Saturday, September 17, 2011

William Ackman On Pershing Square's Fascination with JCPenney

I caught Pershing Square hedge fund manger William Ackman on CNBC last week extolling JC Penney, of which his fund has become a major owner.

Perhaps it's only me, but I found him to be somewhat delusional, going on about Penney's real estate values and locations, a 'jeans bar' to be like an Apple store's 'genius bar,' and his seeming reliance on his mother's and wife's views.

Contrast this with Kyle Bass' hedge fund commissioning market research in Germany pursuant to his investments in the Eurocrisis.

Didn't Ackman unsuccessfully tried to force Target to mortgage its real estate values several years ago? Then failed to take over or rescue Borders more recently?

Here's a chart depicting price series for Penney, Target, Sears Holdings and the S&P500 Index for the past five years.
Not surprisingly, Target and the S&P have outperformed Ed Lampert's Sears and the Penney. Lampert hasn't seemed to have done all that well with his Sears/KMart conglomeration. Despite seeing this, Ackman seems to believe that, though also a hedge fund manager, he has the magic touch for retail success.

Retail is a very tough business. Why these hedge fund guys think they can just swarm into an underperforming retailer, buy control and force it to revert back up to some better-performing mean is beyond me.

Sometimes, underperformers, especially retailers, are so for a valid reason. And they aren't likely to come back from the ailing/dead. Customer perceptions and buying habits aren't necessarily easily changed, once soured on a brand or retailer.

I guess we'll see how magical Ackman's- and his wife's and mother's- touches are at Penney in the months/years ahead.

Friday, September 16, 2011

Regarding UBS, Their Rogue Trader, John Mack, Morgan Stanley & Howie Hubler

Yesterday's two big financial stories, outside of the continuing soap opera "As The Euro Implodes," were John Mack's retirement from Morgan Stanley and the revelation that UBS rogue trader Kweku Adoboli lost $2B for the bank. Both stories dutifully appeared as prominent pieces in this morning's Wall Street Journal.

There is, however, a deliciously ironic link between the two tales. For me, it took finishing Michael Lewis' The Big Short to realize the connection. Here's the clue from the Journal piece,

"But in 2007, it hit a rough patch, losing $9 billion on a proprietary mortgage bet that cost the jobs of several of Mr. Mack's lieutenants, including Zoe Cruz, who was widely viewed as a top candidate to succeed Mr. Mack."

Now, it's tempting to think of the Morgan Stanley loss as not caused by a rogue trader. In fact, elsewhere in the Journal article on Mack, it contends,

"He's a battlefield commander who knows how to lead troops......Mr. Mack pushed traders to take more risk and sell more esoteric but profitable mortgage products. Briefly, that move paid off. In 2006, the firm enjoyed record results."

Funny, that's not at all how Michael Lewis described Howie Hubler's calculated $9B loss on mortgage-backed derivatives.

How do you suppose UBS suffered only a $2B loss and blamed it on a rogue trader, whereas John Mack presided over a $9B loss in 2007 and kept his job? In fact, he essentially lost the firm, as it required a federal bailout, plead to convert to a chartered commercial bank, and had to arrange other financing to remain solvent.

Yet Mack kept his job and never called Hubler's loss a rogue trade.

We don't yet know precisely how Adoboli accomplished his allegedly-undetected losing trade(s). One assumes, like Nick Leeson who brought down Barings Bank, he somehow fooled the various electronic systems purporting to monitor positions, desk P&Ls and risk.

But here's how Michael Lewis explains Morgan Stanley's star fixed income trader Howie Hubler's stunning $9B loss. For those wishing to follow along, I'm synopsizing Lewis' Chapter 9 in The Big Short (Norton, 2010), entitled A Death of Interest, pages 200-225. I'm not going to retype the chapter, nor major parts of it, as that would, I think, be a waste of my time, and probably violate Michael Lewis' copyright. Instead, I'm going to abstract the highlights of what went on at John Mack's (and Zoe Cruz's) Morgan Stanley during 2006 & 2007. But I heartily recommend, if you find any of this of interest, that you run over to Amazon and buy a copy (new or, as I prefer, used but 'like new' for only about $6) of Lewis's book.

Howie Hubler was a star trader of mortgage-backed bonds. Sometime in 2004, Hubler begins to realize that a lot of the bonds he's selling, for which Morgan Stanley, like Goldman Sachs, has built its own origination system to capture the entire profit stream, are of highly suspect quality. So he, in conjunction with a colleague, Mike Edman, hatch a proprietary swap which they convince some of their clients to sell to Morgan Stanley. This allows Hubler's desk to own protection, for a small annual fee, on billions of dollars of dodgy subprime-backed mortgage bonds.

