It's mid-afternoon, and the topic for today's post became obvious a few hours ago.
Among, I am sure, others, this piece in yesterday's New York Times, co-authored by Andrew Ross Sorkin, details the evolving mess now catching up with Lehman's ex-CEO, Dick Fuld. A similar article appeared on the Wall Street Journal's front page this morning, as well.
The dead bank's examiner has uncovered Lehman's use of a structure known as 'Repo 105.' This was a sale/repurchase agreement which delivered 105% of the assets' value to Lehman's balance sheet during the term of the sale.
Similar in effect to the once-derided SIVs at Citigroup, these assets were moved off of Lehman's balance sheet, thus dressing it up as healthier than it actually was.
As you might expect, Fuld's attorney stated that he
“did not know what those transactions were — he didn’t structure or negotiate them, nor was he aware of their accounting treatment.”
However, Bart McDade, one of Fuld's hand-picked lieutenants, was cited in the Journal and the NY Times as having explicitly briefed the ex-CEO on the particulars of the structure.
Bottom line, Fuld is going to have one hell of a time wiggling out of this one. McDade will have no reason to perjure himself on Fuld's behalf, and Fuld's public statements, and declarations to a Congressional Committee will probably now look suspect.
Looked at from the vantage point of a later date, with more pieces to the puzzle now publicly available, it sure looks like Dick Fuld consciously directed Lehman's financial balance sheet moves to disguise the firm's problems, then asserted there were none.
Was it not Greenlight Capital's David Einhorn who pursued this like a terrier during the summer of 2008? Dogging then-CFO Erin Callan?
Seems he was onto something, doesn't it? Perhaps more than he knew. This examiner's report should set the stage for quite the trial if/when Fuld is charged with violating Sarbanes-Oxley regulations regarding the accounting maneuvers he authorized to attempt to deceive Lehman's creditors, rating agencies and regulators in the final months before the firm's collapse.
As a final note, and food for another post, does this not serve as a cautionary tale regarding regulation, and reliance on it to detect and prevent this sort of behavior?
With the Lehman example so fresh, financial sector misbehaviors are looking an awful lot more like crimes committed with illegal firearms. That is, we've passed lots of laws forbidding them, and hire police to enforce the laws.
But the truth is, the laws and enforcers don't stop the illegal behaviors in either case. They just provide more charges when the guilty are finally caught and tried
What's that tell you about the grand schemes afoot to 'reform' US financial sector regulatory oversight?
Friday, March 12, 2010
Thursday, March 11, 2010
On Proposed Naked Swaps Regulations
Yesterday's Wall Street Journal featured a lengthy piece on swaps regulations. With the recent Greek bond problems as a context, European regulators want to ban dealing in naked swaps, i.e., trading/holding swaps when one does not hold the underlying instrument on which the (risk of default) swap is written.
I had a long conversation with a colleague about this yesterday over lunch.
Why, I asked, is there a presumption of pressure on the interest rate and value of the underlying instrument from naked dealings in a side bet which is the default swap on the instrument?
Swaps are not options. They are simply insurance against default.
If there is any basis for disliking their naked trading, it would seem to be more akin to the aversion regulators have for people purchasing life insurance on third parties in whom they are disinterested. It's become a hot field lately, with investors picking up life insurance policies for the aged, in exchange for paying the premiums.
Our society has had moral reservations against bets on death of this sort for a long time.
As my colleague pointed out, nobody would probably mind if you could bet on a bond's performing as promised. It's the bet on failure that seems to arouse angst and emotion.
Yet, in the case of Greek bonds, it's hard to see how an unrelated, naked derivative position would or could possibly affect the bonds' values as much as the simple trading in the bonds themselves, isn't it?
It's understandable how heavy pressure on an equity's price from options or shorting can occur. Shorts have obvious affect by causing selling pressure, driving equity prices down. Lopsided options activity can create arbitrage opportunities which affect equity prices, too.
But simply executing a parallel bet on an event by buying, or selling, a credit default swap, wouldn't seem to do more than, as today's Journal piece on the topic notes, provide a sentiment indicator. Since the swap confers no rights to buy or sell the underlying bond, it simply can't have an influence on the bond's price beyond that of trading activity in the actual debt instrument.
The entire discussion topic seems, to me, to be one sparked by hysteria, emotion and faulty logic, rather than a genuine, proven causal effect between swaps prices and the price of the underlying debt instrument.
I had a long conversation with a colleague about this yesterday over lunch.
Why, I asked, is there a presumption of pressure on the interest rate and value of the underlying instrument from naked dealings in a side bet which is the default swap on the instrument?
Swaps are not options. They are simply insurance against default.
If there is any basis for disliking their naked trading, it would seem to be more akin to the aversion regulators have for people purchasing life insurance on third parties in whom they are disinterested. It's become a hot field lately, with investors picking up life insurance policies for the aged, in exchange for paying the premiums.
Our society has had moral reservations against bets on death of this sort for a long time.
As my colleague pointed out, nobody would probably mind if you could bet on a bond's performing as promised. It's the bet on failure that seems to arouse angst and emotion.
Yet, in the case of Greek bonds, it's hard to see how an unrelated, naked derivative position would or could possibly affect the bonds' values as much as the simple trading in the bonds themselves, isn't it?
It's understandable how heavy pressure on an equity's price from options or shorting can occur. Shorts have obvious affect by causing selling pressure, driving equity prices down. Lopsided options activity can create arbitrage opportunities which affect equity prices, too.
But simply executing a parallel bet on an event by buying, or selling, a credit default swap, wouldn't seem to do more than, as today's Journal piece on the topic notes, provide a sentiment indicator. Since the swap confers no rights to buy or sell the underlying bond, it simply can't have an influence on the bond's price beyond that of trading activity in the actual debt instrument.
The entire discussion topic seems, to me, to be one sparked by hysteria, emotion and faulty logic, rather than a genuine, proven causal effect between swaps prices and the price of the underlying debt instrument.
Wednesday, March 10, 2010
Scary News of the Fed's Regulatory Snafus in the WSJ
Yesterday's Wall Street Journal carried an extensive article reporting on internal Fed bickering and regulatory oversight errors stretching back to the Greenspan era. It's a troubling, scary and cautionary tale for those who believe that regulatory Nirvana for the US financial sector consists of simply giving any one regulator, especially the Fed, omnipotent and sole power for this task.
Or, perhaps, any believing that regulation will really cure future systemic ills.
In any event, we learn that Greenspan claims he punted on regulatory matters to his colleagues. Does this inspire confidence in a Fed-only regulatory scheme? What if another Fed chairman eschews much interest in this function, and there's nobody at FDIC or OCC to provide any sort of complementary coverage?
Then we have Helicopter Ben issuing bone-chilling warnings to Congress, saying it would be a "grave mistake" to 'dilute' its regulatory and supervisory role. Nevermind that they had sufficient powers before and during the recent meltdown, and failed to prevent it.
Then we have Tim Geithner, when NY Fed chief, fighting for regulatory power, and dragging his weaker fellow regional Fed Bank presidents behind him for cover. Of course, those presidents had a lot to gain by allying with Geithner back then.
Now, of course, safely ensconced at Treasury, Geithner is mum about the issue.
Here's a thought. Rather than be entertained by news of fights between the Fed Banks and their Washington colleagues, or the Fed and other regulatory agencies, why not dream of a 'best practices' approach?
Surely our multiple financial sector regulatory agencies have more than sufficient data with which to supply objective, academics for in-depth research into what factors pre-figured bank failures, and what the corresponding ratings by various regulators were along the way.
I'm put in mind here of something analogous to NYU's Ed Altmann's pioneering and still-outstanding work on the factors predicting bond defaults.
Why are we forced to watch, and, through Congress, choose among qualitatively-determined regulatory schemes and standards, when the best approach should, and could be, objectively and quantitatively determined?
That, to me, is the scariest aspect of this topic. There should be no qualitative wiggle room on this issue. Collectively, our regulators have the descriptive data and outcomes, in sufficient volume, to identify statistically significant predictors of bank failure, along with time paths to that failure.
Why is developing and implementing a regulatory solution along those lines so hard?
Probably because a lot of rice bowls are at stake among our government regulatory entities. Salaries to be lost, careers truncated, children's' educations to be paid for by another line of work, less-lush pensions from other employers, as the mystery and duplication of this activity is drained, and fewer, more objectively focused regulators engage in less expensive, more timely and effective regulation of our nation's banks.
Or, perhaps, any believing that regulation will really cure future systemic ills.
In any event, we learn that Greenspan claims he punted on regulatory matters to his colleagues. Does this inspire confidence in a Fed-only regulatory scheme? What if another Fed chairman eschews much interest in this function, and there's nobody at FDIC or OCC to provide any sort of complementary coverage?
Then we have Helicopter Ben issuing bone-chilling warnings to Congress, saying it would be a "grave mistake" to 'dilute' its regulatory and supervisory role. Nevermind that they had sufficient powers before and during the recent meltdown, and failed to prevent it.
Then we have Tim Geithner, when NY Fed chief, fighting for regulatory power, and dragging his weaker fellow regional Fed Bank presidents behind him for cover. Of course, those presidents had a lot to gain by allying with Geithner back then.
Now, of course, safely ensconced at Treasury, Geithner is mum about the issue.
Here's a thought. Rather than be entertained by news of fights between the Fed Banks and their Washington colleagues, or the Fed and other regulatory agencies, why not dream of a 'best practices' approach?
Surely our multiple financial sector regulatory agencies have more than sufficient data with which to supply objective, academics for in-depth research into what factors pre-figured bank failures, and what the corresponding ratings by various regulators were along the way.
I'm put in mind here of something analogous to NYU's Ed Altmann's pioneering and still-outstanding work on the factors predicting bond defaults.
