Last week's Wall Street Journal of Wednesday, November 12, sounded an alarm regarding AIG's continuing credit default swaps positions.
However, just this week, a Journal article contended that, of all the malfunctioning fixed-income markets, the CDS market had actually done remarkably well during the past few months, including settling the now-defunct Lehman positions.
According to the editorial, CDS pricing now provides a better, more continuous measure of the value of debt of many firms than their own, non-trading debt does.
Even so, I can't help but believe that the CDS market would do better in the future if two things were changed, as I have suggested in prior posts: create a formal exchange, and; restrict the leverage allowed for entities holding and trading CDS.
The first change would provide greater transparency for many aspects of the CDS market, including gross and net outstanding volumes, trading volumes, and a better identification of the major players who, therefore, are exposed to risk in the market.
The second change would limit the damage to the CDS market and, by extension, to other markets, by assuring the availability of equity for CDS positions which require more collateral, as could be required by the exchange on an intra-day basis.
Together, these improvements would limit the likelihood that another mess like that which consumed AIG could occur. Exchanges monitor the financial ability of members to fulfill their obligations to other members, which would have provided a more public warning regarding AIG's over-extension in CDSs.
I don't doubt the CDS market is vital. But leaving it to exist as an over-the-counter market with no clear rules or standard clearing mechanisms invites another disaster by another firm as inept as AIG was at correctly assessing its risks under the many billions of dollars worth of securities price protection it sold as CDSs.
Thursday, November 20, 2008
Wednesday, November 19, 2008
Four Pigs At The Trough: Auto CEOs & UAW Chief Beg For Government Rescue
Today, as I worked on various posts and equity/options management activities, I listened and watched the morning's entertainment. By that I mean the appearance of the Four Pigs from Detroit- CEOs Wagoner of GM, Mulally of Ford, Nardelli of Chrysler/Cerebrus, and Gettelfinger of the UAW.
Yes, even UAW chief Ron Gettelfinger has cheerfully pitched in. In a moment of pure deceit, Gettelfinger alleged that, failing a massive, immediate cash infusion by the government into GM, Ford and Chrysler, at least GM would be forced to file a Chapter 7 bankruptcy.
Gettelfinger's wrong. I checked online, and chapter 7 means, in effect, immediate liquidation. Nobody is suggesting that for GM.
Instead, a Chapter 11 reorganization is the logical alternative. Of course, in this scenario, Gettelfinger knows he's going to have to force his UAW members to swallow massive benefit cuts. And Gettelfinger's days as a powerful union boss will be shortened, as perhaps the largest remaining, old-line unionized sector in America takes a giant step closer to oblivion.
Among the more hilarious moments I saw before dashing off to a business meeting were these:
-Rick Wagoner fumbling for about five minutes, with no clear 'elevator pitch' reply to the question,
'Just how much money do you need? When are you going to run out of money now?'
Wagoner failed miserably to provide a clear, concise grasp of his own company's financial situation. If he were applying for a management job at the company he misleads, and provided such a response in a job interview, I'm sure he'd be rejected forthwith.
-A Democratic Congresswoman noting, while unable to pronounce the name of Cerebrus, and being obviously totally unaware of what it is or that it owns Chrysler, that by bailing the auto company out, Congress was essentially providing public financing to a private equity firm partially-owned by two vociferously free-markt Republican former-office holders; John Snow and Dan Quayle.
When Nardelli generously offered that Cerebrus would surrender 'all upside potential' in Chrysler, in exchange for this public bailout, he was tacitly admitting, as my partner agreed, that Cerebrus sees no hope whatsoever for any profit from its Chrysler deal. Thus, it is willing to surrender 100% of nothing, to get a percentage of the requested $25B 'loan.' A loan which only Wagoner, Mulally and Nardelli may actually believe will ever be repaid.
-Various Democratic Congress members reading from obviously-scripted statements provided to them by auto maker staffs, declaring that all sorts of catastrophe will befall the US if these three companies' awful management teams and too-richly-priced union workers are not given money immediately.
-A very articulate Republican Congressman from North Carolina asking why the three ailing, failing auto makers should be given aid, when, as he noted, picture by picture, so many of their cars are made in Canada, Mexico, and Germany. He then noted that the newly-elected President promised to deny tax credits to US companies which export jobs to other countries. How, then, he asked, could the US Congress, at the same time, give $25B to GM, Ford and Chrysler.
-A Congressman asking which, if any, of the testifying CEOs (and, one presumes, Gettelfinger) flew to Washington on commercial flights, would return on commercial flights, and would sell the company fleet of private jets. None volunteered in the affirmative.
Yes, even UAW chief Ron Gettelfinger has cheerfully pitched in. In a moment of pure deceit, Gettelfinger alleged that, failing a massive, immediate cash infusion by the government into GM, Ford and Chrysler, at least GM would be forced to file a Chapter 7 bankruptcy.
Gettelfinger's wrong. I checked online, and chapter 7 means, in effect, immediate liquidation. Nobody is suggesting that for GM.
Instead, a Chapter 11 reorganization is the logical alternative. Of course, in this scenario, Gettelfinger knows he's going to have to force his UAW members to swallow massive benefit cuts. And Gettelfinger's days as a powerful union boss will be shortened, as perhaps the largest remaining, old-line unionized sector in America takes a giant step closer to oblivion.
Among the more hilarious moments I saw before dashing off to a business meeting were these:
-Rick Wagoner fumbling for about five minutes, with no clear 'elevator pitch' reply to the question,
'Just how much money do you need? When are you going to run out of money now?'
Wagoner failed miserably to provide a clear, concise grasp of his own company's financial situation. If he were applying for a management job at the company he misleads, and provided such a response in a job interview, I'm sure he'd be rejected forthwith.
-A Democratic Congresswoman noting, while unable to pronounce the name of Cerebrus, and being obviously totally unaware of what it is or that it owns Chrysler, that by bailing the auto company out, Congress was essentially providing public financing to a private equity firm partially-owned by two vociferously free-markt Republican former-office holders; John Snow and Dan Quayle.
When Nardelli generously offered that Cerebrus would surrender 'all upside potential' in Chrysler, in exchange for this public bailout, he was tacitly admitting, as my partner agreed, that Cerebrus sees no hope whatsoever for any profit from its Chrysler deal. Thus, it is willing to surrender 100% of nothing, to get a percentage of the requested $25B 'loan.' A loan which only Wagoner, Mulally and Nardelli may actually believe will ever be repaid.
-Various Democratic Congress members reading from obviously-scripted statements provided to them by auto maker staffs, declaring that all sorts of catastrophe will befall the US if these three companies' awful management teams and too-richly-priced union workers are not given money immediately.
-A very articulate Republican Congressman from North Carolina asking why the three ailing, failing auto makers should be given aid, when, as he noted, picture by picture, so many of their cars are made in Canada, Mexico, and Germany. He then noted that the newly-elected President promised to deny tax credits to US companies which export jobs to other countries. How, then, he asked, could the US Congress, at the same time, give $25B to GM, Ford and Chrysler.
-A Congressman asking which, if any, of the testifying CEOs (and, one presumes, Gettelfinger) flew to Washington on commercial flights, would return on commercial flights, and would sell the company fleet of private jets. None volunteered in the affirmative.
The Mounting Cry Against A GM Rescue
As time passes and the CEOs of GM, Ford and Cerebrus/Chrysler continue to cry for Federal aid, more and more Americans seem to be raising objections.
For example, the Wall Street Journal's weekend edition had a nearly-full page article entitled, "Just Say No to Detroit."
It was a thorough, reasoned analysis of how GM has destroyed nearly $200B in capital over the past decade.
As David Yermack, the article's author, writes,
"Yet one can only imagine how the $465 billion (the once-Big 3's total value destruction) could have been used better- for instance, GM and Ford could have closed their own facilities and acquired all of the shares of Honda, Toyota, Nissan and Volkswagen."
There is also a growing awareness on the part of average Americans that rescuing GM is really about propping up the UAW via aiding the auto maker. It's dawning on more non-union workers, which means most Americans, that the UAW workers have unparalleled benefits unavailable to most of us.
For example, yesterday's Journal featured an editorial by Michael Levine, a "former airline executive" and "senior lecturer at NYU School of Law," entitled, "Why Bankruptcy Is the Best Option for GM." My business partner noted that the same day's NY Times gave the front page of its business section to reporter Andrew Ross Sorkin for a similarly-themed piece on GM.
Levine's editorial is noteworthy for highlighting an underestimated area of auto maker troubles- dealership networks. I touched on it in this post from July of last year. Levine notes that only in bankruptcy could GM renegotiate its suffocating state-by-state dealership agreements.
So bankruptcy is about much more than the old view of filing Chapter 11 as closing a business. In fact, only last night, by business partner noted that the retail chain of Dave & Barry's is now in liquidation. I mentioned, 'oh, yes, they filed chapter 11 this summer.' My partner noted, however, that doing that simply allowed them to reorganize. Now, however, they are actually closing.
Thus, with GM, although its management, the UAW, and even, this morning, on CNBC, government representatives such as Bart Stupak of Michigan would have you equate filing for bankruptcy with being closed for business, that's not true at all. He and another government official alleged that, because so many middle class employees would be affected, the entire country must save them. And that Goldman Sach's average compensation/person was too high to be 'middle class,' so they never should have been given any help whatsoever.
It's also extremely disingenuous for Stupak to keep saying,
'This would be a loan, not a bailout. It'll be paid back.'
Yeah. Right. Bart, nobody but Michiganders believes this. And that's why it won't happen.
A GM bankruptcy, with Federal aid in that context, would allow the firm's management, and/or the government, to tear up existing contracts- including those with unions- and renegotiate them. Perhaps sell the profitable parts, or slim down and then sell the whole package to a better-run auto maker.
But if, as my partner noted, the left-leaning NY Times is running prominent pieces against a loan to GM, or any of the Detroit auto makers, you know broad public sentiment is probably going to be against a Federal rescue of GM prior to its filing Chapter 11. Once in bankruptcy, GM could be extended a debtor-in-possession loan by the Federal government, which, according to bankruptcy law, assumes senior position among all other creditors.
No matter how you try to spin the troubles of GM, Ford and Chrysler, they are too late in the game to be helped now. The UAW is crying that their employers are victims of the financial crisis, and deserve TARP money.
No such luck. Nobody believes that. And, anyway, we all see the self-serving argument by Gettelfinger, the UAW's chief, as trying to preserve the union's ultra-lush compensation and benefits packages.
The senior management of the three companies are trying that tack, as well as arguing over gasoline prices, 'green cars,' and anything else to avoid admitting that the same lousy management that brought them to this point is going to be wasting...er.....investing and spending the tens of billions of dollars of "loans" they now insist must come before January.
So, on a final note, let's ask this question.
If GM, Ford and Chrysler so badly misforecast their cash and liquidity positions as to be running out of money in a month, when, only two months ago, they reported that they were good through June of next year, what does that say about the quality of management which we, as taxpayers, are being asked to rescue?
Wouldn't we all be better off if any Detroit auto maker receiving a loan from the Federal government did so only after filing Chapter 11 and firing its senior management team, so a more effective, capable team could be put in charge as receivers?
