The Missing 'Cap and Trade' Market Reaction

The House passed a carbon 'cap and trade' bill Friday afternoon by just a 7 vote margin.

Funny how it missed the major news feeds, isn't it?

By scheduling the vote prior to a weekend, and the July 4th holiday recess, the House virtually guaranteed that the average American wouldn't notice the vote. The unplanned coincidence of Michael Jackson's death that afternoon virtually assured the vote's disappearance from major coverage over the weekend.

What has mystified me, though, is the lack of apparent reaction in equity markets of institutional investors. This bill, as currently written, constitutes the most massive tax and wealth transfer probably ever proposed by the US Congress.

Perhaps the lack of investor reaction is due to the Senate's not yet passing a compromised version into law.

Still, I'm just amazed that such a huge tax increase and energy policy rewrite which will radically shift fortunes among US business sectors and regions is only one chamber away from passage, with no observable sign of distress among professional equity investors.

CNBC's Hidden Advertising

I happened to be watching CNBC earlier this morning, when I saw a guy named Brian Singer, formerly a senior asset management executive at UBS, appear on Squawkbox.

The ostensible reason for having Singer on the program was his former status as the overall manager of $300B when at UBS. But the real reason was essentially to let Singer advertise that he has left UBS and formed a new hedge fund group.

So, in effect, if you are well-connected with CNBC and can provide some apparent newsworthy spin to your self-promotion, you can use their platform for free advertising.

Singer's big news? That he's starting a hedge fund in this time of market turbulence. That he decries 2/20 pricing. Instead, he is offering 1% and, after five years, 20% of the gains above the S&P500.

Actually, that's an old idea. I offered that back when I partnered with a hedge fund a decade ago. What Singer rambled on about for quite some time was something I had succinctly stated in a Powerpoint slide.

Perhaps in the wake of some mediocre performances by the hedge fund community generally, Singer feels he has nothing to lose promising to only take performance fees on above-market gains, since customers are looking more judiciously at the performance for which they are paying.

What was somewhat striking about the whole 5 minute episode, though, is that Singer was basically allowed a free infomercial just for having been a senior executive at a large firm.

I guess it's a 'hide in plain sight' sort of thing. Claiming something is newsworthy allows CNBC to dispense free air time to friends and perhaps repay favors, or offer exposure as a quid pro quo to sources.

How's that for journalistic ethics from a 'news' network?

Forget Responsibility- Let's Just Blame Bernie Madoff

I've written eight other posts concerning the Bernard Madoff investment fraud, all of which may be found by clicking on the 'Madoff' label, in the list along the right side of this page. Of all of them, I think this one, from late December of last year, best captures my feelings on the entire affair.

Of course, since Madoff was sentenced yesterday to 150 years in prison, the topic of his epic fraud was headline news again yesterday.

CNBC and Fox News made much of the wailing of various 'victims' of Madoff's fraud. Once again, the media helped shift responsibility from the so-called sophisticated investors who ignored the many warning signs concerning the fraudulent scheme, and place the entire blame on Madoff.

In contrast, I wrote in that prior post,

"To me, the key observation, which I read in the Journal last week, was that an outside analyst had done a sort of 'back of the envelope' calculation to determine that Madoff's portfolios, according to estimates of the assets he ran being in the tens of billions of dollars, must have had trading activity exceeding the entire market for various index puts or calls. Additionally, experienced clients seemed to think nothing of the fact that blue chip equities showed no decline in prices earlier this year, although they were key to the alleged strategy.

This smacks of convenient denial of reality by so many clients. The suspension of disbelief, and a desire to simply believe that unbelievably good, and not just consistently, but uniformly constantly good results, were real.

As I reviewed the mechanics of Madoff's scheme of undisclosed numbers of individual accounts, rather than a single, explicitly-spotlighted fund, with my partner, my belief that Madoff had long ago discovered loopholes that I, too, observed earlier this decade grew significantly.

The most important element of his fraud, without question, was the lack of independent custodial inventory reports of financial assets held in accounts for clients. I can't emphasize enough that this alone left every one of Madoff's clients vulnerable.

Coupling this with a curious lack of diversification, a/k/a greed or stupidity, and you have the recipe for disaster among so-called 'sophisticated' investors.

How many once-wealthy Americans having millions of dollars of accumulated financial assets are now simply bankrupt? Or nearly so, with almost nothing to show for decades of successful careers?

And all of this....all of it...would have been minimized, if not totally avoided, had each and every investor insisted on receiving a regular asset inventory report from an independent custodian. This would have prohibited false claims of asset ownership, or required an entire custodian's business to be in league with Madoff.

I don't believe any more regulations will prevent a repeat of this type of periodic investment fraud. There are plenty of safeguards required by current regulations. But nobody can prevent a person from simply throwing caution to the winds, trusting in a manager, and his 'special' inner client circle, without any objective, confirming evidence."

Rather than the sort of statements no doubt made by various clients of Madoff's in court, which I'm sure portrayed themselves as victims who bear absolutely no responsibility for what happened to them and their money, I would love to read in this morning's newspapers, and see video on cable news, statements like these:

"I was greedy and failed to diversify my millions of dollars of assets as I have been advised and taught for decades.

I foolishly asked no questions as to how Mr. Madoff could achieve such uniformly-constant, positive returns for decades, when no other manager ever demonstrated such performance perfection.

I took the advice of my friends at face value and asked no questions.

I felt so fortunate to be allowed to give Mr. Madoff all of my assets to manage that I never bothered to ask questions about how he achieved his performance.

Learning that my money would be refused for management by Mr. Madoff if I asked a single probing question, I kept my mouth shut and just wrote the checks.

Despite the fact that Mr. Madoff did not have a publicly-listed mutual fund with an independent accounting firm auditing the accounts, and a custodian of assets, I gave him all of my assets.

I never bothered to demand a quarterly custody report from an independent custodian verifying that Mr. Madoff's firm held the assets claimed in a separate account for my benefit.

I suspended disbelief that anyone could achieve such uniformly perfect investment returns, because I didn't want to discover that this was all a fraudulent scheme.

It never occurred to me to do a rough estimate of whether the options markets were sufficiently large to accommodate Madoff's claimed strategies.

