The Reasoned Sceptic

MF Global, Corzine & Gensler

2011-12-05T00:45:00.023-05:00

The lead staff editorial in Thursday's Wall Street Journal provides a nice overview of what's wrong with federal regulation of the banking and securities sector.

The piece details how, once Jon Corzine became CEO of MF Global, the Fed reconsidered and reversed its earlier decision to deny the firm its request to become a primary dealer.

The Journal notes that MF Global had posted six losses in the past seven quarters, but drew no extra regulatory scrutiny. It was more than halfway through that period when the Fed granted MF Global its primary dealer status.

What the editorial explains, correctly, I believe, is that it's not quite correct to simply say that Dodd-Frank and the overall federal regulatory scheme worked, because MF Global failed without larger consequences or incidence. But the apparent misuse of customer funds, and outsized position risks taken by the firm, were completely overlooked by regulators.

Isn't that what the system is supposed to prevent? The actual illegal and overly risky types of actions which MF Global is suspected to have taken?

Gensler recused himself from the case, which tells you how much this is all about crony capitalism, which the Journal contends. Either Gensler shouldn't have had to recuse himself, or he should have admitted the cronyism back when Corzine took the helm of MF Global.

It's tempting to write off the MF Global collapse as a one-off, smallish, successful proof of Dodd-Frank. But, in reality, it's proof that our federal financial system regulations don't seem to have clear-cut objectives, or, quite likely, if they do, are not capable of actually implementing them and protecting anyone or anything- not customers, shareholders or the larger US financial system.

Regarding Facebook's Valuation

2011-12-02T08:05:00.000-05:00

The Wall Street Journal has published several page one articles recently concerning Facebook's putative $100B market value. I had to go to the Journal's site to confirm Tuesday's edition's lead which contained that number, it seemed so staggering. Facebook is looking to sell just 10% of that value in its IPO scheduled for early next year.

Much is being written regarding the appropriateness of that valuation. I'm not in that business, so I'm not going to argue over billions.

What I am, though, is a strategist who has learned to apply that type of critical thinking to business and equity management.

Among online ventures, I would agree that Facebook should be at the upper end of the valuation scale. Here's why.

Zuckerberg's- and his famous twin collaborators- big idea was initially simply replacing the once-popular college paper 'picbooks' or 'facebooks,' which I first encountered as a graduate business school student at the University of Pennsylvania, with an online version. From there, the rest is history.

Like Google's Brin and Paige, Zuckerberg and his colleagues invented one thing, which just happened to be a popular 'app' for which, in time, advertising was a natural fit. For Google, the search results were just begging for nearby ad placement. And the best part was that, unlike passive television, active searches allowed Google to sell literal terms to advertisers, thus making specific buyers much more valuable.

Facebook has the same characteristic. By developing an application which induces people to spill their guts about their lives onto a webpage, it's tailor made for associating advertising with these pages. And because of its communal nature, it multiplies that value through the various platinum-plated, self-organized, genuine communities of great and frequent interest.

For a marketer, it's a dream come true. Instead of searching for, say, early adopters, you have the ability to link to the close friends of one by virtue of the site's very nature.

How can that not be valuable? Or, as the late Steve Jobs might say, 'insanely' great and valuable?

And because Facebook is simply a generic self-expression tool, it's potentially usable by every living person on the planet, and maybe, in the future, the dead, as well, in absentia. So the accessible market is literally the entire global population that has web access.

Search engines have come and gone. Who even recalls Webcrawler or Lycos anymore? But, like telephony or the mail, social networking technologies become more valuable and monopolistic by their very nature. That's why MySpace became such a money sink and, ultimately, loss for NewsCorp. Second place in social networking is nowhere. Especially when the market share leader is so far ahead as Facebook is.

Thus, while Linked-In is, by comparison, relatively narrow, with its business- and skills-focus, and Groupon is deal-specific, Facebook is perhaps the most common of social networking applications. It probably does belong, if not now, then eventually, in Google's league, which is now about $200B.

Stunningly, that's only twice what Facebook's IPO-imputed valuation. Barring gross mismanagement, I think that sort of valuation range is quite reasonable and appropriate. In the future, who knows by how much that could increase?

From an equity management perspective, of course, that doesn't mean my portfolios would include Facebook in the future. Google never made it into the portfolio. In the early years, its valuation was simply too rich, relative to its growth rate. By the time the valuation had become reasonable, according to my selection criteria, its growth, too, had moderated. Perhaps Facebook will undergo the same dynamics. It will be interesting to see.

About Angela Merkel's Prussian Values

2011-12-02T07:39:00.000-05:00

I wrote this post last week, in which I provided a disclaimer relating to my views on how Germany views the profligacy of many of its fellow EU members,

"As a disclaimer, let me mention that my own heritage is Germanic. So the Teutonic insistence on the profligate Europeans paying for their sins is not foreign to me."

By the way, I'm not just of German extraction, but Prussian. Both sides- one from the permanently-German states, the other side from borderlands between Poland and Germany.

Thus, I was amused to read this in Wednesday's lead Wall Street Journal staff editorial,

"In opposing that option, the Germans are said to be imposing their Prussian morality on everyone else. But without reforms, the countries of southern Europe will never pull out of their downward debt spiral. The Germans are at least telling the truth."

I highlighted the two words in the passage which I found so amusing. It's not just me who sees this long-evolving crisis as a morality tale now relying on Prussian values and discipline to resolve it.

Monetary Cocaine From Six Central Banks

2011-12-01T09:15:00.000-05:00

What can you say about yesterday's equity index responses to the announcement that six large-country central banks, and the ECB, provided coordinated dollar funding support to European financial concerns? This news, along with a optimistic ADP payroll forecast, drove the S&P500 Index up 4.3%.

But if you listened to various pundits on CNBC and Bloomberg television, the news wasn't actually so good. It gradually dribbled out that un unnamed European bank was set to go bankrupt over this coming weekend from insolvency due to an inability to replace lost dollar funding. The credible pundits, people like El Erian of PIMCO and Alan Meltzer, for example, were relieved with the immediate move, but remain concerned that the longer-term problems in the Euro zone remain unresolved. Meltzer advocated a two-track Euro, effectively saying he believes the currency, as we now know it, is finished.

But let's be blunt, if seemingly cynical.

What you heard from the asset management community was a gigantic sigh of relief that these six central banks have put their taxpayers' incomes behind promises to dollar-fund failing European banks, thus providing a free floor under the values of those managers' portfolios.

This is the sort of hyper-global crony capitalism against which Occupy Wall Street rails, only most of them aren't actually sufficiently knowledgeable to understand that.

Does anyone who is informed about the history of markets actually believe that a handful of central banks, several of which, I believe, aren't exactly all that significant (Canada, Switzerland), can outgun the world's hedge funds? Recall how George Soros gained a huge leg up in his net worth by betting against the British pound, allegedly on an inside tip, and won?

What about the Baker Plaza Accords of the 1980s? When central banks go to war in the markets with fund managers, the managers typically bring more assets to bear. Yes, the banks can 'create' money, but, in doing so, depreciate the value of the currency they are printing. There's a relevant range of effective expansionary monetary policy, i.e., printing or borrowing money, with respect to time, quantity and fiscal context. Right now, the Euro nations don't have much range, the US a bit more, but, in total, global economies are phenomenally over-leveraged already.

So how is it that a Euro-zone crisis caused by over-borrowing will be solved by central banks....borrowing or printing more money to magically produce dollar funding for near-insolvent European banks?

That said, I hope you enjoyed yesterday's landmark US equities rally. I'm sure the hedge fund managers whose asset values have been saved, provided they weren't naked short Euros, or can wait out the short-term pop in the currency's value, are very pleased. Everybody who was in the market got a nice 4% or so boost in value before selling the top in the coming months.

But as Rick Santelli said on CNBC this morning, the Fed is now 'all in' backing the Euro-zone and ECB. Helicopter Ben has linked the US economy and dollar to a bunch of entitlement-loving Euro nations and their failed fiscal policies.

Tom Keene's Housing-Related Program Yesterday On Bloomberg

2011-11-30T11:23:00.000-05:00

Bloomberg's Tom Keene continues to slip in my estimation with almost every program of his that I view. His guests are of uneven quality, and Keene tends to project this naivete that makes you wonder if he's really up to cross-examining his guests. I'm guessing not.

Yesterday he had two women guests discussing the US housing situation. First was, I believe, Laurie Goodman, a principal with an asset manager.

Goodman declined to attribute responsibility for how we came to have 20% of all mortgages in existence five years ago now delinquent, and 23% of all US mortgages underwater.

Keene was totally in love with a trend chart purporting to illustrate that job growth was dependent upon housing, so without housing growth, the US economy is dead. He never questioned whether perhaps this had been a short-term (only a decade or so, I believe) and artificial correlation that is, in fact, unhealthy for the US economy.

Goodman sensibly said that thing will get better as new construction stops, thus forcing the huge foreclosure overhang to be worked off. And that two other events need to occur.

One, which Lew Ranieri explained over six months ago on CNBC, is the appearance of a government program allowing local investors to buy foreclosed properties and rent them. The second is to process as many foreclosures as possible in order to eliminate the old, high costs bases and allow new owners to buy at market prices.

She added that lending for these new mortgages is stalled, presenting a stumbling block.

The second guest, Stephanie Meyer, now with BofA Merrill Lynch, echoed Goodman's sentiments. She was clear about the need for foreclosures to move along and allow repricing of housing stock.

Interestingly, and another incident of Keene's failure to adequately question his guests, neither woman, nor Keene touched on the political issue of dumping so many existing delinquent homeowners out of their homes. That the current administration is trying to prevent this by threatening 'cramdowns' and such forcible taking of investor value to reward delinquent homeowners.

Disappointing, too, was Keene's failure to challenge whether the housing sector should ever have become so central to the US economy, and whether its removal of mobility for homeowners was a mistake in our modern economy?

Still, the raw information from these two guests concerning what would move the housing sector forward was refreshing.

Black Friday & Yesterday's Equity Market Pop

2011-11-29T08:46:00.000-05:00

Positive news about Black Friday's sales numbers propelled equity indices up sharply yesterday. The S&P500 Index rose 2.92% on the strength of the information.

However, as a Wall Street Journal article explained, there's actually little correlation between Black Friday sales and sales for the entire holiday season. It mentioned the 2008 holiday season, when Black Friday sales were up 3%, leading estimates for the entire season to be increased to 7.2%, only to see the actual data come in at -4.9% for holiday season spending.

Moreover, as I watched CNBC's coverage of the unfolding Friday shopping, guest hosted by well-regarded retail analyst Dana Telsey, it was clear that people were out shopping because of the large discounts being offered. Telsey admitted that this season's sales would be low-margin in nature but that, due to falling commodity prices, hopefully 2012 would be 'the year of the margin.'

Meaning that Black Friday's sales were robust because many people were out taking advantage of sales. And this is good news? This is going to fuel a long-lived US economic expansion?

I doubt it.

Another reason for yesterday's equity index performance was reported to be, as one analyst coined the term, 'hope-ium' that Euro governments discussing coordinated, tougher and enforceable fiscal policies would eventually resolve that trading bloc's sovereign debt woes.

If that isn't a pipe dream, what is? Looking at the reactions of the populace in Greece and Italy to austerity measures, what do you think will occur if/when the same is applied to Spain and France?

As I write this, the S&P futures are up to 1194, presumably on the news that Cyber Monday sales were 15% higher than last year.

Again, fine for a passing S&P500 rise, but suspect as the source of lasting US economic expansion. As a friend of mine opined last night regarding the holiday sales reports, and his own experience at a crowded restaurant over the weekend,

'It seems like if you have a job, you're spending. But if you don't, it's a different story.'

Just so. And with broadly-defined, actual US unemployment between 15 and 16%, and real median income for the past decade flat, that doesn't seem to be an improving underpinning for the US economy going forward.

US equity indices reflect global economic activity, so they may outpace US economic growth. But Europe's slide into recession should concern investors looking at the global GDP outlook.

The Economist's Denial Concerning The Euro & Europe's Entitlements Crisis

2011-11-28T11:31:00.000-05:00

The current issue of The Economist entitled it's lead staff editorial "Is This Really The End?" Of the Euro, of course.

The piece then goes on to examine various ways Euros may be printed or borrowed, or back yet another instrument in hopes of fooling investors into overlooking the EU's real problem.

While usually on target, the Economist is hopelessly in denial on this issue. They concentrate mostly on the topic of Germany and Merkel simply bailing out Europe, about which I wrote recently. But that's almost a sideshow.

What the editorial never mentions is that this isn't simply a financial or sovereign debt crisis, per se.

It's a European entitlements crisis.

The Economist can blather on all it wants about the ECB, the EFSF, the Euro, and various means to move the same old monetary pieces around the same board, sometimes with new labels on them. But none of that will solve the problem.

The United States and Europe's nations all share a common, heretofore not experienced problem. Their lush government defined-benefit obligations have finally outstripped their abilities to fund said obligations. They are all gigantic Ponzi schemes, in which 1.5-2 generations have legislated extravagant benefits for themselves, to be paid by borrowing now and taxing later generations, or simply taxing later generations. Thus, there's no possibility of resolving the loss of confidence by global investors, because the money to solve the problems doesn't exist yet.

And with the suffocating tax and regulatory burdens besetting all these nations, it's looking like economic growth won't be helping anytime soon.

Face it, the developed nations are in for a rough economic ride for probably at least one decade- maybe more. Since WWII, governments have voted their older citizens benefits never before enjoyed in the history of civilization. And clearly won't be again, either. It's been a massive acceleration of spending fueled by wealth borrowed from future generations. Thus, GDPs since the war have also probably been artificially pumped up on this monetary equivalent of steroids.

Only a return by all large economies and nations to defined-contribution social welfare and corporate pensions and health care schemes will bring this unsustainable financial joy ride to an end.

And forget what you hear about any of these oldsters having "earned" their promised benefits. That's a lie. Those benefits were legislated without a clear explanation of their funding, while economists stood by and remained silent on the senselessness of promising such large-scale fixed and escalating benefits to be funded by dynamic, competing, uncertain economies throughout the world.

In America, beneficiaries of Ponzi schemes are forced to return their payouts by virtue of the scheme being a fraud and, thus, no real gains being available for anyone to realize. As an example, witness the ongoing recoveries of the Madoff fraud's payouts.

Why should the payouts of similar government-run Ponzi schemes for retirement and medical care be any different? Nobody 'earned' those benefits. They were never really affordable in the first place.

It may take years, but eventually, voters will have to accept that they elected governments which promised benefits many voters knew weren't really affordable. And they'll all have to take haircuts on those benefits.

Which brings me back to my starting point.

Germany can't fix the Euro problems because they aren't, strictly speaking, just about sovereign debt, the Euro and defaults. They are about totally unsustainable government benefit programs which can't be financially finessed back into solvency.

It's not a liquidity or currency issue. It's a social welfare state issue around the globe.

The Economist should know better than to go into denial about this truth.

Great Expectations

2011-11-26T00:18:00.057-05:00

If you want to understand how America has corrupted itself while amassing $15T in debt, with even more in still-unborrowed, unearned entitlement liabilities, consider this thought experiment.

It is 1925. WWI is behind us, and the Roaring '20s are in full swing. GDP growth is torrid, new products and innovations abound. Incomes are rising, as are standards of living. Electricity, telephones and the car have revolutionized American life.

Income tax must be paid in one lump sum, while medical expenses and retirement are self-funded. People are still self-reliant.

Ten years later, global economic conditions, bad, constrictive monetary policy and too-liberal borrowing to buy equities have resulted in a market crash and simultaneous global recession which becomes the Great Depression in the United States. FDR's response is to print money to fund various government giveaway programs, while pushing Congress to pass the act that creates the greatest social welfare mistake, Social Security, which will inexorably change peoples' savings behaviors and the social structure of families.

Over the next few decades, young and old alike begin to rely on government promises of defined, ever-increasing benefits, and spend more, instead of saving for old age. Three decades later, Medicare and Medicaid are similarly mistakenly designed on the same lines as the original error, Social Security. Dependence on government for near-total pension and medical care funding are complete.

Now the experiment.

Imagine an America that never created Social Security, Medicare or Medicaid. Imagine that, like in 1925, future decades saw an America without government promises of retirement income and medical expense funding.

Instead, Americans remained self-reliant on themselves or their employers for retirement and medical care funding.

Since, ultimately, Americans were going to pay for these expenses themselves in some way, whether privately-funded, through taxes, or government borrowing financed by taxes on later generations, the real question is: how would their interim spending and savings behaviors have been affected?

What did Americans do before the government-promised benefit schemes of the 1930s and 1960s? I believe they spent more prudently, saved more, and expected to work longer. So if we'd never had the badly-designed Social Security, Medicare and Medicaid programs, it's likely people would have continued to do the same- spend less and save more for their own retirement and medical needs.

See, whether government provides it, or individuals save for it, the money for post-work living expenses and medical care come from the same place- wages earned while people work.

You can call it taxes, government borrowing or you can call it forced individual savings, but, either way, money for people's old age living and health care can only come from wages they, and/or future generations, don't spend.

If government had begun to mandate savings for both needs, kept in individual accounts, the effect would have been the same as if everyone behaved prudently and saved enough of their incomes to fund those needs.

However, the major difference would have been that there would have been no looming unfunded government-suppled defined-benefit pension liability or medical care funding, including generational shifts in the liabilities for them, because no such benefits would have been promised. Instead, savings would have gone to accounts meant to fund individuals' old age and medical care.

Of course, one other major difference is how these schemes affect the financial behaviors of individuals. When told government is supplying benefits, people spend more. Even though the money for the 'guaranteed' benefits has to come from taxes now and borrowing which is repaid with taxes on future generations. And it's a safe bet that cycling money through taxes, Washington and and back again adds to the cost of the benefits which are being funded by taxes on individuals' wages anyway.

There's one more difference. When benefits, instead of contributions, are promised, then timing can become mismatched. And one generation can enjoy benefits which leave debts for the next generation to pay.

Which is where we are now. But reasonable people realize that the defined-benefit schemes of the 1930s and 1960s have over-promised and won't be affordable for another generation. So, in reality, one generation promised itself lush benefits and left the bill to following generations.

That's why defined contribution schemes are inherently more fair and moral. They leave the cost of old age and medical care with the generation incurring them.

I find it fascinating to consider how families in the 1920s considered funding for the retirement of the adults in, say, the 1960s. Or their medical care. Without government programs promising those benefits, or company-supplied medical insurance, didn't they just save more and spend less, budgeting those costs into their existing lifestyles?

Why couldn't the same behaviors return for Americans, once we abolish unsustainable group defined-benefit programs? The money comes from the same place.

The real difference, in the end, affecting behaviors, is the expectations set by either self-funding or government promises of defined benefits. And the past 80 years have demonstrated that inappropriately-raised expectations by government's unaffordable and unsustainable promises have raised expectations to unaffordable levels for our entire society.

Germany, Merkel, EuroBonds, The ECB & The Euro-Crisis

2011-11-25T08:54:00.000-05:00

It's almost funny now to hear pundits and reporters on CNBC and Bloomberg gush over how the only solution left that will placate investors is for German PM Angela Merkel to agree to either ECB issuance of bonds/printing of Euros, or EuroBond issuances.

Anything else, one European correspondent solemnly intoned, and the world will plunge into financial chaos and ruin. Did the Germans really want this?

Or will they step up to the plate and save the global financial system all by themselves? C'mon, he implied, why can't Germany just open its checkbook to bail out everyone else?

As a disclaimer, let me mention that my own heritage is Germanic. So the Teutonic insistence on the profligate Europeans paying for their sins is not foreign to me.

But I do, honestly, see the Germans' viewpoint. Why should they mortgage their economy to bail out those of France, Greece, Italy, Spain, etc.? Where will it all end?

The foreign correspondent who tut-tutted Germany for playing chicken with global ruin also confessed that, sure, in such a scenario, Germany comes out best among the ruined financial world.

It has become borderline-hilarious to me how media pundits and analysts desperately hope that Germany will ruin itself financially in an insufficient attempt to rescue the entire rest of Europe and, by implication, the world financial system. And why? Because it's the last apparently large, solvent European nation, and a fairly comparatively conservatively-managed one, as well.

As I wrote in a prior piece, echoed in a humorous piece by a Harvard economic historian in last weekend's edition of the Wall Street Journal, what the Germans couldn't accomplish with their 88mm guns in WWII, they may well achieve simply by being patient as the rest of Europe offers more and more financial and political control to the Germans, in exchange for a gigantic bailout.

In the meantime, regardless of the global consequences, I can't but respect and agree with the German reticence to be sucked into financially rescuing the rest of Europe.

S&P500 Index Performance vs. US Economy- Now You Know Why They've Diverged

2011-11-25T00:24:00.036-05:00

Finally, a really good, solid datapoint!

Tuesday's Wall Street Journal featured an article on the front place, top, of its Marketplace section with the headline,

"U.S. Firms Eager to Add Foreign Jobs"

The first paragraph said it all,

"U.S.-based multinational corporations added 1.5 million workers to their payrolls in Asia and the Pacific region during the 2000s, and 477,500 workers in Latin America, while cutting payrolls at home by 864,000, the Commerce Department reported."

Further, regarding the other important business input, capital, the article stated,

"The multinational companies, for instance, reduced capital-investment spending in the U.S. at an annual rate of 0.2% in the 2000s and increased it at a 4.0% annual rate abroad. Still, they allocated $2.40 in capital spending in the U.S. for every $1 spent abroad."

In summary, US-based multinational companies cut 864,000 workers in the US and added 2.9 million workers overseas from 1999 to 2009.

If this doesn't explain why the US economy and GDP growth are slowing, with stubborn unemployment, while S&P500 company profits continue to rise, what else do you need?

It also explains why business investment spending, while remaining robust, isn't helping US employment. It's reasonable to expect that much of that new investment spending is being serviced by overseas units and, thus, workers, of US-based companies.

