Yesterday's Wall Street Journal contained an article describing hedge fund manager William Ackman's ambitious plans to cajole the board and senior management of retailer Target Corp. into spinning its real estate into a separate REIT.
Ackman was stumping the plan on CNBC that morning, as well, assuring one and all that Target, as a tenant, would never default, so the REIT would be totally safe.
Here's what the Journal piece had to say about Ackman's plan,
"Mr. Ackman, whose Pershing Square Capital Management owns just under 10% of the Minneapolis-based retailer, says that Target has a huge real-estate company buried inside a retailer that isn't properly valued by the stock market. Target owns the land under 85% its 1,680 stores, the highest percentage of any retailer.
In a statement, Target said that it hadn't reached any conclusion on the proposal, but said its analysis of "similar ideas," conducted with advisers Goldman Sachs Group Inc., "raises serious concerns," including the validity of Mr. Ackman's assumptions about the valuation of Target and the separate REIT entity.
Target also said it is worried about the large expense of lease payments, which are subject to annual increases, plus the adverse effect the company believes the structure would have on its debt ratings, which presently stand at single-A. The retailer said it may respond to the plan "in the near future."
Other potential benefits to shareholders of a spinoff, he said, include a reduced tax burden for Target. A REIT is exempt from paying federal income taxes as long as it distributes 90% of its earnings to shareholders through dividends. For Target, foregoing those several hundred million dollars in taxes would boost cash flow and earnings, Mr. Ackman insisted.
He also argued that the combined values of Target and its REIT would likely be greater than Target's current market value because of the tax savings and the stability of Target as a tenant for the REIT.
If enacted, Mr. Ackman's proposal could cause debt-rating agencies to lower Target's credit ratings because of land transfers to the REIT, said Ee Lin See, a debt analyst with Credit Suisse."
As it happened, I ran into an old friend this morning at my fitness club. BW is a retired retail executive and consultant who spent his entire career in the business. I asked him if he had heard of Ackman's proposal. Not recalling his exact quote, I can paraphrase BW's response as follows,
'Yes, I read it in today's Journal. It's more grab and run. He'll drain the real estate value from Target, load it up with debt, and ruin it.'
Since I don't have operating experience in the sector, and BW does, I asked him, for argument's sake, how it was that a retailer could be so marginally profitable as to be driven into bankruptcy, over time, when forced to pay rent for land it now probably does not charge back for to each store.
BW explained the operating model for big box anchors like Target. Prior to ten years ago, he said, chains like Target were simply given the land beneath their stores by developers as an inducement to anchor a mall or shopping center. Such land, of course, has gained tremendously in value, albeit somewhat less so after the last twelve months.
Thus, he contended, all the major, older retailers operated without actually charging themselves for rent.
In response to my question about the effect of charging rent on Target's individual stores, BW did some quick math and estimated that a fair rent was roughly 3% of the total sales of a store, per year. He correctly estimated Target's gross margin to be roughly 35%. A quick look on Yahoo's page for Target gives a profit margin of about 4%.
Thus, adding rent into Target's cost base would, in fact, reduce its profitability quite a bit, on a percentage basis, from the current level.
So, essentially, Ackman is seeking to unlock and separately monetize years of real estate gains, while simultaneously making Target's operating model change to explicitly include the cost of leases in its income statement. Something it does not currently do. Nor, according to BW, do the other major retail chains so favored, as Target was, with gratis land for store locations.
Ackman would be able to reap gains from selling his fund's resulting REIT shares, and, then, also sell his fund's remaining Target operating company equity position, thus realizing instant profit from the underlying asset. It's a debatable question whether the new Target, stripped of low-cost land, would be as valuable over time. It might eventually lose as much, or more, than was monetized and siphoned out by the REIT.
I should also note that the Journal published a humorous piece in the past few days on this story involving a reporter who attended Ackman's New York presentation of the proposal.
Taken together- Ackman's CNBC appearance, the two Journal pieces and BW's comments- I find myself doubting that Ackman plans to continue holding Target equity in the proportion his fund currently does, statements on air notwithstanding.
This really does, as BW contends, look like the old 'lever them up and dump them' cash extraction of a classic leveraged buyout. And it appears that, rather than viewing their real estate as a passive accidental acquisition of no particular value to their operating model, Target's management realizes that it is, to the contrary, an important component of cost control.
Friday, October 31, 2008
Thursday, October 30, 2008
Your New Bank: Goldman, Morgan Stanley or GMAC?
If I tell you that tomorrow I intend to become a steel company, will that actually make me a competitor of Posco and Nucor?
Of course not.
When Lloyd Blankfein and John Mack changed their firms from investment banks to Federally-chartered bank holding companies, did that actually make them commercial banks?
No.
And, parenthetically, despite Wednesday's Wall Street Journal piece detailing GMAC's bid for Federal aid via a bank charter, the auto maker's finance arm won't magically become a real bank, either.
In two separate articles that day, the WSJ discussed the prospects for all three firms as commercial banks, rather than their former incarnations.
GMAC, of course, is simply searching for a way to feed at Treasury's bailout trough, as if the direct Federal "loan" to its nearly-dead parent is not sufficient. To suggest the auto loan and mortgage finance company could really function as a full-service bank, and profitably, is ludicrous.
But it does highlight the ingenuity of Americans. When our government ladles out cash, we figure out how to qualify in a flash.
Goldman Sachs and Morgan Stanley have more options, because they aren't really dead yet.
Goldman's Blankfein displayed his chutzpah by offering to merge with Citigroup, if novice CEO Pandit would kindly step aside and let the veteran investment bank's management run things.
Rumors swirled about a Morgan Stanley-Citigroup merger, too, with the alleged common heritage of Citigroup's CEO and the investment bank supposedly greasing the deal.
Truth is, as the WSJ article about them hinted, but failed to describe in detail, merely saying they are now commercial banks does not, by any stretch, make Goldman Sachs and/or Morgan Stanley commercial banks.
Can you imagine a Goldman staffer guiding you through a consumer loan or credit card application? Handling your electronic transfer or opening a safe deposit box for you?
Me neither.
In fact, as the Journal piece suggested, these two late converts can't really be commercial banks in any meaningful, consistently profitable way, so long as they remain as bloated, publicly-owned hedge funds.
Sooner or later, the Fed will force them to shrink or spin off those assets which make them, well, too risky to be a commercial bank in these times. What's left at either company is essentially asset management, some trading and underwriting.
No credit cards. No mortgages. No consumer loans. No transactions processing businesses. No basic commercial loan businesses.
That's why Blankfein and Mack, being smarter than the average real commercial bank CEO, are looking to infect/invade an old-line money center or regional bank much as a virus invades its host.
Rather than buy and bolt on, for example, Capital One, a medium-sized deposit-taking bank, and some out-of-work mortgage, consumer and commercial loan officers, it would be far easier for Goldman to merge with the likes of Citigroup or even PNC. The former, ailing as it is, might accept the marriage as a way to further disguise its true lack of progress on returning to health, while the latter could be vaulted into the ranks of high finance overnight.
Either way, if Goldman and Morgan Stanley don't soon sell themselves to some decent-sized banks, or buy various consumer loan and deposit-taking operations, they will lose their independence as federally-chartered entities the harder way, in forced marriages arranged for them.
Of course not.
When Lloyd Blankfein and John Mack changed their firms from investment banks to Federally-chartered bank holding companies, did that actually make them commercial banks?
No.
And, parenthetically, despite Wednesday's Wall Street Journal piece detailing GMAC's bid for Federal aid via a bank charter, the auto maker's finance arm won't magically become a real bank, either.
In two separate articles that day, the WSJ discussed the prospects for all three firms as commercial banks, rather than their former incarnations.
GMAC, of course, is simply searching for a way to feed at Treasury's bailout trough, as if the direct Federal "loan" to its nearly-dead parent is not sufficient. To suggest the auto loan and mortgage finance company could really function as a full-service bank, and profitably, is ludicrous.
But it does highlight the ingenuity of Americans. When our government ladles out cash, we figure out how to qualify in a flash.
Goldman Sachs and Morgan Stanley have more options, because they aren't really dead yet.
Goldman's Blankfein displayed his chutzpah by offering to merge with Citigroup, if novice CEO Pandit would kindly step aside and let the veteran investment bank's management run things.
Rumors swirled about a Morgan Stanley-Citigroup merger, too, with the alleged common heritage of Citigroup's CEO and the investment bank supposedly greasing the deal.
Truth is, as the WSJ article about them hinted, but failed to describe in detail, merely saying they are now commercial banks does not, by any stretch, make Goldman Sachs and/or Morgan Stanley commercial banks.
Can you imagine a Goldman staffer guiding you through a consumer loan or credit card application? Handling your electronic transfer or opening a safe deposit box for you?
Me neither.
In fact, as the Journal piece suggested, these two late converts can't really be commercial banks in any meaningful, consistently profitable way, so long as they remain as bloated, publicly-owned hedge funds.
Sooner or later, the Fed will force them to shrink or spin off those assets which make them, well, too risky to be a commercial bank in these times. What's left at either company is essentially asset management, some trading and underwriting.
No credit cards. No mortgages. No consumer loans. No transactions processing businesses. No basic commercial loan businesses.
That's why Blankfein and Mack, being smarter than the average real commercial bank CEO, are looking to infect/invade an old-line money center or regional bank much as a virus invades its host.
Rather than buy and bolt on, for example, Capital One, a medium-sized deposit-taking bank, and some out-of-work mortgage, consumer and commercial loan officers, it would be far easier for Goldman to merge with the likes of Citigroup or even PNC. The former, ailing as it is, might accept the marriage as a way to further disguise its true lack of progress on returning to health, while the latter could be vaulted into the ranks of high finance overnight.
Either way, if Goldman and Morgan Stanley don't soon sell themselves to some decent-sized banks, or buy various consumer loan and deposit-taking operations, they will lose their independence as federally-chartered entities the harder way, in forced marriages arranged for them.
Washington Impedes A Financial Sector Recovery
Gordon Crovitz writes a weekly editorial column in the Wall Street Journal entitled "Information Age." On Monday, it was entitled, "Credit Panic: Stages of Grief," and it dealt with how are Federal government is actually prolonging the healing of our financial markets by its explicit denial of its own role in starting the mess.
Specifically, Crovitz writes,
"This matters because regulatory denial is suppressing confidence in markets, especially now that the country's financial capital is in Washington, not in New York."
Crovitz notes the House grilling of Greenspan and their attacks in hearings on rating agency executives, while ignoring their own culpability. He continues,
"Politicians of all parties thrive by shifting blame. Congress has not even held hearings yet in the area where it is most clearly responsible: social engineering through banking by pumping mortgages to unqualified borrowers via Fannie Mae, Freddie Mac and laws that require banks to make bad loans. Hearings are promised after the election."
Don't hold your breath on that one.