Lewis writes,

"It's now April 2006, and the subprime mortgage bond machine is roaring. Howie Hubler is Morgan Stanley's star bond trader, and his group of eight traders is generating, by their estimate, around 20 percent of Morgan Stanley's profits. Their profits have risen from roughly $400 million in 2004 to $700 million in 2005, on their way to $1 billion in 2006. Hubler will be paid $25 million at the end of the year, but he's no longer happy working as an ordinary bond trader......"

Along the lines of my long-expressed belief, Lewis notes that "the best and the brightest Wall Street traders are quitting their big firms to work at hedge funds, where they can make not tens but hundreds of millions."

So Hubler wangles a deal with Morgan Stanley to set up his own proprietary trading group, take his existing desk's swaps positions with him, and get a sweet deal for his group to own a stake in the group, to be subsequently spun out from Morgan Stanley. In short, Hubler extorts Mack and Cruz to give his group a semi-private business and stake in its future value, in return for not bolting from Morgan Stanley.

Here is where the story becomes interesting as it relates to today's WSJ articles about a rogue UBS trader and John Mack being paid homage as a wise senior Wall Street CEO.

Hubler's new group is given a profit bogey of $2B, but is paying about 10% of that, or $200MM, in fees to maintain its swaps, or shorts on bad mortgage bonds. Hubler wants to eliminate this drain, so he sells credit default swaps on a much larger amount of allegedly higher-quality mortgage bonds. About $16B of bonds.

As Lewis puts it,

"In effect, Howie Hubler was betting that some of the triple-B-rated subprime bonds would go bad, but not all of them. He was smart enough to be cynical about his market, but not smart enough to realize how cynical he needed to be."

For some perspective, the original credit default swaps which Hubler and his colleagues sold to their customers only required a 4% default rate among the subprime mortgages backing the bonds, which Lewis writes was expected in good times, to allow the swaps to pay off.

Next, Lewis writes about how Zoe Cruz' risk management people ask for stress tests of Hubler's aggregate positions under scenarios involving a default rate of 10%. A rate Hubler's people, who, remember, are just traders- not PhDs in economics or seasoned mortgage industry researchers (like, for example, Lew Ranieri's original Salomon group contained)- protested would never occur.

I need to make a brief side point here on which I'll elaborate in a subsequent post. Value-at-risk is the main component of most trading desk risk management systems. I've worked on and been around these systems since my days at what is now Accenture consulting back in 1995. One of the problems with VAR systems is that, since they require and assume variance in valuation to impute the capital required for a position, and, thus the losses possible at some probability level, they don't work well with bespoke instruments. Like, say, credit default swaps or so-called 'off the run' fixed income instruments.

Since the entire credit default swap market, as it evolved among AIG, Goldman Sachs, Deutsche Bank, Morgan Stanley,, was a telephone bid/ask market in which valuation was an exercise in judgement, variation in values was meaningless. As my old, sometime-business partner Bob Mankin is fond of saying,

"A model can tell you what something was worth yesterday or may be worth tomorrow. But the only way to know what it's worth today is to sell a piece of it in the market to someone else."

Thus Morgan Stanley's risk group's slow realization that its VAR reports on Hubler's groups risks were also meaningless.

The 10% stress test showed that Hubler's group wasn't short subprime mortgage-backed bonds. It was long, and the 10% default scenario would create a $2.7B loss. Lewis notes that the actual eventual default rate on the bonds on which Hubler sold swaps, i.e., went long, became 40%.

Again, to synopsize, by mid-2007, Deutsche Bank, which had bought the swaps Hubler sold to get a $200MM income stream to offset his negative carry on his base position of being long credit default swaps on allegedly-worse subprime mortgage-backed bonds, called Hubler to demand payment on the shifting, now higher value of the swaps Hubler sold. Again, because they aren't exchange-traded or continuously-quoted instruments, their value was the subject of what, in effect, became a verbal pissing contest between Deutsche and Morgan Stanley. By later in 2007, Morgan Stanley had paid Deutsche Bank at least $3.7B, eventually losing the net $9.2B. Hubler had, as Lewis writes,

"...been allowed to resign in October 2007, with many millions of dollars the firm had promised him at the end of 2006. The total losses he left behind him were reported to the Morgan Stanley board as a bit more than $9 billion: the single largest trading loss in the history of Wall Street......Hubler and his traders thought they were smart guys put on earth to exploit the market's stupid inefficiencies. Instead, they simply contributed more inefficiency."