No surprise to me. This is pretty much what I would have expected to see. This is simply the first solid piece of data on the phenomenon which I've seen.

If you heard interviews with the author of Steve Jobs' authorized biography, you may have heard him recount Jobs' frustration with US immigration policy. The story involved Jobs and Google chairman Eric Schmidt, at a White House dinner with its current occupant, explaining that a lack of US engineering talent forced Apple to build a facility in Southeast Asia, where the engineers were available. In addition to the hundreds of engineers, Jobs told the president, Apple also hired thousands of local workers for the production facility.

That, writ large, is what these recent Commerce numbers capture.

Shareholders of these companies should rejoice that the firms are doing what is economically best for them. That includes...ahem.....union members whose pension funds own shares of the S&P500 Index or companies therein.

I wouldn't go pillorying the executives or boards of these companies. They are simply reacting to global demand, costs, tax rates and regulatory environments.

The US Congress and administration should take note. This report illustrates Ricardian comparative advantage economics in action. And that clearly portrays a US labor market that has become overly-regulated, too expensive and difficult to accommodate in exchange for the presumed benefits. Thus, these multinationals find it more cost-effective to service overseas demand with overseas labor, capital equipment and facilities.

Larry Fink On Warren Buffett

2011-11-23T00:14:00.039-05:00

I had the opportunity yesterday to watch the hour-long Bloomberg program I had recorded on Monday evening which featured an interview at UCLA's Anderson School of Business with graduates Bill Gross of PIMCO and Larry Fink of BlackRock. It's well worth some 40 minutes of your time- sans commercials- to view. Two of the smartest asset allocators in the world answer some pretty direct, potentially embarrassing questions. I learned a lot, if only, in many cases, that my own views are pretty close to those of these two asset management titans.

Of particular interest to me, after both veteran asset managers' generalized asset allocations for the near term future, were Larry Fink's remarks about Warren Buffett. They illustrate, for me, the continuing perception of Buffett that is so at odds with reality.

Fink told a story of meeting with Buffett on a day on which equity markets were plunging. He spoke admiringly of Buffett getting up several times during their meeting- apparently in his office- to 'buy more stocks.'

Then Fink reinforced his point by saying that 'everyone should behave more like Buffett,' lauding the Omahan's tactics of 'ignoring quarterly results and investing for the long cycle.'

Fink went on to say more glowing words concerning Buffett's track record.

Only here's the point. We don't know what Buffett's actual equity selection performance record is. We only know what Berkshire Hathaway's total returns have been. And those haven't been exactly consistently stellar in recent years. Moreover, Fink was stressing buying dividend-paying classic industrial or consumer goods stocks, while Buffett has been crowing about technology and banks. The latter, by the way, I believe both Gross and Fink said they wouldn't go near.

It seemed to me that Larry Fink was more repeating what he'd read in the fawning press regarding Buffett's long-ago equity selection results, rather than commenting on what's observable recently.

He also skipped over the part about Warren not needing to worry about short term performance. In that recent linked post, I wrote,

"I contend that if Berkshire's price charts were labeled Fund X and compared to other funds, Buffett's company would be judged inadequate, inconsistent and, at best, mediocre."

What Gross and Fink, termed by the Bloomberg host as the two men with more assets under management than anyone else in the world, both glossed over is how different management of institutional money by very large, now-reputable firms is than what individuals can accommodate.

It's simply not possible for the average retail investor of a few tens of thousands, perhaps hundreds of thousands of dollars, to emulate Buffett. Nor should they. They don't have the risk profile that Berkshire/Buffett does, nor access to the same risk management analyses, nor tools to manage risk. Buffett's corporate billions can withstand losses that individuals cannot. Individuals facing retirement and worried about market downdrafts don't have Buffett's luxury of riding out Fink's "long cycles."

Further, they can't get an inside track to lend BofA money at preferred rates, plus warrants. Or get an otherwise-illegal inside track to make a tender offer for Burlington Northern while excluding any competing bids.

I have tremendous respect for Larry Fink. He's built one of the two largest money management businesses in the world, from scratch. He clearly does good work for his clients.

But I don't think that makes him either objective or an expert about Warren Buffett's equity management style or its utility and applicability for average retail investors. And his comments illustrated how widely-accepted, without evidence, Buffett's reputation remains.

Examining The Context of Market Timing

2011-11-22T09:18:00.001-05:00

Yesterday I wrote this post, in which I noted how the S&P has been around the 1180-1190 level several times in the past few months and, in fact, a year ago this week. Thus suggesting that overly-active management has pitfalls. Because in some market conditions, if you wait long enough, you'll see the market return to a level.

However, while discussing the post with a friend, I articulated a key facet of overly-active management, or timing, that makes it so dangerous and prone to overestimation of success.

Consider the following datapoints pairing dates and closing values of the S&P500 Index.

6/24/2011 1268.45

6/27/2011 1280.1
6/28/2011 1296.67
6/29/2011 1307.41
6/30/2011 1320.64
7/1/2011   1339.67
7/5/2011   1337.88
7/6/2011   1339.22
7/7/2011   1353.22

10/19/2011 1209.88

10/20/2011 1215.39
10/21/2011 1238.25
10/24/2011 1254.19
10/25/2011 1229.05
10/26/2011 1242
10/27/2011 1284.59
10/28/2011 1285.09

11/1/2011 1218.28

11/2/2011 1237.9
11/3/2011 1261.15
11/4/2011 1253.23
11/7/2011 1261.12
11/8/2011 1275.92

In each case, the last datapoint is the local maximum, from which the S&P fell. Yesterday's close was 1192.98.

When index gains seem to be part of a monotonic upward series, there's nothing magical about the peak closing value. A priori, amidst the justifications of many pundits who suddenly appear on cable networks, an investor is prone to be concerned that if he sells now, he'll miss a big move in an obviously upward-trending market.

This is where discipline makes a difference. Investing discipline is particular in its meaning to the style of the investor. It may involve adhering to signals and rules, rather than letting contemporaneous market conditions affect sentiment which overrides those signals or rules. Or it may involve some target rate of return, after the attainment of which positions are closed to cash or some fixed income instruments.

On one extreme, one might be a dollar-averaging, long term buy-and-hold index investor. In which case trends are moot. Or one might engage in some hyper-active style which buys upon a certain percentage downward index movement and sells upon a corresponding move upward. These are, of course, simplistic examples meant to mark the poles of market timing.

But rest assured, local equity index maxima don't come with identification tags or warnings. Attempting active timing without some well-founded, researched approach invites disaster.

Google Speeds Cable Disintermediation Via YouTube Celebrity Channels

2011-11-22T00:18:00.037-05:00

After reading a piece in the Wall Street Journal yesterday concerning Google's $100MM bet on celebrity channels on YouTube. It reminded me of my old mentor, Gerry Weiss' insights into competition and colliding arenas.

Gerry and his colleagues developed the concept as strategic planners at GE under Jack McKittrick. Essentially, a technology that is at the core of one entity in one 'arena,' or business area, uses said technology to expand into a new business. The entity's technological and/or other business model attributes strike at a vulnerability of existing occupants of the new business, causing a radical upheaval.

That's what seems to be about to occur at Google/YouTube.

I've been writing about the disintermediation of cable television for a few years. Now I realize that Google's recent staking of various media celebrities to $100MM worth of channels for their own creative usage will only speed that disintermediation. The Journal article cites several actors having broken into work on cable television programs via viral YouTube videos.

I've contended for several years that a writer/producer like Larry David would be foolish to bother putting his next series on cable. He could easily go right to streaming video from a website.

Then Glenn Beck departed Fox News for his own website-based media empire.

The Journal piece ended on a cautionary tone, noting that Google isn't likely to be earning revenues from any of this YouTube effort anytime soon. But offered a silver lining that in just three years, its Android cell phone alternative has grown to take half of the smart phone market.

My own sense of Google and YouTube is that, in the simplest case, they get eyeballs on which to earn advertising revenues. Then, over time, as viewers are trained to watch streaming web videos as their natural way of viewing heretofore broadcast- and cable-only frequently-aired (i.e., weekly programs) content, the step to paying for new content from a bankable talent like David or some other writer will be simple.

At that point, it wouldn't be a stretch for Google to be straying into signing and backing new talent, would it?

Even if not, just by migrating more and more viewers to their streaming video, they'll drain the last drops of life from broadcast network television, while accelerating the problems at cable providers.

That's one of the hallmarks of arena competition. Whether it's smart or not, the new entrant can afford to subsidize its intrusion into the new business with profits from its existing businesses. In Google's case, they aren't unconnected. But its targets don't really have multiple revenue sources on which to rely in the coming video content sourcing battle.

What Did I Miss? Evidently Nothing.

2011-11-21T11:27:00.000-05:00

As I write this post at 11:15AM today, the S&P500 Index is at 1187. My proprietary vvolatility measure, which more or less tracks the VIX, has been above a critical threshold since early August.

Interestingly, you could have been gone for the past two months and missed nothing in terms of S&P level. Or three months, since mid-August, for that matter, if you're a buy-and-hold kind of guy.

Or a year, for that matter! The S&P was at today's levels a year ago this week.

Of course, if you were invested for the past year, but rebalanced gains or were incredibly lucky with your market-timing, perhaps you sold above 1300, realizing a 10%+ gain.

But the point is, volatility has been above my threshold more than not since early 2008, or three and a half years! The interval between the US equity market turnaround in March of 2009, and the initial Greek debt crisis was only about 13 months. The highs of 1400+ on the S&P of early 2008 have never been revisited.

At present, November's S&P monthly return is below -5%.

Which is why market-timing on relatively small gains and losses in the indices is such a dangerous practice. Especially now.

This Morning's Stupid Remark on CNBC

2011-11-21T07:55:00.000-05:00

Howard Ward, a growth portfolio manager at GAMCO, made a rather naive and stupid pair of remarks this morning, and it's not even 8AM.

First he asserted that there have been 'five or six weeks of good economic news' in the US, so "we're doing okay."

Really? 9% unemployment and 2%+ GDP growth is okay Howard? Wow, I'd hate to see bad.

Ward then proceeded to declare that even as Europe slips into a recession,

'The rest of the world can keep on growing and Europe can have its recession separately.'

Where has Ward been for the past two decades? Global interconnection of supply chains and US companies' dependencies, especially recently, for growth overseas has resulted in a much more correlated global economic picture than ever before.

Europe is a huge economic trading bloc. Growth in one of its larger member countries, Italy, is projected to be negative next year.

I guess CNBC is desperate for guests if they're getting this caliber of pundit on their morning program.

More Housing Missteps By Congress

2011-11-18T08:18:00.000-05:00

Yesterday's Wall Street Journal's lead staff editorial reported the disappointing news that, with so much public attention focused on Fannie Mae and Freddie Mac, the FHA is being granted a rise of about $100K in value, to almost three quarters of a million dollars, in the size of mortgages it can guarantee.

Various data detailing the FHA's precarious capital position (about .25%, rather than the mandated 2.5% or so) and enormous, though underestimated future defaults on its portfolio.

FHA was supposed to be the original low-income government-assisted housing loan program. I recall selling my first home some twenty years ago to a veteran who received special treatment under the FHA loan for which he applied. Incredibly, as the seller, I had to pay his points. Imagine my surprise at the closing when I learned the couple had therefore gone and borrowed significantly more than they had initially represented in their purchase offer, sticking me with higher fees for selling my house.

The FHA program was designed long ago as a vehicle to assist the emerging middle class in what was then viewed as a laudable goal- home ownership.

It's hard to see how even in the New York Metro area, at this time, a $725K home can be considered either a starter, or deserving of any sort of special government assistance.

No doubt those defending this increase in FHA mortgage size will claim it is to boost housing demand in order to rescue the housing sector, create sales and, somehow, magically, ignite housing starts.

How many times have you heard pundits and, of course, National Association of Realtors officers blather on about how a US recovery must begin with housing? How we have to get housing fixed to fix the economy? How much the US economy relies on the construction sector which is sustained by housing?

What happened to letting the US economy, with its hundreds of millions of actors, determine sector activity through their genuine demand for various goods and services?

From my youth, to now, I can cite three industries which were supposed to be the backbone of the US economy in their day- steel, autos and, now, housing.

Each had a parasitic union which ultimately sapped its host nearly to death. Each sector had its productivity peak, the bulk of its value-added fall victim to lower-wage, and thus, higher-productivity foreign competitors. Which led to the exit of US producers as the products became more commoditized and the US lost competitive advantage in those products.

Housing, being a locally-produced and -consumed good, didn't get sent offshore. We killed this one by over-subsidizing it.

I've been very impressed by the studies I've read that demonstrate home ownership to be the enemy of the once-vaunted mobility of the US labor market. And never moreso than....at the low end of the income distribution. The absolute worst thing you can do for the lower income worker is to chain her/him to a home, so that when their semi-skilled job vanishes, they can't pick up and move immediately. Oh, and by the way, when that job does vanish, probably with hundreds or thousands of others like it, local property values will plummet, causing them to lose what little savings they had, as the home goes upside down with respect to its mortgage.

Maybe it's time we finally just stop subsidizing any sectors out of an arrogance which assumes a few legislators, with the 'help' of lobbyists for a sector, know what's best for American consumers and the US economy.

As of 2011, we've reaped a moribund housing industry from too many years of subsidizing the consumption of ever-larger houses by ever-more Americans. We've binged on housing, and now the value of that housing stock has fallen.

Market economics would lead us to let housing prices go where supply and demand take them. In this case, falling to a point where a newly-enabled tranche of buyers can afford that which was previously beyond their means, and at realistic interest rates and by appropriately careful lending standards.

No other path will resolve the housing sector's ills, nor cause it to have a positive effect on the US economy.

Rather than listen to politicians and pundits who declare we need this or that special program to incent consumers or business owners to behave in a certain way, to 'jump start' the US economy, perhaps, now, after several years of lackluster growth and a subsidized-housing-sector financial crash, we might just let market forces, in their own time, produce a real, sustained recovery driven by genuine market demand and, consequently, supply.

Non-Breaking News On Tom Keene's Bloomberg Program

2011-11-17T13:25:00.002-05:00

Sometimes I think Tom Keene purposely acts stupidly in order to make his guests feel smart. Other times, I think he really is as clueless as he periodically makes out.

Take this afternoon's closing segment on Keene's noontime program.

Keene's guest used the UBS announcement that it is simplifying its business model by shedding a few thousand investment banking employees. After a few minutes of discussion, Keene had his 'gee whiz, I'm surprised' moment regarding the rise of privately-held financial services boutiques. Then he let on that he knew Blackstone has a very healthy and large M&A advisory business.

Subsequently, the term 'brain drain' was used to describe the movement of talent from publicly-held formerly investment banks, now commercial banks (Goldman Sachs, Morgan Stanley & the IB divisions of legitimate commercial banks such as Chase, Citi and BofA/Merrill Lynch).

Except this isn't news. It's been going on for over a decade.

Ever here of a little outfit called Long Term Capital Management, Tom? That was 1998 when it imploded.

I've written a handful of posts dating back over several years observing the history of Wall Street- the real Wall Street, not the commercial money center banks outsiders incorrectly call by that term.

Hutton, Shearson, Lehman Brothers, Kidder Peabody, First Boston, Salomon, Morgan Stanley, Bear Stearns, et.al., rushed to go public in the first big hoodwink of investors back in the 1970s and '80s. I've argued that since then, investment bankers discovered how to get a one-time huge windfall for dumping risk onto public shareholders at a premium.

Some former partners hung around for the lush paychecks and options. Others quickly moved back into private partnerships. That's how Blackstone, BlackRock and other private shops were founded. Add in hedge funds for the veterans of the formerly-private firms' trading desks, and you pretty much have the recreation of the old, old Wall Street of the partnership era.

Then there's Dillon Read, which has sold itself at a market top, then gone private at the bottom, so many times that it makes your head spin.

Schwarzman's Blackstone has even initiated round two of the big bilk, selling a slice of the private equity firm a few years ago, at what astutely proved to be a market top. You gotta love these equity mavens- convincing investors to buy shares of their own firm, while forgetting they were putting themselves on the other side of the trade from the sharpest equity valuation guys around.

What passes for the public face of it has been run by mediocre talent for some time. Even Goldman let itself get tangled up in seamy, public messes rising from originating, then betting against mortgage-backed structured instruments.

Meanwhile, the new barons of the financial sector are people like BlackRock's Larry Fink, Wilbur Ross, and Blackstone's Stephen Schwarzman, along with hedge fund titans like Steve Cohen and James Simons.

How this has escaped Keene for over a decade is beyond me.

Even in commercial banking, two of the nation's largest, old money centers Citi and BofA, are headed up by inexperienced, inept seat-warmers Vik Pandit and Brian Moynihan. A failed hedge fund manager and a lawyer. Some talent, eh?

As nearly the entire publicly-held US financial sector had to be rescued in 2008, thanks to poor risk management, it should tell you where the real brains of finance were- in private practice. Where they've been moving since the first wave of mergers after the original going-public wave of the '70s and '80s.

Phil Angelides on Bloomberg TV Last Week

2011-11-17T00:18:00.012-05:00

Former FCIC chairman Phil Angelides appeared on Bloomberg TV last week one afternoon for a fawning interview during which he was asked to dispense his wisdom on a variety of topics.

What stuck with me was his insistence that the recent nearly-trillion dollar stimulus bill wasn't enough, and more must be spent to create jobs.

There were several other topics on which he was asked to opine. So many that I reasonably thought he must have some broad, long career in business, prior to his California political career. To ascertain that, I found and read Angelides' biography on a Stanford FCIC webpage.

To my disappointment, but, frankly, not surprise, he has a degree from Harvard in 'government' and absolutely no private sector experience. The Wikipedia page offers more detail on Angelides' political life. Suffice to say, he plunged into California Democratic politics upon graduation. Becoming Treasurer opened many more doors, including leading to his stint at CALPERS.

I suppose that career path, coupled with a Democratic Congress in 2008, with a Speaker from California, led to Angelides' chairing the FCIC.

What's curious is that there's nothing in his background to suggest he would actually comprehend all of the complex nuances of the events and actions by many players, including those in government, GSE and the private sector, which led to the boiling over of the crisis three years ago this fall.

Yet, having served on the FCIC, I guess Angelides is viewed as an expert on all things governmentally financial.

Nevermind that California's finances are a mess, and CALPERS has had its share of serious missteps, as well. Both of which you'd like to think would disqualify Angelides from being considered an expert on anything.

Which brings me to Bloomberg's producers. They must know that Angelides is essentially an empty suit. Like many other career politicians having no business experience, he would seem to have no basis on which to answer many of the questions a business cable television channel would ask of him.

But that doesn't stop Bloomberg from interviewing him on topics far afield from Angelides' experience, or the former FCIC chair from launching into lectures on such topics.

It seems to me telling that Bloomberg- and CNBC- focus so much on guests with essentially no business background but, rather, experience as government officials dabbling in business.

As they used to say in Hollywood.....that's entertainment!

Puzzling Economic News

2011-11-16T09:05:00.000-05:00

This passage appeared yesterday evening in a daily email from a financial services provider which attempts to explain the drivers of US equity and fixed income market performance,

"Retail sales in the US were stronger than anticipated and prices at the wholesale level cooled markedly from the levels seen the month prior, while the first read on manufacturing activity for November coming from the New York region unexpectedly moved back to a level depicting expansion and business inventories were flat."

Yet we know that the real median consumer income has declined in the last decade, and unemployment remains high- in the 9% neighborhood on the narrowest definition, probably 16% on the widest one.

If there wasn't a large and high-profile environmental variable, i.e., the European sovereign debt/banking crisis, currently causing uncertainty, these slightly positive economic data reports might be seen as harbingers of economic recovery.

However, as I wrote yesterday, in retrospect, the signs of mounting trouble in 2007 didn't prevent hope and cheerleading by the financial community through much of 2008.

I believe it was Larry Fink, in his CNBC appearance yesterday, who proclaimed that when an economic and financial market recovery occurred, it would be a surprise which moved faster than investors might expect. Isn't that always how it is?

The overall macroeconomic picture today seems very cloudy. Even Fink agreed that while current economic signals appear weakly positive, the environment is gloomy. By that he apparently meant the political climate of excessive, intrusive governmental policy, weak employment picture, and low GDP growth.

It's been written that during the Great Depression, things were tight but bearable if you had a job. Those who were employed at larger companies tended to weather the period pretty much intact. But new job growth was absent, so the unemployed remained so for a long time.

Our current economic situation is beginning to resemble that scenario. There were brief periods of equity market rises and seeming economic expansion during the 1930s, but none of them lasted for long.

With that example in mind, I wonder whether profits from US companies, by themselves, are sufficient to trickle through to shareowners and drive a US economic recovery in the face of stagnant employment. It wouldn't seem that's a likely recipe for a robust US economic expansion.

Selective Memory In The Economist

2011-11-16T08:18:00.001-05:00

I've subscribed to The Economist for over two decades now. I can't recall when the magazine's editorial pages didn't insist American tax rates had to be higher.

You'd think, given the publication's pedigree, that this would not be so. But, it is.

Yet, there's more to it than simply a stance on taxes that favors making the US more like, well, European welfare states. You know, like Britain.

There's also selective reporting to slant events.

For example, in an editorial regarding the Congressional supercommittee in the magazine's November 12th edition, you would read,

"Mr Obama and the House Speaker, John Boehner, discussed just such a grand bargain back in July, before the anti-tax wing of the Republican Party took fright."

Implying, of course, that Boehner succumbed to pressure from his more conservative House members. But that's not what happened at all.

Rather, as Boehner explained, he and Obama had a deal, then Obama succumbed to pressure from his base and added one more tax demand. Boehner walked on both principle and the particular tax issue.

But you'd never know it from reading that editorial.

It's tough to evaluate business and economic information when the reporting sources don't even get their facts straight.

