Thain Ousted From Merrill-BofA By Lewis

John Thain's recent firing as head of the Merrill Lynch units of BofA seems to reinforce the sentiments I expressed only last month, in this post. I wrote,

"Now, Thain is also remembered for gulling investors in December and the first quarter of 2008 to put money into the disintegrating brokerage firm, then claiming they didn't need to raise any more capital. To me, Thain is tarnished by some of what he did early on at Merrill, and for even leaping into the mess. I think it smacks of too much ego and too little perspective on the unfolding disaster that was in process a year ago.

Maybe I'm alone in this view, but I think Thain's time at Merrill has diminished his reputation and raises questions about his judgment."

My view hasn't changed. And I've held it since back in late 2007, when, in this post, I wrote,

"Merrill represents the last of an otherwise dead model, the retail wire house. Sure, Merrill bought and grafted on investment banking in the past decade. But it hasn't internalized the risk management skills which seem to have prevented Goldman Sachs, Morgan Stanley, and Blackstone from suffering the same losses during this year's financial crises.

For an experienced, capable outsider, though, the job might ultimately hold more risk than opportunity."

To me, this whole affair continues to be an embarrassment and the downfall, in time, of both CEOs- Thain and Lewis.

Sure, this week's revelations of Thain's expensive renovation of his office at Merrill amidst its hemorrhaging losses is quite a statement to his lack of judgment, even at micro-levels. That sort of arrogance and waste looks really bad in retrospect. It's hard to believe the stories are only surfacing now.

But, judging from the recent editions of the Wall Street Journal, and comments on CNBC, others are finally seeing what I did over a year ago. Thain didn't perform proper due diligence on Merrill, in so great a rush was he to prove himself one more time. His ego got the better of him.

But Lewis looks bad for throwing over his own common shareholders, under government pressure. Not to mention his first mistake, which was even offering to buy Merrill.

I thought he should have simply hired their brokers, if he really had to have them, rather than buy the whole mess. Merrill never had a particularly stellar investment banking team, nor trading function, for that matter. And Lewis wouldn't know how to manage those anyway.

But, given that he mistakenly wants a full service, full cost brokerage force, simply luring them from Merrill, or, better, picking them off from a bankrupt Merrill, or one taken over by another firm, would have been cheaper and simpler.

But, for now, Thain is the goat. And I agree that it might be a long time before he is well-regarded again in financial services. For now, it's probably time for him to open that small hedge fund and take money from a few friends, so he can hang out a shingle and expense some of his business activities for the coming few years.

Our Resilient Economy: Remembering Nixon's Wage and Price Controls

Last year's ineffective tax rebate checks for how many hundreds of billions of dollars? I can't even recall.

The badly-managed, ill-conceived and ineffective TARP for $350B, with another like sum to follow this year.

Now, a $1T+ 'stimulus' plan to allegedly fix an economic recession. Except the larger part of the economic shrinkage is due to deleveraging, more than recession. And spending doesn't fix recessions, it only adds to government debt.

Still, we've endured worse. Perhaps the very worst, the nadir of America's free-market economy, was the 1971 imposition of wage and price controls by Republican President Richard M. Nixon.

Having defeated the hapless socialist Senator from Minnesota, and sitting VP, Hubert Humphrey, Nixon was viewed as a cold-hearted, paranoid conservative. If any Republican in then-recent memory embodied corporate politics, it was Nixon.

Yet, in what was to become a new paradigm for US Presidents, the ardent cold warrior opened China. And, as conservative, business-supporting President, he crossed over to commandeer the economy though cumbersome wage and price controls. All because inflation rose to the then-scary range of 2-3%. Union demands drove wage increases beyond prior experience.

Just about two years later, on January 11, 1973, Nixon called the whole thing off, ending the two-year travesty.

Later, in the late 1970s, Jimmy Carter almost instituted gasoline rationing. My girlfriend in the early 1980s had worked on the program for Energy Secretary James Schlessinger as a consultant at one of the beltway firms.

Yet, some thirty-five years later, in the mid-2000s, our economy had risen to unbelievable size and prosperity.

Ronald Reagan's tax cuts, Paul Volcker's steady hand at the Fed, and American enterprise combined to usher in the most productive, wealth-producing era in modern American history.

If our economy could withstand the body blows of Nixon's wage and price controls, Carter's energy policy, and even, before both of them, LBJ's inflationary financing of the Vietnam War as he raised taxes, it can also probably survive the current tough times, and those to come.

There's still hope for the US economy not because of, but despite, the planned programs of Congress and the administration.

GE's Weakness & Immelt's Defense

Well, it's GE earnings time again. And time for its inept CEO, Jeff Immelt, to bluster with excuses about his weak leadership of the ailing conglomerate.

I caught some of King Jeffrey I's interview with his own minions on GE-owned CNBC this morning. Salient among Jeff's various excuses was this gem, as closely paraphrased as I can recall,

'We made $4 billion last quarter. I'm not apologizing for that.'

My old boss at Chase Manhattan Bank, Gerry Weiss, then SVP of Corporate Planning, and a longtime GE senior planning officer, used to comment on the inertial earnings power of large companies.

At Chase, he noted, we made enormous profits just by being one of the three largest US commercial banks. In fact, he would frequently say,

"We make money in spite of ourselves."

But that line of reasoning, as Gerry also noted, is inherently flawed. It ignores returns on equity, market value, or even assets. It's a desperate play for the shock and awe of big numbers.

As the nearby 1- and 5-year price charts for GE and the S&P500Index indicate, shareholders have voted, via price, that Immelt's profit numbers are not acceptable. Over the past five years, GE's price has fallen at a faster rate than the S&P. In the past twelve months, GE's earnings have apparently continued to disappoint investors. Just this year, the company's stock price has declined faster than the price of the S&P.

GE had, as of last quarter's report, assets of $829B. On that basis, $4B of quarterly earnings doesn't seem all that awesome, does it?

For Immelt to resort to that is an indicator of just how desperate he is to somehow explain GE's sudden collapse under his mismanagement.

Microsoft Cuts Workforce, Ends Growth Era

Yesterday's pre-market open announcement by Microsoft that it is cutting 5,000 of its 91,000 employees marks the first time the company has trimmed its workforce.

For some, this is a sign that the firm is no longer a high-growth technology company. For me, though, charts like the one nearby have said it for years, as my prior posts on the company have stated.

