Regarding Amazon's Fire Tablet- And Apple

The big news in online business last week was Amazon's unveiling of its Fire tablet. By now, you've doubtless read plenty of reviews of the product, comparisons with Apple's iPad, heard and seen countless pundits pontificate on the new entry.

Here's my take.

First, as I've always contended, and several pundits reinforced, Amazon will always trail Apple in this product space, by virtue of its entirely outsourcing the design and manufacture. For example, from what I've read, the Fire has no camera and lacks some connectivity options.

Second, the real and most important aspect of the Fire is its $200 price point. While it technically exploits a market segment which Apple doesn't care to currently address, it does begin to exert more downward pressure on pricing and margins in the product/market. In fact, the Wall Street Journal's report on the Fire alleged that Amazon is not only pricing to profit on the downloadable content, but that the $200 list price doesn't even cover the Fire's production costs.

Thus, as I told a friend over lunch last Friday, Amazon is embarking down a very dangerous road- using a sprawling, integrated business model including its entire online general store to subsidize the cost of its latest deliverable tablet. Sooner or later, some aspect of Amazon's business will probably begin to experience pricing problems as the transfer pricing and allocation of overheads begin to distort the prices and margins of products which effectively fund the Fire.

Mixed into that mess is Amazon's tying the Fire to an automatic Premium subscription. So various shipping and other discounts on content are included with the tablet, but it's unclear that buyers of the Fire actually want, prefer or will use much of that content. Or spend more money to buy or rent what isn't free with the Fire.

In contrast, Apple's business model seems simpler and cleaner.

As I also explained to my friend last Friday, this development is why Apple won't be in my equity portfolios forever. Eventually, one or more of three forces tend to drive equities from the buy list: investor expectations adjust to the firm's actual performance, resulting in the equity's price no longer rises so smartly; competitive forces attenuate the firm's revenue and profit growth, and/or; regulatory action puts a stop to the firm's previously-unstoppable growth.

I've seen a succession of former portfolio holdings fall victim to one or more of these forces over time: Kohls, Dell, Microsoft, Home Depot and Wal-Mart.

Now Apple and Amazon seem to be heading in that direction. Both have been recent portfolio members. But now their evolving struggle involving tablets and online-delivered content- music, video and books- is likely to limit margins and pricing power for both.

Thus, Amazon's Fire has accelerated the move of the tablets and their content toward commoditization. Good for consumers, not so great for investors in the providers of these services.
Interestingly, in his weekend Wall Street Journal column, Holman Jenkins, Jr. contended that the real reason for the demise of technology firms Microsoft and HP has been that their product lines are devoid of the social media content which Apple, Amazon, Google, and Facebook have so zealously and successfully pursued. Including, for the first three, developing special-application computers, a/k/a tablets and smartphones, which undercut general-purpose computers and emphasize media consumption.

Certainly, that's one view. But personal computers became commoditized some years ago- well before the rise of Facebook, social media and the general accessibility of media content via cheap, ubiquitous wireless connections.

Still, as I contended in today's companion post, competitive forces tend to affect every product/market, even if at different speeds.

Competition Eventually Visits Every Product/Market

I wrote a post last year involving History Channel programs featuring a pawn broker and two Iowa-based "pickers."


Both History Channel programs have already spawned competitors.

The pickers now have competition on Lifetime. The new series stars two pretty young Southern sisters, Tanya McQueen and Tracy Hutson, who call themselves Picker Sisters. They differentiate themselves by focusing on the storefront gallery they run, and how they envision transforming their derelict picks into trendy furnishings. Their refurbishment guy is often included to discuss how the piece will be treated to arrive at the sisters' desired look.

Unlike the Iowa pickers, Frank and Mike, who seem to mostly just recycle their picks as-is, the sisters' and their program seeks to engage buyers' and viewers' sense of style, fashion and interior decorating.


Pawn Stars has provoked a low-rent version of itself on another network. The name escapes me, but it's pretty much a direct rip-off, but with far less humor, drama and educational value.

But it just goes to show that, even with what you'd think would be fairly innocuous products, like quirky cable television special-interest programs, knockoffs arrive with surprising speed.

Pawn Stars, American Pickers & Efficient Markets

Back in May of this year, I wrote a post concerning a popular History Channel program, Pawn Stars. I find the program to be a great exposition of business model implemented by owners who grasp the model and typically stick to it.