Why are we forced to watch, and, through Congress, choose among qualitatively-determined regulatory schemes and standards, when the best approach should, and could be, objectively and quantitatively determined?
That, to me, is the scariest aspect of this topic. There should be no qualitative wiggle room on this issue. Collectively, our regulators have the descriptive data and outcomes, in sufficient volume, to identify statistically significant predictors of bank failure, along with time paths to that failure.
Why is developing and implementing a regulatory solution along those lines so hard?
Probably because a lot of rice bowls are at stake among our government regulatory entities. Salaries to be lost, careers truncated, children's' educations to be paid for by another line of work, less-lush pensions from other employers, as the mystery and duplication of this activity is drained, and fewer, more objectively focused regulators engage in less expensive, more timely and effective regulation of our nation's banks.
Comings, Goings & Returns On Business Television
I get a lot of visits to this blog from people searching for Charlie Gasparino or news of his latest row with Dennis Kneale on CNBC.
After seeing several of those searches in the past week, I began to wonder where Gasparino had gone, since I literally cannot recall when he was last on CNBC.
Now, I know why. He popped up on Neil Cavuto's Fox News program last night in the 4-5PM hour.
As of mid-February, Gasparino joined the Fox News channels of Rupert Murdoch's NewsCorp.
I still can't get Fox Business News on ComCast, but I am sure that is where Gasparino is spending his daytimes. At this rate, perhaps the fledgling channel will eventually assemble a sufficient number of interesting on-air people to challenge CNBC.
So it's goodbye to the days of verbal fist-a-cuffs between Alan Murray and Charlie Gasparino on CNBC. Both are now at NewsCorp, and couldn't see them if they do spar during market hours.
Which brings to mind the also-absent Herb Greenberg. I vaguely recall him announcing some changes in his status a few years ago, having found this missive about him. He's a guy I truly do miss on CNBC, or anywhere during business days.
Meanwhile, this morning, on CNBC, I saw a very old face who I haven't seen for over a decade.
Long-time auto sector analyst Mary Ann Keller appeared this morning to discuss the latest Toyota problems, i.e., yesterday's runaway Prius in California.
I recall Keller as a frequent guest on Lou Rukeyser's old PBS program. Back in the day, she was the go-to auto sector analyst. Then, at least to me, it seemed that she disappeared. A Forbes bio of her career reveals that she moved from, I believe, PaineWebber to Furman Selz, which was bought by ING. Then she worked in a senior position at Priceline.
In any case, it was good to see her on air again dispensing sensible insights about her sector.
After seeing several of those searches in the past week, I began to wonder where Gasparino had gone, since I literally cannot recall when he was last on CNBC.
Now, I know why. He popped up on Neil Cavuto's Fox News program last night in the 4-5PM hour.
As of mid-February, Gasparino joined the Fox News channels of Rupert Murdoch's NewsCorp.
I still can't get Fox Business News on ComCast, but I am sure that is where Gasparino is spending his daytimes. At this rate, perhaps the fledgling channel will eventually assemble a sufficient number of interesting on-air people to challenge CNBC.
So it's goodbye to the days of verbal fist-a-cuffs between Alan Murray and Charlie Gasparino on CNBC. Both are now at NewsCorp, and couldn't see them if they do spar during market hours.
Which brings to mind the also-absent Herb Greenberg. I vaguely recall him announcing some changes in his status a few years ago, having found this missive about him. He's a guy I truly do miss on CNBC, or anywhere during business days.
Meanwhile, this morning, on CNBC, I saw a very old face who I haven't seen for over a decade.
Long-time auto sector analyst Mary Ann Keller appeared this morning to discuss the latest Toyota problems, i.e., yesterday's runaway Prius in California.
I recall Keller as a frequent guest on Lou Rukeyser's old PBS program. Back in the day, she was the go-to auto sector analyst. Then, at least to me, it seemed that she disappeared. A Forbes bio of her career reveals that she moved from, I believe, PaineWebber to Furman Selz, which was bought by ING. Then she worked in a senior position at Priceline.
In any case, it was good to see her on air again dispensing sensible insights about her sector.
Tuesday, March 09, 2010
Passive Risk Management Tools
Almost a month ago, I wrote this (second) review of Wall Street Journal reporter Scott Patterson's recently-published book, The Quants.
The book's early chapters, on which I did not dwell in my review, discuss Ed Thorp's early exposure to Claude Shannon at MIT and, through Shannon, the work of John Larry Kelly.
Thorp was the prototypical quant hedge fund manager, but, in a sense, he simply followed, then outstripped, Shannon's and Kelly's own instincts of applying information theory to gambling opportunities, or any other situation in which imperfect information allowed for profitable employment of risk capital.
As I sped through the early chapters of Patterson's tale, I noted the mention of Kelly's name and general idea, but, since Patterson never focused on it, neither did I.
Fortunately, one of my friends and former colleagues, once a member of Bell Labs' EMT staff, reads this (and its companion political) blog on a daily basis. Thinking I'd find Kelly's work useful, he lent me William Poundstone's Fortune's Formula, published in 2005. The linked page on Kelly is from Poundstone's website.
Here is a paper Ed Thorp wrote concerning Kelly's Criterion over a decade ago.
My friend has been considering applications of Kelly's Criterion to his own work involving defense project management, so passing on the references and book to me were topical for him.
When I began reading Fortune's Formula, I found it engaging, but not particularly compelling. Until I came to Poundstone's painstaking explanation of how elegant Kelly's application of Shannon's theory was in the area of risk capital investment, be it at the track, casino, or securities markets.
Unlike the unsuccessful active risk management methods applied by traders before and during the financial market meltdowns of 1987, 1998 and 2008, Kelly's approach is passive in nature. The difference is important.
As Patterson portrayed in the latter chapters of his book, the major quant hedge funds employed pretty much similar VAR-based risk management systems. These systems naively assumed that, in the event of sharp losses in portfolio positions, there would exist a relatively unfettered ability to sell, or buy, the offsetting leg of existing portfolio positions, in order to hedge exposure.
Patterson didn't really dwell on the details of Ed Thorp's original employment of what Poundstone correctly identified as 'delta hedging.' It's an active risk management approach for adjusting hedges between equities and the companion warrant or option position.
Thorp originally did this in relative isolation and obscurity, with little in the way of market pressure from similar strategies swinging tens or hundreds of millions of dollars of such activity.
In the 1980s, the variant of active risk management was known as portfolio insurance. And it failed in 1987. When major trading operations all attempted to hedge the plummeting values of their positions in major indices, the values of which they were arbitraging, values plunged even further and orders went unfilled.
In 1998, similar results occurred in the last gasp of pre-swaps markets amidst a panic. In that era, there were quite a few statistical arbitrage clone funds, but only LTCM was actually brought down by the market plunge.
The 2007-08 financial market meltdown featured newer instruments, e.g., CDOs and swaps. But, in reality, these were simply variants of older financial products, albeit inherently possessing greater risks.
And, thus, when market values reversed their ascent, and active hedges became unbalanced, the usual stampede of many managers employing similar strategies to sell additional exposure in order to re-align their hedges once again failed.
Among my more experienced securities markets friends, and me, we agree on the notion that risk management solutions need to be passive and in place before a market event, because active risk management approaches never actually work as planned. A sort of 'fallacy of composition' defeats them, as abstruse investment strategies, employed in parallel by many smart quants, simultaneously react identically, pushing market values even further in the direction that is already causing them such large losses.
Kelly's Criterion is the ultimate passive risk management tool because it addresses the size of the investment, and is not affected, per se, by the actions of others. In fact, one of the valuable extensions of Kelly's work by Thorp was his apparent refusal to leverage his funds.
This was something ignored by the next generation of quants, including his own acolyte, Ken Griffin, founder of Citadel.
Reading Poundstone, on Kelly, provides a very clear, refreshing portrait of a seriously intelligent, rigorous mind grappling with the realities of risk capital deployment. And Thorp, with his casino beginnings, understood this perspective intuitively.
Sadly, quant kids two generations and more on, do not.
And that is why active risk management has been so ineffective. It becomes not a matter of discretion, but of survival.
That is, in Thorp's world, trimming the exposure to a Kelly bet is advantageous, but not essential. Because the bet was scaled according to rigorous theoretical principles, losing it all isn't crippling.
When that bet is with 3x, or more, levered money, you only have a 25-33% loss cushion before you've burned through equity and are out borrowed money.
The gambler's ruin. Busted.
Needless to say, we've already begun working on applications of the Kelly Criterion to our proprietary options investment strategies. As a passive, rigorously theoretical and internally-focused approach, it meets our criteria.
The book's early chapters, on which I did not dwell in my review, discuss Ed Thorp's early exposure to Claude Shannon at MIT and, through Shannon, the work of John Larry Kelly.
Thorp was the prototypical quant hedge fund manager, but, in a sense, he simply followed, then outstripped, Shannon's and Kelly's own instincts of applying information theory to gambling opportunities, or any other situation in which imperfect information allowed for profitable employment of risk capital.
As I sped through the early chapters of Patterson's tale, I noted the mention of Kelly's name and general idea, but, since Patterson never focused on it, neither did I.
Fortunately, one of my friends and former colleagues, once a member of Bell Labs' EMT staff, reads this (and its companion political) blog on a daily basis. Thinking I'd find Kelly's work useful, he lent me William Poundstone's Fortune's Formula, published in 2005. The linked page on Kelly is from Poundstone's website.
Here is a paper Ed Thorp wrote concerning Kelly's Criterion over a decade ago.
My friend has been considering applications of Kelly's Criterion to his own work involving defense project management, so passing on the references and book to me were topical for him.