Citing Robert Higgs and Amity Schlaes' works, Crovitz reminds us of a still-ignored truth. That is, FDR prolonged the Great Depression with his 'regime of uncertainty.' Both authors have recently published works noting that confiscatory tax rates, crowding out of private investment by public fiat and takings caused private capital to flee the economy. This led to an extended Depression.
Rather than be lauded as the hero who pulled us out of the Depression, FDR was, in reality, a ham-handed economic mis-manager.
Crovitz maintains, reasonably, that Washington's failure to assure clarity and transparency in many of the modern financial instruments- swaps, derivatives and structured financial instruments- resulted in market-damaging uncertainty.
He closes by contending,
"A proper role for government is to require better disclosure of information. This would help balance risks and rewards. Just as in the 1930's, more transparent information would restore trust in financial markets, both in Washington and on Wall Street. If Washington can catch up to the private sector in admitting its mistakes, we can move beyond the credit crisis and forward to restore stability, with an end in sight to the current cycle of grief."
I believe Crovitz is correct. Unfortunately, I don't see it happening if the current Congressional majorities remain.
Specifically, Crovitz writes,
"This matters because regulatory denial is suppressing confidence in markets, especially now that the country's financial capital is in Washington, not in New York."
Crovitz notes the House grilling of Greenspan and their attacks in hearings on rating agency executives, while ignoring their own culpability. He continues,
"Politicians of all parties thrive by shifting blame. Congress has not even held hearings yet in the area where it is most clearly responsible: social engineering through banking by pumping mortgages to unqualified borrowers via Fannie Mae, Freddie Mac and laws that require banks to make bad loans. Hearings are promised after the election."
Don't hold your breath on that one.
Citing Robert Higgs and Amity Schlaes' works, Crovitz reminds us of a still-ignored truth. That is, FDR prolonged the Great Depression with his 'regime of uncertainty.' Both authors have recently published works noting that confiscatory tax rates, crowding out of private investment by public fiat and takings caused private capital to flee the economy. This led to an extended Depression.
Rather than be lauded as the hero who pulled us out of the Depression, FDR was, in reality, a ham-handed economic mis-manager.
Crovitz maintains, reasonably, that Washington's failure to assure clarity and transparency in many of the modern financial instruments- swaps, derivatives and structured financial instruments- resulted in market-damaging uncertainty.
He closes by contending,
"A proper role for government is to require better disclosure of information. This would help balance risks and rewards. Just as in the 1930's, more transparent information would restore trust in financial markets, both in Washington and on Wall Street. If Washington can catch up to the private sector in admitting its mistakes, we can move beyond the credit crisis and forward to restore stability, with an end in sight to the current cycle of grief."
I believe Crovitz is correct. Unfortunately, I don't see it happening if the current Congressional majorities remain.
Wednesday, October 29, 2008
Selling At The Peak: Blackstone's Schwarzman
In yesterday's post, I related some of the conversation I had recently with an acquaintance who works as a manager at one of the three rating agencies.
With respect to Blackstone's IPO, I found this post from a date just prior to the event, in June of 2007. The accompanying chart confirms this with a beginning date of BX's price chart in July of last year.
Besides fixing the date of the IPO, my post noted some of the strategies Schwarzman and his colleagues employed to quell any effective questions from financial analysts regarding the valuation of the firm's assets as it sold part of itself to the public. 
Here's the five year price chart for the S&P500 Index. The recent peak for the price series is clearly in mid-2007. There were two similar 'tops,' one in June, and the other just after September.
As he and I parted company, we were talking about the excessively short-term nature of investment bank compensation. On that theme, I mentioned Blackstone's IPO of last year.
Now, to be completely candid, I couldn't recall exactly when Steve Schwarzman took his private equity firm semi-public. I knew that I wrote a series of posts about the momentous event. But I couldn't accurately place in which month the firm sold its IPO in 2007.
This being the case, I was merely conjecturing when I told my colleague that I'd bet, if you looked, that Blackstone's IPO was at or near the top of the S&P500 Index.
Call me cynical. Or sceptical, which I think is more appropriate. Sometimes, they are the same. Like in this instance.
I know this sounds contrived, but it's really true. I was conjecturing without having checked either a chart of the last few years of the S&P or the actual date of Blackstone's IPO.
Besides fixing the date of the IPO, my post noted some of the strategies Schwarzman and his colleagues employed to quell any effective questions from financial analysts regarding the valuation of the firm's assets as it sold part of itself to the public.
Here's the five year price chart for the S&P500 Index. The recent peak for the price series is clearly in mid-2007. There were two similar 'tops,' one in June, and the other just after September.The next chart, a two-year view of the S&P500 Index price series, more clearly identifies the peaks as July and October.
Tuesday, October 28, 2008
More Trouble Ahead for the S&P Ratings Group?
Back in August- which now seems like an eternity ago- I wrote this post regarding two Wall Street Journal pieces of several weeks earlier. The articles focused on Terry McGraw, CEO of McGraw-Hill, and the company's evolving woes from its S&P ratings unit.
A quote from one of the WSJ articles which was pointedly repeated by some House member in a committee session last week involving rating agency executives was this pair of comments from an email, and its reply, between S&P staffers,
"We should not be rating it."
"We rate every deal......it could be structured by cows and we would rate it."
It seems that each major financial crisis has one or more signal phrases or quotes associated with it. Surely, this pair of email fragments is likely to be among those for this crisis.
Last night, I ran into an acquaintance who is a manager at one of the ratings agencies. In order to protect his identity, I won't divulge with which agency he is connected.
We had another in what has been a series of interesting discussions over the course of the summer and fall. This time, with last week's Congressional grilling of executives from his sector still fresh, our conversation seemed more emotional.
I suggested that Terry McGraw could well be on the way out in twelve months. On the basis of those August WSJ articles, alone, questions will be asked, and pressure will be applied to make S&P's parent pay a public price for its role in this financial mess.
My colleague noted that very few people realize just how powerful and unmovable, in the sector, S&P is. That they would have been insensitive to the evolving signs of stress in rated instruments, such as CDOs, because their market power is so great.
He told me the head of S&P's ratings unit during the past few years is already gone. Upon hearing this, I promptly suggested that this ex-S&P manager will, in all probability, wind up testifying before a Congressional committee next year, and will promptly roll and give up Terry McGraw as the instigator of the problem, due to pressure for growth and earnings.
My colleague agreed.
You'd have to be an idiot to not envision clever, eager young staffers for Democratic party Representatives and Senators compiling published material, e.g., those WSJ pieces, and assembling a fairly plausible theory that the heads of S&P, Moody's and Fitch pushed too hard for growth, abandoned prior ratings standards, and succumbed to pressure from their clients, the originating investment and commercial banks.
What was a bit surprising to me was my colleague's description of how investment bankers often successfully embarrass and humiliate agency analysts who cannot completely understand the complex instruments brought to them for ratings.
The result of this process has been, as is now clearly seen, the issuance of ratings by agencies on instruments which they either don't completely understand, or do understand, but yield to pressure from their banking clients, in exchange for fees.
My colleague and I then noted how this process insidiously aids the short-term focused bonus compensation at investment and commercial banks. It seems incomprehensible to many who do not work in financial services that what happened with the ratings of new CDO products can stem from something as simple as unbridled opportunism at issuing banks.
To understand this, consider the following example. If for a period of only three years, an investment bank's mortgage-backed securities business churns out record amounts of CDOs, bonuses can run into the low millions of dollars for quite a few mid-level managers. For most people, three years of $2-3MM bonuses, even after taxes, results in a sort of 'game over' financial position.
Regardless of the disposition of the enormous bonus pools paid out of the issuing profits on structured instruments rated by the agencies, the systemic damage was done.
Simply put, the issuing and trading profits on the most exotic instruments, which tend to be the most profitable, filtered their way through to the agencies which have been given special protections, in order to operate their oligopoly without anti-trust worries. Even in a sector with only three major players, someone will oblige an issuer flush with money, and provide the desired rating on an untested security.
As the largest of the ratings agencies, S&P is almost certainly going to become a target for Congressional fury. My colleague noted that more regulation is coming anyway. When I opined that perhaps protection from lawsuits would be removed, he quickly predicted that the business would vanish.
To which I replied that maybe that would not be a bad thing, or even a problem.
Do institutional investors really need ratings on large corporate credit? It's debatable. There's plenty of information available with which such sophisticated investors can assess risk.
The area where ratings really do provide value is in the municipal bond market. Of course, this is a sleepy, low-growth segment, which accounts for the push by MBIA, AMBAC and the ratings agencies into more exotic products in the first place, as I noted in this post.
Perhaps we'll have to see a radical transformation of the ratings business, now that it has publicly shown that it was for sale all along. Sort of like the tainted research of sell-side brokerages during the dot com equity bubble of a decade ago.
Not to mention, once it becomes clear to the public how the ratings business model works, the revulsion over how agencies are paid by the or issuer of the rated instruments.
Long ago, a friend who worked at S&P, but not in the ratings unit, told me a story about a multi-unit meeting he attended. At the meeting, one of the ratings staffers told what was obviously an old joke,
"What's the difference between piracy and the ratings business? Piracy is illegal."
Not a pretty picture for the average retail, or less-skilled institutional investor to envision.
It's a pretty sure bet that, one way or another, the ratings business, and some of its senior executives, are in for major changes in the years ahead.
A quote from one of the WSJ articles which was pointedly repeated by some House member in a committee session last week involving rating agency executives was this pair of comments from an email, and its reply, between S&P staffers,
"We should not be rating it."
"We rate every deal......it could be structured by cows and we would rate it."
It seems that each major financial crisis has one or more signal phrases or quotes associated with it. Surely, this pair of email fragments is likely to be among those for this crisis.
Last night, I ran into an acquaintance who is a manager at one of the ratings agencies. In order to protect his identity, I won't divulge with which agency he is connected.
We had another in what has been a series of interesting discussions over the course of the summer and fall. This time, with last week's Congressional grilling of executives from his sector still fresh, our conversation seemed more emotional.
I suggested that Terry McGraw could well be on the way out in twelve months. On the basis of those August WSJ articles, alone, questions will be asked, and pressure will be applied to make S&P's parent pay a public price for its role in this financial mess.
My colleague noted that very few people realize just how powerful and unmovable, in the sector, S&P is. That they would have been insensitive to the evolving signs of stress in rated instruments, such as CDOs, because their market power is so great.
He told me the head of S&P's ratings unit during the past few years is already gone. Upon hearing this, I promptly suggested that this ex-S&P manager will, in all probability, wind up testifying before a Congressional committee next year, and will promptly roll and give up Terry McGraw as the instigator of the problem, due to pressure for growth and earnings.
My colleague agreed.
You'd have to be an idiot to not envision clever, eager young staffers for Democratic party Representatives and Senators compiling published material, e.g., those WSJ pieces, and assembling a fairly plausible theory that the heads of S&P, Moody's and Fitch pushed too hard for growth, abandoned prior ratings standards, and succumbed to pressure from their clients, the originating investment and commercial banks.
