Saturday, October 22, 2011

A Windbag's Failed Wind Project

I caught Boone Pickens on Bloomberg television last week extolling the praises of natural gas. But, oddly, when asked, he downplayed windpower, explaining that it was priced at the margin and, as such, would be unusable and unprofitable until natural gas rises to $6/tcf.

Is this the same Boone Pickens who was gloating over his huge wind project from Texas to the Montana, or thereabouts, only a few years ago? How he had contracted for large windfarms of tall turbines to produce cheap electricity?

I believe it is.

It's understandable that Pickens would shelve a project which is no longer economically feasible. But what I find troubling is how sure Pickens was at the time that his wind project was a surefire success. That alternative energy was the way to go. He didn't suggest how tenuous the project's economics apparently were.

Now, with the Marcellus shale deposit and fracking having added incredible capacity to America's natural gas supply, the price of that commodity won't be rising anytime soon. And, with it, according to Pickens, wind power won't be economically competitive for, well, decades.

Friday, October 21, 2011

A Chilling Statistic

I opened this morning's edition of the Wall Street Journal to the Money & Investing section to read a chilling set of statistics.

According to an article about MBA program graduates,

"Employers such as banks, hedge funds, investment managers, private equity and venture capital firms hired 39% of job-seeking 2011 graduates at Harvard Business School and the Yale School of Management, 36% at the Stanford Graduate School of Business and 51% at Columbia Business School."

You see, many years ago, I read of similar numbers at a then-hot technology company.

If my memory is correct, Atari had the dubious distinction of hiring a quarter of the Harvard Business School class the year before it went bankrupt. At the time, someone wrote a waggish Journal editorial suggesting using the HBS hiring figures as a sort of early warning indicator for companies or sectors about to implode.

Reading that passage from this morning's Journal piece, I find troubling parallels to that article from around 1980.

First, banks are basically utilities. I don't see MBAs adding much value there. Investment management companies would seem to need new ideas born of experience and judgement, not mostly young, fresh-faced MBAs eager to be the marginal 10K analysts.

Packing more MBAs into venture capital firms, hedge funds and private equity firms seems to be adding capacity to an already over-served group of markets.

I don't have a problem with value being added by astute investing, whether it be via venture capital or private equity placements. Or shrewed investment, either in public or hedge funds. But most new firms in these areas are started by veterans with money. Adding MBAs is adding capacity without much actual initial value.

It would seem, in the current market situation, that at least the US is somewhat over-served by financial service providers. So seeing such large numbers of graduates from the better-ranked business schools flood into the financial sector seems troubling.

Joseph Stiglitz & Peter Orszag- Upward Failures?

The Wall Street Journal features a brief daily column entitled Notable & Quotable. Recently, Mark A. Calabria of the Cato Institute was quoted on the shifting arguments of liberal Nobel Economics laureate Joseph Stiglitz.

"Speaking before a group of protesters in Zuccotti Park, Nobel economics prize winner Joseph Stiglitz urged on the crowd, telling them they are "right to be indignant." Professor Stiglitz goes on to explain, correctly in my view, that we have a financial system of socialized losses and privatized gains.

What the good professor fails to mention is only a few years ago . . . he was denying this very fact. In 2004, along with Jonathan and Peter Orszag, Professor Stiglitz wrote a paper for Fannie Mae in which he "estimated" that the "risk to the government from a potential default on GSE debt is effectively zero." The paper goes on to argue "that the expected cost to the government of providing an explicit government guarantee on $1 trillion in GSE debt is just $2 million." Now I understand his Nobel is in economics, not math, but $2 million sounds nowhere near the actual cost so far of $160 billion."

Ah.....Peter Orszag again. I can't quite figure that guy out.

It's bad enough that Stiglitz, who won a Nobel, with Michael Spence for work on markets with asymmetric information, has strayed far afield. But Orszag is significantly less accomplished.

When I saw Orszag's name affixed to the Fannie Mae paper, I was reminded of a long-ago humorous piece in Life Magazine entitled Upward Failure. Though I can't find anything on the internet about it, it ran in the late 1960s or early '70s. I recall the essence of the piece very clearly. The tongue-in-cheek article purported to track the progress of a CEO who had failed spectacularly on every major project in his career, including while serving in WWII. From a Himalayan mission which lost nearly all the C-47s which flew, to the failure of a men's suite made from synthetic fabric which caused a rash, the subject of the piece was promoted from failure to failure.

Now we have Peter Orszag, going from co-author of a wildly-inaccurate and misleading paper which understated the true costs of government guarantees of GSE debt, to ineffectual budget director of the current administration, to, finally, a senior executive at Citigroup.