I violated almost every precept of intelligent money management- diversification of instruments and managers, validation of assets held- in my greedy and reckless pursuit of constantly-positive returns from Mr. Madoff."

Alas, I know I won't be reading or seeing those statements from people who lost money in Madoff's scheme. No, they are being portrayed only as victims. Nobody seems to be forcing them to admit to their own greed, bad judgment and denial while they were receiving custom-created reports falsely reporting such amazingly constant gains in the worst equity market in generations.

In fact, I continue to find some humor in ongoing 'searches' for the 'missing billions.'

Haven't people gotten "it" yet? There weren't any 'missing billions.' The totals of those numbers on all those fraudulent, typed-up account statements are themselves fictitious. Madoff never made those profits. He spent them.

People, it's a Ponzi scheme. The gains were illusory. The money people gave Madoff was spent and is either gone, or cleverly hidden in several or many blind accounts, to be eventually accessed by his family after enough time has passed for them to safely recover and launder the money.

So, sure, there's probably a lot of money hidden somewhere. But it's unlikely to be on the scale of what people believe. The false gains which pumped up expectations of Madoff's phantom horde have probably created an equally-false expectation of the size of his remaining illicit plunder.

It's sad that the major lesson of the Madoff fraud is going largely untaught and unreported. By making Madoff the only villain, and excusing the greed and stupidity of his pigeons, the media are fostering the sense that what happened to Madoff's clients could not have been avoided, and involved no amount of naive and inept investing behavior.

Cable TV Attempts To Fend Off Internet Video

I've written several posts, most recently, here, regarding the efforts of cable television providers to cope with an initially small, but growing segment of viewers who are turning to the internet for all of their video programming.

Last week, the Wall Street Journal carried two separate articles on the response of cable systems to this phenomenon. Basically, they cable system providers are offering their customers access to exclusive video content, and internet access to existing cable video content, in exchange for not disconnecting their cable feeds, and merely keeping their high-speed internet access.

I don't think this will work. It seems to me that people tend to want known content for the lowest price, consistent with their viewing habits or access capabilities. Quite a bit of existing cable content is now available on Hulu, or on an inexpensive, per-episode basis on iTunes.

Like many technologies, there's a growing rift between younger consumer segments and older ones. For example, I prefer to watch most television programming on a large screen, but my children have learned to be fairly ambivalent between a television screen or their laptops.

Promising as-yet-unspecified video content in exchange for very pricey access to content you can access either via Netflix, Amazon, iTunes or Hulu doesn't seem like such a great deal anymore. Further, consumers are learning to accept and use a variety of means by which to access video content.

Finally, as I noted in this post, in February, TiVo is now fully capable of adding a menu of internet URLs to its menu, thus allowing a subscriber to access any internet site for video content. It's not clear to me why TiVo is waiting to do this. Perhaps it's a matter of quid pro quo with content providers continuing to make it easy to use TiVo instead of their proprietary DVRs.

In any case, there are a multitude of paths to video content that don't lead through a paid cable television subscription.

Adding a few exclusive video programs is, in my opinion, unlikely to be a long-term solution for the cable providers. Eventually, they're going to face what music and movie producers have already undergone- technological advances which render their proprietary hold over video content moot and of much less value than it could command in the past.

New Regulations' Effects On US Banking Profitability

This morning's Wall Street Journal featured an article in the Money & Investing section contending that proposed new financial regulations could, by mandating 'plain-vanilla' financial products, such as mortgages and credit cards, result in a reduction in bank profitability.

I think the article's premise is correct. Having worked in one of the nation's large, money-center banks, Chase Manhattan, for years, I can attest to the truth that the more complex, illiquid and/or non-standardized financial products are, the higher their profit margins tend to be.

That's why bond and derivative trading are nice businesses. Without centralized clearing and settlement and/or transparent price quotes, margins stay high. Especially on retail customer transactions.

In product lines like credit cards and mortgages, various fees and the all-important credit card balance-maintaining customers drive the above-bank-average profitability of these businesses.

However, I don't see anything wrong with this particular type of regulatory reform, nor its effects on bank profits.

I've contended for some time that financial services business growth, over time, can't legitimately exceed that of the economy. Financial services is a purely derivative activity. It's done to facilitate other activities, not for its own reward.

Therefore, in order to 'goose' growth and profits, bankers routinely develop new products with extra fees or complexities which allow premium pricing, at least for a while. After seeing how many people failed to understand, or claimed to fail to understand their mortgage documents during the recent mortgage lending problems, it may well be a good idea to mandate simpler, plain 30-year, fixed-rate home loans be available as a default choice for consumers. The same could well be true for credit cards, which also seem prone to misuse and abuse by under- or uneducated consumers.

If these proposed regulations retard bank profit growth or margins, so be it. Better to have a healthier, slower-growing financial services sector with fewer catastrophic losses than what we've seen out of mediocre bank management for the past half-decade.

More "Green Energy" Lies

There's a group named "Repower America" which has been running a series of deceptive ads on cable television for the past few months.

Here's one of them from a few months ago.



They take a craggy-faced actor and dress him up to appear like a real, wizened, concerned old geezer who knows what's right for America, by gosh!

The current ad features the same 'old crag face,' this time alleging that we are borrowing billions to pay for our gasoline. That new ways are necessary, and, of course, the oft-repeated canard that wind and solar power will create lots of new, 'good-paying' jobs.

Of course, what none of these commercials tell you is that the infrastructure expense and effort, not to mention consumer tradeoffs to accept electric cars, are enormous. As I explained, with the help of a Wall Street Journal article, in this recent post, you just cannot feasibly replace locomotion-focused carbon-based energy with a few windmills and solar panels. The author noted,

"The latest data from the U.S. Energy Information Administration show that total solar and wind output for 2008 will likely be about 45,493,000 megawatt-hours. That sounds significant until you consider this number: 4,118,198,000 megawatt-hours. That's the total amount of electricity generated during the rolling 12-month period that ended last November. Solar and wind, in other words, produce about 1.1% of America's total electricity consumption."

