GM: The Strike and The Settlement

I would be remiss if I let the week pass without commenting on one of the biggest news stories about corporate America- the GM-UAW strike and subsequent contract.

A few weeks ago, I wrote about GM's stock price surge, here, suggesting that it is the product of speculation, rather than consistently excellent performance.

As the nearby Yahoo-sourced price chart of GM and the S&P500 for the last three months clearly shows, even the recent spike in GM's price, due to the UAW contract, only brings it to rough parity with the Index. For much longer periods, such as more than 2 years, the picture still looks even worse, as in that prior post.

However, leaving aside the immediate ramifications of the contract on GM's market value, there are two other aspects to this deal I wish to discuss.

The first comes by way of Wall Street Journal editorialist Holman Jenkin's excellent piece in yesterday's edition. He notes that the brief strike of the UAW GM workers called by Ron Gettelfinger may well have been so he could get them in the right head space regarding the sacrifices they are going to be asked to make in the new contract. Rather than it being a product of the negotiations, Jenkins reasonably theorizes that Gettelfinger, presiding over an ever-shrinking, less-important union, is worried that they won't accept the new contract, sending the near-term status and health of the union, with GM, into free fall.

That alone tells you something about the severity of the situation in Detroit right now.

But there's so much more to it. Many articles and pundits are trumpeting the new pact as a sea change in the American worker's situation.

This is because of the key element of the new contract, wherein GM finally exits the employee medical care guarantee business, in which it, and other firms, have been since WWII, by way of a $51B payout to a new union healthcare trust find.

Sure, GM is out of the business of yet another benefit provision. Along with defined contribution plans, rather than the older, now nearly-extinct defined benefit pension plans, healthcare is returning to its rightful place- as the province of the worker, paid for with cash from his own pocket.

However, given the context of the GM deal, instead of going right to the worker, the UAW-administered trust fund idea was used. It's necessary because of the mixed durations of claims by so many former and current GM workers on the company for healthcare.

Look at what this does. It now makes the workers' own union, the UAW, responsible for any healthcare shortfalls, service gaps, funding shortages, etc. Responsibility has hit the union movement at last. It's as if they returned to an ancient medieval guild structure, wherein they have provided in common for their retirement and healthcare.

I have several observations on this. First, the $51B number seems suspect to me. If the same minds that usually mess up healthcare cost management and estimation were involved, and it's hard to imagine who else would have been, it stands to reason that this amount will, ultimately, prove unequal to the claims made on it. Look out if you happen to succeed Ron Gettelfinger as UAW chief.

Second, there's a subtle, but important, aspect to the timing of this change. Right in the middle of a Presidential campaign featuring many Democratic candidates calling for more government-run universal healthcare, you have the major US union, the UAW, reverse course and take on the responsibility for its own healthcare insurance provision.

Will a major, blue-collar Democratic voting bloc now get a taste of individual control of their own health insurance, and lose their appetites for HillaryCare 2.0, as well as other Democratic health insurance plans which promote socialism?

It's an interesting thought.

Jenkins mentioned another interesting aspect of the deal. By moving the union's healthcare administration to .....the union.....the UAW has assured its existence and relevance for a little while longer, assuming they can get the contract passed by the membership. Because, now, the union has to exist to administer the healthcare benefits.

Otherwise, the UAW was in danger of simply being outsourced out of existence, as GM, Ford and Chrysler slowly lose market share and jobs in the US.

Finally, there's GM itself. What does this UAW pact do for it? Is it now going to soar like an eagle, with the dreaded healthcare burden about which Rick Wagoner has complained for his entire tenure as CEO finally lifted?

Well, first, as some have pointed out, GM has to actually fund the new UAW healthcare trust fund. Then there's the sad fact that being quit of some legacy expense base bears no relationship to an inability of GM to design and build cars which sell at prices for which a sufficient number of people will pay the sticker, in order to make the necessary profit per vehicle to stay in business for the long run.

Like draining a swamp, and still having to wrestle the alligators, this healthcare trust fund deal may simplify matters for GM, but it by no means solves its toughest market-related survival issues.

It will still take several years of consistently superior total return performance for me to judge GM as having "turned around." And, frankly, I just don't see that coming down the road for many years- UAW contract, or not.

Microsoft Tries New Online/Ad Strategies- Again

Yesterday, I wrote this post regarding a Wall Street Journal article which harkened back to GeoCities, the very first online networking site, and discussed today's landscape in that product space.

I suppose the timing of Dennis Berman's piece was no accident, appearing, as it did, as Microsoft is in talks to buy up to 5% of Facebook for a reported $300-500MM.

Tuesday's Journal carried a front-page article describing Microsoft's many, failed attempts to break into online businesses, from browsers to ad placement businesses. As I wrote here, in May of last year, I think the only way Microsoft will realize consistently superior returns for its shareholders is to break itself up into three pieces, each focusing on one business: applications software, operating software, and internet-related businesses. As it stands now, and for some years, Microsoft's diversified structure has simply led the software giant to become a veritable Gulliver, tied down in competition with many, more nimble adversaries in each of the niches in which it does business.

According to the Journal article, this time around, Microsoft is pinning everything on one Brian McAndrews, an executive whom it acquired in the deal to buy aQuantive, Inc., an online ad company, for $6B.

Of course, as the article also details,

"Just 17 months ago Microsoft hired Steve Berkowitz, from Internet search company Ask.com, as a vice president in its online group. Much as Mr. McAndrews is seen today, Mr. Berkowitz was positioned as the outsider needed to lead a cultural change at a company strong on technology but short on experience in the advertising industry.

A lack of political chops in working within the huge company and a clash with a highly respected engineering manager have hampered Mr. Berkowitz, say people familiar with the matter. Several of Mr. Berkowitz's duties were recently ceded to Mr. McAndrews."

So, once more, Microsoft has thrown money at a business in which it lags, without really re-orienting the company to address the fundamental strategic shift such actions implicitly acknowledge.

As I've written before, I don't think Microsoft truly understands, nor is currently capable, of competing totally all-out to win in the online business arena. It's still a software company trying to re-ignite growth by viewing online as a distribution platform, rather than a do-or-die business.

