Carol Bartz Finally Ties Yahoo Up With Microsoft

The big news in the technology sector this week was Yahoo's deal with Microsoft. Ever since the latter launched its semi-hostile takeover bid for the former, some sort of alliance has been talked about.

With Carol Bartz' recent assumption of the CEO position at Yahoo, investors' hopes brightened. Yet, after reading the reports on the actual deal, and various pundits' reactions to it, it seems many of those investors headed out of Yahoo positions, causing a one-day 12% drop in its stock price after the Microsoft deal was announced.

Meanwhile, an article in the Wall Street Journal this week extolled Microsoft's Ballmer for finally getting a few things right, e.g., Windows 7, improved XBox revenues, and the Yahoo deal.

As the nearby two-year stock price chart for Microsoft, Yahoo and the S&P500 Index shows, there wasn't a huge difference between the three. Certainly, after applying some risk premium for the two companies, they would both have underperformed the index.

The second chart, a five-year view, reinforces that conclusion.

I don't think Ballmer is by any means out of the woods yet.Microsoft has not convincingly outperformed the S&P for years, and I don't really think it's about to start now.

As for Bartz and Yahoo, I'm inclined to be a little less critical than most published pundits.

Unless you think she simply lost her mind last week and got snookered by Ballmer, the odds are that, despite her upbeat remarks to the media since she took over the helm at Yahoo, Bartz found things much, much worse than she feared.

To have gone from forecasting a 'boatload of cash' to come Yahoo's way from Microsoft for any tie-up, to getting very little, clearly disappointed a lot of shareholders. Even Ballmer chimed in with helpful comments like, 'people don't understand how good this deal is for Yahoo,' or some similar quote.

I think Bartz got the best deal she could for a firm, the very existence of which, prior to her arrival, was in doubt. She managed to outsource development for search, keep a lot of ad revenue, and get breathing room to pursue her objective of pumping up Yahoo's content.

If you revisit Bartz' remarks about the future she envisions for Yahoo, it's all about content, not search. She has managed to narrow the management focus of the firm and get continued search technology for free.

Not too bad. My guess is Bartz saw things as much worse than outsiders, and just couldn't drive a bargain that would effectively pay Yahoo up front for the Microsoft deal. But she still got what she wanted, and probably the best result among several not so stellar ones available.

While I would be unlikely to own Yahoo anymore, and don't forsee it entering our equity portfolio anytime soon, Bartz seems to have done a lot in a short time to begin reversing the damage done over many years by Terry Semel and Jerry Yang. Investors who want to own Yahoo should at least be thankful for that.

The Myth of "High Paying Manufacturing Jobs"

Earlier this week, I saw a surrealistic debate on CNBC between an SEIU representative and Wharton's Professor Jeremy Siegel.


Siegel cited economic theory that advanced economies typically lose lower-paying jobs, including simpler manufacturing, to lesser-developed, lower-wage countries. He cited, over the past several decades, the loss of comparatively few US manufacturing jobs, in the tens of thousands, in comparison to the addition of millions of service jobs. Siegel also asked the SEIU rep if he truly wanted his union members to be paid wages on a par with those of lesser-skilled Asians?

Somehow, all of this was lost on the SEIU guy, including the irony of Siegel pointing out how his own sector benefited.


The SEIU rep kept babbling about how we "need to create high-paying manufacturing jobs," as if they are simply devised out of thin air. And, that by saying that phrase, tautologically, such jobs must exist in a long run, profitable US manufacturer.


He then continued by ticking off various guarantees that workers should have- pensions, high pay, health care. Michele Caruso-Cabrera replied that there are no guarantees now, anyway. Unions price their workers out of the market, so continued employment with such lush packages as the SEIU rep listed was often in jeopardy.

Such as at GM and Chrsyler.

The SEIU guy went nuts.


What was evident, though, was his inability to understand Siegel's first, simplest point, i.e., you really don't want US workers being paid Chinese rates for manufacturing.


Missing, too, was an understanding by the union member that advanced manufacture requires education and training. If workers can't cut it, they're destined for lower-paying jobs. Period.


There just are no guarantees with global competition.


Along the way, GE CEO Jeff Immelt's dopey speech calling for more US manufacturing was cited, and Siegel sort of laughed and implied Immelt is an idiot. That's when he began to describe the low-paying type of work that manufacturing now typically is which has been sent overseas. That we are a service and IP giant, not really destined to grow manufacturing in a world with cheaper labor overseas.