Expanding on the historical theme of vintage items, the History Channel added a program called American Pickers. The two stars of that program are Iowa-based friends of middle-age who drive across America seeking vintage collectibles which they 'pick,' to resell through their shop.

Whereas the pawn brokers are essentially deal-takers, due to the nature of their walk-in business, the pickers are deal-makers who typically offer a price, and certainly negotiate.

Having watched a fair number of episodes in both series, I've come to wonder how long the American Pickers can sustain their program and their business model. Here's why.

The pawn brokers have their customers freely offer goods, usually because they want money for the items, and either don't want to, or can't pursue a narrower, more specialized market segment in which to maximize the value of their wares. Time and again, people bring valuable, vintage firearms or curios, only to be talked into values which are half of what Rick and his crew allege they will get for the item, after it ties up their working capital for months.

Every time I hear that line, I think to myself, if it were me, I'd be heading over to a specialty dealer, if I hadn't done that in the first place. Whenever the weapons experts makes an appearance to authentic some rifle, pistol or knife, I wonder why the seller hadn't just gone to directly that expert's shop? Well, obviously, those who do aren't on Pawn Stars. But it's surprising to me how much money is probably left on the table by naive sellers.

Still, everybody understands that the pawn brokers want a 50% margin, although they might not understand the pawn shop's ultimate sale price, of which they may receive half, will be lower than more specialized buyers.

The American Pickers, however, seem to be playing a more dangerous game. They cajole and push old collectors into parting with items on a largely unsolicited basis. Sometimes they are invited to visit and buy items, but, typically, they are pressing themselves on people who've collected massive amounts of what most people would call junk, begging to buy some of the items.

Quite often, they will drive a good bargain, as illustrated by the end-of-show tallies of the prices they paid for various antiques, and what they believe to be the market price they can realize. Sometimes they have markups of as much as 200%!

Now, if you are a collector who's been visited by the American Pickers, won't you want to watch the program to see yourself? Then, won't you become a little irritated when you see the pickers post so many items with margins in excess of 50%?

How likely is it that the pickers from Iowa can make it through three seasons without either losing their sources, or watching their margins shrink below 50%?

Would you sit still for these guys to manhandle you over various vintage items after you saw them publicly exclaim how they bought something really valuable off of you at some embarrassingly low price?

I think Pawn Stars is pretty entertaining and, due to the nature of its customer base, has at least a few more seasons to run. Its History Channel derivative series, American Restoration, starring the guy who does most of their vintage vending machine and similar merchandise restoration, will also likely have a non-toxic effect on his own business model. That guy, again, has a willing, walk-in clientele eager to realize value.

But the efficient markets being openly created and publicised by the pickers strike me as likely to undermine their own business model, and soon.

One only has to look to the markets for financial instruments to see how a little pricing information, made public, tends to rapidly collapse margins, as well as spawn competitors. All of which tends to ruin what was once a quiet, dark, smaller but more lucrative market in whatever items now become so publicly priced.

It's A Little Late For That Now.....

Tenneco's CEO, Gregg Sherrill, wrote an editorial in yesterday's Wall Street Journal entitled Speaking Up for American Capitalism.

Nice, Gregg, but you're about 18 months too late, and by your own admission.

Consider this passage from Sherrill's piece,

"In one such poll, as the Economist reports in a feature titled "The 70-30 Nation," the Pew Research Center asked respondents whether they were better off in a free market rather than a socialist economy "even though there may be severe ups and downs from time to time." Seventy percent said yes.

So why are the 30% in charge of the 70%? According to American Enterprise Institute President Arthur Brooks, the "game changer" was the economic crisis. It was the financial crisis of 2008-2009, which was used as a tool to attack the free enterprise system..."

Mr. Sherrill neglects to mention what Mr. Brooks also omitted in the quoted passage, i.e., that American investment and commercial bankers threw themselves on the federal government's and the Fed's mercies to save their institutions from ruin.

As I wrote in a prior post, both business and government leaders failed the American people in this regard. CEOs never should have asked for government help, and George W. Bush should have steadfastly refused said requests.

Instead, Americans witnessed overpaid CEOs of badly-run financial institutions beg to be individually rescued with taxpayer funds.

