The last few days have been filled with news about business with an explicit political bent. I refer, of course, to the game of chicken that various parties played during the pre-Chapter 11 filing negotiations among the federal government, the UAW, management, and senior secured lenders, i.e., bondholders.
Yesterday, the nation's president took industrial policy to a new extreme, publicly calling for a "buy American" ethic, explicitly supporting Chrysler's survival/revival, and excoriating those who lent to the failed car company in good faith for wishing to exercise their legal rights.
Truly, it seemed like a scene right out of Ayn Rand's "Atlas Shrugged."
Later in the day, I briefly viewed Michigan's Democratic governor at a press conference, exhorting all parties to produce a solution that will make the state the new leader in whatever sort of futuristic car design and manufacturing is required. Nevermind that industry usually locates in a geography for a particular reason related to either transportation, markets, or resources. Michigan would no longer seem to have any of those, since the newest auto makers have chosen to locate in right-to-work states in the southeastern US.
Today, Michigan Democratic Representative John "Tailpipe Johnny" Dingell continued the president's assault on capital, decrying "speculators" as "vultures" for sinking the pre-bankruptcy negotiations over Chrysler's future. Apparently he, too, prefers government agendas to the rule of law.
Today's Wall Street Journal published a piece noting how the Chrysler dilemma is a trial balloon for GM's own turn in the barrel later this month. If the former's capital structure does, indeed, award more control in the surviving company to a junior, unsecured creditor, i.e., the UAW, than to the senior secured creditors, the impact on general corporate debt issuance and pricing will be chilling. Any company with a strong union workforce will be viewed sceptically by potential debt investors, because the government's manipulation of the Chrysler and GM situations will alert them to the ultimate unenforceability of the bond covenants under which they lend corporations capital.
How long will it take to reverse that sort of loss of confidence? What effect will it have on the apparently still-fragile US capital markets?
What is the longer term implication of a federal government which does not enforce laws, but, instead, inserts itself on one or another side of private sector conflicts, then seeks to manipulate public opinion to get its way before legal remedies may be employed?
How is this sort of government behavior conducive to a vibrant, strong, risk-taking private sector of our economy?
The effects of this misguided government intervention in the Detroit-based auto makers' situations have implications for the US economy far, far beyond just two failing auto makers.
Friday, May 01, 2009
Thursday, April 30, 2009
More On Corporate Governance: David Einhorn's Book
I finished Greenlight Capital founder David Einhorn's book, "Fooling Some of the People All of the Time," this afternoon, and wanted to record some reflections while they are still fresh.
By the end of the book, my sense of disgust for Lanny Davis, first mentioned in this post on my companion political blog, was even more pronounced.
Mr. Einhorn obviously is quite passionate about the events surrounding the Allied Capital matter. The latter half of the book contains more about his and Greenlight's activities beyond buying, or selling short, Allied's shares, than it does about the actual, simple investment position. He reproduces, at length, the SEC finding which effectively agreed with Greenlight's contentions over a number of years, but failed to punish Allied, it's management or board. Instead, the typical regulatory agency solution of a 'cease and desist' order, also popular at the FTC, ended the SEC's interest in the matter.
On the last few pages of the book, the author cites a conversation with Warren Buffett regarding short selling, as well as reviews the uneven justice dispensed to various corporate charlatans.
As I read those pages, I considered my own experience with short equity positions. About a decade ago, when I began rigorous application of my equity portfolio selection and management approach with a hedge fund based in New York, we paired longs and shorts in a fairly static strategy. After some lessons learned in 2001, and the fortunate collaboration with a private investor doing extensive research on variations of the strategies I had employed, the concept of a dynamically shifting long/short allocation arose and proved to be a much more robust approach than static hedging.
Thus, were my current partner and I running an equity fund, we'd have been short since last July, and have racked up very healthy, double-digit net performance for 2008, and a positive performance this year, to date.
But our shorts are selected quantitatively, in a manner similar to our longs. I use a blend of technical and fundamental factors. As such, I explicitly build in an expectation of market reaction to near-term future events.
In fact, though, we now eschew clients and focus, instead, on proprietary derivative implementations of my original equity strategy. It's simple, cost-effective and much more profitable, on a consistently-invested basis, with far less total risk, than the equity strategy would be.
Right now, we hold puts. But, as with the equity strategy, we expect performance due to the market's reaction to subsequent performance of the underlying equity, not due to a sudden change in awareness of something about the companies themselves.
In this, I believe, my own approach is radically different than that of some other well-publicized hedge fund investors who sometimes, or nearly always, are short-sellers. Mr. Einhorn emphasizes that the bulk of his fund's positions are not usually short, and certainly not on the basis of some short-only ideology. Noted successful investors such as James Chanos or Doug Kass are probably more consistently in short positions.
But since Mr. Einhorn's book was about his entanglement with Allied Capital as a result of both a short position, and a speech he made at a charity in which he offered that suggestion as an investment recommendation, I want to touch on his comments about short selling.
Specifically, one, or at least I, left his book, and, particularly, that last chapter, with the sense that Mr. Einhorn's, and his colleagues' careful, painstaking investigative analyses cause them to believe they see problems others have not yet observed. In this, their work can yield them early exit on an equity, via a short sale, which legitimately and fairly compensates their research.
But, in this sort of 'early awareness' short selling, one seems to depend upon a sea change in awareness by many others in the equity markets. Thus, it's almost impossible for someone with this approach to dodge the charges of manipulation, because they by definition hope that others change their perception of an equity which, heretofore, has not had its warts unveiled so publicly.
Since my own business background was from outside the investment community, I have an entirely different, and, perhaps, opposite approach. As a marketing strategist, then a business strategist, consultant and research director, I came naturally to a desire to understand how to quantify performance, and, then, attempt to discover the causes of differing corporate performances.
To skip a few decades of work and insight, let me just conclude that I settled on examining companies for signs of consistency. Consistency, I found, is its own reward. Find a consistently-superior performing equity, buy it, hold, and, depending upon your bases of analysis, you may well be rewarded without needing to change any other investors' perceptions.
And, no, it's not simply momentum investing. As I noted above, there are substantial and non-trivial fundamental factors involved in our strategy.
But, if you correctly anticipate enough consistent, but under-appreciated equity opportunities, the result is a consistently positive portfolio performance.