Europe's Crisis & US Equities

2011-11-15T10:16:00.000-05:00

Two asset managers appeared on CNBC this morning- Mario Gabelli and Larry Fink.

Of course, these days every manager is asked about Europe. I didn't pay enormous attention to Gabelli's comments, but recall him pushing industrial sector equities, which probably means that's where his book is.

Fink, however, was more interesting for several reasons. First, his firm, BlackRock, runs much more money than Gabelli. And Fink tends to be more thoughtful and expansive in his comments.

Listening to Fink, I was struck by two aspects of his remarks.

First, like many pundits and observers, he continues to see the prospect of countries leaving the Euro to return to their own currencies strictly in economic terms. This morning, Fink sort of threw up his hands and contended that it would be unmanageable for a country to have Euro-denominated liabilities while leaving the currency. But that's not really true. The country would simply have to manage its positions with the Euro like any other foreign currency. It's liabilities in Euro terms would require FX transactions to settle payments, just like dollar-denominated obligations.

Second, Fink began to describe the US economic condition as not getting worse, but a terrible surrounding environment. Then he generally recommended dividend-paying equities, as if to suggest that it would be unwise to expect price-based total returns going forward for the next several years.

When someone like Larry Fink, who controls the allocation of billions of dollars of investments, makes remarks like the ones he did this morning, I think you have to read between the lines. Fink knows that blunt remarks from the likes of him will move markets. That's not the type of book-talking he can afford to do. It might even make him, and BlackRock, liable for damages resulting from such gloomy public remarks which would negatively affect returns in the portfolios which the firm manages.

In that vein, Fink asserted that the current situation is not at all like that of 2008-09.

Yet, I can't help thinking that it actually is, in several respects.

Back in 2007, there was already a lot of discussion about commercial bank-sourced SIVs. Remember when those off-balance sheet holders of mortgage-backed instruments began to run into problems? Then in late 2007, several large US financial firms began to scour the globe for additional equity investments as they wrote off large losses on mortgage-related assets. By the spring of 2008, Bear Stearns was pushed into bankruptcy as counterparties withdrew funds and short term lending lines dried up.

My own proprietary equity allocation signal moved from long to short by the summer of 2008. In retrospect, the signs of a building problem with US equity valuations could have been said to have been building for nearly a year before the collapse of equity prices in the fall of 2008.

In the current situation, we've seen the European debt crisis begin in earnest in the spring of 2010. Things haven't really gotten better since then. Granted, the Greek and Italian governments have changed, but the realities of outstanding debts haven't.

Meanwhile, some fancy footwork avoided an outright default on Greek debt which would have triggered credit default swaps to pay off. But now, as Fink acknowledged, Europe is entering a recession. His comments about the US economy and equity strategies are tepid, at best.

Will we look back, from a year or so from now, and wonder how anyone could have missed the building signs of problems with global equity values which began to be apparent in the spring of 2010?

Perhaps in that sense, the current developing global financial strains do resemble the period of 2007-2009. A series of unresolved, connected and deepening financial problems that can't be magically resolved by climbing equity values.

It's one thing for equity prices to climb 'a wall of worry' about environmental variables which are missed or misread. But it's an entirely different matter for equities to rise amidst a large scale environmental variable such as global deleveraging in the wake of the 2007-09 financial crisis and its impact on Europe's large economies and nations. That's more like climbing in the face of real problems, not simply worries about whether problems exist.

Government-Sanctioned Ponzi Schemes Come Under Pressure- Here & Abroad

2011-11-15T00:10:00.072-05:00

This past week's changes of government in Greece and Italy brought forth the following headline in the weekend edition of the Wall Street Journal: Europe Pulls Back from Brink.

Indeed, the last two days of the week saw a rise in the S&P500 of a combined nearly 4%. Hooray! All is well!

Ah.....not quite.

I've had discussions with several people over the past week on this topic. A few were kindred business persons, while several others were not. It's very good practice to explain these matters to economic neophytes, because one's reasoning has to be tight and sensible.

Simply put, since 1971, when the US dollar was decoupled from gold and became a fiat currency, inflation has raged. The Euro, too, is a totally fiat currency. As such, both have have been debauched by the governments which control them, promising ever-larger benefits and engaging in larger budget deficits so that politicians could buy re-elections.

When was the last time you heard a genuine discussion in the US Congress about cutting one or more programs in order to afford spending elsewhere? No, it's just spend more and print or borrow the money.

But the Ponzi scheme hasn't been confined to only government-provided defined benefit schemes.

In the November 7, 2011 edition of the Wall Street Journal, the Marketplace section's headline screamed Pension Trusts Strapped. It seems that the UAW and USW are finding their VEBAs- Voluntary Employee Beneficiary Associations- running out of money to satisfy the pension and health care obligations they were created to serve. VEBA's were conceived so that otherwise-bankrupt companies could off-load their legacy pension and health care obligations to the unions whose members were owed the benefits. In effect, for the unions and their members, it was take some money and manage the mess themselves, or see it all vanish in bankruptcy.

The UAW's VEBAs cover 820,000 employees and is said to be short some $20B for meeting its obligations.

Now, union officials are the ones telling recipients to expect higher premiums, larger contributions by retirees, or perhaps further benefit cuts. It seems that, once in union hands, the UAW VEBAs quickly cut some of the lusher medical benefits, such as prescription Viagra. Returns for the funds under custody of the unions aren't clearing hurdles of 9% per annum, thus squeezing the VEBAs from that side, as well.

Everywhere you turn, somebody's pie-in-the-sky, group defined benefit plan is being threatened by economic reality. Whether Greek public sector unions, Italy's generous social spending, US Social Security or the remaining private sector union defined-benefit pension and health care plans, they are all under pressure as a generation of retirees has pushed these legal Ponzi schemes to the breaking point.

You think any of this is going to be fixed in the next year or so? Or right after the 2012 election in America, if either party runs the table at the federal level to hold the White House and both chambers of Congress?

Think again.

Slowly, people in Western democracies are waking up to the reality that, whether public or private sector in nature, many retirement and medical benefit promises simply won't ever be kept. They can't be because they were never realistic in the first place.

If someone informs you that you will only collect, for argument's sake, half of the benefits you were promised, what would you do? The people with whom I discussed this all automatically said the same thing:

"spend less, save more."

Guess what will happen to OECD nation GDP growth rates for the next decade or more?

Forget any more "stimulus" spending by the major economies' governments. Who will be be lending to meet such borrowing? Which countries, while cutting entitlements, will simultaneously be splurging on other debt-fueled spending?

Due to a confluence of several factors, we're probably on the threshold of a phenomenon nobody's ever seen before- the vaporization of expected benefits for hundreds of millions of people which will affect spending and saving behavior, causing unexpected consequences at the macroeconomic level on a global scale.

I don't think it necessarily means equity market crashes. But I do think it means we are entering a period of heretofore unexperienced changes in the factors which will drive those markets.

More Warren Buffett Cornpone On CNBC This Morning

2011-11-14T11:33:00.000-05:00

Warren Buffett appeared on CNBC this morning with plenty of his trademark cornpone and increasingly annoying guffaws.

This time he was spewing socialistic comments on taxing the rich, plus issuing ridiculous calls for higher taxes in general. Put Warren down as a limousine liberal. Would he have thought the same twenty years ago? More?

Absent on Buffett's part were such important aspects of the consequences of his views as the fact that taxing all of the income of the top 1% won't fund the government for even a year, if I recall Kyle Bass' analysis correctly. And there's the dangerously slippery slope which Buffett, having billions to give to charity, won't have to endure, i.e., how much 'more' is enough, and who judges that?

A young entrepreneur looking at confiscatorily high rates at the upper income ranges will likely behave differently than an old 'fat cat' like Buffett who has already amassed his fortune. Buffett's lifestyle won't be affected by almost anything the federal government does with tax policy, but that's not true for the younger, upcoming millionaires and billionaires of tomorrow. The more the chance to keep one's own earned money is reduced, the more the entire idea of the American Dream is subjected to socialism.

What's more sickening is that CNBC can't even dare to question Buffett's views, airing them with absolutely no critical challenges whatsoever. How about having Kyle Bass on the phone available to engage Buffett in defending his rank socialist views?

On the professional front, Buffett's big announcement was that he's accumulated about 5.5% of IBM's equity. Then he went on to babble about 11% of the firm's equity changing ownership in a year, and that turnover is so high these days. Of apparent note was that IBM is considered a technology company, which is a sector Buffett has historically shunned out of lack of understanding.

It was a charming throwback to antiquity when Buffett told how he actually read the recent annual report and, gosh darn it, liked what he read, so he bought 5.5% of the firm. And encouraged other investors to read that report, too!

Unfortunately, real investing is a bit more complicated than reading annual reports. At least it is if you plan on owning equities that constitute a portfolio which consistently outperforms the S&P500.

What Buffett doesn't seem to acknowledge, regarding the share turnover question, is that, in the decades since the Big Bang on the NYSE which cut brokerage fees, and the subsequent explosion of volume and mutual funds, people have access to cheaper professional management of their money. Especially via 401Ks invested with mutual funds. Buy and hold a la Graham and Dodd was conceived in an era of a 14% round trip charge on trades, versus flat dollar fees today.

The volatility and erratic performance that individuals might have to live with when investing on their own is probably less tolerable from a paid manager. Thus, more trading occurs in the quest for better returns all the time.

Now consider what Buffett reiterated this morning regarding his own holdings- Wells Fargo and BofA. They are erratic. Buffett no longer behaves like a typical manager, in that he doesn't even attempt to mitigate inconsistencies in his company's returns. While IBM has been moving toward being a consistently superior equity for years, BofA and Wells Fargo are not. BofA is a disaster, and Wells has tracked the S&P, meaning you'd be exposed to similar returns for far less risk by owning the index, rather than WFC. These price series are illustrated in the first nearby chart.

I contend that if Berkshire's price charts were labeled Fund X and compared to other funds, Buffett's company would be judged inadequate, inconsistent and, at best, mediocre.

But being Buffett, people forgive performance lapses because they buy into a now decades-old performance that no longer exists.

A firm Buffett said he can't and won't buy- Microsoft- tells you something about his judgement.

Microsoft, as my prior posts have illustrated, has had a lost decade of flat returns. It's been a disaster. Yet Buffett claimed he won't invest because, as a friend of Bill- Gates, that is- he would be accused of having inside information. He didn't just bust out laughing at the prospect of throwing his investors' money away on a moribund has-been technology company if he bought shares of MSFT.

To illustrate the inconsistency of Buffett's firm's performance, consider the next three price series charts. They compare BerkshireA with the S&P500 Index for the past 1, 2 and 5 years.

For the past year, the S&P has outperformed Buffett by 10 percentage points. For the past 24 months, they are even. For the past five years, Berkshire outperforms the S&P by 20 percentage points.

Berkshire has become something of a timing stock, at best. At worst, whether due to size of the portfolio, or Buffett's outdated selection strategy, it's simply seen its returned attenuating toward the index.

For what its worth, IBM has been near qualifying as an equity in my portfolios because of its increasingly-consistent relative performance on several key criteria. But, unlike Buffett, my strategy doesn't blindly hold for years. It continually assesses consistency of performance.

Of course, I'm not Buffett. As I noted earlier in the post, investors have long since given up measuring him by the same standard as they would other managers. Thus my point that if Berkshire were included as a choice among funds to choose, with its name changed, I doubt it would get the investment it does because it's affiliated with Buffett.

Frankly, anyone who would seriously consider investing in Microsoft would, on that basis alone, scare me off.

But that's the world according to Buffett. It's a different investing world with different rules. Performance doesn't matter as much as it does for lesser-publicized investment managers.

Is There Really US Income Inequality & What Exactly Would Be Its Impacts?

2011-11-14T00:19:00.078-05:00

Some months ago, I had a discussion with a friend regarding income inequality. Being a systems engineering consultant primarily working with he military and its suppliers, he cited an author who claimed that significant income inequality had presaged the fall of great powers in the past.

Currently, the Occupy Wall Street crowd focus on income inequality, screaming about the "1%" versus the "99%."

Income inequality is often measured via some variant of the Herfindahl Index, described in that linked source as it applies to its original subject, market share concentration,

"It is defined as the sum of the squares of the market shares of the 50 largest firms (or summed over all the firms if there are fewer than 50) within the industry, where the market shares are expressed as fractions. The result is proportional to the average market share, weighted by market share. As such, it can range from 0 to 1.0, moving from a huge number of very small firms to a single monopolistic producer. Increases in the Herfindahl index generally indicate a decrease in competition and an increase of market power, whereas decreases indicate the opposite."

As applied to incomes, one simply substitutes that variable for market shares. The principle is the same.

However, regardless of how one measures income concentration, the question is the same: what exactly are the impacts of various levels of income equality or inequality?

I can't answer those questions, because I don't have primary research data to support any specific response. But the constant harping by many liberals on this question causes me to ask three more related ones:

1. What would be the empirical relationship, were we to have the data to assess it, between income concentration and periods of human innovation and growth in average standards of living?

2. What were US income concentrations in past eras? Particularly, for example, after the Revolutionary War, during the pre-Civil War era, then 1880s-1890s, and the early 20th century?

3. What are the percentages of various income levels that change to higher or lower levels through time?

Let's take the first question. What I'm attempting to get at is the phenomenon of capital accumulation and its effect on civilization. Whether it involves infrastructure such as roads, dams, water provision, sewage or art, such non-subsistence-level human activities require capital. And capital comes from savings, which is, definitionally, the positive difference between production and consumption.

If a society doesn't have capital accumulating, it's not going to advance on any significant dimension. Historically, unless you sign up for hereditary monarchies or feudalism, capitalism is the economic system which has done the best job combining merit-based wealth accumulation and the ability of a society to accumulate capital for which allow investments that, over time, improve general standards of living.

Specifically, in the US, I'd love to know the answer to the second question. Has the US experienced major changes in income concentrations over these eras? What do you think income concentration was like before the middle class ushered in by the Industrial Revolution?

Further, what does it say about US income concentration that Steve Jobs, Bill Gates and Mark Zuckerberg, none of whom apparently completed a four-year college degree, all became billionaires within the past two decades? And Larry Page and Sergey Brin, the co-founders of Google, did so within the past several years, though they finished college.

It appears that the potential for Americans to create wealth for themselves still exists. Perhaps not all are created equal and, thus, incomes won't ever be equal. Or perhaps some of the now-vocal 99% are simply lazy, or have made poor career choices.

Thirdly, from years in business, and my own proprietary equity research, I'm rather distrustful of simple static analyses. Simple static pictures of US income concentrations aren't as useful, informative or actionable as would be quintile-quintile migration tables for US incomes. Or any of several other ways of depicting the dynamics of US income concentration among specific groups of Americans.

What percent of the current top 5% of US income earners are children of similar income earners? How many years, on average, do people remain in a particular income strata?

The existence of Jobs, Gates, Zuckerberg, Page and Brin tell us that it's still quite possible in America to vault from median income to substantial wealth, even to the level of the top 1% of American incomes, in just a few short years.

So we know that US income mobility is still alive and well. And, really, that was one of the fundamental purposes of our nation's founding. You know, that old line,

"....life, liberty and the pursuit of happiness...."

If, as I hypothesize, the early days or our Republic were marked by greater income concentration than that over which people currently Occupy parks in various US cities, perhaps they weren't all that discouraged. After all, having liberty was not a trivial thing. And still isn't.

And the pursuit of happiness was, for many homesteaders both before and after the Civil War, the ability to have and work their own farm or business, regardless of its economic prosperity.

It seems to me that we have far too little evidence of a problem with the dynamics of US income concentration at this time. There will always be a lower echelon of income earners. And, if I'm correct in my hypothesis about the early years of our nation, income disparities didn't prevent people from immigrating to America- it spurred it. As it has until very recently, when the economic growth of the nation began to slow.

How people got to an income level, and for how long, on average, people stay there, and how many rise, is of more interest in determining both if there is a problem in the US with income concentration, and what to do about it.

Regarding Investing In Commercial Banks

2011-11-11T00:06:00.059-05:00

This week's European government and financial tumult brings me to once again review the position of large US commercial bank CEOs, led by Chase's Jamie Dimon, that their firms should be allowed to take risks, presumably in order to drive high total returns.

At issue currently are two changes which bank managements despise: the Volcker Rule and higher primary equity capital requirements. The former strips large commercial banks of the ability to pursue riskier profits via proprietary trading, while the latter adds capital, which will depress returns on assets.

It's fair to say that, with recent hindsight, on average, the Volcker Rule will minimize societal costs of banks trying, but usually failing, to earn profits on risky trading with their own capital. The recent financial crisis demonstrated that those financial concerns capable of not losing on such risky trades are small in number, and often privately-held, while the larger US commercial banks carry deposit insurance, and, thus, indirectly, are themselves insured by the US federal government. The Dodd-Frank bill has made such insurance of firms explicit.

After several decades of US commercial money center banks cyclically posting large losses on everything from sovereign lending to credit cards, mortgages, and energy lending, requiring higher capital levels doesn't seem so harsh. For example, as I noted in this recent post, fund manager Ron Baron declined to invest in Jon Corzine's now-failed MF Global in part because, with capital constituting only 3% of assets, the risk of total loss of equity from trading positions was too great. Today's US money center banks are fighting to avoid capital levels only a little higher, i.e., going from 7% to 9%. It seems like a lot when seen as a percentage of balance sheet assets. But it's trivial when seen as the potential loss in a trading position. What's another 3, 4 or 5 percentage points of loss once a derivative or badly-hedged asset goes wrong? It's rounding error.

But to CEOs of these companies, that means relegating them to a role much more like energy utilities than like investment banks or faster-growth firms.

Which brings me to the central point about this debate over permissible money center bank activities and their primary capital levels.

My now-deceased mentor at Chase Manhattan Bank, Gerry Weiss, observed decades ago that since banking is a derivative industry, it can't, in total, grow faster over time than the economy which it serves. Thus, shorter-term, faster growth typically comes by taking more risks. Which pays off for management when it works, and leaves shareholders with losses when it doesn't. Only, in reality, those losses now become spread to taxpayers, as well.

So long as a bank is allowed access to taxpayer money for insuring deposits, and is allowed to become sufficiently large that its collapse would create counterparty problems for the nation, it has to be restricted to a role as a financial utility. Much as CEOs like Dimon want to have the latitude to chase total returns that match the US equity market's best, doing so as a money center bank simply isn't in society's interest.

Time and again over the past several decades, US money center banks and their managements have exhibited poor judgement and incompetence at avoiding bank-collapsing risks. When enough commercial bank assets pursue similar risks, which typically occurs, the resulting systemic risk endangers the US economy.

Dimon and his fellow CEOs like Vik Pandit at Citi or Brian Moynihan at BofA may grouse about being shackled and prohibited from pursuing brisk income growth which outstrips that of their markets. But to allow them to talk their way out of both measures- restraint of proprietary trading and higher equity capital requirements- will more quickly and certainly lead to the occasion of another taxpayer-rescue of a US money center bank.

CNBC's GOP Event & Flaming Media Liberal Bias

2011-11-10T12:04:00.000-05:00

I'm sorry to find out how right I was in my predictions in yesterday's post regarding last night's CNBC GOP presidential candidate roast...errr....event. Because it was on CNBC, and ostensibly about economics and business, I'm writing this review on this blog, rather than my political one.

Here are some of the passages from that post,

"...you can bet most of the two hours will consist of baiting the GOP candidates with questions designed to create convenient sound bites for the current president's re-election staff to use in subsequent campaign commercials.

This won't be anything remotely resembling an honest, non-partisan attempt to ascertain the candidates' views on the economy and business.

At present, I think it's fair and accurate to say that the truly conservative candidates would, ideally, say that the most they can do is to reduce growth-retarding uncertainty caused by the federal government. This would largely consist of reversing excessive energy- and finance-related regulations, a tax-code overhaul to reduce rates, remove preference items and simplify the code, and the exit of federal government from subsidizing any businesses, such as so-called 'green energy' investing and mortgage bond guarantees, to the detriment of private sector efforts to do the same things.

The problem, of course, is that these reasonable steps will sound insufficient, because they don't purport to immediately "create jobs."

Never mind that conservatives, and most of the GOP candidates, don't believe government should directly create jobs. They will be pummeled by most of the CNBC panel for being cold-hearted, uncaring and, in effect, promising a priori to do nothing to help millions of unemployed Americans."

There's actually quite a bit to cover, so let me highlight the four themes I'll discuss. The first three are the CNBC panel's:

1. Attempt to criticize GOP candidates for their conservative, non-Keynesian economic views.

2. Attempt to engage candidates on non-economic issues and invite mutual attacks.

3. Cluelessness on the publics' intolerance for liberal media attacks, via my second point, on the GOP candidates.

The fourth is the after-event panel's explicit liberal slant, used to lament how weak the GOP field was.

An example of the first point was the panel's question regarding three issues- student loan debt, housing and health care. The panel characterized the second as 'complex and large,' of which America's housing problem is really only the latter- large. Regarding student loan indebtedness, the panel was clearly looking to draw the candidates into competitive bids to please the student audience. But, in a larger sense, the questions were formed with a Keynesian, government-activist bias. It was a 'what would you do, as President,' not, 'is it appropriate for government to attempt to solve' sort of bias.

Regarding student loans, Gingrich fired back accurately, and quickly, given the usual inane sub-minute time limits. He concisely traced the history of the program, from LBJ onward, and dismissed it as having led to excessively-inflationary higher education costs. Summing up, he essentially pronounced the program a typical failure of government by causing unintended consequences. Newt slipped in a competing model, which was, I believe, College of the Ozarks, where students work while at school. They leave, on average, with no debt, except for students who purchased cars during their enrollment. Gingrich, as usual, had amazing facts at his command, ticking off the lengthier college careers of students borrowing money to attend.