Never mind that failed institutions would not have destroyed either our economy, nor our financial system. With some alacrity, the attractive portions of said institutions would have found backers or buyers in short order, while the money-losing businesses and their inept management would have been closed.

That's how free markets are supposed to work. Mr. Sherrill doesn't acknowledge that some American businessmen chose to succumb to socialism, rather than suffer the consequences of their mistakes and fall on their financial swords.

Thus, I found Sherrill's entire editorial to be largely empty words and sanctimonious preaching. And very late.

His protestations would have been appropriate during the financial crisis, not after. The time to remind people of the realities of capitalism was at its worst, so that there wouldn't have been so much aberrant government and business behavior.

Not now, when the damage has been done.

Americans won't easily root out and destroy the recent socialistic changes to our economic system until they are confident that the resulting businessmen will live with the consequences of their decisions, and not go running to the federal government for rescues.

The Flaw In Federal Vehicle Mileage Regulations

There's been quite a bit of media buzz regarding the new, accelerated vehicle mileage and emissions requirements announced unilaterally by the administration this week.

Even last night, on Bill O'Reilly's Fox News program, he argued for the new regulations, saying they would help decrease the country's dependence on foreign oil.

This is a good example of what a head fake this autocratic directive really is. Holman Jenkins, Jr., would agree, based upon this morning's topical Wall Street Journal editorial.

What O'Reilly failed to grasp, despite a clear explanation from one of his guests, Monica Crowley, is that mandating fuel efficiency revokes consumers' rights to choose what they want among transportation tradeoffs. Jenkins has written of this in prior editorials.

One critical piece of evidence that fuel efficiency supporters either dismiss, or fail to understand, is that, despite over 30 years of CAFE standards, US gasoline usage, on a per/driver basis, has not fallen.

Greater fuel economy simply results in people using more fuel! Wow, imagine that!

Further, as Jenkins has tirelessly noted, Americans don't want the kind of cars that meet the most extreme fuel efficiency standards. That's one reason why Chrysler and GM have gone bankrupt. They've been forced to produce and sell unprofitable small, fuel-efficient cars, to meet federal CAFE standards.

Linking those standards to emissions standards won't do much, either. Does anyone think driving a car so small, light and unsafe that you wear, more than drive it, is really going to offset China's and India's overwhelming expansion of coal- and oil-fired power generation plants in the next decade?

Americans innately understand this, and are unlikely to go meekly into the future in Euro-style mini-cars. Especially when their federal government officials are seen whizzing around Washington in large, inefficient vehicles.

How much simpler it would be for the government to simply set a variable tax on gasoline, equivalent to making the pump price, say, $4/gallon, then use the revenues to fund alternative transportation fuels with a steadily declining scale of subsidies, and an increasing required efficiency over time. Perhaps even fund a 'prize' for the first viable, scalable alternative technology to meet a set of practical requirements.

With a known, higher price of gasoline, consumers will then choose according to their preferences. Those wishing to save money might buy smaller, more fuel-efficient cars. Or they may keep to larger vehicles, but drive less.

At the same time, the remaining, non-government-owned auto makers would obviously compete to offer more fuel-efficient vehicles according to their reading of consumer preferences. Market-driven innovation is always going to be more effective than government-mandated regulations, if only because fewer of our brightest minds work in government bureaucracies than work in the private sector.

Jenkins' conclusion in his column today is correct. The administration can regulate all it wants, but US consumer behavior is going to find its way around regulations and eventually have what it demands. Either economically or, if necessary, through political/governmental change.

The Market Solves While Congress Debates A Bad Bill

As I wrote yesterday, in this post, it seems that several steps to rationalizing the US financial services sector are already underway, with or without Congressional action.

For example, Glass-Steagall has, in a sense, been re-instituted in a de facto manner. No large, publicly-held investment bank exists anymore, nor will one likely again for at least a few decades.

The integrated commercial banks which absorbed Bears Stearns, Merrill Lynch and parts of Lehman are unlikely to ever operate those remnants with the leverage or innovation- for better or worse- as they were in the past.

FDIC and SIPC insurance provides some measure of safety for depositors in those institutions that were absent before the original Glass-Steagall bill of the 1930s.