For the past five years, Microsoft has been unable to outperform the S&P500Index. Say what you will about employee or revenue growth, the total return simply hasn't provided sufficient, risk-adjusted reasons for holding the equity, versus the index.

One fund manager on CNBC today complained bitterly of the firm's pre-open announcement, and swore never to hold any of Microsoft's equity ever again.

The layoffs were blamed, in part, for the major selloff of the equity market from the opening bell.

I haven't seen Microsoft in my equity portfolios for over a decade. Looks like market perceptions are finally catching up with mine.

Another Blunder At Citigroup

Just when you thought Citigroup couldn't make another blunder, it managed to do just that by naming failed Time Warner ex-CEO Dick Parsons as Chairman.

Talk about going from the frying pan into the fire. As bad as Bob Rubin was for the firm, Parsons may well be worse.

True, Parsons probably won't actively and knowingly mislead the board and the rest of the bank into risky CDOs and other ill-advised business decisions, as Rubin did.

Parsons might, I suppose, simply do nothing. Which, in a way, would be an improvement over Rubin.

But Parsons has no track record of succeeding at anything at Time Warner, where he replaced Gerald 'let's buy AOL' Levin. Nor at Citigroup, either, as a board member.

Citigroup has now managed to shuffle executives over the past year or so in such a way as to have no experienced commercial banker as either chairman or CEO.

Nice job, guys.

The nearby price chart for Citigroup and the S&P500Index shows that the bank's equity has declined by some 60-70% in the past year, while the S&P declined 'only' about 40%.

Does anyone really believe Parsons can do anything to help the situation?

State Street Bank's Troubles

State Street Bank has now joined the ranks of US commercial banks experiencing problems from asset value declines.

I provided consulting to the bank's then-CEO, Marsh Carter, some years ago, in the company of my mentor and one-time boss, Gerald Weiss. The three of us knew each other well from our days at Chase Manhattan Bank, and Gerry was a more or less permanent, personal consultant to Carter when he ran State Street.

From the work I did for the company in 1997-98, I recall that the bank's primary competitive advantage was, and probably still is, its immense custody function. As a result of bidding a low price to service pension fund custody needs, the company knew where to locate quite a few securities, as well as became the institutional broker for trades from those customer accounts.

With this huge front end asset servicing business, State Street's other, downstream businesses could make money as a result of information about these securities. All perfectly legal.

Among the bank's least-related businesses was its own asset management group. The current CEO, Ron Logue, headed that group back when I consulted with the firm. So it's rather ironic that, now, the Wall Street Journal reported yesterday that Logue cited the asset management business as the source of the bank's current losses.

On Friday, it disclosed- unexpectedly- that it had some $9.1B of unrealized portfolio losses.

I haven't followed State Street very closely since Carter departed. He went on to become chairman of the NYSE in the wake of John Reed's departure. His successor, David Spina, was a somewhat myopic, cost-conscious operations executive who never understood that the key to State Street's long term ability to earn consistently superior returns was the investment in its ability to process more diverse and foreign-sourced assets, in support of its main customer base, US pension and other large asset funds.

I have no idea how it came to pass that Logue, an outsider to the bank's core functions, has eventually become CEO. But to read that State Street now has problems involving off-balance sheet conduits and other asset quality issues makes it sound like it began to operate more like Citigroup, and less like the less-risky, fee-based custody and processing bank it has historically been.

As the nearby price chart for State Street and the S&P500 Index shows, the company enjoyed a period of fairly consistent outperformance of the index from 1991 through about 1998. It was at that point that my consulting findings predicted that, if management failed to change some operational parameters, it would see a corresponding decline in its future total returns, relative to the S&P. Only a few days after my final presentation, the bank reported results which triggered a 10% drop in the price of the firm's equity in a single day.

Since that time, State Street's performance has been about the same as the index's. As I expected, Spina's cost focus eventually ended the firm's ability to continue benefiting from its massive market share. I would venture to guess, not having access to internal financial information, that State Street's market shares in key custody segments either eroded, or became less profitable.

Thus, it is understandable that they began to look to unrelated asset management units to make up the shortfall. But, in this area, the bank had no particular competitive advantage.

But in the last decade, it would have been fairly easy for even mediocre asset management by those units to offset the falling custody profitability and provide Logue with his ticket to the top job.

It is, in my opinion, yet another example of how failure to understand and manage a company's core businesses can result in a serious failure due to the attempt to maintain performance in the face of changing business realities. Either State Street's main business began to grow much more slowly, signaling an end to its natural period of consistent market outperformance, or they attempted to harvest the business prematurely. In either case, by using ever-riskier asset management to offset this decline, the once-conservatively managed bank has now joined so many other US commercial banks in requiring Federal money to stave off the effects of serious losses due to badly chosen business actions in the past few years.

Fiat Proves My Point On Detroit Bankruptcies

Yesterday's Wall Street Journal reported Fiat's interest in taking a controlling interest in Chrysler.

According to the article, Fiat would begin by taking a 35% position, with the option of increasing to a controlling 55% ownership. Incredibly, Chrysler has fallen so far that all Fiat must do for this position is to cover

"the cost of retooling a Chrysler plant to produce one or more Fiat models to be sold in the U.S."

Thus, my claim, along with others, expressed in this November post, is being shown to be true. Given the opportunity, other auto makers will step in to buy parts of the troubled Detroit-based US auto makers, when they prove attractive for those buyers' own strategies.

Fiat is essentially getting a US base on the cheap. They don't even want to build Chrysler cars, just use the existing plant infrastructure. Then they'll escape foreign-import laws and sell their cars as US-made.

If Congress and the prior administration had simply let GM file Chapter 11, the same sort of market self-cleansing would have occurred. Maybe it still will, but the odds grow longer as Wagoner feels he's successfully elbowed his way to the Federal cash trough.

It's really a shame, because now, during the very week of US political power transfer, Schumpeter's theory of creative destruction is being proven true for the zillionth time.

Chrysler's millstone becomes Fiat's new beginning in the US market. Problem solved!

When, if ever, will politicians, collectively, ever learn that markets do right themselves, and, short of that, forced, arbitrary intrusions by government, and false price-setting always distorts or delays eventual market self-healing?

Another GE-Welch Alum Goes Down: "Rusty" Mike Zafirovsky

Last Thursday's Wall Street Journal reported that the former "Iron" Mike Zafirovsky has put his company, Nortel, in to Chapter 11. Thus becoming, I guess, "Rusty" Mike, and the latest of Jack Welch's spawn to fail in running a company.