The conversion of electricity into oil terms is straightforward: one barrel of oil contains the energy equivalent of 1.64 megawatt-hours of electricity. Thus, 45,493,000 megawatt-hours divided by 1.64 megawatt-hours per barrel of oil equals 27.7 million barrels of oil equivalent from solar and wind for all of 2008.Now divide that 27.7 million barrels by 365 days and you find that solar and wind sources are providing the equivalent of 76,000 barrels of oil per day. America's total primary energy use is about 47.4 million barrels of oil equivalent per day.

Of that 47.4 million barrels of oil equivalent, oil itself has the biggest share -- we consume about 19 million barrels per day. Natural gas is the second-biggest contributor, supplying the equivalent of 11.9 million barrels of oil, while coal provides the equivalent of 11.5 million barrels of oil per day. The balance comes from nuclear power (about 3.8 million barrels per day), and hydropower (about 1.1 million barrels), with smaller contributions coming from wind, solar, geothermal, wood waste, and other sources.

Here's another way to consider the 76,000 barrels of oil equivalent per day that come from solar and wind: It's approximately equal to the raw energy output of one average-sized coal mine." "

After you build some windmills, where are the jobs? And won't ending the use of coal, oil and natural gas put tens of thousands of miners, pipeline workers, refinery workers and drillers out of work? Most of which, I'd guess, make more than a mundane job in a factory producing solar panels or windmill parts.

Finally, I didn't borrow any money to fill my gas tank this week. So I don't know where the people who put the words into ol' crag face's mouth get their facts.

Probably, they are using the following specious logic. America sells debt to investors around the globe. America imports many things. One of those things is oil.

Let's just assume, and say, that all that borrowed money via T-bills is used to pay for imported oil.

Simple, huh? Wrong, but simple and, to the uninformed, scary and powerful.

But you could point to anything and say it is the source of our trade flow imbalances. I noted this in my critique of Boone Picken's flawed arguments in this prior post.

"Repower America" makes deceptive ads and claims on so many levels, it's disgusting. Let's hope people see through the lies and misleading inferences in their commercials.

Robert Reich's Flawed Analysis of Public Healthcare

Robert Reich, former Clinton labor secretary and liberal economics professor, now at UC Berkeley, wrote an extensive defensive of a governmental healthcare option in yesterday's Wall Street Journal entitled "Why We Need a Public Health-Care Plan."

My overall reaction to Reich's poorly-reasoned argument is that, if this is an example of his thinking, I can't understand how he managed to receive an academic appointment, let alone a PhD in his field. His logic is flawed and his reasoning is sloppy.

Essentially, the error Reich commits is to assess the impact of a public health option in the future as if vibrant, profitable private healthcare options were still available, which therefore would be carrying much of the burden of the true cost of healthcare not paid by that same public option.

For example, Reich wrote,

"But before we even get to this point, it's important to recognize that those terrifying CBO cost projections significantly overstate the costs. They did not include potential cost savings from the lynchpin of health-care cost containment: a so-called public option that would give people who don't get health care from their employer the choice of a public insurance plan. Why? For the simple reason that the Senate committees hadn't yet agreed on a public option. Yet without a public option, the other parties that comprise America's non-system of health care -- private insurers, doctors, hospitals, drug companies, and medical suppliers -- have little or no incentive to supply high-quality care at a lower cost than they do now."

Reich's final statement in this passage is simply untrue, and displays his ignorance of how business, as opposed to economics, actually works. Implicit in Reich's statement is an accusation of illegal oligopolistic behavior by private healthcare providers. Even without a public option, each healthcare insurer/provider has a motivation to supply lower-cost care in order to secure a larger market share and, thus, enjoy economies of scale and higher profits for shareholders. With each provider attempting to do this, they all have to keep up with each other in competing for healthcare dollars.

Of course, allowing cross-state-line competition would make this motivation even stronger.

Reich later wrote,

"Critics say the public option is really a Trojan horse for a government takeover of all of health insurance. But nothing could be further from the truth. It's an option. No one has to choose it. Individuals and families will merely be invited to compare costs and outcomes. Presumably they will choose the public plan only if it offers them and their families the best deal -- more and better health care for less."

This is highly disingenuous of Reich. He ignores, or fails to understand, that practitioners of medicine, and drug manufacturers, can only give special discounts to the federal government's "public option" so long as they can make up the profits on the private healthcare plans.

In effect, Reich fails completely to realize that subsidization will occur, in part, as a result of government's coercive behavior with providers of medicine and medical care.

Ask yourself this question. If the government did not, itself, provide a 'public option,' but, instead, issued limited-purpose, government back debt specifically to fund a standalone, independent provider of the 'public option,' licensed to do so by the government, but without coercive legislation or other actions, how many pharmaceutical companies, doctors and hospitals would cut special deals with this firm?

Wouldn't that new 'public option' firm's attraction for healthcare deliverers be its potential market share? Why would it have any competitive advantage over existing private firms, other than government coercion?

Reich continues his misleading and wrong-headed reasoning in the following passages,

"But, say the critics, the public plan starts off with an unfair advantage because it's likely to have lower administrative costs. That may be true -- Medicare's administrative costs per enrollee are a small fraction of typical private insurance costs -- but here again, why exactly is this unfair? Isn't one of the goals of health-care cost containment to lower administrative costs? If the public option pushes private plans to trim their bureaucracies and become more efficient, that's fine.

Critics complain that a public plan has an inherent advantage over private plans because the public won't have to show profits. But plenty of private plans are already not-for-profit. And if nonprofit plans can offer high-quality health care more cheaply than for-profit plans, why should for-profit plans be coddled? The public plan would merely force profit-making private plans to take whatever steps were necessary to become more competitive. Once again, that's a plus.

Critics charge that the public plan will be subsidized by the government. Here they have their facts wrong. Under every plan that's being discussed on Capitol Hill, subsidies go to individuals and families who need them in order to afford health care, not to a public plan. Individuals and families use the subsidies to shop for the best care they can find. They're free to choose the public plan, but that's only one option. They could take their subsidy and buy a private plan just as easily. Legislation should also make crystal clear that the public plan, for its part, may not dip into general revenues to cover its costs. It must pay for itself. And any government entity that oversees the health-insurance pool or acts as referee in setting ground rules for all plans must not favor the public plan."