Almost as if one failure deserves another.

Thursday, October 20, 2011

The Fed's Beige Book

I wrote this post on Tuesday suggesting there are few reasons to believe that the US economy is in recovery or expansion, and more to expect some sort of continued sluggishness or recession.

Yesterday's Fed Beige book release didn't seem to help matters. Today's Wall Street Journal article on the subject stressed the report's mention of weak economic growth and no good news on jobs. In short, the good news was, well, no really bad news.

On Bloomberg television after the report's release, a Chase economist kept saying there won't be another recession, but that was about it. He seemed mostly focused on that point, while soft-pedaling when pressed by the anchor to discuss any really good economic news from the Fed.

This morning's housing data featured a drop in the sale of existing homes. Meanwhile, Angela Merkel cancelled her big speech to the German legislature on the Euro bailout mess. Grecians continue to riot.

The result in US equity markets? A 1200 S&P, plus or minus a few points depending upon exactly when you look today. Sustained volatility.

Hardly what I'd call the underpinnings of a strong, healthy, vibrant equity market.

Morgan Stanley's & Goldman Sachs' Quarterly Earnings

The past few days have seen some really fast dancing by Morgan Stanley's executives, and some financial sector pundits, concerning the firm's just-released quarterly operating results.

Some financial news networks were calling the firm's results stellar. It took a few more objective observers on both Bloomberg and CNBC to note how much so-called profit was due to the decline in value of the firm's debt.

A relatively new wrinkle, the thinking goes that when a firm's debt declines in value, it could retire it at a discount, which can then be booked as profit. In Morgan Stanley's case, concerns over its viability this past quarter sent insurance on its debt skyward, and its debt values plunging.

So the upshot is an unexpectedly large profit. Go figure.

Stripping that out, the real operating results aren't so pretty. In fact, the Wall Street Journal published an article on Tuesday detailing the ugly consequences of the firm's attempts to insulate itself from positions relating to MBIA. The crippled bond insurer's condition caused gyrations in the value for its debt, and insurance thereon, which, despite their best efforts, confounded Morgan Stanley's fixed income and derivatives strategists, causing a not insignificant loss.

Meanwhile, Goldman Sachs actually booked a quarterly loss. The Journal contrasted the firm's healthy old core business with its money-losing proprietary activities.

For both Morgan Stanley and Goldman, it's finally dawning on investors and analysts that these firms, despite their rush to secure bank charters in 2008, aren't truly commercial banks. They still market-fund short term, which is what led them to near-collapse three years ago, when Lehman's real collapse froze debt markets.

Looking at the three price charts in this post for Morgan Stanley, Goldman and the S&P500 Index for, first, 5 years, then 2, then 1 year, it's clear how investors have adapted their perspectives on these two firms.

Going into and coming out of the 2008 crisis, Goldman handily outperformed Morgan Stanley. But from early 2009, the two have essentially shared the same fate. The 1-year chart makes this crystal clear. Both are down 40% while the S&P has managed to stay roughly flat for the past 12 months. Morgan exhibits more volatility than its better-regarded peer, but they end up in the same place.

With the crisis now three years past, and the prospect of serious implementation of the Volcker Rule impending, investors and analysts are finally getting through their heads that the proprietary trading/investing profits of these two firms are largely history. Meanwhile, their continuing reliance on short term funding at a time when a Euro financial crisis of significant size is unfolding poses other significant risks.

Thus, both have been hammered over the past year, especially the past six months.

So much for what used to be the wildly-profitable component of the US financial services sector. The large commercial banks are either mired in post-mortgage-fiasco litigation and foreclosure problems, or wrestling with consumers who are deleveraging and repairing their own balance sheets.

Not much good news anywhere, Tom Brown and Dick Bove, who make a living out of touting this sector, notwithstanding.

Europe's Debt Crisis & Bear Stearns

David Skeel wrote an insightful and timely editorial in Tuesday's edition of the Wall Street Journal suggesting that European leaders looking for parallels with America's 2008 financial crisis should focus on the Bear Stearns rescue, not the Lehman Holdings failure.

If anything, Skeel may be a bit late with his reminder.

Essentially, he notes that it wasn't Lehman's collapse, per se, which need have roiled US financial markets. Rather, it was Lehman's not being rescued, after Bear Stearns was earlier that year.

Skeel contends, as have others, that Lehman's Dick Fuld proceeded to run his firm into the ground, believing that, at the last moment, the federal government would magically stop the music, pluck Lehman from the jaws of bankruptcy, and arrange a shotgun marriage for it with some other firm.

Instead, federal officials stood by and let Lehman fail.

