Friday, July 08, 2011

Chase's History Dogs Its Overseas Expansion Efforts

Wednesday's Wall Street Journal's Money & Investing section featured a piece on Chase's inability to significantly expand its international banking business while CEO Jamie Dimon has been running the firm.

According to the article, overseas revenues have fallen below 25% of the bank's total revenue, a level it was above in 2006 & 2007.

By contrast, zombie bank Citigroup "gets roughly twice as much revenue outside the U.S." as does Chase.

This comes as no surprise to me. Believe it or not, large US banks, once known as money center banks, had their long term international fortunes shaped by the Latin American debt crisis of the 1980s. At the time, only three US banks had international networks of significance- BofA, Citi and Chase.

When the Latin American defaults hit, Citibank took a then-staggering writedown of $3B, while Chase took a $1B loss. That's how big the difference in their overseas business volumes were even then.

The ultimate outcome of the crisis, however, was that BofA was forced to severely curtail its overseas network, while Chase and Citi, while maintaining theirs, no longer expanded them as aggressively.

There's no point in going into details concerning the next 25+ years of the management of those banks, but, suffice to say, Chase stalled under mediocre management while Citibank swung between tremendous earnings and business unit problems so severe that their entire St. Louis-based mortgage business was nearly shuttered by the feds in the 1990s.

Ironically, these hallmarks of the two remaining old-line money center banks- BofA being the name which NationsBank assumed when it took control of the old San Francisco-based outfit- remain pretty much intact.

Citigroup should have become insolvent and bought in pieces out of bankruptcy in 2008-09, so badly mismanaged were its risks in mortgage lending. Chase, on the other hand, was so moribund in moving into anything new that it never had time to become ensnared in that business' problems. Little wonder, then, as it bought Bear, Stearns and WaMu at fire-sale prices, generously allowed by the Fed and FDIC, that its domestic business became even larger as a percentage of its total revenues.

Meanwhile, foreign-domiciled banks such as UBS and Barclays have larger presences in the US than in past decades. Such is the nature of modern international finance that there's no shortage of large financial institutions with balance sheets to fund project finance. They all have similarly-capable trading floors.

Back when I was with Chase, I did some analysis of the international businesses under then Vice-Chairman Tony Terracciano. The results weren't flattering to Tony or his management team. Attempting to discredit the work, Terracciano asked the source of my data, to which I replied it was from his own financial people.

Ever the loyal manager, he promptly sneered,

'They wouldn't know their asses from a hole in the ground,' and summarily, in his mind, dismissed the findings as irrelevant.

However, the truth was that many of the international unit's businesses and countries weren't able to command superior profit margins. Even then, with Citibank and various local and regional competitors, the international bank's profits were nothing to write home about.

The real action back then, and still, I'd expect, were in faster-growing onshore consumer finance businesses, securities trading and the then-hot real estate finance unit.

Funny how things didn't change much two decades on, isn't it? But that's the manner of financial services- businesses cycle through booms and credit-loss busts with painful regularity.

Which suggests that one should be wary, should Chase suddenly begin to grow significantly overseas. Prices paid for local banks will probably be a bit too rich, or risks won't be adequately understood by the suits from New York, as they hoover up the deals local and regional veteran bankers choose to pass by.

As I wrote recently regarding the fuss bank CEO made over rumored capital level increases,

"I've written in a post some years ago that banks want to portray themselves as competitive companies in terms of equity values and growth, even though the business in which they are in doesn't lend itself- no pun intended- to such dynamics. And the traditional nosebleed level of regulatory capital/risk assets doesn't really matter once risk becomes loss. Which happens in as little as one or two days, if not overnight. Ask the former executives of Bear Stearns."

Banking, for the long term, sensibly managed, was and is never a high-growth prospect. When a former henchman (Dimon) of the guy who cobbled together a string of Wall Street wire houses into Shearson Lehman (Weill) becomes regarded as a savvy international commercial banker, you should worry.
Rather, the history of large US bank management over the past three decades has been more often one of loss, ignorance and disgraced CEOs. It would be a rare CEO of Citi, Chase or BofA who was capable of not presiding over some disaster on his watch (The aggregation of Chemical, MannyHanny and Chase by the Chemical management team doesn't count, since that was simply the integration of three large mediocre money centers).