It's understandable, sadly, that the SEIU representative continues to believe in the myth of "high paying manufacturing jobs" in the US, with no thought of how they would possibly be globally competitive.

It's totally baffling, at first, why GE's Immelt would be similarly ill-informed. But, then, as readers of this blog know, I have never believed that Immelt has been a worthy successor to Welch, or, for that matter, that the former has shown any ability to merit his current position and compensation.

Housing Starts From A Fresh Perspective

Tuesday's Wall Street Journal had a great little article by staff writer Mark Gongloff, entitled "Pyrrhic Victory in June Housing Data," about the June housing starts. It was tucked away on the back page of the Money & Investing section.

It's fairly short, so I've pasted it below:

Many investors celebrated Monday after June's "surge" in U.S. new-home sales. Alas, it was largely wishful thinking.

True, the Census Bureau reported sales up 11% from May. That is a big number, at first glance justifying Monday's 4.5% leap in the Dow Jones U.S. Home Construction Total Stock Market Index. But it fails a close inspection.

First, home sales quite often jump in June, the height of the spring selling season. When trying to gauge the strength of home sales, then, it makes more sense to compare them with the same month a year ago. That comparison is less kind -- sales were down 21.3% from June of 2008.

Seasonally unadjusted data show a total of 36,000 new homes were sold last month, the lowest June total since 1982, notes Richard Moody, chief economist at Forward Capital.

And the Census Bureau warns against assuming too much precision in these numbers, which are based on a sample survey. Accounting for a 13.2% margin of error -- at a 90% confidence level, suggesting the actual error could be higher -- new-home sales enjoyed somewhere between a 24.2% gain or a 2.2% decline from May.

New-home inventories are falling, an encouraging development. But inventories are still higher than their historical norm, and there remains an avalanche of distressed sales.

Little wonder, then, that June's "surging" sales were driven by heavy discounting. The median new-home price -- not seasonally adjusted -- fell 12% in June from a year ago, to $206,200, the lowest June sales price since 2003. And it was down 5.8% month on month.

To paraphrase Pyrrhus, if sales keep soaring like this, then home builders will be utterly undone.

That sounds more like it. Sales are down, year-over-year. And prices were discounted to get that.

Hardly a housing boom, is it? Or even a 'recovery.'

Yes, inventories of unsold houses are being sold off, but at lower prices. Which is a good thing.

But don't kid yourself that this is going to turn around next quarter....or the one after that.

The Economy: Recovering, Or Ready To Plunge Again?

Alan Blinder's recent editorial in the Wall Street Journal extolled the imminent blast-off for the US economy of Samuelson's accelerator-multiplier effect.

Blinder didn't credit the retired MIT Nobel Economist in his editorial, but he provided the math to explain how housing and autos, having plunged so low, will kick-start the US economy in the next quarter just by being non-negative.

Dick Hoey, whom I knew briefly at EF Hutton many years ago, was saying the same things on CNBC yesterday afternoon.

Then we have a very detailed, persuasive editorial in last Tuesday's Journal, written by Mort Zuckerman. In his piece, the chairman of US News & World Report, and head of Boston Properties, dwells almost exclusively on the under-representative current unemployment rate of 9.5%.

Zuckerman lists 10 separate, but related points, all of which provide evidence that the demand side of the economy, via consumer spending, will almost certainly be much lower in the next few years than most pundits, analysts and economists realize.

Among his points, Zuckerman cites: underemployed, those no longer even looking for work, workers 'employed' but on unpaid leave, part-time workers who were once full-time, shorter work weeks among the employed, a 65% capacity utilization at US factories, and, finally, the longest average length of official unemployment- 24.5 weeks- since this data item has been tracked back in 1948.

For good measure, Zuckerman adds that low consumer confidence and high debt levels have increased the savings rate which will, of course, dampen any subsequent recovery, as the consumer's 'marginal propensity to consume' will be much lower than in recent years. He laments that now, when a truly job-creating, infrastructure-building federal spending bill would help, it's too late. That's because $787B was allocated for what has been, to date, largely increases in Medicare and other state-based transfer payment programs.

In effect, Zuckerman would conclude that people like Bank of New York's Hoey mistakenly believe that there will be sufficient consumer demand to justify rebuilding inventories, building new cars and houses.

Who's right?

Personally, I'd put my money on Zuckerman. Leaving aside that Dick Hoey was a fixed income manager back in the day, and his BONY/Mellon/Dreyfus bio doesn't exactly laud him as an economic Nobel Laureate, I don't think Hoey is sufficiently observant of the real differences in the effects of the recent recession on the US labor force from those of recessions prior to 1992.