Mr. Einhorn's road is clearly a much rougher one to tread. Not only does Greenlight obviously apply careful and deep analysis by intelligent people. They seem, given what I read in his book, to seek out the lesser-known equities in which something will be discovered by other investors at a later date. I suppose that, anytime you buy, or sell, in advance of a major change in sentiment by other investors, you take a significant risk.
If you find yourself on the record about those positions, and they are short sales, it's inevitable that the targeted company is going to cry 'manipulation.'
Even my business partner attests to feeling uncomfortable when we are buying puts, as opposed to calls. He hates to hope for equity market declines, in which our put selections will typically outperform. He's much happier to experience gains in calls, although there's nothing particularly ethical at stake.
For me, it's just math. Puts, calls, I couldn't care less, if the signals are clear and strong. And since we count on continuation of existing patterns or trends, it's probably better that we don't call attention to our selections.
In closing, I wanted to write this post today, because it dovetails, in my opinion, so nicely with one of today's earlier posts. Mr. Einhorn's saga involving Allied Capital reads, from a distance, as yet another salvo in the ongoing war over appropriate corporate governance.
He states several times in the book that Allied was only one of many portfolio positions. His fund probably lost comparatively little on the position, judging from the Greenlight Capital performance numbers sprinkled throughout the book.
Thus, the book is probably a passionate catharsis for him for the time, energy, money spent, and reputational damage sustained, during the long-running matter.
I think it's also another good example which supports my contention that corporate governance, beyond simply buying, or selling equity positions, is a thankless and profitless task in almost every instance. There might be personal satisfaction in being 'right' after relentlessly pursuing a corporate governance agenda.
But Mr. Einhorn's own revelations of the lack of justice and effect of so many existing agencies, billions of dollars of regulatory budgets, staff, etc., reinforces my own belief that you're better off just sticking to either buying, selling, or avoiding an equity, than you are going after any management team.
Despite all the laws, courts, regulations and agencies created to change this reality, like it or not, the game is stacked in management's favor. Every time.
Thus, my own preference is to either pick a superior, inadequately-recognized equity, or the call thereon, to buy, or an inferior, but inadequately-recognized equity, or the put theron, and buy. But, unless you have substantial and uniquely superior detailed analytical prowess and firepower, which Mr. Einhorn and his firm evidently possess, avoid taking equity or derivative positions in which you expect massive change in either investor sentiment or senior management and/or board action.
By the end of the book, my sense of disgust for Lanny Davis, first mentioned in this post on my companion political blog, was even more pronounced.
Mr. Einhorn obviously is quite passionate about the events surrounding the Allied Capital matter. The latter half of the book contains more about his and Greenlight's activities beyond buying, or selling short, Allied's shares, than it does about the actual, simple investment position. He reproduces, at length, the SEC finding which effectively agreed with Greenlight's contentions over a number of years, but failed to punish Allied, it's management or board. Instead, the typical regulatory agency solution of a 'cease and desist' order, also popular at the FTC, ended the SEC's interest in the matter.
On the last few pages of the book, the author cites a conversation with Warren Buffett regarding short selling, as well as reviews the uneven justice dispensed to various corporate charlatans.
As I read those pages, I considered my own experience with short equity positions. About a decade ago, when I began rigorous application of my equity portfolio selection and management approach with a hedge fund based in New York, we paired longs and shorts in a fairly static strategy. After some lessons learned in 2001, and the fortunate collaboration with a private investor doing extensive research on variations of the strategies I had employed, the concept of a dynamically shifting long/short allocation arose and proved to be a much more robust approach than static hedging.
Thus, were my current partner and I running an equity fund, we'd have been short since last July, and have racked up very healthy, double-digit net performance for 2008, and a positive performance this year, to date.
But our shorts are selected quantitatively, in a manner similar to our longs. I use a blend of technical and fundamental factors. As such, I explicitly build in an expectation of market reaction to near-term future events.
In fact, though, we now eschew clients and focus, instead, on proprietary derivative implementations of my original equity strategy. It's simple, cost-effective and much more profitable, on a consistently-invested basis, with far less total risk, than the equity strategy would be.
Right now, we hold puts. But, as with the equity strategy, we expect performance due to the market's reaction to subsequent performance of the underlying equity, not due to a sudden change in awareness of something about the companies themselves.
In this, I believe, my own approach is radically different than that of some other well-publicized hedge fund investors who sometimes, or nearly always, are short-sellers. Mr. Einhorn emphasizes that the bulk of his fund's positions are not usually short, and certainly not on the basis of some short-only ideology. Noted successful investors such as James Chanos or Doug Kass are probably more consistently in short positions.
But since Mr. Einhorn's book was about his entanglement with Allied Capital as a result of both a short position, and a speech he made at a charity in which he offered that suggestion as an investment recommendation, I want to touch on his comments about short selling.
Specifically, one, or at least I, left his book, and, particularly, that last chapter, with the sense that Mr. Einhorn's, and his colleagues' careful, painstaking investigative analyses cause them to believe they see problems others have not yet observed. In this, their work can yield them early exit on an equity, via a short sale, which legitimately and fairly compensates their research.
But, in this sort of 'early awareness' short selling, one seems to depend upon a sea change in awareness by many others in the equity markets. Thus, it's almost impossible for someone with this approach to dodge the charges of manipulation, because they by definition hope that others change their perception of an equity which, heretofore, has not had its warts unveiled so publicly.
Since my own business background was from outside the investment community, I have an entirely different, and, perhaps, opposite approach. As a marketing strategist, then a business strategist, consultant and research director, I came naturally to a desire to understand how to quantify performance, and, then, attempt to discover the causes of differing corporate performances.
To skip a few decades of work and insight, let me just conclude that I settled on examining companies for signs of consistency. Consistency, I found, is its own reward. Find a consistently-superior performing equity, buy it, hold, and, depending upon your bases of analysis, you may well be rewarded without needing to change any other investors' perceptions.
And, no, it's not simply momentum investing. As I noted above, there are substantial and non-trivial fundamental factors involved in our strategy.
But, if you correctly anticipate enough consistent, but under-appreciated equity opportunities, the result is a consistently positive portfolio performance.