For example, the Wall Street Journal's weekend edition had a nearly-full page article entitled, "Just Say No to Detroit."
It was a thorough, reasoned analysis of how GM has destroyed nearly $200B in capital over the past decade.
As David Yermack, the article's author, writes,
"Yet one can only imagine how the $465 billion (the once-Big 3's total value destruction) could have been used better- for instance, GM and Ford could have closed their own facilities and acquired all of the shares of Honda, Toyota, Nissan and Volkswagen."
There is also a growing awareness on the part of average Americans that rescuing GM is really about propping up the UAW via aiding the auto maker. It's dawning on more non-union workers, which means most Americans, that the UAW workers have unparalleled benefits unavailable to most of us.
For example, yesterday's Journal featured an editorial by Michael Levine, a "former airline executive" and "senior lecturer at NYU School of Law," entitled, "Why Bankruptcy Is the Best Option for GM." My business partner noted that the same day's NY Times gave the front page of its business section to reporter Andrew Ross Sorkin for a similarly-themed piece on GM.
Levine's editorial is noteworthy for highlighting an underestimated area of auto maker troubles- dealership networks. I touched on it in this post from July of last year. Levine notes that only in bankruptcy could GM renegotiate its suffocating state-by-state dealership agreements.
So bankruptcy is about much more than the old view of filing Chapter 11 as closing a business. In fact, only last night, by business partner noted that the retail chain of Dave & Barry's is now in liquidation. I mentioned, 'oh, yes, they filed chapter 11 this summer.' My partner noted, however, that doing that simply allowed them to reorganize. Now, however, they are actually closing.
Thus, with GM, although its management, the UAW, and even, this morning, on CNBC, government representatives such as Bart Stupak of Michigan would have you equate filing for bankruptcy with being closed for business, that's not true at all. He and another government official alleged that, because so many middle class employees would be affected, the entire country must save them. And that Goldman Sach's average compensation/person was too high to be 'middle class,' so they never should have been given any help whatsoever.
It's also extremely disingenuous for Stupak to keep saying,
'This would be a loan, not a bailout. It'll be paid back.'
Yeah. Right. Bart, nobody but Michiganders believes this. And that's why it won't happen.
A GM bankruptcy, with Federal aid in that context, would allow the firm's management, and/or the government, to tear up existing contracts- including those with unions- and renegotiate them. Perhaps sell the profitable parts, or slim down and then sell the whole package to a better-run auto maker.
But if, as my partner noted, the left-leaning NY Times is running prominent pieces against a loan to GM, or any of the Detroit auto makers, you know broad public sentiment is probably going to be against a Federal rescue of GM prior to its filing Chapter 11. Once in bankruptcy, GM could be extended a debtor-in-possession loan by the Federal government, which, according to bankruptcy law, assumes senior position among all other creditors.
No matter how you try to spin the troubles of GM, Ford and Chrysler, they are too late in the game to be helped now. The UAW is crying that their employers are victims of the financial crisis, and deserve TARP money.
No such luck. Nobody believes that. And, anyway, we all see the self-serving argument by Gettelfinger, the UAW's chief, as trying to preserve the union's ultra-lush compensation and benefits packages.
The senior management of the three companies are trying that tack, as well as arguing over gasoline prices, 'green cars,' and anything else to avoid admitting that the same lousy management that brought them to this point is going to be wasting...er.....investing and spending the tens of billions of dollars of "loans" they now insist must come before January.
So, on a final note, let's ask this question.
If GM, Ford and Chrysler so badly misforecast their cash and liquidity positions as to be running out of money in a month, when, only two months ago, they reported that they were good through June of next year, what does that say about the quality of management which we, as taxpayers, are being asked to rescue?
Wouldn't we all be better off if any Detroit auto maker receiving a loan from the Federal government did so only after filing Chapter 11 and firing its senior management team, so a more effective, capable team could be put in charge as receivers?
Tuesday, November 18, 2008
Retail Woes Foretell The Recession
Beginning with its November 7 edition, the Wall Street Journal has published a number of articles describing the evolving and steadily increasing weakness in US retailers.
A closer look at the chart, however, and another Journal article, spell more trouble. Yesterday's edition reported on "sharp earnings declines" at Penney's and A&F, as well as "forecasts that fell shy of Wall Street expectations."
The November 7 Journal headline article, "Global Push to Beat Economic Downturn," was accompanied by a picture of an unemployment line in Spain.
In that edition's Marketplace section, the lead piece was entitled, "Retailers Wallow and See Only More Gloom."
The lead in the article stated,
"U.S. retailers reported the worst monthly sales decline in more than three decades, prompting them to resort to steeper discounts and earlier promotions as they try to salvage the coming holiday season.
Sales by department stores and upscale retailers slid 11.7% overall from a year ago, led by a 17% decline at Saks Inc., while J.C. Penney Co's sales fell 13% and Kohl's Corp.'s slid 9%. All three said customers just weren't walking in the door.
Upscale retailer Neiman Marcus said its same-store sales fell a staggering 28% while catalogue and Internet purchases plummeted 23% compared to a year ago.
Once again, the exception to the dire data was Wal-Mart Stores Inc., whose reputation for lower prices has siphoned off shoppers from other retailers. Wal-Mart's sales at stores open at least a year rose 2.4%, well above its prediction of a 1% to 2% gain.
Retailers has been braced for a slow holiday season, and most thought they had planned for the worst by paring back inventories. But since September, sales slowed far more than expected. Retailers now have pinned their hopes on heavy discounting."
The piece goes on to cite more gloomy statistics and provide background anecdotes and details which reinforce that there is now a serious cutback by US consumers in spending on clothing, appliances, and the general assortment of goods at the nation's larger retail chains.
Many conclusions may be drawn regarding the US economy's imminent performance, and that of financial markets, based upon these numbers and comments.
First, ironically, Wal-Mart's senior management may actually be better off due to the failure of its failed strategy to move upmarket several years ago. More on that can be found among the "Wal-Mart" labeled posts on this blog. Suffice to say, Wal-Mart's experience demonstrates why companies move in and out of periods of long term, consistently-superior total return performance.
The nearby, Yahoo-sourced price chart for the past year for Kohl's, Wal-Mart, Penney's, Sears, Target and Abercrombie & Fitch, and the S&P500 Index, for comparison, clearly indicates how Wal-Mart has sailed through the current economic difficulties almost unaffected.
The nearby, Yahoo-sourced price chart for the past year for Kohl's, Wal-Mart, Penney's, Sears, Target and Abercrombie & Fitch, and the S&P500 Index, for comparison, clearly indicates how Wal-Mart has sailed through the current economic difficulties almost unaffected.By contrast, three of the retailers included in the chart fall below the S&P500 curve for the past year, with Kohls and Target basically holding even with the index.
This can briefly be interpreted as Wal-Mart's being well-positioned, despite any actual strategic designs the chain may have, whereas Kolhs and Target tend to continually be among the best-managed of retailers.
A closer look at the chart, however, and another Journal article, spell more trouble. Yesterday's edition reported on "sharp earnings declines" at Penney's and A&F, as well as "forecasts that fell shy of Wall Street expectations."
Penney's profit fell 52% quarter-on-year-ago-quarter, with sales down 10% at stores open at least a year.
A&F's profit declined 46%, with a 14% same-store sales decline.
To me, the key phrase 'Wall Street expectations,' signals that analysts and, probably, investors, are not really paying attention to current consumer behavior, and the degree to which it will affect both coming economic growth, and equity market valuations.
Due to the cascading economic effect of last summer's mark-to-market-based financial services crisis, consumers have now begun to lose jobs, home equity wealth, and confidence in the next few years of US economic health.
The retailers, being on the front line of everyday consumer spending that is not necessary, e.g., food, are seeing plummeting sales, traffic, and equity valuations. And the latter is probably not low enough, yet.
Wal-Mart's position as one of the nation's larger food chains has providentially insulated it from the sole vagaries of discretionary consumer spending in this unfolding weak economy.
In retrospect, Brian Wesbury (see labeled posts) has been correct to refrain from calling the US economy 'in recession' as recently as this summer. However, I have little doubt that in January, or perhaps late next month, he will write a Journal editorial confirming that, as of December, the entire country is in a recession.
As my friend B wrote me last year, pertaining to the Democratic presidential candidate's constant drumbeat of assertions that we were in an economic situation that was 'the worst since the Great Depression,' accompanied by countless pundits and media personages, most of whom are not economists, sagely assuring one and all that the US was in a recession as of mid-2007,
'If enough people keep saying we are in a recession, then we'll soon have one.'
Touche, B. That's exactly what happened. Consumer confidence is a fragile thing. Take a financial sector beset by a stupid, narrowly-defined valuation principle, add the subsequent evaporation of several hundred billion dollars of equity value, follow that with consequent declines in lending, job losses, and falling home and personal equity portfolio values, and you will create a recession.
I suspect the retailers' equity price trends are going to continue for at least a few more months. The news and data are there for everyone to see. Retail is clearly weakening, consumer sentiment is not good, and spending is simply going to decline, with discretionary purchasing becoming increasingly hard to stimulate.
That's why, among other reasons, my partner and I continue to expect a declining S&P500 for several more months. The consumer behavior measures tell us that real economic weakness is just beginning, and will probably cause unexpected equity valuation declines.
Couple this with a change in federal administration from a market-based approach to governmental intrusion to a political/fiat-based one, and you have a recipe for a milder and, hopefully, shorter rerun of FDR's lost decade of the 1930s, marked by inept and ineffectual governmental interference in economic and capital markets.
Good News At Yahoo- Yang Resigns!
In June of 2007, I wrote this post concerning Terry Semel's departure as Yahoo CEO. At the time, co-founder Jerry Yang assumed Semel's post. I wrote, in that post,
"To me, however, the most likely epitaph for Yahoo is that it remained the used car of the online world for too long, wasting its early, premier position in so many nascent areas. Now, I believe Schumpeterian dynamics have overtaken it, rendering it a largely has-been collection of concepts, technologies and online information offerings. If they haven't managed to collect revenues for most of this by now, thus setting expectations of free services, what makes you think someone else can do better without losing visitors, resulting in continued problems achieving profitable growth and, with it, consistently superior total returns?"
The nearby, two-year price chart of Yahoo's equity, compared with the S&P500 Index for the same timeframe, illustrates how destructive Yang's temporary reign has been for the firm's shareholders.The two curves are basically on top of one another at the point at which Yang succeeded Semel.
As inept and ineffective as Semel had been, Yang was no picnic. From that point in June of 2007, the S&P declined about 40%, since the curves were both slightly positive at the point of Yang's accession.
In that same time period, Yang managed to drive Yahoo's price down about 60%, or an additional 50% greater loss than that of the S&P.
Reading this morning's Wall Street Journal, I was somewhat shocked that the board has only just retained a search firm to replace Yang. And that the value-destroying co-founder isn't actually out the door yet. He won't leave until a replacement is found.
Oh my. Poor shareholders.
What if nobody wants the job?