What was a bit surprising to me was my colleague's description of how investment bankers often successfully embarrass and humiliate agency analysts who cannot completely understand the complex instruments brought to them for ratings.
The result of this process has been, as is now clearly seen, the issuance of ratings by agencies on instruments which they either don't completely understand, or do understand, but yield to pressure from their banking clients, in exchange for fees.
My colleague and I then noted how this process insidiously aids the short-term focused bonus compensation at investment and commercial banks. It seems incomprehensible to many who do not work in financial services that what happened with the ratings of new CDO products can stem from something as simple as unbridled opportunism at issuing banks.
To understand this, consider the following example. If for a period of only three years, an investment bank's mortgage-backed securities business churns out record amounts of CDOs, bonuses can run into the low millions of dollars for quite a few mid-level managers. For most people, three years of $2-3MM bonuses, even after taxes, results in a sort of 'game over' financial position.
Regardless of the disposition of the enormous bonus pools paid out of the issuing profits on structured instruments rated by the agencies, the systemic damage was done.
Simply put, the issuing and trading profits on the most exotic instruments, which tend to be the most profitable, filtered their way through to the agencies which have been given special protections, in order to operate their oligopoly without anti-trust worries. Even in a sector with only three major players, someone will oblige an issuer flush with money, and provide the desired rating on an untested security.
As the largest of the ratings agencies, S&P is almost certainly going to become a target for Congressional fury. My colleague noted that more regulation is coming anyway. When I opined that perhaps protection from lawsuits would be removed, he quickly predicted that the business would vanish.
To which I replied that maybe that would not be a bad thing, or even a problem.
Do institutional investors really need ratings on large corporate credit? It's debatable. There's plenty of information available with which such sophisticated investors can assess risk.
The area where ratings really do provide value is in the municipal bond market. Of course, this is a sleepy, low-growth segment, which accounts for the push by MBIA, AMBAC and the ratings agencies into more exotic products in the first place, as I noted in this post.
Perhaps we'll have to see a radical transformation of the ratings business, now that it has publicly shown that it was for sale all along. Sort of like the tainted research of sell-side brokerages during the dot com equity bubble of a decade ago.
Not to mention, once it becomes clear to the public how the ratings business model works, the revulsion over how agencies are paid by the or issuer of the rated instruments.
Long ago, a friend who worked at S&P, but not in the ratings unit, told me a story about a multi-unit meeting he attended. At the meeting, one of the ratings staffers told what was obviously an old joke,
"What's the difference between piracy and the ratings business? Piracy is illegal."
Not a pretty picture for the average retail, or less-skilled institutional investor to envision.
It's a pretty sure bet that, one way or another, the ratings business, and some of its senior executives, are in for major changes in the years ahead.
Monday, October 27, 2008
Art Laffer's Editorial In Today's WSJ
Economist Arthur Laffer wrote a notable editorial in today's Wall Street Journal entitled, "The Age of Prosperity Is Over."
It would be difficult to understate the sense of gravity that Laffer conveys in this piece. There's no way to adequately quote just a few of the passages and do the piece article justice.Perhaps one way to begin is to let the graphic accompanying the editorial, seen nearby, speak for itself. If I'm not mistaken, it is meant to portray the familiar 'Monopoly Man' in tatters.
Just the same, here are a few passages from Laffer's piece, to give you the main points in his argument,
"When markets are free, asset values are supposed to go up and down, and competition opens up opportunities for profits and losses. Profits and stock appreciation are not rights, but rewards for insight mixed with a willingness to take risk. People who buy homes and the banks who give them mortgages are no different, in principle, than investors in the stock market, commodity speculators or shop owners. Good decisions should be rewarded and bad decisions should be punished. The market does just that with its profits and losses.
No one likes to see people lose their homes when housing prices fall and they can't afford to pay their mortgages; nor does any one of us enjoy watching banks go belly-up for making subprime loans without enough equity. But the taxpayers had nothing to do with either side of the mortgage transaction.
But here's the rub. Now enter the government and the prospects of a kinder and gentler economy. To alleviate the obvious hardships to both homeowners and banks, the government commits to buy mortgages and inject capital into banks, which on the face of it seems like a very nice thing to do. But unfortunately in this world there is no tooth fairy. And the government doesn't create anything; it just redistributes. Whenever the government bails someone out of trouble, they always put someone into trouble, plus of course a toll for the troll. Every $100 billion in bailout requires at least $130 billion in taxes, where the $30 billion extra is the cost of getting government involved.
If you don't believe me, just watch how Congress and Barney Frank run the banks. If you thought they did a bad job running the post office, Amtrak, Fannie Mae, Freddie Mac and the military, just wait till you see what they'll do with Wall Street.
The stock market is forward looking, reflecting the current value of future expected after-tax profits. An improving economy carries with it the prospects of enhanced profitability as well as higher employment, higher wages, more productivity and more output. Just look at the era beginning with President Reagan's tax cuts, Paul Volcker's sound money, and all the other pro-growth, supply-side policies.
The stock market is obviously no fan of second-term George W. Bush, Nancy Pelosi, Harry Reid, Ben Bernanke, Barack Obama or John McCain, and again for good reasons.
These issues aren't Republican or Democrat, left or right, liberal or conservative. They are simply economics, and wish as you might, bad economics will sink any economy no matter how much they believe this time things are different. They aren't.
The consequences of these actions were disastrous. Just look at the stock market from the post-Kennedy high in early 1966 to the pre-Reagan low in August of 1982. The average annual real return for U.S. assets compounded annually was -6% per year for 16 years. That, ladies and gentlemen, is a bear market. And it is something that you may well experience again.
Yikes!
Then we have this administration's panicked Sarbanes-Oxley legislation, and of course the deer-in-the-headlights Mr. Bernanke in his bungling of monetary policy.
There are many more examples, but none hold a candle to what's happening right now. Twenty-five years down the line, what this administration and Congress have done will be viewed in much the same light as what Herbert Hoover did in the years 1929 through 1932. Whenever people make decisions when they are panicked, the consequences are rarely pretty. We are now witnessing the end of prosperity."
Strong stuff, to be sure. And make no mistake, Laffer is an economic heavyweight. It is chillingly easy to see his predictions coming true with sickening results for the next 15 or so years.
Then, on the other hand, we have Brian Wesbury calling attention to 'internet time,' as I discussed in this recent post, which links to my original piece on Wesbury's observation, here.
To me, the question is whether Wesbury is correct, and voters will stop a second round of the socialization of the US economy- and society- which will make FDR and LBJ look like fiscal and social conservatives.
Or is Laffer correct, and US voters will cling to fear and government handouts, causing a long winter of economic sluggishness and the temporary- we hope- vanishing of the risk-taking, innovative economic behavior that so distinguishes the US economy?
I don't see Laffer's comparison of the current situation with Hoover from 1929-32. A much better one would be with FDR's NRA and, to some extent, the over-regulation of the US economy in the early 1970s- precisely when Laffer served in George Schultz's OMB. Perhaps, too, with elements of LBJ's large-scale, expensive social programs of the mid-1960s.
Laffer's piece does one really good thing. It reminds us of a possible, extremely bad economic result if the current financial and economic situations are resolved badly, with too much government control and spending.
Hopefully, reality will stop far short of Laffer's chilling prediction of doom. Perhaps due to the effects predicted by Brian Wesbury.
As I noted in a discussion with my business partner yesterday, no two financial or economic crises are ever identical.
In this case, the easily- and freely-available information both to and from average Americans, and, thus, among them, via the internet, short circuits much of the ability of government or a favorable, liberally-biased press to hide the truth.
Wesbury believes that this will create "real political pain" for the politician who gets it wrong.
Let's hope he's correct, so the full extent of Art Laffer's gloomy prediction never comes to pass.
Sunday, October 26, 2008
Sunday Odds & Ends
Here's the YouTube video of some 10 minutes of Alan Greenspan's testimony in front of a House committee on Thursday of last week. I wrote about his appearance here.
Of particular note is Greenspan's self-defense at minutes 3:45 and 9.
What's missing was Greenspan's ridiculous response to a question regarding his public support of ARM mortgages.
When asked about his public remarks, in the Q&A on Thursday, Greenspan actually said that, to understand his real feelings about ARMs, one should note that he personally has only ever held 30-year fixed rate mortgages. Thus, despite his public backing of ARMs as having the potential to lower borrowing costs for millions of other borrowers, the former Fed Chairman now claims you'd have to 'do as he did,' not 'do as he said.'
What's next? Will we learn that Fed board meetings were run like an 'Alan says' game?
In this weekend's Wall Street Journal, former senior Dow Jones executive and Pulitzer Prize winning author Paul Ingrassia wrote an extensive piece on the Detroit-based US auto maker's current straits.
Perhaps nothing conveys the trouble they are in as these two passages,
"It wasn't that American auto executives were always malicious and stupid while the Japanese were always enlightened and smart. Japanese car companies have made plenty of mistakes, most recently Toyota's ill-timed move into full-sized pickup trucks and SUVs. But just as America didn't understand the depth of ethnic and religious divisions in Iraq, Detroit failed to grasp -- or at least to address -- the fundamental nature of its Japanese competition. Japan's car companies, and more recently the Germans and Koreans, gained a competitive advantage largely by forging an alliance with American workers.
Detroit, meanwhile, has remained mired in mutual mistrust with the United Auto Workers union. While the suspicion has abated somewhat in recent years, it never has disappeared -- which is why Detroit's factories remain vastly more cumbersome to manage than the factories of foreign car companies in the U.S.
But to thrive, instead of just survive, Detroit will have to use the brains of its workers instead of just their bodies, and the UAW will have to allow it. Two weeks ago some automation equipment broke down at the Honda factory in Marysville, Ohio, but employees rushed to the scene and devised a temporary solution. There were no negotiations with shop stewards, no parsing of job descriptions. Instead of losing an entire shift of production, Honda lost just 150 cars. The person overseeing Marysville's assembly operations is Brad Alty, still with Honda after nearly 30 years. These days, instead of a Gremlin, he's driving a Honda Pilot -- made at a Honda factory in Alabama."
Paul makes a caustic remark about how crisis often breeds mistakes, which explains GM's pursuing a merger with the remnants of Chrysler. I think he's right on target.
Instead, he favors what I have suggested, which is the dismantling of the better GM brands into pieces which more successful car companies can absorb.
Of particular note is Greenspan's self-defense at minutes 3:45 and 9.
What's missing was Greenspan's ridiculous response to a question regarding his public support of ARM mortgages.
When asked about his public remarks, in the Q&A on Thursday, Greenspan actually said that, to understand his real feelings about ARMs, one should note that he personally has only ever held 30-year fixed rate mortgages. Thus, despite his public backing of ARMs as having the potential to lower borrowing costs for millions of other borrowers, the former Fed Chairman now claims you'd have to 'do as he did,' not 'do as he said.'
What's next? Will we learn that Fed board meetings were run like an 'Alan says' game?