That so-called 'jobless recovery' may well have marked a turning point for the US economy which has not yet been captured in various models and adequately observed by pundits-cum-economists like Hoey. Or even Alan Blinder.

Prior to the 1991-92 recession and recovery, you are looking back to 1982-83, the early Reagan years, now very nearly thirty years ago. For perspective, was the 1960 economy different from that of 1930? Very much so. And the 1980 economy was so radically different from that of 1950, thanks to electronics and technological advances in communications as to make forecasting the former with models of the latter seem laughable.

I suspect that's what is happening now. Those analysts and economists harking back to the early 1980s and using conventional models with estimates of consumer spending and labor growth have missed some important transformations in the US economy of 2009.

I don't think Zuckerman is one of them.

Barnes & Noble Enters The Electronic Reader Business

Last Tuesday's Wall Street Journal reported on Barnes & Noble's entry into the electronic book market. In a direct challenge to Amazon and its Kindle e-reader, the bookstore chain is seeking to extend its business into providing e-books across a range of readers. And, the Journal report states, probably enter the e-reader market, as well, with its own proprietary device, to be developed by Plastic Logic.

I find this very exciting.

Up to now, Amazon has had a lock on this market, although nobody knows just how lucrative it has been. Whatever that profitability level has been, watch it shrink.

Credit Barnes & Noble, too, with not waiting around to be cannibalized by a potentially growing market in electronic readers and content.

The nearby, Yahoo-sourced price chart of Barnes & Noble and the S&P500 Index shows that the bookseller has held its own with the market over the past five years, but dipped lower during the turmoil of the past 18 months.

If you think about it, there's little about Amazon's book and e-reader business that B&N can't duplicate. It has a well-known brand, and its website ought to be able to hold its own, as well.

If this boils down to a battle of pricing and features of e-readers, Amazon could be in a lot of trouble. In fact, per classic marketing theory, Amazon could actually end up paying a price for being the 'first mover' in this new publishing area.

Often, early entrants into a new field eventually suffer by becoming the target of later, better-focused and technologically-superior competing products.

Given that neither Amazon, nor B&N are doing in-house development of e-readers, it could well come down to the delivery of content. On that basis, too, B&N should be able to remain competitive.

I wonder if Jeff Bezos is worried. My guess is he should be. Not because B&N could become the market share leader in e-readers and e-books, but because it could slow Amazon's own growth, dragging the online merchant back to parity among other competitors in this new publishing area.

The Myth of Consumer Over-Spending

Last week, I caught a few minutes of CNBC's morning program, Squawkbox, when a market strategist for, I believe, Citibank, Tobias Levkovich, made a clear and succinct statement regarding US consumer debt and spending.

Levkovich unequivocally stated that he had studied data over some longish period, perhaps the past 7-8 years, and concluded that the wealth created among consumers over that time vastly outweighed what had been borrowed against housing equity and on credit cards.

David Malpas, once the chief economist of Bear Stearns, is the only other prominent analyst to have noticed this.

Levkovich then addressed the many who consistently claim that US consumers simply 'used their houses as piggybanks,' and said they are wrong. That this is a myth and it's simply, clearly, wrong.

Ford's Big Quarter

I saw in Friday's Wall Street Journal that Ford finally posted a profitable quarter. Granted, much of it was due to various restructuring-related, non-comparable income statement items. But evidently analysts and investors are whooping it up.

Pardon my lack of interest.

Truth is, Ford is unlikely to ever appear on my equity and option strategy's list of investments.

There are several reasons why Ford's quarterly performance is probably not the beginning of a pattern of consistently superior total returns which would truly reward investors.

For some perspective, observe the nearby 6-month, 2-year and 5-year performances of the price of Ford, compared with the S&P500 Index.

Ford is up 200%, meaning it's price quadrupled in the past six months, but is down 20% over the past two years. Over the past five years, Ford is down about 50%, while the S&P is just below flat.

Much of Ford's recent gains are simply the snap-back after the entire sector was in trouble at the end of last year. Like many other companies, values in the first quarter of this year were often far below longer term values, if the company survived. Thus, the six-month Ford stock price performance isn't really due to operating improvements.

It's not at all clear, and, actually, is pretty unlikely that this phenomenon can continue into the future.