And, when that becomes true, well, it'll be because the business has become such a regulated, slow-growing financial utility that it wouldn't take anyone very talented or smart to simply sit still and leave such an institution on autopilot.

So if Chase does begin to grow its international businesses significantly and quickly, one might want to regard the bank's future performance as suspect.

Thursday, July 07, 2011

Goldman Sachs & the Metals Markets

I had to laugh when I read Tuesday's Wall Street Journal piece headlining the Money & Investing section- Commodities Beckon Banks.

Essentially, several firms, including Goldman, Chase, Trafigura & Glencore, are linking possession of massive amounts of metals including aluminum, copper, zinc, tin and nickel with their trading operations, thus allowing them to conduct some market squeezes. These firms recently bought metals warehouse operations which serve as custodians of LME-traded metals. According to the Journal piece, these four firms now own warehouses which store "about two-thirds of the LME's entire metal stocks, from aluminum to zinc."

This passage from the article says it all,

"But the growing muscle of securities firms in the metal-storage business is riling users and traders, who say the firms have both a bird's-eye view of supply and demand and the ability to control what goes in and out of their warehouses. These traders worry the firms could exploit their knowledge. The new owners say they keep their trading arms and warehouse operations separate, and there is no evidence to suggest they share information."

Does anyone really believe that? I sure don't. First, Goldman's involved- so you automatically suspect them of finding a way to coordinate trading and supply, even if the two operations don't "share information" directly.

Second, why else on God's earth would these firms buy the warehouses if not to take advantage of the potential to coordinate trading moves and availability of physical supply of these commodities?

The Journal piece mentions Goldman's Detroit aluminum storage sites as being curiously coincident with the higher prices for the metal there than in London. It's contended that those Goldman's Detroit metals warehouses store 25% of the LME's aluminum.

Incredibly, LME rules and Goldman's own procedures allow them to delay the release of stored metals which owners sent there for safekeeping. It's quite clearly the basis for an artificial supply squeeze by Goldman. Reading how the arcane procedures for releasing metals from warehouses to the metal's owners under LME rules makes you see that it was a situation ripe for manipulation.

And it seems that's exactly what is going on.

Oh, and while we're on the subject, does it strike anyone else as odd that Chase and Goldman Sachs, both 'too big to fail' taxpayer-supported and -insured commercial banks, are involved in this? Funny, because this doesn't sound like a classical, conventional commercial banking business, does it?

No, it sounds more like the sort of risk-arbitraging, market-manipulating enterprise that a brokerage, investment bank or private partnership would run.

Truly, you cannot make this stuff up, can you?

Wednesday, July 06, 2011

Regarding Analysts' Estimates

As earnings season for US equities begins this quarter, it's worthwhile to take note of a recent Wall Street Journal column by Jason Zweig concerning analysts' earnings estimates.

Consider this gem,

"On average, according to Denys Glushkov, research director at WRDS, stock analysts are revising their earnings forecasts nearly twice as frequently as they did a decade ago. And while the typical forecast missed the mark by 1% in the 1990s, that margin of error has lately been running at triple that rate."

Which is sort of shocking, since I recall back in 1997, my business partner at the time noted how analysts' earnings estimate errors had risen significantly from prior years. Even then, analysts' estimates had become somewhat of a joke.

Now, a decade and a half later, they've deteriorated even more.

Zweig goes on to describe a process by which companies actively guide estimates and play games in order to make sure that their actual earnings announcement is a bona fide "surprise."

Again, from Zweig,

"In the first quarter of 2011, according to Bianco Research, 68% of the companies in the S&P500 earned more than the consensus, or median, forecast by analysts. What's more, that quarter was the ninth in a row when at least two-thirds of the companies in the S&P generated positive surprises- and the 50th consecutive quarter in which at least half of the companies surpassed the consensus forecast of their earnings."

My equity portfolio selection process has never used anything but historic information. However, I recall, back in 1998, that the hedge fund with which I was collaborating was investigating another person's work claiming to add value to equity selections by analyzing earnings estimates. Apparently it looked very promising. But after a few months of scrutiny and testing, whatever alleged value in the method was found to be non-existent.

Still, the process employs a lot of people at sell-side brokerages and buy-side funds. So I guess, despite its relative lack of usefulness, the process of estimating corporate earnings adds value by keeping some people on payrolls in the financial services industry.