In this era, it is no longer proper etiquette to parachute into a firm as CEO, sell or dismember it within a year, and then grab a huge payout and ride off into the sunset. And Susan Decker has now been at Yahoo long enough to be part of the problem, not the solution.
As my earlier posts about Yahoo, one of which is linked to the already-linked post mentioned above, noted, the company's basic business concept is now bankrupt. There is no real value left to manage and grow.
If the board were really smart, they'd send Jerry Yang packing right now, have Carl Icahn call Steve Ballmer, and just sell the whole mess.
Shareholders would get something, and no longer risk getting even less as the aging technology-based online firm slowly sinks into irrelevance.
Once a replacement is found, though, s/he will take time to 'add value' by assessing the situation, and more time- and value- will be irreparably be lost.
This may just be a golden opportunity for Yahoo to escape with what little value remains, intact.
Monday, November 17, 2008
Citigroup's Pandit Tries Again
This morning's news was full of stories concerning Citigroup Pandit's 'townhall' meeting and his announcement that the firm is cutting some 25,000 positions, in addition to plans to sell some small units, and previously-announced cuts, all totaling 50,000.
The nearby, Yahoo-sourced chart of the prices of Citigroup's equity and the S&P500 Index for the past five days indicates Pandit's latest attempt to mollify investors didn't work, either.
As a Wall Street Journal Online piece reported this afternoon,
Still, Mr. Pandit cautioned that tough times may lie ahead. "There is still a lot of rebalancing ahead of us," he said. In a memo distributed to employees after the town hall, he noted that "the coming year could be a difficult one for our clients and customers."
About 15,000 Citigroup employees either attended or tuned in for the town hall, which was closed to investors, analysts and reporters. Some had lukewarm reactions.
Since becoming CEO, Mr. Pandit, a former finance professor, has frustrated some executives and directors with his academic style. Some employees said Monday's presentation fit that mold, dwelling on financial issues without doing much to pep up Citigroup's dispirited troops."
Pandit clearly has no clear grasp on the severity of Citigroup's problems. He's been in the job nearly a year, yet look at the firm's performance, as seen in the third Yahoo-sourced chart.
The nearby, Yahoo-sourced chart of the prices of Citigroup's equity and the S&P500 Index for the past five days indicates Pandit's latest attempt to mollify investors didn't work, either.While the S&P declined by about 5% in the past five trading days, Citi sank by 20%.
Today alone, as the second chart, below, illustrates, Citigroup's stock price fell by more than 5%, while the Index fell roughly 2.6%.
Various pundits opined that Pandit continues to resist calls to breakup Citigroup's non-performing, dysfunctional business collection. Bob Rubin's head has also been called for.
Even Pandit was rumored to be at risk as the board argues over what to do about Citigroup's dire straits.
As a Wall Street Journal Online piece reported this afternoon,""We have spent the last year getting fit, are more streamlined, and are in a strong competitive position to take advantage of future opportunities," Mr. Pandit said, according to his prepared remarks. "We will be the long-term winner in this industry."
Still, Mr. Pandit cautioned that tough times may lie ahead. "There is still a lot of rebalancing ahead of us," he said. In a memo distributed to employees after the town hall, he noted that "the coming year could be a difficult one for our clients and customers."
About 15,000 Citigroup employees either attended or tuned in for the town hall, which was closed to investors, analysts and reporters. Some had lukewarm reactions.
Since becoming CEO, Mr. Pandit, a former finance professor, has frustrated some executives and directors with his academic style. Some employees said Monday's presentation fit that mold, dwelling on financial issues without doing much to pep up Citigroup's dispirited troops."
Pandit clearly has no clear grasp on the severity of Citigroup's problems. He's been in the job nearly a year, yet look at the firm's performance, as seen in the third Yahoo-sourced chart.Citigroup has declined by about 70%, while the S&P has lost a relatively modest, by comparison, 40% over the past twelve months.
Yet Pandit has offered nothing in the way of strategic change at Citigroup. It's entirely possible that, like Rick Wagoner's GM, Pandit's Citigroup won't make it long enough to see those 'future opportunities.'
Perhaps the real problem at Citigroup is so much overhead to stitch together businesses which have little in common, and, for the most part, simply have over-capacity in this new, credit-constrained environment.
Why Mortgage Forgiveness Is Just Loan Loss Recognition In Disguise
As the months have gone by since various politicians, beginning with Hillary Clinton, began calling for either a moratorium on foreclosures and/or interest rate adjustments and forgiveness on some aspects of troubled mortgages, I have given a lot of thought to these suggestions.
Initially, I thought the suggestions of mortgage rate reductions and/or balance adjustments for a period of time, or permanently, to be an unwise intrusion of governmental regulation, a la a 'taking.'
Recently, however, several large banks, including Chase, have unilaterally begun to take these steps. By reducing rates and/or modifying the mortgage loan balances at points in time, these lenders are basically recognizing loan losses in a non-traditional manner.
Rather than classify some mortgages as either defaulted or delinquent, the banks are taking a smaller haircut on a larger base of home loans. Either way, the financial consequence is to reduce the effective rate of interest which accrues as revenue, and potentially write down some loan values.
Last week, my business partner and I were discussing this phenomenon. As we thought about what we, if we owned a bank, would do with a delinquent or defaulted mortgage borrower, it became obvious that foreclosures aren't a good idea in this environment, irrespective of governmental pressure.
With most real estate prices having declined in the past year, and credit availability much worse than it was even three months ago, a foreclosed home has virtually no chance of being purchased at a price that will preclude a significant loss for the mortgage lender.
Instead, if the borrower is still employed and able to pay something, it would behoove a bank to simply treat him/her as either: a temporary renter, with the loan conditions to be reinstated in the near future, making the mortgage loan currently delinquent, or; modify the loan's conditions to equate the borrower's ability to pay with a new interest rate and/or balance, or some combination of the two, and record a loss while the (newly modified) loan remains current and performing, or; modify the loan's conditions to be a combination of the first two, both temporarily suspending the loan payments, then returning to a modified mortgage payment and terms in the near future.
All three options provide some cash flow for the bank, and the ability to avoid foreclosure, evictions, and an overall worsening of the probabilities that the lender can recover looming losses.
Because of the gradual spread of what began as a largely technical issue of requiring securities held by banks, backed by mortgages to be marked to market (rather than allowed to be valued based on their economic potential while partially or wholly performing), eventually, to engulf the entire banking sector in hundreds of billions of dollars of writedowns, resulting in a credit contraction, the environment in which troubled mortgages now exist is much worse than it was last year.
The credit contraction has, of course, affected business volumes, economic growth, and job losses. Thus, by late 2008, the unforeseen consequences of Congress' narrow-minded insistence, in Sarbanes-Oxley, on 'mark-to-market' valuation turned what was initially an accounting matter into a a policy choice which has amplified accounting valuations to the point where they have reached out and damaged the entire US economy.
A year ago, the failure of a couple of Bear Stearns mutual funds, due to this dry accounting issue, seemed manageable. But in time, as investors understandably began to recoil from any structured finance instrument potentially containing recent, riskier mortgages, mark-to-market rules caused a chain reaction which has resulted in a real credit and economic contraction that is many times worse than it otherwise might have been.
In this new environment of fallen home values, few new mortgage loans, and rising joblessness, banks really have no choice but to work out non-performing home loans, rather than simply begin foreclosing on every defaulted loan and displacing residents, to no better effect for the bank, the residents, or society in general.
Initially, I thought the suggestions of mortgage rate reductions and/or balance adjustments for a period of time, or permanently, to be an unwise intrusion of governmental regulation, a la a 'taking.'
Recently, however, several large banks, including Chase, have unilaterally begun to take these steps. By reducing rates and/or modifying the mortgage loan balances at points in time, these lenders are basically recognizing loan losses in a non-traditional manner.
Rather than classify some mortgages as either defaulted or delinquent, the banks are taking a smaller haircut on a larger base of home loans. Either way, the financial consequence is to reduce the effective rate of interest which accrues as revenue, and potentially write down some loan values.
Last week, my business partner and I were discussing this phenomenon. As we thought about what we, if we owned a bank, would do with a delinquent or defaulted mortgage borrower, it became obvious that foreclosures aren't a good idea in this environment, irrespective of governmental pressure.
With most real estate prices having declined in the past year, and credit availability much worse than it was even three months ago, a foreclosed home has virtually no chance of being purchased at a price that will preclude a significant loss for the mortgage lender.
Instead, if the borrower is still employed and able to pay something, it would behoove a bank to simply treat him/her as either: a temporary renter, with the loan conditions to be reinstated in the near future, making the mortgage loan currently delinquent, or; modify the loan's conditions to equate the borrower's ability to pay with a new interest rate and/or balance, or some combination of the two, and record a loss while the (newly modified) loan remains current and performing, or; modify the loan's conditions to be a combination of the first two, both temporarily suspending the loan payments, then returning to a modified mortgage payment and terms in the near future.
All three options provide some cash flow for the bank, and the ability to avoid foreclosure, evictions, and an overall worsening of the probabilities that the lender can recover looming losses.
Because of the gradual spread of what began as a largely technical issue of requiring securities held by banks, backed by mortgages to be marked to market (rather than allowed to be valued based on their economic potential while partially or wholly performing), eventually, to engulf the entire banking sector in hundreds of billions of dollars of writedowns, resulting in a credit contraction, the environment in which troubled mortgages now exist is much worse than it was last year.
The credit contraction has, of course, affected business volumes, economic growth, and job losses. Thus, by late 2008, the unforeseen consequences of Congress' narrow-minded insistence, in Sarbanes-Oxley, on 'mark-to-market' valuation turned what was initially an accounting matter into a a policy choice which has amplified accounting valuations to the point where they have reached out and damaged the entire US economy.
A year ago, the failure of a couple of Bear Stearns mutual funds, due to this dry accounting issue, seemed manageable. But in time, as investors understandably began to recoil from any structured finance instrument potentially containing recent, riskier mortgages, mark-to-market rules caused a chain reaction which has resulted in a real credit and economic contraction that is many times worse than it otherwise might have been.
In this new environment of fallen home values, few new mortgage loans, and rising joblessness, banks really have no choice but to work out non-performing home loans, rather than simply begin foreclosing on every defaulted loan and displacing residents, to no better effect for the bank, the residents, or society in general.
Saturday, November 15, 2008
Lloyd Blankfein's Goldman Sachs: Same As It Ever Was?
In this post two weeks ago, I wrote about how merely obtaining a Federal commercial bank charter hardly makes Goldman Sachs and Morgan Stanley real, functioning commercial banks.
This past week, two articles in the Wall Street Journal demonstrated how these two former investment banks are already parting ways.
Goldman CEO Lloyd Blankfein was quoted as saying,
"We're going to consider everything," but won't do "something rash."
The article further noted, regarding Goldman Sachs developing a consumer banking business,
"Mr. Blankfein seemed to knock down that idea, stressing that Goldman has little, or no exposure to credit cards, auto loans, home-equity loans or other consumer loans, all of which could suffer if the U.S. falls into a significant recession."
On the subject of a merger, Blankfein remarked that he'd consider one,
"only if the deals keep Goldman's focus and culture intact."
