer to run Sabre, the spun off ticketing business, because it was much more profitable.

With one URL pretty much as good and accessible as the next, why shouldn't airlines begin to foster customer loyalty by tying more services and benefits to patronage, albeit in legally-defensible ways? Its' the sine qua non of marketing, i.e., get away from price competition and focus the customer on the total product/service experience.

No, it doesn't mean complete price freedom for the airlines. At some point, price ranges will become too great to sustain, but some latitude will be available as flyers are drawn into loyalty webs and, with the less pleasant environment for commercial flight, the ability to enjoy better overall treatment while traveling in exchange for choosing a preferred air carrier.

Sounds like a partial return to the 1960s that my late father knew, only with immediate mobile access.

Monday, January 24, 2011

GE's Immelt Gets A Political Sop for His Support

Friday was a big day for GE's hapless CEO, Jeff Immelt.

All his political ass-kissing and support for the administration's uneconomic green, alternative energy initiatives paid off in his being named as head of a new jobs & competitiveness council.

Funny, isn't it, how a guy who ran his company so badly that it had to be rescued by the Fed's cheap funding, with no questions asked, is rewarded with a job telling others how to do what he couldn't, i.e., compete effectively?

Because Immelt would have run GE out of business, but for a generous federal government. It's difficult to figure out just what he's supposed to know about competition that he could teach anyone else.

Wouldn't it have made more sense, provided more inspiration, for the administration to have selected the CEO of a firm that didn't have to be bailed out in order to avoid bankruptcy?

Take a look at the nearby price chart of GE and the S&P500 Index. From late 2001, when Immelt took the helm of GE, until now, the company's relative price to the index has fallen precipitously. Even Friday's earnings announcement and price rise couldn't save nearly a decade of mediocre misleadership by Immelt. At GE's recent 2009 lows, Immelt had destroyed cumulative value stretching back 13 years, to 1996. That takes talent!

Meanwhile, with NBC/Universal being taken over, for managerial purposes, next week, Immelt was treated to one last softball interview on his company's CNBC network this afternoon. What will happen when Immelt doesn't have the power to hire and fire in order to command such creampuff scenes?