Mr. Einhorn's road is clearly a much rougher one to tread. Not only does Greenlight obviously apply careful and deep analysis by intelligent people. They seem, given what I read in his book, to seek out the lesser-known equities in which something will be discovered by other investors at a later date. I suppose that, anytime you buy, or sell, in advance of a major change in sentiment by other investors, you take a significant risk.
If you find yourself on the record about those positions, and they are short sales, it's inevitable that the targeted company is going to cry 'manipulation.'
Even my business partner attests to feeling uncomfortable when we are buying puts, as opposed to calls. He hates to hope for equity market declines, in which our put selections will typically outperform. He's much happier to experience gains in calls, although there's nothing particularly ethical at stake.
For me, it's just math. Puts, calls, I couldn't care less, if the signals are clear and strong. And since we count on continuation of existing patterns or trends, it's probably better that we don't call attention to our selections.
In closing, I wanted to write this post today, because it dovetails, in my opinion, so nicely with one of today's earlier posts. Mr. Einhorn's saga involving Allied Capital reads, from a distance, as yet another salvo in the ongoing war over appropriate corporate governance.
He states several times in the book that Allied was only one of many portfolio positions. His fund probably lost comparatively little on the position, judging from the Greenlight Capital performance numbers sprinkled throughout the book.
Thus, the book is probably a passionate catharsis for him for the time, energy, money spent, and reputational damage sustained, during the long-running matter.
I think it's also another good example which supports my contention that corporate governance, beyond simply buying, or selling equity positions, is a thankless and profitless task in almost every instance. There might be personal satisfaction in being 'right' after relentlessly pursuing a corporate governance agenda.
But Mr. Einhorn's own revelations of the lack of justice and effect of so many existing agencies, billions of dollars of regulatory budgets, staff, etc., reinforces my own belief that you're better off just sticking to either buying, selling, or avoiding an equity, than you are going after any management team.
Despite all the laws, courts, regulations and agencies created to change this reality, like it or not, the game is stacked in management's favor. Every time.
Thus, my own preference is to either pick a superior, inadequately-recognized equity, or the call thereon, to buy, or an inferior, but inadequately-recognized equity, or the put theron, and buy. But, unless you have substantial and uniquely superior detailed analytical prowess and firepower, which Mr. Einhorn and his firm evidently possess, avoid taking equity or derivative positions in which you expect massive change in either investor sentiment or senior management and/or board action.
The Health of The US Economy: GDP & Spending
Yesterday's economic news was mixed. First quarter GDP fell at an annualized rate of -6.1%, marking a third consecutive quarter of contraction.
At the same time, consumer spending was announced as up +2.2% over, the prior quarter, as this article states.
I discussed these numbers at length over lunch with a colleague yesterday. We agreed that the consumer spending number is really difficult to interpret, since it is apparently a relatively short period-on-period measure.
Let me explain.
After vainly Googling for the actual series of Commerce Department consumer spending over time, I have no way of knowing what the actual level of consumer spending, in billions of dollars, was in 2006-2008. But my colleague and I estimated that it must have been declining in 2007, and really plunged last year.
Housing had already weakened by late 2007, and, thus, home-formation durable goods spending would have been down. We know that Loews and Home Depot got hammered last year.
Then we recalled that auto financing dried up last year, as a consequence of the weakness of the financial sector, which was reeling from leveraged losses in mortgage-related assets.
Yesterday's report noted the decline in consumer spending in the last quarter of 2008 of roughly -4%. Thus, a +2.2% rise this past quarter still leaves spending down 2% for the last six months.
Somehow, I doubt that the size of this positive spending number does much to offset what has probably been six quarters of dismal results. But, as I noted, I can't find anything on the annual series, or the quarterly changes.
It's difficult to see where the financial resources exist for the consumer to sustain an economic recovery. Other than spending on sales of non-durables and selected, bargain-priced real estate, should we expect the recent jobless claims, credit card limit cuts, and house value declines to underpin a dramatic rise in consumer spending for the next few years?
Judging by the last seven weeks, yesterday, and today's equity market performances, many investors appear to believe that the recession will be over later this year, as Bernanke promised. Thus, by conventional reasoning, since equity markets must rise prior to that recovery point, now must be the snap-back in equity markets.
QED.
If only it were that simple.
Having patiently watched our recent put portfolios steadily decline in value, I reviewed equity market performance in the spring of 2002. By that season, the S&P had posted some good positive monthly returns, along with mild negative returns, resulting in my equity allocation signal indicating a re-entry into long positions. That only lasted for a month, though, as July and September saw the S&P post -8% and -11% returns, respectively.
It was not until spring of the next year that my signals correctly indicated the sustained recovery in the equity market. That spring, 2002 indication was a false positive.
Perhaps this recent 20+% rise in the S&P is another equity market head fake. The 2002 incident was accompanied by a decline in volatility to a point that corroborated a move to long allocations in equities, and puts in options.
Now, however, volatility remains high. A Wall Street Journal article today mentioned the VIX having declined from a peak of around 80 to 38. Thus, the VIX is at 48% of its peak. Our proprietary equity volatility measure is currently at 36% of its peak of last fall. For our measure, it remains significantly above a threshhold at which we would consider switching from puts to calls.
To listen to most market pundits, they are putting the best possible spin on every non-negative piece of economic news, while hoping the negative items confirm that things aren't getting any worse anymore.
Here's a final thought on this topic.
Back in 2002, the equity markets were reacting to a post-tech bubble economy, as well as consumer behavior in the post-9/11 environment. Nobody claimed it was 'the worst economic time since the Depression.' Yet we saw two years of declining equity values in what was, in retrospect, a relatively mild recession.
Now, we have the aftermath of massive deleveraging, the collapse or exit of every major publicly-held investment bank, a handful of commercial banks, government intervention in finance and industry. Joblessness has risen to nearly 10%. Consumer balance sheets have taken hits in both financial and real estate assets.
Does this sound like an economy and an equity market that will recover more quickly than those of 2001-2003?
Or, as Martin Feldstein has been objectively predicting, does a recovery no earlier than late 2010 seem more believable?
At the same time, consumer spending was announced as up +2.2% over, the prior quarter, as this article states.
I discussed these numbers at length over lunch with a colleague yesterday. We agreed that the consumer spending number is really difficult to interpret, since it is apparently a relatively short period-on-period measure.