It seems to me, per Mr. Berman's article, that Facebook is the big winner here. Microsoft will, as usual, pay up but cede control. It won't seriously change to address the new business. And Facebook will reap a huge payday simply for carrying Microsoft ads.

If there's any downside for Facebook, it would be these: it's not selling enough of itself while the premium is stratospheric, and; it may, as Yahoo did with its payments from ATT years ago, grow fat and lazy on the passive revenue stream, only to wake up in a few years behind its competitors.

Time will tell. However, I cannot help but think that, once again, Microsoft's unfocused, half-hearted attempts to 'beat Google,' simply to do so, will enrich third parties, further impoverish its own shareholders, and continue the software giant's slide into relative unimportance as a leader in the technology product/market.

Online Communities: The GeoCities Story

Today's Wall Street Journal featured, on the front page of its Money & Investing section, one of the best analytical, staff-written articles I've read in the paper in ages.

Dennis Berman provides a timely and fascinating look back at the very first, now almost-forgotten online social networking site, GeoCities. Back in 1994, before, as Berman reminds us, high-speed cable or DSL, full motion video, etc., GeoCities, created by David Bohnett, contained the essential elements which today characterize FaceBook, MySpace, et. al.

To summarize the GeoCities story, it rose rapidly among then-popular websites, becoming the "third most-visited site on the Web" in August, 1998. In early 2000, amidst the dot com craze, Yahoo paid $4.7B to buy GeoCities. Bohnett and his team received his payday, and, as Berman writes,

"...their creation would soon wither before their eyes."

He further describes the wrenching, profound changes for GeoCities under Yahoo,

"Life inside Yahoo was smothering for GeoCities, say a number of people familiar with the transition. Developing new technologies for GeoCities' communities slowed to a crawl, as its staff of 30 software developers was cut to a skeleton crew. Yahoo focused instead of building traffic, not necessarily on the programming for improving person-to-person interaction. "Had they done things right with GeoCities, there would be no Facebook, YouTube or MySpace," says one. "

With my own posts regarding Terry Semel's 'leadership' of Yahoo, as may be found by searching on that label on this blog, the following passage almost made me laugh,

"Yahoo's treatment of GeoCities is particularly relevant for Mr. Zuckerberg, who reportedly rebuffed a $1 billion buyout from former Yahoo CEO Terry Semel."

So, having bungled the purchase, integration and management of the internet's very first social networking site, Yahoo was going back for a second bite of this hideously expensive apple? Amazing!

What intrigued me about Berman's article, and the GeoCities/Facebook story, is how perfectly it showcases the basics of Joseph Schumpeter's now long-ago vision of the dynamics of industry and competition. Note that GeoCities was sold to the one firm, Yahoo, which, at the time, could have capitalized its new acquisition and buried all comers with innovation, expansion of services and scale, etc.

Instead, Yahoo thought small, cut costs, and opened itself up to competition, and mismanaged this expensive beachhead into what has become a very hot online business. Talking to Bohnett about this, Berman writes,

"But if he could give advice to Mr. Zuckerberg, he'd recommend heavy investment in new technology to "stay true to what the user experience is." And he stressed the importance of keeping a young audience: "Those kids tend to get older and maintain some connection with an online community. You've got to capture that early adopter, young audience." "

At this point, Mr. Berman had already written a great article. But, next, he further probed the Schumpeterian nature of this product/market space, without explicitly acknowledging the famed dynamic.

In the final paragraphs of his article, Berman reviews Zuckerberg's (Facebook's founder) options and risks,

"Mr. Zuckerberg is in an especially good place right now. His site has developed a patina of invincibility, which in 2006 enabled him to wrangle an especially good advertising deal with Microsoft. Ever the Net-laggard, Microsoft is now guaranteeing about $75 million in revenue this year, which could become as much as $300 million by 2011 if traffic grows rapidly.

Alas, advertisers have found Facebook users to be a huge audience -- that could care less about ads. The percentage of users clicking onto site advertisements on Facebook and MySpace are lower than typical Web sites. That means it's essentially sucking up a subsidy from Microsoft, which wants to get its hooks into Facebook the best it can."

Which leads Berman to what I feel makes this an outstanding article. Rather than stopping short with an excellent review of GeoCities, a comparison of it and its fate with today's Facebook, and leaving it at that, he goes one step further. Berman risks alienating the entire business, i.e., Facebook and MySpace, by noting how dependent it is upon advertising, and how horribly, traditionally difficult it has been to make this work,

""It's not that easy to monetize social media," says Eric Hippeau, a managing partner of Softbank Capital that made more than 20 times its investment in GeoCities. He also sits on Yahoo's board. "Once Microsoft's deal with Facebook expires, as does Google's deal with MySpace, they're going to have to sell advertising for themselves and it's going to be a challenge." So far, he says, "it's not that easy to match the right advertising with the right audience."

That squares with the experience of Thomas R. Evans, GeoCities' former chief executive. "When you're as successful as GeoCities, everyone tells you how wonderful you are. It causes you to miss opportunities." Now the CEO of Web site Bankrate.com, he added that, "People at the time were dismissive of old media experience. But it turned out looking exactly like the old media business. You have to execute and provide both the consumer and the advertiser with significant value."

At some point, the questions about Facebook the business will eclipse the praise of Facebook the social phenomenon. And once that point hits, Mr. Zuckerberg will be less able to dictate the terms of how fresh capital is put to use."

Mr. Berman pulls no punches. From his initial description of the now-essentially-defunct GeoCities, to the likely fate of Facebook, his superb writing uncovers a wonderful, timeless story of business innovation, absorption, mismanagement, the rise of new competitors, and the continuing weakness of the underlying business model.

Aside from the marvelous business strategy expose, Mr. Berman makes it hard for the reader to avoid asking the question,

"If no other, larger firm, had bought, or bought stakes in, GeoCities, or was trying to buy or invest in Facebook, would Bohnett and Zuckerberger realize millions in wealth simply from the profitability of their businesses and business model? Or would they become, like Amazon, long on initial market value gains, but short on realized profits?"

Thus, leading to the ultimate question,

"Were/are the acquiring giants of these online social networking businesses the greater fools?"