Granted, Ford borrowed heavily while it could, during Mulally's early tenure, and generally cleaned up its balance sheet, thus avoiding GM's need to file for bankruptcy. But it still has the UAW with which to contend, and, now, is competing with two government-assisted auto makers, GM and Chrysler.

Finally, auto making just isn't the sort of business in which a has-been, ailing competitor like Ford is likely to suddenly surge forward and become a consistently superior total-return performer.

Barriers to entry are so low that Chinese cities are building cars. Newer vendors of alternative energy cars, such as electric, stand ready to compete Ford back to the point of merely average profits and growth.

Vehicle production just isn't the sort of business that has characteristics of defensible advantages, low union involvement, and high growth that are so often found in the best companies.

Ford reported one good quarter. Maybe it'll have one or two more. But the probabilities that Ford is going to be a long term bet for consistently beating the S&P500 just aren't very high. And that's as much a function of the sector in which the company competes as it is of the company's particulars.

CNBC's Resident Idiot Strikes Again

Earlier this week, CNBC resident idiot and economic-pretender Steve Liesman demonstrated why he loses so many debates, especially with Rick Santelli.

On the morning in question, Squawkbox had Wisconsin Republican House member Paul Ryan as guest-host.

Ryan, in response to a typical charge that conservatives/Republicans in Congress were simply 'against healthcare reform' and had no ideas of their own, quickly rattled off several bills proposed by Senate or House Republicans, but ignored by Democrats. His own proposal, he noted, covers the poor uninsured by providing a (roughly) $5,000 amount as a credit or rebate to use for health insurance.

When Liesman contended that this would cost Treasury, Ryan corrected him, explaining current treatment, taxes typically paid by these filers, i.e., not much, and the alternative of redesigning our entire healthcare finance system just to cover several million people.

Liesman then stared blankly at Ryan, mouth open, eyes dull, uttering something like,

'I'm sorry, I'm just not getting it, Congressman.'

Even I had understood Ryan's explanation, and I'm sure most viewers did, too.

Ryan smiled and patiently replied that he'd take Liesman back through the numbers- again- after the commercial break.

It was a priceless moment. CNBC's clueless economic reporter didn't have a clue about Ryan's rather straightforward manner of providing healthcare insurance for the poor, and the entire program had to stop until the staff dunce 'got it.'

As if it mattered. Or Liesman would be able to retain the explanation for more than a few minutes.

That's Why We Have Anti-Trust Laws

Holman Jenkins, Jr. wrote a curious editorial in Wednesday's Wall Street Journal.

In the piece, he spent considerable ink asking why Google and Microsoft don't figure out how to collude in staying out of each other's way. By comparing Google's relationship with Apple, on whose board Google CEO Eric Schmidt sits, Jenkins noted the animosity present between the other pair of companies.

Going through various detailed examples, such as Microsoft's new Bing search engine and Google's online office applications, Jenkins contended, probably correctly, that each has less prospect of gaining much revenue from encroaching on the other's turf than they have profit to protect by demonstrating their ability to hurt each other.

Somewhere in the piece, Jenkins noted the likely cross-ownership of Google and Microsoft by many shareholders, reasoning that, because of this, it would be a good thing if the two firms could somehow learn to back off and let each other's businesses alone.

But that is exactly why we have anti-trust laws. Microsoft is already moving to cut prices on Office applications and ready its own free internet version because Google entered the business with its own free online applications.

The two also tangle in search applications.

If Google weren't threatening several of Microsoft's businesses simply by its existence, we'd all be paying higher prices for less productive software from the Redmond giant.

Anti-trust law is a good thing. I don't quite understand Jenkins' contention that if only it were legal, gee whiz, these two large companies could save so much money by not building businesses which antagonize and threaten each other.

If that were so, the entire Schumpeterian dynamics process in the businesses in which Google and Microsoft engage would be slowed to a crawl.

The two firms' mutual pressures on each other to continue to innovate, offer more value for price, and worry about the other's encroachment all serve consumers well.

Why change that?

What Ben Bernanke Didn't Tell You In His Editorial

Fed Chairman Ben Bernanke wrote a long editorial in Tuesday's Wall Street Journal, appearing the morning of his Capitol Hill testimony, entitled "The Fed's Exit Strategy."

You see, many people, including me, doubt that the Fed can effectively avoid rampant inflation caused by its monumental explosion of the US money supply and guarantees.

Ben patiently attempted to reassure readers by listing the many ways he feels the Fed can rein in much of the liquidity it recently created.

Here's the one thing Ben never mentions in his editorial.

All of the methods he described involve raising interest rates.