This last paragraph is Reich's most egregious error of logic. He points to a sort of portable voucher which he hypothesizes being given to each consumer, with which to purchase healthcare. But he simply omits, and denies the potential for the 'public option' program to additionally run at a loss, charging below-market prices in order to gain share. Were it a standalone firm, the 'public option' purveyor would be charged with anti-competitive pricing behavior. In anti-trust law, it's called "predatory pricing."

The legislation to which Reich refers is hypothetical, and, in the event, will never have real force. The phrase "it must pay for itself" is laughable, and simply reveals Reich, even with his Washington experience, to be hopelessly naive about how the healthcare plan which he champions will really work.

Honestly, if the terms on which Reich insists a public option were actually used, and enforced, there wouldn't be a problem, because the effort would fail miserably. However, you can be sure that none of Reich's provisos will be included in Congressional legislation or, if included, will not be enforced.

Just consider what a mess Congress made of the mortgage markets by failing to oversee Fannie and Freddie. Thanks to Congress, both parties, by the way, private mortgage conduits were elbowed out of business by GSEs which ran amok and ruined a big chunk of our financial system.

Do you want the same type of results in the healthcare sector?

Reich makes another statement near the end of his editorial,

"As a practical matter, the choice people make between private plans and a public one is likely to function as a check on both. Such competition will encourage private plans to do better -- offering more value at less cost. At the same time, it will encourage the public plan to be as flexible as possible. In this way, private and public plans will offer one another benchmarks of what's possible and desirable."

Again, he's off in academic economic dreamland. This is not what will occur.

Instead, a heavily and stealthily-subsidized federal 'public option' will drive private healthcare insurers out of business by underpricing care and risk. When employers realize that they can more cheaply fund their healthcare benefits by buying the public option, private plans will disappear.

Reich simply ignores that almost all US consumers are covered by third-party payer plans, and, thus, don't even make their own decision about who provides their healthcare insurance.

Why did the Journal even print this naive blather? Perhaps to embarrass and reveal Reich for the misinformed, lazy analyst that he obviously is?

Comments On The Proposed Financial Regulatory "Reforms"

The current administration's blueprint for extensive financial regulatory "reform" was recently released. It's instructive to note the assumptions which must underlie its format.

Specifically, I refer to two aspects of the changes. First, it provides vast new regulatory powers to two federal institutions- the Federal Reserve and the FDIC- which utterly failed to prevent the recent mortgage-related financial collapses of both firms and the entire US financial system.

Second, it calls for a super-regulator to oversee systemic issues and be the locus of ultimate regulatory authority.

It doesn't take a genius to realize how badly flawed these assumptions are.

In the real world, why would you give more power to an institution that just failed at its existing mandate with its current personnel? Rational people would investigate why the organization failed. Was it staff, training, processes, procedures, leadership, or something else?

Was that 'something else' perhaps an outside authority or player? Perhaps named 'Congress?'

Whatever the cause, it has to be discovered, and a specific remedy suggested to reform the existing regulatory body.

Regarding the hope that a single super-cop on the financial beat will somehow permanently eliminate all future financial disasters, it's a pretty naive one.

Only this morning, a former FDIC chairman laughed at the idea, noting that competing regulatory agencies are more likely to discover problems than a single, unchallenged one.

I'd go further. There is, or ought to be, already, between the Fed, FDIC, OTC and other agencies, sufficient information on US financial institutions to provide other, perhaps new regulatory authorities with data to observe and analyze.

Just because the Fed collects bank data does not mean you want to fuzz up and confuse its mission and focus. Only naive and inexperienced systems designers would equate collecting data with necessarily using it as a regulator.

Why not consider, socialize and then organize generally-agreed regulatory panels or organizations which use data from the existing institutions, but each take a particular perspective on oversight, e.g., institutional risk, leverage, counterparty risk, systemic risk, etc.

Ideally, the Fed should focus on managing the nation's money supply. The FDIC should focus on quickly closing ailing banks.

The information the two existing institutions collect could be used by other, new, when necessary, purpose-driven regulators who could then apply specific tools to the data already collected. This would avoid needless blurring of institutional focii, overburdening of staff, and preserve a diversified, multiplicity of observers of various financial system risks and potential problems.

But it's highly unlikely that anything as simple and blunt as just anointing one agency as super-regulator will solve anything. Or prevent a repeat, in a different area, of the mortgage finance-sourced financial problems of recent years.

Jack Welch University

Yesterday's Wall Street Journal featured Jack Welch's investment in an online business school and MBA in its Marketplace section.

The former GE CEO has bought a 12% share of the former Myers University, now renamed Chancellor University System, for "more than $2 million."

Welch and his latest wife, whom he married after having an affair with her while married to his prior wife, will both be involved in the venture. Welch's current wife, Suzy, was the editor of the Harvard Business Review until 2002, when her affair with then-married Welch brought about her resignation.

Another figure from Welch's past, Noel Tichy, his adoring biographer and one-time head of GE's Crotonville management center, is to be the online school's new Dean. Tichy was a relatively non-descript management professor in Michigan until he fell into the GE gravy train a few decades ago. The best break he ever had- until now, I suppose.

So, now Welch is going to lend his name to an MBA program and apparently transfer his vast knowledge of how to manage businesses successfully to thousands of MBA students via the internet.

Here's my question.

If Welch has value as an educator, shouldn't we see it in the performance of the company which he led for nearly 30 years, GE? Shouldn't his business and educational acumen have left a team of deeply-talented, well-educated (by Welch) managers to continue Welch's performance at GE?

However, that's not what actually occurred. No, instead, as I've noted in my numerous (labelled) posts about GE and Immelt, and the nearby price chart of GE and the S&P500 Index displays, the company's performance headed into the toilet as soon as Immelt, Welch's hand-picked successor, took the reins in September of 2001.

In fact, Immelt has managed to destroy all the premium, above-equity-index value his predecessor built over several decades Now, you'd have been about as well off owning the S&P since 1963 as you would have been buying and holding GE until the present.