The emergence of three gigantic financial 'utilities'- Chase, Citigroup and BofA- marks the evolution of financial services, after a period of expansive innovation, to a quasi-governmental oligopoly.

John Bogle, the farsighted founder of the Vanguard Group, has stated for years that, as a sector, financial services cannot add value, per se, and certainly not at a rate greater than the long term growth of the economy. He's right.

Thus, as I wrote here, after a nearly 50-year period in which private investment banks sold themselves at peak prices to the public, the sector had taken on too much risk and caused so much counterparty risk as to result in the seizure of credit flows among large financial service players.

Excess capacity has been removed. Excessively risky activities such as securitizing mortgages and selling credit default swaps have been curtailed.

And all this before any Congressional action.

At this point, a very minimal solution from Congress would provide the needed respite for publicly-held banks. The Republican House idea of using Federally-sold credit default insurance for structured finance instruments, backed by mortgages of dubious, or unknown quality, would effectively solve the counterparty risk debacle now affecting financial markets.

I don't know why Paulson and his team either failed to conceive of that brilliant idea, or dismissed it. In no way is it necessary for the Federal government to purchase structured finance paper in the amount of some $700B. All that is required is to cause that paper to be valued on bank balance sheets at their longer term, economic, 'hold to maturity' value, rather than the near-zero value they have in current, non-actively traded markets.

Perhaps the 107 point drop in the S&P reflects the market's concern over the basic lack of understanding of this issue in Washington. Because, as Ben Graham noted some 50 years ago, it's unlikely that the real, tangible value of US business assets in the S&P500 fell by over a trillion dollars yesterday.

The Most Outrageous Myth...

Yesterday I wrote this post about what I consider to be some of the significant myths surrounding the current US financial services sector debacle.

Since I published that post, I heard one more myth I feel it is important to expose and refute. The exact language was uttered by the Democratic junior windbag (Senator) from Ohio.

Herewith is my additional myth...

Myth #6: "Wall Street" let us down and broke the public trust. Doesn't "Wall Street" owe the American people an apology (and that pretty much IS a direct quote from this windbag) for creating this mess by being greedy?"

No, it absolutely does not. The lesser-regulated, free-wheeling world of investment banking, hedge funds and private equity are all a recognized equivalent of the Wild West, financial style.

It's buyer beware, pure and simple. For every seller of a toxic, mortgage-backed CDO or dubious swap, there is a willing buyer who thinks s/he is getting the better of the exchange.

Nobody who owns a CDO or credit default swap was forced, at gunpoint, to buy it. Nobody kidnapped the buyer's children and held them for ransom until s/he bought the toxic financial stuff.

No, each party felt they were getting a better deal than their counterparty. There is nothing to apologize for. Shareholders knew, or should have known the type of firm in which they were investing. That goes for union pension funds, too.

Simply put, to the rube Ohio windbag, there IS no trust on Wall Street. That's why exchanges require collateral, as do swaps deals. You only have what you can grab from escrow.

This is how we have built our non-commercial bank financial sector. We want innovation and efficiency. To get that, we have to allow what is basically a free-for-all, free-fire zone of finance. Trading in instruments, securitizing, buying and selling said securitized fixed income instruments, is for professionals.

Any professional at an investment bank, asset management firm, investment committee of a trust or pension fund who says they got taken, didn't understand the risks, or otherwise ducks responsibility, is lying.

Where, I ask are all the originators or buyers of CDOs and swaps at Merrill Lynch, Lehman, Bear Stearns, Morgan Stanley, Goldman Sachs, Wachovia, Citigroup and BofA? At all the various asset management firms or hedge funds which bought the same instruments?

As I wrote here recently, your first mistake, Mr. Brown, is to associate the word "trust" with securities origination, sales or trading.

So, no, do not expect any apologies from anyone working on "Wall Street" for what has happened. They were all just doing their jobs. Some did them better, and some did them worse, than others. Mostly, a lot of risk managers did lousy jobs. Now, many of them don't have those jobs anymore.

As to the first causes of this mess, Windbag Brown, as I wrote here and here, look to Bill Clinton and Bob Rubin, and to your own House....errr....Senate......for demolishing Glass-Steagall and explicitly turning a blind eye to Fannie's and Freddie's practices and growth, while taking their campaign fund cash.