Let me explain.
After vainly Googling for the actual series of Commerce Department consumer spending over time, I have no way of knowing what the actual level of consumer spending, in billions of dollars, was in 2006-2008. But my colleague and I estimated that it must have been declining in 2007, and really plunged last year.
Housing had already weakened by late 2007, and, thus, home-formation durable goods spending would have been down. We know that Loews and Home Depot got hammered last year.
Then we recalled that auto financing dried up last year, as a consequence of the weakness of the financial sector, which was reeling from leveraged losses in mortgage-related assets.
Yesterday's report noted the decline in consumer spending in the last quarter of 2008 of roughly -4%. Thus, a +2.2% rise this past quarter still leaves spending down 2% for the last six months.
Somehow, I doubt that the size of this positive spending number does much to offset what has probably been six quarters of dismal results. But, as I noted, I can't find anything on the annual series, or the quarterly changes.
It's difficult to see where the financial resources exist for the consumer to sustain an economic recovery. Other than spending on sales of non-durables and selected, bargain-priced real estate, should we expect the recent jobless claims, credit card limit cuts, and house value declines to underpin a dramatic rise in consumer spending for the next few years?
Judging by the last seven weeks, yesterday, and today's equity market performances, many investors appear to believe that the recession will be over later this year, as Bernanke promised. Thus, by conventional reasoning, since equity markets must rise prior to that recovery point, now must be the snap-back in equity markets.
QED.
If only it were that simple.
Having patiently watched our recent put portfolios steadily decline in value, I reviewed equity market performance in the spring of 2002. By that season, the S&P had posted some good positive monthly returns, along with mild negative returns, resulting in my equity allocation signal indicating a re-entry into long positions. That only lasted for a month, though, as July and September saw the S&P post -8% and -11% returns, respectively.
It was not until spring of the next year that my signals correctly indicated the sustained recovery in the equity market. That spring, 2002 indication was a false positive.
Perhaps this recent 20+% rise in the S&P is another equity market head fake. The 2002 incident was accompanied by a decline in volatility to a point that corroborated a move to long allocations in equities, and puts in options.
Now, however, volatility remains high. A Wall Street Journal article today mentioned the VIX having declined from a peak of around 80 to 38. Thus, the VIX is at 48% of its peak. Our proprietary equity volatility measure is currently at 36% of its peak of last fall. For our measure, it remains significantly above a threshhold at which we would consider switching from puts to calls.
To listen to most market pundits, they are putting the best possible spin on every non-negative piece of economic news, while hoping the negative items confirm that things aren't getting any worse anymore.
Here's a final thought on this topic.
Back in 2002, the equity markets were reacting to a post-tech bubble economy, as well as consumer behavior in the post-9/11 environment. Nobody claimed it was 'the worst economic time since the Depression.' Yet we saw two years of declining equity values in what was, in retrospect, a relatively mild recession.
Now, we have the aftermath of massive deleveraging, the collapse or exit of every major publicly-held investment bank, a handful of commercial banks, government intervention in finance and industry. Joblessness has risen to nearly 10%. Consumer balance sheets have taken hits in both financial and real estate assets.
Does this sound like an economy and an equity market that will recover more quickly than those of 2001-2003?
Or, as Martin Feldstein has been objectively predicting, does a recovery no earlier than late 2010 seem more believable?
Corporate Governance for Dummies: Ken Lewis & BofA
There are plenty of topics on which I could opine this morning. Originally, I was going to comment on Holman Jenkins' column in yesterday's Wall Street Journal regarding GM's and Chrysler's looming bankruptcies. But, really, the major point of that was to highlight Jenkins' review of the realities of how government regulation fed the UAW's bloated compensation demands, while GM, Ford and Chrysler, to varying degrees, acquiesced.
That, in itself, is a sort of corporate governance story. Jenkins and I agree that the UAW and the federal government are both getting the just desserts of their earlier behavior.
But yesterday's news featured a much more sharply-defined example of corporate governance. And not a good one.
Ken Lewis was rejected by shareholders as Chairman of BofA but, for now, remains CEO. Personally, I agree with the Journal columnists who noted Lewis' gigantic mistakes of late, i.e., overpaying for Countrywide, then foolishly buying a dying Merrill Lynch, all the while contending that both were fabulous deals for BofA.
As the details of Lewis' intimidation by Bernanke and Paulson have come forth, one wonders why any shareholder would trust Lewis to run anything material anymore. He's clearly a seat-warmer without principles or much common sense.
But, faced with three examples of clear cut, anti-shareholder behavior, the morons who still hold BofA stock seem unable to get rid of him.
How is this possible? Is this appropriate 'corporate governance?'
Jason Zwieg, a columnist in the Wall Street Journal, wrote a piece a few months ago castigating those who, like me, take the position that one should simply sell the shares of companies whose behavior varies from what one would desire.
Is there any clearer case today of a company run ineptly by a clueless CEO? One who has now publicly admitted being guilty of Sarbanes-Oxley felonies?
But they still can't get rid of him. Some say that Lewis only has 'one more chance' left.
My God! I wish the rest of us had so many chances to screw up at several million dollars per year of total compensation.
My point is, Zwieg is wrong, and I am right. For the average shareholder, rather than, say, Carl Icahn or Eddie Lampert, there's just no leverage or percentage in holding the equity of a poorly-run company. Hoping that, over time, you and a few thousand other, unknown shareholders will somehow, magically, nominate another candidate to be CEO, or replace all of the board members, who will then fire the sitting CEO, only happens in a movie. If then.
In a fair world, Lewis would be gone. But the board is in his pocket. That they are insensitive to shareholder wishes is clear by their support for Lewis as Chairman, while the owners whom they are supposed to represent voted to split the job from CEO.
You just can't, in my opinion, get a clearer example of a company in which the CEO should be fired, and then probably charged with a felony, yet he continues to hold his job.
That's what you get for believing in the fairy tale of 'corporate governance.'
Here's the reality- you don't like what's going on at a company? Sell the shares. Period.
That, in itself, is a sort of corporate governance story. Jenkins and I agree that the UAW and the federal government are both getting the just desserts of their earlier behavior.
But yesterday's news featured a much more sharply-defined example of corporate governance. And not a good one.