Whether it's by paying higher interest rates on bank reserve deposits, selling Treasuries, or any of the other approaches he outlined, they all necessarily involve boosting interest rates.

It's fundamental economics. Money supply down, rates up. Pushing securities into investors' hands via sales pushes those prices down, thus raising effective interest rates.

You know what rising interest rates tend to do?

Yes, that's right. Choke off recoveries and slow economic growth.

Granted, rates are basically at zero for now. But they are at zero with much, much more US obligations outstanding than ever before. To move the needle on these massive obligations, interest rates will have to rise.

Oh, yes. That's right, the rate the US pays on its debt will...have to...rise.....too.

Oh, my. Doesn't that raise our cost of government and the deficit?

You betcha!

Thanks for the tutorial, Ben. Next time, maybe be more honest about the effects trying to shrink the money supply will have on the economy's effective interest rates?

The Coming Financial Sector Troubles: Commercial Real Estate

Last week, in this post, I cautioned against becoming too optimistic over Goldman Sachs' recent blowout quarterly earnings.

Sure enough, yesterday's Wall Street Journal warned that Morgan Stanley is likely to report a loss this quarter, due in large part to bad commercial real estate performances.

This is precisely the sort of thing I had in mind when I wrote about Goldman. Goldman's earnings were trading-related, something at which the firm has always excelled. And it has been rather aggressive at writing down its commercial real estate holdings.

Morgan Stanley, however, seems to be reminding investors that it is an also-ran in investment banking, and, now, commercial banking, too. It plunged into real estate late and ineptly, being burned badly enough to have to plead for a commercial banking license, and actually consider behaving like one.

But, like most investment banks, Morgan Stanley doesn't really have a great deal of successful experience with holding physical assets like real estate for long term gains. This is now becoming clearer.

In fact, the drumbeat of commercial real estate troubles, which began some months ago, are growing louder and touching more companies, including GE.

I think it's way too early to declare soundness in the banking sector, or a healthy, recovering economy.

So long as joblessness continues to grow and federal spending fuels GDP, real estate lending of both types, residential and commercial, seems destined to limp along until prices finally fall to market-clearing levels.

Morgan Stanley's imminent disclosure of more real estate losses is probably just the tip of another expensive iceberg for the financial sector.

GE's Continuing Pathetic Performance

The Wall Street Journal's headline on GE's performance results this past weekend said it all, "GE Net Falls 49% as All Units Hit."

Ouch!

Perhaps the most glaring insult to shareholders was inept CEO Jeff Immelt's quote,

"Despite a difficult overall economy, we are pleased with our results."

That sure took a lot of gall for Immelt to say, didn't it? Look at the nearby stock price charts for GE compared with the S&P500 over the past 3, 6 and 12 months.

The financial unit saw profits plunge 80%! Once again, Immelt's mismanagement and continuation of the firm's senseless, grab-bag diversification, has injured shareholders more than was necessary.

With virtually no relationship between the major components of the firm, those shareholders wishing to hold only industrial or media properties could have avoided the enormous losses of the financial unit's toxic holdings.

The same day, a Journal analytical piece in its 'Heard On The Street' column spanked GE for two weaknesses.

First, the piece noted how GE, contrary to many commercial banks, has continued to issue debt with government guarantees. Without conventional bank deposits for funding, the company has issued $68B of obligations under various federal programs, and there's no clear end in sight of the company's dependence upon, basically, all taxpayers.

The article also draws attention to GE's lower reserves for commercial and residential mortgage losses than its commercial bank competitors. This is an area on which the firm has been castigated in prior months, and there doesn't appear to be any sign that its management has seriously considered more realistic treatment of asset values in its real estate portfolios.

Take these two items together, and you conceivably have GE raising taxpayer-guaranteed debt while inaccurately leaving questionable real estate asset values inflated.

All in all, hardly a picture of competent, prudent management of the diversified conglomerate of which so much glowing press has been written in past decades. Instead, it's become a bloated, over-valued collection of unrelated, struggling businesses dependent upon government aid to fund itself.

This is a business model of which Immelt is proud, and the performance with which he is pleased?

Jack Welch must be spinning in his grave. Oh, wait, Neutron Jack's still alive!

More Signs of Schumpeterian Weakness At Microsoft

In a rather innocuous article in last Tuesday's Wall Street Journal, the paper reported that Microsoft is set to offer a free, online version of its Office software in the first half of next year.