Understanding that Goldman Sachs currently looks a lot like a hedge fund, it's difficult for me to see how Blankfein expects his firm to be able to simply exist unchanged.
If, as most observers expect, the FDIC and Federal Reserve mandate that the firm reduces its leverage and business mix to more closely resemble those of commercial banks, Goldman will have a very hard time finding non-consumer banking business volumes sufficient to retain its current size, expense and infrastructure bases.
If, on the other hand, it tries to merge with a commercial bank, there's just no way the vaunted Goldman culture will remain intact. Apparently, Blankfein's bid to outs Pandit at Citigroup and merge with that money center bank, came to naught.
Maybe, with the rumors of Citi's board's split over Pandit, Blankfein may have another shot at that merger. Maybe not.
Either way, it's just hard to see how Goldman can tread water and remain as profitable as it has been in the past, with a similar business mix.
Morgan Stanley, on the other hand, was written up on Thursday's Journal as cutting more than 2,000 employees while hiring two outside commercial bankers; Cece Sutton and Jonathan Witter, both formerly of Wachovia.
The two Wachovians are to become Morgan Stanley heads of retail banking and CEO of the retail banking group, respectively.
While in obvious contrast to Goldman Sachs, Morgan Stanley's more aggressive move to build a consumer business calls into question just what it can ever hope to add in an already-consolidating market.
Note that Mack hired two executives from a bank that essentially failed, due to its retail-oriented mortgage banking strategy. And Morgan Stanley took its own licks from mortgage finance, too.
As a consumer, would you have much reason to suddenly drop your current bank and take new credit cards, a mortgage, and open checking accounts with the former investment bank?
New entrants in a product market typically offer some new or unique value proposition. Morgan Stanley's seems to be something like,
'Hi. We used to be a highly-leveraged investment bank-cum-hedge fund. But that didn't turn out so well.
Now, we've decided to try to be a commercial bank, because we might survive that way.
Won't you please do business with us?'
Hardly compelling, is it? Somehow, the former loss-making investment bank is hardly in a position to cross-sell it's asset management/high net worth business skills anymore.
Which brings me to the point I made in that prior, linked post,
"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."
Growing its own consumer banking from scratch is unlikely to do much for Morgan Stanley. Eschewing the segment totally probably won't help Goldman Sachs, either. Right now, based on existing information, I'd say neither is in particularly good, long term shape.
This past week, two articles in the Wall Street Journal demonstrated how these two former investment banks are already parting ways.
Goldman CEO Lloyd Blankfein was quoted as saying,
"We're going to consider everything," but won't do "something rash."
The article further noted, regarding Goldman Sachs developing a consumer banking business,
"Mr. Blankfein seemed to knock down that idea, stressing that Goldman has little, or no exposure to credit cards, auto loans, home-equity loans or other consumer loans, all of which could suffer if the U.S. falls into a significant recession."
On the subject of a merger, Blankfein remarked that he'd consider one,
"only if the deals keep Goldman's focus and culture intact."
Understanding that Goldman Sachs currently looks a lot like a hedge fund, it's difficult for me to see how Blankfein expects his firm to be able to simply exist unchanged.
If, as most observers expect, the FDIC and Federal Reserve mandate that the firm reduces its leverage and business mix to more closely resemble those of commercial banks, Goldman will have a very hard time finding non-consumer banking business volumes sufficient to retain its current size, expense and infrastructure bases.
If, on the other hand, it tries to merge with a commercial bank, there's just no way the vaunted Goldman culture will remain intact. Apparently, Blankfein's bid to outs Pandit at Citigroup and merge with that money center bank, came to naught.
Maybe, with the rumors of Citi's board's split over Pandit, Blankfein may have another shot at that merger. Maybe not.
Either way, it's just hard to see how Goldman can tread water and remain as profitable as it has been in the past, with a similar business mix.
Morgan Stanley, on the other hand, was written up on Thursday's Journal as cutting more than 2,000 employees while hiring two outside commercial bankers; Cece Sutton and Jonathan Witter, both formerly of Wachovia.
The two Wachovians are to become Morgan Stanley heads of retail banking and CEO of the retail banking group, respectively.
While in obvious contrast to Goldman Sachs, Morgan Stanley's more aggressive move to build a consumer business calls into question just what it can ever hope to add in an already-consolidating market.
Note that Mack hired two executives from a bank that essentially failed, due to its retail-oriented mortgage banking strategy. And Morgan Stanley took its own licks from mortgage finance, too.
As a consumer, would you have much reason to suddenly drop your current bank and take new credit cards, a mortgage, and open checking accounts with the former investment bank?
New entrants in a product market typically offer some new or unique value proposition. Morgan Stanley's seems to be something like,
'Hi. We used to be a highly-leveraged investment bank-cum-hedge fund. But that didn't turn out so well.
Now, we've decided to try to be a commercial bank, because we might survive that way.
Won't you please do business with us?'
Hardly compelling, is it? Somehow, the former loss-making investment bank is hardly in a position to cross-sell it's asset management/high net worth business skills anymore.
Which brings me to the point I made in that prior, linked post,
"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."
Growing its own consumer banking from scratch is unlikely to do much for Morgan Stanley. Eschewing the segment totally probably won't help Goldman Sachs, either. Right now, based on existing information, I'd say neither is in particularly good, long term shape.
Friday, November 14, 2008
Reality Hits Starbucks' Growth Plans
Starbucks is in the news again this week!
In my last post on the coffee retailer, here, I noted that Howard Schultz's vaunted turnaround, for which he returned to the company as CEO, had cratered in a quarterly loss.
This week's Wall Street Journal piece reaffirms the coffee roaster's cutbacks on US store openings, fights with landlords as it closes locations, and even a slowdown in its overseas store openings. According to the Journal piece, same-store sales at Starbucks are down 8% among the conventional 'open at least a year' category.
The nearby 3-month price chart for Starbucks and the S&P500 Index shows the coffee giant falling by more than the market average. Significantly more. Starbucks has lost nearly half its value amidst the market turmoil which began in September.
Clearly, the chain reaction of financial losses to consumer spending has now hit the upscale coffee retailer.
Back in January, I wrote a post concerning the marketing battle brewing between Starbucks and McDonalds. In it, I observed,
"To me, having followed this building story for nearly a year, Schultz' and Starbucks' logic and expectations are wrong. They expanded into more price-sensitive, lower-income segments, and are now struggling to make that business more constant. But it will be precisely those customers who are vulnerable to McDonalds and Dunkin' Donuts. Further, the changes in its product strategies is causing confusion and morale problems among Starbucks' workforce."
This is now coming home to roost big time at Starbucks. As cost-conscious, lower- and middle-income consumers flee the pricey coffee seller's offerings, the other two, more middle-market brands are likely to increase share.
It's not fair to accuse Howard Schultz of not foreseeing this financial-market triggered economic downturn. But he is responsible, never the less. As CEO, he presided over the expansion of the Starbucks brand into ever-lower income customer segments. This was bound to affect sales and profits growth come an eventual economic softening, never mind a serious recession.
Now the full import of the coffee roaster's years of breakneck expansion are coming back to haunt shareholders.
Will Schultz finally admit defeat and just accept that Starbucks' rapid growth phase is over?
In my last post on the coffee retailer, here, I noted that Howard Schultz's vaunted turnaround, for which he returned to the company as CEO, had cratered in a quarterly loss.
This week's Wall Street Journal piece reaffirms the coffee roaster's cutbacks on US store openings, fights with landlords as it closes locations, and even a slowdown in its overseas store openings. According to the Journal piece, same-store sales at Starbucks are down 8% among the conventional 'open at least a year' category.The nearby 3-month price chart for Starbucks and the S&P500 Index shows the coffee giant falling by more than the market average. Significantly more. Starbucks has lost nearly half its value amidst the market turmoil which began in September.
Clearly, the chain reaction of financial losses to consumer spending has now hit the upscale coffee retailer.
Back in January, I wrote a post concerning the marketing battle brewing between Starbucks and McDonalds. In it, I observed,
"To me, having followed this building story for nearly a year, Schultz' and Starbucks' logic and expectations are wrong. They expanded into more price-sensitive, lower-income segments, and are now struggling to make that business more constant. But it will be precisely those customers who are vulnerable to McDonalds and Dunkin' Donuts. Further, the changes in its product strategies is causing confusion and morale problems among Starbucks' workforce."
This is now coming home to roost big time at Starbucks. As cost-conscious, lower- and middle-income consumers flee the pricey coffee seller's offerings, the other two, more middle-market brands are likely to increase share.
It's not fair to accuse Howard Schultz of not foreseeing this financial-market triggered economic downturn. But he is responsible, never the less. As CEO, he presided over the expansion of the Starbucks brand into ever-lower income customer segments. This was bound to affect sales and profits growth come an eventual economic softening, never mind a serious recession.
Now the full import of the coffee roaster's years of breakneck expansion are coming back to haunt shareholders.
Will Schultz finally admit defeat and just accept that Starbucks' rapid growth phase is over?
Thursday, November 13, 2008
Immelt's Mistakes Come Home To Roost: GE Takes Government Money
Tuesday's Wall Street Journal described GE's capitulation to market forces by registering "to sell as much as $98 billion of CP (commercial paper) to the government."
The article even ends with the observation,
"Buying a large bank might be an option. But it might come with assets GE wouldn't want and could force change in GE's overall corporate structure- perhaps even requiring the finance business to be spun off."
Bingo!
As I have written most recently in this blog here and here, Immelt brought GE to this impasse by foolishly retaining the unwieldy, value-destroying diversified conglomerate structure. In the latter piece, I wrote,
"There are several businesses in GE's portfolio that would not, on their own, suffer so badly as GE's financial units. But, thanks to Immelt's insistence on keeping these units needlessly shackled to each other, shareholders don't get to select which they wish to own, and which they do not.
It's likely that, somewhere in GE's business portfolio, there are units which have not lost 40% of their value in the past 12 months.
Thanks to Immelt's poor stewardship and lack of leadership of GE, his shareholders won't get to know which those are, and benefit from their performance."
Look at the nearby price chart for GE and the S&P500 Index for the past three months.
Even with two of the worst months in the S&P's history, Immelt's GE still managed to fall by even more. And not just a little, but a full 10 percentage points, or 33% more than the index.
That's the penalty Immelt has imposed on his shareholders in order to retain an outdated, useless conglomeration of unrelated businesses under the GE moniker.
Now, things have become so dire that Immelt must go, hat in hand, to the US government in order to sell commercial paper to fund its financial services unit.
GM is nearly dead. GE, the other once-mighty US industrial firm, is reduced to government intervention in order to fund itself.
Nice going, Jeff. Any chance, given how much damage you've inflicted on your shareholders this year, that you'll forego any bonus for 2008?
Shareholders, don't hold your collective breaths.
The article even ends with the observation,
"Buying a large bank might be an option. But it might come with assets GE wouldn't want and could force change in GE's overall corporate structure- perhaps even requiring the finance business to be spun off."
Bingo!