When I began reading Fortune's Formula, I found it engaging, but not particularly compelling. Until I came to Poundstone's painstaking explanation of how elegant Kelly's application of Shannon's theory was in the area of risk capital investment, be it at the track, casino, or securities markets.
Unlike the unsuccessful active risk management methods applied by traders before and during the financial market meltdowns of 1987, 1998 and 2008, Kelly's approach is passive in nature. The difference is important.
As Patterson portrayed in the latter chapters of his book, the major quant hedge funds employed pretty much similar VAR-based risk management systems. These systems naively assumed that, in the event of sharp losses in portfolio positions, there would exist a relatively unfettered ability to sell, or buy, the offsetting leg of existing portfolio positions, in order to hedge exposure.
Patterson didn't really dwell on the details of Ed Thorp's original employment of what Poundstone correctly identified as 'delta hedging.' It's an active risk management approach for adjusting hedges between equities and the companion warrant or option position.
Thorp originally did this in relative isolation and obscurity, with little in the way of market pressure from similar strategies swinging tens or hundreds of millions of dollars of such activity.
In the 1980s, the variant of active risk management was known as portfolio insurance. And it failed in 1987. When major trading operations all attempted to hedge the plummeting values of their positions in major indices, the values of which they were arbitraging, values plunged even further and orders went unfilled.
In 1998, similar results occurred in the last gasp of pre-swaps markets amidst a panic. In that era, there were quite a few statistical arbitrage clone funds, but only LTCM was actually brought down by the market plunge.
The 2007-08 financial market meltdown featured newer instruments, e.g., CDOs and swaps. But, in reality, these were simply variants of older financial products, albeit inherently possessing greater risks.
And, thus, when market values reversed their ascent, and active hedges became unbalanced, the usual stampede of many managers employing similar strategies to sell additional exposure in order to re-align their hedges once again failed.
Among my more experienced securities markets friends, and me, we agree on the notion that risk management solutions need to be passive and in place before a market event, because active risk management approaches never actually work as planned. A sort of 'fallacy of composition' defeats them, as abstruse investment strategies, employed in parallel by many smart quants, simultaneously react identically, pushing market values even further in the direction that is already causing them such large losses.
Kelly's Criterion is the ultimate passive risk management tool because it addresses the size of the investment, and is not affected, per se, by the actions of others. In fact, one of the valuable extensions of Kelly's work by Thorp was his apparent refusal to leverage his funds.
This was something ignored by the next generation of quants, including his own acolyte, Ken Griffin, founder of Citadel.
Reading Poundstone, on Kelly, provides a very clear, refreshing portrait of a seriously intelligent, rigorous mind grappling with the realities of risk capital deployment. And Thorp, with his casino beginnings, understood this perspective intuitively.
Sadly, quant kids two generations and more on, do not.
And that is why active risk management has been so ineffective. It becomes not a matter of discretion, but of survival.
That is, in Thorp's world, trimming the exposure to a Kelly bet is advantageous, but not essential. Because the bet was scaled according to rigorous theoretical principles, losing it all isn't crippling.
When that bet is with 3x, or more, levered money, you only have a 25-33% loss cushion before you've burned through equity and are out borrowed money.
The gambler's ruin. Busted.
Needless to say, we've already begun working on applications of the Kelly Criterion to our proprietary options investment strategies. As a passive, rigorously theoretical and internally-focused approach, it meets our criteria.
Monday, March 08, 2010
Hank Greenberg's Rx For Financial Sector Reform
Last Friday's Wall Street Journal featured an editorial by Hank Greenberg, former CEO of AIG, entitled "Six Steps Toward Financial Reform."
His six steps include:
-Improve regulation and regulators
-Tie compensation to long-term performance
-Make rating agencies independent
-Allow our financial institutions to remain competitive
-Institute responsible risk-management systems
-Use stimulus money strategically
Like these sorts of recommendations by other well-known CEOs, public office-holders or academics, Greenberg's list contains some gold and some dross.
His first suggestion is rather tautological, but enduringly debatable. It's a desirable-sounding goal, but seems always to be over the horizon. One could argue, and I do, that the Fed was responsible and well-armed to have identified and stopped much of the irresponsible behavior which contributed, but did not directly, solely cause, the recent financial sector meltdown. For example, Greenberg does not mention, by name, Fannie Mae, Freddie Mac, nor the public officials responsible for fueling the unwise growth of those two agencies. Yet, that growth in low-quality, risky mortgages was the spark that touched off the fuse which caused the financial services sector explosion.
I like Greenberg's second recommendation. As long ago as the late 1990s, I wrote public pieces endorsing such policy. But which CEO or senior manager, in the heat of the moment, faced with a talented trader, or desk, will deny them short-term compensation in some new, clever, regulation-evading manner, in order to book current profits and gain market share in selected markets?
Isn't that, indeed, how we arrived at the current third-party payer health care mess? By causing businesses to evade Congressional restrictions on cash compensation during WWII?
Does any thinking person honestly believe this can be legislated and enforced?
In fact, it's debatable that Greenberg's contention,
"No one is worth a $60 million cash payment a year,"
is true.
If a talented trader or deal-maker at some financial services company is given capital to deploy, and, either through trading or astute M&A activity, engages in activities which bring cash profits to the firm, through closed trades or advice on corporate actions, in the range of hundreds of millions of dollars, who is to say that person isn't worth 5% of that value?
Greenberg's third suggestion is also problematic. Who would judge whether the employees at rating agencies have "the appropriate background and abilities?"
From my discussions with executives at one agency, it became clear that the issue was not one of competence, but opportunity and the market share power of clients.
For someone so hounded by a "government institution," I am shocked that Greenberg would offer this option to ostensibly make rating agencies non-profit in nature.
That said, the very model of client-paid ratings ought to simply cause users to beware. I remain convinced that ratings, in this era, are simply less valuable than they once were. Any investment committee relying solely, or largely, on ratings is probably already in trouble.
Perhaps the most tenuous suggestion is Greenberg's third one, implying allowing "too big to fail" institutions to continue to exist in their current forms, with current government backing. He specifically rejects the Volcker Rule. In that linked post about Volcker's recommendation, I wrote,
"The solution we need isn't more complex regulation, so much as a reasoned return to a past regulation, and better, permanent severing of the riskier finance activities from the federally-insured, mainstays of deposit-taking and basic consumer and commercial lending. "
Greenberg continues to mouth the fallacy that integrated, universal banks are somehow better, and more competitively advantaged in the marketplace.
Which integrated, globe-girding bank didn't experience trouble in 2008? Which major US financial institution didn't risk its shareholder's equity and require taxpayers to provide ultimate backstopping? The only two that come to mind, Wells Fargo and Chase, are sufficiently lackluster to begin with that they were simply too late to the risk party of 2003-2007.
What Greenberg truthfully acknowledges in his comment is that this issue ultimately leads to regulator domicile shopping. In effect, any constraints applied by the US will result in the flight of those companies wishing to be integrated banks.
I say, good riddance. Is the price I pay not having to bail them out? I'm so worried.
Because if it's financial services competitiveness you want, integrated banks aren't where you find that. Typically, that comes, initially, from privately-held monoline financial entities. Trading, asset management, underwriting, can and are all performed in non-publicly-held companies. Often by far more talented people than are left out in the poorer-paying, regulated, publicly-held part of the sector.
Greenberg's views on risk management, while laudable, are equally unenforceable as are his notions about regulation and compensation. It's well and good to call for "responsible risk-management systems."
Just what would one look like? Will ten of the same still be considered 'responsible?'
Because, according to Scott Patterson's recently-published book, The Quants, that's pretty much what happened in 2008. So much for cutting-edge risk management.
By the way, where does leverage factor into this, Hank?
Greenberg's final thought concerning government stimulus money. To me, it's unrelated to the other issues as Greenberg treats it. If he had simply railed against using it as a bailout fund, that would make sense. Instead, he wanders out of the financial sector to make unsupported assertions about economic policy.
Hank Greenberg is a very smart, tough cookie. He has unique and vast experience in the financial services sector. If someone of his stature, intellect and experience can't get this topic right, who can?
Perhaps this, alone, suggests that the solution is not more regulation, but less. End government subsidies to risk-taking entities in the form of deposit insurance. Let rating agencies be who and what they are, with users of their information aware of the conflicts and history of their ratings.
Then, ultimately, let investors bear the risk of assessing their own selections, with no recourse to the political sector for bailouts, do-overs and insurance.
That might be reform which actually brings individual responsibility in line with financial services choices.
His six steps include:
-Improve regulation and regulators
-Tie compensation to long-term performance
-Make rating agencies independent
-Allow our financial institutions to remain competitive
-Institute responsible risk-management systems
-Use stimulus money strategically
Like these sorts of recommendations by other well-known CEOs, public office-holders or academics, Greenberg's list contains some gold and some dross.
His first suggestion is rather tautological, but enduringly debatable. It's a desirable-sounding goal, but seems always to be over the horizon. One could argue, and I do, that the Fed was responsible and well-armed to have identified and stopped much of the irresponsible behavior which contributed, but did not directly, solely cause, the recent financial sector meltdown. For example, Greenberg does not mention, by name, Fannie Mae, Freddie Mac, nor the public officials responsible for fueling the unwise growth of those two agencies. Yet, that growth in low-quality, risky mortgages was the spark that touched off the fuse which caused the financial services sector explosion.
I like Greenberg's second recommendation. As long ago as the late 1990s, I wrote public pieces endorsing such policy. But which CEO or senior manager, in the heat of the moment, faced with a talented trader, or desk, will deny them short-term compensation in some new, clever, regulation-evading manner, in order to book current profits and gain market share in selected markets?
Isn't that, indeed, how we arrived at the current third-party payer health care mess? By causing businesses to evade Congressional restrictions on cash compensation during WWII?