When it came to housing, the CNBC panel focused on Romney, who is already on record, in Nevada, as having called for normal foreclosures and an end to the administration's many attempts to subsidize homeowners who are underwater on their mortgages, relying on market-clearing forces to eventually help the sector find its bottom.

For once, Romney didn't disappoint, reiterating, with vigor, his earlier comments. He chided the panel, asking if they thought the federal government should buy up every home in America to fuel economic growth?

The reactions of the panel members to these replies seemed muted, due in large part to the roars of approval by the audience in each instance.

On health care, Bartiromo asked Gingrich what he would do to solve America's health care mess. Newt grinned and baited his own trap, saying he'd been writing whole books on the topic, and did Maria really expect him to answer this complex question in less than a minute? The audience shouted its approval for his reply, and Bartiromo then said, 'take as much time as you need.'

Newt replied with another question, noting that his fellow candidates wouldn't like him taking up the remainder of the evening. Bartiromo tried to one-up him, arrogantly closing with, to paraphrase,

'Then you don't want to answer how you'd handle health care?'

On the second point, Maria Bartiromo asked Herman Cain if it was appropriate for Americans to elect him as CEO of the country, when he was being assailed for character flaws. Cain shot back fluidly and effectively, explaining that Americans don't want anonymous, unspecified character assassination to decide whom they will elect as president. Cain got cheers, and the audience was clearly cool to the panel.

Then Bartiromo unwisely followed up by asking Romney if he'd retain Cain in management if he were a private equity buyer of a firm including Cain, given the recent sexual harassment allegations.

Romney rose to the challenge and pointedly rejected Bartiromo's bait, while the audience, just after her question, but before Romney began to reply, loudly booed and jeered the CNBC reporter.

What Romney actually said was that he wasn't going to answer, that it was Cain's issue to handle with voters.

Regarding my third point, the CNBC panel seemed really tin-eared and ham-handed in how the audience and general public would react to its attempts to rough up and bait the GOP candidates. The audience reacted quite angrily to Bartiromo's questions regarding Cain and the alleged harassment charges. On Fox News just minutes later, Sean Hannity actually covered that segment, castigating CNBC for trying to manipulate the candidates into non-economic issues during an event ostensibly about economics and business, then bait Romney into criticizing Cain.

Later, in their own after-event program, Carl whathisname congratulated himself, Harwood and Bartiromo, smugly, on their performances in bringing the enemy, i.e., the GOP candidate field, to account, completely ignoring the audience's reaction to their attempted baiting of the candidates. Wildman Jim Cramer went so far as to criticize Romney and Gingrich for daring to take on the panel, rebuking them for pushing back against the media.

Cramer then went on a rant, claiming that voters didn't want candidates reacting to the media, only to answer questions about the economy. Totally off base and, as usual, wrong.

It was, however, quite surreal to see the action on CNBC, then see it covered live on Fox News only minutes later.

Finally, in the CNBC spin zone, two rather bizarre scenes occurred.

One was Larry Kudlow being seated with three prominent former Democratic administration officials to critique the event. All three of course lambasted the performances, trying to essentially close the door on all but Romney. Kudlow didn't look all that comfortable, but it was clear that CNBC's liberal producers and management wanted to give a final, anti-GOP spin to the event with an all-Democratic review of the two hour program.

Separately, minutes prior to that panel, Carl whathisname gave Cramer the stage to spin some false history of his own, while extensively criticizing all the GOP candidates, and the whole party, for good measure.

One has to have some perspective on Cramer's career journey to understand his views and actions. Harvard-educated, he began as a wannabe reporter, eventually realizing a desire to run money, working as a broker at Goldman Sachs along the way. He's not an experienced business person, nor economist. He's politically very liberal.

During his hedge fund running days, he engaged in explicit manipulation of media, including an admission of using CNBC floor reporter Bob Pisani, to spread rumors allowing Cramer to finish the second half of 'pump and dump' schemes. If Cramer were remembered for his hedge fund antics, he'd probably be under indictment, rather than on CNBC.

Thus, he's tickled pink to have exited that earlier career, and been refurbished and rehabbed as a cable business news anchor. To be seen on the panel of a presidential candidate debate is extremely tall cotton indeed for the hotheaded, big-mouthed former hedge fund manager of questionable practices.

In response to GOP calls for the repeal of excessive and ineffectual regulation, Cramer assailed them all as wrong-headed and small-minded. He cited Eisenhower's highway-building program to claim that Republicans needed to act like that again, spending hundreds of billions for public works to employ, well, construction workers.

Never mind that the current administration chose to ignore a key highway bill several years ago, and now has let much nearly-automatic road building lapse. Or that, per this recent post of mine, anything economically worthwhile will be done anyway, and needn't require government funding.

The GOP and its candidates don't believe we should let US highways disintegrate. Simply that, to refurbish them, after decades of excessive social welfare spending instead, other cuts have to be made to do so within balanced federal budgets.

Then Cramer engaged in his personal, wrong history of the recent financial crisis. He began by erroneously contending that the US has to bail out Europe, or the contagion will spread here. That may well occur, but even the US, borrowing, as it does, 40 cents of every dollar it prints/spends from China, doesn't have enough wealth to fix Europe's over-indebted social welfare spending mess.

Cramer routinely, and wrongly, calls the European crisis a banking crisis, when it's a social spending and governmental crisis. US funding won't fix that.

Then Cramer rolled on unabated to charge that the recent US financial crisis was all about criminal capitalistic behavior. Somehow, Jimbo overlooked, and never mentioned, Barney Frank, Kent Conrad, Chris Dodd, Fannie Mae or Freddie Mac. Or how Countrywide's ex-CEO, Angelo Mozillo, is alleged, on pretty good evidence so far, to have bribed Frank, Dodd and Conrad, and maybe more, to mandate Fannie and Freddie to accept Countrywide's low-quality mortgages for securitization.

In short, the Fed's low-rate policies and Congress' mandates of expanded GSE activity set the table for private finance's participation in the crisis. Moreover, there were sufficient agencies and regulations in existence to have stopped wrongful behavior.

The problem is, the regulations don't work. The people aren't adequately skilled, motivated, compensated and/or enabled to ever catch such activity. In fact, the very existence of the regulatory framework fools investors into a false sense of security. Something Cramer will never acknowledge.

Too bad Cramer won't let facts get in the way of his anti-GOP view of the nation's financial and economic history.

That's my current take on last night's GOP event. More to come....

Jerry Yang's Recent Antics At Yahoo

2011-11-10T00:04:00.022-05:00

The comedy that is Yahoo continues, even in the wake of Carol Bartz' departure.

Jerry Yang, in a Wall Street Journal article last week, was described as claiming to be 'Chief Yahoo' and wanting to organize holding of a significant percentage of the firm's equity, while also allegedly fielding overtures for sale.

Yang, as the piece noted, can't be both buyer and seller, and acting CEO. There are too many conflicts.

Personally, I can't understand why anyone takes Yang seriously. Or, for that matter, Yahoo while Yang remains at the firm in any capacity.

Carol Bartz must be kicking herself for ever accepting Yang's invitation to his home to discuss taking the CEO job at Yahoo. Before then, she was a widely-respected leader due to her phenomenal accomplishments at AutoDesk.

Now, she's criticized for her Yahoo tenure and, I think, misunderstood. In my opinion, she shares company with Lou Gerstner, Art Ryan and, to some extent, John Thain. All had some accomplishment at a firm which they headed, although Ryan didn't really do anything at Chase, but sort of seat-warmed the CEO job.

Gerstner moved from RJR Nabisco to IBM, Ryan to Prudential, then in the throes of litigation, and Thain from Goldman to the NYSE to Merrill Lynch. In each case, I believed that they couldn't really lose. If any of them succeeded in turning around the mess they inherited, they'd become even more wealthy, and receive credit for their work. If they failed, many would view the situation as too far gone for rescue.

I think Gerstner did that at IBM, and Thain at the NYSE. Ryan didn't tank Prudential, but I wouldn't say he worked miracles. But Thain at Merrill and Bartz at Yahoo clearly weren't able to succeed. Thain exhibited some bizarre behavior. Remember the extravagant office redecoration? And then there were the conflicting stories regarding year-end bonuses paid out amidst the firm's near-collapse.

Perhaps Bartz' reputation will be regained if and, as I expect, when, Yahoo slides further in valuation. So long as Yang remains a part of the firm's grappling with its future, it's almost certain that shareholders will see Bartz in a different light.

Andrew Sorkin's Revealing Limousine Liberal Moment On CNBC This Morning

2011-11-09T09:51:00.002-05:00

If you doubted that CNBC co-anchor, and New York Times columnist Andrew Sorkin is a limousine liberal, consider this moment from this morning's Squawk Box program.

A guest who was a former CEO of Staples was discussing the effects on the average American household of increasing taxes. He explained how most Americans would react to threats of higher taxes by cutting spending elsewhere and treating the planned tax increases as a negative uncertainty.

Sorkin chimed in with this gem, as closely paraphrased as I can recall,

'Do you really think people do that? Do they really notice tax increases?'

I think Sorkin has finally marked himself as a liberal now completely out of touch with the average American, what with his three careers- columnist, CNBC anchor, and published writer with an HBO movie based on his book.

You can't make this stuff up, can you?

Tonight's CNBC GOP Presidential Candidates' Event

2011-11-09T09:44:00.000-05:00

It appears to be CNBC's turn to create havoc among the sheep-like field of GOP presidential candidates this evening in a 2-hour event I won't dignify with the term 'debate,' but, rather, the more appropriate term 'event.'

I've written a series of posts over on my companion political blog regarding the prior events here, under the 'debate' label.

After the September Fox News/Google event, I wrote this post wherein I suggested a better format for cable channels to provide voters with access to candidates and their ideas,

"I think what would be more meaningful to me would be something like the following. A network provides a weekly two-hour slot for its 'candidate of the week.' One of the GOP presidential hopefuls sits on a set with one or two moderators and answers questions from online feeds and a live audience. Moderators provide follow-up questions and/or fill in background on the candidate's prior remarks on the topic. Or contrast their stance with other candidates, etc.

And, for good measure, the original audience/online questioner gets a few minutes of give-and-take with the candidate, so if the latter evades the question, the questioner can complain about that and note it for everyone else.

I really don't care so much what Mitt thinks about Rick. Or what Newt thinks about anyone. Or what Rick (Santorum) does to try to look relevant.

In the end, I care more about how these people interact with prospective voters than how they fence with each other. I don't expect them to agree with each other, so what's the surprise in these bear-baiting formats?"

Fox News subsequently began something like that with Brett Baier's Special Reports "Center Seat" segment. Once each week, they invite a major GOP candidate to spend about 10 minutes taking questions from and discussing issues with Baier's panel, usually including Charles Krauthammer, Juan Williams or Mara Eliason, and Steve Hayes. Last night Newt Gingrich was the guest candidate. It's a far better approach, because the focus is on one candidate and his/her positions.

For example, coming immediately after Herman Cain's tension-filled press conference to address his anonymous and named accusers of sexual harassment, Juan Williams asked Newt, point blank, if his various marriages, infidelities and the story of his serving divorce papers to his wife while she was in the hospital, didn't constitute too much baggage for him to win the Oval Office. Gingrich answered calmly, referring to his daughter's accusations, which he never the less labeled as false.

With this as background, let me comment on the face which will take place on CNBC this evening from 8-10PM, EST. With a panel including Maria Butt-iromo and her annoying lisp and general air-headedness, and socialist political commentator and New York Times correspondent "Red" John Harwood, you can bet most of the two hours will consist of baiting the GOP candidates with questions designed to create convenient sound bites for the currend president's re-election staff to use in subsequent campaign commercials.

This won't be anything remotely resembling an honest, non-partisan attempt to ascertain the candidates' views on the economy and business.

I've been hearing CNBC's self-aggrandizing promos for this event for days now. Breathless soundbites alleging that this is what voters have been waiting for, it's the big moment to underpin their decisions. That we'll learn how each candidate plans "to jumpstart the economy." That's a direct quote.

So let's examine it.

A conservative's approach to the economy specifically eschews the belief that government can 'jumpstart the economy" in some direct, active manner.

At present, I think it's fair and accurate to say that the truly conservative candidates would, ideally, say that the most they can do is to reduce growth-retarding uncertainty caused by the federal government. This would largely consist of reversing excessive energy- and finance-related regulations, a tax-code overhaul to reduce rates, remove preference items and simplify the code, and the exit of federal government from subsidizing any businesses, such as so-called 'green energy' investing and mortgage bond guarantees, to the detriment of private sector efforts to do the same things.

The problem, of course, is that these reasonable steps will sound insufficient, because they don't purport to immediately "create jobs."

Never mind that conservatives, and most of the GOP candidates, don't believe government should directly create jobs. They will be pummeled by most of the CNBC panel for being cold-hearted, uncaring and, in effect, promising a priori to do nothing to help millions of unemployed Americans.

You need to remember that most CNBC on-air anchors believe in failed Keynesian economics and the current administration's economic policies.

However, with the exception of Rick Santelli, a former CME trader and executive, who I believe will be on the panel of questioners, the rest of the CNBC panel will likely be liberals who simply don't believe, if they even understand, how conservatives approach government's role in the US economy.

Which brings me to a post entitled Ronald Reagan's 11th Commandment & The CNN Las Vegas GOP Event, which I wrote on my political blog late last month. In it, I opined,

"Why aren't the top 8 candidates coordinating how they will control so-called debates at which they appear? Didn't anyone's communications directors or campaign managers realize that attending a CNN event was to invite disaster and humiliation?

Perhaps the RNC should get between the candidates and the networks, brokering formats so that the focus is on moderator or audience questions, not candidate-to-candidate criticism. Honestly, voters are smart enough to figure out what they want to know from each candidate. They don't need other candidates to help them on that score.

Networks want to create newsworthy events, which typically means force in-fighting and embarrassing gaffes. The RNC and the candidates should all want to provide voters with opportunities to learn more about each candidate's positions, not how the candidates feel about other candidates' positions.

I would really love to see the RNC chair now step forward and take control of future candidate events, mislabeled as 'debates,' and enforce formats that minimize violations of Reagan's 11th commandment, i.e., Thou shalt not criticize a fellow Republican."

How I wish the RNC had taken my advice prior to tonight's CNBC event.

Will I watch it- almost certainly not. I'll likely Tivo it, in order to fast forward through the questions from the more liberal, less intelligent CNBC staffers, stopping where I see Santelli participating.

MF Global's Regulatory Lessons

2011-11-09T00:18:00.024-05:00

Holman Jenkins, Jr., wrote a thoughtful piece in his weekend edition column regarding MF Global's demise. Jenkins rebuked those who were disappointed with the regulatory failure involving the firm. He celebrated that a financial firm engaged in overly risky activity and paid the price with bankruptcy, without government intervention.

I agree with him on that point.

However, I think he misinterprets the motivation for some, including me, to express consternation that new regulatory agencies, powers and legislation did nothing to prevent the collapse of MF Global.

I actually don't support the bulk of existing financial regulatory legislation and agencies. In my opinion, they represent the foolish wishes of largely inept, naive members of Congress and various administrations that it is practical or effective to have our existing, expensive and intrusive regulatory machinery.

It doesn't work. It gives investors, borrowers and depositors false hope. It risks making those parties insensitive to the realities of the marketplace and the vendors with whom they choose to do business.

I'd prefer to see government leave the business of deposit insurance, financial statement regulation, and most other detailed, intrusive financial regulatory areas.

Without such government-provided, monopolistic services, private solutions would arise. Firms would offer competitively-priced deposit insurance, differing by bank, thus providing an implicit credit rating. The same would be true for the purchase of various levels of audit attestation.

I'm not upset that government regulatory personnel failed to understand MF Global's condition until it was too late, or that it may have failed to identify the wrongful use of customer funds by the firm, if that occurred.

Rather, I see MF Global as the latest poster child for throwing in the towel on regulatory solutions and ripping out most of them as ineffective and overly expensive.

What's worse, looking out for your own interests, or wrongly believing the government's regulators will inform you, in advance, when your interests are in jeopardy?

Recent Odds & Ends

2011-11-08T12:15:00.000-05:00

Barry Knapp, US equity strategy chief of Barclays, was cited in a Wall Street Journal article saying that a European recession won't really affect US firms. Maybe it will trim sales 2%, and that Europe is only 13% of US economic GDP

But later that same day, on Neil Cavuto's Fox News program, another pundit forecast crushing effects on Apple and some other US firms with sizable European operations.

They can't both be right, can they? Being that Knapp is responsible for a sizable equity book, I would doubt he'd be completely candid. That would be rather like yelling "Fire!" in a crowded theater when you are near the doors. So I guess I lean more toward the guy on Cavuto's program.

Ron Baron was on CNBC as they hosted a segment from his investing conference at the Metropolitan Opera of New York. He disclosed that Jon Corzine had solicited his firm to invest in MF Global. In an all too rare example of common sense, Baron declined. His explanation?

First, MF Global's business was a bit too complicated for him to fully understand. Second, what Baron did understand that at 33x leverage, a mere 3% loss would wipe out the firm's equity.

Case closed.

Evidently Baron didn't need the CFTC, SEC or any other regulatory agency to assure him of anything.

Re Greece, Europe & Global Economic Conditions

2011-11-08T00:16:00.035-05:00

There's so much political turbulence in Greece this week that it's challenging to write anything at a point in time which purports to be current.

So, rather than focus on that, let me opine on what has already transpired.

I thought Papandreou's call for a referendum was a breath of fresh air, and real sensibility, amidst all the political maneuvering among other European national leaders and bankers. As CNBC's Rick Santelli opined, let the Greek people speak out once and for all to either suffer and stay in the Eurozone, or return to the Drachma and experience the consequences of that move. Pain either way, but, in the latter, perhaps a bit more controllable.

What was, I think, as important about Papandreou's call, even though it was subsequently rescinded, is that it reminds everyone who is affected by the European debt crisis, which is pretty much the global economy, that the entire mess among all the free-spending European countries depends on the people of those countries.

I have heard, even after Papandreou's referendum announcement, several pundits recite, for the umpteenth time, how leaving the Euro would be so costly for Greece. How, if the ECB will just print money or buy bonds, which is another variant of printing money, the major French banks can probably squeak by. One of those pundits was, I believe, CNBC's wild man, Jim Cramer.

What pundits of that belief miss, yet Papandreou demonstrated, is that this isn't about a few large European banks, the ECB, the ESFS, or just Germany's economy's ability to cover Europe's debts.

On a much deeper level, it's about, now, Europe's populace's and, later, that of the US, tradeoff between significant economic pain now to fund benefits promises that aren't otherwise affordable, or less pain now and probably fewer benefits later, too. The various banks' and nations' debts are simply the circulated, legal instantiations of those promises, and, thus, subject to the vagaries of actual funding over time.

Post-WWII societal structures and benefit schemes were always going to be unaffordable, since they were, for the major European nations and the United States, inappropriately designed as communal defined benefit plans, rather than more sensible and affordable individual defined contribution plans. As such, now, Greece is the proverbial canary in the coal mine, signaling that one nation has reached the point at which its spending can no longer be continued on affordable terms. Other nations aren't far behind, as we know from credit downgrades or problems in Spain and Italy, to name two largish EU members.

I find it not accidental that August saw the 40th anniversary of Nixon taking the US off the gold standard. Similarly, at least one pundit on either CNBC or Bloomberg this week pronounced the Euro the least-credible, purest fiat currency of all. In a post I wrote on the occasion of Lew Lehrman's Wall Street Journal editorial commemorating Nixon's act, I referred to his chart that showed how inflation galloped out of control after that severing of gold and the dollar's value.

Recently, the Vatican has picked up the same theme. Few people are doing an adequate job of seeing the larger global finance and economic picture at work now.

When money supply was related to gold, money supplies had some countervailing pressures which reined in excessive printing or borrowing of a currency.

Fiat currencies have only confidence in a nation's economic capability to fund the government's debts. When that confidence is shaken, as it has been now with a handful of European nations and, imminently, the US, the lack of any real basis for valuation becomes clear.

Beginning with offshore Eurodollar liabilities in the 1960s, in reaction to a tax on Treasury interest, and accelerating with the closing of the gold window, US dollar liability creation has outpaced what anyone can reasonably forecast as the nation's ability to generate wealth to repay such obligations. When US corporations were able to sell dollar-denominated bonds in Europe, dollar obligation creation left the province of just the Fed or Treasury.

But, ultimately, the total claims against a nation's currency lead back to its citizens. Honoring or defaulting upon those obligations, whether by the sitting government, or a change in government, is a decision the citizenry ultimately makes.

In Greece, Papandreou stepped down after surviving a no confidence vote. The referendum will not take place, but it is, again, an open question what Greece will do. Rumors continue that the new coalition will seek better terms from the EU.

I continue to believe that the dry, economic arguments by some pundits focusing just on rational, economic costs and implications of whether this or that country leaves the Euro are misplaced.

We are seeing a rare spectacle of many large countries simultaneously coming to terms with their swollen, unsustainable obligations, whether held by private parties, the nation's banks, or other governments. As I conjectured several years ago, during the 2008 financial crisis, it would seem reasonable that a long term outcome is a global deleveraging. I think we're seeing that now. But when too much money has been created relative to the value being forecast to support it, eventually, some parties will have to take losses for the gap between what was created/borrowed, and what actually can be counted on to support the monetary bases outstanding.

Mike Mayo's Book & Essay In The Weekend WSJ

2011-11-07T08:12:00.001-05:00

I read Mike Mayo's extended article/book excerpt in this past weekend's edition of the Wall Street Journal. Sad to say, I was underwhelmed.

My memory of Mayo as a capable bank analyst goes back to my days with Chase Manhattan Bank in the the early 1980s. Back when Dick Bove, Bob Albertson, Tom Brown and Sally Pope were frequently on page one of the daily American Banker.