In this weekend's Wall Street Journal, former senior Dow Jones executive and Pulitzer Prize winning author Paul Ingrassia wrote an extensive piece on the Detroit-based US auto maker's current straits.
Perhaps nothing conveys the trouble they are in as these two passages,
"It wasn't that American auto executives were always malicious and stupid while the Japanese were always enlightened and smart. Japanese car companies have made plenty of mistakes, most recently Toyota's ill-timed move into full-sized pickup trucks and SUVs. But just as America didn't understand the depth of ethnic and religious divisions in Iraq, Detroit failed to grasp -- or at least to address -- the fundamental nature of its Japanese competition. Japan's car companies, and more recently the Germans and Koreans, gained a competitive advantage largely by forging an alliance with American workers.
Detroit, meanwhile, has remained mired in mutual mistrust with the United Auto Workers union. While the suspicion has abated somewhat in recent years, it never has disappeared -- which is why Detroit's factories remain vastly more cumbersome to manage than the factories of foreign car companies in the U.S.
But to thrive, instead of just survive, Detroit will have to use the brains of its workers instead of just their bodies, and the UAW will have to allow it. Two weeks ago some automation equipment broke down at the Honda factory in Marysville, Ohio, but employees rushed to the scene and devised a temporary solution. There were no negotiations with shop stewards, no parsing of job descriptions. Instead of losing an entire shift of production, Honda lost just 150 cars. The person overseeing Marysville's assembly operations is Brad Alty, still with Honda after nearly 30 years. These days, instead of a Gremlin, he's driving a Honda Pilot -- made at a Honda factory in Alabama."
Paul makes a caustic remark about how crisis often breeds mistakes, which explains GM's pursuing a merger with the remnants of Chrysler. I think he's right on target.
Instead, he favors what I have suggested, which is the dismantling of the better GM brands into pieces which more successful car companies can absorb.
Friday, October 24, 2008
Today's Financial Markets & Wesbury's "Internet Time"
Back in June of this year, I wrote this post concerning an excellent editorial by Brian Wesbury in the Wall Street Journal. Wesbury's focus was that one current Presidential candidate's call for 'change' is, actually disingenuous, given the real economic change all around us.
However, I wanted to highlight something Wesbury noted at the end of his piece,
"Americans have had it so good, for so long, that they seem to have forgotten what government's heavy hand does to living standards and economic growth. But the same technological innovation that is causing all this dislocation and anxiety has also created an information network that is as near to real-time as the world has ever experienced.
Decades ago the feedback mechanism was slow. The unintended consequences of the New Deal took too long to show up in the economy. As a result, by the time the pain was publicized, the connection to misguided government policy could not be made. Today, in the midst of Internet Time, this is no longer a problem. So, despite protestations from staff at the White House, most people understand that food riots in foreign lands and higher prices at U.S. grocery stores are linked to ethanol subsidies in the U.S., which have sent shock waves through the global system.
This is the good news. Policy mistakes will be ferreted out very quickly. As a result, any politician who attempts to change things will be blamed for the unintended consequences right away.
Both Mr. McCain and Mr. Obama view the world from a legislative perspective. Like the populists before them, they seem to believe that government can fix problems in the economy. They seem to believe that what the world needs is a change in the way government attacks problems and fixes the anxiety of voters. This command-and-control approach, however, forces a misallocation of resources. And in Internet Time this will become visible in almost real-time, creating real political pain for the new president."
My own observation regarding Wesbury's contentions was to concisely restate his several points as,
"Thus, Wesbury notes that because of recent rapid change, originally economic-based, in information technology, boneheaded governmental changes will be quickly penalized in the next election cycle, rather than, as in the last century, 30-40 years later."
I thought of this as I watched S&PIndex futures go to limit-down before the market open this morning.
It looks like global understanding of economic repercussions of the recent financial market crises has morphed to 'internet time,' as well. Financial equity markets are now digesting and reacting to economic news in hours, rather than months, as they may have in decades past.
So, as steep and swift as the evaporation of value in the equity markets has been in the past month, it's quite possible that any resulting snap-back, once bad news abates, will be similarly faster and further upward than what has been historically experienced.
I suspect that Wesbury's observation about internet time is influencing how quickly global perceptions of various interdependencies among economic players affect the value of debt and equity.
We haven't seen this sort of speed and volume of reaction in prior financial market crises or the now-probably onset of a recession.
Right now, we're seeing the more-sudden plunge into financial market and economic gloom. Could it be that the ensuing emergence into the light will be just as unexpected and fast?
I suspect so.
However, I wanted to highlight something Wesbury noted at the end of his piece,
"Americans have had it so good, for so long, that they seem to have forgotten what government's heavy hand does to living standards and economic growth. But the same technological innovation that is causing all this dislocation and anxiety has also created an information network that is as near to real-time as the world has ever experienced.
Decades ago the feedback mechanism was slow. The unintended consequences of the New Deal took too long to show up in the economy. As a result, by the time the pain was publicized, the connection to misguided government policy could not be made. Today, in the midst of Internet Time, this is no longer a problem. So, despite protestations from staff at the White House, most people understand that food riots in foreign lands and higher prices at U.S. grocery stores are linked to ethanol subsidies in the U.S., which have sent shock waves through the global system.
This is the good news. Policy mistakes will be ferreted out very quickly. As a result, any politician who attempts to change things will be blamed for the unintended consequences right away.
Both Mr. McCain and Mr. Obama view the world from a legislative perspective. Like the populists before them, they seem to believe that government can fix problems in the economy. They seem to believe that what the world needs is a change in the way government attacks problems and fixes the anxiety of voters. This command-and-control approach, however, forces a misallocation of resources. And in Internet Time this will become visible in almost real-time, creating real political pain for the new president."
My own observation regarding Wesbury's contentions was to concisely restate his several points as,
"Thus, Wesbury notes that because of recent rapid change, originally economic-based, in information technology, boneheaded governmental changes will be quickly penalized in the next election cycle, rather than, as in the last century, 30-40 years later."
I thought of this as I watched S&PIndex futures go to limit-down before the market open this morning.
It looks like global understanding of economic repercussions of the recent financial market crises has morphed to 'internet time,' as well. Financial equity markets are now digesting and reacting to economic news in hours, rather than months, as they may have in decades past.
So, as steep and swift as the evaporation of value in the equity markets has been in the past month, it's quite possible that any resulting snap-back, once bad news abates, will be similarly faster and further upward than what has been historically experienced.
I suspect that Wesbury's observation about internet time is influencing how quickly global perceptions of various interdependencies among economic players affect the value of debt and equity.
We haven't seen this sort of speed and volume of reaction in prior financial market crises or the now-probably onset of a recession.
Right now, we're seeing the more-sudden plunge into financial market and economic gloom. Could it be that the ensuing emergence into the light will be just as unexpected and fast?
I suspect so.
Holman Jenkins On Detroit's Federally-Mandated Failure
Holman Jenkins wrote an interesting piece in Wednesday's Wall Street Journal. In it, he contended that Washington's latest sop to the auto industry, in the form of $25B in loans, isn't the start of Federal intervention in the industry. It's more like nearing the end.
Among the more salient points Jenkins makes are,
"The talk is of synergies and cost-cutting, of tapping new lodes of cash to ride out the storm. Don't believe it. These negotiations are about one thing: creating a political last stand of American auto making that a Democratic Congress and president won't be able to resist bailing out.
All parties to the Chrysler talks have adopted Election Day as a deadline, the better to trap both presidential campaigns into committing to support a deal. But it also slipped out that iconic Ford had been GM's first choice of partner -- a prospect that could yet be resurrected now that superinvestor Kirk Kerkorian has withdrawn his vote of confidence in Ford's survival.
Congress has already agreed to provide the Big Three with $25 billion in loans to help with a shift to green cars -- likely to become plain survival cash in the event. And Congress's very nature requires throwing good money after bad, specifically financing a GM-Chrysler merger if Michigan Sen. Carl Levin has his way. Don't be surprised if President-elect Obama is dropping hints in two weeks that this also would be a good use of the $125 billion Washington just injected into J.P. Morgan, Citigroup and friends. The government could even end up owning a car company directly before it's over, as the U.K. government once owned British Leyland.
Banking in fact illustrates what might be called the GM Effect, for both industries have been around long enough to have accrued an almost incalculable baggage of government intervention, which explains why more intervention is demanded today.
Why don't the auto makers limit themselves to paying competitive wages and benefits in line with what workers could earn elsewhere? Because, in the 1930s, Congress passed the Wagner Act with the nearly explicit purpose of imposing a labor monopoly on Detroit to keep wages at higher-than-competitive levels.
Why doesn't Detroit rationalize its musty brand lineups and dealer networks? Because, in the 1950s, legislatures across the country imposed franchising laws, including the federal "dealer day-in-court clause," to make such rationalization prohibitively expensive.
Why don't the auto giants do as Whirlpool and other manufacturers have done, and move their production to cheaper offshore locales? Because, in the 1970s, Congress enacted fuel economy rules to penalize homegrown auto makers if they don't build the lion's share of their cars in high-wage, UAW-staffed domestic factories.
No, Detroit's troubles don't arise because its executives are morons. Look today at the desirable, fuel-efficient cars that GM and Ford sell in large numbers in Europe. Does anybody imagine the U.S. public derives any benefit from keeping these cars out of our country? Yet they are kept out to preserve the amour propre of the regulators who enforce our emissions and safety standards, however trivially different from Europe's standards.
Cerberus, stars in its eyes, perhaps didn't quite understand all this about the auto industry when it bought Chrysler thinking it would be free to make business-like decisions. Now it does.
Any rescue mounted today in Washington won't be so much a "rescue" as a final admission that the industry can no longer bear its regulatory burdens without direct subsidies. Any life supports GM, Ford and Chrysler are hooked up to now, for that reason, will have to be permanent."
Throughout my 3+ years of writing this blog, I have spared no sympathy for the US auto makers. My judgment has been that they've been incompetent.
Now, Jenkins offers a different view. And, to be truthful, I give him credit for making the points he has made.
Somehow, though, I don't think that means management is blameless. Rather, I view them as having decided to become willing accomplices, rather than vigorously fight and expose what was slowly done to them, law by law.
If anything, this demonstrates why real executive talent, rather than more of the usual bean-counting variety, e.g., Rick Wagoner, was required to give shareholders any chance at all of not being wiped out in bankruptcy, or, frozen into permanent government partnership.
In our mixed economy, sooner or later, every large employer has to either fend off Washington and/or unions, or proactively trudge to Washington and maneuver to set its own terms of competition before Congress and competitors, unions, or somebody else does it for them.
I just think the auto executives didn't work sufficiently hard to make it clear under what sort of restrictive regulatory burdens they have been forced to labor. If they had, either a governmental solution would have developed earlier, before so much shareholder value was destroyed, or perhaps they could have received dispensation from many of those ill-considered laws that so affected their ability to profitably operate in the US for these past decades.