Does any thinking person honestly believe this can be legislated and enforced?
In fact, it's debatable that Greenberg's contention,
"No one is worth a $60 million cash payment a year,"
is true.
If a talented trader or deal-maker at some financial services company is given capital to deploy, and, either through trading or astute M&A activity, engages in activities which bring cash profits to the firm, through closed trades or advice on corporate actions, in the range of hundreds of millions of dollars, who is to say that person isn't worth 5% of that value?
Greenberg's third suggestion is also problematic. Who would judge whether the employees at rating agencies have "the appropriate background and abilities?"
From my discussions with executives at one agency, it became clear that the issue was not one of competence, but opportunity and the market share power of clients.
For someone so hounded by a "government institution," I am shocked that Greenberg would offer this option to ostensibly make rating agencies non-profit in nature.
That said, the very model of client-paid ratings ought to simply cause users to beware. I remain convinced that ratings, in this era, are simply less valuable than they once were. Any investment committee relying solely, or largely, on ratings is probably already in trouble.
Perhaps the most tenuous suggestion is Greenberg's third one, implying allowing "too big to fail" institutions to continue to exist in their current forms, with current government backing. He specifically rejects the Volcker Rule. In that linked post about Volcker's recommendation, I wrote,
"The solution we need isn't more complex regulation, so much as a reasoned return to a past regulation, and better, permanent severing of the riskier finance activities from the federally-insured, mainstays of deposit-taking and basic consumer and commercial lending. "
Greenberg continues to mouth the fallacy that integrated, universal banks are somehow better, and more competitively advantaged in the marketplace.
Which integrated, globe-girding bank didn't experience trouble in 2008? Which major US financial institution didn't risk its shareholder's equity and require taxpayers to provide ultimate backstopping? The only two that come to mind, Wells Fargo and Chase, are sufficiently lackluster to begin with that they were simply too late to the risk party of 2003-2007.
What Greenberg truthfully acknowledges in his comment is that this issue ultimately leads to regulator domicile shopping. In effect, any constraints applied by the US will result in the flight of those companies wishing to be integrated banks.
I say, good riddance. Is the price I pay not having to bail them out? I'm so worried.
Because if it's financial services competitiveness you want, integrated banks aren't where you find that. Typically, that comes, initially, from privately-held monoline financial entities. Trading, asset management, underwriting, can and are all performed in non-publicly-held companies. Often by far more talented people than are left out in the poorer-paying, regulated, publicly-held part of the sector.
Greenberg's views on risk management, while laudable, are equally unenforceable as are his notions about regulation and compensation. It's well and good to call for "responsible risk-management systems."
Just what would one look like? Will ten of the same still be considered 'responsible?'
Because, according to Scott Patterson's recently-published book, The Quants, that's pretty much what happened in 2008. So much for cutting-edge risk management.
By the way, where does leverage factor into this, Hank?
Greenberg's final thought concerning government stimulus money. To me, it's unrelated to the other issues as Greenberg treats it. If he had simply railed against using it as a bailout fund, that would make sense. Instead, he wanders out of the financial sector to make unsupported assertions about economic policy.
Hank Greenberg is a very smart, tough cookie. He has unique and vast experience in the financial services sector. If someone of his stature, intellect and experience can't get this topic right, who can?
Perhaps this, alone, suggests that the solution is not more regulation, but less. End government subsidies to risk-taking entities in the form of deposit insurance. Let rating agencies be who and what they are, with users of their information aware of the conflicts and history of their ratings.
Then, ultimately, let investors bear the risk of assessing their own selections, with no recourse to the political sector for bailouts, do-overs and insurance.
That might be reform which actually brings individual responsibility in line with financial services choices.
Friday, March 05, 2010
Vik Pandit's Sorry Performance On Capitol Hill
Citigroup CEO Vikram Pandit's performance before the TARP oversight panel yesterday in Washington must have Walter Wriston spinning in his grave.
So craven was Pandit that he renounced the bulk of Wriston's vision of money as an equivalent of information. Instead, Vik basically apologized for Citigroup ever attempting to be more than your good ole' neighborhood bank with a heart, only on a global basis.
He prostrated himself, verbally, in front of the panel, thanking them profusely for taxpayer funds which saved his bank.
When attacked for Citi's overseas presences and investments, Pandit claimed that Citigroup wasn't global, but American. Indeed, America's global bank.
How heartwarming. Patriotic, even.
Then Vik went on to assert that, after much rumination, he personally decided that Citi should be a bank. So he's been selling everything that isn't a bank. When asked how he felt about the "Volcker Rule," Pandit disingenuously claimed he was adhering to it by selling off little pieces of Citigroup. Of course, what Volcker really means is for banks like Citi, which enjoy FDIC deposit insurance protection, to stop risking solvency, and, thus, taxpayer funds on proprietary trading.
Either Pandit is so naive as to not understand this, or so clever as to believe his claims would fool the panel and viewers of his live act.
I wrote this spoof of an interview with Pandit 2 1/4 years ago, upon his being named CEO in December, 2007. The nearby price chart for Citigroup and the S&P500 Index for the past two years illustrates how much Citigroup has lost in value for its shareholders under Pandit.The second chart provides a longer term perspective from five years back for the same series. About the best that could be said is that Pandit chose to accept the promotion from relative safety, running Citigroup's asset management unit, at an inauspicious time. Whether simply greedy, egotistical, or foolish, he walked into a maelstrom from which he, his bank and its private, non-governmental shareholders have yet to emerge.
There will be those, like someone who commented on one of my posts about Citigroup last year, who are short term opportunists, and have profited from the relative rebound of the company's equity since early 2009. But the risks associated with such a strategy were not low, and it appears that markets have taken back about a third of that temporary increase.Even this morning, perennial Citigroup bullish analyst Dick Bove was, as usual, giving a glowing vision of the bank's future and firmly endorsing Citigroup as an investment.
I just can't get the image out of my mind of Pandit groveling before the government panel, clearly afraid of being accused of yet more misdeeds, made to suffer more penalties, perhaps even dismembered under the implementation of the Volcker Rule.
Is it realistic to bet on such a timid, defensive posture for Citigroup and its CEO for the coming years?
Thursday, March 04, 2010
Alan Mulally's Wall Street Journal Interview
This past weekend's edition of the Wall Street Journal featured, as its signature long interview, Paul Ingrassia's discussion with Ford CEO Alan Mulally.
I wrote some initial posts about Mulally's arrival, in September of 2006, and early tenure at Ford here, and here.
I wasn't very optimistic at first, as this passage from the first linked post demonstrates,
"Will Mulally's sensible initiatives matter? Truthfully, I doubt they have the time. Still, oddly, I can't but help root for the guy. Maybe in 3-4 years, Ford will make my equity portfolio selection list. Although, my hunch is, not as an independent company. Perhaps as part of an alliance with Nissan. If it merges with GM, I would lower the probabilities of its performing sufficiently well to make my selection list."
I was more impressed in the next post, nearly two years ago, when I noted,
"But, as I have asked in prior posts about 'turnarounds' at other firms, what will constitute a successful turnaround?
To me, net income performance, impressive as it has improved under Mulally, is not alone sufficient.
The pattern and magnitude of a firm's fundamental operating results create investor perceptions that underpin a firm's attainment of consistently superior returns for its shareholders.
Unless Ford is planning on really strong, consistent double-digit revenue growth in the years ahead, it's going to have to achieve any consistent total return performance mostly by productivity improvements.
It's clear that the Journal likes Mr. Mulally very much. All three articles about him provide unfailingly upbeat, flattering profiles. And my guess is they are not wrong.
Even this piece's details about Mulally's pushing to sell Jaguar and Land Rover, redesign the Ford Focus, and attack inventory problems all ring with the sense of a really good manager at work.
Still, call me sceptical. It's not just that Mulally must haul Ford back from the brink of bankruptcy or sale. He must, in my opinion, then lead the company to several years of unexpectedly good performance, either with new revenue and volume growth, or incredible productivity gains, in order to provide the basis for consistently superior total returns for shareholders.
Can Mulally accomplish this? Who knows? I'm a 'show me' kind of investor, and Ford has years to go before it can possibly, in my view, be accorded the title of a 'successful turnaround,' or 'recovery.'"
The nearby five-year price performance chart of Ford and the S&P500 Index shows that Mulally is actually only even with the index after 3 1/2 years on the job.
Considering the risk inherent in owning a single equity, risk adjusting the implied returns would put Ford below the index.
Still, Mulally's Ford is still alive and kicking. He's managed to reduce hourly labor costs impressively, down to $50 from $75. Regardless of GM's inventory excuses, Ford did outsell GM this past month, which is a milestone. Ingrassia was certainly very positive in his expectations for the new Ford.
But looking at the second price chart of Ford and the S&P500, from 1977-present, provides a context in which to more soberly evaluate Mulally's and Ford's prospects.
The company's value managed to rise again in the mid-late 1980s, and again through the 1990s.
But its fall from its 1999 peak has been precipitous, losing nearly all the value built from its early-80's nadir. The steepness of the rebound in its equity price since last year has been nearly alpine-like. Such a relentless pace of price improvement and the implied total return is simply unlikely to be sustainable.
My proprietary equity performance research has uncovered many companies which rebound sharply, like Ford, and post a few years of outsized returns. Only to then fail to sustain the momentum and plateau, falling back to being a fairly staid, unremarkable company to own.
Ingrassia wrote glowingly of Mulally, and justly so. But he didn't touch on topics like longer term total returns for the recovering auto maker. It wasn't really the point of the interview.
So I will.
Thanks to global government support of various auto producers, industry over-capacity remains. Ford has to grapple with a government-owned and -subsidized competitor, GM, and a Congress and administration willing to and capable of attacking that failing auto maker's competitors, e.g., Toyota.