It wasn't the failure, so much as market concern that the US government had become quixotic and erratic in its financial markets policies, which caused the massive selloff in the wake of Lehman's closure.

Skeel warns Merkel, Sarkozy and their colleagues that the Greek bailout could be a very expensive and dangerous save, only to lead to Spain's, Italy's or some other, much larger country's sovereign debt let to resolve itself without EU help. Skeel points out Sarkozy's self-interest in helping Greece, in order to protect asset values at French banks which hold much Greek debt.

Of course, since this has become a political matter in Euro-land, long term planning is pretty much out the window. It's Greece now, and whichever country follows it to the brink, next.

Consistency in these affairs is what matters, implies Skeel. And a failure to plan ahead will likely lead the Euro zone officials to make the same sorts of mistakes, with similar consequences, as US government officials did when they short-sightedly resolved one crisis at a time, with no longer term plan.

Wednesday, October 19, 2011

Continued High Equity Market Volatility

Thanks to Angela Merkel's comments over the weekend, then some positive earnings announcements, the S&P500 Index fell 1.9% on Monday, then rose 2% yesterday.

This drove my proprietary volatility measure back to new heights not seen since mid-September.

Which is why I continue to maintain scepticism regarding October's +7.9% S&P return. With daily moves of 2% commonplace, that could go to zero by week's end. Even if not so suddenly, it simply is not a stable equity market in which to calmly enjoy a sizable monthly index return like that.

IBM's Revenue Growth

Tuesday's Wall Street Journal reported on IBM's quarterly earnings announcement with the headline Worries Persist for IBM and the subheading Tech Bellwether's Profit up 7%, but Contracts Disappoint.

I've written in prior posts that it seems passe to consider IBM a 'tech bellwether.' Be that as it may, the firms nominal year-on-year revenue growth was only 7.8%.

My proprietary equity performance research found that earnings growth isn't significantly related to changes in total return. Which means that managers will do whatever they must in the near term to make earnings targets, thus making them meaningless as indicators. In this case, doing so led to profit growth which almost matches revenue growth. The latter qualifies for being a high growth rate, unless you're talking about a conventional slow-growth firm. Otherwise, it suggests economic weakness.

But revenues are a different story. And IBM's near-flat revenues growth ought to trouble those who monitor the US economy. If the firm is a bellwether, be concerned.

Tuesday, October 18, 2011

The US Economy- Are We Really In An Expansion and Not Re-Entering Recession?

Over the past week or so, a number of pundits, including a handful of equity fund investment officers, have appeared on cable business news channels to assert that the US economy is expanding, not entering a recessionary phase. They point to some marginally-lower unemployment filings, or slightly-increased consumer spending.

But I've been noticing some larger trends which would seem to suggest otherwise.

For example, I've seen one or two analyses in the past few months which have clearly illustrated that real US median income has has been flat, or declining, over a decade or more.

We know unemployment is very high. Mort Zuckerman estimated, in a weekend Wall Street Journal edition interview, that real total un- and underemployment is above 19%.

Consumers continue to attempt to deleverage their personal balance sheets of short term liabilities. Meanwhile, values of US housing stock remains significantly lower than it was 3 or 5 years ago. So it would seem both personal incomes and assets are not a source of new spending, nor are liabilities. And employment in gross total terms remains low.

US businesses continue to post profits and spend, but much of those flows relate to international, overseas business volumes, not US-based activity. That's why, like Britain in the 1960s and '70s, US corporate performance doesn't imply that US employment activity will be correlated with said performance.

The US financing sector isn't doing a lot of consumer nor small business lending. Large businesses have atypically large amounts of cash on their balance sheets, in order not to rely on banks and debt markets which dried up in 2008. So that doesn't seem to be a source of growth.

Just where do pundits assume the growth they contend is occurring is sourced?

Do they believe that, in a bifurcating US economy, the still-employed, better-off segments continue to spend, thus offsetting the belt-tightening of the lower-income segments of the population?

I do not have the data, but wonder if the lack of worse US personal economic activity statistics results from those with higher incomes and asset levels masking the declining spending and asset bases of those less fortunate?

Then there's Europe. Just yesterday, Angela Merkel publicly warned that the fix for the continent's debt problems isn't going to come from simply opening up German wallets. Others, notably Kyle Bass, who correctly foresaw the housing bubble's bursting, caution that, along with asset value losses which are certain to come from Europe's financial troubles, will be lower economic activity which will spread back to the US in the form of lower demand and, thus, lower US export levels and resulting recessionary pressures.

I am just not seeing a large silver lining in any of this. Nor, for that matter, much unadulterated, absolutely healthy economic data suggesting a healthy US economic expansion anytime soon.