Greenspan's Book & A Week of Reactions

Last week's business media was filled with news of and interviews with Alan Greenspan, retired Chairman of the Federal Reserve.

Appearing on CBS' 60 Minutes, NBC's Monday morning talk show, and numerous CNBC interviews, Greenspan was plugging his just-published book, "The Age of Turbulence."

Monday's Wall Street Journal had an 'official' staff article reviewing the book. It was pretty standard fare, recounting Greenspan's comments concerning various Presidents, how he handled the 1987 and 1998 market crises, his views on the current President and various economic affairs.

I think it's fair to say that the initial 48 hours of 'shock and awe' at Greenspan's apparently magisterial disrobing of his past obfuscations contained an almost-uniform measure of reverence. As if the various pundits and interviewing heads were saying,

"Alan said it, so it must be so. He was so awesome as Fed Chairman, we're lucky to get these nuggets of wisdom for only $35."

Then James Grant, editor of Grant's Interest Rate Observer, and noted monetary conservative, weighed in on Tuesday. In a Wall Street Journal review of the book, he panned Greenspan's consistency, credentials, and motives.

This passage aptly illustrates Mr. Grant's tone and perspective on Greenspan, and his book,

"The fantastic irony of Mr. Greenspan's career path -- from gold-standard libertarian to federal interest-rate fixer -- seems hardly to have registered on Mr. Greenspan himself. The closest he comes to acknowledging it is his description of how the Fed looked to him from the outside. It was, he writes, a "black box." Having watched his mentor, Arthur Burns, struggle with the chairmanship, Mr. Greenspan notes, "it did not seem like a job I felt equipped to do; setting interest rates for an entire economy seemed to involve so much more than I knew." A deeper kind of libertarian might have added: "Maybe nobody can know enough to set interest rates for an entire economy." "

He goes on to write,

"So Mr. Greenspan, a consulting economist of no special attainments (on the eve of the 1974 stock-market collapse, he was quoted in the New York Times saying "it is rare that you can be as unqualifiedly bullish as you can now"), agreed to perform the impossible. Succeeding Paul A. Volcker, he became America's monetary central-planner-in-all-but-name. Mr. Greenspan ruled the roost in 74 fiscal quarters, of which recession darkened only five.

Nobody can identify a bubble as it is inflating, Mr. Greenspan has long insisted -- though, as you will not read in these pages, Mr. Greenspan was so certain that he detected a stock-market bubble in 1994 that he tried to prick it by pushing interest rates up. Strangely, the author's bubble-sensor failed him later in the decade. He did, in 1997, utter the innocuous phrase "irrational exuberance," but that was as far as he went in attacking sky-high equity valuations.
Mr. Greenspan now writes that the enlightened central banker will let speculation take its course. Following the inevitable blow-up, he will clean up the mess with low interest rates and lots of freshly printed dollar bills -- thereby gassing up a new bubble.

Only one of the troubles with this prescription is that it requires an enlightened central banker to carry it out. Nowhere in this book does Mr. Greenspan own up to his role of underestimating the severity of the credit troubles of 1990, or of cheering on the tech-stock frenzy in 1998-2000, or of dangling the most beguiling teaser rate of all during the mortgage frolics of 2004 -- i.e., that 1% federal-funds rate. In February 2004, only months before the Fed started to raise its rate, in a speech titled "Understanding Household Debt Obligations," Mr. Greenspan demonstrated next to no understanding. His advice to American homeowners was not that they lock in a fixed-rate mortgage while the locking was good, but rather that they consider an adjustable-rate model. He who set the rates got it backward."

Grant pulls no punches in questioning Greenspan's consistency as a libertarian, and acolyte of Ayn Rand, by ending up as the sole determiner of the economy's key interest rate. He makes clear Greenspan's lack of significant accomplishment as an economist or equity savant, prior to his role as Fed Chairman, and his misunderstanding of housing finance, after he took the position.

As Joe Kernen, an anchor on CNBC, articulated, Grant also seems to question Greenspan's motive in writing this book. Whereas Kernen opined that Greenspan wants back in the limelight, Grant suggests it's about trying to write his own legacy, before someone else writes a less flattering one.

As the week went on, the Fed cut rates half a point, and the market surged, more people were beginning to wonder if perhaps Greenspan was being rather too self-important by writing his book.

By comparison, Greenspan's predecessor, Paul Volcker had a much harder job to do, and left things in far better shape than he found them. Yet, in over twenty years, Volcker has never spoken out about his Fed tenure, told tales out of school, nor, to my knowledge, even remarked on either Greenspan's or Bernanke's performances and policies as Fed Chairmen.

Instead, being, obviously, incredibly secure, Volcker moved on and continued his career of public service, assisting in cleaning up the Arthur Andersen mess, and hunting out graft and corruption in the recently-retired UN Secretary General Kofi Annan's troubled administration.

Were that Alan Greenspan were possessed of similar self-esteem, that he would not have needed to attempt another run into the public spotlight which he so recently left, when he retired as Fed Chairman. In some sense, he reminds me of Jack Welch, now-retired CEO of GE, who seems to have to pop up on business talk shows with now-annoying regularity, spouting little of current relevance.

I've always thought that Paul Volcker received far too little acclaim or gratitude for the heroic, difficult job he performed, taming the roaring inflation of the 1970s, left to us by Lyndon Johnson's fiscal policies during the Vietnam War, and compounded by economic mismanagement and taxation policies during the ensuing decade.

Compared to him, Greenspan seems to have performed capably, steering a large ship on, for the most part, calm seas. However, this summer's debt market troubles suggest that perhaps Greenspan's legacy won't be sterling, because it's now becoming evident that he owns the source of this latest marke.....ahhh.... turbulence.

Berkeley's Haas School's Dubious Move Into "Socially Responsible" Investing

This Tuesday's Wall Street Journal contained an article detailing the University of California, Berkeley's Haas Business School's new program to teach its MBA students about asset management. This will be done via a new, "socially responsible: fund, the $250,000 of initial capital for which was donated by Charlie and Doris Michaels. Mr. Michaels is a Haas alumnus and currently president of Sierra Global Management, to be managed by Haas students.