To further add to today's trading loss/John Mack retirement irony, Lewis continued, on page 216,

"The other, bigger, buyer was UBS- which took $2 billion in Howie Hubler's triple-A CDO's, along with a couple of hundred million dollars' worth of his short position in triple-B-rated bonds.....A few months later, seeking to explain to its shareholders the $37.4 billion it had lost in the U.S. subprime markets, UBS would publish a semi-frank report, in which it revealed that a small group of U.S. bond traders employed by UBS had lobbied hard right up until the end for the bank to buy even more of other Wall Street firms' subprime mortgage bonds.....said one UBS bond trader close to the action, "It was a very controversial trade in UBS. It was kept very, very secret.....He further explained that the traders at UBS who executed the trade were motivated mainly by their own models- which, at the moment of their trade, suggested they had turned a profit of $30 million." "

Small world, indeed, eh?

Now with all this information, stop and reflect with me for a moment.

You are John Mack. It is 2006. You meet with your chief risk officer, Zoe Cruz, to ask for a complete examination of Howie Hubler's group's positions, strategies, assumptions, forecasts, etc., because that single eight-person desk is generating, according to Lewis, roughly 20% of Morgan Stanley's profits. You tell Zoe to set aside an entire day- maybe two. You surely want to understand in detail how these eight traders are producing 20% of your firm's profits, and what concomitant risks they are taking to do so.

Or maybe you don't.

The same thing would seem to apply to Zoe Cruz, would it not? Wouldn't she want to protect herself by conducting such a thorough examination of Hubler's group's business, in order to brief Mack prior to presiding over a blow-up of that desk's business?

Evidently not.

Instead, Lewis quotes verbatim from Mack's December 19, 2007 investor phone call. I won't republish the detailed exchanges between Mack and his questioners, including Goldman Sachs analyst William Tanona. Instead, here's what Lewis wrote about Mack's statements,

"The meaningless flow of words might have left the audience with the sense that it was incapable of parsing the deep complexity of Morgan Stanley's bond trading business. What the words actually revealed was that the CEO himself didn't really understand the situation. John Mack was widely regarded among his CEO peers as relatively well informed about his bond firm's trading risks.....Yet not only had he failed to grasp what his traders were up to, back when they were still up to it; he couldn't even fully explain what they had done after they had lost $9 billion."

In a footnote to the verbatim exchange on page 218, Lewis also wrote,

"What John Mack's trying to say, without coming right out and saying that no one else at Morgan Stanley had a clue what risks Howie Hubler was running, is that no one else at Morgan Stanley had a clue what risks Howie Hubler was running- and neither did Howie Hubler."

In an earlier footnote on page 210, Lewis provides a brief discussion of the differing explanations offered by those close to Hubler and Cruz regarding who was ultimately responsible for Hubler's positions' losses- Hubler or Cruz? Lewis sides with those who believe Hubler hoodwinked Cruz into believing the positions' net risks were minimal.

So, what is my point at the end of this very long post involving today's WSJ articles about yesterday's two big breaking stories at UBS and Morgan Stanley, and their mortgage-backed credit default swaps losses four years ago?

It's that, to me, John Mack shouldn't be retiring now as chairman of Morgan Stanley. He should have been fired by his board in 2007 for allowing Hubler and Cruz to lose $9B on one desk. Then Cruz should have been fired, and Hubler, Cruz and Mack all sued by the Morgan Stanley for fraud and breach of fiduciary duty to the firm's shareholders.

That if Howie Hubler was allowed to exit with tens of millions of dollars, and no criminal charges, after putting a $9B hole in Morgan Stanley's 2007 balance sheet, maybe UBS' Adibolo isn't guilty of anything, either.

Maybe both Hubler and Adibolo are rogue traders, or neither one is.

Now, I know that the foregoing story paints Adibolo as a trader trying to hide his known losses, whereas Hubler is portrayed as just too inept to realize what he thought was a net short position in derivatives was actually a net long position.

Personally, I have some trouble really belieiving Hubler was that stupid. Or, if he was, are we actually to believe that people that stupid can make $25MM a year? Plus, Cruz's people did the stress test which alerted them, and Hubler, to just how risky his positions actually were. So, from that point on, it seems unarguable that all concerned at Morgan Stanley could or should have known the truth about Hubler's positions.