Despite taking two pages to write it, Mayo's point boils down to one he doesn't actually state, and apparently doesn't choose to acknowledge, i.e., equity research shouldn't be housed in the same firm as underwriting or other services bought by the banks and non-bank financial firms being evaluated by the analysts.

We already learned this in the late 1900s when technology analysts fawned over the companies that their firms brought to market via IPOs. It's not a new revelation.

Mayo tells the same story over and over. How he virtuously made tough 'sell' calls, only to be reprimanded, gagged, taken aside and 'talked to,' cut off from contact with management of the firms he followed, etc.

I don't doubt that Mike made those tough calls. Somehow, I don't think he's so naive as to be ignorant of what would happen when he did. He is evidently still and MD these days, but now has slipped to being one at Credit Agricole Securities.

Perhaps he should note that Tom Brown and Meredith Whitney finally just struck out on their own. Brown runs a financial sector portfolio, and, thus, is suspect every time he opens his mouth to tout the shares his fund owns. Whitney went the pure research route, and appears to be keeping her firm afloat.

It's no secret that analysts who truly have conviction eventually want to, or ought to, run portfolios. Mayo would have been able to have achieved legendary status, according to the article, had he shorted massively in late 2007, when he went on CNBC to predict the coming financial crisis.

Of course, one problem with the transition from analyst to portfolio manager is that the former are industry-focused. So when they run sector portfolios, they necessarily are exposed to sector cycles, which I would think could make for some pretty lean times. Not to mention the tendency to hype positions which are losing money, as Tom Brown now does with sickening regularity concerning BofA.

Still, I expected more, and better, from Mike Mayo. If all he has to tell us is whining about a conflict of interest that's existed since the dawn of sell-side analysis, well, that's not news.

The Groupon IPO

2011-11-04T11:01:00.000-04:00

Groupon's IPO, according to this morning's Wall Street Journal, will raise $13B. The article emphasized Groupon's own attempt to liken itself to Amazon, even to the extent of claiming it is a sort of Amazon 2.0.

Groupon has recruited several former senior-level Amazon executives.

For perspective, nearby is a chart depicting the prices for Amazon's equity and the S&P500 Index from Amazon's public inception.

Yes, in theory, one would have enjoyed an enormous return if one had bought Amazon at its public offering and simply held it. But 2000-2002 was a time of steep downdraft for the firm's equity price.

Amazon took a long time to become profitable. It's operation involves substantial physical logistics, as well as inter-related information systems with its many suppliers and customers. In time, all these became barriers to entry, resulting in the firm becoming a one of a kind entity.

In contrast, Groupon is a fairly simple operation. The Journal article mentions how Groupon's founder entertained investment from, then a venture with Amazon, but ultimately chose not to pursue either. Jeff Bezos subsequently backed a competitor to Groupon.

This morning, on CNBC, Melissa Lee noted that Groupon's revenue per customer transaction has declined from over $5 several years ago to, most recently, just over $1. Certainly, the immense publicity regarding the firm's service has declined from its faddish popularity only a few months ago.

To date, after having subscribed to the service back then, I've never actually spent a dime on or with the service. Contrary to its self-described position as the new way the world will buy products, I am hard-pressed to find anything among the offers emailed to me daily for which I'd spend money.

As I explained in a prior post, Groupon presents quirky deals which typically don't fit with my own lifestyle or needs. The Journal has run several articles in the past detailing the problems merchants have with one-time buyers from the service, as well as some sharp-penciled competitors offering better revenue splits.

If the Groupon method of selling/buying takes hold, it's got plenty of competition. If not, it was just a flash in the pan.

In short, Groupon's barriers to entry are far lower than Amazon's, making it seem much less like a near-clone of the now-dominant online seller. It's difficult to dismiss Groupon's IPO as having a very 'party like it's 1999' feel to it. That is, high point before a downdraft reminiscent of the 2000 technology equity bubble deflation.

Today's Employment Numbers- More Gloomy News

2011-11-04T09:41:00.000-04:00

By now you've probably heard or seen the October employment numbers from the BLS. Net jobs were 80,000 and the narrowest unemployment level was notionally down from 9.1% to 9%. CNBC's various reporters and anchors all tried to talk up these continuing weak economic numbers, claiming that, once you got past the anemic new jobs created, all is bright with the US economy.

The phrase that came to my mind was 'angels dancing on the head of a pin.'

I mean, really, look at the trends. How long has unemployment, narrowly measured, been at or above 9%? A year? It's at least twice what Americans are used to seeing.

The widely-defined unemployment measure, U6, is still up in the teens and largely unchanged.

And the monthly jobs number- only +80,000.

You can search various prior posts I've written discussing what the monthly new jobs number must be just to absorb the new entrants into the US labor pool. I feel like I'm writing about France now. That's how sluggish the economy has become on the employment front.

Meanwhile, I read a piece in this morning's Wall Street Journal discussing China's slow but steady rise in innovation ranking, while the US fell from 4th to 5th in the most recent table. Several pundits cited US firms continuing to base more plants and research facilities in China, hiring Chinese PhDs who file patents. And noting that, over time, innovation occurs at and with manufacturing sites, thus slowly hollowing out more of the US manufacturing base from an innovation perspective.

Fresh in my mind as I write this is the anecdote involving recently-deceased Steve Jobs assailing Obama for not opening the US labor market to more foreign-born PhDs. That Apple had to locate plants overseas, in Asia, because it couldn't recruit sufficient numbers of US engineers, so both the engineering and production jobs, numbering in the tens of thousands, went to Southeast Asia. The president's reply was a muddled, political obfuscation involving the complexity of immigration policy.

Much like it ignores the true depth and breadth, and causes, of the current European debt crisis, US equity investors are seemingly sticking their heads in the sand regarding US economic growth and unemployment. As I write this, the Bloomberg anchor is citing 7 years as the time required, at 80,000 net jobs created per month, to re-employ US workers back to, I believe, the 2007 level.

As I wrote here yesterday, there's simply no way these monthly numbers should give anyone confidence that the US economy is healthy and undergoing a normal expansion.

CNBC's Continuing Non-Coverage of Corzine's Behavior

2011-11-03T15:59:00.000-04:00

Rather incredibly, CNBC's Carl whathisname, now on from 9AM to noon, literally laughed while a Fortune magazine writer discussed MF Global CEO Jon Corzine's involvement in and/or knowledge of the use of customer funds by the firm.

The writer, whose name I did not catch, was earnest in contending that no former Republican Senator or Governor would be given the light treatment that CNBC accorded Corzine. Carl literally smirked and laughed at the allegation.

What I found so ironic is that the anchor, whose network has conspicuously not touched the issue all week, found it humorous and only remotely possible that a liberal Democrat is not investigated with the vigor that any Republican would be.

You can't make this stuff up. That's how hopelessly liberally biased the network and its producers are.

In fact, as the writer began to explain his recent discoveries regarding Corzine's involvement, Carl asked if he really wanted to go forward on air with the charges.

Clearly, Carl and his producers were hoping that they wouldn't have to be responsible for breaking bad news about Corzine's potential criminal liability.

After all, that might spoil his next gig as guest host. Then, again, Stever Rattner settled his charges with the SEC, paid a fine, and appears regularly on CNBC.

So maybe Corzine can break new ground, should he be charged with malfeasance, as a soon-to-be-tried guest host.

NBER's Definition of Recession

2011-11-03T00:39:00.059-04:00

The US economy is, at best, in the midst of one of the most sluggish expansions in memory. At worst, it's teetering on the edge of a slow slide back into recession- if it ever emerged from the recession declared to have begun in December, 2007.

Thus, it's instructive to revisit the National Bureau of Economic Research's webpages on recession for clarification on how this official umpire of US economic phases defines recession.

"A recession is a period between a peak and a trough, and an expansion is a period between a trough and a peak. During a recession, a significant decline in economic activity spreads across the economy and can last from a few months to more than a year.

The Committee applies its judgment based on the above definitions of recessions and expansions and has no fixed rule to determine whether a contraction is only a short interruption of an expansion, or an expansion is only a short interruption of a contraction.

The Committee does not have a fixed definition of economic activity. It examines and compares the behavior of various measures of broad activity: real GDP measured on the product and income sides, economy-wide employment, and real income. The Committee also may consider indicators that do not cover the entire economy, such as real sales and the Federal Reserve's index of industrial production (IP). The Committee's use of these indicators in conjunction with the broad measures recognizes the issue of double-counting of sectors included in both those indicators and the broad measures. Still, a well-defined peak or trough in real sales or IP might help to determine the overall peak or trough dates, particularly if the economy-wide indicators are in conflict or do not have well-defined peaks or troughs."

On its FAQ page, the NBER further explains,

"Q: The financial press often states the definition of a recession as two consecutive quarters of decline in real GDP. How does that relate to the NBER's recession dating procedure?

A: Most of the recessions identified by our procedures do consist of two or more quarters of declining real GDP, but not all of them. In 2001, for example, the recession did not include two consecutive quarters of decline in real GDP. In the recession beginning in December 2007 and ending in June 2009, real GDP declined in the first, third, and fourth quarters of 2008 and in the first quarter of 2009. The committee places real Gross Domestic Income on an equal footing with real GDP; real GDI declined for six consecutive quarters in the recent recession.

Q: Why doesn't the committee accept the two-quarter definition?
A: The committee's procedure for identifying turning points differs from the two-quarter rule in a number of ways. First, we do not identify economic activity solely with real GDP and real GDI, but use a range of other indicators as well. Second, we place considerable emphasis on monthly indicators in arriving at a monthly chronology. Third, we consider the depth of the decline in economic activity. Recall that our definition includes the phrase, "a significant decline in activity." Fourth, in examining the behavior of domestic production, we consider not only the conventional product-side GDP estimates, but also the conceptually equivalent income-side GDI estimates. The differences between these two sets of estimates were particularly evident in the recessions of 2001 and 2007-2009.

Q: How does the committee weight employment in determining the dates of peaks and troughs?
A. In the 2007-2009 recession, the central indicators–real GDP and real GDI–gave mixed signals about the peak date and a clear signal about the trough date. The peak date at the end of 2007 coincided with the peak in employment. We designated June 2009 as the trough, six months before the trough in employment, which is consistent with earlier trough dates in the NBER business-cycle chronology. In the 2001 recession, we found a clear signal in employment and a mixed one in the various measures of output. Consequently, we picked the peak month based on the clear signal in employment, as well as our consideration of output and other measures. In that cycle, as well, the dating of the trough relied primarily on output measures.

Q: Isn't a recession a period of diminished economic activity?
A: It's more accurate to say that a recession–the way we use the word–is a period of diminishing activity rather than diminished activity. We identify a month when the economy reached a peak of activity and a later month when the economy reached a trough. The time in between is a recession, a period when economic activity is contracting. The following period is an expansion. As of September 2010, when we decided that a trough had occurred in June 2009, the economy was still weak, with lingering high unemployment, but had expanded considerably from its trough 15 months earlier.

Q: How do the movements of unemployment claims inform the Bureau's thinking?
A: A bulge in jobless claims usually forecasts declining employment and rising unemployment, but we do not use the initial claims numbers in determining our chronology, partly because of noise in that data series.

Q: How do the cyclical fluctuations in the unemployment rate relate to the NBER business-cycle chronology?
A: The unemployment rate is a trendless indicator that moves in the opposite direction from most other cyclical indicators. Its level in February 1949 was the same 4.7 percent as in November 2007. The NBERhe unemployment rate is a trendless indicator that moves in the opposite direction from most other cyclical indicators. Its level in February 1949 was the same 4.7 percent as in November 2007. The NBER business-cycle chronology considers economic activity, which grows along an upward trend. As a result, the unemployment rate often rises before the peak of economic activity, when activity is still rising but below its normal trend rate of increase. Thus, the unemployment rate is often a leading indicator of the business-cycle peak. For example, the unemployment rate reached its lowest level prior to the December 2007 peak of activity in May 2007 at 4.4 percent and climbed to 5.0 percent by December 2007. On the other hand, the unemployment rate often continues to rise after activity has reached its trough. In this respect, the unemployment rate is a lagging indicator. For example, in the recovery beginning in March 1991, the unemployment rate continued to rise for 15 months after the trough. The lag was 19 months in 2001 to 2003. In the current recovery, the lag was only 4 months, from the trough in activity in June 2009 to the highest level of the unemployment rate in October 2009."

Clear enough?

What is clear is that there is no single definition by the NBER on what constitutes a US recession.

Thus the headline of a Wall Street Journal article in Monday's edition, Slow Recovery Feels Like Recession.

The NBER FAQ page includes the detail that the entity was established in the 1920s. That's relevant because evidently much of its approach dates from an era way before today's globalized supply chains and tightly-interrelated economies. Even when I studied Samuelson's Economics as an undergraduate at Saint Louis University in the late 1970s, the export component of demand (C+I+G+E) was a sort of afterthought. Now, much of the growth in revenues and profits of the S&P500 has been overseas.

What I don't think the NBER ever imagined and, even now, doesn't quite know how to consider, is a scenario, common to the US economy for over two decades now, in which GDP, based on business exports and sales in units located overseas, grows far in excess of US employment. Scenarios in which there is an absolute bifurcation in corporate profits and revenue growth from the fortunes of the US work force.

Thus, since late 2007, we've seen a disparity between business and individual economic fortunes. What the NBER won't call a recession, because, by some technical measures over which it has discretion to choose, the GDP side of the economy is growing, albeit fitfully, while the unemployment picture clearly portrays an economy still in neutral.

I've argued in prior posts that we are in an entirely new economic era with respect to phases like expansion and recession. Global trade has allowed for the growth in overall business activity for companies based in the US, but that growth, thanks to US immigration and tax policies, and comparative costs and productivity levels, is being serviced by overseas employees and operations. Thus, a lowest percentile of every nation's work forces is becoming unproductive on global terms and, thus, unemployable.

Further, in the US, the Fed's wrongheaded low-interest rate, easy money policy under Greenspan and Bernanke led to substantial overinvestment in housing, which, effectively, poured wealth into unaffordable, unnecessary homes. Fannie and Freddie, mandated by an inept Congress, further fueled this mistake with low-cost mortgages to the unqualified.

Is it really a surprise that the US is mired in an unemployment recession and a fitful, sluggish business expansion, after having destroyed so much private wealth in egregious housing investment?

It shouldn't be. In a newly-multilateral global economy where other nations, such as China, didn't make those mistakes, US economic policy mistakes now carry more immediate and significant penalties. I suspect we are now living through our first bout of such a scenario, and it won't be over anytime soon.

Christina Romer on Bloomberg

2011-11-03T00:24:00.021-04:00

Former Obama economic adviser Christina Romer made a brief appearance on Tom Keene's Bloomberg noontime program yesterday. I must say I'm rapidly growing weary of Keene's apparent lack of ability to challenge any of his guests. They all seem, to him, equally profound and worthy of his unstinting praise. It's getting old.

Romer managed, in just a few minutes, to make a complete fool of herself. Never mind that her entire body of work while with the administration for the past three years has been discredited as a complete disaster. Never mind that her work there countered that of her research for years prior.

Yesterday, she argued that if the Fed would just announce that, by golly, they WERE going to lick this economic sluggishness, why, then, people "might feel they'd still have their job next year" and spend.

Her remark really showcased Romer's complete detachment from reality. Does anyone reading this know of anyone stupid enough to rely on the Fed's easing as a reason to suddenly feel their job is much safer than it had been?

The only hope the US economy, and that of the global economic system, has is for central banks to quite maintaining near-zero interest rates and begin to let the down-phase of the economic cycle clean out the excess dreck of the last phase, let prices drop to market-clearing levels for a variety of assets, and thus form a base for subsequent expansion.

Romer's remarks, made with a sort of giddy, goofy looking grin, portrayed her as an ivory-towered idiot.

MF's Illegal Use of Customer Funds

2011-11-02T13:23:00.000-04:00

You'd think it would be a business news sensation. Perhaps earning a picture on the front page of the Wall Street Journal.

A former co-head of Goldman Sachs, former US Senator from and Governor of New Jersey, gone missing. His residence staked out and the FBI reportedly examining the books of MF Global.

More detail regarding not just a 'missing' $600-900MM of funding in the company's books, causing Interactive Brokers to walk away from a bid to buy MF Global, but the misuse of money in that general amount from customer accounts.

I wrote this post a few days ago regarding the rather mild story of MF Global's Corzine-led big bet on European debt.

Now the story has become much deeper. At least the Wall Street Journal managed a brief piece yesterday suggesting that Chris Flowers, Corzine's backer as CEO of MF Global, has lost his golden touch of late. But no reminder of the connection which the Journal exposed in its January piece on Corzine's appointment as CEO of the firm.

Curiously, this wasn't a big story this morning on CNBC. As a frequent guest host, you'd think they'd have discussed it. But I'm being sarcastic- CNBC is a heavily liberal-leaning network, so it was and is unlikely to do much more than broadcast stories the staff has already read in the New York Times or Wall Street Journal. Bloomberg wasn't much better.

At least I had the satisfaction of watching Bloomberg use the headline of this recent post nearly verbatim on Friday morning.

Of course, MF Global's rapid demise begs the question of how US financial regulators can possibly handle a large, allegedly 'too big to fail' institution, when they were caught flatfooted by the broker's situation. As a registered Fed dealer, one wonders where that regulator was? Not just because of the excessive risk in the European bond positions but, now, the news of misusing customer funds in an attempt to avoid collapse.

It's as if the umpires of a AA minor league baseball game gone wrong are suddenly sent to handle a World Series. If regulators can't identify and measure such outsized risk as MF Global took, not to mention the funny business with customer funds, how are they ever going to manage to pre-emptively flag and liquidate an excessively-risky Citi, BofA or Chase?

Answer- they can't and won't.

Meanwhile, it should be an interesting week for breaking news on Corzine and MF Global.

Ed Lazear's Dominos vs. Popcorn Analogy

2011-11-02T00:21:00.017-04:00

Ed Lazear wrote a thoughtful Wall Street Journal editorial on Monday contrasting the conventional dominos view of the US 2008 financial panics and the current European debt crisis with one which he calls 'popcorn.'

Lazear, the previous President's chairman of the CEA, suggested that both crises were more like the various, individual kernels of popcorn exploding independently in hot oil, than a case of dominos toppling one after another.

As a strategist and researcher, I put great value on correct conceptual models, and Lazear, in my opinion, has done some good work here pointing out the fundamental mistake of assuming these financial panics are always domino-like.

Lazear went to some lengths to detail how various banks had binged on mortgage-backed securities long before Lehman's demise. That several shotgun mergers/acquisitions, e.g., BofA/Merrill, Chase/WaMu and Chase/Bear Stearns, occurred before Lehman's filing.

Similarly, in Europe, Lazear notes that the general, common problem are continental governments having lived and promised significantly beyond their means for decades. It simply happens that the unpayable debts are now coming due, with no country really capable of funding the others, or sufficiently strong on its own to avoid problems, either.

Thus, Lazear doesn't see Greece as a triggering event, but, rather, simply the first kernel in the popper to pop. If it had not, Spain, Italy, Portugal and Ireland would still be themselves, and one of them would have been first.

That's not to say there aren't knock-on, domino effects once a major entity, whether company or country, goes down. But the initial shock isn't one of dominos, so much as many bad decisions at multiple entities which happen to come a cropper at nearly the same time.

Corzine's MF Global Declares Bankruptcy

2011-11-01T00:11:00.016-04:00

Last Thursday's post concerning Jon Corzine's bungling at MF Global evidently drew plenty of traffic yesterday, despite my being unable to post due to power outages.

Imagine my horror though, reading this weekend, pre-Chapter 11 filing, of- you guessed it- J. Christopher Flowers' potential bid for the firm's wreckage.

Did I not predict this one? I did, in this passage from that post,

"The only thing that could top this week's MF Global news is to learn that, as rumors swirl regarding the firm now being an acquisition target, we learn that Chris Flowers' private equity shop is involved in such an acquisition. I don't know what portion of MF's equity is owned by Flowers, but it's just possible that half the value of the rest of the firm, which would now not be paid to own 100% of the firm, might well be more than the losses Flowers has just taken on his share of MF Global.

That would be just too much, wouldn't it, if it occurred? Watching a private equity guy install a partner in a firm on the board of which one of his representatives sits as CEO of the company. Then seeing said CEO dramatically and quickly lop off half the value of the publicly-held firm. Followed by the private equity guy opportunistically buying the now-tainted firm for half of what it would have cost him last year."

What's curious is how silent all the cable news media are about this. Neither CNBC nor Bloomberg, nor even the Journal, bothered to note Flowers' original intrusion into MF Global's board to force Corzine's selection as CEO. Nor do any of them now note how Flowers must have been on board with Corzine's strategy.

Regarding that strategy, I heard it lampooned on CNBC last night as having basically gone all in on a specific European debt play. It's hard to believe Corzine would be so stupid, or Flowers would consent.

Funny, though, isn't it? All that silence on the original Corzine-Flowers connection? Even now they don't remind us that Corzine is a partner in Flowers' group.

Or is it more of being muzzled to power, because nobody with a network with hours of programming to fill wants to cross a private equity mogul like Chris Flowers?

Perhaps the Chapter 11 filing will take Flowers out of contention for swallowing the whole of MF Global on the cheap. We can only hope so.

Alan Mulally On Pent-Up US Car Demand

2011-10-28T00:14:00.111-04:00

I caught Ford CEO Alan Mulally on one of the two business cable networks, CNBC or Bloomberg, earlier this week on the occasion of the firm's earnings release.

Mulally was excited about the average age of the US auto fleet, which was somewhere in the 10 year range. He noted that this was an all-time high.

Fair enough, but is that really a fair historic comparison?

I drive a Subaru that is by no means new. But it's in infinitely better condition at its 7+ years than its predecessor, a 1986 Subaru, was at the same point in its life. My current car has had fewer serious problems than the earlier one. For example, my older one lost a timing belt, which is a car-stopping problem, after about 7 years. My present Subaru hasn't suffered that. Instead, it had a leaky fuel injector, which was, while annoying and not inexpensive to repair, not a problem which caused the car to cease functioning.