Meanwhile, you might think about this topic and post in the next few weeks, as all those earnings "surprises" roll in among S&P500 companies.

Tuesday, July 05, 2011

Yahoo Board Plotting Carol Bartz' Exit

Stories were rampant in the last two weeks that Yahoo's board is interviewing replacements for CEO Carol Bartz.

Nearby is the price chart for Yahoo and the S&P500 Index, including January, 2009, when Bartz became the firm's latest leader.

By one view, Bartz at least stopped the downward spiral of the firm's shareholder's fortunes. During her tenure as CEO thus far, the firm's share price is up modestly, while the S&P has risen roughly 30%.

Personally, I think Yahoo's sluggish performance is less about Bartz and more about the wreck she inherited. A wreck with nearly nothing left on which to build the fabled "turnaround."

As I've contended in many posts, after Jerry Yang screwed up the exit strategy of selling the firm to Microsoft, there was little left to do. For shareholders, just selling and walking away was the best option.

I suspect it probably still is. At this point, Yahoo is most likely a risk arb's play, if it's anything.

Even the latest bad break involving Alibaba had Yang's fingerprint's on it.

Whether Bartz ought to be replaced or not is probably moot. Yahoo's fortunes are unlikely to improve under any other CEO. At this point, though, there may not be any buyers for the firm at prices that the board and shareholders will tolerate, so badly has the firm been mismanaged since when Terry Semel ran it.

Monday, July 04, 2011

Fourth of July & America's Porkiest Generation

Last week I wrote this post discussing, on the occasion of economics Nobel Laureate Michael Spence's excellent Wall Street Journal editorial, why the US may be carrying a significant percentage of unemployed for years to come, thanks to global trade, strong foreign competition, and the end of of a fortuitous 30 year post-WWII era of economic dominance.

Today, being July Fourth, is a traditional celebration of American Independence and, coincidentally, though perhaps less so than Memorial Day or November 11th, a day that honors American service personnel. The link, of course, is that freedom, independence and liberty have cost American lives since 1776 to purchase and maintain.

Liberal network icon Tom Brokaw bestowed the moniker "The Greatest Generation" on those Americans who came of age to fight WWII.

I think the time has come to consider and acknowledge that generation's total impact on America, and rename it The Porkiest Generation.

Some of that generation were young Democratic Congressmen, like LBJ, who helped FDR enact the Social Security Act in 1935. That was the first true misstep down the road of social pork.

After winning WWII, the Porkiest Generation came home to, after some uncertain steps by the federal government to absorb those millions, fairly smooth economic and job growth for thirty years. Along the way, many of the Porkiest became the entitled blue-collar middle class who ran the steel mills, auto plants, manned the dockyards and drove the trucks and trains that supported America's post-war economic expansion. They demanded, and were given, promises of lavish health care and pensions as defined benefits plans.

When these mostly-unionized employees wanted more, the unions struck until a profoundly dumb American management class, being, as I contended in that prior, linked post, luckier than smart, simply promised more future defined benefits to bring the workers back into the factories.

Between the 1930s commencement of the folly of Social Security as a defined benefit scheme, and the use of that template by private unions for the next forty years, the idiocy of defined benefits amidst war and economic havoc in the rest of the world became the rule in America.

I should add, here, as a footnote, that defined benefit schemes were given a boost by the federal government's wartime wage and price controls. In order to entice skilled workers to change companies, so-called "fringe benefits," now simply defined benefits, were promised. As non-cash compensation, they didn't trigger federal wage control violations, while, as future benefits, they didn't affect current profitability. Being rather new concepts, accounting principles weren't yet well-established to correctly reflect the costs of such expensive promises.

By the late 1960s, the Porkiest Generation, then firmly in control of Congress, tripled-down on intellectual economic stupidity by enacting two more general-pool, defined benefit programs, Medicare and Medicaid. And, for good measure, every so often, they larded up Social Security's benefits, too, so that children of deceased Americans began to have their college education funded by this social safety net.

What astounds and confounds me is that, for forty years, from 1935-75, apparently no economist of standing bothered to note that it was a mistake promise defined benefits, over time, from the proceeds of a national economy subject to the vagaries of recessions, depressions, monetary crises, global competition and occasional wars. After 1945, the same economists should have warned Congress not to use a temporary period of US economic hegemony as the baseline from which to forecast the availability of lavish wealth for decades hence, from which to pay ever-growing defined benefits of health insurance, care, and retirement pensions.