From the interview with Kellie McElhaney, the faculty member who is director of the Center for Responsible Business at the Haas School, we learn that the intent of the program is to teach MBA and MFE (Masters of Financial Engineering) matriculants about investing.

Just on this information alone, I have grave concerns about the direction Haas is taking business education.

In January, I wrote this post, commenting on an article in the Wall Street Journal regarding the very theme of this new Haas program, "socially responsible investing." It wasn't very pretty. Not at all.

I will cite just three passages from the Journal piece by Jon Entine, a fellow at the American Enterprise Institute, which I also cited in the January post,

"The social investing community also suffers from the hubris that it can separate the good guys from the bad guys. The Times report mentioned that half of the children attending a high school in South Africa suffer from asthma and other respiratory disorders that the Gates Foundation is committed to eradicating. It noted that a nearby refinery that spews out pollutants is owned in part by a foundation-held company, BP. Outrages like this would not happen, the Times suggested, if only the foundation would use socially responsible rating services of firms like the Calvert Group in Bethesda, Md. So much for investigative reporting. Calvert not only invests in BP, it praises the company as an environmental leader. For the record, Calvert added Enron to its approved list in March 2001, just as its ethical house of cards was collapsing, and also owned HealthSouth, ImClone and other ethically-challenged firms.

The dark secret of "social investing" is that it is neither art nor science: It's image and impulse. It reflects perceptions, not performance. Years ago I did a report on the Body Shop, the U.K.-based cosmetic company whose founder, Anita Roddick, was hailed as the Mother Teresa of Capitalism. In the early 1990s, the Body Shop was the world's most popular "socially responsible" investment. It was touted for its natural products, charity, fair trading and integrity. I discovered that Ms. Roddick had stolen the name, concept, product line and even its brochures from the San Francisco-based Body Shop that started seven years before she opened her copycat version. Ms. Roddick fabricated her history; she gave almost no money to charity over the company's first 11 years, and has given meagerly since. The Body Shop's products were made mostly from water and cheap petrochemicals; it had a record of exploiting poor Third World producers; and its franchise system was riddled with mismanagement, which eventually resulted in the company paying more than $500 million to buy out dissidents and diffuse fraud suits. My report sent the company's stock down by more than $600 million -- causing great anguish to social investors -- and contributed to a 10-year tailspin that resulted in its being sold.

It should come as no surprise that a recent Wharton study calculated that funds that layer on ideological screens often perform worse than the general market by about 31 basis points a year, a huge discrepancy. Domini Social Equity Index, considered the gold standard of social index funds, rates a lackluster C- in Business Week's latest ratings. Calvert's Social Index Fund has lost 1.82% since its inception in 2000, ranking it in the bottom 15% of all funds. Now Bill and Melinda Gates are being asked to turn over investment for billions of dollars to these same social researchers?"

Well, at least the kids in the new Haas program don't have such a high hurdle to clear, in order to beat the average "socially responsible" fund's returns.

Seriously, though, Entine's piece suggests that the Haas program is, to be blunt, folly. The very credentialing process by which firms are judged to be "socially responsible" looks to be pure art, and easily fooled, at that.

So how are 10 MBA and MBE students going to outwit the fraudsters who, for a living, fool professional investors on this dimension?

Then there's the "MBE" matriculants.

As I contended in my recent video post, here, the 'financial engineering' degree represents yet another step in the continuing degradation of the MBA into a purely narrow, technical degree, now far removed from the certification of general business management knowledge and capability for which it used to stand.

As Wilbur Ross hilariously commented, cited in this post, from one of his appearances on CNBC this summer,

'When someone mentions two words, financial engineering, you know it's really an attempt to underprice risk.'

Great. Now we have burgeoning degree programs designed explicitly to teach new wunderkinds how to parse, conceal and pass along mis-priced risk.

Haven't we just learned what systemic folly this is in the past two and a half months?

However, perhaps the most chilling part of the Journal article, for me, was these two passages,

"Will this experience give students the skills they need to land jobs with funds that have a social-responsibility focus?

Absolutely. It will give them a competitive advantage over students with just course work on social responsibility or just investment experience. There have been a lot more SRI funds created in recent years, and I see an increasing number of job opportunities out there. What I have yet to see are the traditional investment houses posting jobs for professionals with SRI experience. But I hope I will be able to send more knowledgeable students into the traditional Wall Street firms where they can raise social-responsibility issues from inside the companies.

Does this take corporate social responsibility to a new level in academia?

It definitely will because we'll have data. It may be negative, positive or inconclusive, but there will be data. We in corporate social responsibility are still really in the throes of proving ourselves to other academicians, and the only way we can do that is through research and data."

Reading these two passages, I don't whether to laugh, or cry.

With Entine's piece as background, the 'spread' of this disease to major institutional portfolio managers is likely to depress already-mediocre average returns, for which fund owners pay good money.

To further state that this program will 'prove' anything to anyone is laughable.

Rather than take even $1MM, ten students, dubious criteria for "socially responsibility," and actually buy and/or sell short various equities, wouldn't it be more useful to task these students to rigorous, refereed papers of the sort financial academics write, to attempt to refute research hypotheses concerning "socially responsible" investing and the performance thereof?

With only $100,000 apiece, these students won't impress anyone in the industry with their performance. Believe me, I know. It takes about $25MM before anyone pays serious attention to an investment track record.

However, financial theory is routinely advanced through the use of rigorous theory development, implementation via backtesting, and analysis of the results. Each of ten students formulating different "socially responsibility"-related hypotheses, then testing them over long periods using market data would produce more, and more convincing results, in my opinion, than the Haas' new, tiny investment laboratory.

Credit Markets: Is Evolution a One-Way Process?

A recent piece in 'breakingviews.com,' a feature on the back page of the Money & Investing section of the Wall Street Journal, touched on an interesting point.

The notional headline concerned whether investment banks/brokers may be bought by, or merge with, commercial banks. The contention is that banks have certain regulatory and accounting features which happen to allow them to weather the current sub-prime mortgage-sourced credit markets turmoil.

For instance, banks may borrow at the Fed's discount window for liquidity purposes, to avoid selling prime assets to raise cash. Brokers may not do this.