Of course, Welch's replacement, Jeff Immelt, has been a complete disaster. Jim McNerney had little to negative effect at 3M, before moving to Boeing and assisting in the Dreamliner snafu.

Bob Nardelli managed to help ruin Home Depot, then jumped out of the frying pan, tens of millions of dollars wealthier for his 'work,' and landed in the fires of Chrysler. No sign yet that Bob has turned that one around, either. I suppose asking for a Federal bailout would qualify as failure, don't you think?

Now we have Mike Zafirovsky. As CEO of Nortel since 2005, he certainly owns the company's current situation. As the nearby price chart for Nortel and the S&P500 Index for the past five years shows, Nortel has been in decline for the bulk of Iron Mike's tenure.

It's now lost nearly all of the value it had when Zafirovsky took over the company.

Like Lucent, it seems the business of developing, manufacturing and selling telephone-based digital processing switching systems just seems to have been the wrong business to be in since the digital revolution.

At least Lucent managed to fall into the arms of Alcatel. No such luck for Nortel, the once-vibrant competitor of Lucent's businesses when they were under the AT&T umbrella so many years ago.

It doesn't seem like any of these companies managed to survive the onslaught of wireless and the digitization of information streams. They might claim to have gone digital with their communications systems, but, somehow, that didn't seem to matter.

As a GE-trained success story, I'd have expected Iron Mike to have either merged or reshaped Nortel before this end befell the company.

Then again, looking at the records of Nardelli and McNerney post-GE, and GE post-Welch, under Immelt, it really doesn't look like any of these guys learned much in their alma mater's famed training program, does it?

Regarding The New Revelations About BofA's Purchase of Merrill Lynch

Yesterday's post discussed Citigroup's recent debacle in some detail. Thanks to long mismanagement and the choice of a novice as its latest CEO, the financial giant has become, essentially, a government-owned banking utility.

Now we come to the other, most recent ward of the government, Bank of America.

Back in December, when Merrill Lynch's shareholders voted to sell their firm to BofA, it seemed rather straightforward. True, BofA's Ken Lewis seemed to be missing the chance to step back and drive a harder bargain, with Merrill's continued weakening condition offering him that opportunity.

But, as I noted in this post from late 2007, commercial bank CEOs are notoriously less capable and effective than their (former) investment bank counterparts. Thus, Lewis' forbearance seemed to be just business as usual.

Now, however, from a spate of Wall Street Journal articles last week, we learn that surprise, surprise- Lewis refrained from backing out of the Merrill purchase due to coercion from Federal government officials.

So, once again, we see that the allegedly passive interest which the Federal government bought last year in our large banks is anything but. In BofA's case, Bernanke and Paulson dictated to Lewis that he must penalize his common shareholders in order to satisfy their demands, and conclude the purchase of Merrill Lynch.

But there's plenty of blame and shame to go all around the table of senior officials, government and private sector, in this travesty.

Lewis claimed that Merrill was a feasible purchase, stating even last Friday, according to the Journal,

"We did not expect the significant deteriorate in mid to late December that we saw."

Gosh, Ken. Isn't that what you are paid to do? Correctly anticipate evolving credit and market risks to your assets?

Apparently Lewis and his team either failed to conduct a proper, updated due diligence on Merrill, didn't insert sufficient clauses to provide for Merrill's asset value shrinkage, or simply did not know what they were seeing when they conducted their analysis of Merrill's books and positions.

Regardless of the reason, this blunder certainly must cost Ken Lewis what little credibility he still has with anyone- analysts, employees, investors.

Oh, and, to close the deal, Lewis then required a further $138B of US taxpayer money, from Treasury, to both provide adequate capital so that the resulting combined firm would pass muster on regulatory bases, as well as provide guarantees for losses on suspect Merrill assets.

It looks like we, the taxpayers, pretty much own another large commercial bank. Nationalization continues apace.

Then we come to John Thain. Reading this morning's Wall Street Journal article about his actions, it is nearly impossible to escape the conclusion that Thain knew very well he had misled Lewis into consummating the deal, while all along knowing of the serious, significant deterioration of Merrill's positions.

Thain disingenuously removed himself from New York during a critical week in December to ski in Vail, Colorado. His spokesperson claims Thain was 'working and available,' while others see him as having deliberately distanced himself from the gathering cloud over the transaction.

It's much more understandable why Thain chose not to revisit the transaction's desirability with his own board or shareholders. Per my prior, linked post, once again, an investment banker managed to out negotiate a commercial banker.

Seen from a distance, once again, we see the needless, expensive and private property rights-trampling behavior of government. Rather than have the excess, incompetent capacity represented by Citigroup, Merrill Lynch and BofA removed, their assets sold at market prices, and only healthy institutions left to compete, instead we have them all being propped up, polluting and delaying the process of the markets to cleanse the financial system.

As I noted in my post from October of last year, reviewing the Journal's interview with Anna Kagan Schwartz,

"Ms. Schwartz won't say so, but this is the dirty little secret that led Secretary Paulson to shift from buying bank assets to recapitalizing them directly, as the Treasury did this week. But in doing so, he's shifted from trying to save the banking system to trying to save banks. These are not, Ms. Schwartz argues, the same thing. In fact, by keeping otherwise insolvent banks afloat, the Federal Reserve and the Treasury have actually prolonged the crisis. "They should not be recapitalizing firms that should be shut down."

Rather, "firms that made wrong decisions should fail," she says bluntly. "You shouldn't rescue them. And once that's established as a principle, I think the market recognizes that it makes sense. Everything works much better when wrong decisions are punished and good decisions make you rich." The trouble is, "that's not the way the world has been going in recent years." Instead, we've been hearing for most of the past year about "systemic risk" -- the notion that allowing one firm to fail will cause a cascade that will take down otherwise healthy companies in its wake. "

I think this past week has more than validated Ms. Schwartz' judgment. We're in for either a very long return to a market-oriented financial system of credit provision, or a very short journey to a fully-nationalized system of core credit provision.

CitiGroup Becomes Our First (or Third?) US National(ized) Bank

Last week's events concerning Citigroup and Bank of America are surely historic and momentous.


Let's consider Citigroup's situation first. Citi was the first of the large banks to be given the sweetheart deal of US government investment beyond the initial TARP funds, with the government taking losses above some maximum level.