But Lewis' book provides details of how Morgan Stanley dithered over exiting the worsening parts of the group's positions. Was that rogue behavior? By Hubler? Cruz?

Something doesn't add up. That's why I don't see a real difference between Adibolo and Hubler. They both were given license to risk their firms' shareholders' capital, and both lost it in positions which should never apparently ever been allowed to exist.

And, yes, Zoe Cruz did lose her job. But not quite the way I suggested above. And neither she, nor Mack, nor, of course, Hubler were sued for violating their fiduciary duty to their firm's shareholders through either gross incompetence, given their compensation and senior positions, or calculated deceit.

I think Lewis' account puts this week's comparatively paltry $2B UBS loss in perspective. And suggests that UBS has an evidently continuing cultural blind spot that makes it vulnerable to rogue trading, however you choose to define the term.

Lewis' book also begs the question, in my view, that Hubler was also a rogue trader. And perhaps Mack was a rogue CEO all the while.

I suspect, if you asked him, that Michael Lewis would say the whole lot- Mack, Cruz, Hubler, Adibolo, UBS's senior management, the boards of Morgan Stanley and UBS- are rogues.

And that anybody who buys shares in those firms, or any of their Wall Street ilk, are foolish and deserve what happens to them. Because for less than twenty bucks, any of those shareholders could buy both of Lewis' appropriately well-regarded books, Liar's Poker and The Big Short, and thus be warned of the risks of owning shares of formerly-private investment banks or brokerage firms.

The Recent Shocking Changed US Income Levels & Distribution

This week's Wall Street Journal very disturbing articles concerning US income levels and distribution.

The first, on Monday was a front-page piece detailing Proctor & Gamble's product development efforts in reaction to what it terms a 'barbell' US income distribution. The longtime leader in household products has officially and pragmatically acknowledged that its middle-class customer base has shrunk, with most of it moving downmarket, and some of the remainder upmarket.

A P&G manager is quoted as noting the Gini coefficient, a measure of income disparity, for the US is now roughly equal to those of the Philippines and Mexico.

Then, on Wednesday, the Journal ran an article containing recent federal government data on US incomes. The big news is that the median income fell 7.1% from its 1999 peak, and is now equivalent to its value in 1996- 15 years ago.

It should be noted that the figure does not include transfer payments, which have grown much more ubiquitous with each decade. Still, a median household income of $49,445 isn't something to cheer about.

P&G's reactions tell you that, from a business perspective, the betting is on stagnant or falling US incomes, not rising ones across the population.

That seems to me to be a significant departure from prior economic assumptions. A change heralding very troubling implications for attempts to reduce US federal debt, while also trying to spur spending.

Common sense would suggest that the median income figure is the result of recent decades' effects on the nature of jobs in America. A bifurcation of fewer high-paying, high-value-adding positions, and more lower-paying jobs, while the middle-management, middle-class types of employment Americans have come to expect since the late 1940s was, in reality, a passing phenomenon that is now over.

Thursday, September 15, 2011

Kyle Bass On CNBC Yesterday

I saw Kyle Bass' appearance yesterday on David Faber's noontime CNBC program which originated from the Seeking Alpha conference.

Bass was on as a guest in order to solicit his unvarnished, blunt opinions regarding the European financial troubles. Specifically, the sovereign debt problems of Greece, Spain, Ireland and Italy, and the accompanying potential insolvency of European banks holding said paper.

When asked for his reaction to US Treasury Secretary Geithner's contention, in an interview earlier that day on CNBC, that no European bank would be allowed to fail "like Lehman did," Bass replied that, technically, he agreed with and believed Geithner's assertion. European regulators, Bass said, would not let any of their large banks just collapse as the US allowed Lehman to do. But in the next breath, Bass said,

'That doesn't mean the equity of those banks is worth anything. Nor their debt.'

He then proceeded to enumerate the problems he saw for any simple Euro-solution, including the myth of a single European-wide TARP-like fund.

In effect, in one sentence, Kyle Bass demolished Geithner's attempt to soothe markets regarding the European financial crisis and revealed the Treasury secretary's insistence that there won't be a European Lehman as a distinction without any real difference.

Then Bass said something which I'll return to, again, in a later post about Michael Lewis' The Big Short. Bass referred to primary market research which his fund commissioned among German citizens to ascertain the opinions of that nation's residents to bailing out the rest of Europe.