Among the more salient points Jenkins makes are,
"The talk is of synergies and cost-cutting, of tapping new lodes of cash to ride out the storm. Don't believe it. These negotiations are about one thing: creating a political last stand of American auto making that a Democratic Congress and president won't be able to resist bailing out.
All parties to the Chrysler talks have adopted Election Day as a deadline, the better to trap both presidential campaigns into committing to support a deal. But it also slipped out that iconic Ford had been GM's first choice of partner -- a prospect that could yet be resurrected now that superinvestor Kirk Kerkorian has withdrawn his vote of confidence in Ford's survival.
Congress has already agreed to provide the Big Three with $25 billion in loans to help with a shift to green cars -- likely to become plain survival cash in the event. And Congress's very nature requires throwing good money after bad, specifically financing a GM-Chrysler merger if Michigan Sen. Carl Levin has his way. Don't be surprised if President-elect Obama is dropping hints in two weeks that this also would be a good use of the $125 billion Washington just injected into J.P. Morgan, Citigroup and friends. The government could even end up owning a car company directly before it's over, as the U.K. government once owned British Leyland.
Banking in fact illustrates what might be called the GM Effect, for both industries have been around long enough to have accrued an almost incalculable baggage of government intervention, which explains why more intervention is demanded today.
Why don't the auto makers limit themselves to paying competitive wages and benefits in line with what workers could earn elsewhere? Because, in the 1930s, Congress passed the Wagner Act with the nearly explicit purpose of imposing a labor monopoly on Detroit to keep wages at higher-than-competitive levels.
Why doesn't Detroit rationalize its musty brand lineups and dealer networks? Because, in the 1950s, legislatures across the country imposed franchising laws, including the federal "dealer day-in-court clause," to make such rationalization prohibitively expensive.
Why don't the auto giants do as Whirlpool and other manufacturers have done, and move their production to cheaper offshore locales? Because, in the 1970s, Congress enacted fuel economy rules to penalize homegrown auto makers if they don't build the lion's share of their cars in high-wage, UAW-staffed domestic factories.
No, Detroit's troubles don't arise because its executives are morons. Look today at the desirable, fuel-efficient cars that GM and Ford sell in large numbers in Europe. Does anybody imagine the U.S. public derives any benefit from keeping these cars out of our country? Yet they are kept out to preserve the amour propre of the regulators who enforce our emissions and safety standards, however trivially different from Europe's standards.
Cerberus, stars in its eyes, perhaps didn't quite understand all this about the auto industry when it bought Chrysler thinking it would be free to make business-like decisions. Now it does.
Any rescue mounted today in Washington won't be so much a "rescue" as a final admission that the industry can no longer bear its regulatory burdens without direct subsidies. Any life supports GM, Ford and Chrysler are hooked up to now, for that reason, will have to be permanent."
Throughout my 3+ years of writing this blog, I have spared no sympathy for the US auto makers. My judgment has been that they've been incompetent.
Now, Jenkins offers a different view. And, to be truthful, I give him credit for making the points he has made.
Somehow, though, I don't think that means management is blameless. Rather, I view them as having decided to become willing accomplices, rather than vigorously fight and expose what was slowly done to them, law by law.
If anything, this demonstrates why real executive talent, rather than more of the usual bean-counting variety, e.g., Rick Wagoner, was required to give shareholders any chance at all of not being wiped out in bankruptcy, or, frozen into permanent government partnership.
In our mixed economy, sooner or later, every large employer has to either fend off Washington and/or unions, or proactively trudge to Washington and maneuver to set its own terms of competition before Congress and competitors, unions, or somebody else does it for them.
I just think the auto executives didn't work sufficiently hard to make it clear under what sort of restrictive regulatory burdens they have been forced to labor. If they had, either a governmental solution would have developed earlier, before so much shareholder value was destroyed, or perhaps they could have received dispensation from many of those ill-considered laws that so affected their ability to profitably operate in the US for these past decades.
Thursday, October 23, 2008
Greenspan's Shocking Admission In Today's Congressional Testimony
This morning's business news featured live feeds of former Fed Chairman Alan Greenspan defending himself during testimony before a House Banking committee.
Although video of this historic moment is not yet on YouTube, I'd bet it is by tomorrow morning.
In a stunning series of remarks, Greenspan alleged surprise that individual, self-interested players in the financial markets did not have an explicit sense of, and desire to maintain, the overall health of those markets as they knowingly engaged in risky activities, e.g., securitizing subprime and Alt-A mortgages.
To cap off his inane comments, Greenspan defended his beliefs and inaction by claiming that his 40+ year "ideology" regarding capital markets turned out to be wrong.
According to Alan, his correctly-functioning model of how markets worked went wrong in the past few years, so it's not his fault.
Moreover, in earlier remarks this morning, he asserted that he believed the operating models of various financial markets competitors were correct, but they just used 'bad data,' and, when replaced with proper data, would result in appropriate decisions and actions regarding risks.
I will be the first one to say that anyone, especially a Fed Chairman, who believes that individual players in financial markets ever look out for the system, or the 'other guy,' is an idiot.
If any sector requires careful and effective regulation, it is our financial sector. My own recommendations for reforming the current financial mess, written on September 23rd of this year, featured three prescriptions for stiffer regulations concerning leverage, exchange-based trading, and retention of securities on an underwriter's balance sheet. Only one recommendation involved loosening a current regulation, and that was to reverse Congress' misguided mandate for all firms to strictly adhere to a narrow usage of 'mark-to-market' pricing of assets, while overlooking the real value inherent in a performing, if untraded security.
Nobody who has been involved with actual banking, securities or the markets can possibly believe they need no regulation, or that any player gives a hoot about systemic issues. That is always 'someone else's' problem.
Thus my posts regarding greed and stupidity, here and here.
Here's a good example.
Back in 1990, I ran a small internal consulting group at Chase Manhattan Bank. It was also given the task of commercializing the tools we used internally. With the forced retirement of my mentor and SVP of Corporate Planning & Development, I reported to the bank's CFO.
As such, I was included in a lunch for all the CFO's direct reports in late 1990 to discuss the brewing commercial real estate problems at the bank.
What I heard was shocking. The CFO wondered aloud if we could have afforded not to compete for all these soured loans, at the height of the lending frenzy. He was fixated on revenues and market share, and seemed genuinely ignorant of the looming large chargeoffs from the excessive lending.
Later, I learned from some colleagues working directly for the CFO that when a post-mortem on the Real Estate Finance division was conducted, many loan documentation folders were literally either empty, or contained a few mostly-blank pieces of paper.
The minimum necessary paperwork for review and approval by loan committees and internal credit audit functions was nonexistent.
Nobody could explain this violation and failure of basic internal bank lending practices. But we all knew why it had happened. Bonuses for the senior management and loan officers of the unit were huge for the last two years of the lending boom.
Nobody gave them back. The bank bore the losses, while the former employees walked off with millions of dollars of 'performance' bonuses.
It's simply human behavior. Salespeople and managers will maximize that behavior which pays them the most money. They will short-circuit, corrupt or remove any checks and balances they can which interfere with that profit-maximizing behavior.
To assume otherwise, either at the business-unit level, corporation level, or among players in banking and financial markets, is to be naive and stupid.
Although video of this historic moment is not yet on YouTube, I'd bet it is by tomorrow morning.
In a stunning series of remarks, Greenspan alleged surprise that individual, self-interested players in the financial markets did not have an explicit sense of, and desire to maintain, the overall health of those markets as they knowingly engaged in risky activities, e.g., securitizing subprime and Alt-A mortgages.
To cap off his inane comments, Greenspan defended his beliefs and inaction by claiming that his 40+ year "ideology" regarding capital markets turned out to be wrong.
According to Alan, his correctly-functioning model of how markets worked went wrong in the past few years, so it's not his fault.
Moreover, in earlier remarks this morning, he asserted that he believed the operating models of various financial markets competitors were correct, but they just used 'bad data,' and, when replaced with proper data, would result in appropriate decisions and actions regarding risks.
I will be the first one to say that anyone, especially a Fed Chairman, who believes that individual players in financial markets ever look out for the system, or the 'other guy,' is an idiot.
If any sector requires careful and effective regulation, it is our financial sector. My own recommendations for reforming the current financial mess, written on September 23rd of this year, featured three prescriptions for stiffer regulations concerning leverage, exchange-based trading, and retention of securities on an underwriter's balance sheet. Only one recommendation involved loosening a current regulation, and that was to reverse Congress' misguided mandate for all firms to strictly adhere to a narrow usage of 'mark-to-market' pricing of assets, while overlooking the real value inherent in a performing, if untraded security.
Nobody who has been involved with actual banking, securities or the markets can possibly believe they need no regulation, or that any player gives a hoot about systemic issues. That is always 'someone else's' problem.
Thus my posts regarding greed and stupidity, here and here.
Here's a good example.
Back in 1990, I ran a small internal consulting group at Chase Manhattan Bank. It was also given the task of commercializing the tools we used internally. With the forced retirement of my mentor and SVP of Corporate Planning & Development, I reported to the bank's CFO.
As such, I was included in a lunch for all the CFO's direct reports in late 1990 to discuss the brewing commercial real estate problems at the bank.
What I heard was shocking. The CFO wondered aloud if we could have afforded not to compete for all these soured loans, at the height of the lending frenzy. He was fixated on revenues and market share, and seemed genuinely ignorant of the looming large chargeoffs from the excessive lending.
Later, I learned from some colleagues working directly for the CFO that when a post-mortem on the Real Estate Finance division was conducted, many loan documentation folders were literally either empty, or contained a few mostly-blank pieces of paper.
The minimum necessary paperwork for review and approval by loan committees and internal credit audit functions was nonexistent.
Nobody could explain this violation and failure of basic internal bank lending practices. But we all knew why it had happened. Bonuses for the senior management and loan officers of the unit were huge for the last two years of the lending boom.
Nobody gave them back. The bank bore the losses, while the former employees walked off with millions of dollars of 'performance' bonuses.
It's simply human behavior. Salespeople and managers will maximize that behavior which pays them the most money. They will short-circuit, corrupt or remove any checks and balances they can which interfere with that profit-maximizing behavior.
To assume otherwise, either at the business-unit level, corporation level, or among players in banking and financial markets, is to be naive and stupid.
Wednesday, October 22, 2008
Celebrity Investors: Kerkorian vs. Buffett
Kirk Kerkorian made major headlines yesterday and today by announcing the reduction of his stake in Ford Motor Company.
According to most stories, the seasoned investor has lost about 70% of the value of his Ford position, or roughly $690 million on a $1B investment earlier this year.
Kerkorian's Tracinda Corporation, his investment vehicle, is privately held, so we can't really know his, or its performance over the decades during which he has been a prominent investor. He's been at it for quite some time, though. I vividly recall a problem in a graduate accounting course which featured an article detailing Kerkorian's transformation of MGM into his personal money machine. He ended up controlling the company's voting shares in such a way that he could use it as an ATM, declaring a dividend payable largely to himself, at will.