Today's cars are much more difficult, both stylistically and condition-wise, to gauge in terms of age. Bodies don't rust as easily, the quality of design and assembly are higher. Overall, a ten year old car doesn't look the same today as a ten year old car did, well, ten years ago.

So I wonder if Mulally's engaging in some wishful thinking. Yes, I understand that recent double-dip recession fears have eased. And I understand that US car sales have been good lately.

Yet I don't see the employment and income growth statistics which would seem to underpin a truly robust growth in US car sales. Moreover, as cars age much better, and, aside from computerized safety and communications systems, which are not essential for driving, have added fewer new systems, like anti-lock brakes, power systems, and such, it's not clear to me that financially-strapped consumers feel the need to replace their cars so quickly.

It would be interesting to know how the average US fleet age has changed with respect to economic conditions and the evolution of cars themselves over the past several decades.

I'd also be curious to know the composition of Ford's and other makers' recent sales growth. My hypothesis is that the growth has probably been among higher-end, higher-priced cars. Bought by upper-income consumers who haven't been affected by the last four years of US economic turmoil.

While it would be nice to accept Mulally's cheerleading about US fleet age and imminent replacement sales at face value, I just can't. There seem to be too many conflicting signals to make such a simple extrapolation.

The Folly of Mortgage Forgiveness

2011-10-28T00:14:00.098-04:00

Alan Blinder's editorial in the October 20 edition of the Wall Street Journal, How to Clean Up the Housing Mess, contains shockingly bad recommendations regarding America's housing hangover from the Greenspan era of easy credit.

For example, Blinder contends, in the opening paragraphs of his editorial,

"Sadly, however, we did almost nothing to stop the predicted foreclosure wave, which is now drowning us. The issue at this late date is how we can mitigate the damage.

One oft-repeated answer comes from the intellectual descendants of Andrew Mellon and Herbert Spencer: liquidate, liquidate, liquidate. Let the housing market find its natural bottom, and the chips fall where they may.

I beg to differ. Some of the reasons are humanitarian. Millions of foreclosures are ruining millions of lives and devastating many communities. We can do better than Social Darwinism."

Blinder refuses to acknowledge that the housing foreclosure mess and overbuilding involved borrowers getting themselves into loans which they should have declined, mostly for houses they could not afford. Simply declaring that they must be spared is a pipe dream. Liquidation of foreclosures doesn't necessarily mean evictions, but we must have an attribution of the loss of value to some party. And that party would, according to mortgage contracts, seem to be the borrowers. If they default and the lenders can't recoup all of their loan value, then they, too, will share some of the loss.

Next, Blinder makes a baldface misstatement,

By now, massive underbuilding during the slump far exceeds the overbuilding during the boom. So, by rights, a shortage of houses should be pushing up house prices, incentivizing home builders, and boosting growth in gross domestic product. Instead, actual and prospective foreclosures hang over the housing market like a wet blanket."

On Monday afternoon, two economists who were guests on Bloomberg television agreed that the recent rise in housing starts is bad news. That the US still suffers from a surplus of housing. So Blinder is wrong to claim that there has been a "massive underbuilding during the slump" that "far exceeds the overbuilding during the boom." If that were true, we wouldn't have a foreclosure dilemma, because demand would be supporting housing prices.

Blinder claims the following regarding federal mortgage relief,

"The first is money. Given the huge magnitude of the aggregate gap between house values and mortgage balances, a comprehensive anti-foreclosure solution requires hundreds of billions of dollars. (Note, however, that this money would be lent, not spent.)"

How does he know the money would "be lent, not spent?" Losses will eventually have to be realized, which means 'spent' money which artificially paid for value that just isn't there.

"The second barrier is a host of legal complications—stemming from such things as securitizations, second mortgages, and the like—that make it difficult to design and execute a comprehensive plan. The details would put you to sleep. But the bottom line is that most serious solutions entail modifying somebody's property rights—which is something we don't do lightly in America, and for good reason."

So Blinder doesn't take this lightly, but, what the heck, let's do it anyway. We'll just say, you know, that we 'didn't do it lightly.'

"The third barrier may be the biggest: politics. Apparently, many Americans view it as unfair to bail people out of unaffordable mortgages. Do you remember the famous Rick Santelli rant on CNBC in February 2009—the one that gave the tea party movement its name? Mr. Santelli was griping about President Obama's new foreclosure mitigation programs—the ones I just characterized as half-hearted. It would have been a brave politician indeed who pushed to make those programs larger and more generous.
Most economists see principal reductions as central to preventing foreclosures. That takes money, of course—plus ignoring the Rick Santelli rant. Perhaps the cost to taxpayers could be reduced by giving the government—or even private investors—some of the upside when house prices finally start climbing."

For some reason, perhaps because he's a liberal, and Rick Santelli is not, Blinder delights in demonizing the CNBC on-air staffer. Calling the process of saddling taxpayers with the losses of injudicious borrowers for homes they could not afford "politics" is a convenient way to disguise and endorsement of moral hazard, as well as bad policy.

"Many vacant houses could be converted into rental units by enterprising developers. The government could make such investments more attractive, e.g., by using mechanisms similar to what the Federal Reserve and the Treasury did during the worst of the financial crisis. Back then the government lent money to investors who were willing to buy mortgage-backed securities; this time it could lend money to investors who are willing to invest in certain rental properties."

Ironically, Lew Ranieri complained on CNBC earlier this year that such federal loan programs for small investors, which were a key part of the 1980s S&L crisis recovery, were not offered in the most recent mortgage-related crisis. Once again, though, one has to ask, who will have born the losses on these houses as they return to the market at lower prices?

Blinder is all for mandated loan forgiveness, forgetting that such losses will make banks take losses, further imperiling their capital adequacy. Large US banks wouldn't even be at the table discussing the issue, had the federal government not intimidated them with baseless litigation as the price of declining to join the talks.

As I explained to a friend the other day, housing value losses are a fact. There are only three groups which can absorb them- homeowners, banks and taxpayers. Blinder wants banks to absorb the losses. That will, as I have explained in this piece, cause capital adequacy issues, as well as reward borrowers for taking excessive risk. If homeowners are left to follow available legal options, including bankruptcy, then housing prices will fall to market-clearing levels and others who can now afford such houses will buy them. If the government, either directly or through GSE pass-through securities, assumes the losses, that means, in effect, taxpayers are bailing out homeowners.

That's no way to treat a private sector, nor to resolve the US housing problems. Blinder's ideas for dealing with the housing sector's woes and coming foreclosure boom should be ignored.

The European So-Called "Solution"

2011-10-27T10:45:00.000-04:00

Having been wary of equity market performance and a host of troubling contextual factors for most of this month, I would, in light of this morning's US GDP and spending data, and the investor reaction to the suspect 'solution' to the European debt crisis, return to a fully-invested long position in my portfolios.

It's not that any of the concerns which roiled the equity markets in early October have disappeared. But there is a sense of unfulfilled, self-fulfilling market behavior. Instead of moving down to a level of 1050 or so, the S&P has fitfully moved higher, then, after news overnight of some sort of initial Greek debt accord in Europe, S&P futures were already at around 1260 this morning. The 8:30AM release of third quarter GDP and spending further boosted investor optimism.

Thus, with market levels well away from those which would signal being out or short, I'd return to full investment levels at this time.

I don't think anyone actually believes the European situation has been resolved in any real sense. The description of the process for handling bond losses provided by a CNBC correspondent this morning was positively laughable. Banks are supposed to take earnings hits to cover writedowns. Then, if necessary, raise capital in public markets. If that doesn't fulfill their needs, then a combination of national treasuries and the EFSF are supposed to provide the necessary capital.

This sounds exactly like what Kyle Bass and others have warned against. It's mostly hope, smoke and mirrors. Spain, Portugal and Italy weren't even mentioned, yet everyone knows they are far larger and share Greece's sovereign debt problems.

Meanwhile, in the US, with unemployment remaining high and real median income down for the past decade, it's tough to see from where the rise in Q3 spending is coming. But when equity markets move decisively in a direction, it's usually foolish to completely ignore that.

In this case, since there are some developments of a non-negative nature in key contextual variables influencing my outlook on equities, their change can lead to a change in my decisions.

Citigroup's Mortgage Fraud Case

2011-10-27T00:16:00.002-04:00

Thursday's Wall Street Journal reported that Citigroup will pay $285MM to settle fraud charges involving the bank's selling mortgage-backed securities to investors while simultaneously shorting some of those same instruments.

This is the same sort of behavior for which Goldman Sachs was excoriated before a Congressional committee, and settled related charges for $550MM.

In Citigroup's case, it seems rather odd to me that the US taxpayer rescued this firm. In effect, rather than let such a management fail, our government saw fit to rescue the management team responsible for such fraud. Something seems very wrong with that.

Wouldn't it have seemed more sensible, given the overcapacity of the financial sector, and the many mistakes made by management in some very large firms, to put those which failed into an orderly Chapter 11 process?

Instead, we have our government using our tax dollars to prop up and revive a management which actively engaged in large-scale fraud of investors in its mortgage-backed securities.

More Upward Failure- MF Global's Jon Corzine

2011-10-27T00:03:00.047-04:00

Yesterday morning's Wall Street Journal featured an article in the Money & Investing section detailing MF Global's troubles stemming from newly-hired CEO Jon Corzine's drive to turn the firm into a replica of the old Goldman Sachs which he once ran.

Two days ago, on Bloomberg television, Corzine was described as stumbling at MF Global, and having lost his last gig as governor of New Jersey. That was before he led MF Global to a 48% drop in its market value after announcing the firm's quarterly loss earlier this week, as well as an out sized risk exposure to European securities for a paltry $12MM of related earnings.

But Corzine's been on an upward failure trajectory for much longer than that.

A one-time bond group head, Corzine was co-head of Goldman Sachs with the less-remembered Stephen Friedman. The latter has recently attained prominence for his alleged conflict of interests during the financial crisis of 2008, when he was chairman of the board of the New York Fed.

As I began writing this post, I remembered that I wrote about Corzine's arrival at MF Global early this year, and his connection with private equity mogul J. Christopher Flowers. In that post, I described the Wall Street Journal's sarcastic asides regarding Corzine's being run out of his job as co-head at Goldman Sachs.

His next post, which he bought, was the job of US Senator from New Jersey. For a Democrat, a veritable walk-in. But Corzine showed poor judgement, leaving the Senate just before the Democrats regained the majority which would have put the former fox in regulatory control of the financial hen house.

Perhaps Corzine had presidential ambitions, because he won election as New Jersey governor after leaving his Senate seat. But, as the Bloomberg anchor noted, Corzine only lasted one term before his poor performance caught up with him by way of Chris Christie.

Now, one imagines at the behest of Chris Flowers, Corzine's attempt to morph MF Global into a miniature version of the Goldman Sachs he and his backing partner once knew, has managed to chop half the market value from the firm.

If you are unlucky enough to be an MF shareholder, perhaps you are now wondering just how a private equity guy has managed to take control of your firm, then ruin it, within a calendar year.

The only thing that could top this week's MF Global news is to learn that, as rumors swirl regarding the firm now being an acquistion target, we learn that Chris Flowers' private equity shop is involved in such an acquisition. I don't know what portion of MF's equity is owned by Flowers, but it's just possible that half the value of the rest of the firm, which would now not be paid to own 100% of the firm, might well be more than the losses Flowers has just taken on his share of MF Global.

That would be just too much, wouldn't it, if it occurred? Watching a private equity guy install a partner in a firm on the board of which one of his representatives sits as CEO of the company. Then seeing said CEO dramatically and quickly lop off half the value of the publicly-held firm. Followed by the private equity guy opportunistically buying the now-tainted firm for half of what it would have cost him last year.

Perhaps people should be wary when a failed CEO of a financial firm is installed in the same job in their firm.

Upward failure- it seems more widespread than many people realize.

Inane Forecasts On Business Cable Channels

2011-10-26T09:58:00.001-04:00

I saw a couple of examples in the last 24 hours of some truly inane market and company forecasting on CNBC and Bloomberg.

Yesterday afternoon, Citigroup equity strategist Tobias Lefkovitch was on Bloomberg pontificating about equity market moves.

He followed an interview with a guy whose name I did not catch, but was something like 'Mark,' who is allegedly famous for making S&P Index top and bottom calls. According to the Bloomberg anchor/interviewer, the guy had correctly called the recent index bottom, around 1090, and top of a few days ago of 1255. The rest of the interview descended into fairly incomprehensible technical lingo. Even the anchor tried to sum up the guy's remarks in something resembling plain English. It left me wondering how many other market calls this guy has made that have been forgotten or ignored because they weren't correct.

Then Lefkovitch appeared. After discussing various topics involving sectors, the anchor, of course, asked the Citi strategist for his US equity outlook. Incredibly, Lefkovitch, after his own brand of obfuscation, finally uttered what I will try to closely paraphrase,

'So we're looking for equity markets to rise sometime in the next 12 months.'

That's it? Incredible.

Reminds you of the stopped watch aphorism, doesn't it? Just exactly what good is someone telling you that they expect the S&P to rise significantly sometime in the next 12 months?

For individual, self-directing investors, sure, that may offer hope that a continuously-long, dollar-averaged approach to S&P ownership will pay off, if they can remain patient. But for anyone purporting to follow even a semi-active equity strategy, it's a useless market call.

Sophisticated investors don't like to sit still for a year's worth of losses, in hopes that eventually things will turn around. They sure don't pay monthly management fees to professional managers for that sort of performance.

Makes you wish the Oracle of Delphi was still around, doesn't it? So that you could compare some of these so-called strategists' market calls with an appropriate peer?

My own take away is how desperate Bloomberg must be to fill air time that it invites these guys on to give nearly useless forecasts on market trends.

Then I watched a few minutes of CNBC's 9AM program, before Cramer's preening, self-congratulatory remarks turned me stomach enough to send me back to Bloomberg. Prior to that, he was extolling Boeing and ATI for what he forecasts as Boeing's coming seven-year fat phase. Never mind David Faber's sobering question regarding investors already discounting this outlook in the price of the equity. One wonders the same regarding ATI, Boeing's titanium alloy supplier.

For what its worth, Boeing has never entered my quantitatively-selected equity portfolios for over twenty years. It's just too erratic, with its boom and bust cycles and ruthless price competition with Airbus, and, prospectively, China's own budding airplane manufacturer.

Amazon's big earnings miss last night didn't faze Cramer. He praised Jeff Bezos for damning near term performance in order to continue building the world's largest online good provider. This morning, the company's equity price is down more than 10% as I write this at 10AM. It's been in some of my equity portfolios over the past year, but, as always, its performance will keep it there. Not promises of uncertain future developments.

Ron Paul's Sensible Reminders of Central Bank Limits

2011-10-26T00:15:00.004-04:00

Ron Paul, Texas Republican Representative and presidential candidate, wrote a well-reasoned editorial in Thursday's edition of the Wall Street Journal entitled Blame the Fed for the Financial Crisis.

Without getting into mind-numbing detail, let me focus on one key passage of his piece,

"The Federal Reserve has caused every single boom and bust that has occurred in this country since the bank's creation in 1913. It pumps new money into the financial system to lower interest rates and spur the economy. Adding new money increases the supply of money, making the price of money over time—the interest rate—lower than the market would make it. These lower interest rates affect the allocation of resources, causing capital to be malinvested throughout the economy. So certain projects and ventures that appear profitable when funded at artificially low interest rates are not in fact the best use of those resources.

The great contribution of the Austrian school of economics to economic theory was in its description of this business cycle: the process of booms and busts, and their origins in monetary intervention by the government in cooperation with the banking system. Yet policy makers at the Federal Reserve still fail to understand the causes of our most recent financial crisis. So they find themselves unable to come up with an adequate solution.

In many respects the governors of the Federal Reserve System and the members of the Federal Open Market Committee are like all other high-ranking powerful officials. Because they make decisions that profoundly affect the workings of the economy and because they have hundreds of bright economists working for them doing research and collecting data, they buy into the pretense of knowledge—the illusion that because they have all these resources at their fingertips they therefore have the ability to guide the economy as they see fit.

Nothing could be further from the truth. No attitude could be more destructive. ...the notion that the marketplace, where people freely decide what they need and want to pay for, is the only effective way to allocate resources—may be obvious to many ordinary Americans. But it has not influenced government leaders today, who do not seem to see the importance of prices to the functioning of a market economy.

The manner of thinking of the Federal Reserve now is no different than that of the former Soviet Union, which employed hundreds of thousands of people to perform research and provide calculations in an attempt to mimic the price system of the West's (relatively) free markets. Despite the obvious lesson to be drawn from the Soviet collapse, the U.S. still has not fully absorbed it.

The Fed has painted itself so far into a corner now that even if it wanted to raise interest rates, as a practical matter it might not be able to do so. But it will do something, we know, because the pressure to "just do something" often outweighs all other considerations.

If the Fed would stop intervening and distorting the market, and would allow the functioning of a truly free market that deals with profit and loss, our economy could recover. The continued existence of an organization that can create trillions of dollars out of thin air to purchase financial assets and prop up a fundamentally insolvent banking system is a black mark on an economy that professes to be free."

It's an instructive and, I believe, correct analysis of what the Fed has done to the US economy for nearly a century since it was created by Congress. In response to populist pressure for a dispersed federal authority, unlike the old First and Second Banks of the US, the regional organization of the Fed was designed to represent the interests more than simply the US financial sector.

Rather than trying to exercise more control over the monster which Congress created, it could, instead, follow the advice of the late Milton Friedman and replace the institution's monetary policy authority with a rule-based approach to monetary base management. John Taylor has suggested a rule which assumes the existence of the Fed, but provides an interest rate-setting formula.

But what Congressman Paul so correctly emphasizes is that the Fed, having a staff and budget, has come to believe it can manipulate the money supply to some good effect, rather than simply adjust its growth to relevant factors involving population and GDP.

As with other governmental institutions, once chartered and funded, the Fed is unlikely to ever unilaterally relinquish its powers and/or admit it is mistaken in its ability to beneficially attempt to fine-tune monetary policy.

Netflix's About Face On Splitting Services

2011-10-25T00:22:00.000-04:00

According to its stock price history, it is clear that Netflix has yet to recoup the massive shareholder value damage which occurred when the firm's CEO first announced the splitting of the firm into online and physical dics video delivery. The nearby 3-month price chart for NFLX and the S&P500 Index, through Friday, clearly displays that. It got worse after the close yesterday when Netflix released earnings and reduced projections for the fourth quarter.

Now about a month old, the furor which the move touched off among investors and customers prompted the firm to reverse its decision a few weeks ago. I wrote in this post a little over a month ago,

"Hopefully, Hastings will go all the way and spin the two businesses- Qwikster and Netflix- into two separate public companies. The segmentation, costs and overall business dynamics are so different as to make that entirely sensible.

As for the anger some customers are experiencing? Get over it. Say goodbye to a business model that simply isn't viable at older price levels anymore.

As for the effect on Netflix's equity price, that's not entirely surprising, either. Thus the benefit of splitting the businesses, with either some sort of transfer price from one unit to the other for content, or a priori shared purchase of said content. In time, the two units should have dramatically different values and growth rates."

Looking at a 6-month chart of the same two series, and noting Hasting's reference, in his September 20 email to customers, that the firm had announced its new pricing structures a few months earlier, one can see that the firm's equity price stopped rising at that point. The formal announcement of a split caused a cliff-like drop in the share price.

Contrary to my own hopes, Netflix has totally reversed itself on splitting, but kept the pricing changes. Probably the worst of all worlds.

Now we'll never know how the online component would have fared alone, although, as I originally noted, there would have been some short term challenges to cost allocations of content acquisition deals.

Unlike the initially-disastrous New Coke introduction decades ago, which ultimately resulted in a new flavor becoming permanent, and more shelf facings for Coke products, I think the longer term consequences of Hastings' dithering, then reversing his company-splitting decision will be negative.

To me, Hastings' actions reflect one or both of two negative components of his decisions as the firm's CEO. To reverse himself on such a crucial customer service issue as splitting the company into online and disc suggests that either Hastings and/or his staff didn't possess a high level of confidence in their knowledge of their customers. One would hope they would have conducted some primary research with a sample of their customers, chosen by usage patterns, to get a good sense of their reactions before even announcing the price changes. That's profoundly poor general and marketing management.

For Hastings to compound this with his missteps regarding splitting the firm shows weakness as Netflix's CEO in understanding what is essential for the firm, going forward, in order to continue to deliver total return to shareholders. Because the decision involved not just investors, but customers, as well, that, too, should have been researched. The reversal of the decision again suggests it was not.

Prior to this past summer, Netflix appeared to be a dominant, well-managed video content delivery firm. In the wake of its actions since the summer involving pricing structure changes, and then corporate structure changes, the core competence of its management team is now in question.

That's reason enough for an investor to be open to reassessing the firm's attractiveness as an investment.

More Puzzling US Equity Market Behavior

2011-10-24T12:47:00.000-04:00

As I write this, it's a little after noon on Monday. The S&P500 Index has moved above 1250. Earlier this morning, one pundit opined that if the index moved above that level- probably closed, I would guess- then the US equity market is in fine shape and will continue to rise. For now, the index's return for October is in excess of +10%. Quite substantial.

Meanwhile, last week, another pundit described this October's S&P rebound as a bear-market rally.

Whom to believe?

Well, consider that the vaunted weekend Euro summit to solve their sovereign debt and related bank solvency problems didn't provide a resolution. That got kicked to later this week. As if that would matter. What, exactly, in the year and a half since April of last year, when Greece's debt problems first roiled markets, has changed? What new solution will occur in the next 3-4 days which will magically avoid defaults, write-downs, and the loss of value across a range of European assets?