This sort of on-the-ground, gritty detailed research was also the hallmark of Bass and others during the building mortgage-backed securities fiasco of 2007-08. It temporarily stunned me that here was a hedge fund manager actually having extensive primary research conducted in order to better his odds of correctly resolving what he called, several times, the game theory problem of how the European financial system will evolve through the default, by whatever name you wish to call it, that Bass sees as inevitable and unavoidable.

Mind you, as far back as last summer and fall, Bass was on CNBC warning viewers that the apparent market values of sovereign debt, and the health of the region's large banks, were not accurate. That the situation was far more dire than it appeared.

I respect and very much enjoyed Bass' detailed explanation of the processes actually necessary, including, to use his term, 'that messy democratic process' of individual country legislatures voting to enact their individual TARP-like funds. I can't possibly capture in this piece the intensity and density of Bass' remarks, but they were extremely convincing on several points.

First, there will be European country defaults. Second, there will be corresponding private sector bank insolvencies. Third, a lot of money will be lost by holders of securities issued by the defaulting countries and bankrupt banks. Fifth, the effect on the US will involve both capital losses and overall economic trade reductions. Sixth, after all this, the global financial and economic systems will then have to pick up and move along, losses absorbed, and work with the resulting situations.

About BofA's Planned Restructuring

The business press and cable channels early this week were all abuzz with articles and segments about Brian Moynihan's plans to cut $5B of expenses and 30,000 net employees from the sluggish financial utility that BofA has become.

My take on Moynihan is aptly captured in these prior posts (here and here), with the second link containing a link to my piece written upon Moynihan's selection as BofA's CEO.

Interestingly, I noted in that last linked post, the one written in December of 2009, when Moynihan was named CEO of BofA, that he said he planned no significant strategic changes at the bank.

Well, it's nearly two years later, BofA is under legal attack for its Countrywide liabilities. Rather than hike the dividend or buy back shares, Moynihan did a generous deal with Warren Buffett to get $5B of additional preferred equity on terms no average investor would ever hope to receive.

And now he's planning on paring back the bank's massive consumer business, largely in response to Dodd-Frank's making those businesses- credit cards, debit cards, consumer lending, mortgages- structurally less profitable. Fair enough. The regulatory environment changed, so Moynihan is reacting, as Dick Bove contended, by retrenching in those areas hardest hit by the new laws.

But from an investment viewpoint, I see BofA as a toxic mess to be shunned for at least three years. Which is not to say that if you buy the bank's equity now, you might not see a big pop in 3-4 years. It's just that between the wait, and the risk of concentrating assets on a single troubled company, the return/risk may not be as rich as you think it will be.

My proprietary equity performance research found turnarounds of the type being attempted at BofA to be highly risky and usually a failure. Between the average total return gain and the chances of such a turnaround succeeding, the expected total return is far lower than investing in more stable, consistently-performing companies.

Then there's the nature of the sector and the bank. BofA has 288,000 employees and $27B in annual expenses, according to a Wall Street Journal article in Tuesday's edition. Thus, expenses are to be cut by 18%, and the net number of employees by almost 10%. But there's an unspecified churn in that employee number, as bank officials have said they'll fire more than 30,000, then hire some new people. That's going to be great for morale, huh?

You can imagine the amount of carnage that will begin to occur in focused businesses and locations. Chances are that expenses won't fall by the entire $5B, 30,000 employees will go, net, and revenues will fall further than Moynihan's optimistic planners expect.

These types of drastic downsizings tend to underestimate how the damage to morale throughout a large company will sap efforts to continue to just do business. Revenues in consumer businesses will likely decline by more than expected, and institutional revenues won't necessarily be immune, either.

Generally, firms which are cutting personnel and spending don't grow. Their total returns aren't typically attractive, either.

If BofA's cost- and personnel-cutting program was to spark a turnaround of some a sort that resulted in the company repositioning itself, exiting bad businesses, or entering promising new ones, there might be a chance that, a few years from now, the company would be an attractive investment.

But that's not the kind of restructuring that BofA is doing. Rather, it's trying to cut levels of spending on existing businesses, while shifting resources around among businesses it will largely still operate.

Worse, the same CEO who said two years ago he wasn't going to do anything substantially different, then said he'd push cross-selling, is putatively leading this effort. The first linked post I included above notes that Moynihan has no prior experience that would lead you to believe he has the slightest value to add to this project.

If BofA's board wanted to increase the chances of this effort making a difference for the company's shareholders, they should probably name Moynihan as a special counsel for mortgage-related legal matters, and replace him with a proven turnaround artist of the caliber of Robert Miller. But that's not going to happen.