Friday's Wall Street Journal reported that,

"The rescue didn't shake Mr. Pandit's confidence in his strategy. He framed the chaotic week as a reflection of the overall financial industry, not Citigroup. "He had a spring in his step," said a Wall Street veteran who met with Mr. Pandit on Nov. 25. "You could not tell that he is a CEO that's under pressure." "

Maybe he wasn't. Pandit never seemed to really, seriously embrace the reality of the crippled institution he had been allowed to lead.


Yet, only a few months later, we see Citi dismantling itself with a rapidity only those like me and other observers of the long-ailing bank for years, have previously advocated.


Pandit, the bank's CEO of only a little more than a year, has suddenly reversed course on the subject of preserving Sandy Weill's treasured financial supermarket, both by shedding the brokerage unit via a joint venture with Morgan Stanley, and the creation of a 'bad bank,' to free what's left to become, again, Citibank.


What caused the sudden change of mind? Vik's newest, large governmental shareholder used some muscle, indicating that the cookie jar of bailout money was closed until and unless Citi finally did something to resolve its mess of an operating structure and business mix.


According to the Journal article,


"By mid-December, Mr. Pandit and his team realized the company was heading for a big fourth-quarter loss, according to people familiar with the matter. Over the course of a week of meetings, it dawned on them that they needed to at least symbolically break with Mr. Pandit's past insistence on preserving Citigroup's business model, these people said."


Indeed.


But let's be clear about what has transpired. After years of flattened returns under Rubin, Weill and Prince, nobody thought to actually fix Citigroup by undoing Weill's tangled business conglomeration.

No, instead of letting market forces, via its mediocre total return performance, push it into either divestiture, or a merger with a healthier bank, the federal government first bought preferred equity in it. Then gave it even more money, and backstopped some of its potential losses.

Then the Feds began to exert the sort of influence that they promised only last fall that they would not, in fact, use.

If you had any doubts about Citigroup, or the other large commercial banks effectively being nationalized, this should dismiss them. Taxpayers, via the Treasury, now own the real market value of Citigroup. It's basically our bank.

So our government is now calling the shots. How long before my various posts on the evolving nationalization of our commercial banking sector are realized?


The Journal article ends with the incredible observation,


"As word of the looming fourth-quarter loss surfaced earlier this month, Citigroup's shares tumbled to their November lows. Colleagues said Mr. Pandit remained in high spirits, pressing his lieutenants to remain focused on their work."


Maybe Vik should change his name to Chance Gardener, the equally-clueless and improbable protagonist of Jerry Kozinski's "Being There."

Carol Bartz Assumes Command at Yahoo

Yesterday's Wall Street Journal carried a very flattering, supportive article describing a more favorable reaction by most interested parties to Carol Bartz' elevation to CEO of Yahoo than prior pieces had been.

The Journal piece noted,



"In a call with analysts Tuesday, Ms. Bartz said, "I don't expect it's going to take an extraordinary amount of time" to examine Yahoo's strategic options, but she indicated she is unwilling to cave in to outside pressure to act. "More than anything, let's give this company some frickin' breathing room. It's been too crazy -- everybody on the outside deciding what Yahoo should do, shouldn't do, what's best for them. That's going to stop." "

You have to love Bartz' attitude. Somehow, you just envision dozens of investment bankers, analysts and related onlookers collectively shutting up and watching while Bartz sorts out the ailing company's fortunes in the next month.

For what it's worth, per my earlier Bartz-focused post, I found my 2006 Yahoo chart comparing GE and Autodesk. Then updated it to the present.

Bartz served as CEO of the cad/cam company from 1192-2006.

As mediocre as GE looked back in 2006 compared to Autodesk, it's even worse now, not even outperforming the S&P.

By viewing the slopes of the price curves, even allowing for GE's dividend, you can see that Bartz outperformed Immelt and, over her tenure, significantly outperformed the S&P. To a degree, I believe, that would work out to a higher rate per annum than Welch's, but I'll have to go to my Compustat data to confirm that.

In any case, Bartz is already taking charge and making it clear she'll be the one running Yahoo and doing the talking. And more than likely, her counterparts elsewhere realize the days of pushing the hapless internet company around are over.

BYD As Auto "Manufacturer"

Amidst the hue and cry over whether and how GM, Chrysler and, in time, Ford might survive and perhaps even prosper again, a mention was made in a recent Wall Street Journal article of battery manufacturer BYD.

This Chinese firm specializes in lithium ion batteries, but is showing its plug-in hybrid at the upcoming Detroit Auto Show.

What I find remarkable is the implication for the three remaining US auto makers which is going largely unheralded.

Part of the recent and, so they hope, upcoming bailout of GM and Chrysler by the US Treasury is an expectation that the companies' new minority partners, Uncle Sam, will mandate 'green' car technology- hybrids, electric cars, and that sort of thing.

But it would seem to be a troubling omen that a Chinese battery-maker is already showing a complete and functioning electric hybrid vehicle. Specifically, given that so much automotive technology is provided by suppliers to the 'manufacturers,' i.e., assemblers, even a simple batter maker can toss a hybrid car together.

This would seem to spell serious doom for the UAW and its employers in America. Not even having marketed production quantities of hybrids yet, these firms and the union depending on them will have to contend with a vehicle built by non-union Chinese workers. Something so simple, evidently, that it would presumably be tough for US auto makers to add sufficient value to make their cars more salable. Yet, the vehicle doesn't emanate from a vehicle manufacturer.

Does this not suggest that hybrids are going to be so easy to make that Detroit producers, with their high legacy costs and union employees, have basically zero chance of making the hoped-for bonanza on this type of vehicle?

So much for throwing tens of billions of taxpayer money into GM and Chrysler so they can make it all back, and then some, with so-called world beating hybrids and other non-gasoline cars and trucks. It's looking like they'll once more be late to market and competing with much more nimble, imaginative and dangerous competitors.

Yahoo Gets An Adult CEO: Carol Bartz

Finally, after years of mistakes, the board of Yahoo did something right. They've attracted veteran technology CEO Carol Bartz to replace hapless Jerry Wang as the CEO of Yahoo.