Other news this morning included a concern that Europe is slipping back into recession. And that's before the effects of whatever value loss recognition will finally occur.

All this and the S&P has climbed back from below 1100 this month. Is this credible and sustainable?

I took a look at how the S&P monthly returns behaved after past triggering of my proprietary equity signal to get out of equities and/or go short.

In 2008, there were no significant positive monthly returns after June, when the signal was triggered, until the fall, when equities collapsed. However, back in 2001, things were different.

The signal was activated in January of that year, but April and November exhibited S&P monthly returns of over 7%. Never the less, the year's total return for the index was nearly -12%.

We often hear that equity markets, to rise, must "climb a wall of worry." And there are other aphorisms, to be sure, for various market situations.

But if you recall 2001 and 2008, there were enough concerns to more than qualify as a wall of worry. Yet the S&P subsequently collapsed. The index posted more than a +20% return in 1999, then flattened to about -1% for 2000, before plunging for the next two consecutive years. In 2008, the S&P lost 36%, then, after a stunning bottom below 1,000 in March, managed to return roughly +26% for the whole year.

My point is that equity market descents of a long and/or excessively severe nature don't necessarily start predictably and monotonically. There can be some healthy monthly index returns amidst what has, in retrospect, become a serious decline.

So far in 2011, the first two S&P monthly returns were each above average. March was flat, followed by April's +3% return. May through September have all been negative, the last month returning worse than -7%.

Wall of worry, or prelude to a plunge?

To me, as I've observed in prior posts on this topic, prudence is a wise course. I became cautious when an early October's intra-day S&P dipped below 1100. That hasn't changed yet, largely due to the context of large, unresolved structural economic and financial problems which exist globally.

When I hear those who argue for a strengthening US economy, I wonder just what about a 9% narrowly-defined unemployment rate is a positive omen to them? I've already explained, as have others, that strong US corporate results reflect global business exposure more than US activity.

Despite today's continuing robust S&P performance, I still would remain cautious for the longer term of at least the rest of the year, pending resolution of some of the existing problems which left the S&P relatively unaffected.

Shareholder Lawsuit In The Wake of Kinder Morgan's Privatization

2011-10-24T00:16:00.004-04:00

A little over five years ago, Richard Kinder took Kinder Morgan private. At the time, I wrote this post about it and, later, one about the inherent unfairness of a management self-dealing against other shareholders in such a gone-private transaction. And what could be done to mitigate this,

"I reasoned something like the following would work. A sort of reverse greenmail. If a management tendered to take the firm private, regulation should provide for the offering of a similar ownership share in the newly-private firm, without voting rights, but with equity rights equal to that of the management's holdings. In effect, whatever management deals itself in for would be available to any shareholders who wished to stay on board for the ride. It would be interesting to see how such a change in the law to mitigate gross underpayment to existing shareholders by the buyout group would affect future private equity deals."

Harman Kardon actually did something like this when it went private in 2007.

So it was with interest that I read, amidst the heavy media coverage of Kinder Morgan's proposal to acquire El Paso, that some disenfranchised shareholders sued over the privatization that closed in 2007. According to a Wall Street Journal article,

"Angry shareholders filed a class action lawsuit contending he had structured the deal to his own benefit, shortchanging them. The company settled last year for $200 million.

In February of this year he turned around and spearheaded an initial public offering that issued nearly 110 million shares and raised roughly $3.3 billion."

The Journal piece says that Richard Kinder currently owns 31% of the firm, which "will have an enterprise value of $94 billion after the El Paso deal."

Kinder Morgan went private for $15.2B in 2007. It's paying $21.1B for El Paso, which means the enterprise value of Kinder Morgan before the deal is roughly $73B.

The Journal article doesn't say what percentage of the pre-privatization Kinder Morgan the disgruntled shareholders owned, but this webpage contends that the shareholders are receiving, before legal fees, only $2/share from the settlement, in addition to the original payment of $107.50. That's less than a 2% increase.

But Kinder Morgan insiders saw a roughly five-fold value increase (from $15.2B to $73B) in the firm's value. That's a huge amount of value which non-management shareholders were forced to forgo by Kinder's original private buyout.

With all of the data now available from before and after Kinder Morgan went private, it's evident that those deals by management insiders are unfair to the average shareholder who is not a member of senior management. They are forced to sell to insiders who would not be buying if they thought the price would likely prevent them from realizing their target return, or better.

I'm not a big fan of more SEC-supervised rules regarding the operation of companies or their ownership transactions. But this sort of self-dealing takes advantage of external shareholders and increases the animosity of the average American against those they believe take such unfair advantage.

Would it really have cost Richard Kinder and his team of insiders so much to allow those shareholders, prior to the company's going private in 2007, who wished, to exchange their voting shares for non-voting equity of equal value?

A Reminder Of The Fundamental Flaw In Government Stimulus Programs

2011-10-23T00:08:00.026-04:00

Here's another recent Wall Street Journal Notable & Quotable that deals with current US federal government financial problems. But it quotes someone from quite long ago, reminding us that government stimulus plans typically overlook something:

"Frederic Bastiat on justifying government spending only based on 'that which is seen,' while ignoring 'that which is not seen.'

French economist Frederic Bastiat in "That Which Is Seen, and That Which Is Not Seen," 1850:

I lose patience, I confess, when I hear this economic blunder advanced in support of . . . a project. "Besides, it will be a means of creating labor for the workmen."

The State opens a road, builds a palace, straightens a street, cuts a canal; and so gives work to certain workmen—this is what is seen: But it deprives certain other workmen of work, and this is what is not seen.

The road is begun. A thousand workmen come every morning, leave every evening, and take their wages—this is certain. If the road had not been decreed, if the supplies had not been voted, these good people would have had neither work nor salary there; this also is certain.

But is this all? Does not the operation, as a whole, contain something else? At the moment when M. Dupin pronounces the emphatic words, "The Assembly has adopted," do the millions descend miraculously on a moon-beam into the coffers of MM. Fould and Bineau? In order that the evolution may be complete, as it is said, must not the State organize the receipts as well as the expenditure? Must it not set its tax-gatherers and tax-payers to work, the former to gather, and the latter to pay?
The sophism which this work is intended to refute is the more dangerous when applied to public works, inasmuch as it serves to justify the most wanton enterprises and extravagance. When a railroad or a bridge are of real utility, it is sufficient to mention this utility."

These latter paragraphs make Bastiat's point- projects worth society's capital need not wait for nor depend upon federal government funding. Excepting cases of military spending and wartime efforts like the Manhattan Project, the long term economic benefits of which, outside of defense purposes, I am not specifically aware, there isn't any significant government spending which can't be undertaken by the private sector instead.

Currently, federal funding is used as a substitute for state and local funding, because the latter two must typically run balanced budgets. Roads, government building such as schools, and even public employees, are all potential uses to which scarce state and local taxpayer dollars must be allocated. To simply declare them all vital and rely on federally-sourced, borrowed money, is to ignore Bastiat's insight that the better projects are already being funded locally.

A Windbag's Failed Wind Project

2011-10-22T10:10:00.000-04:00

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.

A Chilling Statistic

2011-10-21T09:24:00.000-04:00

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?

2011-10-21T00:06:00.036-04:00

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.

The Fed's Beige Book et.al.

2011-10-20T14:06:00.000-04:00

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

2011-10-20T00:33:00.036-04:00

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

2011-10-20T00:11:00.032-04:00

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.

Continued High Equity Market Volatility

2011-10-19T10:12:00.000-04:00

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

2011-10-19T09:07:00.001-04:00

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.

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

2011-10-18T00:23:00.040-04:00

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.

CNBC & Bloomberg Odds & Ends

2011-10-17T12:39:00.001-04:00

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

2011-10-17T09:11:00.000-04:00

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.

Great by Accident?- More Flawed Research by Jim Collins

2011-10-14T00:52:00.178-04:00

Several years ago, after seeing multiple references to it, I bought a used copy of Jim Collins' Good To Great, published originally in 2001. I wrote this brief review in 2005 and, judging by the lack of subsequent pieces on the topic, didn't really find more of interest in the book to bother critiquing. Some of my key observations were captured in these passages from that post,

"Much of my work for the last decade has involved measuring the performance of publicly-held U.S. corporations. There is really only one body of work of which I am aware that sounds remotely similar to mine.

What I found upon reading Collins’ methodology was an odd mixture of quantitative and qualitative bases of analyses. There are a variety of problems with his methods, which I will address.....here ......."

I must admit, I was rather shocked that such slipshod and simplistic quantitative definitions of “good” and “great” performances would exist in a book so seemingly well-regarded in the business community. Perhaps it is yet another case of the broad class of mediocre managers and leaders being unable to distinguish “great” work when they see it.

Between his use of market value, rather than total return, and a simple point-to-point measurement, Collins' metrics in his original book left a lot to be desired. As did his mixing in of qualitative measures which tend to be so judgemental as to be nearly useless for interpretation or application in other contexts.

Unless, of course, you were using the book as a marketing tool for your consulting efforts. Which Collins does.

Thus, I was interested to read in this past Tuesday's edition of the Wall Street Journal a review, by longtime Journal executive Alan Murray, of Collins' recently-published book, Great by Choice. The review's title was Turbulent Times, Steady Success, which I found a bit of a reach, for reasons I'll explain later in this post. The highlight, or subheadline for the review read How certain companies achieved shareholder returns at least 10 times greater than their industry.

To start with, Collins uses cumulative returns over long periods of time to judge a company as “good” and/or “great.”

However, my own research on large U.S. publicly-held companies reveals that among companies which outperform the S&P 500 average total return over a period of years, firms which consistently outperform the S&P index, on average, create shareholder wealth at a much higher rate than companies which earn most of their total returns with a few years of outstanding performance.

Just reading those few lines told me a few things about problems with Collins' latest work. In fact, Murray's review contains enough information for me to find significant problems with Collins' latest work without having to actually waste time reading the whole thing.

First, I'm suspicious of published work of this type because no sane, intelligent person in the business world has published complete information on any market-beating strategies for decades. Whether a business school professor, consultant or equity portfolio manager, it doesn't pay to tell all. You always save something so that your published work can't be totally replicated or reverse-engineered, and prospective customers have to engage your services professionally to really benefit from your research findings.

One thing I discovered in my own proprietary research on US corporate performance over many years is that there is a limited timeframe within which most companies can demonstrate superior performance. And it's not a sufficient length of time to typically exhibit "steady success" during "turbulent times."

But, let me get to Murray's review. He begins with this telling paragraph,

'Great by Choice" is a sequel to Jim Collins's best-selling "Good to Great" (2001), which identified seven characteristics that enabled companies to become truly great over an extended period of time. Never mind that one of the 11 featured companies is now bankrupt (Circuit City) and another is in government receivership (Fannie Mae). Mr. Collins has a knack for analysis that business readers find compelling."

Murray may have written that with his tongue in his cheek, but it lays bare a serious weakness with that type of approach. One I mentioned in an email to Murray after reading his review. I likened Collins' work to that of long-ago consulting guru Tom Peters, of "In Search of Excellence" fame. As I explained to Murray in my note,

"But the other aspect of his work which I noticed, having the benefit now of being aware of two of his works, is how much it reminds me of the Tom Peters' old type of 'great companies' books. Being, like me, of that certain age, I'm sure you recall the book which launched Peters out of McKinsey. Sadly, only a few years later, his great companies were no longer so.

I'd expect Collins' companies are likely to experience similar fates, because both authors use fixed timeframes of specific companies to construct their measures of greatness, rather than observe statistically-valid large samples that include many different time periods.

Peters wrote before the era of cheap desktop computing and inexpensive, exhaustive corporate data. But Collins hasn't. Yet his work still smacks of that 'hit parade' style of spotlighting a few companies for specific time periods, then extrapolating their idiosyncracies into strategic wisdom, rather than the other way around."

Suffice to say, starting with Peters, and now continued by Collins, this type of misleadingly shallow analysis provides business execs with easily-consumable 'best practices' candy, without actually being rigorous or deep in its methodology.

Murray describes the book's objective next,

"Mr. Collins's new book tackles the question of how to steer a company to lasting success in an environment characterized by change, uncertainty and even chaos."

Unfortunately, the objective is a chimera. I'm not going to divulge my own proprietary findings, because, among other uses, they help drive my own equity portfolio management process. Let me just assure readers that 'lasting success' is a good deal shorter time period than you'd ever believe. If more boards knew this, they'd be radically restructuring CEO compensation over time.

But, to provide a little more insight, all truly exceptionally-performing companies fall victim, within a definable number of years, to one or more of three forces: adjusted investor expectations; competition, and/or; regulatory scrutiny and action. Between the three, no company succeeds for too long. Here's a brief list of the once-great, now-fallen: Home Depot, Microsoft, Dell, Compaq, and Wal-Mart.

Murray then provides the reader with some information on the data which drove Collins' latest book,

"The data set that Messrs. Collins and Hansen examine so carefully ends in 2002, well ahead of the change, uncertainty and chaos of the 2008 financial meltdown. The intervening years were spent conducting their research. Still, the lessons of "Great by Choice" are not meant to apply to a particular moment of economic turbulence but to a continuous condition—a business world "full of rapid change and dramatic disruption."

For their study, the authors chose a set of major companies that achieved spectacular results over 15 or more years while operating in unstable environments; Messrs. Collins and Hansen call them "10Xers" for providing shareholder returns at least 10 times greater than their industry. Then the authors compared those companies—Amgen, Biomet, Intel, Microsoft, Progressive Insurance, Southwest Airlines, Stryker—to similar, but less successful, "control" companies: Genentech, Kirschner, AMD, Apple, Safeco, PSA and United States Surgical. It is an indication of the volatile nature of today's business success that, using 2002 numbers, Microsoft came out as a "10Xer" while Apple was its less successful "control" company, a ranking now reversed. More on that below."

Right away, I find serious flaws with Collins' approach.

First, no company posts "spectacular results" for 15 years. Yes, perhaps "over" 15 years, i.e., from point to point, over 15 years, there were some spectacular periods. But consistency has a value beyond a mere endpoint to endpoint total return value.

I've seen this sort of simplistic apparent performance phenomenon many times. Consider the nearby price chart for Dell, Microsoft, Apple, Home Depot and Google. Taken over the right timeframe, early years of stratospheric performance can offset a full decade of subsequent flatlining, as Microsoft's curve demonstrates.

Further, Collins' industry-specific metric renders his whole enterprise useless- except for, well, someone who wants to consult with his results to rather mediocre senior managers who read his book.

Here's why.

Investors can choose from among all public companies in which to invest. Even among private companies, in some cases. So to be truly exceptional, a manager should perform at a level among the best of, say, a broad equity market average. Not just his own industry.

By the way, just what defines an industry, anyway? Some companies don't have directly-comparable industry competitors. Others do, but only a very few. Consider auto makers. Do you count three- Ford, GM and Chrysler? Or two, when Chrysler was privately-held? Do you count Mercedes, Toyota, Honda, BMW, et.al., although their parents and sizable operations are located outside the US?

And who believes Microsoft's badly-performing look-alike was ever Apple? Historically, Apple's integrated software and hardware competed with the Wintel combine of Intel and early PC makers IBM, Compaq or Gateway. Microsoft's Bill Gates was actually a guest at one of Steve Jobs' early Apple product debuts, as an example of a collaborative software publisher who appreciated having two platforms for which to create their products. Apple didn't do application software- just its proprietary operating system.

But that would make Collins' simplistic approach nearly impossible to use. So, instead, he opted for a comparison that has no credibility.

Having a point-to-point 15 year total return that is "10X" that of the average of three other firms in a poorly-performing sector like autos is hardly laudable. But if you plan to consult to Ford or GM, well, you could probably hoodwink those CEOs into at least listening to your sales pitch.

It's amazing how often people form impressions, a priori, on what constitutes a high-growth company. I've had some companies in my equity portfolios which few people would have thought would qualify if they knew the criteria for inclusion. Trust me, growth companies aren't just in technology sectors of the US economy.

Murray then provides his meatier treatment of the newly-published book,

"Messrs. Collins and Hansen draw some interesting and counterintuitive conclusions from their research. First, the successful leaders were not the most "visionary" or the biggest risk-takers; instead, they tended to be more empirical and disciplined, relying on evidence over gut instinct and preferring consistent gains to blow-out winners. The successful companies were not more innovative than the control companies; indeed, they were in some cases less innovative. Rather, they managed to "scale innovation"—introducing changes gradually, then moving quickly to capitalize on those that showed promise. The successful companies weren't necessarily the most likely to adopt internal changes as a response to a changing environment. "The 10X companies changed less in reaction to their changing world than the comparison cases," the authors conclude.

The book's organizing metaphor is built around the story of Roald Amundsen and Robert Falcon Scott, the two men who set out separately, in October 1911, to become the first explorers to reach the South Pole. Amundsen won the race by setting ambitious goals for each day's progress but also by being careful not to overshoot on good days or undershoot on bad ones, a disciplined approach shared by the 10Xers, according to Messrs. Collins and Hansen. Scott, by contrast, overreached on the good days and fell apart on the bad, mirroring the control companies in "Great by Choice."

If "Great by Choice" shares the qualities that made "Good to Great" so popular, it also shares some that drew criticism. The authors' conclusions sometimes feel like the claims of a well-written horoscope—so broadly stated that they are hard to disprove. Their 10X leaders are both "disciplined" and "creative," "prudent" and "bold"; they go fast when they must but slow when they can; they are consistent but open to change. This encompassing approach allows the authors to fit pretty much any leader who achieves 10X performance into their analysis. Would it ever be possible, one wonders, to find a leader whose success contradicted their thesis?"

Not content to critique the book generally, Murray fortunately, and shrewdly, provides an accidental example to which he referred earlier in his review,

"Which brings us back to Apple. Messrs. Collins and Hansen had no way of knowing, when they began sifting through their data in 2002, that Apple would become one of the most stunning turnaround stories in business history, soaring past Microsoft in market value. The late Steve Jobs accomplished that turnaround with a run of boldness, innovation, visionary thinking and egotism that might seem counter to the studied conclusions of "Great by Choice" as well as those of "Good to Great," in which Mr. Collins found that one of the leading attributes of the best business leaders was "humility." Steve Jobs?"

All of which satisfies me that Collins hasn't changed his approach much at all. He's still mixing hard-to-define qualitative assessments with quantitative ones. And applying them with, as Murray notes, considerably less than the precision one would wish.

Mr. Murray is not in the business of offending either an author who may advertise his book in the Journal, nor his readers. So he isn't about to land hard punches in his review by concluding that Collins' work is so vague and flawed as to be practically meaningless.

But I don't share Murray's constraints.

As I noted earlier, Collins' recent effort is perfect if what you hope to do is sell a book, for profits, that becomes a resident sales tool in many C-suites. And it even has an impressively-titled co-author from an equally-impressive university. But that doesn't make it valid or profound.

On that note, here's anecdote I learned years ago when I worked for Accenture's predecessor, Andersen Consulting. I had been chatting with Bob Gach, then a partner in the financial service group whose clients included Morgan Stanley and a few other investment banks. Since then, Bob has risen to become a very senior global partner in Accenture's financial services practice.

Back then, Bob was fretting because of the difficulty he was having closing a consulting contract with a Morgan Stanley executive.

As we discussed the firm's, and executive's behavior, Bob enunciated a principle which I've found to be pretty much universally true ever since. To paraphrase his remarks,

'This guy at Morgan Stanley really frustrates me. He's smart enough to force me to keep giving him enough examples of our work in his area, and to sign small pieces of work, that he keeps me from selling him the larger, more profitable interpretative and application modules.

When you think about it, the worst consulting customers are executives who are either really smart or really stupid. The smart ones know how to cherry pick a consultant's work and do the high value-added application of results to the rest of his businesses or operations.

The stupid ones are so thick they don't even understand why they need the consultant.

A consultant's best prospects are in the middle. Smart enough to know they need help. Dumb enough not to be able to get ahead of you in the thought process and rein in the scope of the project.'

Collins' work strikes me as designed to hit that middle group. It's too simplistic and flawed to sell to really intelligent business leaders. And the really slow ones will just never realize where to start to fix their problems.

But I can imagine quite a few middling companies with average executives jumping on Collins' rather shallow analyses as the answer to their prayers for some path out of mediocre performance.

And the beauty of Collins' approach, as Murray so deftly illustrates, is that there's always some other qualitative variable to blame when a CEO pays Collins for a lengthy engagement, follows his advice, and his business still doesn't outperform his peers.

I actually thought through all these issues when I was actively marketing the consulting application of my proprietary research on corporate performance. I even sold an engagement to the current chairman of the NYSE when he ran State Street Bank. Suffice to say, my consulting approach, as well as the research methods underpinning it, remains proprietary. But I will divulge that it is all quantitative, with no qualitative wiggle room.

Taxing Wealth, High Income, or....What?

2011-10-14T00:18:00.000-04:00

The Wall Street Journal published an interesting editorial recently discussing the tax consequences of someone who realizes a large gain in the last year of his moderately-high income working life. The writer's point was that a one-time, larger-than-$250K income makes an otherwise-middle income person look 'rich' by the standards of today's arguments over tax rates and income levels.

This caused me to think of the larger picture, i.e., income versus net asset wealth.

To hear politicians from both parties these days, there seems to be confusion over what constitutes 'wealthy' or 'rich' people. Is it a net asset value, or an AGI level?

It matters. And causes me to wonder if this confusion affects taxation policy.

Currently, one's wealth is taxed when it was income. If earned, it's taxed each year it has been earned. If inherited, it is the detritus of the rather sizable haircut given by a dead benefactor's death taxes.

The current tax code has many provisions which reduce notional rates. If a person who, in the past, earned a lot of money, and has become an owner of substantial assets, uses tax code provisions to reduce his/her current income tax liability and rate, s/he is viewed as doing something immoral, if not illegal.