Banks may use their discretion in valuing questionable assets by placing them in an 'investment' account, thereby avoiding the need to mark them to current market value. Brokers must carry all of these types of assets at the best current market value they can deduce, regardless of the loss to the brokerage firm that such valuation may entail.

The column simply addressed the potential for mergers of banks and brokers. Perhaps brokers are merger fodder for commercial banks.

But a larger issue struck me in this piece. Maybe credit markets went too far in their evolution to total market pricing of credit and debt.

Commercial banks seem, after all, to have a few advantages that were unapparent in a consistently up-market.

Could it be that, rather than a uni-directional march toward market pricing and underwriting, credit markets are, in reality, about to swing between extremes? Moving from all-bank balance sheet valuation and warehousing, to heavily market-priced and securitized, and now back toward the original pole of bank-sourced and distributed credit instruments?

It's not something I've read anyone else hypothesizing. Even I just assumed that banks had pretty much become a mere origination platform for credit.

Now, with this latest credit market debacle, the first since really heavily asset securitization of mortgages and corporate loans have kicked in, we are learning that there are market conditions under which non-banks may not be viable for very long, if they originate and/or hold volatile fixed income assets.

It's an interesting phenomenon. Who would have guessed that there was life in the old commercial bank model, yet?

Back in my days at Chase Manhattan, our group's boss, Corporate Planning & Development SVP Gerry Weiss, attempted a number of efforts calculated to move Chase into some sort of arrangement with a US investment bank, in order to, as he put it, so to speak,

'get their management in charge of our assets, with the advantages of our regulatory structure.'

Therefore, it's ironic to me that something like this might happen. Sure, Sandy Weill agglomerated a bunch of different piece parts to form the now-unwieldy Citi bank. But Salomon and Smith Barney are now almost lost inside of it. And the bankers remained in power, as the investment banks they took over had been weakened by various events.

Now, it would be possible to see a Chase or BofA take Bear Stearns, for example.

An interesting development in the quest for a viable, efficient, profitable organizational structure with which to transact fixed income businesses.

GE's Immelt To Be Next (Democratic) President's Secretary of Commerce

Last week's Friday Wall Street Journal carried a page-one article extolling GE CEO Jeff Immelt's tackling of global warming with his firm's "ecoimagination" program. A program so important, it even has its own manager- Lorraine Bolsinger.

I won't go into details- you can find the article and read it. But suffice to say, Immelt's got a lot of unhappy power generation customers on his hands. Mostly coal-fired utilities and such.

Even within GE, many are angry at him for pushing to make ecological footprints of the company's businesses on a par with growth and profits.

Let me be just a wee bit cynical here, and suggest what is really going on.

Could Immelt be showcasing himself to be the next (Democratic) President's: Secretary of EPA, Commerce, or (gasp) Treasury?

Perhaps realizing he's already ruined GE in terms of long run growth prospects and lackluster under-performance during his current CEO tenure, he will go green. He can complain that "big business" just does not "get it."

Wouldn't a John Edwards or Hillary Clinton eat that up? Good cover, just like Bob Rubin was for Bill Clinton. A bona fide corporate chieftain joins the eco-camp and demands that business come to heel under the newly-green hobnail boot of the Federal government.


Thereby becoming highly useful cabinet material for a green Democratic President. Or even a moderate Republican.

By pretending to grapple with ecological issues at GE, involving customers, the EPA, talking about carbon caps and trading, etc., he actually benefits from failure to make much headway. He can cite his futile efforts as having given him depth and breadth of experience in the politics of corporate pollution and eco-business, while aspiring to go into 'public service,' where, thanks to his travails at GE, he will now realize the real source of power is to effect corporate eco-change.

Failing to nab the EPA job, which would be a power portfolio in a Democratic administration, Immelt could easily try for Commerce or Treasury, citing Carlos Gutierrez or John Snow as recent precedents.

With his tens of millions of dollars of cash compensation from GE, and much more in deferred compensation, Immelt is well-positioned to leave GE considerably wealthier, personally, than he has made his shareholders. No need for further headaches trying to lift GE out of the dumpster of long term, consistent total return under-performance. Just declare victory, or frustrating eco-defeat, and head off to Washington.

In the wake of Immelt's departure, GE will perhaps fall to a group of private equity firms, newly-emboldened by the Fed's newly-cheap funds, and be split up into its constituent parts. Which, as I have argued in prior posts involving GE, would be a natural and beneficial end to the company, as it is currently structured, in terms of shareholder returns.

Admittedly, it's a wild card scenario. But if something like this happens, you read it here first.

On MBA's, Financial Institutions, and Market Pundits

GM's Short-Term Surge

Saturday's Wall Street Journal carried the usual broadbrush coverage of the prior day's equity markets activities.

The headline of this edition's article, however, caught my eye. It read,

"GM Shares Surge 16% on the Week"

Do tell!

My equity portfolio, run according to my proprietary equity strategy, is up just shy of 20%, gross, as of the end of Friday. So GM's performance, while not quite up to my portfolio's, is indeed, well, eye-catching.

As this nearby Yahoo-sourced chart of GM's recent six-month price shows, it's been very choppy.

You would have had to hold GM for just the right period to gain this 16%. Sell to early, and you're out of luck. Buy too late, same thing.

For instance, this chart of the past year of GM's price performance is much less appealing. Over the past twelve months, the stock is up just a little over $2/ share, or less than 10%.

It's a lot like the market dynamics which I profiled in this recent post on the S&P's total ten-year performance tending to be concentrated in just 10 best days of the decade!

For reference, here are the same two GM charts, with the S&P500 Index added.

For the last six months, GM is significantly ahead of the index. Of course, much of this is a result of the past week's speculation on the outcome of the current labor contract negotiations between the firm and the UAW. Prior to that, GM's return had bounced down to 0%. Twice, since August first.

Over the past year, The S&P has outperformed GM for nearly the entire period. In the few days or weeks where GM was on top, it was briefly, and not by much.

Clearly, much of the play in GM's stock has to do with the UAW contract risk.

Hardly a company in which to make a long-term investment, is it?

Thus my continuing emphasis on consistently superior total return outperformance. Attempts to capture short-term, speculation-fueled returns like those of GM are fraught with excessive risk.