Ken Lewis was rejected by shareholders as Chairman of BofA but, for now, remains CEO. Personally, I agree with the Journal columnists who noted Lewis' gigantic mistakes of late, i.e., overpaying for Countrywide, then foolishly buying a dying Merrill Lynch, all the while contending that both were fabulous deals for BofA.
As the details of Lewis' intimidation by Bernanke and Paulson have come forth, one wonders why any shareholder would trust Lewis to run anything material anymore. He's clearly a seat-warmer without principles or much common sense.
But, faced with three examples of clear cut, anti-shareholder behavior, the morons who still hold BofA stock seem unable to get rid of him.
How is this possible? Is this appropriate 'corporate governance?'
Jason Zwieg, a columnist in the Wall Street Journal, wrote a piece a few months ago castigating those who, like me, take the position that one should simply sell the shares of companies whose behavior varies from what one would desire.
Is there any clearer case today of a company run ineptly by a clueless CEO? One who has now publicly admitted being guilty of Sarbanes-Oxley felonies?
But they still can't get rid of him. Some say that Lewis only has 'one more chance' left.
My God! I wish the rest of us had so many chances to screw up at several million dollars per year of total compensation.
My point is, Zwieg is wrong, and I am right. For the average shareholder, rather than, say, Carl Icahn or Eddie Lampert, there's just no leverage or percentage in holding the equity of a poorly-run company. Hoping that, over time, you and a few thousand other, unknown shareholders will somehow, magically, nominate another candidate to be CEO, or replace all of the board members, who will then fire the sitting CEO, only happens in a movie. If then.
In a fair world, Lewis would be gone. But the board is in his pocket. That they are insensitive to shareholder wishes is clear by their support for Lewis as Chairman, while the owners whom they are supposed to represent voted to split the job from CEO.
You just can't, in my opinion, get a clearer example of a company in which the CEO should be fired, and then probably charged with a felony, yet he continues to hold his job.
That's what you get for believing in the fairy tale of 'corporate governance.'
Here's the reality- you don't like what's going on at a company? Sell the shares. Period.
Wednesday, April 29, 2009
GM's Last Gasps
Yesterday's Wall Street Journal story concerning GM's last-ditch maneuvering highlighted the fact that the firm's latest pre-Chapter 11 offer would give all taxpayers, via the federal government, half-ownership in the failed auto-maker, while it's main union, the UAW, would receive 39% ownership in payment for some of its claims.
That leaves a little over 20%, at best, for bondholders.
But to me, it seems fitting that the two major owners will be those who are most responsible for the way this melodrama is ending.
Washington, under the Bush administration, could have easily denied GM any loans, directing it to seek Chapter 11 protection for reorganizing itself. But it did not do so. By beginning the drip feed of 'loans,' the last administration virtually guaranteed the current outcome.
The UAW, through years of hanging tough on its above-market compensation packages, justly now may own the mess it helped create. Things sure will be different now, eh?
Who will the union blame a year from now, when GM is still ailing and selling few of its largely unwanted vehicles?
Of course, the darker interpretation to all of this is that the government will infect GM like a virus in a host, commanding it to pump out millions of "green cars" and such.
More power to them! Good thing no ordinary shareholders will be around to suffer the financial impact of that mistake.
Perhaps I've become dulled and insensitive to any more of this long-running debacle. I didn't even write an 'I told you so' post when, as I predicted, Wagoner was booted as CEO, fulfilling my prophesy of several years ago that there would be a failed company and/or CEO in Detroit.
I'm so sick of the GM mess that I don't even care what happens to the remaining bondholders. Anyone smart would have dumped GM debt years ago. At this point, in my opinion, let the festering remains that is GM fall to the UAW and the federal government.
Short of bondholders forcing Henderson into Chapter 11, to get radical surgery performed on the company, I don't think it will matter much what shape any negotiated outcome, short of a bankruptcy filing, ultimately takes.
That leaves a little over 20%, at best, for bondholders.
But to me, it seems fitting that the two major owners will be those who are most responsible for the way this melodrama is ending.
Washington, under the Bush administration, could have easily denied GM any loans, directing it to seek Chapter 11 protection for reorganizing itself. But it did not do so. By beginning the drip feed of 'loans,' the last administration virtually guaranteed the current outcome.
The UAW, through years of hanging tough on its above-market compensation packages, justly now may own the mess it helped create. Things sure will be different now, eh?
Who will the union blame a year from now, when GM is still ailing and selling few of its largely unwanted vehicles?
Of course, the darker interpretation to all of this is that the government will infect GM like a virus in a host, commanding it to pump out millions of "green cars" and such.
More power to them! Good thing no ordinary shareholders will be around to suffer the financial impact of that mistake.
Perhaps I've become dulled and insensitive to any more of this long-running debacle. I didn't even write an 'I told you so' post when, as I predicted, Wagoner was booted as CEO, fulfilling my prophesy of several years ago that there would be a failed company and/or CEO in Detroit.
I'm so sick of the GM mess that I don't even care what happens to the remaining bondholders. Anyone smart would have dumped GM debt years ago. At this point, in my opinion, let the festering remains that is GM fall to the UAW and the federal government.
Short of bondholders forcing Henderson into Chapter 11, to get radical surgery performed on the company, I don't think it will matter much what shape any negotiated outcome, short of a bankruptcy filing, ultimately takes.
Tuesday, April 28, 2009
Robert Merton's Academic View of Risk & Financial Innovation
Last week, in the April 20th Wall Street Journal, columnist L. Gordon Crovitz wrote a piece focusing on Nobel Laureate and failed hedge fund co-founder Robert Merton, entitled "In Finance, Too, Learning Entails Risk."
After beginning his editorial by describing early trials and errors in elevator development, Crovitz then wrote,
"Our era may be losing the tolerance for the trial and error needed to make innovations successful. Consider the financial engineers whose mistakes led to today's financially led recession. They thought they were creating a more stable economy by applying mathematical models to markets, using new technologies of computing power and global trading. Even having lost fortunes, today they and their financial institutions are pariahs, subject to media frenzy and government regulation.
The innovators who thought up the elevator, the cotton gin and space travel didn't intend to kill or injure people as they perfected the technologies. Likewise, today's financial engineers never imagined their miscalculations could result in a global recession.