The other celebrity investor who comes to mind, of course, is Warren Buffett. Buffett works through the publicly-held Berkshire Hathaway, and maintains a high profile. He has made himself the darling of the CNBC set, publicly jumping on the Obama bandwagon, and no doubt enjoyed being mentioned by both candidates in a debate earlier this fall.
Nearby is a 5-year price chart for Berkshire and the S&P500 Index. It's easy to see that, despite all Buffett's publicity, you'd have been better off, on a risk-adjusted basis, owning the S&P for most of the past five years. Since 2003 market the onset of the most recent period of an up market for equities, this chart tells you that Buffett, no matter what he might have once done, is no longer a serious outperformer in healthy equity markets.
The accompanying 2-year view of the same series gives a closer look at the split, whereupon Berkshire parted company with the index and began to outperform it.When the very beginning of the current financial crisis began to be noticeable, in August of last year, Berkshire rose, while the S&P flattened, then, of course, began to significantly slide in the spring of this year.
Looking at just the past six months, in this chart, we see that, even recently, Berkshire tracked the index almost perfectly until the carnage in September. In fact, in the brief period of a 'false positive' in May, Berkshire actually underperformed the index.My point is that, on evidence of the past five years, Buffett's Berkshire is hardly the paragon of investing prowess that so many believe when referring to him as the "Oracle of Omaha."
Even in recent months, his bets have been focused on lending money, at very high interest rates, to better-quality US firms, e.g., Goldman Sachs and GE. It's a bit galling to hear Buffett mentioned in Congressional hearings by our elected representatives as if he's some sort of investment deity, when, in fact, his record is actually so inconsistent, or, at best, usually mediocre.
Because Tracinda leaves no long term footprints, it's impossible to show a comparative chart of Buffett's and Kerkorian's performance. But I can't help suspecting that Kerkorian has a better, more consistent track record over time.
Call it my innate scepticism, but I'm leery of Buffett's obvious use of his own public image as the best investor on the planet to draw attention away from his firm's actual performance, versus the market, over time.
Ironically, I'm more impressed with the entire Kerkorian saga of investing in the auto sector. I wrote about it, and Buffett's Mars-Wrigley investment, in this post, back in May of this year.
While Kerkorian didn't realize his objectives with his Ford stake, you cannot criticize him for a lack of appetite for risk. A Wall Street Journal article attributed some of Kerkorian's motivation for selling his Ford stake to the recent departures of the CFO and a board member, raising the specter of increased control by the Ford family.
Whatever the reasons, I sense, in Kerkorian's shunning of the public spotlight, a more hard-nosed, focused approach to finding opportunities for investing. I wish we all knew more about his investment performance over the years.
It would be a fascinating comparison.
Tuesday, October 21, 2008
Bernanke On Yet Another Pointless Congressional "Stimulus" Package
Did you see Fed Chairman Ben Bernanke's testimony on Capitol Hill yesterday?
An editorial in today's Wall Street Journal characterized it as Ben's application for another term as Fed Chair.
I'm referring, of course, to his fawning and eager agreement that Congress should pass another multi-hundred billion dollar 'stimulus' package.
Surely Bernanke doesn't think we saw any lasting effects of the last stimulus, does he? Other than increasing a deficit with which Congressional Democrats have tarred President Bush for years, it didn't make any difference.
Am I the only person left who believes that only permanent tax rate cuts have a quick and lasting effect on economic behavior?
Or, having passed a $700B 'urgent' TARP bill that has been dwarfed by the Treasury buying equity in our nation's banks, has Congress simply decided it no longer matters what deficits we create by paying citizens to spend now?
This just makes no sense whatsoever. It seems that any sense of self-reliance in our country has vanished.
An editorial in today's Wall Street Journal characterized it as Ben's application for another term as Fed Chair.
I'm referring, of course, to his fawning and eager agreement that Congress should pass another multi-hundred billion dollar 'stimulus' package.
Surely Bernanke doesn't think we saw any lasting effects of the last stimulus, does he? Other than increasing a deficit with which Congressional Democrats have tarred President Bush for years, it didn't make any difference.
Am I the only person left who believes that only permanent tax rate cuts have a quick and lasting effect on economic behavior?
Or, having passed a $700B 'urgent' TARP bill that has been dwarfed by the Treasury buying equity in our nation's banks, has Congress simply decided it no longer matters what deficits we create by paying citizens to spend now?
This just makes no sense whatsoever. It seems that any sense of self-reliance in our country has vanished.
Must Bankers Always Be Stupid and Overly Opportunistic?
I wrote a post about a month focusing on how regulation won't ever prevent stupidity and excessive opportunism, from running amok in business- even financial services.
This came to mind because of a discussion I had with my business partner and several acquaintances on Saturday morning. We are all involved in some facet of the financial sector, and were discussing the origins of the current crisis, and what would eventually resolve it.
One salient topic was the 'too big to fail' nature of US commercial banks. My acquaintances felt that had to somehow be remedied by the spread of banking assets among other organizations. I, to the contrary, felt that technology has made banking concentration inevitable, as I wrote here, recently,
"With technology and market concentration of banking, we have probably crossed an important Rubicon years ago. Ben Bernanke's answer to a question at yesterday's lunch at the Economic Club of New York, where he spoke, did not, to me, seem to acknowledge the obvious.
At this point, I think Bernanke would do well to accept that the speed with which financial markets can process data and trade, and, thus, the degree to which they have relied on large investments in information technology systems and software have been a significant factor in the concentration of financial assets in just a handful of large US banks.
This will not change now. So, yes, I believe, contrary to Bernanke's assertion, that each of those banks into which Treasury has invested some of its initial $250B is, indeed, 'too big to fail.'"
Perhaps the scariest moment of the conversation on Saturday, however, was when we discussed bank lending officer stupidity in making mortgage loans based on marginal borrower capacities to repay or, worse, no data.
How, I asked, are we to prevent future systemic problems like we are now experiencing, if bankers are too stupid to know what kind of loan to deny?
My colleagues alleged that, if a given banker said "no," another one at the next bank would simply say "yes."
Thus, my argument, which I then voiced, for Federal regulation of core bank lending so heavy as to put the sector on the equivalent of thorazine. They laughed, but then they actually agreed.
You have to ask yourself, how can we ever design and operate a 'safe' banking system if we have to constantly worry that misguided, stupid bank CEOs will push for growth in a sector in which that always means taking excessive risks?
I think it is by clamping down on core, insured and quasi-government-owned banks with inflexible guidelines for loan qualifications.
This came to mind because of a discussion I had with my business partner and several acquaintances on Saturday morning. We are all involved in some facet of the financial sector, and were discussing the origins of the current crisis, and what would eventually resolve it.
One salient topic was the 'too big to fail' nature of US commercial banks. My acquaintances felt that had to somehow be remedied by the spread of banking assets among other organizations. I, to the contrary, felt that technology has made banking concentration inevitable, as I wrote here, recently,
"With technology and market concentration of banking, we have probably crossed an important Rubicon years ago. Ben Bernanke's answer to a question at yesterday's lunch at the Economic Club of New York, where he spoke, did not, to me, seem to acknowledge the obvious.
At this point, I think Bernanke would do well to accept that the speed with which financial markets can process data and trade, and, thus, the degree to which they have relied on large investments in information technology systems and software have been a significant factor in the concentration of financial assets in just a handful of large US banks.
This will not change now. So, yes, I believe, contrary to Bernanke's assertion, that each of those banks into which Treasury has invested some of its initial $250B is, indeed, 'too big to fail.'"
Perhaps the scariest moment of the conversation on Saturday, however, was when we discussed bank lending officer stupidity in making mortgage loans based on marginal borrower capacities to repay or, worse, no data.
How, I asked, are we to prevent future systemic problems like we are now experiencing, if bankers are too stupid to know what kind of loan to deny?
My colleagues alleged that, if a given banker said "no," another one at the next bank would simply say "yes."
Thus, my argument, which I then voiced, for Federal regulation of core bank lending so heavy as to put the sector on the equivalent of thorazine. They laughed, but then they actually agreed.
You have to ask yourself, how can we ever design and operate a 'safe' banking system if we have to constantly worry that misguided, stupid bank CEOs will push for growth in a sector in which that always means taking excessive risks?
I think it is by clamping down on core, insured and quasi-government-owned banks with inflexible guidelines for loan qualifications.
Monday, October 20, 2008
More Debate On Glass-Steagall
This past weekend's Wall Street Journal published an editorial by Charles W. Calomiris, a Columbia Business School professor, entitled, "Most Pundits Are Wrong About the Bubble."
In his piece, Calomiris contends,
"As for the evils of deregulation, exactly which measures are they referring to? Financial deregulation for the past three decades consisted of the removal of deposit interest-rate ceilings, the relaxation of branching powers, and allowing commercial banks to enter underwriting and insurance and other financial activities. Wasn't the ability for commercial and investment banks to merge (the result of the 1999 Gramm-Leach-Bliley Act, which repealed part of the 1933 Glass-Steagall Act) a major stabilizer to the financial system this past year? Indeed, it allowed Bear Stearns and Merrill Lynch to be acquired by J.P. Morgan Chase and Bank of America, and allowed Goldman Sachs and Morgan Stanley to convert to bank holding companies to help shore up their positions during the mid-September bear runs on their stocks."
I disagree. Calomiris' retroactive judgment of the repeal of Glass-Steagall suggests that, even if it was a mistake, its absence let the mess which developed in its absence be cleaned up in a manner which would not have been quite so neat without its absence.
Sound like circular reasoning to you? Me, too.
No, as I wrote here in March of this year, the true effects of Glass-Steagall's repeal were slower to observe. But Gerry Weiss, my boss and one-time SVP and Chief Planning Officer of Chase Manhattan Bank for David Rockefeller, noted this in the 1980s. As I wrote in that post,
"My long-ago mentor at Chase Manhattan Bank, then-SVP of Corporate Planning & Development, Gerry Weiss, was fond of saying, when asked about working to remove Glass-Steagall, something like,
'Are you kidding? We'll just find some new ways to lose a lot of money on badly risk-managed positions. Not to mention that, being commercial bankers, once we get into these businesses- M&A, underwriting, equity trading- we'll cut prices to gain share and ruin the business' profitability for all concerned.'
Judging by the behavior of Citigroup and BofA in last summer's CDO, SIV and other fixed income messes, I'd say he was right on the money, as it were, as usual.
Commercial banks appear to be no better off in terms of profitability, risk management or total return after the repeal of Glass-Steagall."
It was this effect of the repeal of Glass-Steagall on the commercial banks, not the investment banks, which began the slide into our current mess.
In fact, to illustrate that investment and commercial banks were misbehaving, and losing money, with respect to mortgages long before our current financial crisis, consider what happened with Norwest Bank's large mortgage business, in conjunction with Salomon Brothers, back in the 1980s.
Norwest ran a huge mortgage lending and securitization pipeline, or 'conduit.' The latter was known as "RFC," for Residential Funding Corporation. Norwest owned RFC, but Salomon distributed the resulting securities because, at the time, it was illegal for Norwest to do the securities underwriting itself.