Do you think that someone of Moynihan's limited banking experience, uneven corporate performance background, and generally legal-oriented skill set is the guy to oversee, let alone restructure, a company so complex as BofA, a modern global money-center bank?

I don't. It's Chuck Prince all over again.

And if Moynihan, by some miracle, succeeds in cutting expenses and headcount? What then? If you bought the stock now, took a lot of risk, you get a pop. Then it's back to your regularly-scheduled sleepy financial utility with little hope for breakout total return performances.

The truth is, banks of BofA's ilk- Chase, Citi, WellsFargo- are all pretty much similarly-organized and operated financial utilities. Aside from occasional timing plays, none are likely, for the foreseeable future, absent regulatory changes or serious breakups, to offer investors much hope of consistently superior total returns.

Wednesday, September 14, 2011

More On Michael Lewis' The Big Short

Last month I published this post based on a partial reading of Michael Lewis' 2010 book involving the recent financial crisis, The Big Short.

While away in New Hampshire late last month and early this month, I finished the book and have since been reflecting on it. I'll be publishing several posts in the near future on various aspects of Lewis' book.

At present, I think the topics will include:

-S&P's inept ratings analyses
-Regulatory failures
-Goldman Sachs' typically rapacious behavior
-Moral bakruptcy among fund managers
-The largely-unpublicized nature of structured instrument valuation and/or non-exchange-traded invesetments

And probably a few more as they occur to me.

McGraw-Hill's Split Up

Only last month I wrote this post concerning outside pressure on McGraw-Hill to break itself up. Two years ago, this post discussed the fallout from Terry McGraw's push for growth on the cheap at his company's S&P Ratings unit.

It doesn't look like David Einhorn made money shorting McGraw-Hill's stock back then.

However, a glance at the firm's equity price since 1985 shows the McGraw's have created no value premium for shareholders, despite exposing them to the risk of owning just one equity.

The company, awkwardly diversified as it is between educational and other publishing, and financial services information, probably reached its zenith of value creation back in 2001. But since roughly 2007, the firm has pretty much tracked its own iconic S&P500 Index performance.

As I wrote in an earlier post, McGraw-Hill's current instantiation is the product of a bygone era in which the commonality among businesses was the physical printing and distribution of information. The planned split finally addresses this now-awkward fact by separating what is referred to as the company's education businesses from its financial information ones.

A decade or more ago, this may well have caused the value of the latter, which CEO Terry McGraw plans to lead, to soar. Now, with S&P's reputation tainted from its inept performance during the mortgage securitization boom/bust which led to the 2008 financial crisis, that may not be true.

I'll have more on that point in a later post.

Terry McGraw was cited in yesterday's Wall Street Journal as insisting this split is the fruit of a year-long effort inside the company, and that it is emphatically not in response to pressure from Jana Partners, an institutional investor in the company, or any other outside pressure.

That's hard to believe. Very few CEOs voluntarily engage in wholesale cuts in the size of their empire without heavy market pressure, e.g., Brian Moynihan at BofA and Jeff Immelt at the struggling GE.

Perhaps the more interesting question is whether the firm's rating business will ever be floated off on its own, if for no other reason than to firewall the other pieces of the firm from legal and reputational backlashes.

In any case, while it's possible the pieces of McGraw-Hill could do worse, going forward separately, than the whole, I suspect they won't. As separate and public companies, a really bad performance would probably led to acquisition by a competitor, while the focused nature of each resulting business group will give each the opportunity to be managed more appropriately to its needs, without distractions from resource allocation across such different types of businesses.

The nature of capital markets for the past 30 years has been to de-conglomerate, and McGraw-Hill is finally about to allow investors to do for themselves what this remaining conglomerate has unsuccessfully attempted to do for them for so long, i.e., diversify and allocate resources as they see fit, rather than pay a family management to do it badly.

Tuesday, September 13, 2011

Jurgen Stark Sparks More Euro Jitters

I'm writing this post on Monday afternoon, while listening to some really serious black crepe-paper hanging on Bloomberg concerning Europe's debt problems. Yesterday's latest Euro-panic was apparently sparked by the resignation from the ECB of Germany's Jurgen Stark.

Here's what the weekend edition of the Wall Street Journal reported on the subject,

"Germany's top representative on the European Central Bank resigned in an apparent protest Friday, dealing a severe blow to the steward of Europe's common currency amid the Continent's worsening debt crisis.