You have to ask yourself, if this is the result of Welch's personally-trained and selected team at GE after his departure, just how effective is the vaunted "Jack Welch way?"

Based on the company's performance under those whom he groomed and chose, I wouldn't be writing checks to Chancellor for either of my children just yet. Or maybe ever.

I've always given Welch credit for his very adept handling of the mess of a company Reg Jones handed off to him in the early 1980s. He coped with inflation, high interest rates and misleading accounting values. Welch's instinctive concentration on businesses in which GE could be among the top three in share and were growing was the right move.

However, as I pointed out to him in a private meeting in the mid-1990s, his performance margin over the equities indices pretty much ended by then. Subsequent events in GE's power business proved Welch wrong in his predictions to me that it was poised to take off. My own advice, that the industrial units, being valued differently than growth businesses, were needlessly weighing on the financial and media properties, proved to be correct.

Further, in the latter years of Welch's tenure, GE's performance rested, I contend, more on Welch's persona and a sort of 'pixie dust' in the eyes of analysts, than on Welch's hard-nosed leadership and management.

After all, how much about GE could really have changed by late 2001, when, under Immelt, the firm's reported performances were savaged by analysts, reserves were called into question, and accounting practices were criticized?

I think you have to see GE's performance subsequent to Welch's departure as an early read on his effectiveness as a manager and teacher, and give him an "F" (hey- that's his middle initial, isn't it!). Hardly an endorsement of Jack's way, is it?

Yes, straight from the gut- Jack's lasting impact on his own chosen few hasn't been very pretty to see.

Granted, though, Professor Jack sounds a helluva lot better than Neutron Jack, doesn't it?

Perspectives On Economic Opportunities, Skills, and Jobs

I had a discussion with a business colleague recently on the topic of how "jobs" are perceived by many non-business people, most often state and federal governmental officials.

For example, we often hear of governors or presidents taking credit for "creating jobs." Or state officials will talk about how many "jobs" are in their state, or leaving their state.

If you think about the references to "jobs" abstractly, these politicians talk as if the term refers to a stock of tangible items to be apportioned out to people.

But that's not what a "job" is at all. I contend these linguistic uses belie a totally incorrect viewpoint and understanding of what a "job" really is.

Here's how I view the context and meaning of a "job."

In a society, people have various skills. Some people also have ideas for developing products and services to sell to other people.

While we all want to have an economy that creates sufficient jobs for the people in our society, jobs are a function of business and economic activity, not the other way around.

For example, long ago, farming and various industrial activities required some number of workers. As time went by and technological advances occurred, the number of "jobs" required to produce a ton of steel, or an acre of wheat, fell. But new "jobs" arose to build the machine tools and farming equipment that saved labor in the older, once labor-intensive sectors.

Economic growth via new businesses and expansion of older ones leads to a need for more workers, thus creating "jobs."

Anything a government does to either stifle business growth, or move it elsewhere, causes "jobs" to move and, thus, be lost to the geography over which that government presides as society's political entity.

If the people in an area don't have the skills to do the work required by a new or expanded existing business, there won't be any new "jobs" there. There might be a need for more workers, but without qualified people, the jobs will appear elsewhere.

Thus the growth of technology firms around Boston in the 1980s, and in Silicon Valley for several decades. Until taxes and other expenses drove firms to add new "jobs" in Oregon, Washington, New Mexico, and even overseas.

Jobs are not a fixed or necessarily growing economic good, able to be traded, 'created' or 'saved' by government.

And economic development and business advancement can cause some 'jobs,' or, really skills, to be no longer necessary. Jobs aren't a static concept or body of things to be simply taxed and relied upon by governments.

They are the by-products of business processes and expansion. Treat business badly, cause it to contract or die, and you remove the production needs which lead to "jobs."

Perhaps my colleague best illustrated the point when he engaged in light discussion with a doctor recently.

His doctor asked what my colleague did for a living and, on hearing he is self-employed with several ventures, observed that "at least you can't be laid off."

"No," my colleague replied, "but I can go bankrupt and lose my businesses."

Jobs aren't just things which you "get" and "keep." They stem from a business' need for work to be done and skills involved in doing that work. If there's a fit with local people, at a price both can afford, then a "job" may be created for that work at that time at that price.

But speaking of jobs in some totally abstract manner, as if they are a constant stock of income-yielding positions to which all Americans, in the aggregate, are entitled, is simply a gross misunderstanding of how business works.

Starbuck's Reconsiders The Details

In yet another chapter in Starbuck's continuing struggles to recapture its former luster, the chain is now planning a significant change in what would seem to be a trivial activity. After what has apparently been intensive study of how and when coffees are brewed in the roaster's many stores, management has decided to focus on having fresher pots of coffee always available.


The Wall Street Journal reported, in a recent article,


"Instead of grinding coffee only in the morning, baristas will grind beans each time a new pot is brewed. Timers will buzz to signal when it's time to make a new batch, according to internal Starbucks documents reviewed by The Wall Street Journal.

The changes are part of the Seattle-based company's effort to reinvigorate the "Starbucks experience" in the face of competition from less-expensive rivals such as McDonald's Corp. and 7-Eleven Inc. With Starbucks' changes, customers will be able to hear the whir of grinders and smell the aroma of fresh coffee all day.


Two years ago, Howard Schultz, then chairman of the company, wrote a memo to executives blaming the chain's excessive focus on growth and efficiency for cheapening the coffee-shop experience he long had championed. Mr. Schultz wrote that an earlier switch to preground coffee had taken the "romance and theatre" out of a trip to Starbucks.

"We achieved fresh-roasted bagged coffee, but at what cost? The loss of aroma -- perhaps the most powerful nonverbal signal we had in our stores," he wrote.


Currently, baristas decide when to brew fresh batches "based on multiple signals ranging from demand (quantity), to expiration and timing," the new documents say, explaining that the revamped process "reduces this complexity by eliminating many of these signals."


The documents say that currently, "by using dedicated [containers] to brew coffee, our customers may experience a coffee outage 14 minutes out of every hour, or 23% of the time! This coffee outage occurs for seven minutes during every batch, making brewed coffee unavailable to our customers." As a result, customers can be forced to wait, choose another type of coffee or leave the store empty handed. "To solve the brewed-coffee outage problem, we must change the way we brew coffee," the documents say.