Perhaps the best person to illustrate this point is Robert Merton, the Harvard economist who won the Nobel Prize for his work that led to the options and futures markets of the 1970s that revolutionized financial markets. He was also a founder of Long-Term Capital Management, the hedge fund that became the poster child for mistakes in financial engineering in the 1990s."
Crovitz usually writes a pretty good column. This one, however, is way off base. He mistakenly compares and equates modern financial instrument innovation with physical product innovation. Years ago, financial innovation may have been closer to the invention of physical products, but not anymore. If for no other reason, any developments post-dating the early 1970s, when financial service firms, including investment banks, began to go public, were rewarded in a radically new way. Rather than becoming a partner, or enjoying increased value as part of the partnership, many investment banking 'innovations' resulted in cash or other near-term, non-partnership compensation.
Thus, longer term considerations of how the innovations actually benefited customers was, frankly, second to how it profited the investment banks.
John Whitehead, one of the last of the old-school heads of the privately-held Goldman Sachs, publicly decried the firm's move into proprietary trading on the other side of its clients. He believed that an investment firm either served clients, or its own interests, but not both directly and simultaneously.
I believe Merton and, by his choice of topic, Crovitz, mistakenly believe that today's financial products innovators have some sort of systemic good as their goal, rather than their own short-term wealth.
Crovitz later quotes Merton as saying,
"In his lecture, Mr. Merton said this crisis was not a failure like the space shuttle Challenger disaster that could be blamed on the single factor of a faulty O-ring. Instead, many factors we're just beginning to understand, sparked by the housing bubble, led to the collapse. Risk grew across interconnected financial institutions as they bundled together assets such as mortgage-backed securities that collapsed together when volatility exceeded what the history-based models considered remotely possible. Government guarantees of deposits held by these banks, he noted, means "the government is writing a put option on a put option," making the plunge deeper.
Our fundamental problem is what Mr. Merton called the structural tension "between financial innovation and crisis." We know a lot about risk, information and probabilities, but not enough. "We've created instruments for manipulating financial risk without a thorough understanding of the underlying engineering." He compared innovations in finance to a new fast train running along tracks not yet redesigned for the speed. The value of the innovation, once perfected, outweighs the problems in the meantime."
If you think, like Merton apparently does, that some financial innovators are now going 'back to the lab' to perfect their instruments, think again. There's little percentage in that. Especially now. This is clearly an ivory-tower academic's view of the rough-and-tumble reality of today's financial markets.
Crovitz ends his editorial by observing,
"In a paper for the scientific journal of the Royal Society back in 1994, Mr. Merton warned that "any virtue can become a vice if taken to extreme, and just so with the application of mathematical models in finance practice." We know even better now that some risks can be calculated and thus reduced, while some unknowns cannot be turned into probabilities. "The mathematics of the models are precise, but the models are not, being only approximations to the complex, real world."
The measure of innovators is not in the mistakes they make, but in the lessons they learn. We now know that our complex markets need better models, which should include more humility, acknowledging that some risks are still too uncertain to measure and should be avoided. Instead of vilifying modern-day elevator engineers, we should challenge financial engineers to find fixes for what's broken."
It doesn't take a Nobel Laureate to realize that financially-engineered structured financial instruments, risk modeling, etc., are imprecise. Nor that some risks should simply be avoided.
Case in point. Years ago, circa 1995-6, when I was Oliver, Wyman & Co.'s (now the financial consulting component of Mercer Management Consulting) first Director of Research, consumer credit risk management was all the rage. The small team of managers working at Advanta, near Philadelphia, was hauling in large fees for equipping the standalone credit-card issuer with the most advanced tools for measuring and managing credit risk.
Eventually, the team was bought by Advanta. It was well-publicized, after the messy departure by several senior managers on the Advanta team, that they promptly went out and bought Dodge Vipers, a very expensive muscle car.
About a year after the team formally joined Advanta, the firm imploded from credit losses.
Oops!
My point is that some of the premier risk measurers and managers, over a decade ago, managed to destroy one of the then-premier US credit card issuers with what they didn't understand. This is a recurring theme in the post-1970 US financial services world.
Publicly-held financial service firms lay off risk to unknowing shareholders, pay themselves large, near-term bonuses, in cash or options, assuming the various sophisticated investors in the markets know what they are buying. There's no assumption by anyone of some sort of systemic 'good.' About as good as it gets is to strive for counterparty non-failure. But without losers, there can't be winners in the business of trading financial instruments.
Merton is, unfortunately, rather naive. Apparently the fate of the hedge fund he co-founded, LTCM, taught him little. And I guess Crovitz, too, has drunk the Kool-Aid, and believes that, somewhere, there is a financial instruments innovator with a heart of gold, in quest of the perfect, value-adding product for financial markets.
After beginning his editorial by describing early trials and errors in elevator development, Crovitz then wrote,
"Our era may be losing the tolerance for the trial and error needed to make innovations successful. Consider the financial engineers whose mistakes led to today's financially led recession. They thought they were creating a more stable economy by applying mathematical models to markets, using new technologies of computing power and global trading. Even having lost fortunes, today they and their financial institutions are pariahs, subject to media frenzy and government regulation.
The innovators who thought up the elevator, the cotton gin and space travel didn't intend to kill or injure people as they perfected the technologies. Likewise, today's financial engineers never imagined their miscalculations could result in a global recession.
Perhaps the best person to illustrate this point is Robert Merton, the Harvard economist who won the Nobel Prize for his work that led to the options and futures markets of the 1970s that revolutionized financial markets. He was also a founder of Long-Term Capital Management, the hedge fund that became the poster child for mistakes in financial engineering in the 1990s."
Crovitz usually writes a pretty good column. This one, however, is way off base. He mistakenly compares and equates modern financial instrument innovation with physical product innovation. Years ago, financial innovation may have been closer to the invention of physical products, but not anymore. If for no other reason, any developments post-dating the early 1970s, when financial service firms, including investment banks, began to go public, were rewarded in a radically new way. Rather than becoming a partner, or enjoying increased value as part of the partnership, many investment banking 'innovations' resulted in cash or other near-term, non-partnership compensation.
Thus, longer term considerations of how the innovations actually benefited customers was, frankly, second to how it profited the investment banks.