Ingrassia did get Mulally to discuss Ford's balance sheet challenges. This only hints at the real issue. In order to continue superior revenue growth, Ford will have to both out-compete rivals on many performance dimensions, both internal and external, as well as be capable of affordably funding such growth. But the sector, at least in the US, is at a crossroads.
Political expediency drives Ford to hybrids and alternative fuel sources for its cars, while end-user demand isn't necessarily there for the longer term. Nor is the economy healed, portending a potential slump in demand in the next few years.
Unless Mulally continues to pull more very sizable rabbits out of his hat at Ford, the pace of revenue growth, cost reductions, and, thus, total return performance, is likely to slow. Ford still competes in a business with too much capacity, a government-owned competitor, capital intensity and fairly volatile demand over time.
For all of the adulation given to someone like Warren Buffett, you don't see him piling into Ford, do you? No, he bought Burlington Northern.
I wrote some initial posts about Mulally's arrival, in September of 2006, and early tenure at Ford here, and here.
I wasn't very optimistic at first, as this passage from the first linked post demonstrates,
"Will Mulally's sensible initiatives matter? Truthfully, I doubt they have the time. Still, oddly, I can't but help root for the guy. Maybe in 3-4 years, Ford will make my equity portfolio selection list. Although, my hunch is, not as an independent company. Perhaps as part of an alliance with Nissan. If it merges with GM, I would lower the probabilities of its performing sufficiently well to make my selection list."
I was more impressed in the next post, nearly two years ago, when I noted,
"But, as I have asked in prior posts about 'turnarounds' at other firms, what will constitute a successful turnaround?
To me, net income performance, impressive as it has improved under Mulally, is not alone sufficient.
The pattern and magnitude of a firm's fundamental operating results create investor perceptions that underpin a firm's attainment of consistently superior returns for its shareholders.
Unless Ford is planning on really strong, consistent double-digit revenue growth in the years ahead, it's going to have to achieve any consistent total return performance mostly by productivity improvements.
It's clear that the Journal likes Mr. Mulally very much. All three articles about him provide unfailingly upbeat, flattering profiles. And my guess is they are not wrong.
Even this piece's details about Mulally's pushing to sell Jaguar and Land Rover, redesign the Ford Focus, and attack inventory problems all ring with the sense of a really good manager at work.
Still, call me sceptical. It's not just that Mulally must haul Ford back from the brink of bankruptcy or sale. He must, in my opinion, then lead the company to several years of unexpectedly good performance, either with new revenue and volume growth, or incredible productivity gains, in order to provide the basis for consistently superior total returns for shareholders.
Can Mulally accomplish this? Who knows? I'm a 'show me' kind of investor, and Ford has years to go before it can possibly, in my view, be accorded the title of a 'successful turnaround,' or 'recovery.'"
The nearby five-year price performance chart of Ford and the S&P500 Index shows that Mulally is actually only even with the index after 3 1/2 years on the job.
Considering the risk inherent in owning a single equity, risk adjusting the implied returns would put Ford below the index.
Still, Mulally's Ford is still alive and kicking. He's managed to reduce hourly labor costs impressively, down to $50 from $75. Regardless of GM's inventory excuses, Ford did outsell GM this past month, which is a milestone. Ingrassia was certainly very positive in his expectations for the new Ford.
But looking at the second price chart of Ford and the S&P500, from 1977-present, provides a context in which to more soberly evaluate Mulally's and Ford's prospects.
The company's value managed to rise again in the mid-late 1980s, and again through the 1990s.
But its fall from its 1999 peak has been precipitous, losing nearly all the value built from its early-80's nadir. The steepness of the rebound in its equity price since last year has been nearly alpine-like. Such a relentless pace of price improvement and the implied total return is simply unlikely to be sustainable.
My proprietary equity performance research has uncovered many companies which rebound sharply, like Ford, and post a few years of outsized returns. Only to then fail to sustain the momentum and plateau, falling back to being a fairly staid, unremarkable company to own.
Ingrassia wrote glowingly of Mulally, and justly so. But he didn't touch on topics like longer term total returns for the recovering auto maker. It wasn't really the point of the interview.
So I will.
Thanks to global government support of various auto producers, industry over-capacity remains. Ford has to grapple with a government-owned and -subsidized competitor, GM, and a Congress and administration willing to and capable of attacking that failing auto maker's competitors, e.g., Toyota.
Ingrassia did get Mulally to discuss Ford's balance sheet challenges. This only hints at the real issue. In order to continue superior revenue growth, Ford will have to both out-compete rivals on many performance dimensions, both internal and external, as well as be capable of affordably funding such growth. But the sector, at least in the US, is at a crossroads.
Political expediency drives Ford to hybrids and alternative fuel sources for its cars, while end-user demand isn't necessarily there for the longer term. Nor is the economy healed, portending a potential slump in demand in the next few years.
Unless Mulally continues to pull more very sizable rabbits out of his hat at Ford, the pace of revenue growth, cost reductions, and, thus, total return performance, is likely to slow. Ford still competes in a business with too much capacity, a government-owned competitor, capital intensity and fairly volatile demand over time.
For all of the adulation given to someone like Warren Buffett, you don't see him piling into Ford, do you? No, he bought Burlington Northern.
Wednesday, March 03, 2010
Carol Bartz & Yahoo One Year Later
I wrote this post slightly more than a year ago, roughly six weeks after Carol Bartz assumed command at Yahoo. In it, I expressed hope that Carol Bartz could turn the troubled company around, and noted approvingly how she began her tenure at the firm's helm.
In July of last year, I wrote this post concerning Bartz' Yahoo tie-up with Microsoft. Looking at my posts as last year progressed, I confess to seeing myself having become more doubtful and much less enthusiastic regarding Bartz' ability to salvage the badly-damaged internet pioneer.
The nearby price chart of Yahoo and the S&P500 Index tells a disappointing story. Roughly since Bartz' arrival at Yahoo, it has trailed the index returns, roughly 19% vs. 50%.
Yesterday's 30 minute interview has, sadly, increased my scepticism about anyone's, even Carol Bartz' ability to fix Yahoo. Bartz' comments and answers to questions were vague, non-quantitative and, I believe, wishful thinking. She didn't do a good job answering Dennis Kneale's simple question about what Yahoo stands for. Yes, information, but that's old and hardly unique.
In fairness, the nearby price chart for the company and S&P500 Index over 5 years shows that the firm has been struggling for quite some time.
In fairness, the nearby price chart for the company and S&P500 Index over 5 years shows that the firm has been struggling for quite some time.
But after a year, having read and listened to Carol Bartz' statements as to how she would turn Yahoo around, I must admit that there's nothing new in her promises or assessments that weren't there a year ago.
Sadly, she stooped to taking an easy way out, when offered it, and complaining that the firm's equity isn't appropriately priced. That it's too cheap, and should be higher.
Uh huh.
When you're hearing that, you know the CEO is out of ammo and just desperate.
I don't hold this against Bartz. It's understandable that she was ready for a change, having successfully led AutoDesk for well over a decade. How could she resist such a train wreck as Yahoo?
Much like CEOs like Lou Gerstner at IBM decades ago, it must have seemed that she couldn't lose. If she failed, it would be viewed as having been an impossible task. If Bartz succeeds in rebuilding market value for Yahoo, she's a hero.
It's looking like it's the former. Yahoo's total returns are less than you'd get in the diversified S&P, and Bartz is offering no explanation of what will change in the near future to make that different.
To me, it does really demonstrate that the massive damage Yahoo suffered under Terry Semel and then, again, Jerry Yang, has been too much for even Bartz to reverse.
Tuesday, March 02, 2010
The Unrealized Value of The Indvidual Pre-Tax Health Insurance Benefit
Recently, a friend who is a retired industrial senior executive wrote me regarding the ongoing debates on government health care legislation,
"Have you ever done a blog on the rationale for a tax on employer-provided health care? I realize that this is a third rail in Congress, but you could make the point that people are economic animals and until an individual has his own interest in the outcome there will be no change in behavior. The government has always encouraged the provision of uneconomic fringes with its tax policy - and this has lead to the demise of the airlines, the autos and the steels."
His point is correct. Government-subsidized health insurance, by way of the tax code and so-called "fringe benefits," have led to third-party payers insulating health care consumers from the costs of their own behaviors. And they are insulated in two ways. First, by the tax-free nature of the implied compensation of health insurance. Second, by being given that benefit as a defined obligation, rather than a defined level of value.
In prior posts, I've mentioned the origin of this sorry state of affairs, i.e., Senator Harry Truman's Senate Committee freezing wages during WWII. The result was non-price competition in the form of then-novel "fringe benefits." These included paid health insurance and pensions.
Thanks to this bone-headed war-era move by Congress, businesses foolishly turned what was a controlled expense, wages, into an open-ended obligation, health insurance and pension promises.
I'm not inclined to excuse the corporate CEOs of the era for this mistake. There were other methods of enabling individuals to receive these benefits, if only by making them defined contribution, rather than defined benefit in nature.
That's really the key point. Most of the private sector has moved non-union employees from the latter to the former when it comes to pensions. It's time to do so for health insurance, as well. It's true that defined-benefit approaches to health insurance and pensions did much to sink the US auto, airline and steel sectors.
One could, as my friend does, argue for removing the tax-preferenced nature of health insurance premiums from businesses, so that they are on an equal footing with individuals who buy their own health insurance with after-tax dollars. I'm fine with doing this, too, if only, as he points out, to force individuals to pay for the implied compensation.
But I think, by far, the more important element in reforming US health care is to move corporate compensation in the form of health insurance obligation, to a cash payment as a wage component. This removes the open-ended obligation from the corporation's balance sheet and income statement, replacing it with a simpler, more easily-valued and controlled cash payment. The obligation's value then becomes the choice of individual employees.