As such, Salomon enjoyed a sweet margin on the securitization, with no asset risk on the pipeline. But it was largely understood throughout the industry that RFC was structured and operated with guidance from Salomon.
At some point, RFC mishedged its enormous inventory of mortgages, and doubled up on an interest rate bet, rather than hedged it. Subsequent losses sank Norwest as an independent bank, while Salomon managed to scoop up RFC for a pittance.
Calomiris goes on to contend,
"Even more to the point, subprime lending, securitization and dealing in swaps were all activities that banks and other financial institutions have had the ability to engage in all along. There is no connection between any of these and deregulation. On the contrary, it was the ever-growing Basel Committee rules for measuring bank risk and allocating capital to absorb that risk (just try reading the Basel standards if you don't believe me) that failed miserably. The Basel rules outsourced the measurement of risk to ratings agencies or to the modelers within the banks themselves. Incentives were not properly aligned, as those that measured risk profited from underestimating it and earned large fees for doing so."
Once again, I disagree with his contention regarding the effect of deregulation on various activities.
Why do you suppose, prior to the repeal of Glass-Steagall, no investment banks engaged in buying and operating mortgage underwriting banks? Or creating large, highly-leveraged mutual funds investing in mortgage-backed securities?
Again, I point to Weiss' prescience on the consequences of removing that regulatory barrier. The subsequent thinning of investment bank profit margins led to these non-deposit funded companies boosting leverage to previously-unheard-of levels, in an attempt to maintain profit margins and growth.
Ironically, the lenders of this highly-leveraged money were.....commercial bank broker-dealer desks!
So Calomiris is wrong to suggest that all of what has transpired since the repeal could or would have happened anyway.
Structurally, investment banks could always do what commercial banks did, except for having access to the Fed window and offering DDA accounts. The repeal of Glass-Steagall drove the weaker-capitalized players, i.e., investment banks, to take more risks.
Calomiris ends with the contention,
"The single most important reform that is needed is the restoration of discipline in the measurement of risk within the banking system."
He's probably correct in this sentiment. The problem, of course, is how to define, measure and calibrate 'risk' in such a broad context.
Particularly when so much of the time, 'risk' can morph from, say, instrument to counterparty risk in the blink of an eye.
We're a long, long way from being able to rely on risk measurement on the panacea to solve our financial market problems.
In his piece, Calomiris contends,
"As for the evils of deregulation, exactly which measures are they referring to? Financial deregulation for the past three decades consisted of the removal of deposit interest-rate ceilings, the relaxation of branching powers, and allowing commercial banks to enter underwriting and insurance and other financial activities. Wasn't the ability for commercial and investment banks to merge (the result of the 1999 Gramm-Leach-Bliley Act, which repealed part of the 1933 Glass-Steagall Act) a major stabilizer to the financial system this past year? Indeed, it allowed Bear Stearns and Merrill Lynch to be acquired by J.P. Morgan Chase and Bank of America, and allowed Goldman Sachs and Morgan Stanley to convert to bank holding companies to help shore up their positions during the mid-September bear runs on their stocks."
I disagree. Calomiris' retroactive judgment of the repeal of Glass-Steagall suggests that, even if it was a mistake, its absence let the mess which developed in its absence be cleaned up in a manner which would not have been quite so neat without its absence.
Sound like circular reasoning to you? Me, too.
No, as I wrote here in March of this year, the true effects of Glass-Steagall's repeal were slower to observe. But Gerry Weiss, my boss and one-time SVP and Chief Planning Officer of Chase Manhattan Bank for David Rockefeller, noted this in the 1980s. As I wrote in that post,
"My long-ago mentor at Chase Manhattan Bank, then-SVP of Corporate Planning & Development, Gerry Weiss, was fond of saying, when asked about working to remove Glass-Steagall, something like,
'Are you kidding? We'll just find some new ways to lose a lot of money on badly risk-managed positions. Not to mention that, being commercial bankers, once we get into these businesses- M&A, underwriting, equity trading- we'll cut prices to gain share and ruin the business' profitability for all concerned.'
Judging by the behavior of Citigroup and BofA in last summer's CDO, SIV and other fixed income messes, I'd say he was right on the money, as it were, as usual.
Commercial banks appear to be no better off in terms of profitability, risk management or total return after the repeal of Glass-Steagall."
It was this effect of the repeal of Glass-Steagall on the commercial banks, not the investment banks, which began the slide into our current mess.
In fact, to illustrate that investment and commercial banks were misbehaving, and losing money, with respect to mortgages long before our current financial crisis, consider what happened with Norwest Bank's large mortgage business, in conjunction with Salomon Brothers, back in the 1980s.
Norwest ran a huge mortgage lending and securitization pipeline, or 'conduit.' The latter was known as "RFC," for Residential Funding Corporation. Norwest owned RFC, but Salomon distributed the resulting securities because, at the time, it was illegal for Norwest to do the securities underwriting itself.
As such, Salomon enjoyed a sweet margin on the securitization, with no asset risk on the pipeline. But it was largely understood throughout the industry that RFC was structured and operated with guidance from Salomon.
At some point, RFC mishedged its enormous inventory of mortgages, and doubled up on an interest rate bet, rather than hedged it. Subsequent losses sank Norwest as an independent bank, while Salomon managed to scoop up RFC for a pittance.
Calomiris goes on to contend,
"Even more to the point, subprime lending, securitization and dealing in swaps were all activities that banks and other financial institutions have had the ability to engage in all along. There is no connection between any of these and deregulation. On the contrary, it was the ever-growing Basel Committee rules for measuring bank risk and allocating capital to absorb that risk (just try reading the Basel standards if you don't believe me) that failed miserably. The Basel rules outsourced the measurement of risk to ratings agencies or to the modelers within the banks themselves. Incentives were not properly aligned, as those that measured risk profited from underestimating it and earned large fees for doing so."
Once again, I disagree with his contention regarding the effect of deregulation on various activities.
Why do you suppose, prior to the repeal of Glass-Steagall, no investment banks engaged in buying and operating mortgage underwriting banks? Or creating large, highly-leveraged mutual funds investing in mortgage-backed securities?
Again, I point to Weiss' prescience on the consequences of removing that regulatory barrier. The subsequent thinning of investment bank profit margins led to these non-deposit funded companies boosting leverage to previously-unheard-of levels, in an attempt to maintain profit margins and growth.
Ironically, the lenders of this highly-leveraged money were.....commercial bank broker-dealer desks!
So Calomiris is wrong to suggest that all of what has transpired since the repeal could or would have happened anyway.
Structurally, investment banks could always do what commercial banks did, except for having access to the Fed window and offering DDA accounts. The repeal of Glass-Steagall drove the weaker-capitalized players, i.e., investment banks, to take more risks.
Calomiris ends with the contention,
"The single most important reform that is needed is the restoration of discipline in the measurement of risk within the banking system."
He's probably correct in this sentiment. The problem, of course, is how to define, measure and calibrate 'risk' in such a broad context.
Particularly when so much of the time, 'risk' can morph from, say, instrument to counterparty risk in the blink of an eye.
We're a long, long way from being able to rely on risk measurement on the panacea to solve our financial market problems.
Anna Schwartz' Thoughts On The Current Financial Crisis
The weekend Wall Street Journal carried two interesting editorials regarding economics and banking.
The first was a thought-provoking interview with Anna Schwartz, co-author of "A Monetary History of the United States," with the late Milton Friedman.
In the half-page piece, Schwartz, now 92 years old, maintained that current Fed chairman Bernanke is 'fighting the last war,' against illiquidity, when today's problem is counterparty risk and market valuation uncertainty.
What's troubling to me is these passages,
"Ms. Schwartz won't say so, but this is the dirty little secret that led Secretary Paulson to shift from buying bank assets to recapitalizing them directly, as the Treasury did this week. But in doing so, he's shifted from trying to save the banking system to trying to save banks. These are not, Ms. Schwartz argues, the same thing. In fact, by keeping otherwise insolvent banks afloat, the Federal Reserve and the Treasury have actually prolonged the crisis. "They should not be recapitalizing firms that should be shut down."
Rather, "firms that made wrong decisions should fail," she says bluntly. "You shouldn't rescue them. And once that's established as a principle, I think the market recognizes that it makes sense. Everything works much better when wrong decisions are punished and good decisions make you rich." The trouble is, "that's not the way the world has been going in recent years."
Instead, we've been hearing for most of the past year about "systemic risk" -- the notion that allowing one firm to fail will cause a cascade that will take down otherwise healthy companies in its wake.
Ms. Schwartz doesn't buy it. "It's very easy when you're a market participant," she notes with a smile, "to claim that you shouldn't shut down a firm that's in really bad straits because everybody else who has lent to it will be injured. Well, if they lent to a firm that they knew was pretty rocky, that's their responsibility. And if they have to be denied repayment of their loans, well, they wished it on themselves. The [government] doesn't have to save them, just as it didn't save the stockholders and the employees of Bear Stearns. Why should they be worried about the creditors? Creditors are no more worthy of being rescued than ordinary people, who are really innocent of what's been going on."
It takes real guts to let a large, powerful institution go down. But the alternative -- the current credit freeze -- is worse, Ms. Schwartz argues.
"I think if you have some principles and know what you're doing, the market responds. They see that you have some structure to your actions, that it isn't just ad hoc -- you'll do this today but you'll do something different tomorrow. And the market respects people in supervisory positions who seem to be on top of what's going on. So I think if you're tough about firms that have invested unwisely, the market won't blame you. They'll say, 'Well, yeah, it's your fault. You did this. Nobody else told you to do it. Why should we be saving you at this point if you're stuck with assets you can't sell and liabilities you can't pay off?'" But when the authorities finally got around to letting Lehman Brothers fail, it had saved so many others already that the markets didn't know how to react. Instead of looking principled, the authorities looked erratic and inconstant."
Ms. Schwartz provides a clear counterpoint to the effective message given to investors and banking executives in the past year. That is, rather than consistent, understandable, principled action, Bernanke, Paulson & Bair have seemingly lurched from crisis to crisis.
Viewing the past 15 months in the financial markets from Schwartz's perspective, we should have seen, beginning with the failure of the two Bear Stearns highly-leveraged mutual funds, a concerted, consistent philosophy in action by the Fed, Treasury, FDIC and SEC.
If that philosophy were to let imprudent institutions fail, and this were clearly articulated in advance, maybe counterparty would have remained at levels of early last year. Or, maybe the explicit promise to let institutions fail would have sparked the recent credit freeze-up 15 months ago.
While I personally share Ms. Schwartz's belief that moral hazard has to remain a credible force in financial markets, our current, consolidated banking sector, with its 3-4 super-sized institutions, might not sustain a strict expression of her preferred philosophy.
I do believe, however, that, back in July of last year, the modification- and I stress that word, rather than 'suspension'- of 'mark-to-market' valuation rules would have avoided at least $150B of asset evaporation among securities which were not all non-performing.