How is it that out of some 200MM+ citizens, nobody was smart enough to point out that promising defined benefits to be funded by varying levels of economic activity and production, i.e., GDP, was folly from the get-go? That the best that could be offered was contemporaneous, annual contributions to individual accounts for health care and old-age pensions?

As I wrote in the first post on this blog, union leaders are to fault for accepting promises of future benefit payments from industry, rather than current cash contributions to individual worker accounts.

But, I digress.

My point for today's patriotic post is to highlight how the generation that deserved credit for fighting and dying to win WWII promptly rewarded itself, through unionism and Democratic control of Congress, by promising itself defined levels of health care and old-age pensions which were never going to be affordable. The mistaken belief that a brief period of unrivaled American economic supremacy would endure and fund such lavish promises should have been challenged and crushed before it could become cemented into the American workers' expectations.

Can it really be that nobody was smart and courageous enough throughout the 1930s-1970s to point out this folly? That no society in history had ever managed the trick of working for about 30-40 years, then being paid near-working wages in retirement for another 20-30 years? That the mechanics of actuarial math and compounding wouldn't sustain those promises without economic assumptions never before seen in global economics?

When you think about it, most of the intent of dedicated health care and old-age pension benefits have more to do with societally-enforced saving for these needs, and necessarily less to do with societal funding of them.

If all Social Security had ever been was a law to mandate workers and employers to dedicate defined percentages of the formers' wages to individual, single-use accounts, it's not clear that federal assistance would have ever been necessary.

After all, using federal funds to augment such accounts is simply a wealth-transfer from those making higher incomes to those making lower incomes. But if actuarially-determined amounts were deducted from compensation, federal funding never would have been required. Besides, society pays, either way. It's just that when the government is involved, it is taking from some to give to others, rather than have those others behave responsibly and live within their means.

But, thanks to the Porkiest Generation, we are now, eighty years on, saddled with their originally self-imposed promises of defined benefits, the crushing burdens of which on the next generation, and subsequent ones, they now complain can't be changed.

What a Ponzi scheme, eh? You get control of unions and Congress, you pass laws to promise wildly unrealistic and unaffordable benefits to be paid by subsequent generations, then retire and complain when the next generation realizes what the Porkiest had done.

In my opinion, enacting foolish and economically impossible legislation and promises is no defense to simply stripping them away- now- totally- and reverting to defined contribution schemes.

Just because one generation managed to gain control of the levers of labor and legislative power to promise itself unaffordable and unsustainable financial benefits is no reason not to reverse those outlandish promises now.

Happy Fourth! Let's declare Independence from the economic enslavement of our nation by the Porkiest Generation!

Sunday, July 03, 2011

Counterparty Risk Arises Where You Wouldn't Expect It

There's an interesting lesson from the current drama playing out between Frank McCourt, owner of the Los Angeles Dodgers, MLB, and the courts.

Buried near the end of a recent Wall Street Journal editorial discussing the situation, Holman Jenkins mentioned that among the creditors of the Dodger organization are two retired players who are each owed several million dollars. Together, I believe they are at risk for about $20MM+.

Reading that caused me to wonder what on earth their agents were thinking when they allowed this to occur.

According to what I've read, McCourt was in violation of MLB funding requirements when he bought the Dodgers, and has more or less used the enterprise as a piggy-bank for his and his soon-to-be-ex-wife's lavish lifestyles.

Knowing that baseball franchises can become financially imperiled, you'd think that any player's agent worth his 10% would demand that a team buy an annuity or similar funding instrument, if not escrow the funds, in order to assure payment of their client's long term monies to be paid out in the future.

As it is now, the two players are unlikely to be able to get J.G. Wentworth of any of its competitors to pay a lump sum to them in exchange for accepting the at-risk time payments on their contracts.

I guess it shows, once again, how sports agents fail their clients when they, well, fail to understand and take steps to limit or hedge risks like this.

Counterparty risk. Once again, it rears its ugly head and demonstrates how the most seemingly-safe transactions can fall prey to this nasty source of unwanted financial surprise.