John Whitehead, one of the last of the old-school heads of the privately-held Goldman Sachs, publicly decried the firm's move into proprietary trading on the other side of its clients. He believed that an investment firm either served clients, or its own interests, but not both directly and simultaneously.
I believe Merton and, by his choice of topic, Crovitz, mistakenly believe that today's financial products innovators have some sort of systemic good as their goal, rather than their own short-term wealth.
Crovitz later quotes Merton as saying,
"In his lecture, Mr. Merton said this crisis was not a failure like the space shuttle Challenger disaster that could be blamed on the single factor of a faulty O-ring. Instead, many factors we're just beginning to understand, sparked by the housing bubble, led to the collapse. Risk grew across interconnected financial institutions as they bundled together assets such as mortgage-backed securities that collapsed together when volatility exceeded what the history-based models considered remotely possible. Government guarantees of deposits held by these banks, he noted, means "the government is writing a put option on a put option," making the plunge deeper.
Our fundamental problem is what Mr. Merton called the structural tension "between financial innovation and crisis." We know a lot about risk, information and probabilities, but not enough. "We've created instruments for manipulating financial risk without a thorough understanding of the underlying engineering." He compared innovations in finance to a new fast train running along tracks not yet redesigned for the speed. The value of the innovation, once perfected, outweighs the problems in the meantime."
If you think, like Merton apparently does, that some financial innovators are now going 'back to the lab' to perfect their instruments, think again. There's little percentage in that. Especially now. This is clearly an ivory-tower academic's view of the rough-and-tumble reality of today's financial markets.
Crovitz ends his editorial by observing,
"In a paper for the scientific journal of the Royal Society back in 1994, Mr. Merton warned that "any virtue can become a vice if taken to extreme, and just so with the application of mathematical models in finance practice." We know even better now that some risks can be calculated and thus reduced, while some unknowns cannot be turned into probabilities. "The mathematics of the models are precise, but the models are not, being only approximations to the complex, real world."
The measure of innovators is not in the mistakes they make, but in the lessons they learn. We now know that our complex markets need better models, which should include more humility, acknowledging that some risks are still too uncertain to measure and should be avoided. Instead of vilifying modern-day elevator engineers, we should challenge financial engineers to find fixes for what's broken."
It doesn't take a Nobel Laureate to realize that financially-engineered structured financial instruments, risk modeling, etc., are imprecise. Nor that some risks should simply be avoided.
Case in point. Years ago, circa 1995-6, when I was Oliver, Wyman & Co.'s (now the financial consulting component of Mercer Management Consulting) first Director of Research, consumer credit risk management was all the rage. The small team of managers working at Advanta, near Philadelphia, was hauling in large fees for equipping the standalone credit-card issuer with the most advanced tools for measuring and managing credit risk.
Eventually, the team was bought by Advanta. It was well-publicized, after the messy departure by several senior managers on the Advanta team, that they promptly went out and bought Dodge Vipers, a very expensive muscle car.
About a year after the team formally joined Advanta, the firm imploded from credit losses.
Oops!
My point is that some of the premier risk measurers and managers, over a decade ago, managed to destroy one of the then-premier US credit card issuers with what they didn't understand. This is a recurring theme in the post-1970 US financial services world.
Publicly-held financial service firms lay off risk to unknowing shareholders, pay themselves large, near-term bonuses, in cash or options, assuming the various sophisticated investors in the markets know what they are buying. There's no assumption by anyone of some sort of systemic 'good.' About as good as it gets is to strive for counterparty non-failure. But without losers, there can't be winners in the business of trading financial instruments.
Merton is, unfortunately, rather naive. Apparently the fate of the hedge fund he co-founded, LTCM, taught him little. And I guess Crovitz, too, has drunk the Kool-Aid, and believes that, somewhere, there is a financial instruments innovator with a heart of gold, in quest of the perfect, value-adding product for financial markets.
Monday, April 27, 2009
Bob Reich's Idiotic Ideas On 'Corporate Governance' & Bankruptcy
Robert Reich, former Clinton Secretary of Labor, former Harvard economics professor, current UCLA public policy professor, wrote a preposterous editorial in this past weekend's edition of the Wall Street Journal entitled, "We Need Public Directors on TARP Bank Boards."
If I recall correctly, the one thing then-Treasury Secretary Hank Paulson promised about institutions which received TARP money was that government would never exercise a role in management or attempting to influence management. The bailout funds were to be a temporary capital loan of passive nature.
Now, we have Reich clamoring for not just "public directors," but,
"Those public directors should be appointed by the president. In exercising their oversight function, they should seek guidance from the president and his top economic officials."
Government policy doesn't get much more fickle than this, does it?
But Reich buried in his editorial an equally-disturbing viewpoint. He wrote,
"Perhaps government had no business meddling in the private sector to begin with. AIG, the big banks and the auto companies should have been forced to work out their problems with their creditors, or else be put into temporary receivership until their profitable units or nonperforming loans could be sold off. Perhaps any company that's judged too big to fail is too big, period. Antitrust laws should have been used to break these giants up before they got so big.
These arguments may be relevant to the recent past and possibly to the future, but they're beside the point right now."
I find it very troubling that a public policy professor at a major US university feels that longstanding, effective institutions and processes for the handling of failed business enterprises were just one option, and not necessarily the best one, for firms like AIG, GM and Citigroup.
Reich allows that we have antitrust laws to prevent problems such as banks that are 'too big to fail,' but he conveniently omits the little detail that his Clinton cabinet buddy, Bob Rubin, was the one who let that happen.
This is precisely the sort of capriciousness that sends investors scurrying to the sidelines when it comes to long term capital commitment to the US economy.
According to Reich, it's a matter of debate whether financial services or auto makers who are technically insolvent, or soon will be, should be directed to our society's chosen paths for this- Chapter 11 bankruptcy filing, in order to operate under court protection while liabilities are sorted out and operations are either reorganized and released to operate again, sold, or closed.
But it's not a matter of debate that, having inserted itself into the workings of private enterprises, government should now also demand board seats, held by activists, voting the wishes of the country's president.
This takes fascism the next logical step toward explicit socialism, doesn't it? And Reich thinks it's just good sense and government.
If I recall correctly, the one thing then-Treasury Secretary Hank Paulson promised about institutions which received TARP money was that government would never exercise a role in management or attempting to influence management. The bailout funds were to be a temporary capital loan of passive nature.