I have written two posts involving Bartz, here and here. The second linked post, from October of 2006, lauded Bartz as an unheralded, effective CEO. I wrote,

"In my opinion, however, Carol Bartz is the class of the class. She has created value consistently at Autodesk for 14 years, with the exception of some rough years in the late '90s. Even then, however, the company tended to tread water, and not lose substantial value for long time periods.

I think it does seem unfair that Bartz is not accorded the type of press that GE's Jack Welch received for his long-term performance. Blogger is not cooperating with the uploading of a price chart comparing GE and Autodesk over many years, but suffice to say, Bartz looks as good as Welch, when the two companies' performances are compared for the years in which they both were CEOs of their respective companies.

If Bartz is being ignored because of her gender, then that's even more bad news to add to Alan Murray's contentions. Not only do poorly performing female CEOs, like Jill Barad, get spotlighted, but the rare excellent performers, like Bartz, are conveniently forgotten."

The nearby price chart of Yahoo for today indicates that there was initial disappointment by Yahoo investors at the news, even allowing for the S&P500's down opening.

Additionally, the Wall Street Journal ran at least one piece critical or questioning of Bartz' ability to sort the Yahoo mess out.

I disagree. Emphatically.

I don't know what Carol Bartz will decide to do to create or extract maximum value from Yahoo for its shareholders. But I am confident that, whatever it is, it will be as good as, or better than others would have done.

To her credit, Bartz was quoted as saying she had,"a lot of ideas " regarding what to do at Yahoo, but "It would be very presumptuous for me to do so on my first day on the job and I am not going to do so."

How very adult and professional! Yahoo shareholders must be shocked at the new quality of management at the firm. If I were one, I'd feel very comfortable with the image of Bartz across a table from the hulking Steve Ballmer in any upcoming discussions regarding search businesses, joint ventures, et. al.

At the same time, the firm is finally rid of Susan Decker. It didn't seem that she ever made a significant difference at Yahoo. Of the two, there's no question Bartz is the better choice to salvage whatever value can be at Yahoo at this very, very late date.

Deleveraging vs. Recession: Recognizing The Effects

I have noted with increasing concern a confusion in the general business media regarding what are the sources of our current economic difficulties. They are not just a bad recession. In fact, the recession, on its own, is probably simply of average depth and duration.


However, mixed in with the recession is a heretofore unseen deleveraging of the global economy. I first called attention to this phenomenon in this post in late November of last year. In it, I wrote,


"Since leverage, a function of debt, implies confidence in the future returns of loans placed with various enterprises, its unwinding corresponds to a loss of such confidence. The forced reduction in this leverage began, understandably, with the short-term borrowing instruments of both financial and non-financial instruments- commercial paper, most notably.


As this massive de-leveraging of fixed income instruments occurred, the simultaneous drop in real estate values and equity market values caused several consequences.


First, large-scale losses in US, and other nation's market, i.e., societal capital stocks, valued notionally, plunged. Those who previously owned the capital suffered large losses.


The second major consequence of the calamitous drop in price of many stores of value- real property, equity, debt- coupled with the deleveraging, was the cessation of bank lending. Thus, a financial crisis, partially unleashed by a narrowly-defined 'mark to market' rule in a single US law, Sarbanes-Oxley, led to the real effects on non-financial sectors of the US economy. As banks struggled to deleverage their assets in order to both conserve remaining equity from further losses, and abide by regulatory capital requirements, lending suffered. This became a self-fulfilling act, as, starved of normal, short-term operating liquidity, more and more businesses began to reduce operations and cut staff.


The third unforeseen consequence, then, to complete the circle, was the rising joblessness as the economy was already softening, of its own accord, by early 2008.


This last link in the circle of economic causes and effects has now driven a dramatic drop in consumer spending, due to: rising unemployment, lower home values as a source of personal household net worths, and lower financial asset portfolios as a source of personal household net worths."

Probably not since the 1950s have we seen such a secular deleveraging of American capital. I vividly recall, while in graduate school, reading articles on the Treasury's attempts to tax gains of foreign bond holders in the 1960s, which led to the creation of the Eurobond market.

I discussed with my business partner recently the evolution of capital formation, beginning with our early ancestors storing extra wood or food in caves. Early barter systems represented market-clearing mechanisms for surplus food or other primitive goods, allowing specialization to develop. With specialization came production for others, rather than mere personal survival consumption. In time, one person's surplus became another's borrowed capital for further expansion of production.

Somehow, through the centuries, capital creation became increasingly dependent not upon hard assets or saved money, but some analyst's or banker's estimation of the forward earnings power of an entity issuing debt or offering equity subscriptions.

Culminating in events including the famed technology equity 'bubble' of the late 1990s and the recent real estate bubble of the late 2000s, the financial community's allowance of increased leverage, via lending on ever-smaller equity bases, resulted in economic expansion which has to have been secularly due to that higher leverage.

This is important right now, because many people, businessmen and politicians alike, are running around declaring the coming of a second Great Depression any moment.

The President-elect has been engaging in economic scare tactics and fear mongering since this past summer's election campaign. Thus his reason for requesting- no, demanding- a $1T stimulus package.

But, in reality, the economic difficulties we currently face are a combination of two very different phenomenon.

On one hand, there is, based upon the NBER's December statement based upon job losses, a US recession which began in late 2007.

However, within this recession is a secular trend of economic shrinkage that will not be reversed by anything but a return to higher leverage. Thus, no amount of unleveraged economic 'help' will reverse these losses and the accompanying fall in GDP growth.

Seen from this perspective, the only way in which a new, massive Federal stimulus package can provide 'recovery' is to substitute government-issued obligations to return US societal economic leverage back to the dangerous, unsustainable levels at which it was before the current crisis.

How is it that leverage undertaken by the private sector, and judged imprudent, can now be replaced with government-sourced leverage, in the form of either: 1) more printed money, or 2) increased sale of government debt, without creating even more risk by spending the money in less accountable, measurable ways through political channels?

The simple fact is that, for the US economy to lower its capital leverage, and adjust to that lower leverage level, some jobs and business activity will have to simply vanish and not return. Whatever economic level we enjoyed, from which our current recession guideposts are measured, it logically follows that we cannot return there anytime soon unless we collectively decide, as a society, to try to raise financial leverage back to what it was.

If we decide this is unwise, then we have to accept that unemployment will be higher, and business activity levels lower, as the marginal, leveraged activities have been eliminated with the fall in financial leverage.

There is no other way around this fact.