As I wrote in yesterday's related post,
"For example, in direct contrast to several Wall Street Journal editorialists with deeper backgrounds on the subject than Buffett, he blithely declared increased spending as essentially wasteful and a crushing burden on American competitiveness.
What Buffett ignored, but others have noted, is that greater discretionary spending on health care is a hallmark of wealthier society.
Here's one way to see Buffett's error.
Americans spend more time and money on leisure activities now than they did fifty years ago. And, given the relatively lower costs, in percentage terms, of various other household expenses, almost certainly more in percentage terms, as well.
Oh my God!
We have a leisure spending crisis! Fifty years ago, nobody spent money downloading music to iPods! Now, they do.
What will we do? American businesses must be shouldering the burden of all that digital entertainment expense, mustn't they?
Buffett confuses changes in discretionary spending with escalating costs for a controlled level of consumption.
Oil prices are higher now than they were fifty years ago, too. Isn't that another crisis? Shouldn't that be tackled by Congress?
The key flaw in Buffett's argument, much as Boone Pickens' over energy costs, is to pick one input to our economy, note the rise in its cost, and declare an emergency, while failing to observe the rise as at least partially attributable to consumer discretionary spending and business use to create even higher-value outputs."
What my friend astutely notes, whether tax-preferenced, or not, is that by shielding workers from the true costs of their behaviors, they over-consume health care. It's one thing for an employee to use his cash wages to buy gasoline, food, health insurance, and save for his own retirement. When all these claims on a household budget are explicit, real lifestyle choices result.
You never hear anyone in Congress complain that gasoline or food prices are hurting US business competitiveness, do you? Why should it continue to be so with health care?
It's almost moot whether one chooses to continue the pre-tax treatment of health insurance premiums and HSA accounts for individuals, or not. The really important change is to make end users pay those amounts out of their own pockets, from a defined cash compensation amount, so that consequences of their behaviors and choices are truly owned.
It's not hard to foresee Americans eating and behaving in healthier ways, once the cost of health insurance is seen as depending, in part, on the buyers' health status.
But, most importantly, by putting the choice of how much health care end users wish to buy and consume in the hands of those consumers, and not leaving it as an open-ended corporate obligation, those consumers will experience the true and full consequences of their behaviors. Thus, as my friend noted, almost certainly changing their behaviors, bringing down the care-level-adjusted cost of US health care.
It will also simplify and separate the US health care problem as distinct from costs of doing business for US businesses.
"Have you ever done a blog on the rationale for a tax on employer-provided health care? I realize that this is a third rail in Congress, but you could make the point that people are economic animals and until an individual has his own interest in the outcome there will be no change in behavior. The government has always encouraged the provision of uneconomic fringes with its tax policy - and this has lead to the demise of the airlines, the autos and the steels."
His point is correct. Government-subsidized health insurance, by way of the tax code and so-called "fringe benefits," have led to third-party payers insulating health care consumers from the costs of their own behaviors. And they are insulated in two ways. First, by the tax-free nature of the implied compensation of health insurance. Second, by being given that benefit as a defined obligation, rather than a defined level of value.
In prior posts, I've mentioned the origin of this sorry state of affairs, i.e., Senator Harry Truman's Senate Committee freezing wages during WWII. The result was non-price competition in the form of then-novel "fringe benefits." These included paid health insurance and pensions.
Thanks to this bone-headed war-era move by Congress, businesses foolishly turned what was a controlled expense, wages, into an open-ended obligation, health insurance and pension promises.
I'm not inclined to excuse the corporate CEOs of the era for this mistake. There were other methods of enabling individuals to receive these benefits, if only by making them defined contribution, rather than defined benefit in nature.
That's really the key point. Most of the private sector has moved non-union employees from the latter to the former when it comes to pensions. It's time to do so for health insurance, as well. It's true that defined-benefit approaches to health insurance and pensions did much to sink the US auto, airline and steel sectors.
One could, as my friend does, argue for removing the tax-preferenced nature of health insurance premiums from businesses, so that they are on an equal footing with individuals who buy their own health insurance with after-tax dollars. I'm fine with doing this, too, if only, as he points out, to force individuals to pay for the implied compensation.
But I think, by far, the more important element in reforming US health care is to move corporate compensation in the form of health insurance obligation, to a cash payment as a wage component. This removes the open-ended obligation from the corporation's balance sheet and income statement, replacing it with a simpler, more easily-valued and controlled cash payment. The obligation's value then becomes the choice of individual employees.
As I wrote in yesterday's related post,
"For example, in direct contrast to several Wall Street Journal editorialists with deeper backgrounds on the subject than Buffett, he blithely declared increased spending as essentially wasteful and a crushing burden on American competitiveness.
What Buffett ignored, but others have noted, is that greater discretionary spending on health care is a hallmark of wealthier society.
Here's one way to see Buffett's error.
Americans spend more time and money on leisure activities now than they did fifty years ago. And, given the relatively lower costs, in percentage terms, of various other household expenses, almost certainly more in percentage terms, as well.
Oh my God!
We have a leisure spending crisis! Fifty years ago, nobody spent money downloading music to iPods! Now, they do.
What will we do? American businesses must be shouldering the burden of all that digital entertainment expense, mustn't they?
Buffett confuses changes in discretionary spending with escalating costs for a controlled level of consumption.
Oil prices are higher now than they were fifty years ago, too. Isn't that another crisis? Shouldn't that be tackled by Congress?
The key flaw in Buffett's argument, much as Boone Pickens' over energy costs, is to pick one input to our economy, note the rise in its cost, and declare an emergency, while failing to observe the rise as at least partially attributable to consumer discretionary spending and business use to create even higher-value outputs."
What my friend astutely notes, whether tax-preferenced, or not, is that by shielding workers from the true costs of their behaviors, they over-consume health care. It's one thing for an employee to use his cash wages to buy gasoline, food, health insurance, and save for his own retirement. When all these claims on a household budget are explicit, real lifestyle choices result.
You never hear anyone in Congress complain that gasoline or food prices are hurting US business competitiveness, do you? Why should it continue to be so with health care?
It's almost moot whether one chooses to continue the pre-tax treatment of health insurance premiums and HSA accounts for individuals, or not. The really important change is to make end users pay those amounts out of their own pockets, from a defined cash compensation amount, so that consequences of their behaviors and choices are truly owned.
It's not hard to foresee Americans eating and behaving in healthier ways, once the cost of health insurance is seen as depending, in part, on the buyers' health status.
But, most importantly, by putting the choice of how much health care end users wish to buy and consume in the hands of those consumers, and not leaving it as an open-ended corporate obligation, those consumers will experience the true and full consequences of their behaviors. Thus, as my friend noted, almost certainly changing their behaviors, bringing down the care-level-adjusted cost of US health care.
It will also simplify and separate the US health care problem as distinct from costs of doing business for US businesses.
Monday, March 01, 2010
Warren Buffett's Muddled Understanding of Healthcare Costs
The Berkshire Hathaway annual meeting must be nearly upon us, as Warren Buffett spent three hours on CNBC this morning. Thanks to his close relationship with co-anchor Becky Quick, the Omaha-based asset manager spends a distressingly large amount of time on CNBC's programs nowadays.
If you are wondering what the term "halo effect" means, just tune into Buffett for 20 minutes or so. He is peppered with questions far outside the range of his asset management skills. And, looking at the nearby price chart of Berkshire and the S&P500 for the past 2 years, those skills are seen to have waned recently.
So we come to the CNBC co-anchors beseeching Buffett to share his vast font of health care knowledge with them, and their viewers.
Now, one thing you need to realize is that Buffett is not a stupid man. He knows he is a potential target of government, should he ever be seen as voicing outright disdain for or opposition to it.
Therefore, Buffett, I believe upon being advised Obama would win the 2008 presidential election, allied himself with the Democrat. Now, despite a year's worth of horrendous mismanagement as president, when asked how he views Obama's performance, Buffett is of course laudatory.
After all, he knows the value being out of the rifle scopes of a sitting administration and a Congress controlled by the same party.
Thus, Buffett then went on to declare his support for the current mess of a health care proposal, rather than have 'the status quo.'
But here's the problem. Buffett isn't viewing the current US health care situation correctly.
In a theme I'll continue in tomorrow's post, Buffett confuses choices about spending one's income, and quality of care, with total cost.
For example, Buffett made some incorrect statements about the quality of US healthcare, relative to other countries, then contrasted health care costs of decades past with those of today.
Unbelievably, Buffett never bothered to even make a glancing reference to the immensely superior level of medical care in the US today, versus the 1960s, nor the enormous increase in years of lives now made possible by more advanced, knowledgeable medical treatment.
At several points in the discussion, Buffett claimed to have no real knowledge of the sector, but then plunged ahead, again, tossing off wrong diagnoses and crying "crisis."
For example, in direct contrast to several Wall Street Journal editorialists with deeper backgrounds on the subject than Buffett, he blithely declared increased spending as essentially wasteful and a crushing burden on American competitiveness.
What Buffett ignored, but others have noted, is that greater discretionary spending on health care is a hallmark of wealthier society.
Here's one way to see Buffett's error.
Americans spend more time and money on leisure activities now than they did fifty years ago. And, given the relatively lower costs, in percentage terms, of various other household expenses, almost certainly more in percentage terms, as well.
Oh my God!
We have a leisure spending crisis! Fifty years ago, nobody spent money downloading music to iPods! Now, they do.
What will we do? American businesses must be shouldering the burden of all that digital entertainment expense, mustn't they?
Buffett confuses changes in discretionary spending with escalating costs for a controlled level of consumption.