As I have written most recently in this blog here and here, Immelt brought GE to this impasse by foolishly retaining the unwieldy, value-destroying diversified conglomerate structure. In the latter piece, I wrote,
"There are several businesses in GE's portfolio that would not, on their own, suffer so badly as GE's financial units. But, thanks to Immelt's insistence on keeping these units needlessly shackled to each other, shareholders don't get to select which they wish to own, and which they do not.
It's likely that, somewhere in GE's business portfolio, there are units which have not lost 40% of their value in the past 12 months.
Thanks to Immelt's poor stewardship and lack of leadership of GE, his shareholders won't get to know which those are, and benefit from their performance."
Look at the nearby price chart for GE and the S&P500 Index for the past three months.Even with two of the worst months in the S&P's history, Immelt's GE still managed to fall by even more. And not just a little, but a full 10 percentage points, or 33% more than the index.
That's the penalty Immelt has imposed on his shareholders in order to retain an outdated, useless conglomeration of unrelated businesses under the GE moniker.
Now, things have become so dire that Immelt must go, hat in hand, to the US government in order to sell commercial paper to fund its financial services unit.
GM is nearly dead. GE, the other once-mighty US industrial firm, is reduced to government intervention in order to fund itself.
Nice going, Jeff. Any chance, given how much damage you've inflicted on your shareholders this year, that you'll forego any bonus for 2008?
Shareholders, don't hold your collective breaths.
Your Next New Bank: American Express
It seems that almost under the radar, and a month late, American Express decided to come in from the cold and convert its status to that of a Federally-chartered commercial bank. As I wrote in this post last month, it seems odd to think of your neighborhood bank as GMAC, Goldman Sachs or Morgan Stanley.
Now, I'll grant you that an Amex store is more ubiquitous than, say, a GMAC location. At least I've never seen a GMAC site. And existing Amex travel stores are more retail in nature than your typical Morgan Stanley or Goldman Sachs location in a major city.
Still, once again, it's hard to visualize Amex being a full service commercial bank. In fact, in the old days, it never would have needed a banking charter, because its Travelers Cheques and credit card businesses nearly perfectly hedged each other. The former took cash deposits against to-be-written cheques, while the credit card paid cash on the cardholder's behalf, for a fee.
Evidently, the model is no longer remotely like that of the old days. Or perhaps the credit card giant's management simply want to avoid standing out in a crowd of Federally-owned financial institutions, lest that difference cause a mass sell off of their equity and a shunning of the firm as a supplier of credit.
My business partner wondered aloud what possible risk to our financial system Amex represents, being primarily a high-end credit card issuer.
No matter. Now even a major standalone revolving credit provider is running into the arms of the evolving US National Bank. And then, immediately upon gaining bank status, puts it hand out for a $3.8B loan from the Fed.
Truly the only financial sector executives who feel capable of running their own businesses will be private equity shops and privately-owned asset managers. And, in time, perhaps those executives sufficiently prudent and confident of their risk management expertise to open up publicly-held loan and investment companies.
Now, I'll grant you that an Amex store is more ubiquitous than, say, a GMAC location. At least I've never seen a GMAC site. And existing Amex travel stores are more retail in nature than your typical Morgan Stanley or Goldman Sachs location in a major city.
Still, once again, it's hard to visualize Amex being a full service commercial bank. In fact, in the old days, it never would have needed a banking charter, because its Travelers Cheques and credit card businesses nearly perfectly hedged each other. The former took cash deposits against to-be-written cheques, while the credit card paid cash on the cardholder's behalf, for a fee.
Evidently, the model is no longer remotely like that of the old days. Or perhaps the credit card giant's management simply want to avoid standing out in a crowd of Federally-owned financial institutions, lest that difference cause a mass sell off of their equity and a shunning of the firm as a supplier of credit.
My business partner wondered aloud what possible risk to our financial system Amex represents, being primarily a high-end credit card issuer.
No matter. Now even a major standalone revolving credit provider is running into the arms of the evolving US National Bank. And then, immediately upon gaining bank status, puts it hand out for a $3.8B loan from the Fed.
Truly the only financial sector executives who feel capable of running their own businesses will be private equity shops and privately-owned asset managers. And, in time, perhaps those executives sufficiently prudent and confident of their risk management expertise to open up publicly-held loan and investment companies.
Wednesday, November 12, 2008
What Has TARP Accomplished?
Back at the end of September, as I note from this post at the time, Congress was wrestling with the passage of the then-claimed, absolutely necessary $700B TARP legislation.
September's S&P return was -8.9%. Clearly, the deteriorating equity market and cessation of lending and markets for structured instruments lit a fire under Treasury, the Fed and FDIC to do something.
As economist Art Laffer noted in a Wall Street Journal article, about which I wrote, here,
"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.
Whenever people make decisions when they are panicked, the consequences are rarely pretty."
So, here's my question, inspired by a comment from CNBC's Rick Santelli this morning.
If the TARP was so necessary, and was the right, or an effective solution to our financial turmoil, why did the S&P decline by a further -16.7% in October? That's almost twice September's decline!
Santelli's insightful comment was, as usual, in response to a typically nonsensical utterance by CNBC's Steve Liesman. The latter insisted that the TARP was absolutely essential to the health of the financial system.
Santelli calmly noted that, in contrast to Liesman's description of the September market free fall, we now have 'slow fall.'
Whether fast, or slow, Santelli's point was, I believe, that the TARP's existence has, if anything, apparently accelerated, and certainly failed to halt further market deterioration.
That's when I was inspired to go to my own files and retrieve the monthly S&P performance for September and October. Not only did the TARP have no positive effect, but our current equity market situation is, by some measures, a reflection of the lowest level of confidence in those markets in many, many years.
For example, one of my equity long/short allocation signals is at its lowest level since 1982. The other, which is the trailing S&P return over a period of fixed length, has never been this low in over 30 years. Which, considering the time periods involved, probably means perhaps not even in the entire time that there has been an S&P500 Index.
Now, with this week's clamoring by Congress to release TARP funds to rescue GM, Chrysler and Ford, we see it has become, predictably, a general-purpose feeding trough for desperate firms, financial or otherwise.
Former Federal Reserve Board member Fred Mishkin warned, in extended comments this morning on CNBC, that including less-regulated, non-financial companies in the TARP is a very, very dangerous step. He noted the necessity of a healthy financial system, most of the players in which are already subject to heavy regulation.
Adding various weak and dying companies on an ad hoc basis, Mishkin noted, is to essentially open the Treasury to anyone who wants help.
Hardly the conditions under or terms on which the TARP was rushed through Congress.
September's S&P return was -8.9%. Clearly, the deteriorating equity market and cessation of lending and markets for structured instruments lit a fire under Treasury, the Fed and FDIC to do something.
As economist Art Laffer noted in a Wall Street Journal article, about which I wrote, here,
"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.
Whenever people make decisions when they are panicked, the consequences are rarely pretty."
So, here's my question, inspired by a comment from CNBC's Rick Santelli this morning.
If the TARP was so necessary, and was the right, or an effective solution to our financial turmoil, why did the S&P decline by a further -16.7% in October? That's almost twice September's decline!
Santelli's insightful comment was, as usual, in response to a typically nonsensical utterance by CNBC's Steve Liesman. The latter insisted that the TARP was absolutely essential to the health of the financial system.
Santelli calmly noted that, in contrast to Liesman's description of the September market free fall, we now have 'slow fall.'
Whether fast, or slow, Santelli's point was, I believe, that the TARP's existence has, if anything, apparently accelerated, and certainly failed to halt further market deterioration.
That's when I was inspired to go to my own files and retrieve the monthly S&P performance for September and October. Not only did the TARP have no positive effect, but our current equity market situation is, by some measures, a reflection of the lowest level of confidence in those markets in many, many years.
For example, one of my equity long/short allocation signals is at its lowest level since 1982. The other, which is the trailing S&P return over a period of fixed length, has never been this low in over 30 years. Which, considering the time periods involved, probably means perhaps not even in the entire time that there has been an S&P500 Index.
Now, with this week's clamoring by Congress to release TARP funds to rescue GM, Chrysler and Ford, we see it has become, predictably, a general-purpose feeding trough for desperate firms, financial or otherwise.
Former Federal Reserve Board member Fred Mishkin warned, in extended comments this morning on CNBC, that including less-regulated, non-financial companies in the TARP is a very, very dangerous step. He noted the necessity of a healthy financial system, most of the players in which are already subject to heavy regulation.
Adding various weak and dying companies on an ad hoc basis, Mishkin noted, is to essentially open the Treasury to anyone who wants help.
Hardly the conditions under or terms on which the TARP was rushed through Congress.
GM's Final Chapter
So many currents are swirling around GM right now that it's hard to know where to begin writing about it. I last wrote about the failing, near-death auto maker in this post, almost one month ago. Perhaps a good starting point is my old squash partner Paul Ingrassia's well-written and -reasoned piece in yesterday's Wall Street Journal.
The salient passages in Paul's essay are these,
"Let's assume that the powers in Washington -- the Bush team now, the Obama team soon -- deem GM too big to let fail. If so, it's also too big to be entrusted to the same people who have led it to its current, perilous state, and who are too tied to the past to create a different future.
In return for any direct government aid, the board and the management should go. Shareholders should lose their paltry remaining equity. And a government-appointed receiver -- someone hard-nosed and nonpolitical -- should have broad power to revamp GM with a viable business plan and return it to a private operation as soon as possible.
That will mean tearing up existing contracts with unions, dealers and suppliers, closing some operations and selling others, and downsizing the company. After all that, the company can float new shares, with taxpayers getting some of the benefits. The same basic rules should apply to Ford and Chrysler.
These are radical steps, and they wouldn't avoid significant job losses. But there isn't much alternative besides simply letting GM collapse, which isn't politically viable. At least a government-appointed receiver would help assure car buyers that GM will be around, in some form, to honor warranties on its vehicles. It would help minimize losses to the government's Pension Benefit Guaranty Corp.
The current economic crisis didn't cause the meltdown in Detroit. The car companies started losing billions of dollars several years ago when the economy was healthy and car sales stood at near-record levels. They complained that they were unfairly stuck with enormous "legacy costs," but those didn't just happen. For decades, the United Auto Workers union stoutly defended gold-plated medical benefits that virtually no one else had. UAW workers and retirees had no deductibles, copays or other facts of life in these United States.
A few years ago the UAW even waged a spirited fight to protect the "right" of workers to smoke on the assembly line, something that simply isn't allowed at, say, Honda's U.S. factories. Aside from the obvious health risk, what about cigarette ashes falling onto those fine leather seats being bolted into the cars? Why was this even an issue?
A thorough housecleaning at GM is the only way to give the company a fresh start. GM is structured for its glory days of the 1960s, when it had half the U.S. car market -- not for the first decade of this century, when it has just over 20% of the market. General Motors simply cannot support eight domestic brands (Cadillac, Buick, Pontiac, Chevrolet, GMC, Saturn, Saab and Hummer) with adequate product-development and marketing dollars. Even the good vehicles the company develops (for example, the Cadillac CTS and Chevy Malibu) get lost in the wash.