But that wasn't done. And Ms. Schwartz's conjecture about Paulson not realizing that buying distressed CDOs at market values would destroy bank capital is truly frightening. Surely this was not a mystery. I even wrote about it in this post, nearly a month ago.
The interview ends with this passage,
"But perhaps this is actually Mr. Bernanke's biggest problem. Today's crisis isn't a replay of the problem in the 1930s, but our central bankers have responded by using the tools they should have used then. They are fighting the last war. The result, she argues, has been failure. "I don't see that they've achieved what they should have been trying to achieve. So my verdict on this present Fed leadership is that they have not really done their job." "
It leaves me thinking that Schwartz is right, even if we don't know precisely how her recommendations would have had an impact on the financial markets.
If mark-to-market were modified, but regulators warned of forced closures of insolvent institutions, would this not have provided for the avoidance of needless destruction of value in performing, but untradeable, securities, while also providing a less-capricious process for treating troubled institutions?
Perhaps there would have been a quicker consolidation of overly-leveraged investment banks with commercial banks, while weaker commercial banks would have merged before the regulators closed them.
As Schwartz theorizes, the remaining fewer, stronger institutions might have resulted in the avoidance of a credit freeze, as only healthy institutions remained, with performing assets so valued.
Further, her approach would have required no draconian actions last summer or fall, when the lack of drastic market behaviors would have failed to support a public understanding of a need for radical action.
On this basis, her judgment of the Fed's performance might, indeed, be correct.
The first was a thought-provoking interview with Anna Schwartz, co-author of "A Monetary History of the United States," with the late Milton Friedman.
In the half-page piece, Schwartz, now 92 years old, maintained that current Fed chairman Bernanke is 'fighting the last war,' against illiquidity, when today's problem is counterparty risk and market valuation uncertainty.
What's troubling to me is these passages,
"Ms. Schwartz won't say so, but this is the dirty little secret that led Secretary Paulson to shift from buying bank assets to recapitalizing them directly, as the Treasury did this week. But in doing so, he's shifted from trying to save the banking system to trying to save banks. These are not, Ms. Schwartz argues, the same thing. In fact, by keeping otherwise insolvent banks afloat, the Federal Reserve and the Treasury have actually prolonged the crisis. "They should not be recapitalizing firms that should be shut down."
Rather, "firms that made wrong decisions should fail," she says bluntly. "You shouldn't rescue them. And once that's established as a principle, I think the market recognizes that it makes sense. Everything works much better when wrong decisions are punished and good decisions make you rich." The trouble is, "that's not the way the world has been going in recent years."
Instead, we've been hearing for most of the past year about "systemic risk" -- the notion that allowing one firm to fail will cause a cascade that will take down otherwise healthy companies in its wake.
Ms. Schwartz doesn't buy it. "It's very easy when you're a market participant," she notes with a smile, "to claim that you shouldn't shut down a firm that's in really bad straits because everybody else who has lent to it will be injured. Well, if they lent to a firm that they knew was pretty rocky, that's their responsibility. And if they have to be denied repayment of their loans, well, they wished it on themselves. The [government] doesn't have to save them, just as it didn't save the stockholders and the employees of Bear Stearns. Why should they be worried about the creditors? Creditors are no more worthy of being rescued than ordinary people, who are really innocent of what's been going on."
It takes real guts to let a large, powerful institution go down. But the alternative -- the current credit freeze -- is worse, Ms. Schwartz argues.
"I think if you have some principles and know what you're doing, the market responds. They see that you have some structure to your actions, that it isn't just ad hoc -- you'll do this today but you'll do something different tomorrow. And the market respects people in supervisory positions who seem to be on top of what's going on. So I think if you're tough about firms that have invested unwisely, the market won't blame you. They'll say, 'Well, yeah, it's your fault. You did this. Nobody else told you to do it. Why should we be saving you at this point if you're stuck with assets you can't sell and liabilities you can't pay off?'" But when the authorities finally got around to letting Lehman Brothers fail, it had saved so many others already that the markets didn't know how to react. Instead of looking principled, the authorities looked erratic and inconstant."
Ms. Schwartz provides a clear counterpoint to the effective message given to investors and banking executives in the past year. That is, rather than consistent, understandable, principled action, Bernanke, Paulson & Bair have seemingly lurched from crisis to crisis.
Viewing the past 15 months in the financial markets from Schwartz's perspective, we should have seen, beginning with the failure of the two Bear Stearns highly-leveraged mutual funds, a concerted, consistent philosophy in action by the Fed, Treasury, FDIC and SEC.
If that philosophy were to let imprudent institutions fail, and this were clearly articulated in advance, maybe counterparty would have remained at levels of early last year. Or, maybe the explicit promise to let institutions fail would have sparked the recent credit freeze-up 15 months ago.
While I personally share Ms. Schwartz's belief that moral hazard has to remain a credible force in financial markets, our current, consolidated banking sector, with its 3-4 super-sized institutions, might not sustain a strict expression of her preferred philosophy.
I do believe, however, that, back in July of last year, the modification- and I stress that word, rather than 'suspension'- of 'mark-to-market' valuation rules would have avoided at least $150B of asset evaporation among securities which were not all non-performing.
But that wasn't done. And Ms. Schwartz's conjecture about Paulson not realizing that buying distressed CDOs at market values would destroy bank capital is truly frightening. Surely this was not a mystery. I even wrote about it in this post, nearly a month ago.
The interview ends with this passage,
"But perhaps this is actually Mr. Bernanke's biggest problem. Today's crisis isn't a replay of the problem in the 1930s, but our central bankers have responded by using the tools they should have used then. They are fighting the last war. The result, she argues, has been failure. "I don't see that they've achieved what they should have been trying to achieve. So my verdict on this present Fed leadership is that they have not really done their job." "
It leaves me thinking that Schwartz is right, even if we don't know precisely how her recommendations would have had an impact on the financial markets.
If mark-to-market were modified, but regulators warned of forced closures of insolvent institutions, would this not have provided for the avoidance of needless destruction of value in performing, but untradeable, securities, while also providing a less-capricious process for treating troubled institutions?
Perhaps there would have been a quicker consolidation of overly-leveraged investment banks with commercial banks, while weaker commercial banks would have merged before the regulators closed them.
As Schwartz theorizes, the remaining fewer, stronger institutions might have resulted in the avoidance of a credit freeze, as only healthy institutions remained, with performing assets so valued.
Further, her approach would have required no draconian actions last summer or fall, when the lack of drastic market behaviors would have failed to support a public understanding of a need for radical action.
On this basis, her judgment of the Fed's performance might, indeed, be correct.
Sunday, October 19, 2008
Immelt's GE Continues To Struggle
Having recently talked with some friends who read this blog, I am now aware that there are readers who consider some of my posts to be 'rants.' Such as this recent one about Jamie Dimon's wrong-headedness regarding the current, strict application of a narrowly-specified 'mark-to-market' accounting rule.
It's safe to say that my attitude toward CEOs and other grandees tends to be, well, sceptical.
Perhaps because I've met enough of them in my career to know that the bulk of them did not rise due to merit. Or maybe it was due to my boss at Chase Manhattan Bank, Gerry Weiss, making sure that colleagues of mine, and I, had lots of exposure to senior bank executives, the better to learn just how mediocre most of them were.
In any case, I'm not especially reverent to just anyone who heads a large company, but a CEO who can consistently outperform the market's total return usually gets positive remarks from me. In contrast, a CEO who can't usually gets negative remarks.
Thus, I'm not particularly impressed with the current CEOs of Chase or Citigroup. Both Dimon and Pandit seem to have lucked into their positions, rather than earned them via long and consistently superior management of some other business or company. Neither is the sort of CEO I'd prefer to be at the helm of one of the largest US commercial banks during this time of extreme stress in that sector.
Today, I touch, again, upon a similar, frequent topic on my blog: GE's hapless, inept CEO, Jeff Immelt.
This time, following on my last post about him and his company less than a month ago, once again, GE's financial business exposure has cost its shareholders plenty.
As I wrote last month,
"Suffice to say, though, that if GE didn't have its huge financial unit, it would not have experienced such a severe recent decline in its stock price and, its total return."
Sadly, judging by the nearby, 5-day price chart for GE and the S&P500 Index, it's true all over again.
In only five days, GE's stock price dropped almost 10%, while the index held steady. It seems that continuing troubles in the financial services sector have exposed all of GE, due to its needlessly-diversified structure, directly to the consequences of the current credit market woes.
Looking at the last 12 months of price performance, as depicted by the second chart, GE has lost about half of its value, while the S&P managed to drop by a lesser amount, 40%.
As I've written frequently in prior posts, if Immelt had broken up GE sometime during his futile, value-destroying 6+ year reign, most of GE's businesses would not have been tarred so heavily with the financial sector brush.
Good job, Jeff.
Once again, your stodgy, 'play it safe' mentality has seriously hurt your shareholders.
How much more of this will it take before GE shareholders push the company's board to oust this underperforming CEO?
It's safe to say that my attitude toward CEOs and other grandees tends to be, well, sceptical.
Perhaps because I've met enough of them in my career to know that the bulk of them did not rise due to merit. Or maybe it was due to my boss at Chase Manhattan Bank, Gerry Weiss, making sure that colleagues of mine, and I, had lots of exposure to senior bank executives, the better to learn just how mediocre most of them were.
In any case, I'm not especially reverent to just anyone who heads a large company, but a CEO who can consistently outperform the market's total return usually gets positive remarks from me. In contrast, a CEO who can't usually gets negative remarks.
Thus, I'm not particularly impressed with the current CEOs of Chase or Citigroup. Both Dimon and Pandit seem to have lucked into their positions, rather than earned them via long and consistently superior management of some other business or company. Neither is the sort of CEO I'd prefer to be at the helm of one of the largest US commercial banks during this time of extreme stress in that sector.
Today, I touch, again, upon a similar, frequent topic on my blog: GE's hapless, inept CEO, Jeff Immelt.
This time, following on my last post about him and his company less than a month ago, once again, GE's financial business exposure has cost its shareholders plenty.
As I wrote last month,
"Suffice to say, though, that if GE didn't have its huge financial unit, it would not have experienced such a severe recent decline in its stock price and, its total return."
Sadly, judging by the nearby, 5-day price chart for GE and the S&P500 Index, it's true all over again.
In only five days, GE's stock price dropped almost 10%, while the index held steady. It seems that continuing troubles in the financial services sector have exposed all of GE, due to its needlessly-diversified structure, directly to the consequences of the current credit market woes.
As I've written frequently in prior posts, if Immelt had broken up GE sometime during his futile, value-destroying 6+ year reign, most of GE's businesses would not have been tarred so heavily with the financial sector brush.
Good job, Jeff.
Once again, your stodgy, 'play it safe' mentality has seriously hurt your shareholders.
How much more of this will it take before GE shareholders push the company's board to oust this underperforming CEO?
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