The ECB said J├╝rgen Stark, its chief economist, was resigning for "personal" reasons with nearly three years remaining in his term. But people familiar with the matter said his decision was driven by frustration over the bank's expanding role in backstopping the region's finances.

The surprise exit of Mr. Stark—the second senior German official to depart the ECB over ideological differences in recent months—jolted markets in Europe and the U.S., as concerns over the stability of the central bank's senior leadership added to fears about Greece and Europe's banks. The euro suffered its biggest one-day drop in two months, finishing at $1.3657, its lowest finish since February.

ECB officials have taken pains in recent weeks to counter growing criticism that the bank is overstepping its charter and assuming untold financial risk with its actions. Such worries are strongest in Germany, where the country's own central bank, the Bundesbank, is firmly rooted on the principle of independence from politics. Many Germans believe that tradition is at the core of their country's own economic success and worry that it is now being undermined.

"From a German perspective, this is not a very good sign," said Kai Karstensen, an economist at Ifo Institute in Munich.

The resignation is fueling a debate in Germany about whether the euro will become a less-stable currency thanks to the escalating euro-zone debt crisis. Such a debate could indirectly make it harder for Chancellor Angela Merkel to justify expensive government policies to prop up the euro.

"Stark is the second German central banker to leave the ship because he sees that the German stability culture can't be upheld in Europe," says Thorsten Polleit, economist at Barclays Capital in Frankfurt. "There's a clear potential now that the German public will become increasingly disenchanted with the euro project."

That disenchantment is already being expressed by leading politicians. German President Christian Wulff, whose position is largely ceremonial, has called the ECB's bond purchases "politically and legally questionable." The head of German's center-left SPD party, Sigmar Gabriel, has also denounced the purchases.

There are worries within Germany that vulnerable countries in Southern Europe will soon have a stranglehold on ECB decision-making. That impression could further undermine Germans' confidence in the euro at a time when their country is being asked to foot much of the bill to bail out the flagging members.

In an op-ed for the German business daily Handelsblatt, released late Friday, Mr. Stark wrote that government efforts to save the euro zone have fallen short. He called for a "far-reaching reform of the mechanism for decisions and sanctions."

"We find ourselves in a situation in which massive sustainability risks in public budgets are eroding financial stability," he wrote. "

The ECB, like the US Fed, is supposed to be apolitical. But, just as our Fed has shamelessly returned to the financing of Treasury debt since 2008, so, too, is the ECB working closely with the the EU by purchasing sovereign debt of countries in trouble. Now, however, it's clear that those countries include Spain and Italy. Two countries whose economic size will almost surely doom any Euro-wide attempt to rescue them. Italy is, in fact, the third-largest sovereign debt issuer in the world. Spain's economy is no Greece- it's substantial and it's in serious difficulty.

Yesterday afternoon's Bloomberg discussion rather bluntly included predictions of failure for many large European banks. Parallels to the situation of the US financial markets and banks just three years ago this month were explicitly made.

Don't forget that on several occasions, business media such as the Wall Street Journal have reported that US money market funds have significant positions in European bank commercial paper. Guess what happens if those banks become insolvent.

The Euro-funding crisis which is spreading from their sovereign debt to their private sector banks will arrive quite quickly on US shores in the form of 'broken-buck' money market funds which will then need...surprise, surprise....another Fed bailout!

Somehow, it seems truly ironic that eighty years after Hitler's Germany provoked such fear in Europe, the countries of that region are now running to (back) to Germany for financial rescue from their subsequent sovereign economic and financial mistakes. Who'd have guessed that the Germans would ultimately dictate the future of Europe not from the strength of their military, but from the strength of their economy?

Monday, September 12, 2011

S&P500 Performance & John Bogle's Views

I spotted a little piece in last weekend's Wall Street Journal by Jason Zweig concerning Vanguard founder John Bogle's recent remarks on equity markets.

Bogle has written a clear and wonderful volume in the The Little Book series entitled Common Sense Investing. Bogle doesn't endorse active management of any equity portfolios- ever. The book explains why.

So it wasn't surprising that he spoke of equity market returns for the next decade averaging 7% per annum. He pointed out that this will double one's investment. It's reasonable to assume, knowing Bogle, that he would expect one to follow his advice by way of investing in a passive S&P500 Index fund.

Of course, many are fixated on the last decade's being a so-called 'lost decade' for equities.

Out of curiosity, then, I calculated the S&P500 Index annual average from January, 1970 through last Friday. Despite the flat performance during the last decade, the Index continues to have an average annual total return of 10.9%, before inflation.