As for Ford and Chrysler, if they want similar public assistance they should pay the same price. Wiping out existing shareholders would end the Ford family's control of Ford Motor. But keeping the family in the driver's seat wouldn't be an appropriate use of tax dollars. Nor is bailing out the principals of Cerberus, who include CEO Stephen Feinberg, Chairman John Snow, the former Treasury secretary, and global investing chief Dan Quayle, former vice president.
Government loan guarantees, with stringent strings attached and new management at the helm, helped save Chrysler in 1980. But it's now 2008, 35 years since the first oil shock put Japanese cars on the map in America. "Since the mid-Seventies," one Detroit manager recently told me, "I have sat through umpteen meetings describing how we had to beat the Japanese to survive.
Thirty-five years later we are still trying to figure it out."
Which is why pouring taxpayer billions into the same old dysfunctional morass isn't the answer."
Contrast Paul's sensibility with this quote from the Journal's article concerning GM's stock price falling to a low not seen since 1946,
"But Mr. Wagoner added in the interview that he would not be willing to resign in return for aid.
"I think our job is to make sure we have the best management team to run GM. It's not clear to me what purpose would be served" by his resignation. "
So, there you have the business-oriented analysis in a nutshell. No less an objective and savvy analyst than Pulitzer Prize-winner Ingrassia, who co-received the prize for his reporting about Detroit's resurgence during the 1980s, sees Wagoner and his team as the problem. Ingrassia's solution is a variant of the one I've suggested for several years, most recently in that linked post from last month, i.e., file bankruptcy for the faded auto maker, sell what can be sold, and let the Federal government do what it can for line workers and middle managers.
Wagoner, ever the poster boy for 'greedy' large-cap CEOs, claims he's just 'doin' his job the best way he knows how.'
As if.
Paul is right. Wagoner and his team of inept misfits have to go. A bankruptcy court-appointed receiver can dismember GM as s/he sees fit. One point on which I disagree with Paul is whether GM can exit bankruptcy, government-aided or not, as an independent firm. I just don't see the few profitable car models justifying a standalone entity. Dealerships wouldn't survive on that kind of volume. Nor would production costs, etc., be competitive on such a small market share.
Now to the political angle.
No less a leading auto industry executive than Mike Jackson, CEO of AutoNation, boldly asserted on CNBC this morning that GM must be saved, and bankruptcy was unthinkable. According to Jackson, nobody will buy a car made by a company in Chapter 11.
Really? I thought we used to trust market forces to determine the clearing price for virtually anything. In this case, you know that NAPA and other aftermarket vendors will always supply parts for high-volume cars, no matter what the make. There'll be no shortage of mechanics to service GM vehicles, either. Warranties on existing vehicles are a balance sheet liability. Warranties on newly-purchased cars and trucks will either become third-party issued with the cars, or available from them as aftermarket extras.
Of course, Jackson would like to reduce all risk associated with his current inventory, not to mention maintain his negotiating leverage with non-GM vehicle producers. That's why he prefers GM to be bailed out by the Federal government.
Politicians see votes. Pumping taxpayer dollars from fifty states into the failed companies in primarily one state is a slam dunk for Dingell, et.al. Additionally, as Ingrassia notes, there's the PBGC liability hanging over the Federal government.
If Ingrassia's (and my) recommendation was followed, the union which supports the current Congressional majority party and the President-elect would, as Paul notes, be forced, in bankruptcy, to see their existing contracts and benefits vanish. The UAW gets a much better deal by feeding off a government-subsidized, barely-living GM corpse than it does in bankruptcy court. Any chance this explains the Congressional insistence on last month's multi-billion dollar loan to the auto makers? And their further desire to shovel more aid without demanding bankruptcy?
Of course, there is a sort of perverse silver lining to all of this.
Schumpeter would note that companies in these straits are hardly the ones from which you will expect any more innovation. So if taxpayers end up owning GM, Chrysler and/or Ford, you can stop worrying that vital American corporate spirits will be crushed. Our government typically 'rescues' those who private capital will no longer touch. It's unlikely that, no matter how badly a government-run GM does, the opportunity cost will be significant.
It's not like anyone will buy a car from a government-run and -owned company. Does anyone seriously believe any good designers and managers will hang around such a company?
In fact, as my friend B and I discussed this morning, GM & Co. aren't even really important as defense contractors anymore. And America has other auto makers, as Ingrassia pointed out. They just happen to be profitable, foreign-headquartered, and located in states that typically vote Republican.
The end result of these various forces is probably going to be a government-influenced, if not run, domestically-headquartered auto sector. My prediction in this post just over three years ago will have finally, definitively come true. At least one, and perhaps three CEOs in Detroit will be gone.
The salient passages in Paul's essay are these,
"Let's assume that the powers in Washington -- the Bush team now, the Obama team soon -- deem GM too big to let fail. If so, it's also too big to be entrusted to the same people who have led it to its current, perilous state, and who are too tied to the past to create a different future.
In return for any direct government aid, the board and the management should go. Shareholders should lose their paltry remaining equity. And a government-appointed receiver -- someone hard-nosed and nonpolitical -- should have broad power to revamp GM with a viable business plan and return it to a private operation as soon as possible.
That will mean tearing up existing contracts with unions, dealers and suppliers, closing some operations and selling others, and downsizing the company. After all that, the company can float new shares, with taxpayers getting some of the benefits. The same basic rules should apply to Ford and Chrysler.
These are radical steps, and they wouldn't avoid significant job losses. But there isn't much alternative besides simply letting GM collapse, which isn't politically viable. At least a government-appointed receiver would help assure car buyers that GM will be around, in some form, to honor warranties on its vehicles. It would help minimize losses to the government's Pension Benefit Guaranty Corp.
The current economic crisis didn't cause the meltdown in Detroit. The car companies started losing billions of dollars several years ago when the economy was healthy and car sales stood at near-record levels. They complained that they were unfairly stuck with enormous "legacy costs," but those didn't just happen. For decades, the United Auto Workers union stoutly defended gold-plated medical benefits that virtually no one else had. UAW workers and retirees had no deductibles, copays or other facts of life in these United States.
A few years ago the UAW even waged a spirited fight to protect the "right" of workers to smoke on the assembly line, something that simply isn't allowed at, say, Honda's U.S. factories. Aside from the obvious health risk, what about cigarette ashes falling onto those fine leather seats being bolted into the cars? Why was this even an issue?
A thorough housecleaning at GM is the only way to give the company a fresh start. GM is structured for its glory days of the 1960s, when it had half the U.S. car market -- not for the first decade of this century, when it has just over 20% of the market. General Motors simply cannot support eight domestic brands (Cadillac, Buick, Pontiac, Chevrolet, GMC, Saturn, Saab and Hummer) with adequate product-development and marketing dollars. Even the good vehicles the company develops (for example, the Cadillac CTS and Chevy Malibu) get lost in the wash.
As for Ford and Chrysler, if they want similar public assistance they should pay the same price. Wiping out existing shareholders would end the Ford family's control of Ford Motor. But keeping the family in the driver's seat wouldn't be an appropriate use of tax dollars. Nor is bailing out the principals of Cerberus, who include CEO Stephen Feinberg, Chairman John Snow, the former Treasury secretary, and global investing chief Dan Quayle, former vice president.
Government loan guarantees, with stringent strings attached and new management at the helm, helped save Chrysler in 1980. But it's now 2008, 35 years since the first oil shock put Japanese cars on the map in America. "Since the mid-Seventies," one Detroit manager recently told me, "I have sat through umpteen meetings describing how we had to beat the Japanese to survive.
Thirty-five years later we are still trying to figure it out."
Which is why pouring taxpayer billions into the same old dysfunctional morass isn't the answer."
Contrast Paul's sensibility with this quote from the Journal's article concerning GM's stock price falling to a low not seen since 1946,
"But Mr. Wagoner added in the interview that he would not be willing to resign in return for aid.
"I think our job is to make sure we have the best management team to run GM. It's not clear to me what purpose would be served" by his resignation. "
So, there you have the business-oriented analysis in a nutshell. No less an objective and savvy analyst than Pulitzer Prize-winner Ingrassia, who co-received the prize for his reporting about Detroit's resurgence during the 1980s, sees Wagoner and his team as the problem. Ingrassia's solution is a variant of the one I've suggested for several years, most recently in that linked post from last month, i.e., file bankruptcy for the faded auto maker, sell what can be sold, and let the Federal government do what it can for line workers and middle managers.
Wagoner, ever the poster boy for 'greedy' large-cap CEOs, claims he's just 'doin' his job the best way he knows how.'
As if.
Paul is right. Wagoner and his team of inept misfits have to go. A bankruptcy court-appointed receiver can dismember GM as s/he sees fit. One point on which I disagree with Paul is whether GM can exit bankruptcy, government-aided or not, as an independent firm. I just don't see the few profitable car models justifying a standalone entity. Dealerships wouldn't survive on that kind of volume. Nor would production costs, etc., be competitive on such a small market share.
Now to the political angle.
No less a leading auto industry executive than Mike Jackson, CEO of AutoNation, boldly asserted on CNBC this morning that GM must be saved, and bankruptcy was unthinkable. According to Jackson, nobody will buy a car made by a company in Chapter 11.
Really? I thought we used to trust market forces to determine the clearing price for virtually anything. In this case, you know that NAPA and other aftermarket vendors will always supply parts for high-volume cars, no matter what the make. There'll be no shortage of mechanics to service GM vehicles, either. Warranties on existing vehicles are a balance sheet liability. Warranties on newly-purchased cars and trucks will either become third-party issued with the cars, or available from them as aftermarket extras.
Of course, Jackson would like to reduce all risk associated with his current inventory, not to mention maintain his negotiating leverage with non-GM vehicle producers. That's why he prefers GM to be bailed out by the Federal government.
Politicians see votes. Pumping taxpayer dollars from fifty states into the failed companies in primarily one state is a slam dunk for Dingell, et.al. Additionally, as Ingrassia notes, there's the PBGC liability hanging over the Federal government.
If Ingrassia's (and my) recommendation was followed, the union which supports the current Congressional majority party and the President-elect would, as Paul notes, be forced, in bankruptcy, to see their existing contracts and benefits vanish. The UAW gets a much better deal by feeding off a government-subsidized, barely-living GM corpse than it does in bankruptcy court. Any chance this explains the Congressional insistence on last month's multi-billion dollar loan to the auto makers? And their further desire to shovel more aid without demanding bankruptcy?
Of course, there is a sort of perverse silver lining to all of this.
Schumpeter would note that companies in these straits are hardly the ones from which you will expect any more innovation. So if taxpayers end up owning GM, Chrysler and/or Ford, you can stop worrying that vital American corporate spirits will be crushed. Our government typically 'rescues' those who private capital will no longer touch. It's unlikely that, no matter how badly a government-run GM does, the opportunity cost will be significant.
It's not like anyone will buy a car from a government-run and -owned company. Does anyone seriously believe any good designers and managers will hang around such a company?
In fact, as my friend B and I discussed this morning, GM & Co. aren't even really important as defense contractors anymore. And America has other auto makers, as Ingrassia pointed out. They just happen to be profitable, foreign-headquartered, and located in states that typically vote Republican.