Will you or any of your colleagues apologize to the rest of us Americans for what you did in this mess, Senator Brown?

About Those GSEs: Fannie & Freddie

There's been quite a bit of ink spilled recently over Fannie Mae and Freddie Mac, the GSEs for mortgage finance. I haven't directly addressed their plight since I wrote this post a little over a month ago.

Now, with both of them near financial death, it's appropriate to revisit the topic. I wrote in that piece,

"My overall view of the situation is that it is a mistake to give more capital access to the same crew that got into this mess.

The implicit Federal Government guarantee clearly led to an imbalanced strategy over the last decade. Both institutions enriched employees, especially senior management, while failing to pay careful attention to the growing risks on their own balance sheets.

For this, we have Congress to thank, since it tends to view Fannie and Freddie as a large real estate finance cookie jar for their own pet agendas.

Of the choices which the Journal's article suggests, I think I would go with the Bush administration's desire to replace the current boards with members whose stated objective would be to clean up the balance sheets of the two firms and gradually shrink their role in the housing markets.

In this day and age, if a government-affiliated lender can't do a decent job securitizing housing loans, why allow it to exist?

We'll always get better performance from the private sector, assuming adequate regulation.

Now, we have the worst of both worlds- shareholders losing value due to entrenched, incompetent management, and the Federal Government picking up the tab.Shareholders chose to own the companies' stocks (I have owned equity in both firms in the past), so they deserve to lose their capital.

But to prevent a replay of this fiasco, I think it's time to remove the governmental connection to the two mortgage securitization firms as soon as it is possible."

Yesterday, over lunch, my partner and I discussed how the situation could best be resolved now. Everyone seems to fear a 'market collapse' in Fannie- and Freddie-issued mortgage-backed securities.

But as I see it, there are actually two distinct problems to be solved.

The first problem involves the treatment of outstanding GSE-issued mortgage-backed securities. These pretty much have to be backed by the US Treasury. To fail in this regard would be to, as my friend B, whose opinions I published in this post, cause large-scale losses in virtually every pension and retirement fund in the nation.

It's instructive to consider that what is involved here is only making up the losses from defaulted mortgages in these securities. If Fannie and Freddie were actually providing a value-adding service, including effective risk management, this wouldn't be a big problem. The expected value of losses from defaults would be low.

If, on the other hand, that expected value is high, then this alone argues for simply shutting the two GSEs down. Service their issued securities, but liquidate the companies.

The second problem is the role of the two GSEs in ongoing US housing finance. Here, articles discuss the new difficulties the two companies have in rolling over their longer-term debt.

To me, the solution here is simple, as I just stated two paragraphs above. Terminate the organizations.

Don't roll the debt over. Liquidate the companies' assets, and use remaining shareholder equity to satisfy any debts. Place what's left into receivership to work out any remaining unpaid creditors.

But, you ask, what about the mortgage finance industry? Won't this, as one Wall Street Journal op-ed cried, bring US housing finance markets to a standstill?

No. Of course not.

In our economy, absent unwise governmental interference or regulation, something worth doing will be done by someone, at a profit.

So, too, will that occur in this case. By killing the GSEs, room will be made for private mortgage conduit companies to do the work, if it's valuable and profitable, of mortgage securitization.

I suppose it's possible that investors might not currently trust any securities backed by mortgages, for fear of experiencing more of the same they have gotten from Fannie's and Freddie's poor underwriting standards and unwise programs requiring too little equity from borrowers.

In time, a well-run portfolio lender could easily begin to liquify their balance sheet via securitization. There's nothing magical about it. A few well-run mortgage banks and a few investment banks could fill investor demand for mortgage-backed securities left by the GSEs.

In time, the better home finance lenders with lower delinquency and default rates would command higher prices, and lower yields, for both their securitized mortgage notes and their debt. And equity.

Simply put, if there's a need for the functions which the GSEs performed, won't we see sufficient capacity, and better performance, from private-sector firms doing the same thing?

Well, we know one thing. We won't see worse underwriting practices in these securities. The very worst system you could possibly design is to pay government-backed entities private-sector-style compensation. Risk is transferred to the government, while rewards accrue, unfairly, to the equity holders and management.