Greenspan's Non-Monetary Opinions

I was going to write this post in a few more days, but given all the hoopla surrounding Greenspan's weekend tour of the media, I think I'll post it today.

Let's face it, Alan Greenspan is an economist. He was a Fed chairman. He's a monetary guy.

Why do we care what he thinks about fiscal policy, more than any other economist who is not a sitting Fed member? Granted, Greenspan is a good economist. But we don't need him to tell us that the Republican Congresses of the past few years failed to restrain spending. And that President Bush might have used his veto more than he did.

I already knew this, Alan.

Frankly, who really cares what he thinks about Congress and the Fed?

And, further, why do I care what Greenspan thinks about Iraq? He happens to agree with Bush, and, therefore, with my own views. But I honestly do not care. He wasn't Secretary of Defense. He was Fed Chairman.

Do I look to Don Rumsfeld to remark on the Open Market Committee's actions? I do not.

Now there's even discussion that Greenspan botched the handling of LTCM. Greenspan is on the record as re-writing his reactions to that debacle. He was never as 'pre-emptive' in his own chairmanship as pundits now criticize Bernanke and his Fed for not being now, amidst a credit market turbulence.

Further, as Joe Kernen remarked pointedly this morning on CNBC, Paul Volcker never did what Greenspan is now doing- breaking silence with his retrospective, and forward-looking, views on the Fed, the economy, etc. Kernen noted Greenspan's response to Leslie Stahl, that he 'has to make a living,' as the reason why he's written the book he is now touting on the talk show circuit.

But, as Kernen further observed, Greenspan doesn't need the money. Both he and his wife, Andrea Mitchell, have done very well in private industry- he as an economics consultant, she as an on-air media personality.

I think Greenspan is doing the country, and himself, a great disservice with his book and outspoken second-guessing of current monetary policies. It seems to me to be a lot of hand-wringing and excitement over nothing.

The Future of Streaming Video

The Wall Street Journal's guest column, 'breakingviews.com', had an interesting, if misguided piece on the future, or lack thereof, of streaming video.

Robert Cyran, evidently someone connected with the firm/website, writes in today's column that Netflix, among others, is pursuing the wrong technology/strategy, by concentrating on delivering video content via streaming.

Cyran argues that with download speeds allowing storage of a movie in only 20 minutes, more people will buy movies, rather than just view them via streaming. He cites the migration of audio from streaming to the iTunes model as further evidence that streaming can't compete with storage/ownership, once bit transfer rates are sufficiently high.

I think Cyran is dead wrong. Here's why.

First, most people whom I know, other than children, which is to say, adults, don't watch a movie very frequently in a short space of time. The desire to own a movie for frequent viewing is, I contend, not all that common.

However, music is different. We take our favorite music with us everywhere on iPods and MP3 players. I have listened to some songs, I'm sure, many hundreds of times. And will hundreds more. So I own that music.

At the iTunes store, I buy tracks, rather than use alternative systems which make me pay monthly to store rented audio content.

Thus, I contend, the audio example is not relevant to video content. Too, audio tracks are priced less than a buck a piece. It's almost a mindless purchase.

But what about all those sales of movies on DVD? Well, that's different.

When VHS came out, and movies were duplicated mechanically on VCR tapes, buying a copy of a movie was expensive. Some people did that, but it was pricey.

DVDs, in contrast, requiring a much cheaper duplicating process and materials, were, thus, less expensive to buy. The difference between buying and renting would be so small that, at volume retailers such as Wal-Mart, people just bought a copy of a movie, rather than pay little less, and only rent it at Blockbuster.

Now, however, the content is available digitally. On demand.

And that, I contend is the difference.

Now, I know that, in time, any movie or TV program episode I want to view will almost certainly be available somewhere, for 'on demand viewing.' Netflix prices by time, not title, so there's no reason to buy any single title. I can watch the same movie constantly, for no additional charge, other than the time I spend viewing it. Which works out to something like $1.50/movie.

So with all this content coming available as on demand streaming, why would I pay money to own video content I don't view too often, when the same dollars provide me with constant access to any video content?

Personally, I think Cyran has it backward. Even with computer storage devices becoming larger and less expensive, more applications are moving to the 'net. Look at Google's office productivity suite. Even Microsoft has quietly begun moving that way.

Cyran closes his piece with this statement,

"From a technological perspective, a song is similar to a small movie. It is likely that video will follow in music's footsteps."

Cyran may be correct, technologically, but he's totally overlooked the different behaviors people have toward music and video. You may listen to music as passive background filler, but video tends to command your total sensory attention. They're not at all the same, and I don't believe the future of their digital delivery will be, either.

Apple In The News Again

I noticed Apple corporation has been in the news again recently. In fact, I wrote a post about Apple's latest product introductions here, within the past week.

On that point, Herb Greenberg, a periodic contributor to the Wall Street Journal's Weekend edition, and columnist/analyst for MarketWatch, penned a piece calling Apple's recent price cuts into question. Essentially, Herb noted the recently-emerging disparity between volume growth of iPods, and the revenue growth rates corresponding to those unit growths. The price cuts, say Greenberg, should cause shareholders to worry that product maturity has finally caught up with Apple and its signature product line.

I like Greenberg. He's one of my favorite guests on CNBC, even if I don't always agree with him. His irreverent, often-minority viewpoint attracts my attention.

Even in his Journal column, Herb quotes another analyst, one Charles Wolf, as noting that the real growth in revenues for Apple's iPod line come from the halo effect it has on other Apple products and services- the Mac computres and the iTunes online store.

In this, I think Wolf is correct. Apple has more than a single hot product line. It has an entertainment system. As I've noted before, you can quibble all you want about its compatibility with MP3 players, and the copyright protection. But nobody forced anyone to buy iPods. They simply are compelling price/performance offerings.

All those iPod owners have helped fuel the iTunes store revenues, no matter what Jobs wrote earlier about how much stored iPod music is ripped off of CDs already in the owners' possession.

Granted, Greenberg charts Apple's declining rates of unit and revenue growth of iPods over the last two years. I don't think this is news to either Jobs, or the firm's management team. In fact, I'd say the recent spate of new products and lower prices is calculated to ignite both growth rates, due to totally new price/performance points. Certainly Apple has done for the iPods, by adding video screens and capacity, something Forman's grills, with which Greenberg compared them, never could.