The end result of these various forces is probably going to be a government-influenced, if not run, domestically-headquartered auto sector. My prediction in this post just over three years ago will have finally, definitively come true. At least one, and perhaps three CEOs in Detroit will be gone.
Monday, November 10, 2008
AIG's Failed Quantitative Risk Models
Last Monday's Wall Street Journal featured a page one piece on the failure of AIG's risk management models.
It definitely caught my attention, because I had written recently on the fallacy of composition in risk management on Wall Street in this post just over a month ago.
"Here we have an unintended consequence affect the situation, due to the fallacy of composition.
Such a downgrade leads each counterparty of such an affected, downgraded firm to require more collateral on each position held with that firm as a counterparty. Thus, in the blink of an eye, or the stroke of a pen at a rating agency, the financial collateral requirements for a firm's book of positions with other trading partners rises significantly.
This is what actually drove AIG into ownership by the US Treasury. Its downgrading by a credit rating agency caused AIG's counterparties to require more collateral for swaps and other insurance arrangements it had sold than the firm had capital available to provide for such needs.
Do you suppose any of the quantitative, computer-based risk management systems of any of AIG's counterparties had the capability to model, forecast and integrate into their risk estimations such an occurrence? Did any of AIG's counterparties have enough knowledge of AIG's exposures to allow it to reasonably estimate the effects on that firm's capital position, and, thus, its risk as a counterparty, if it were downgraded?
I doubt it.
Thus, in yet another perverse way, the individual, similar actions of many financial service players, collectively, lead to a result which causes more risk and uncertainty in the system, even as each individual party seems to act to reduce its own risk to its positions and its counterparties."
Well, the Journal's AIG piece basically confirms my suspicions. Specifically, the article begins by describing how AIG's risk modeling was dependent upon the work of an outside consultant, Gary Gorton, who teaches at Yale's management school. It notes,
"Mr. Gorton, who teaches at Yale School of Management, is best known for his influential academic papers, which have been cited in speeches by Federal Reserve Chairman Ben Bernanke. But he also has a lucrative part-time gig: devising computer models used by the giant insurer to gauge risk in more than $400 billion of devilishly complicated deals called credit-default swaps.
AIG relied on those models to help figure out which swap deals were safe. But AIG didn't anticipate how market forces and contract terms not weighed by the models would turn the swaps, over the short term, into huge financial liabilities. AIG didn't assign Mr. Gorton to assess those threats, and knew that his models didn't consider them. Those risks have cost AIG tens of billions of dollars and pushed the federal government to rescue the company in September.
The swaps expose AIG to three types of financial pain. If the debt securities default, AIG has to pay up. But there are two other financial risks as well. The buyers of the swaps -- AIG's "counterparties" or trading partners on the deals -- typically have the right to demand collateral from AIG if the securities being insured by the swaps decline in value, or if AIG's own corporate-debt rating is cut. In addition, AIG is obliged to account for the contracts on its own books based on their market values. If those values fall, AIG has to take write-downs.
Mr. Gorton's models harnessed mounds of historical data to focus on the likelihood of default, and his work may indeed prove accurate on that front. But as AIG was aware, his models didn't attempt to measure the risk of future collateral calls or write-downs, which have devastated AIG's finances."
Thus, AIG used a fairly simple set of assumptions which neglected to consider both the effects of actions by other investors in similar assets, and the resulting changes in collateral, should those investors' actions lead to downward price spirals.
It should give you pause to realize that there has been a fairly widespread knowledge of the cascading effect of position liquidation ever since the failure of 'portfolio insurance' in the 1987 Crash. That's over twenty years ago.
Where have Mr. Gorton and AIG's senior and risk management executives been during that time? How could they have possibly believed that a quantitative risk management system which deliberately omitted effects of panic selling and attendant collateral increases due to other position value declines would have much relevance to the real world facing AIG and its trading and investment books?
Yet, even with such glaring holes in its approach to risk measurement and management, AIG paid Mr. Gorton a small fortune to do an inadequate job. Nice work, indeed, if you can get it. You can bet that Mr. Gorton will not be liable for any damages to AIG.
To understand how out of touch with real market behavior Gorton is, the article quotes his comments to one of his classes at Yale recently,
"On a rainy morning last week, Mr. Gorton briefly discussed with his Yale students how perplexing the struggles of the financial world have become. About 30 graduate students listened as Mr. Gorton lamented how problems in one sector caused investors to question value all across the board. Said Mr. Gorton: "There doesn't seem to be a fundamental reason why." "
Of course there is a fundamental reason why. That 'one sector' just happened to be one involving sophisticated investors and traders valuing structured and arcane financial instruments. When the CDOs, MBSs and swaps all went untradeable due to real, identifiable underlying trends, e.g., the cooling of the mortgage origination market and the observable rise in alt-a and subprime mortgage defaults and delinquencies, the broader markets began to realize that the so-called 'sophisticated' investors had gotten valuations terribly wrong.
In effect, the fact that many institutional investors who were presumed to be so astute were seen either holding untradeable paper, worth little in a 'mark-to-market' world, or dumping that paper at large losses, when possible, caused bystanding investors to wonder what the value of anything now was. Especially the equity and debt of the publicly-held institutions visibly undergoing value evaporation due to having misunderstood the values of these exotic structured instruments.
This whole mess didn't start because your grandmother worried about the value of Google's equity.
It began because sharp-elbowed asset managers and traders at opportunistic investment banks and hedge funds, such as Bear Stearns, Lehman, Goldman Sachs, and Citadel, began to react, logically, to the news of economic trends in mortgage markets which had all-too-obvious implications for holders of structured finance instruments and swaps.
That's why it only took one sector's actions to cause the resulting cascade of value destruction and, eventually, AIG's demise amidst a sea of poorly-understood risks on its balance sheet.
It definitely caught my attention, because I had written recently on the fallacy of composition in risk management on Wall Street in this post just over a month ago.
"Here we have an unintended consequence affect the situation, due to the fallacy of composition.
Such a downgrade leads each counterparty of such an affected, downgraded firm to require more collateral on each position held with that firm as a counterparty. Thus, in the blink of an eye, or the stroke of a pen at a rating agency, the financial collateral requirements for a firm's book of positions with other trading partners rises significantly.
This is what actually drove AIG into ownership by the US Treasury. Its downgrading by a credit rating agency caused AIG's counterparties to require more collateral for swaps and other insurance arrangements it had sold than the firm had capital available to provide for such needs.
Do you suppose any of the quantitative, computer-based risk management systems of any of AIG's counterparties had the capability to model, forecast and integrate into their risk estimations such an occurrence? Did any of AIG's counterparties have enough knowledge of AIG's exposures to allow it to reasonably estimate the effects on that firm's capital position, and, thus, its risk as a counterparty, if it were downgraded?
I doubt it.
Thus, in yet another perverse way, the individual, similar actions of many financial service players, collectively, lead to a result which causes more risk and uncertainty in the system, even as each individual party seems to act to reduce its own risk to its positions and its counterparties."
Well, the Journal's AIG piece basically confirms my suspicions. Specifically, the article begins by describing how AIG's risk modeling was dependent upon the work of an outside consultant, Gary Gorton, who teaches at Yale's management school. It notes,
"Mr. Gorton, who teaches at Yale School of Management, is best known for his influential academic papers, which have been cited in speeches by Federal Reserve Chairman Ben Bernanke. But he also has a lucrative part-time gig: devising computer models used by the giant insurer to gauge risk in more than $400 billion of devilishly complicated deals called credit-default swaps.
AIG relied on those models to help figure out which swap deals were safe. But AIG didn't anticipate how market forces and contract terms not weighed by the models would turn the swaps, over the short term, into huge financial liabilities. AIG didn't assign Mr. Gorton to assess those threats, and knew that his models didn't consider them. Those risks have cost AIG tens of billions of dollars and pushed the federal government to rescue the company in September.
The swaps expose AIG to three types of financial pain. If the debt securities default, AIG has to pay up. But there are two other financial risks as well. The buyers of the swaps -- AIG's "counterparties" or trading partners on the deals -- typically have the right to demand collateral from AIG if the securities being insured by the swaps decline in value, or if AIG's own corporate-debt rating is cut. In addition, AIG is obliged to account for the contracts on its own books based on their market values. If those values fall, AIG has to take write-downs.
Mr. Gorton's models harnessed mounds of historical data to focus on the likelihood of default, and his work may indeed prove accurate on that front. But as AIG was aware, his models didn't attempt to measure the risk of future collateral calls or write-downs, which have devastated AIG's finances."
Thus, AIG used a fairly simple set of assumptions which neglected to consider both the effects of actions by other investors in similar assets, and the resulting changes in collateral, should those investors' actions lead to downward price spirals.
It should give you pause to realize that there has been a fairly widespread knowledge of the cascading effect of position liquidation ever since the failure of 'portfolio insurance' in the 1987 Crash. That's over twenty years ago.
Where have Mr. Gorton and AIG's senior and risk management executives been during that time? How could they have possibly believed that a quantitative risk management system which deliberately omitted effects of panic selling and attendant collateral increases due to other position value declines would have much relevance to the real world facing AIG and its trading and investment books?
Yet, even with such glaring holes in its approach to risk measurement and management, AIG paid Mr. Gorton a small fortune to do an inadequate job. Nice work, indeed, if you can get it. You can bet that Mr. Gorton will not be liable for any damages to AIG.
To understand how out of touch with real market behavior Gorton is, the article quotes his comments to one of his classes at Yale recently,
"On a rainy morning last week, Mr. Gorton briefly discussed with his Yale students how perplexing the struggles of the financial world have become. About 30 graduate students listened as Mr. Gorton lamented how problems in one sector caused investors to question value all across the board. Said Mr. Gorton: "There doesn't seem to be a fundamental reason why." "
Of course there is a fundamental reason why. That 'one sector' just happened to be one involving sophisticated investors and traders valuing structured and arcane financial instruments. When the CDOs, MBSs and swaps all went untradeable due to real, identifiable underlying trends, e.g., the cooling of the mortgage origination market and the observable rise in alt-a and subprime mortgage defaults and delinquencies, the broader markets began to realize that the so-called 'sophisticated' investors had gotten valuations terribly wrong.
In effect, the fact that many institutional investors who were presumed to be so astute were seen either holding untradeable paper, worth little in a 'mark-to-market' world, or dumping that paper at large losses, when possible, caused bystanding investors to wonder what the value of anything now was. Especially the equity and debt of the publicly-held institutions visibly undergoing value evaporation due to having misunderstood the values of these exotic structured instruments.
This whole mess didn't start because your grandmother worried about the value of Google's equity.
It began because sharp-elbowed asset managers and traders at opportunistic investment banks and hedge funds, such as Bear Stearns, Lehman, Goldman Sachs, and Citadel, began to react, logically, to the news of economic trends in mortgage markets which had all-too-obvious implications for holders of structured finance instruments and swaps.
That's why it only took one sector's actions to cause the resulting cascade of value destruction and, eventually, AIG's demise amidst a sea of poorly-understood risks on its balance sheet.