With private-sector players doing this work, risk and reward would be appropriately put back together, where they belong. But, most importantly, Fannie and Freddie should be prevented from doing anymore ongoing mortgage finance securitization. With their track record, whether taken over by Treasury, or not, they simply have to be shut down, so room can be made for more effective firms with better risk management to replace their shoddy underwriting practices.

Bill Gates' Stupid New Charity Idea

Bill Gates made big news this week with his charity pitch at the Davos World Economic Summit. Called 'kinder capitalism,' Bill wants his corporate friends to assign their best minds to charity projects, and to donate some of their net income, as well.

Give me a break!

There's Bill, looking appropriately nerdy, sitting with Michael Dell and.....Bono!

Now we get it!

Here's the five-year price chart for Bill's company, Microsoft, Dell, and the S&P500 Index.

Notice how neither Bill nor Michael have managed to do for their shareholders in the past five years what a cheap, passive S&P500 Index fund could have done?

Dell ends up flat- his shareholders basically finished dead even over five years. Bill returned 1/3 less to his shareholders than the index- and most of that occurred in just the past six months.

Gates has it all wrong. But, hey, if it gets you face time with a real rock star, who cares how you treat your shareholders? And looking at Gates and Dell, you can just see these guys as the nerdy college-age kids they were, busily building businesses in their dorm room or buying MS-DOS on the cheap from the original owner/developer, rather than develop normal social networks.

According to the plan, companies assign bright personnel to figure out what they can do to alleviate some global poverty ill, and levy a mandatory tax on their shareholders out of net income with a donation.

Bono had a great big, silly grin while telling CNBC viewers,

'You don't have to donate anything. You buy these guys' products, and make them donate.'

Well, uh, not quite Bono. Make that,

'..and make their shareholders donate, whether they want to, or not.'

Here's another idea, Bill. How's about you and Michael Dell learn how to outperform the market again. Then, ask shareholders if they will vote, individually, for their shares, to donate a portion of any dividend you pay, out of equity gains above those of the S&P, to the charity you choose?

That way, you have an incentive to actually do your job. And Mike, too, for that matter.

Honestly, if this wasn't so pathetic, it'd be funny. Gates makes his billions, and people still don't like him.

So he establishes a foundation, perhaps in hopes that this will make people like him. Then he suddenly gets religion, like Ebenezer Scrooge, and declares that now he'll be a kind and nice guy.

Perhaps Gates has it backwards. Allowing for his last five years of drought in performing for his shareholders, Gates at least once was good at making money from software. What if Bill concentrated on using his unique talents for that, and using some of the excess profits to do good.

Anyone can give (someone else's) money away. Or exhort others to do so. It seems to me that corporations should focus on enriching their shareholders, preferably in a consistently superior manner, and let the shareholders decide whether or not to support charities.

Gates' idea would sound a lot better had he discovered it when he was leading Microsoft to consistently superior total returns. Now, he just looks desperate to get attention and hang with the Davos "in" crowd.

Not content to merely underperform for his shareholders, now he wants to take their profits, too, so he can be popular with the international set.

More On Cramer, Santelli & Financial Markets Turmoil & Excesses

Yesterday's post involving Jim Cramer's attempts to bully and intimidate other CNBC on-air participants- notably Rick Santelli and Brian Wesbury- attracted what I believe to be a record number of readers. The number of visitors who simply Googled something like,

"rick santelli jim cramer cnbc"

was astonishing. And that my blog post ranked among the first results for that Google search. I'm still getting hits this morning, as I write this piece.

Even Jack Welch, this morning's CNBC SquawkBox guest host, took time to specifically and explicitly give Santelli an on-air 'well done' for shutting Cramer up.

Carlos whats-his-name seconded, safely, declaring that the incident was "good television."

But back to the main topic- the financial markets.

Somewhere yesterday afternoon or this morning on CNBC, a few very calm, sane, well-reasoned guests offered the following recap of the current situation, and the path to it. I've summarized their joint specific wording, but the thrust of my synopsis is faithful to their points and, for what it's worth, also reflect my own thinking:

"We have a free market economy and free financial markets. There's regulation, to be sure, but, mostly, participants are free to take risks and make money as they choose.