One Forman grill is pretty much like another. Yes, the larger sizes and removal grill plates are nice product line extensions. But not so vital that most people would replace their existing grill. I haven't. Part of their original allure was the incredible ease with which they can be cleaned. Who really had to have them removable?

The new iPods are very different. Whole new, valued functionalities are included, at dramatically lower prices.

Speaking, or writing, of Apple's entertainment system, another Journal article mentioned that NBC is removing its video content from iTunes after their contract expires in December. Apparently, Fox and NBC hope to collaborate on their own, new online video site.

While I still believe there won't be just one site which all video viewers learn to visit, as Comcast's CEO contended some months ago, I believe a few, such as YouTube and iTunes, tend to predominate their respective product/service spaces.

Will people re-learn to visit iTunes for music and some videos, then skip over to Hulu.com (the new NBC-Fox site), remembering their TV program shopping list while they buy more content there? Perhaps so, perhaps not. I suppose die-hard program fans will do that, if they haven't already visited the free replay sites right after the episodes aired. Or wait to rent them on Netflix.

Personally, I think Apple is still in the driver's seat on this one, because of formats. Will the downloads on Hulu support iPods? If not, will iPod users bother?

GE/NBC is too diversified and sprawling to have anywhere near the intellectual horsepower and financial incentives to attract sufficiently talented people to out-manage Apple on this. Fox is similar. Apple, by contrast, tends toward laser-like focus on their few product lines- music players, downloading services, computers, and now, phones.

Besides, Apple has Jobs. Neither Fox nor GE appear to have a similarly motivated, talented key executive facing off against Jobs in this matter.

In accordance with my recent piece on financial institutions, competitiveness, and diversification, it should be no surprise that my money is on Apple in this fight.

Equivocation from the Pages of The Wall Street Journal

Last week, the Wall Street Journal published a rather equivocating piece by one of it's columnists, Justin Lahart. I found the piece to be, at best, a waste of time and, at worst, supporting and advocating specious analysis regarding Fed rate cuts and subsequent investment performance.

Consider these quotes from the Lahart's piece,

"Perhaps some of the rules are changing. Investors tend to believe that interest-rate cuts are good for stocks. Research seems to bear that out....

But interest rate cycles don't always appear to be a great guide to stock performance. In the 1960's, for example, stocks did well even as interest rates were rising. It would be unwise to ignore the past 33 years of history, but it might also be unwise to put too much weight on them."

Gee, thanks Justin. Glad you could add value on this issue.

Does Lahart fill us in on inflation rates during the periods involved? That might help us understand the effect of Fed rate cuts, in that the overall market and economic contexts clearly matter. How about GNP growth during the periods, too?

Oh, and what about the market impact of technology in at least three ways: the advent of derivatives trading; computerized trading technology, and; availability of information via computerized technology, to more rapidly and thoroughly react to fundamental and technical information?

Does anyone really believe that you can just compare one activity or measure, such as Fed rate cuts, over time, and assume it will soak up/account for total variance of something like overall stock prices?

Not only is Lahart's piece of no actionable use, it questions credulity as to its reasonability.

I wonder if this thesis would even rate a grade of "D" in any graduate economics course. I expect better from the Money Section of the Wall Street Journal.

Don't you?

Money Center Banks as Investments

Last Thursday, the Wall Street Journal ran an article entitled, "Do-It-All Banks' Big Test."

In it, Robin Sidel focused on how the nation's largest three commercial banks- Citi, Chase, and BofA- will be able to whether the current turmoil in the credit markets.

Her emphasis was on profitability, losses from exotics and mortgage lending.

She quoted one Robert Maneri, a portfolio manager at an also-ran bank, KeyCorp, of Cleveland, as saying,

"These banks rarely hit on all eight cylinders at the same time, but they can make a pretty good profit hitting on six out of the eight."

True. My old boss, Gerry Weiss, one-time SVP of Corporate Planning and Development at Chase Manhattan Bank, used to note,

'Despite our ineptitude, we still make a lot of money. Can you imagine how well we'd do if we really tried?'

Sadly, they never actually try. I conducted extensive research into the performance of a wide variety of financial service firms, while Director of Research at Oliver, Wyman & Co., now the financial services unit of Mercer Consulting.

What I discovered is that universal banks and diversified brokers/investment banks almost never attain consistently superior total return performance, relative to their industry index. Later, I found the same to be true for them regarding the S&P500, as well.

The Yahoo-sourced price charts for Citi, Chase, BofA, and the S&P500, for periods of 1, 5, and longer numbers of years, appear in this post.

All three banks have drastically underperformed the index over the last year, as shown in the one-year chart.

The five-year chart, which appears nearby, finds only Chase outperforming the index over the past five years. But most of the outperformance can be traced back to early 2003- well before the current conglomeration. Otherwise, Chase has more or less mirrored the index, and the other banks.

Only looking back much further, to the mid-1970s, do we see Citi significantly outperforming the S&P. In this case, we see BofA and Citi even with the index in 1996.

It is essentially the next five years that account for Citi's current return lead over the index during this 30-year timeframe. Even then, it experienced a severe dip during those five years, in 1998- the Asian crisis and LTCM debacle.

Hardly 'consistently superior total return' performance, is it? More like a lucky five years over a period of 30+ years. The other two banks, ending up below the S&P over the same period, couldn't even manage that and hang on.

Avoiding risk and loss is not the point of super-money center banks. Consistently superior total returns is. And none of them have demonstrated the ability to do it. Ever.

It's extremely unlikely that these companies will ever achieve such performance going forward, either.

Why?

Basically, because they are too diversified. Last December, I wrote this post, in which I quoted Kirk Kerkorian said,

"Diversification is for people who aren't sure about what they are doing."

Just so. Money center banks are in so many businesses that one is always blowing up. Same thing with large investment banks. This is what I learned in my research at Oliver, Wyman.

The only types of financial service firms which showed themselves capable of consistently outperforming their sector index were mono-line firms: credit card companies, asset managers, and mortgage bankers. They would have streaks of several years of outperformance, then fall back to earth. It's just the way Schumpterian dynamics works.