Oil prices are higher now than they were fifty years ago, too. Isn't that another crisis? Shouldn't that be tackled by Congress?
The key flaw in Buffett's argument, much as Boone Pickens' over energy costs, is to pick one input to our economy, note the rise in its cost, and declare an emergency, while failing to observe the rise as at least partially attributable to consumer discretionary spending and business use to create even higher-value outputs.
Buffett is right in one respect, though. He doesn't understand the health care sector. And, thus, should probably just remain silent when questioned about it. In fact, that's probably a pretty good idea for him on anything outside a rather narrowly-defined scope of asset management questions.
If you are wondering what the term "halo effect" means, just tune into Buffett for 20 minutes or so. He is peppered with questions far outside the range of his asset management skills. And, looking at the nearby price chart of Berkshire and the S&P500 for the past 2 years, those skills are seen to have waned recently.So we come to the CNBC co-anchors beseeching Buffett to share his vast font of health care knowledge with them, and their viewers.
Now, one thing you need to realize is that Buffett is not a stupid man. He knows he is a potential target of government, should he ever be seen as voicing outright disdain for or opposition to it.
Therefore, Buffett, I believe upon being advised Obama would win the 2008 presidential election, allied himself with the Democrat. Now, despite a year's worth of horrendous mismanagement as president, when asked how he views Obama's performance, Buffett is of course laudatory.
After all, he knows the value being out of the rifle scopes of a sitting administration and a Congress controlled by the same party.
Thus, Buffett then went on to declare his support for the current mess of a health care proposal, rather than have 'the status quo.'
But here's the problem. Buffett isn't viewing the current US health care situation correctly.
In a theme I'll continue in tomorrow's post, Buffett confuses choices about spending one's income, and quality of care, with total cost.
For example, Buffett made some incorrect statements about the quality of US healthcare, relative to other countries, then contrasted health care costs of decades past with those of today.
Unbelievably, Buffett never bothered to even make a glancing reference to the immensely superior level of medical care in the US today, versus the 1960s, nor the enormous increase in years of lives now made possible by more advanced, knowledgeable medical treatment.
At several points in the discussion, Buffett claimed to have no real knowledge of the sector, but then plunged ahead, again, tossing off wrong diagnoses and crying "crisis."
For example, in direct contrast to several Wall Street Journal editorialists with deeper backgrounds on the subject than Buffett, he blithely declared increased spending as essentially wasteful and a crushing burden on American competitiveness.
What Buffett ignored, but others have noted, is that greater discretionary spending on health care is a hallmark of wealthier society.
Here's one way to see Buffett's error.
Americans spend more time and money on leisure activities now than they did fifty years ago. And, given the relatively lower costs, in percentage terms, of various other household expenses, almost certainly more in percentage terms, as well.
Oh my God!
We have a leisure spending crisis! Fifty years ago, nobody spent money downloading music to iPods! Now, they do.
What will we do? American businesses must be shouldering the burden of all that digital entertainment expense, mustn't they?
Buffett confuses changes in discretionary spending with escalating costs for a controlled level of consumption.
Oil prices are higher now than they were fifty years ago, too. Isn't that another crisis? Shouldn't that be tackled by Congress?
The key flaw in Buffett's argument, much as Boone Pickens' over energy costs, is to pick one input to our economy, note the rise in its cost, and declare an emergency, while failing to observe the rise as at least partially attributable to consumer discretionary spending and business use to create even higher-value outputs.
Buffett is right in one respect, though. He doesn't understand the health care sector. And, thus, should probably just remain silent when questioned about it. In fact, that's probably a pretty good idea for him on anything outside a rather narrowly-defined scope of asset management questions.
Friday, February 26, 2010
More Congressional Ineptitude
Maxine Waters is not the only incompetent House member. Not by a long shot.
Yesterday, as I watched/listened to the so-called health care summit, Fox News cut to an interview by Megyn Kelly with Florida Democratic Representative Debbie Wasserman-Schultz.
It was, to say the least, revealing.
Kelly asked Schultz to explain why Democrats continue to push a 2,300 page health care bill too complex for anyone to fully comprehend, when so many polls indicate that about 55% of voters want a new health care bill to be written from scratch by both parties, together, and something like only 30% of voters want the current proposed legislation.
Schultz replied with a laundry list of items which she claimed voters were for, on an individual basis. Among the items she listed were:
-low insurance premiums or small increases
-no dropping coverage because of sickness
-insurance available for pre-existing conditions
-coverage of all Americans
What Schultz and, for that matter, Kelly, overlooked and ignored, is the flaw inherent in asking interviewees on a questionnaire for multiple, serial responses on attributes of a choice.
Back in the late 1970s, when I attended graduate business school, conjoint analysis was already a fairly mature, well-regarded technique in marketing research. That was over 30 years ago!
What conjoint analysis does is allow respondents to choose, usually in either paired-comparisons or rank ordering tasks, between various sub-optimal combinations of attributes.
In the case of health care, for example, a 'choice' might be low premium increases, but no pre-existing condition coverage and coverage for 90% of Americans.
By working through such choices, respondents reveal their relative values for each attribute. The key is being forced to choose among alternatives combining various levels of the various attributes.
Why isn't Congress commissioning some conjoint analysis-based research to provide members with information on what Americans value most, and least, among the possible, but expensive, attributes of a health care reform bill?
This is the sort of omission that drives me crazy. Sad to say, a look at Schultz's bio tells you a lot. She was a carpetbagging resident in her district when she went to work for a state legislator. She then ran for his vacated seat at the tender age of 26, won it, and served the maximum number of terms. Then she ran for Congress.
So, once again, as in the case of Carolyn Maloney or, for that matter, my old civics teacher, longtime Bob Michel aide and current Secretary of Transportation, Ray LaHood, we have a Representative with no more than perhaps 3-4 years of experience actually working for a living. And those years were quite long ago.
No wonder our elected representatives provide so few modern, easily-available techniques to assist in resolving policy questions. They truly are clueless, because they've spent too much of their adult lives as professional office-holders.
And, again, as I did at the end of my post about Maxine Waters, I want to stress the business implications of this post. Provisions of the current health care bill will cause businesses to dump their employees into government-run plans. This will cause health insurance costs to skyrocket, increasing our national debt and, eventually, raising taxes. This will lead to less job creation and lower economic growth rates.
It's important for all of us to push back ill-advised, stupid legislation and government overreach. It begins by getting rid of lifetime officeholders of all parties, and striving to elect experienced, non-professional candidates for a few terms, so that their goals and those of ordinary citizens who work for a living are aligned.
Yesterday, as I watched/listened to the so-called health care summit, Fox News cut to an interview by Megyn Kelly with Florida Democratic Representative Debbie Wasserman-Schultz.
It was, to say the least, revealing.
Kelly asked Schultz to explain why Democrats continue to push a 2,300 page health care bill too complex for anyone to fully comprehend, when so many polls indicate that about 55% of voters want a new health care bill to be written from scratch by both parties, together, and something like only 30% of voters want the current proposed legislation.
Schultz replied with a laundry list of items which she claimed voters were for, on an individual basis. Among the items she listed were:
-low insurance premiums or small increases
-no dropping coverage because of sickness
-insurance available for pre-existing conditions
-coverage of all Americans
What Schultz and, for that matter, Kelly, overlooked and ignored, is the flaw inherent in asking interviewees on a questionnaire for multiple, serial responses on attributes of a choice.
Back in the late 1970s, when I attended graduate business school, conjoint analysis was already a fairly mature, well-regarded technique in marketing research. That was over 30 years ago!
What conjoint analysis does is allow respondents to choose, usually in either paired-comparisons or rank ordering tasks, between various sub-optimal combinations of attributes.
In the case of health care, for example, a 'choice' might be low premium increases, but no pre-existing condition coverage and coverage for 90% of Americans.
By working through such choices, respondents reveal their relative values for each attribute. The key is being forced to choose among alternatives combining various levels of the various attributes.
Why isn't Congress commissioning some conjoint analysis-based research to provide members with information on what Americans value most, and least, among the possible, but expensive, attributes of a health care reform bill?
This is the sort of omission that drives me crazy. Sad to say, a look at Schultz's bio tells you a lot. She was a carpetbagging resident in her district when she went to work for a state legislator. She then ran for his vacated seat at the tender age of 26, won it, and served the maximum number of terms. Then she ran for Congress.
So, once again, as in the case of Carolyn Maloney or, for that matter, my old civics teacher, longtime Bob Michel aide and current Secretary of Transportation, Ray LaHood, we have a Representative with no more than perhaps 3-4 years of experience actually working for a living. And those years were quite long ago.
No wonder our elected representatives provide so few modern, easily-available techniques to assist in resolving policy questions. They truly are clueless, because they've spent too much of their adult lives as professional office-holders.
And, again, as I did at the end of my post about Maxine Waters, I want to stress the business implications of this post. Provisions of the current health care bill will cause businesses to dump their employees into government-run plans. This will cause health insurance costs to skyrocket, increasing our national debt and, eventually, raising taxes. This will lead to less job creation and lower economic growth rates.
It's important for all of us to push back ill-advised, stupid legislation and government overreach. It begins by getting rid of lifetime officeholders of all parties, and striving to elect experienced, non-professional candidates for a few terms, so that their goals and those of ordinary citizens who work for a living are aligned.
Thursday, February 25, 2010
"So Dumb, Her Head Must Hurt...."
Years ago, a college friend had a saying about really stupid people. It was,
"He's so dumb, his head must hurt."
This phrase came to mind yesterday morning as I heard and watched California Democratic Representative Maxine Waters question Fed Chairman Ben Bernanke.