You have people like Warren Buffett and Jim Chanos publicly declaring their willingness to pay more tax on their income. Chanos went even further, claiming that, contrary to what economists predict, he would change nothing about his work life, work just as hard, even if he knew that the federal government would take a larger share of each year's income.

I thought about those two very wealthy businessmen, and what would motivate them to so publicly endorse the idea that they should pay more in taxes.

Aside from purely political persuasion, one is pretty much forced to believe that only people who had amassed so much wealth that current income really doesn't matter anymore would say things like they say.

Particularly Chanos. I'm not intimately familiar with any large windfall income years from his hedge fund management, but I have the general sense that he's worth hundreds of millions of dollars, or more.

I've written in prior posts about GE's Jeff Immelt, who has, as a matter of public record, already earned in excess of $20MM in cash during the past decade that he has been that firm's CEO. I contended that, once someone has been paid that much money, and hasn't simply pissed the bulk of it away, they are no longer motivated by future earnings. So when Immelt makes it a point to publicly claim that his current or future incentive payments will be more difficult to earn, I pay no attention. At this point, it's unlikely his lifestyle would change much if he earned those bonuses, or became a dollar a year man, like the late Steve Jobs, the recently-deceased CEO of Apple.

How do you suppose people like Chanos and Buffett would react if Congress announced that it was considering amending the tax code to require payment of, say, 2% of net worth from any tax filer with a net worth over $1MM?

Perhaps the law would simply change the basis of tax once one amasses a net worth of $1MM, including real estate. That would certainly address the issue of "the rich" paying "their fair share," wouldn't it? In effect, for wealthy Americans, federal tax would become a property tax, not an income tax.

Perhaps it would be scaled, like the income tax, so that above certain net worth levels, one paid multiples of the 2% of net worth.

After all, if it's just simple class warfare that the masses want the tax code to address, isn't a federal property tax on the very wealthy simpler to understand and apply?

Isn't net worth what most people mean when they say someone is "rich?" I don't really think that someone who, for one or two years, earns a lot of money, is seen, per se, as "wealthy." Unless perhaps it's a trader whose compensation for a few years is in the tens of millions, like Howie Hubler at Morgan Stanley, or Wing Chau at Harding Advisory. But, in those cases, someone's one or two year income pushes them right into the very wealthy group that would be subject to the federal property tax.

I don't really have firm answers for these questions. Rather, it simply occurred to me that if people are really out to "soak the rich" with taxes, shouldn't they be more clear about what they mean by "rich?"

And if they mean high net worth, then why not just tax that directly, rather than the income of people with high net worth?

Of course, it's quite possible that many so-called limousine liberals might change their mind about endorsing higher taxes on the wealthy if it applied to their net worth, rather than their annual incomes, isn't it?

Regarding $2Trillion of Cash On Corporate Balance Sheets

2011-10-13T00:18:00.000-04:00

Last week's Wednesday edition of the Wall Street Journal carried an article discussing the $2 trillion of cash on US non-financial corporate balance sheets.

It's an eye-popping number, to be sure. According to the article, the level of corporate cash was $1.4 trillion in 2008.

Thus, a nearly 50% increase in cash levels on those balance sheets in 3 years is one of the costs of the continuing turbulence in financial markets and global economies.

After seeing firms go bankrupt as a consequence of relying on short term funding during the financial crisis of 2008, it appears that many US non-financial corporations simply have ceased to trust or depend on their commercial banks and financial markets for operating funds.

Some view this large amount of cash as an impediment to a US expansion, as companies conserve those resources, rather than spend or invest them. And that's true.

But it's a consequence, rather than a first cause. That is, its CFOs' distrust of their prior, typical funding sources that caused them to essentially shift to self-funding. So it really identifies a heretofore hidden, lingering cost of the financial problems of three years ago. And the continuing global economic weakness.

Determined not to be caught out by unreliable funding sources again, US corporations have adapted to current circumstances. And that adaptation does seem to be resulting in a lack of expansive spending and investment.

Yet another source of uncertainty, along with tax and regulatory uncertainties, which drives US business behavior to be more prudent than it otherwise might be. With real consequences for the US economy.

Sales vs. Income Taxes- Why The Panic?

2011-10-13T00:15:00.026-04:00

I'm writing this post on this blog, rather than my companion political one, because it's a non-partisan, economic topic of interest to me.

Ever since Herman Cain announced his 9-9-9 tax plan, there have been objections from those who are also adamantly against an American VAT tax, as well.

The most commonly-heard criticism of Cain's plan is that the sales tax portion is set at 9%, but can be raised in the future. So therefore, it's a bad idea.

Why is the fact that our income tax, initiated by a Constitutional amendment, has been raised and radically modified many times, not relevant in this regard? Clearly, whatever federal tax is proposed and levied on individuals, Congress will seek to modify it, effectively, or not, when they spend more than they collect in taxes.

A sales tax, or a VAT, is no different in this respect than an income tax. Congress will attempt to raise any of them when it suits their purpose, and voters let them get away with it.

Cain's sales tax is simpler to understand and operate than a VAT. Or that other odd tax that Huckabee was pushing in 2008 when he ran for president. And it does two valuable things which many critics miss.

First, it is actually less regressive, as Cain maintains, because a 9% sales tax is less onerous to the poor than a 15% payroll tax. Second, it hits the 50% of Americans who currently pay no federal income tax.

Taken in the context of eliminating all other taxes, a 9% sales tax isn't such a bad idea. It taxes spending, not savings. It is imposed as the double-taxation of dividends is eliminated, as is the separate taxation of capital gains.

Though many criticize Cain's tax plan as too simplistic, I don't really think it is. It is, instead, an Alexandrian type of solution to a tax code which is the equivalent of the famous Gordian knot.

Regarding Bloomberg's GOP Candidates' Event Last Night from Dartmouth College

2011-10-12T09:45:00.000-04:00

To read my reactions to Bloomberg's two-hour GOP presidential candidate event- I won't misuse the term debate- held last night, go here.

Why Is Leo Hindery Seen So Frequently On Business Cable News Channels?

2011-10-12T00:16:00.048-04:00

What is it about former TCI and ATT executive Leo Hindrey that merits his being seen so frequently on CNBC and Bloomberg? As I wrote in this post yesterday, be critical and sceptical of the pundits you see on those networks.

To my knowledge, the guy's biggest break was being one of John Malone's lieutenants at TCI when the latter sold it to Mike Armstrong's ATT. Hindery made a bundle on the deal, briefly became an ATT senior executive, then moved on to help destroy value by running a unit of Global Crossing.

Aside from Malone, a PhD and former Bell Labs techie, the bulk of the managerial so-called talent in those days dragged their knuckles when they walked. I know a bit about this because my mentor at Chase Manhattan, Gerry Weiss, made a lot of money personally from his cable investments. He was an early enthusiast, thanks to work he did at GE as chief planner there. He was an early advocate of the Kagan cable newsletter and, from that, learned to stay invested with Malone. Besides him, Gerry was dismissive of most of the industry, as was Kagan.

In case I'd missed something about Hindery, such as a PhD in finance or economics, or a Nobel prize in something, I searched for his bio. The best I could do was this bio on Wiki. It confirms that Hindery went to Stanford and that, otherwise, he was lucky to be in Malone's organization at the right time.

Yesterday morning, Hindery was on Bloomberg pontificating about how the GOP candidates are weak on job creation policies. How the federal government just has to get involved. Then he derisively snorted at Herman Cain's 9-9-9 plan and judged it too simple.

Doesn't anyone at Bloomberg do any background checking? Hindery is a long time Democratic party backer. So much so that he was considered at one point to head the DNC. He's the guy who caused Tom Daschle his post in this administration's health care cabal by lending Tom a chauffeur and car, which Tom neglected to declare as income to the IRS.

Asking Hindery to handicap GOP presidential contenders is like asking the Koch brothers or Ken Langone to moderate a Democratic candidate debate.

Moreover, what's Hindery actually done since working for Malone and fortuitously cashing in on TCI options from the ATT deal? Nothing I can see. Sure, he's on boards and involved in philanthropy. Heads up his own activist foundation. But basically Leo is a cable guy who hit it big because of his boss' prescience. No track record in consulting, or creating his own business. No history of shrewd corporate strategy work. Nothing like that. Nothing which would cause you to suspect he's a business statesman and savant behind that unassuming visage.

Why he belongs on CNBC and Bloomberg so often to broadcast his personal views is beyond me.

As I noted yesterday and at the beginning of this post, just because someone is on a major cable network program doesn't mean you should accept their comments uncritically.

Disappointment About Bloomberg's GOP Presidential Debate Tonight

2011-10-11T09:14:00.000-04:00

I must say that I'm profoundly disappointed by what I've heard- on Bloomberg TV- concerning the network's GOP candidate debate this evening from Dartmouth College in New Hampshire.

The questioner/moderator is apparently going to be Charlie Rose.

Charlie Rose??????

You have to be kidding.

On a network featuring Margaret Brennan and the very knowledgeable pair of anchors on the pre-market-open program, not to mention Tom Keene, Rose is the best they can do?

Rose doesn't know anything about economics or business. He's an idiot with a southern drawl who, from the times I've seen his boring interview program over the years, specializes in behaving and looking stunned and awed by anything any guest says.

I'll probably tune in for the first few minutes of the, well, debate isn't really the right word for these spectacles. I wrote recently on my political blog about a format I'd prefer. And, again, more recently, concerning Fox News' nod in that direction.

But having someone as clueless as Charlie Rose asking questions will likely have me channel surfing within five minutes, and probably, as usual, looking to various news programs tomorrow for a more concise reprise of what occurs this evening in Hanover.

Don't Believe Everything You See On Cable Business Channels

2011-10-11T06:20:00.041-04:00

Neil Cavuto hosts a 4PM weekday program on Fox News which he tries to make into a blend of political and business news, typically beginning the hour by discussing the US equity market performance of the day.

Last week, I caught a few minutes of a misleading and, frankly, just wrong-headed segment in which a guest contended that Costco will be losing business by raising its membership fee.

I forget the woman's name, but she had an axe to grind against the warehouse discount store chain. All the woman could talk about was that Costco was raising its annual membership fee by about 10%, so she alleged, to around or just below $55. For the record, I know Costco has raised my annual fee once since I joined over four years ago. It was $50 when I joined, and I just wrote them a check for $53.50 last month.

In the past year, I realized that there is almost nothing which I used to buy at my former usual grocers, Kings and Stop 'n Shop, that I cannot also buy at Costco for roughly half the price. The biggest surprise was how much I save on staples- milk, juice, lettuce, chicken breasts, cereal, salad dressings and fruit. I now buy a package of six romaine lettuce heads for about $5, or what two heads cost at Kings.

I probably visit Costco once per week, since it's located within a couple of miles from my fitness club. My actual visits per week probably average 1.3.

While there, usually after playing squash and working out, I usually eat a light dinner for a laughably small sum. It's hard to spend more than $3.50 to eat dinner there, and the choices include a surprisingly healthy array of choices.

While having dinner and reading the editorials in the Wall Street Journal, I also watch the parade of shoppers checking out and leaving the store. I'd say roughly half are families or a couple with a very full shopping cart. Just from my experience behind people buying large amounts of food, and my own bills, I'd estimate that a full cart can easily represent $200-300 worth of groceries. Multiply that by 50 weeks, and you have at least $12,500 annual sales for a family that shops at Costco. I'm reasonably sure that's a low estimate.

On that base, a $5 annual fee increase is 4 hundredths of a percent! Even for me, it would be only about a tenth of a percentage point.

Yet the woman whom Cavuto had as a guest railed against Costco needlessly increasing its fee, insisting that many families would bolt the warehouse chain to return to their local grocery stores.

To use a phrase, 'in a pig's eye!'

Has this woman ever seen families carting out a 40" flat panel plasma TV? A workbench, chair or bicycle? You can't believe the bargains to be had on high-end electronics- camera, TVs, gaming accessories, laptops and tablets. Microwave ovens, office furniture, and medium-sized appliances. All half-price.

You can't seriously believe anyone who uses Costco frequently would change stores over much less than a doubling of the membership fee. The economics are simply too compelling.

Yet Cavuto himself was unable to do this math on air and challenge the woman's assertions. It was really pathetic. She was a moron clinging to a totally indefensible viewpoint, while Cavuto just sat there and expressed dumbfounded surprise, without asking the woman why such a small fee increase would matter to people spending thousands of dollars per year at Costco.

Taxing Billionaires To Fund The US Government- More Liberal CNBC Bias

2011-10-11T00:25:00.031-04:00

In this recent post I discussed comments on Europe's troubles by Kyle Bass from his Barefoot Economic Summit 3 in Texas.

Bass was interviewed as part of David Faber's noontime CNBC program. Faber proclaims that he and Bass are 'old friends.' Probably from Faber's days as a regular morning SquawkBox co-anchor, when he cultivated sources like Bass, then a debt trader at Bear Stearns.

However, it's clear the two part company on politics. Consider the exchange between Bass and Faber when the latter asked the former for his take on US sovereign debt and the economy.

Bass pointedly noted that the fortunes of Bill Gates and Warren Buffett would only fund a month's federal government spending.

"So who pays for November," Bass challenged Faber?

Then Bass observed that confiscating all of the wealth of the Forbes 400 only funds the US government through the end of the year.

'So who will pay for 2012,' asked Bass rhetorically?

Faber grew increasingly uncomfortable with Bass' aggressive challenges on 'tax the rich' policies, replying rather meekly,

'But nobody's actually suggesting that the government do anything like that.'

It was a weasel-like comment for Faber to make, because he, like every viewer, knew that Bass was not suggesting that any Congressman or the president wanted this. Bass' point, which even Faber understood, is that you can confiscate all the wealth from the so-called wealthiest 400, probably even 2,000 Americans and you still can't fund the US government for a full year.

Thus the emptiness of calls to 'tax the rich,' or claim that they 'don't pay their fair share.'

Faber's dumbfounded reaction and, then, silence, once more illustrated CNBC's latent liberal bias. The liberal on-air reporters and anchors can never back up their liberal bias with facts. When confronted with facts they don't like, they just sort of stare at the offending guest, then change the subject.

In this case, Faber couldn't think of a comeback to refute the obvious point that no amount of 'more' and 'their fair share' of taxes from the wealthy which are designed to be above-average will ever actually close any federal funding gap.

It's an appeal to class warfare, pure and simple.

The obvious conclusion to be drawn from Bass' anecdotal statistics is that only by allowing the wealthy to invest their capital to allow business creation and expansion can new jobs be created in the US, thus aiding economic growth, from which the government can collect taxes on new economic activity.

Merely soaking the rich for more of their current wealth will do nothing serious nor sustainable to make a dent in America's horrific debt levels.

The Perils of Predicting Equity Market Moves

2011-10-10T14:24:00.000-04:00

Last Thursday I published this post discussing US equity market levels and volatility. Among other observations, I wrote,

"Now, on any given day, the S&P can easily close in territory that moves the signal to 'short' for next month. Specifically, if the S&P return for this month is much worse than -2%, the signal will go 'out/short.'

Thus, I moved the bulk of my funds which were in equities into cash yesterday. Because the signal wasn't 100% solid, but only an intra-day low, I didn't move 100% of the assets.

For what it's worth, more than a few pundits and fund managers appearing on CNBC and Bloomberg have said they are doing the same in the past week.

For perspective, I took a look at the S&P levels and volatility since then. Beginning with that first Greek crisis in the markets, the S&P was at roughly 1110 to 1130. My proprietary options volatility signal rose to 'put' levels by early April, and stayed there for the next six months.

In the intervening months, the S&P has climbed as high as 1363 on 29 April 2011. Now it's back to where it was, more or less, at the start of the Greek crisis last year. Holding long equity portfolios generated by my proprietary strategy in the interim would have allowed an investor to realize gains for most of that period. Gains which would be rebalanced as portfolios rolled on and off. A sort of slightly more sophisticated variant of dollar-averaging, if you will.

But now, volatilities, and, thus, risk, in both my proprietary options and equities signaling systems have risen to critical levels amidst equity market levels which aren't providing concomitant returns.

As I write this post at about 1PM on Wednesday afternoon, the day before it will publish, the S&P is at 1131. A slight gain from yesterday. But in times like these, any one day's equity market performance isn't the point. It's the overall trend, or lack of one, coupled with instantaneous and recent volatility that guides my quantitative long/short signals. The qualitative economic and financial information I process provides context.

And now, the context and the signals are flashing to be mostly out of US equities."
The S&P finished Wednesday at 1144, then 1165 the next day, when the post was actually published. Today, Monday, at 1:50PM, it's at 1189.

Yes, making public statements about the direction of equity markets surely can be painful- at least in the short term. Or longer, I suppose, if you're Byron Wien and predicted an equity market collapse for about, what, three straight years? Until finally, like a broken watch, his prediction coincided with reality?

However, volatility is actually greater today than it was last Wednesday, when I wrote that post. The S& closed at 1210 three weeks ago. Meaning that the movement in the index continues to be violent. The pattern of the S&P daily closes, resembles, graphically, a distinctive saw-toothed pattern of generally range-bound values with rapid, sharp changes vertically over the past three months. Thus the abrupt rise in volatility at the beginning of August which has continued, only moderately abated.

Today's rally is based upon investors' hearing that Germany's and France's leaders claim to have a plan to resolve the European debt crisis. On Friday morning, US equities were up on what some believed were good jobless numbers. So why did the S&P close down -.8% that day?

What will happen in a few days, when the Euro-bears like Kyle Bass reiterate their fairly sensible, sane observations that there isn't enough money in the European Union to rescue all of the endangered sovereign credit, now including downgraded Spain and Italy? That there will be defaults and corresponding declining economic activity which will have effects on the US economy? I wrote in that post,

"Bass discussed how ludicrous it is to expect some nations, like Spain and Italy, to be guarantors of bad Greek debt today, then turn around and become receivers of further Euro help tomorrow. Bass referred, again, to his firm's original market research among Germans regarding their attitudes toward bailing out the rest of Europe, and added, this time, a reference to private conversations with senior German government officials. This smacks of the legwork Bass was known for, ex post, in the 2007-2008 mortgage crisis, as displayed on Faber's House of Cards documentary."

While CNBC, Bloomberg and the Wall Street Journal all strive to make an entertaining, must-watch or -read day out of every day the equity markets are open for trading, the truth is that to an equity portfolio manager of other people's money, such daily moves don't affect most of the portfolio. In my case, my call that it's time to be out of US equities won't really be clearly right or wrong for at least another month. Back in 2008, my equity signal was triggered in mid-summer. The equity market cratered first, rapidly, in October, with Lehman's bankruptcy, then again in March of the next year. The signal didn't recommend re-entry until after that.

So for the meanwhile, I'll continue to monitor S&P daily closes and associated volatility. It's not clear to me yet that it's safe to remain fully invested in equities. A month's S&P gains can be made up by a portfolio manager with a consistently superior-performing strategy. But a month's losses of, say, 7% is quite different. In the former case, the assets are still there, and the S&P has a slight incremental lead. In the latter case, it's likely that more than 7% of your assets are gone in one month, meaning you must earn the losses back from a smaller base.

Thus the asymmetrical risk, if you wish to call it that, of sitting out a positive S&P month amidst excessive turbulence, versus actually losing money as the market disintegrates, when your signaling system warned you to be cautious as the equity market neared a precipice.

Conflicting Opinions on China's Economic Collapse

2011-10-10T09:19:00.000-04:00

There's an interesting contradiction regarding China's potential economic woes in the Economist and the Wall Street Journal this week.

Over the weekend, I read the current edition of the Economist, including an article lauding noted hedge fund bear Jim Chanos' longtime short on China. He's reputed to be traveling to Hong Kong this month, his first trip ever, apparently, so close to China. In his piece, the Economist reporter cited several pundits who feel it's now rather risky to short Chinese investments, so heavy have been losses in some of their values. Apparently as much as 30%, with P/E ratios down to only 8 for some equities. According to the piece, anyone rushing to short Chinese assets now is rather late to the party.

Meanwhile, in this morning's edition of the Journal, the back page of the Money & Finance section cautions that it's much too early to short China!

That reporter cites the continuing movement of people from country to cities, and China's national balance sheet's ability to absorb all manner of defaulted municipal projects while still maintaining a debt/GDP ratios of well under 100%.

I have no idea who is more correct. But it's clear somebody's going to be wrong.

To me, the fascinating aspect to this story is that two major, respected business publications have taken very public, contrary stands on an economic story of substantial global import.

Dueling Economists on Bloomberg

2011-10-07T08:44:00.000-04:00

Earlier this week I caught about ten minutes of dueling economists on Tom Keene's noontime Bloomberg program. One was Andrew Tilton, and the other was Michael Darda. The two were starkly different.

What struck me was that Tilton had this 'head down, read the numbers' sort of attitude, which led him to make assorted ludicrously optimistic statements. Then, again, he works for Goldman, which probably doesn't want to spook markets while their and their customers' money is long.

Darda, on the other hand, made sensible comments about real world economic events. He wasn't totally candid, but at least he gave reasonable weight to qualitative events occurring in Europe and various debt markets.

Sadly, Keene sat there and, as I've learned he often does, played up to both guests as if they offered unalloyed wisdom. I suppose he was practicing the usual on-air media nonsense of never asking tough questions of a guest because they might not return if he did.

Thus, it was a mostly wasted ten minutes of my time.

This Morning's Fake Job Numbers

2011-10-07T08:38:00.000-04:00

It's 8:35AM and I've just watched the release of the September Labor Department employment numbers.

Allegedly, consensus was for +60K jobs and 9.1% unemployment.

In reality, jobs rose by 110K with a flat 9.1% unemployment rate. However, we then quickly learned that August jobs were restated upwards, and September jobs were high, by roughly the number of striking Verizon craft workers.

Meaning that August wasn't really flat, and September didn't really add 110K jobs.

What kind of bizarro employment measurement system distorts results over a strike that everyone knows happened?

You wonder why any one month's numbers are useless? This is why.