Thus, the component of the current US economic weakness which represents simple, normal cyclicality is smaller than the overall, measured recession which includes the results of this deleveraging process. Any Federal programs which seek to, in a carefully identified and measured way, "fix" the economy beyond this normal cyclical impact, will be a disguised attempt to reflate our economy with added leverage through public debt and spending, rather than private resources and channels.

Citigroup Finally Considers Largescale Change

Today's business news is all a-twitter over the Citigroup-Morgan Stanley brokerage joint venture.

Forgive me if I yawn.

What, exactly, is all the excitement about? Two has-been financial giants with huge long term viability issues toss both their mundane, yesteryear personal retail, full-service brokerage businesses into a common pot?

For Vik Pandit, it's too little, too late. As the price chart for Citigroup in yesterday's post illustrated, the bank has lost nearly 80% of its equity price in the past twelve months. Surely, as others have also noted, Pandit would have gotten much more value for his shareholders had he done this early last year, rather than now.

This is precisely the sort of long term damage that results from in-denial, head-in-the-sand approaches to the actual condition of a business. By insisting on keeping Citigroup's unwieldy, difficult-to-effectively-manage business assortment intact, Pandit simply destroyed more shareholder value faster than he would have otherwise.

For this, alone, it should be time for him to go. And what more convenient time for the board, than in tandem with the guy who mistakenly hired Pandit, Bob Rubin.

Yes, there's also talk of selling Citigroup's Banamex unit. But with Citigroup effectively owned by the Federal government, dismantling it any further is probably academic.

With both Morgan Stanley and Citigroup having significant Federal government ownership stakes, I have trouble understanding how the brokerage joint venture is much different than two related businesses reorganizing units serving similar markets. This is one of the effects of Treasury's actions.

If anything, it probably argues that such combinations and consolidations should continue, until wholesale banking, retail banking, etc., are centrally managed, but dispensed to Americans via different old, familiar brands, e.g., Morgan Stanley, Goldman Sachs, BofA, Wells Fargo, Citigroup and Chase.

The names might differ, but the credit allocation policies, interest rates and such will be unvaried.

It's simply hard for me to take seriously the notion that two government-dependent commercial banks, each unable to prosper, let alone survive on its own, can effect much exciting, useful change for their shareholders anymore.

Let's be honest, even if the Wall Street Journal and CNBC won't. This is a government-owned sector now. It's no longer truly private enterprise.

Citigroup's actions are, at least, explained as being coerced by government officials who are now more owners than regulators.

How do you report that and still believe there's any private enterprise angle to these stories anymore?

Bob Rubin Finally Leaves CitiGroup- In Ruins

Finally, after assisting in wrecking the firm to which he was recruited as non-executive Chairman not quite ten years ago, with unusual powers, Bob Rubin has resigned.

The nearby chart shows the effects of Rubin's last major act at Citigroup, the hiring of CEO Vikram Pandit. Compared to the S&P500 Index, which suffered its worst year ever, the large money-center bank performed even worse under its novice CEO.

In the Wall Street Journal article this weekend discussing Rubin's gift to his erstwhile shareholders, he is reported as having excused the damage he caused at Citigroup by citing the fact that Alan Greenspan, among others, had failed to forsee the totality of the financial sector crisis which crippled the bank this past year.

Where was the Citigroup board all these years? Didn't they ever consider the losses to shareholders brought on by following Rubin's 'counsel?'

Allegedly, Rubin's letter of resignation expressed his desire to "intensify my engagement with public policy."

Seeing as how Rubin presided over a loss of some 70% in Citigroup's share price over the time he served as chairman, one wonders just what benefits Rubin imagines he now can add to public policy debates.

Instead, one wishes he would have written,

'Because my leadership at Citigroup was so disastrous, my counsel on risk-taking and entering the mortgage finance business so wrong, I have decided to retire permanently from any work, private or public, involving finance. I have clearly caused far more damage than could ever be corrected by my further involvement in this sector, and it is debatable that my future decisions or advice would be any better than that of the last decade.'

But we all know Rubin wrote, nor will express, anything of the kind. Sadly, he may, in fact, go on to badly advise the incoming administration in Washington.

Continuing Erosion of Music Label Power: The Case of Erin McCarley

This past Thursday's Wall Street Journal contained a review of a new artist named Erin McCarley.

I'm not interested in reviewing Ms. McCarley's music here. But what did catch my attention was the manner in which she has risen to some measure of popularity prior to having a recording contract with any major label.

As I have written elsewhere on this blog in prior years, including this post, it's only a matter of time before record labels are nearly useless. In that post, from October, 2006, I noted,

"The second one ran in yesterday's edition, and dealt with, ironically, how easy it now is for independent bands to become successful with little or no money, no traditional record label and, thus, no old media agent. Some indie bands do retain what one might call eagents, such as NetWerk Records, a combination indie label and artist management firm. This seems to support my contention that agents, as we have known them, will also be unnecessary for the coming era of online digital video content production, found here.

What's interesting is that established bands are also exploiting digital downloads, in order to capture immediate interest by fans. Rather than expect, or let, prospective buyers go to iTunes to buy and download music, they are embedding a MySpace MP3 player on their MySpace sites."

This is exactly what Ms. McCarley had done. The Journal article details her being paired with another musician to complete her own song-writing and singing efforts for a first album of work,

"As they cut the record without any outside funding- Mr. Kenney pulled together a band for the sessions- Ms. McCarley understood she could have a level of control over her career.

They sent out a six-song sampler to industry insiders and posted some songs on Ms. McCarley's MySpace page. A showcase performance at last year's South by Southwest Festival resulted in a bidding war for her disc.

Having a finished album they could distribute without a major-label marketing push, Ms. McCarley and Mr. Kenney negotiated from a position of strength."

I found and listened to her music on the MySpace page, just as the article described. They are full-length, high-quality tracks. The article also mentions her being featured on iTunes, with the opening track of her album available there for free.

It's wonderful to see such a seamless combination of technological and marketing/promotional channels occur to give small business people, i.e., a musical artist, the ability to start her career without the suffocating 'help' of a major recording label.

Instead, today's mix of free internet social sites, layered applications like embedded music and video, and iTunes have resulted in a talented artist building her own business and career her way, with minimal need for outside funding or technology.

Along with others, I foresaw this several years ago. But, with each passing year, it's evidently becoming easier to execute.