Waters distinguished herself with a new low in ineptitude when she began by confusing the discount rate with the Fed Funds Rate. After Bernanke patiently explained the difference, Waters then spent long minutes insisting that mortgage interest rates must remain low, so she wanted Bernanke to guarantee and assure the House Financial Services Committee that market interest rates would not increase due to the increase in the discount rate.
Now, if you visit that link, you'll see a list of the House members on the committee. Because they are not listed in alphabetical order, it's a reasonable guess that they are in order of seniority. Thus, Waters is at least the third-longest serving Democrat on the panel. I know I've heard Waters' idiotic questions and comments on this committee for years.
Don't you think it's fair to expect such a long-serving committee member to know, by now, the difference between the discount window rate and the Fed Funds rate? How about expecting them to know a fair amount about the structure of the US financial system, basic economics, and some international trade economics, as well?
But, no, instead, we get Maxine Waters.
"So dumb, her head must hurt."
Just once, I'd like to, and would pay money to hear a Fed Chairman respond to a question like Waters' as follows,
'Ms. Waters, your question is idiotic. It conveys a total lack of understanding of the workings of the Fed.
How long have you been on this committee, Rep. Waters? Don't you think you owe it to your constituents and all American voters, to actually understand the matters before this committee?
Have you not taken the time, over the years you've been on this panel, to learn about our financial and economic system? Or are you simply overwhelmed by the subject matter?
Mr. Frank, this is ridiculous. I'm casting pearls before swine, here.
Please make sure, in the future, that the members on this committee have passed a basic test of knowledge on the subject matter that the committee oversees.
Until such time as you can assure me that all of your committee members have passed such a test, a test which I will sit with you to create, I will not bother to waste my valuable time sitting for questions from uninformed, stupid Members.
That is all for today. I have work to do.'
This is why so many of us cringe at the prospect of Congress having more and more power over all facets of American life. Congressional members sit on committees, the subjects of which they have absolutely no knowledge.
It's frightening that these people think they can regulate or oversee anything. Few seem to have even held a private sector job recently.
Just imagine you were Ben Bernanke and had to continually explain complex, inexact economic matters to more than 30 Maxine Waters clones.
It's not a political matter, nor a partisan issue. It's about the ability of Americans to conduct business in the face of inept, inexperienced and unqualified federal legislators trying to accrete more power to themselves, while remaining ignorant of how business and economics actually work.
It's enough to make you go insane, isn't it?
"He's so dumb, his head must hurt."
This phrase came to mind yesterday morning as I heard and watched California Democratic Representative Maxine Waters question Fed Chairman Ben Bernanke.
Waters distinguished herself with a new low in ineptitude when she began by confusing the discount rate with the Fed Funds Rate. After Bernanke patiently explained the difference, Waters then spent long minutes insisting that mortgage interest rates must remain low, so she wanted Bernanke to guarantee and assure the House Financial Services Committee that market interest rates would not increase due to the increase in the discount rate.
Now, if you visit that link, you'll see a list of the House members on the committee. Because they are not listed in alphabetical order, it's a reasonable guess that they are in order of seniority. Thus, Waters is at least the third-longest serving Democrat on the panel. I know I've heard Waters' idiotic questions and comments on this committee for years.
Don't you think it's fair to expect such a long-serving committee member to know, by now, the difference between the discount window rate and the Fed Funds rate? How about expecting them to know a fair amount about the structure of the US financial system, basic economics, and some international trade economics, as well?
But, no, instead, we get Maxine Waters.
"So dumb, her head must hurt."
Just once, I'd like to, and would pay money to hear a Fed Chairman respond to a question like Waters' as follows,
'Ms. Waters, your question is idiotic. It conveys a total lack of understanding of the workings of the Fed.
How long have you been on this committee, Rep. Waters? Don't you think you owe it to your constituents and all American voters, to actually understand the matters before this committee?
Have you not taken the time, over the years you've been on this panel, to learn about our financial and economic system? Or are you simply overwhelmed by the subject matter?
Mr. Frank, this is ridiculous. I'm casting pearls before swine, here.
Please make sure, in the future, that the members on this committee have passed a basic test of knowledge on the subject matter that the committee oversees.
Until such time as you can assure me that all of your committee members have passed such a test, a test which I will sit with you to create, I will not bother to waste my valuable time sitting for questions from uninformed, stupid Members.
That is all for today. I have work to do.'
This is why so many of us cringe at the prospect of Congress having more and more power over all facets of American life. Congressional members sit on committees, the subjects of which they have absolutely no knowledge.
It's frightening that these people think they can regulate or oversee anything. Few seem to have even held a private sector job recently.
Just imagine you were Ben Bernanke and had to continually explain complex, inexact economic matters to more than 30 Maxine Waters clones.
It's not a political matter, nor a partisan issue. It's about the ability of Americans to conduct business in the face of inept, inexperienced and unqualified federal legislators trying to accrete more power to themselves, while remaining ignorant of how business and economics actually work.
It's enough to make you go insane, isn't it?
Wednesday, February 24, 2010
General Growth Properties' Fall From Grace
I have read, with some dismay, the articles concerning Simon Properties' bid to take over the remains of General Growth Properties.
My own connection with the firm, though brief and passing, goes back to 2000.
At the time, a prominent hedge fund manager and former Salomon Brothers partner offered to assemble a hedge fund around my equity strategy. His anchor investor, as it were, was GGP's then-chairman, Matthew Bucksbaum. At the time, Bucksbaum was a billionaire, thanks to his personal investments in GGP. The firm had been built by his family over decades, then gone public as a REIT, providing substantial, liquid wealth for them.
As part of the process of securing Bucksbaum's investment, the partner assembling the hedge fund asked me to do some analysis of GGP's competitors, and GGP, using the consulting version of my research. It was to be a threefold activity: a chance for Matt Bucksbaum to evaluate me and my work; a good faith provision of free analysis, and; a formal reply to a question Bucksbaum had regarding GGP's valuation relative to his company's peers. Vornado, Simons and Rouse were among the REITs which I analyzed.
It didn't take me long to do the analysis, nor identify a probable cause of GGP's relatively lower valuation, particularly when compared to Vornado. Put simply, GGP had a bad habit of selling properties when they had accrued substantial gains, providing shareholders at those times with extraordinary gains. Thereafter, investors knew such gains would be years in coming.
Consequently, GGP's earnings were more volatile than Vornado's, and its valuation was lower, due to this lack of consistency. I provided some guidance as to how GGP could improve its earnings consistency, and offered to provide additional presentations to the firm's management team.
Bucksbaum understood my analysis, conclusions, and recommendations, though he evidently declined to pursue them further.
However, he agreed to back our hedge fund.
When I read of GGP's sudden spiral toward bankruptcy in the last year or so, it took me back to my meetings with Bucksbaum in the spring of 2000. I can't, of course, estimate how much of GGP's troubles were due to the operating policies which I identified as probably depressing the firm's value to investors. Articles in the Wall Street Journal suggested that, like investment and commercial banks, and many hedge funds, GGP had unwisely used too much short term borrowed funding. Adding to that problem, the firm's COO, Matthew's son, John, had apparently borrowed heavily against family-owned GGP shares. When margin calls came due during the 2008 financial debacle, the firm's and family's fortunes began to rapidly unravel.
Last I read, Matthew Bucksbaum was reduced to being worth only tens of millions. Still more money than most Americans will see at his age. But something like 1% of his peak net worth.
A good lesson in how fleeting business success can sometimes be.
My own connection with the firm, though brief and passing, goes back to 2000.
At the time, a prominent hedge fund manager and former Salomon Brothers partner offered to assemble a hedge fund around my equity strategy. His anchor investor, as it were, was GGP's then-chairman, Matthew Bucksbaum. At the time, Bucksbaum was a billionaire, thanks to his personal investments in GGP. The firm had been built by his family over decades, then gone public as a REIT, providing substantial, liquid wealth for them.
As part of the process of securing Bucksbaum's investment, the partner assembling the hedge fund asked me to do some analysis of GGP's competitors, and GGP, using the consulting version of my research. It was to be a threefold activity: a chance for Matt Bucksbaum to evaluate me and my work; a good faith provision of free analysis, and; a formal reply to a question Bucksbaum had regarding GGP's valuation relative to his company's peers. Vornado, Simons and Rouse were among the REITs which I analyzed.
It didn't take me long to do the analysis, nor identify a probable cause of GGP's relatively lower valuation, particularly when compared to Vornado. Put simply, GGP had a bad habit of selling properties when they had accrued substantial gains, providing shareholders at those times with extraordinary gains. Thereafter, investors knew such gains would be years in coming.
Consequently, GGP's earnings were more volatile than Vornado's, and its valuation was lower, due to this lack of consistency. I provided some guidance as to how GGP could improve its earnings consistency, and offered to provide additional presentations to the firm's management team.
Bucksbaum understood my analysis, conclusions, and recommendations, though he evidently declined to pursue them further.
However, he agreed to back our hedge fund.
When I read of GGP's sudden spiral toward bankruptcy in the last year or so, it took me back to my meetings with Bucksbaum in the spring of 2000. I can't, of course, estimate how much of GGP's troubles were due to the operating policies which I identified as probably depressing the firm's value to investors. Articles in the Wall Street Journal suggested that, like investment and commercial banks, and many hedge funds, GGP had unwisely used too much short term borrowed funding. Adding to that problem, the firm's COO, Matthew's son, John, had apparently borrowed heavily against family-owned GGP shares. When margin calls came due during the 2008 financial debacle, the firm's and family's fortunes began to rapidly unravel.
Last I read, Matthew Bucksbaum was reduced to being worth only tens of millions. Still more money than most Americans will see at his age. But something like 1% of his peak net worth.
A good lesson in how fleeting business success can sometimes be.
Subscribe to:
Posts (Atom)