Now, we have Reich clamoring for not just "public directors," but,
"Those public directors should be appointed by the president. In exercising their oversight function, they should seek guidance from the president and his top economic officials."
Government policy doesn't get much more fickle than this, does it?
But Reich buried in his editorial an equally-disturbing viewpoint. He wrote,
"Perhaps government had no business meddling in the private sector to begin with. AIG, the big banks and the auto companies should have been forced to work out their problems with their creditors, or else be put into temporary receivership until their profitable units or nonperforming loans could be sold off. Perhaps any company that's judged too big to fail is too big, period. Antitrust laws should have been used to break these giants up before they got so big.
These arguments may be relevant to the recent past and possibly to the future, but they're beside the point right now."
I find it very troubling that a public policy professor at a major US university feels that longstanding, effective institutions and processes for the handling of failed business enterprises were just one option, and not necessarily the best one, for firms like AIG, GM and Citigroup.
Reich allows that we have antitrust laws to prevent problems such as banks that are 'too big to fail,' but he conveniently omits the little detail that his Clinton cabinet buddy, Bob Rubin, was the one who let that happen.
This is precisely the sort of capriciousness that sends investors scurrying to the sidelines when it comes to long term capital commitment to the US economy.
According to Reich, it's a matter of debate whether financial services or auto makers who are technically insolvent, or soon will be, should be directed to our society's chosen paths for this- Chapter 11 bankruptcy filing, in order to operate under court protection while liabilities are sorted out and operations are either reorganized and released to operate again, sold, or closed.
But it's not a matter of debate that, having inserted itself into the workings of private enterprises, government should now also demand board seats, held by activists, voting the wishes of the country's president.
This takes fascism the next logical step toward explicit socialism, doesn't it? And Reich thinks it's just good sense and government.
Sunday, April 26, 2009
The Myth of Lax Regulation
Friday's Wall Street Journal contained an editorial by George Akerlof and Robert Shiller entitled, "Good Government and Animal Spirits."
Their editorial essentially argued that effective capitalism requires rules and regulations. From their tone, one would get the sense that the authors believe this is not universally believed.
They contend, in the fourth paragraph of their piece,
"The debate about the proper role of government in the economy goes far back in American history. At the beginning of the 19th century, the Democrats were fiercely opposed to government intervention, while the Whigs thought that the government should provide the backdrop for a healthy capitalism.
Controversy about the proper relationship of the government and the economy has continued since then."
Fair enough, and correct. But then the authors go on to allege, concerning the recent financial sector excesses,
"The regulatory failure led to a profound systemic instability in our economy, which accounts for the severity of our economic crisis. Devising new regulatory structures that will allow financial innovation to proceed and yet prevent new such systemic problems is the major challenge to our creative capitalism today.
Public antipathy toward regulation supplied the underlying reason for this failure The U.S. was deep into a new view of capitalism Americans believed in a no-holds barred interpretation of the game.
....and American financial regulation hasn't had an overhaul in 70 years."
On this, I disagree totally with Messrs. Ackerlof and Shiller.
If there was regulatory failure, and there was, it's not necessarily true that the solution is new regulation or structures. Further, the public wasn't antipathetic to regulation- Congress and the various agencies were. Finally, I'd hardly call Sarbanes-Oxley descriptive of 'no-holds barred' capitalism, would you?
Between lax Congressional oversight of mortgage giants Freddie Mac and Fannie Mae, the senseless redaction of Glass-Steagal by Clinton Treasury Secretary Bob Rubin, at Sandy Weill's behest, and a failure of the Fed, FDIC and OCC to properly examine, supervise and halt improper mortgage lending practices, we can safely say that the problem isn't a lack of regulations. It's a failure of people in the system to do their job.
Rather than setting to work to design new regulations, as Ackerlof and Shiller recommend, I would suggest that the first order of business is to identify the people and processes which existed to regulate the financial excesses of the past few years, but failed to do so, and consider how better to assure that these failures will not recur.
Does anyone seriously believe that simply passing new laws will result in any better outcomes than occurred under old, largely adequate laws, which were improperly administered and enforced?
Their editorial essentially argued that effective capitalism requires rules and regulations. From their tone, one would get the sense that the authors believe this is not universally believed.
They contend, in the fourth paragraph of their piece,
"The debate about the proper role of government in the economy goes far back in American history. At the beginning of the 19th century, the Democrats were fiercely opposed to government intervention, while the Whigs thought that the government should provide the backdrop for a healthy capitalism.
Controversy about the proper relationship of the government and the economy has continued since then."
Fair enough, and correct. But then the authors go on to allege, concerning the recent financial sector excesses,
"The regulatory failure led to a profound systemic instability in our economy, which accounts for the severity of our economic crisis. Devising new regulatory structures that will allow financial innovation to proceed and yet prevent new such systemic problems is the major challenge to our creative capitalism today.
Public antipathy toward regulation supplied the underlying reason for this failure The U.S. was deep into a new view of capitalism Americans believed in a no-holds barred interpretation of the game.
....and American financial regulation hasn't had an overhaul in 70 years."
On this, I disagree totally with Messrs. Ackerlof and Shiller.
If there was regulatory failure, and there was, it's not necessarily true that the solution is new regulation or structures. Further, the public wasn't antipathetic to regulation- Congress and the various agencies were. Finally, I'd hardly call Sarbanes-Oxley descriptive of 'no-holds barred' capitalism, would you?
Between lax Congressional oversight of mortgage giants Freddie Mac and Fannie Mae, the senseless redaction of Glass-Steagal by Clinton Treasury Secretary Bob Rubin, at Sandy Weill's behest, and a failure of the Fed, FDIC and OCC to properly examine, supervise and halt improper mortgage lending practices, we can safely say that the problem isn't a lack of regulations. It's a failure of people in the system to do their job.
Rather than setting to work to design new regulations, as Ackerlof and Shiller recommend, I would suggest that the first order of business is to identify the people and processes which existed to regulate the financial excesses of the past few years, but failed to do so, and consider how better to assure that these failures will not recur.
Does anyone seriously believe that simply passing new laws will result in any better outcomes than occurred under old, largely adequate laws, which were improperly administered and enforced?
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