However, by being focused on one or just a few businesses, these companies were able to actually grow fast and profitably. Money center banks just can't do this. They're too big, complicated, and costly to run.

Even back over a decade ago, when I was a senior strategist at Chase, my SVP, Gerry Weiss, noted how complicated a money center bank was to manage. That it was probably beyond most of the best CEOs in the country- and we didn't get them. We got loan officers who had been promoted too far.

So I think Ms. Sidel is focused on the wrong measure of success. Money center banks may well avoid disaster in the near future. But they won't be worthy of investing, beyond some lucky timing plays.

Countrywide's Mozillo's Irresponsible Letter

The weekend edition of the Wall Street Journal carried an article focusing on Countrywide Financial's 20% cut of its work force, and selected quotes from the related letter by CEO Angelo Mozillo to employees of the firm.

In my opinion, at least one part of the letter was totally irresponsible, as well as misleading.

For instance, the Journal article cites Mozillo as writing that current downturn is the

"most severe in the contemporary history of our industry."

Let's consider that statement from a few angles.

First, it appears to let Mozillo off the hook as CEO of Countrywide, as he is about to fire 20% of his employees. It's as if he's saying,

'Hey, people.... It's not my fault...look at this terrible market...yep, most severe ever.....'

Nice try, Angelo. But didn't you lead the charge with alt-a and sub-prime loans? Aren't you CEO? Shouldn't you have been appropriately hedged, and have obtained longer-term, secured lines of funding, to avoid cashiering a fifth of your workforce? Just weeks after declaring that this shakeout was great, as your firm would take increased market share in the mortgage sector?

Then there's the lack of context of Mozillo's comment. Does it not arguably follow that the 'most excessive upturn' in the industry's contemporary history was followed by its 'most severe' downturn? Seems reasonable to me.

Was that excessive upturn not led, in part, by Angelo's company's "innovations?"

It's not only the mortgage banking industry that has had trouble with explosive growth. Look at, in their time, Boeing, the railroads, Advanta, and Atari, to name just a few.

This is pretty much your average story of a firm letting details go, loosening operating standards and, as befits a financial firm, scraping ever-lower down the creditworthiness scale to find customers. All of this finally came home to roost, and Mozillo would have you believe it's someone else's fault.

Maybe he's watched Bear Stearn's Jim Cayne's attempt to blame 'the market' for Bear's fund management woes, which I described here, and figured he'd give it a try, as well.

Apparently one of the behaviors we must now live with in this age of instant electronic communications is that of CEOs getting out in front of an issue and pointing their fingers at anyone and everyone else in blame, rather than take responsibility for their own actions, or inactions, as the case may be.

(Southern) California Dreamin' : Real Estate Woes

A friend of mine who works in the Southern California real estate industry spoke with me at length about a week ago regarding the status of the sector, buyers, and her own firm's experience.

In order to disguise her firm and the major project on which she works, I'll leave details vague.

However, what she explained both reinforced my sense of the nature and extent of the country's mortgage problems, as well as highlighted how detached from reality a particular locale can become.

One clear signal that the credit woes of the housing market are having real effects is that instead of her project's escrow closing late this fall, she now casually remarked that it won't close until, I believe, sometime late next year. In fact, there was evidently some question as to whether the entire venture was still viable. Which is why I'm being careful to completely avoid any reference to the project, beyond noting that it is residential in nature, and in southern California.

When I related MarketWatch's Herb Greenberg's observations that southern California real estate "values," meaning notional asking prices, in places like Riverside, had risen far above the national average home price, my friend agreed that the regional real estate market had become unsustainably over-valued.

Thus, her firm's project was already selling into an over-priced market, on a national basis.

Yes, I know, you're saying,

"But don't you realize, real estate is local?"

Well, yes, and no. Yes, if it's priced within reasonable, national parameters. No, if it's not, because of the securitized nature of the broad market, and the specialized nature of jumbo mortgage financing.

Put the two together, and you have expensive real estate projects which rely on short-term construction financing, and consumers taking jumbo mortgage loans to buy them, depending upon a very precarious long term credit market.

As I spoke of this situation with my business partner, we agreed that the only way my friend's project could have become insulated to credit forces was to have secured long term lines of construction financing, and, then, secured forward commitments to lend to its buyers who met certain criteria, from jumbo mortgage lenders. Absent such arrangements, a project such as my friend's, located in an area of stratospheric housing prices, was bound to be among the first to experience difficulties, once the credit market tightened.

Did I mention, by the way, that my friend told me she does not know of one person, directly, who has not bought a home in southern California without using two mortgages? The main mortgage for 80% of the purchase price, and the piggybacked alt-A or sub-prime for the remaining 20%.

That second part? That's what we in the Midwest, where I grew up, and even out here, in the East, call the "down payment." That's the part that assures all other parties that you have sufficient personal equity invested in your commitment to buy and pay for your home.

My friend is well aware that the California market, like Las Vegas, Florida, and a few other well-contained markets, simply became over-priced, with respect to what the now-national, if not global, ultimate holders of mortgage paper, would consider affordable by the borrowers.

Thus, new residential purchases on the same old terms is finished. And my friend's project is in somewhat dire straits. Essentially, they can only complete their sales by attracting buyers who can afford the full 20% down payment, in order to take a conventional jumbo mortgage for the balance.

It's ironic. My friend is educated, intelligent, and very competent. She chose to work in an area that, until recently, added considerable value to the local economy, and promised her substantial rewards for successful job performance.

No more. As she told me recently,

"I might well be able to visit you next week, or the week after. Because I may not have a job tying me down."

Such is the manner in which a thousand or more similar stories, combined, make for a national economic event. Everyone in California, in the housing-related sectors, knew that some of their real estate values were indefensible to the larger financial markets, should credit conditions change in a tighter direction. But they still behaved as if it would not, did not, matter.

Perhaps this fact, more than any other, demonstrates why financial-related businesses need to remain vigilant about creditworthiness. Financial lending bubbles and high-growth businesses always implode when lowered lending standards at least meet initial defaults and delinquencies. It has ever been thus, and, probably, ever shall be.