Bloomberg's Tom Keene had Bob Albertson, a longtime banking analyst, as a guest yesterday on his noontime program. When he queried Albertson about his stance on financial and banking stocks, Albertson of course was bullish. After all, he's a sector analyst. What else can he say?

Then he blustered about banks leading an equity market rally. Then, finally, when Keene asked for a timeframe, Alberstson stalled, finally saying over the next 'year or two or three.'

My God!

The equity market disintegration of 2008 was three years ago this month. Would Albertson have said the same thing three years ago- to just hold on, eventually the market levels would recover?

I continue to view the optimism of pundits as book-talking and self-interested calming of investor nerves. A broad, deep array of supporting economic data, and positive trends in Europe and the US regarding financial sector issues, remain missing.

Monday, October 17, 2011

CNBC & Bloomberg Odds & Ends

While working and writing this morning, I observed the following on the CNBC and Bloomberg business cable networks.

On the former, David Faber's noontime Strategy Session has become a ratings casualty. I happened to be listening to the 9-11AM program, which announced it was newly-extended for another hour. Faber and his former co-host, Gary Kaminsky, appeared in discrete segments, as did Rick Santelli, with Kevin Ferry and The Wolfman, from the CME. The CME-based segment is apparently intended to be a frequent and longer featured element going forward.

Checking internet chatter, I see that the move was announced last week. One reviewer claimed that Faber's program wasn't sufficiently visual, i.e., didn't feature shots of the NYSE floor.

Well, neither does the options program. Nor Tom Keene's Bloomberg midday hour.

I suspect that, in line with CNBC's typically shallow, brief approach to any finance or business story during the day, Faber's cerebral treatment of topics just didn't fit, whereas Keene's program does mesh with his network's deeper, more insightful treatment of business and finance stories.

Elsewhere, various sites either stated or implied that CNBC's 11AM-noon The Call, with Melissa Francis and Larry Kudlow, was too non-liberal in sentiment, so it had to go. And along those lines, Michele Caruso-Cabrera was ousted from the early afternoon Power Lunch and named some sort of senior international correspondent. Thus cleansing CNBC of any objective political viewpoints in New York between 9AM and whenever Francis is allowed on again in the afternoon.

Still, that doesn't mean that Bloomberg can't be biased and shallow, too.

For example, this morning the network aired a real time interview with James Galbraith, an economics professor and son of the late prominent liberal economist John Kenneth Galbraith. In his mercifully brief appearance, Galbraith assured one and all that the president is in an ideal spot, politically, on economic matters. That his jobs bill is the magical elixir for the US economy, regardless of its cost, and that Republicans have 'no ideas' to counter it.

I can't speak to Galbraith's first point, since it's merely an opinion, but the second and third are sheer nonsense.

Does it not concern you that the president calls for massive (re)building of schools, roads, and bridges, all of a sudden? The House Transportation Committee is an historically large one, for all the infrastructure pork to be had by serving on it. This nation has appropriated tens of billions of dollars for such infrastructure for years- decades, even. Where'd it all go?

Schools are the province of local communities, not the federal government. Why do we suddenly want the federal government making decisions regarding local school needs? I certainly don't.

Doesn't that also suggest that a nation full of local school districts have been totally negligent in overseeing the nation's physical educational assets? Why don't we fix that, if it's a problem, and not just send the problem up to Washington?

Then there's the massive public sector union hiring to do all the (re)building, not to mention teaching. Except  that, elsewhere, on my companion political blog, I've discussed evidence illustrating that many US states have suffered growth in numbers of teachers and their associates which far outpace the growth of relevant student populations. In some states, the growth rates actually go in opposite directions!

Again, hardly something we either need or should want federal "help" to sort out.

Galbraith then proceeded to call for a whole new set of FDR-like GSEs to replace old, outdated and shuttered programs like RFC. When challenged that Fannie and Freddie had resulted in the 2007-08 financial crisis, Galbraith falsely replied that they didn't cause the problem, and only experienced losses near the end of their long lives. So it was okay to expand them again, or just create replacements.

Just incredible!

Finally, Galbraith's breezy dismissal of Republican ideas about job growth was just insulting. But perhaps only slightly less so than the Bloomberg anchor's failure to challenge him on this false contention. Just because Republican solutions to US job growth don't involve throwing half a trillion dollars at public sector union members doesn't mean they don't offer any. In fact, GOP Congressional leaders have argued long and loud for less government-generated uncertainty in the business sector, and less regulation of sectors such as energy and finance, so that job losses could be reversed.