The past few years saw excesses involving, but probably not limited to:

-people buying houses that they could not, in the long run, actually afford
-financial institutions creating opaque structured financial instruments whose ultimate value and trading patterns were actually unknown and, thus, very risky
-some homebuilders (over) built in markets known to be overheating

Beginning last summer, this all came to a boil. As a result, private investors, large and institutional, and small and retail, lost money due to these financial excesses.

The smaller investors lost on housing and rising mortgage payments. The larger, institutional investors lost on opaque credit instruments which, in the event, turned out not to actually have continuous markets in which to trade them.

With this background, many institutional financial market participants and related pundits, such as Jim Cramer and Steve Liesman, both of CNBC, regularly began to excoriate Fed Chairman Ben Bernanke.

Two commentators noted that this is grossly unfair. How, they asked, can one man and the rest of the Fed be expected to correct, at a stroke, with just interest rate cuts, what an entire financial market and one economic sector took years to screw up?

Alan Reynolds, in his superb editorial in yesterday's Wall Street Journal, noted, similarly, that President Bush and Congress can't just wave a fiscal stimulus wand and prevent a recession, either. If it was that easy, we'd never suffer recessions.

No, we have recessions as the natural counter-cycle to financial market and/or economic excesses.

But we aren't in a recession yet. And we don't seem to actually be headed for one. It's just a financial market panic reaction to a slowing, but still growing, economy.

One commentator opined that what we have is

'A bunch of Wall Street investors whining because they aren't making money this week. Grow up!' "

This Fed-bashing, which even as I write this, is being continued by CNBC's on-airhead Mark Haines, misses the point. The Fed can't magically undo in weeks or months what a host of investors and economic players took years to do.

If you want that type of centralized financial and economic control, maybe you should climb in Professor Peabody's WayBack machine and return to the Soviet Union of 1965.

In our economy, you have to take the bad with the good. Someone else's excess can affect you. It's just part of the world of free economic and financial markets.

In fact, another reason that magical elixirs evade us is that there are so few genuine recessions and financial meltdowns.

In a falling market, everybody is working in unfamiliar territory. My partner noted that, while my long-oriented equity, and derived options strategy, work superbly 90% of the time, we really are in uncharted waters when my market allocation signal indicates the need to take short or put positions. There are just so few, recent, relevant market samples on which to do research and base strategies that bear market equity-related strategies are inherently riskier. There's less data and, thus, far more volatility in any particular approach to profiting, or limiting losses, during such inflection points and subsequent bear markets, followed, usually pretty soon, by the inevitable second inflection point on the way back up.

Guess what? It's the same for the Fed and most market participants.

If you carefully consider the origin of the Fed, and its most unique role, it has to be fighting inflation through the provision of stable monetary policy. It's not actually supposed to cure recessions.

Financial panics? Yes. Financial liquidity shortages? Yes.

In the final, summary analysis, here's what I think is going on now.

The past few years saw an excessive buildup of investment in housing-related sectors. Too many houses were built, too many people bought homes they couldn't really pay for, and too many financial services firms churned out structured, mortgage-based securities to fund them.

Aside from that, the other sectors of the US economy were firing on all cylinders, energy price increases due to legitimate global demand increases notwithstanding.

Eventually, beginning last summer, the financial house of cards built upon suspect mortgages began to collapse.

Private investors lost a lot of money. Perhaps something like 15% of the $1.5Trillion subprime mortgages outstanding could default. That's about $200Billion.

However, associated with these are many over the counter interest rate and credit swaps that now carry much counterparty risk.

When these risks and losses began to become apparent, large US commercial and investment banks wrote off nearly $100B in losses, prompting a corresponding loss in equity values in the sector, and then some.

Now, the credit market losses have hit the equity markets, resulting in trillions of dollars of US equity market losses in January, 2008, already.

Eventually, these levels of losses will affect consumer financial behavior in a more slowly-growing, but not recessionary, US economy.

In the meantime, a lot of less-skilled, mediocre institutional investors, analysts, pundits, traders, etc., are panicking. Thus, what would have been a softening economy with a loss of some credit instrument investments due to the mortgage sector mess, seems to have amplified into a near-term financial panic that assess the US economy as already in recession.

As my longtime friend and sometimes business partner, B, emailed me a few months ago,

'We're not in a recession yet. But if enough people keep saying we are, we will be soon.'

So true.