Being Used...And Loving It
I've been used! And I loved it!
Last week, I wrote this objective piece in regard to a Wall Street Journal article reporting on Boeing's latest snafu, the further delay of its 787 Dreamliner.
To my great surprise, it was picked up by this engineer's union website. As of Monday morning, November 10, as I write this, my blog post has slid off of their 'News Clips' section. But visitors to my blog from that site accounted for at least 50% of the near-record 217 visits here on Friday.
The record was 315 on the day I posted this piece about the commercial bank aspirations of GMAC, Goldman Sachs and Morgan Stanley.
It's not hard to see why the engineer's union chose to publicize my piece. And it's very instructive concerning modern media and not only business, but politics, as well.
The Wall Street Journal might highlight the Dreamliner's problems, but, due to its need for continued access to sources and advertising revenues, it was unlikely to be brutally honest about how badly Boeing's management has messed up the Dreamliner.
I, however, have no such constraints. So, as do thousands of other bloggers, I objectively opine on news articles, adding a bit more bite and candor to softer business news stories already available in the general media.
For the engineer's union, my post must have seemed like a gift. I focused responsibility squarely on the company's surprisingly-unaccomplished CEO, Jim McNerney, and the management which allowed fastener specifications to be made with too little specificity.
For a labor union to find an objective business writer taking this position is sweet, indeed. Rather like Bill O'Reilly finding my blog to be, in the words of his producer, the only place where an objective assessment of Jeff Immelt's dismal misleadership of GE, and the firm's awful performance under his oversight, were available among all the print and electronic media they canvassed.
When I was discussing my blog with a friend at my fitness club recently, he asked why I wasn't trying to find a paid, syndicated writing gig somewhere. As I considered his question, I replied that I guessed I'd first have to approach someone like King World, to get syndication.
I can't imagine that is very easy. Probably a lot like getting your first book published.
Then there's the question of how much the shrinking pool of print media would pay for my writing? The Wall Street Journal doesn't use syndicated writers, and they don't need another Holman Jenkins, whose work my own closely resembles. Neither, I'm guessing, do the best-known business weekly or monthly magazines, such as Forbes, Fortune and Businessweek.
What's left? USA Today and a few large city dailies?
After a few remarks about this, I told my friend, Larry, that probably my best bet would be to hope to be hired as a contributor to either Fox Business News or CNBC, based upon their reading of my columns.
It's an interesting revelation that, were I to want to attempt to make a living writing as I do on this blog, it's not clear that it is really possible anymore. And, ironically, I write more frequently than your average WSJ columnist, because they editorialize weekly, while I write daily.
Multiply me by a few thousand, and you essentially have the free availability of reasonably informed and educated opinions on business ruining the for-fee business editorial market.
In the meantime, the combination of Google's search engine and its free blogging platform have allowed it to affect a large element of business and, as importantly, political writing.
The emergence of person-to-person communication, in a thoughtful and respectful manner, will certainly continue to augment and, perhaps eventually, in the not too distant future, even supersede print editorials.
Thus is Brian Wesbury's 'internet time' arriving at an accelerating pace.
Last week, I wrote this objective piece in regard to a Wall Street Journal article reporting on Boeing's latest snafu, the further delay of its 787 Dreamliner.
To my great surprise, it was picked up by this engineer's union website. As of Monday morning, November 10, as I write this, my blog post has slid off of their 'News Clips' section. But visitors to my blog from that site accounted for at least 50% of the near-record 217 visits here on Friday.
The record was 315 on the day I posted this piece about the commercial bank aspirations of GMAC, Goldman Sachs and Morgan Stanley.
It's not hard to see why the engineer's union chose to publicize my piece. And it's very instructive concerning modern media and not only business, but politics, as well.
The Wall Street Journal might highlight the Dreamliner's problems, but, due to its need for continued access to sources and advertising revenues, it was unlikely to be brutally honest about how badly Boeing's management has messed up the Dreamliner.
I, however, have no such constraints. So, as do thousands of other bloggers, I objectively opine on news articles, adding a bit more bite and candor to softer business news stories already available in the general media.
For the engineer's union, my post must have seemed like a gift. I focused responsibility squarely on the company's surprisingly-unaccomplished CEO, Jim McNerney, and the management which allowed fastener specifications to be made with too little specificity.
For a labor union to find an objective business writer taking this position is sweet, indeed. Rather like Bill O'Reilly finding my blog to be, in the words of his producer, the only place where an objective assessment of Jeff Immelt's dismal misleadership of GE, and the firm's awful performance under his oversight, were available among all the print and electronic media they canvassed.
When I was discussing my blog with a friend at my fitness club recently, he asked why I wasn't trying to find a paid, syndicated writing gig somewhere. As I considered his question, I replied that I guessed I'd first have to approach someone like King World, to get syndication.
I can't imagine that is very easy. Probably a lot like getting your first book published.
Then there's the question of how much the shrinking pool of print media would pay for my writing? The Wall Street Journal doesn't use syndicated writers, and they don't need another Holman Jenkins, whose work my own closely resembles. Neither, I'm guessing, do the best-known business weekly or monthly magazines, such as Forbes, Fortune and Businessweek.
What's left? USA Today and a few large city dailies?
After a few remarks about this, I told my friend, Larry, that probably my best bet would be to hope to be hired as a contributor to either Fox Business News or CNBC, based upon their reading of my columns.
It's an interesting revelation that, were I to want to attempt to make a living writing as I do on this blog, it's not clear that it is really possible anymore. And, ironically, I write more frequently than your average WSJ columnist, because they editorialize weekly, while I write daily.
Multiply me by a few thousand, and you essentially have the free availability of reasonably informed and educated opinions on business ruining the for-fee business editorial market.
In the meantime, the combination of Google's search engine and its free blogging platform have allowed it to affect a large element of business and, as importantly, political writing.
The emergence of person-to-person communication, in a thoughtful and respectful manner, will certainly continue to augment and, perhaps eventually, in the not too distant future, even supersede print editorials.
Thus is Brian Wesbury's 'internet time' arriving at an accelerating pace.
Sunday, November 09, 2008
A Refreshing Retail Experience- LifeTime Fitness
The first Northeastern location of a LifeTime Fitness facility opened this weekend in Northern New Jersey only a few miles from where I reside. Watching the progress of the company as it built the fitness club and its customer base has been a lesson in superb retail marketing.
Beginning earlier this year, in the summer, the advance party of LifeTime employees began to launch direct mail shots and fulfill them from a storefront office located a mile or so from the eventual facility site.
Word began to spread among members of the fitness club to which I have belonged for some 25 years.
Lifetime facilities come in four levels of quality, but all are geared to family fitness and offer a desirable mix of activities, including several swimming pools, racquet sports, and large exercise spaces with an equally large quantity of machines.
Dwarfing even the local YMCA's in size and range of services, the Lifetime facilities do for the communities into which they enter, and to the existing, small-scale fitness clubs, what Home Depot did for these communities in hardware. And, of course, to the small, old-line hardware store.
You might think the Lifetime fitness clubs are impersonal, being as large as they are. Certainly, the owners and manager of my longtime fitness club, and others, hope so. And warn their members of the lack of friendly, familiar staff at the large new facility.
But this isn't so. In fact, far from being cold and impersonal, the staff of the newly-opened Lifetime Fitness facility has clearly been thoroughly and well-trained in cheerful, courteous, friendly service.
The things that the firm has done right are easily enumerated. They have chosen two sensible locations in the area, which is one of the more densely-populated, higher-income sections of the state, but underserved in terms of fitness facilities. Their price points and service offerings provide a compelling value propositions for middle-income and higher families.
No doubt the firm's national scale, use of standardized club designs and their own construction company serves to put them in a position of having significantly lower costs than a smaller, local club would have for the same physical facility.
The staff are all customer-focused, fit-looking and efficient. Far from being overwhelmed by the size of their membership base, they seem to connect well with their customers. The woman responsible for the metabolic analysis and services remembered me, though we had met only once, for an assessment several weeks ago.
As part of the opening process of the first location, the management held a 'get acquainted' cocktail party a few weeks ago, followed by an opening night in the facility two days prior to it opening for business.
Both events served to expose the staff to their customers, answer questions, and prospect for more members through the people who had already taken advantage of early-membership deals.
Lifetime's new facility opened for business yesterday morning in flawless style. They obviously had all of their staff on duty for the opening weekend, and it resulted in a very positive experience.
The place was packed, yet without a sense of chaos.
The building is designed so that the two highest-margin services- a cafe and a spa/massage service- open onto the front lobby. It's no secret that Lifetime aims to make fitness a business. Their employees are all trained to offer, in a polite, non-pressuring manner, additional, fee-generating services. But they also are trained in a general sense to solve problems, answer questions and generally provide a very positive customer experience.
For example, when I asked a cafe staffer about using my member card to charge items, she instantly explained how that was done, where to sign for the service, and, if one's card was not handy, what information they use to allow charging to one's account.
Current economic conditions notwithstanding, the spa and cafe were doing land office business this weekend. Between the people I saw from my longtime fitness club, and the stories of other customers in the locker room coming from other fitness clubs, it's clear that Lifetime has successfully taken significant market share from existing fitness competitors.
It's difficult to see how any local, general fitness businesses, except for the YMCA's, will be capable of prospering, let alone surviving this new competitor's entry into the fitness market.
I checked Lifetime's last five year price chart, as depicted nearby. While roughly even with the S&P500 Index for the period, the company's price soared well above the index for the early part of the term.I don't follow individual companies for investment purposes, and I don't own any positions in Lifetime Fitness. Looking at the chart, I can't say definitively why the company's stock price began to plummet late last year.
Perhaps it is viewed as a discretionary service which will be hard hit by the likely recession.
If so, the experience of the past few months in New Jersey suggests that they are far better managed than that. Nearly everyone with whom I've spoken at the new facility feels the services are much less expensively priced than what is comparably available. The staff performs in a manner that makes you feel you are watching a well-oiled retail machine at work. It doesn't take much thought to understand that Lifetime's size and growth potential allow its employees to consider career development options which are simply nonexistent in your local, smaller-scale fitness business.
I've always liked the people who own and operate the fitness club to which I have belonged for nearly a quarter of a century. Were it not for Lifetime, I would have had no reason to sample another competitor, nor plan not to renew my membership when it expires early next year.
However, there's no realistic way in which that business can compete for my fitness dollar now. Due to a mistake made locating on a wetlands parcel, the owners cannot add more fitness services, such as swimming or tennis. The relatively high fixed cost nature of fitness clubs means that just a small loss of customers will have a severe impact on my current club's profitability.
Faced with, by March, two Lifetime fitness facilities bracketing it within a few miles on each side, my old club won't be able to raise prices and retain members. They obviously can't lower prices to retain members and still maintain profitability.
On both financial and service offering bases, it would appear that the club has a relatively short future. Schumpeterian dynamics, in the nature of a large, lower-cost, more service-rich chain of fitness clubs, has irrevocably altered the local competitive landscape for fitness facilities.
And, true to form, it has resulted in more and better fitness services for the customer's dollar.
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