Sometimes cable network bias is so subtle and quick that you almost don't even notice it.

Robert Frank's Wacky Economic Ideas

I saw a rather chilling exchange last Friday on Bloomberg television. On the network's midday program hosted by Tom Keene, Cornell's Robert Frank spewed some incredible economic nonsense. Here's his personal website.

On it, for example, is this passage,

"My conversation with Rachel Maddow on the lunacy of not extending long-term unemployment benefits"

On Keene's program, Frank went even further. For example, he berated Herman Cain's flat consumption tax, insisting it had to be made progressive. He naively claimed that by spending federal money now to build roads, we'll get a benefit of lower materials costs and lower labor costs because the latter are unemployed.

Hasn't Frank heard of the Davis-Bacon Act, which can add as much as 20% to the cost of such projects? Why must the federal government take on these projects? Why not state and local governments with, if need be, federal loan guarantees?

Frank also railed against libertarians, but used a straw man to do so. He began by pontificating about how ludicrous it is to consider taxes as 'theft' and oppose all government spending. I don't know of anyone who holds those positions, save perhaps Robert Nozick in his theoretical texts.

A more reasonable and pragmatic example of modern, real world libertarianism is the Tea Party movement. Those people want less government intrusion into the economy, lower spending and taxes. I never saw anyone at a Tea Party event at the Capitol arguing for no federal government whatsoever, or zero spending.

But straw men are easier to lampoon caricature. Frank, as a Cornell economics professor, should know better.

Frank's latest book is The Darwin Economy, reviewed here on Slate. Keene mentions it on his program occasionally. Here are a few paragraphs from the Slate review which provides a sense of Frank's arguments,

"Frank bases his argument on the Darwinian notion that life is graded on a curve. How much is enough depends on what others have got. Most people, for example, would rather live in a 4,000-square-foot house that was bigger than their neighbor's than a 6,000-square-foot house that was the smallest on the street. Economists call these positional goods, and contrast them with things that aren't so relative, such as safety at work, where most people think it's better to be safe in absolute terms than the safest worker in a hazardous factory.

Positional goods lead to waste, says Frank, because people end up living in bigger houses than they need to, throwing lavish parties, and spending money on pool cleaners. This pressures other people to do the same, and so takes money from the better uses that might be predicted by Smith's rational model.

Frank's elk vs. gazelle example may not be so useful, but in exploring the tension between natural selection and the common good, he touches on the toughest question in evolutionary biology: How has natural selection, which drives individuals to compete with their own kind, nevertheless produced so many examples of cooperation and altruism?

Frank's economics are implicitly group-selectionist. He wants to maximize the good of society as a whole by reforming the tax system so as to deter what he sees as antler-like arms races. To reduce positional spending, for example, he wants to replace income taxes with consumption taxes, calculated on the difference between what people make and what they save."

Elsewhere, even the liberal reviewer on Slate admits that Frank misapplies Darwinism in his quest to apply it to economics.

I find two things very troubling in Frank's work. First, his move to group welfare maximization, an old utilitarian concept which the US Constitution rather explicitly negates in its promise to protect individual rights, among which, from the Declaration of Independence are liberty and the pursuit of happiness.

In effect, Frank presumes the Progressive movement's objective of collective welfare as given. That's just wrong.

Secondly, sloppy and seemingly-inventive borrowing of a concept such as natural selection and evolution, and injecting it into economics, is extremely suspect. I'd have a lot more tolerance for such clearly self-serving nonsense if Frank was on record citing numerous controlled experiments which support his contentions. But nobody, including Frank, mentions them, which would seem to indicate they are non-existent.

However, Frank does touch on something that I think is important, and for which there is some historical precedent. When the wealthy members of a society possess some extreme proportion of that society's wealth, and behave in a way that leaves the poorer segments of that society at or below some threshold level of poverty, then the latter will rise up and forcibly seize the former's property.

Whether you choose Communist Russia or the French Revolution, or even point to the Magna Carta, this is a real human phenomenon. But blind, unfettered progressivism which simply makes the wealthy pay "more" of society's burden isn't a fair solution.

If a society, through its government, serves notice on its wealthier members that their share of societal expenses will be higher if certain metrics of distributional welfare levels are not met, that's fine. Perhaps a government would even prohibit certain investments which move employment overseas under such conditions.

But such conditional rules and taxation schemes merely add to uncertainty in the business sector. Which typically results in reduced investment and production, all other things held constant.

In short, you can dress up socialism however you like. But it seems true that the wealthy ignore extreme income and welfare disparities at their peril, while governments ignore the effects of punitive legislation directed at those who create society's wealth and income, at that nation's peril.