Cable Television's Problems Hit Home At Time Warner

Last October, in this post, and earlier, in 2006, in this post, I have voiced my belief that, in the not too distant future, half of cable companies' revenues will be shorn, as their television packages begin to be disconnected.

In 2006, I wrote,

"I now wonder whether half of cable's revenues will go away as more consumers find and buy/view content directly on urls via their hi speed data facilities. With destination sites like Youtube, who will need a pre-packaged suite of programming content like Comcast currently has for TV, or is attempting for the internet? And then, we'll probably see cable and telephone company DSL-based content offerings compete each other's prices downward to retain some measure of revenue from these antiquated, pre-packaged content services.

Instead, we'llprobably buy a wireless box which takes the hi speed online signal, directs it with a handheld wireless controller, and displays url-based video on your in-home TV display."

And, in October, I added, in that post,

"It won't be surprising to me at all if we unplug from Comcast's television services within two years. I'll save about $600/year, which means the most expensive of the new wireless internet-to-television boxes will have a 6 month payback. Schumpeterian dynamics are quickly moving internet-based video content, that is not business news, into a competitively-advantaged position relative to packaged video content services offered by cable operators."

Well, two things have occurred to speed my prediction along.

First, Time Warner took a $35B charge yesterday for impairment of value in its cable properties. The company's new CEO, Jeff Bewkes, explained that, due to the company's equity price having been mercilessly hammered, it was forced to recognize the reduction of the economic value of its cable system assets.

The Wall Street Journal article reporting this pointedly noted that disintermediation via services like Hulu and iTunes were causing viewers to find alternative, cheaper, or even free sources of programming which used to be accessible only via paid cable television packages.

On a personal note, I can vouch for this. My daughters and I took a giant leap forward in this direction with the holiday season purchase of a TiVo HD DVR. With a wireless adapter, we now can stream Netflix on demand program content directly to our television.

Further, it's already affected my cable television subscription. Rather than consider upgrading to a more expensive package to receive Disney channels, I now have next-day access, for free, via Netflix. Netflix also offers a huge number of recent television programming, plus several thousand movie titles for on-demand streaming.

Because TiVo upgrades its boxes with software downloads, how long will it be before the service begins to offer direct streaming from various other internet-bases sites, including Hulu or individual cable channel-related sites?

Today, it's Disney that I'm not buying from Comcast. Tomorrow, who knows which channels will have also become redundant?

The second linked post, from last October, detailed how some younger video content consumers are dropping their cable television subscriptions, substituting them with set-top boxes streaming Netflix and/or other content to their televisions.

Time Warner's write down was an unexpected piece of additional evidence that this vision of the future disintermediation of cable content by internet-based content sites is approaching much faster than anyone believed even a year or two ago.

Chances are, it will accelerate from here.

An Example of Ineffectual Competitive Response- Part Two

Earlier this week, I wrote about a local example of ineffective competitive response to a new market entrant.

Throughout the past few years, I've written many pieces on the inevitable demise of GM, but that's a global- and national-scale story. In the case of the local fitness club, I am fascinated by the operation of similar principles, but on a much smaller, totally observable scale.

In the prior post, I detailed some of the history of my old fitness club. How it began, what crucial decisions the owners made which cast their future options in stone.

The current attitude of the owners is summed up in the notion expressed in their recent letter to members,

"We are small enough to know you and large enough to serve you."

Unfortunately, that's only the demand side. What about the supply situation? That is, the financial realities of operating such a facility?

Fitness clubs have a fairly high proportion of fixed to variable costs. The building must be opened, heated/cooled, lit, towels washed and water provided, the facility cleaned. A few people are needed for administrative purposes, and to conduct various classes. But for the most part, the daily costs of running such a club are pretty constant, whether 20 or 200 people use it that day.

Based upon the known membership size as of the middle of last year, the pricing plans, and the number of higher fee-paying squash members, the revenue for the club in a recent full year of operation was probably something in the neighborhood of $3-3.3MM, including some estimate for personal training revenues, which vary by membership size.

From various sources, including a rough count of the number of former members of the old club appearing at the newly-opened LifeTime Fitness club, it has been estimated that about 10% of the members of the old club have switched to the new one. Most of those who switched play squash, thus representing the highest-margin members at the old club. Since LifeTime Fitness has a single fee per person, rather than charging extra for using various parts of their club, this was one of the attractions of the new club to many squash players from the old fitness club.

If one assumed a fairly standard profit rate of 10% on sales, the old fitness club probably earned a pre-tax income for its owners of something in the range of $300-330K annually. But with so many of its higher-paying members gone, some of my more financially-savvy friends and myself have estimated that this has now dropped to near breakeven.

We may be off by a few percentage points, but, from the standpoint of an external consultant, the direction of the changes, and their relative magnitudes, are fairly clear. If you were given the job of managing my old fitness club, you'd have a considerable challenge on your hands.

For instance, you've probably lost almost 10% of your revenues, but your costs are still pretty constant. Furthermore, in less than a month, a second LifeTime Fitness club will open a few miles away, taking perhaps another 50-100 members, or another 3-6% of the original member base.

Because the club's membership loss comes from a new entrant, it's unlikely that many new members will be joining the old club. Those that do will probably fit a rather narrow profile: 30+, single or married, living very near to the facility. Otherwise, those with families or more distant will find one of the two LifeTime Fitness clubs a better economic value while being no further away.

If the old club attracted as many as 50 new members per year, it's reasonable to assume that would fall to no more than perhaps 10-20 now. And those are unlikely to be the higher-priced squash members.

Thus, revenue and profit growth for the old club are now limited. A manager's next move would be to cut expenses. Since desk and other low-paid, part-time workers are necessary and provide little in the way of profitability improvement, the only reasonable alternative is to either cut the higher-paid activities staff, or move them to the same basis of compensation as LifeTime Fitness employees, i.e., a heavy incentive component based upon member involvement.

The owners of my old club are very successful, accomplished, likable older men. Having owned and operated the club since 1978, they are not looking toward additional decades of involvement in the facility.

So, if you were a consultant hired to advise them on alternatives, you'd know that, whatever money they were making prior to the entry of LifeTime Fitness into the local market, they will probably never make that much profit again. New member growth is unlikely. Raising prices even higher above LifeTime's levels will probably drive even more members away. Cutting prices will, of course, only result in member retention with less profit. Moving some of the program-related employees, such as the aerobics program director and various class leaders to variable compensation, will only result in a one-time drop in expenses.