Some baristas said the extra grinding and brewing might slow service and turn off customers with added noise.

But demonstrating to customers that coffee is ground and brewed on the spot could help Starbucks maintain its premium position, especially as rivals tout less-expensive alternatives."


What struck me about Schultz' approach and concerns is that it probably won't attract coffee drinkers the chain hasn't already won over long ago. I'm not a big Starbuck's fan, personally, but I visit their stores with/for my daughters on occasion. The same people are generally in the one we most often frequent.

I honestly don't think more freshly-ground or -brewed coffee aroma will bring (back) Dunkin' Donuts' and McDonalds' coffee drinkers. It's a segmentation issue, and Starbucks long ago sewed up the segment that celebrates expensive coffee and the coffee houses in which one may linger to drink it.

Finally, in these times of government intervention into financial services, auto production and healthcare, I find it instructive how detailed and minute are Schultz' and Starbucks' managers' focus on their business.

Look again at how deeply and precisely the firm's management had studied a specific part of their operation with an eye to customer motivations and need satisfactions.

No governmental civil servant is going to do that. Yet, that's what it takes to succeed in business. Focus on customer wants and needs. Diligent, constant, detailed review of your own business' offerings, strategies, and operations.

Is Schultz right in changing the Starbucks' stores' coffee brewing? I don't know, but I doubt it. Still, he and his managers feel it's an important change to make in order to revive growth, profitability and equity value for the firm.

I just don't see that sort of combination of analytical rigor and imagination from any government hacks trying to oversee, restructure or operate significant portions of the US economy.

New Financial Regulation May Finally Unwind GE's Pointless Diversification

I've argued in prior posts that GE is an organizational anachronism. It's my belief that current CEO Jeff Immelt is likely to be the company's last.

In past years, I honestly thought there was a chance that a private equity hunting party, composed of several of that breed, would team up to bring GE down, buy and quickly dismember it, unlocking value in the better industrial units, while minimizing the value loss in its financial and media properties.

Now, however, the unwinding may come from a totally unexpected source- regulation. It appears that the newly-proposed financial services regulations will sweep up corporations with significant finance units. Thus, what analysts, irate shareholders and private equity shops could not accomplish, Congress just might- the beginning of GE's dissolution.

From what has been written in the Wall Street Journal, it appears that the GE finance unit's leverage, asset quality, and financial structure might all fail to pass muster, once explicit allocations of the parent are made. The regulatory compliance nightmare may just be enough impetus to cause the company to shove its troublesome financing business out the door via a spin-off.

Funny how that may work, isn't it? After so much braying about the value of diversification, which, by the way, has been empirically disproven for over twenty years, Immelt may be forced to begin dismantling the failed conglomerate that is GE for regulatory reasons, rather than to avoid either being ousted or bought for salvage value.

Jack Welch & John Bogle On The New Financial Regulators

Stripping away all the bluster and lying premises of the newly-proposed financial regulator scheme, one sees that there is considerably less than meets the eye.

This morning, on CNBC, both John Bogle and Jack Welch trashed the proposals. Bogle, I believe, criticized the idea of centralizing regulation too much. Welch, in my opinion, attacked the plan's most glaring weakness.

It ignores how the current financial mess truly unfolded, conveniently overlooking Congress' own role. Welch explicitly brought this point up, reminding one and all of how Congress fostered the mess by:

-passing CRA legislation mandating that banks lend mortgage money to people who otherwise would have been judged too risky

-pushing Fannie and Freddie to securitize increasing amounts and percentages of subprime mortgages

-foolishly ignoring those GSE's bloating up in a market which would have been better-served by private securitizers with private capital discipline, rather than the implicit, now explicit US government funding guarantee

Further, the FDIC and the Fed have been ostensibly given even more power, when they failed to use what they had to head off the current crisis. Welch and, I believe, Bogle, both noted this.

It's a fact that bank examiners should have halted the subprime and liar loan mortgages several year ago, but failed to do so. They simply failed in that job.

So what is the current administration proposing? To try once more to have the FDIC and Fed attempt to regulate banks. Maybe this time they'll "really" examine banks.

Maybe not.

But it's folly, and, one definition of insanity, to do the same thing over and over, expecting a different result when nothing has changed.

Besides, how much more powerful does the Fed have to be? It's already coerced a bank, BofA, into buying an overpriced broker, Merrill Lynch, then hiding financial problems from shareholders in order to make sure they voted to close the purchase.

It doesn't take a genius to realize that if you don't have a correct, honest analysis of what went wrong, you have little chance, except being tremendously lucky, of fixing the problem so it won't recur.

The unintended consequence of over-regulation by government, whether it be mandating expensive audits for publicly-traded corporations, complying with Sarbanes-Oxley, or expanding the powers of financial regulators, is usually to falsely assure the public that things are safe, when, in fact, fraud and incompetence will still be present.

The Daily Show Mocks The New York Times

This video says it all. No deep analysis of economics, changed media consumption behaviors, etc., is really required to 'get' the newspaper sector's problems. Just watch this hilarious, scathing and mocking clip about the NY Times.

Sent to me by a friend, it's a piece from the Daily Show, which I don't watch, lampooning the Old Gray Lady, which I don't read.

Ironic that Stewart sticks it to this liberal publishing icon. I can't figure out why the Times agreed to even allow this story to be done, and collaborated, too. I kept thinking I was watching a comedy sketch, but I believe the Times staffers are real.

The Heavy Hand of Government Already Distorts US Economy

Monday's Wall Street Journal features a piece on how recent government interventions into the economy have already skewed terms of competition. The article reports,

"The effects are rippling into nooks of the economy far beyond Wall Street and Detroit's troubled car industry. The massive intervention has shifted the way companies do business in a host of ways -- not all of them intended by the government. Increasingly, companies big and small are competing on the basis of their ability to tap government money. A divide is opening between gets and get-nots.