One could do much, much worse than dollar-averaging into and out of the S&P over time. I suspect most retail investors have, indeed, done far, far worse.

And, to Bogle's point, paid handsomely for the privilege.

An Interim Report On Glenn Beck's New Online-Only Venture

Back in July, I wrote this post discussing Glenn Beck's move from Fox News to his own online-only media base, as well as Oprah Winfrey's recent move to her own cable network. I closed the post with these passages,

"Beck made sure his new venture is easily found, cheap to join, and ubiquitous. By emphasizing smart phones and tablets, plus political action projects, he's opened up his venture to younger audiences, as well as older ones.

Whether Winfrey or Beck proves to be more financially successful might be less important for the old media world, in the long run, than that both former conventional media stars bolted their former homes to control their future media destinies with so much apparent ease. How they fare may vary, of course, as Winfrey's management headaches attest. But their example may begin to sink in with more conventional entertainment creators who, until now, have sold their television series to broadcast and cable networks.

How long will it be before Glee, MadMen and Psyche simply go to websites and enjoy 100% of subscriber fees, selling by the episode, season or more, via credit cards and PayPal?"
This morning's edition of the Wall Street Journal provides some interim information on Beck's move. First, it refers to "clashes with network management" as part of Beck's motivation for the move. I'm sure Fox was getting pressure from various sources, given Beck's unvarnished, in-your-face style of confrontational video journalism.
But, as Beck explained in his web-based infomercial for his new online network, which aired immediately after he closed his last Fox News program, he had been urged by others to make such a move earlier than just this year.
According to the Journal piece,
"Because Mr. Beck owns the show and the network, he could make substantially more than the $2.5 million salary he got each year at Fox. GBTV is on track to take in more than $20 million in revenue in its debut year, according to a person close to the company.

The television industry will be watching closely to see whether the TV host can preserve his popularity while migrating to the Web, where efforts to get consumers to pay to watch online-only channels are just beginning.

When Mr. Beck announced GBTV in June, the network had 80,000 subscribers. In the months since, GBTV subscribers have swelled to more than 230,000, according to people close to the network, even though Mr. Beck's show hasn't yet begun.

The audience is far less than the more than 2.2 million daily viewers his program on Fox drew, on average, over its 27-month run, which ended in June after clashes with the network's management.

But it is more than the average 156,000 people who were watching the Oprah Winfrey Network in June.

Like GBTV, OWN was started by a major TV personality, but it's available through a traditional cable subscription. By contrast, Mr. Beck's network is available a la carte to subscribers who pay $9.95 a month to stream the network on and over interconnected devices such as tablets and mobile phones. The network's programming includes a reality show about the making of GBTV and a program anchored by Mr. Beck's co-hosts from his nationally syndicated radio show, which draws 10 million weekly listeners. A block of children's programming is slated to start later this month.

Mr. Beck said one of the reasons he ditched a network for the Web was a desire to reach out to young people. "I think networks are a thing of the past," he said. "I don't know anybody under 30 who is watching television the way I watched television. Technology has allowed people to change the way they consume the news, and we want to be where people are going." "

I'm impressed. Beck is already drawing almost 50% more in directly paying audience than Winfrey is via included cable distribution. Not to mention that Beck's program, which aired on Fox at 5PM, can now reach subscribers via wireless iPads and smartphones while the adults commute home from work. And Beck isn't wrong in his views, presented in the last paragraph of the quoted text. He's playing a long game for younger hearts and minds which don't see a few bucks per month as too much to pay for video programming.

In fact, Beck is teaching people to more aggressively disintermediate their cable television bills by beginning to pay directly for individual channels. The Journal article contends that Beck's subscription is $9.99/month, buy my July post, written soon after I watched the channel's infomercial, clearly states that the price closer to $5/month. I believe it was a charter-member price. But isn't it likely that, over time, Beck's channel will offer attractive renewal prices, or significantly lower rates for annual members? Not to mention begin to offer private social-networking marketing deals a la Groupon and LivingSocial? And discounts for referring friends to become subscribers?

Of course he will.

I don't have much doubt that Beck's experiment will succeed, even if not immediately. I believe he's shown insight in identifying how to secure editorial independence, the entire cashflow stream of a network, and adapt to video buying and viewing habits made possible and becoming predominant, thanks to evolving technology.

And, in time, I suspect, because of the nature of Beck's topics and audience, he'll have shown himself to be shrewder than Winfrey by assuming full ownership and risk, but retaining total control and financial rewards.