Thus, from the supply side of the fitness club's financial equation, it's unclear whether it can prosper by fulfilling its stated objective.

In more graphic terms, it's unclear that a collection of aerobics class-using housewives, older, retired couples and some locally-residing members, all of whom value the club's proximity and friendly, small environment, can ever provide the prior level of profitability, or even a breakeven level of profit.

I would wonder how long the current owners can afford to fund the lower level of profitability. If there were a competitive environment in which the owners of the old club could add programs, facilities, or cut prices, they might hope for a return to the prior level of profitability. But this isn't really feasible anymore.

Like GM, though on a much smaller scale, one wonders how long managers and/or owners of an enterprise can afford to be in denial about financial realities facing them in the future?

I guess, for my old fitness club, it's a function of how long the owners choose to fund a less-profitable, and perhaps even losing enterprise, than they had in the past. Unfortunately, good intentions and prior accomplishments don't necessarily count for much when a more economical, fully-featured competitive facility enters the market.

Thirty years is a very long time for a relatively static business enterprise to have survived and prospered. Ceasing operations under these circumstances wouldn't mean a failure of the business, so much as a change in the competitive environment, and market, which the older club is simply unable to profitably address any longer.

The Next Union Victims: US States

Last November, amidst the dust up regarding the US auto maker's, and UAW's plea for a Federal bailout, I wrote this post discussing that union's chief's surreal press conference.

I closed that post with this thought,

"This, sadly, is a fact. It's clear that Gettelfinger's UAW is salivating at the prospect of raiding the Federal Treasury, courtesy of the Illinois rookie, Frisco Nan and Harry Reid, without taking any wage or benefit cuts whatsoever. So desperate are they that Gettelfinger is trying to mau-mau President Bush to cough up the funding in advance. The greed and lack of a sense of reality on the part of the UAW's senior officials is just mind boggling."

In discussing this whole mess with my partner recently, I noted that, thankfully, the entire range of Federal bailouts of late 2008- banks, insurance firms, auto companies- don't seem to involve any of America's highest-growth, innovative and/or superior value-adding companies or sectors.

For this, we should give tremendous thanks.

In truth, as is often the case, the economy's laggards and commodity providers are seeking relief. So, aside from wasting our society's scarce resources on these inefficient, dying or low value-added producers, the bailouts don't seem to be hampering the creation of new value on the cutting edge of our economy. It's not like Washington is getting into bed with Google, Intel, HP or Gilead via financial investments and coercion.

Unfortunately, we have seen substantial evidence that the stream of entities heading to Washington for relief has not yet ended.

Rather than companies, it seems the next beggars will be profligate US states, brought low, economically, by their own spending and, of course, promises to unions.

It's become widely understood recently, including being a subject of a Wall Street Journal piece, that California, Illinois and New Jersey- blue states all- are on the brink of bankruptcy.

California has its own myriad reasons for financial distress, from what I read. However, regarding Illinois and New Jersey, I have, sadly, more personal acquaintance with and knowledge of their travails.

In both cases, lush benefits promised to AFSCME are proving to be unaffordable.

Speaking personally, I noticed this trend as far back as when I was a VP at Chase Manhattan Bank in the 1980s, during the radical transformation of the steel industry. What occurred to me then was what I expressed in this first post on this blog in 2005. Specifically,

"What I find ironic is that, while so much of this week’s, and many prior years’ focus, is on union leaders squaring off against company managements, nobody has bothered to ask how it is that the unions got themselves in this mess in the first place?

Why did unions ever begin taking future pension contributions from the companies for which their members worked, instead of cash compensation?

In hindsight, “defined benefit” plans of any type or name, public or private, are a clever way for a public corporation or a government to fund operations with implicit loans. For big steel, autos and airlines, as well as other labor-intensive sectors in the ‘50s, ‘60s and later, this amounted to labor union members lending, via unsecured future compensation and fringe benefit promises from their employers, sums of money for which they had no collateral. Financial engineering which puts modern investment bankers to shame."

The same goes for public workers and their union. They foolishly accepted inflated promises of future benefits from various governmental entities, beginning in lavish style in the 1960s.

However, what has befallen private sector unions such as the steel and airline workers since then is surely coming soon to the AFSCME chapter near you.

How many voters will actually accept much higher taxes to pay for retirements they don't, themselves, enjoy? That's the crux of the lack of support by most Americans for the UAW in the recent Detroit bailout.

But, as my partner and I noted, there is a major problem looming for states such as California, Illinois, New Jersey, and their ilk, and their AFSCME locals. We've already begun to see it in the worst-off state, California.

People can leave states which have overwhelming financial obligations. They can choose to walk away from a financially bankrupt state entity, leaving fewer residents to shoulder the fixed pension obligations promised so many decades ago.

What will happen when a state like Illinois watches younger, more productive and higher-earning citizens depart, along with the companies that employ them, for lower-taxing states with better financial health?

Don't think it can't or won't happen. Look at the diaspora of industry and residents from California over the past decade. Washington, Oregon, New Mexico and Nevada have all grown due to emigration from the Golden State.

As an economic dilemma, this one will rank up with the great ones for the US. We've seen school boards like Chicago's taken over, and even New York City endured a form of Chapter 11 reorganization under 'Big Mac' for several years.

But we have yet to see an entire state seek the governmental equivalent of Chapter 11 bankruptcy. California seems close, in that, last month, it began to issue paper script IOUs to vendors, in lieu of cash, so it could husband funds to pay its bondholders, thus avoiding defaults, and severe credit rating consequences.

To me, it just makes sense that each group of parties in our society which promised, and accepted, unrealistically lavish financial benefits decades ago, at the height of the post-WWII American prosperity, will have to eventually reduce the magnitude of those promised benefits.

Whether through private corporations and their unions, or governmental entities and their unions, our society has to face the fact that a lot of unwise, irredeemable financial guarantees were foolishly given and accepted years ago by people who should have known better.

As we saw in the steel sector collapse of the 1970s and '80s, then the airline reorganizations and, now, the auto sector, economic realities typically, if painfully, trump unrealizable contractual obligations.

I don't think the case of states and AFSCME demands will be any different, in the end. But the process of our society, on a state-by-state basis, acknowledging the reduction of pension and benefit promises from decades-old pacts between governments, as agents of their populations, and employees of those governments, will likely create watershed economic events heretofore unimagined in our society.