Thanks to federal loans, Cabela's Inc. didn't have to slash credit to its customers. But Genworth Financial Inc., a big insurer, failed to get bailout money, and has raised capital in other ways, such as cutting its dividend. Still other firms hope to gain an edge by steering clear of the government. UMB Financial Corp., a bank in Kansas City, Mo., is going after new customers by boasting that it hasn't taken any bailout money.

Government spending as a share of the economy has climbed to levels not seen since World War II. The geyser of money has turned Washington into an essential destination for more and more businesses. Spending on lobbying is up, as are luxury hotel bookings in the capital."

These last two sentences should send a chill through every reader. Competition is officially becoming a matter of who can curry more favor with Congress and the administration, as both wade ever more deeply into the private sectors of the economy.

It doesn't take a genius to realize that efficiency will now be taking a back seat to politics on a growing basis. Which reinforces Art Laffer's contention that prospects for the US economy going forward are likely to be very bleak.

Art Laffer Again On the Coming Hyper-Inflation

Last October, shortly before the November election, economist Art Laffer wrote a blistering piece in the Wall Street Journal, on which I wrote this post.

Before knowing of the extensive governmental intervention into autos and, planned, into healthcare, Laffer wrote,

"If you don't believe me, just watch how Congress and Barney Frank run the banks. If you thought they did a bad job running the post office, Amtrak, Fannie Mae, Freddie Mac and the military, just wait till you see what they'll do with Wall Street.

Whenever people make decisions when they are panicked, the consequences are rarely pretty. We are now witnessing the end of prosperity."

In last Wednesday's Journal, Laffer was even more bleak. He wrote,

"Here we stand more than a year into a grave economic crisis with a projected budget deficit of 13% of GDP. That's more than twice the size of the next largest deficit since World War II. And this projected deficit is the culmination of a year when the federal government, at taxpayers' expense, acquired enormous stakes in the banking, auto, mortgage, health-care and insurance industries.

With the crisis, the ill-conceived government reactions, and the ensuing economic downturn, the unfunded liabilities of federal programs -- such as Social Security, civil-service and military pensions, the Pension Benefit Guarantee Corporation, Medicare and Medicaid -- are over the $100 trillion mark. With U.S. GDP and federal tax receipts at about $14 trillion and $2.4 trillion respectively, such a debt all but guarantees higher interest rates, massive tax increases, and partial default on government promises.

But as bad as the fiscal picture is, panic-driven monetary policies portend to have even more dire consequences. We can expect rapidly rising prices and much, much higher interest rates over the next four or five years, and a concomitant deleterious impact on output and employment not unlike the late 1970s.

The percentage increase in the monetary base is the largest increase in the past 50 years by a factor of 10 (see chart nearby). It is so far outside the realm of our prior experiential base that historical comparisons are rendered difficult if not meaningless. The currency-in-circulation component of the monetary base -- which prior to the expansion had comprised 95% of the monetary base -- has risen by a little less than 10%, while bank reserves have increased almost 20-fold. Now the currency-in-circulation component of the monetary base is a smidgen less than 50% of the monetary base. Yikes!

Alas, I doubt very much that the Fed will do what is necessary to guard against future inflation and higher interest rates. If the Fed were to reduce the monetary base by $1 trillion, it would need to sell a net $1 trillion in bonds. This would put the Fed in direct competition with Treasury's planned issuance of about $2 trillion worth of bonds over the coming 12 months. Failed auctions would become the norm and bond prices would tumble, reflecting a massive oversupply of government bonds.

In addition, a rapid contraction of the monetary base as I propose would cause a contraction in bank lending, or at best limited expansion. This is exactly what happened in 2000 and 2001 when the Fed contracted the monetary base the last time. The economy quickly dipped into recession. While the short-term pain of a deepened recession is quite sharp, the long-term consequences of double-digit inflation are devastating. For Fed Chairman Ben Bernanke it's a Hobson's choice. For me the issue is how to protect assets for my grandchildren."

Laffer's a pretty smart guy. His insights into the likely hyper-inflation dovetail neatly with his October piece. It's hard to see how inflation won't be coming barrelling into the US economy soon. Those who keep saying they are more worried about deflation seem to have forgotten the Carter years.

Given the expanded monetary base, how on earth will inflation not roar ahead, with so many dollars shoved into international portfolios?

Frankly, I'm at a loss as to understand how the equity markets can have risen some 30% in two months or so, with these numbers available for all to see.

Ken Lewis Speaks Out

Ken Lewis' Congressional testimony yesterday painted an interesting picture of a guy trying to have it both ways.

According to today's Wall Street Journal reporting on the event, Lewis both claimed he was strongarmed and coerced by Bernanke and Paulson to close the Merrill Lynch purchase, but then claimed it was a good deal, just the same.

How could both be true? If it was a good deal, why did Lewis need to be coerced?

Lewis also seems to be backtracking somewhat on the disclosure aspect of the deal. Prior to this, I am reasonably sure Lewis claimed that Bernanke told him not to disclose his concerns to shareholders prior to the vote to close the Merrill Lynch sale.

Now, Lewis is saying Bernanke didn't tell him to hide "something that should be disclosed."

One wonders whether Lewis is taking this line in order to protect himself from SEC charges.

Overall, reading the article, I'm struck with how Lewis is complicating the story as the consequences of his statements, as originally reported, have become clearer. Perhaps, too, having been relieved of his chairman role at BankAmerica, Lewis may realize that the company will not be going to bat for him if he comes clean about what really happened.

His own apparent hiding of his concerns from shareholders, and true feeling that the Merrill purchase should not have been closed, would, today, likely end in serious penalties for Lewis.

Now that this is clear, he seems a whole lot more tentative about speaking truth to power, doesn't he?

Once again, we see the results of government intervention and coercion on business and truth-telling, in general.

Another Boneheaded Union Speeds Its Own Demise

According to Tuesday's Wall Street Journal, the Boston Globe's union employees rejected, by a 277-265 vote, management's package of wage cuts calculated to keep the paper operating.

I guess that means that just 7 employees will likely be responsible for delivering a death blow to the ailing, aged newspaper.

After years of being the subject of various celebrity investors in late 2006, the Boston Globe doesn't seem to be attracting any more white knights to peel it off of the New York Times Corporation.