Even so, because the basic economic signals remain non-recessionary, most investors are likely to be surprised that, later in the year, the economy will appear to be healthier. And the equity market downdraft will seem to have been overdone.

It's likely that the particulars of how long the equity markets turmoil and bear market will last, as well as how long the economy will remain soft, have to do with the degree to which the recent events become central determinants of longer term consumer behavior. And right now, nobody knows how that will develop.

Distorted Market Signals On Insurance In The Hurricane Belt

Yesterday's Wall Street Journal featured an excellent piece on the shifting burden of homeowner's insurance for those who build and live in the known or highly-probable path of hurricanes.

As I explained to my 11-year old daughter over breakfast, while we looked at the headline, when governments attempt to control the price of risk for insuring things like building vacation, or even primary, homes in the likely path of destructive weather, the tendency is for private capital to flee, and government, meaning, all of us who don't enjoy that ocean view, to subsidize those who have so built.

As the article clearly describes, the recent trend has been for states to attempt to cap insurance rates, companies to leave states, then the same states organize their own 'insurance funds,' which are, logically, inadequate to the task at hand. The ultimate guarantor, since the people in these states see fit to guarantee coverage to their coastal-dwelling denizens, is going to be Uncle Sam.

Let's review the history. The year after I was born, there was a decade-long hiatus in killer hurricanes along the Gulf and Atlantic coasts. The resulting rush to build in these hurricane alleys resulted in today's dilemma. People have been allowed to expect that they will always be given coverage, at affordable rates, for their dubious choice of location for a vacation home. Or, in some cases, primary residence.

Now that nature has returned, as it were, to the field, there's been millions of tons of toothpicks created since Hugo set down in North Carolina those many years ago. Most recently, Katrina and Rita wrecked the New Orleans and parts of the Texas, Mississippi and Louisiana coasts.

Someone must pay!

But why? Back when I began this blog, in September of 2005, I quickly wrote about who really bore the cost of location decisions in the Gulf Coast areas. Leaving aside industry, it is pretty clear that, through distorted market signals on the price of risk for homeowner insurance, too many people have built too much housing which they cannot personally afford to insure at market rates, or rebuild from their personal fortunes, in the likely path of hurricanes.

A reasonable person will see in a hot minute that the most effective solution is to reduce insurance regulation, not involve more state and Federal price signal distortion.

On a related matter, what do you think is really happening every time some Gulf Coast location is declared a "Federal disaster area?" The local residents get to rely on every other US citizen to bail them out of their choice of living in an area which may be too risky for their own wallets.

The net effect of today's mess of homeowners insurance in hurricane areas is to make all Americans ultimately pay the tab for the difference between what local politicians feel they can ask their ocean-front-dwelling homeowners to pay for insurance, and what private insurers would actually demand for those risks. So you and I, if you don't have a beachfront home somewhere between North Carolina and Texas, pay a form of rent to those who do, but we never get to enjoy their view.

Common sense says that if it's too expensive for a person to afford privately-offered insurance to replace the value of a home built so near the ocean in hurricane territory, then the home shouldn't be built. Not that 'someone else' should step in and pay to make it affordable. How long can we, as a nation, afford this sort of economic idiocy?

When I read in the Journal article that,

"lawmakers in some states are also facing deep public anger about the rising cost of insurance on the coast,"

I was dumbfounded. Who's fault is this? The 'rising cost' reflects reality peeking in on an otherwise state of denial.

Something's very wrong. The incentives for rational decision-making with respect to economic development is distorted. Back in the post-Katrina era, I wrote a post quoting a Holman Jenkins WSJ editorial in which he revealed that southern Senators demanded the removal of a provision in Federal flood insurance laws that put a limit on the number of times a homeowner could file claims under the insurance. They explicitly admitted that the insurance guaranteed 'economic development' by way of assuring the rebuilding of the initially dubiously-sited homes.

This sort of market price signal distortion, on such a grand scale, is bound to come a cropper at some point. It's a good argument for simplifying the insurance market to become a national one, rather than 50 local ones, each hostage to local political appointees who try to beggar their neighbors by capping risk prices in their own states, and attempting to force the insurers to recover the true risk premiums 'somewhere else.'

The way things are looking, this would seem to cast doubt on the wisdom of investing in property and casualty firms anytime soon, if one expects consistently superior total returns.