What do you suppose those 7 union employees don't get about what is happening to daily newspapers in even large US cities, let alone smaller ones? They have been the victims of Schumpeterian dynamics for at least a decade.

Craigslist help give the sector a big, final push by thinning advertising revenue after basic economics and television news had gutted afternoon editions and newspapers several decades ago. Even if a few of the big dailies survive, you have to wonder how much they will still rely on printed editions, rather than online publication.

I laughed when I read this passage at the end of the Journal piece, quoting Guild (union) president Dan Totten,

"Globe workers and the New England community understand that the quality of The Boston Globe- an institution so vital to the life and culture of the region- depends on the fair treatment of the men and women who work so hard to produce it."

Talk about clueless! If the paper was so damned 'vital,' it wouldn't be having such profitability problems, or would have been sold or spun off by now.

Counting On A Consumer-Led Recovery?

Yesterday's Wall Street Journal presented a chilling chart pertaining to consumer debt.

Since 70% of US economic spending comes from the consumer, that segment's ability to finance further spending would seem to have a lot to do with any imminent, sustainable recovery, would it not?

According to the chart, sourced from the Fed, consumer household debt as a percentage of disposable income has remained above 120% since roughly 2005.

Whatever increased savings have occurred in the past six months has had little impact on overall consumer indebtedness.

The visual in the chart makes clear how the rate of increase in this measure moved up from a clear inflection point in about 1999. Thus, we've had nearly a decade of pretty much monotonic growth in this debt/income measure.

That's not going to go away very quickly.

Since federal stimulus spending does not lead to the same quality of jobs as those in the private sector, recent jobless increases are only going to exacerbate this picture. Either spending will slow due to joblessness, or debt will be paid off, and savings will effectively rise. Both will hamstring consumer spending.

Don't expect a sudden lift to the US economy from domestic consumer spending anytime soon.

Indiana Fights For Business & The Rule of Law

Indiana treasurer Richard Mourdock, seen in this interview on Fox News, articulates the state's points vis a vis the Chrysler bankruptcy.

Supreme Court Justice Ruth Ginsberg has agreed to stay the sale of Chrysler assets to Fiat, pending consideration of Indiana's case.

Perhaps the rule of law will be upheld yet in America!

Steinhardt's Economic Outlook

One of my readers sent me the URL of a website containing this clip. It's a recent interview with Michael Steinhardt, about whose opinions I have written in this prior post from March of this year.

I remain impressed by Steinhardt's careful, deliberate, logical explanation for his expectations on the near term US economic outlook.

And I want to thank my reader for the link. Very illuminating, if disconcerting. But Steinhardt echoes the opinions of others whom I respect, including Martin Feldstein.

Do Healthcare Costs Make US Business Uncompetitive?

What sort of analysis would make you conclude that a sector of the US economy accounting for 17% of GDP requires radical, forcible restructuring?

If someone told you that the sector's costs, as inputs to other parts of the US economy, were inhibiting US competitiveness on a global basis, what evidence would you require to believe that contention?

Friday's Wall Street Journal featured an article by Betsy McCaughey, the now-legendary figure who is credited with having derailed HillaryCare in the 1990s. She was a lieutenant governor of New York who switched parties, left the field of political offices and now runs a health-related concern to reduce deaths from infection.

Responding to the current administration's claim that US healthcare costs are an economic burden on American business which must be forcibly restructured, Ms. McCaughey offered rebuttals to five claims by the administration.

First, Ms. McCaughey correctly dissects the administration's claim that because Medicare is in financial trouble, all Americans must be put on a federally-mandated healthcare 'diet.' It's a non-sequitor.

If anything, Medicare's and Medicaid's problems suggest they should be fixed prior to giving the federal government any further role in healthcare.

Next, Ms. McCaughey notes that the rate of increase in healthcare spending has actually fallen in the past five years, to a 6-7% range, from 13% in 1980. She notes an apple-to-oranges comparison by the current administration alleging that premiums have risen, writing,

"The real cause is the declineing share of care paid for out of pocket (down to 15% today from 33% in 1975). Auto-insurance premiums would also skyrocket if coverage suddenly included oil changes and tune-ups."

Regarding the alleged added 'burden' of healthcare spending today by families, the author notes that, since 1960, four budget items have accounted for a little over half of American family spending- food, energy, housing and healthcare. These made up 53% of the 1960 average household budget, and 55% today. She goes on to contend that Americans spend more for healthcare in part because they can afford it, and they "get more for it" than do Europeans using state healthcare systems.

Ms. McCaughey revisits, again, the tired old argument that Euopean state-run healthcare is cheaper than that in America. She cites statistics on medical innovation in America, and the rising rates of surviving various health problems, such as breast cancer or heart disease. As she notes,

"If you had a heart attack in the 1980s and made it to the hospital you had only a 60% chance of living a year. Now your chance is over 90%. No one wants 1980s medicine at 1980s prices. And in 10 years, no one will want 2009 care."

Finally, she tackles the economic argument that we need to cut healthcare spending in order to save American jobs. She writes,

"At a time when the economy is ailing and the president is bailing out industries to protect jobs, his advisers recommend shrinking the health-care industry. It currently provides 1.4 million jobs- 10 times the U.S. work force of General Motors and Chrysler."

Ms. McCaughey provides some persuasive arguments not to attempt to pass an omnibus healthcare bill this summer, as the Democrats are so eager to do.

But, beyond her excellent refutations of the White House's report on the healthcare situation, there remains a fundamental lack of a convincing, compelling business case to sustain the contention that American medical costs currently cost American business growth, profits, or jobs.

We have no trend information demonstrating the contention. Nothing about comparative medical expense levels and corresponding health indicia across the globe. Nothing relating healthcare spending, health, and business growth, profitability or job growth.

Nothing has been presented which clearly demonstrates a significant decline in American economic performance traceable to, and only to, rising healthcare costs.

Without this type of evidence, who would be foolish enough to radically, but vaguely, restructure our healthcare sector?

Ironically, this drive by the Democrats to federalize healthcare may, and probably will, only succeed in putting larger costs and clumsier procedures into practice, while resulting in a less-healthy American population.

This is progress? Or change you would want?