It doesn't get much more Schumpeterian than that, does it? Google's intense pressure on Microsoft, including helping starve the former of search revenues, then offering its own free online suite of applications software, has finally caused the software titan to buckle on maintaining Office's conventional product strategies and policies.

Despite the company's insists that it will continue to grow Office revenues at a healthy rate, I'm rather more suspect about this.

My own children have learned to subsist nicely with web-based spreadsheet and text programs. Most people don't even use 80% of what Office products contain anyway. I have never bothered to upgrade from Office 2003, which has precious little advantage over my prior copy of Office2000, and contains copy limitations, too.

It's unclear to me that I'd shell out over $600 again for a private copy of the professional version of Office. There just doesn't seem to be that much comparative advantage anymore. As it is, so long as Office2003 is compatible with a next Microsoft operating system, I would have absolutely no need to upgrade.

I'm sure I'm not alone. Microsoft didn't come to be so reviled by good product management. Like many companies and other individuals, I'm always open to ways to avoid paying the Redmond giant another buck. Especially when no new significant value has been added to its products.

With their imminent admission that the web is a required distribution channel for Office, and on a free basis, at that, I think the end of Office as a main revenue growth engine at Microsoft is in sight.

Hank Paulson's Congressional Show Trial

I happened to see several minutes of Hank Paulson's Congressional show trial of last week. Specifically, I heard a Representative, from which party I honestly don't know, lambaste Paulson for having enjoyed a statutorily provided tax deferment on profits earned from premature sale of assets upon being confirmed Treasury Secretary.

Sounding like a mad dog with no common sense whatsoever, this thin, older-looking male Representative repetitively demanded to know how much in taxes Paulson had avoided paying due this provision.

This particular line of 'questioning' was quite far afield from the stated reason Paulson was appearing before the Committee, i.e., to determine whether he and/or Ben Bernanke used undue coercion on BofA CEO Ken Lewis to force him to complete the Merrill Lynch acquisition.

If we are to attract candidates of merit and suitable qualifications and accomplishments to cabinet-level offices, we can't have Congressional members behaving like Grand Inquisitors. Specifically, twisting legitimate actions of government servants to appear as something else- in this case, tax evasion by the rich.

We're all going to be much poorer, economically and otherwise, if our Congress continues to attempt to criminalize every aspect of any administration's behavior with which it disagrees.

Let CIT Die

There has been much handwringing regarding CIT's imminent demise, amidst discussions with the federal government for yet another rescue package.

According to Tuesday's Wall Street Journal, CIT has suffered heavy losses in its lending to small- and medium-sized businesses, but is not really considered a lynch-pin of the overall banking system.

Still, federal administration members worry about the signal that would be sent if a major lender to small business goes bankrupt.

Honestly, how hard is this one to figure out?

CIT has lost money doing its business. It's evidently not very good at making credit risk and/or funding decisions, which are the two most important aspects of a lending business.

If there is sufficient profitability in well-made small business loans, some other firm will enter the market as CIT vacates it with its collapse. Hopefully, doing the business better than has CIT.

But why in God's name would anyone wish to prop ups a badly-run lender that isn't crucial to the nation's financial system?

This is really a no-brainer. The loans which are outstanding will be assumed or bought by some entity. New credit will flow if it's viable and profitable.

If it's not, then these borrowers were not the ones we should want to have receiving loans in the first place.

Things generally work better when you leave market forces to figure them out. The mere fact that the administration has been discussing bailing out CIT tells you they don't really understand the dynamics involved in this matter.

Rather than clear out an incompetent source of business lending, to make room for better ones, administration officials are seriously contemplating aiding idiots who have run their own business into the ground.

This is no way to recover an ailing economy, nor, for the long run, promote efficient economic activity in the US.

Exxon Blinks On Alternative Energy

In a scene very reminiscent of the 1970s- and isn't much of our political economy these days?- Exxon announced a strategic reversal on alternative energy sources.

Yesterday's Wall Street Journal reported that Exxon is pairing with esteemed biologist J. Craig Venter to research the use of algae to clean greenhouse gases and secrete oil.

Honestly, reading that last part, it sounds like a sci-fi novel.

And maybe- just maybe, if we are lucky- it is.

Because the last time Exxon appeared to abandon its primary business, oil exploration and refining, and jumped into something else, it wasted billions of dollars. According to the Journal article, this time, it seems to be anteing up only $600MM. Truly a pittance for the oil giant.

Some historical context is required to properly understand what's happening here.

Back in the 1970s, when the Clean Air Act Extension and high oil prices put pressure on oil companies, Exxon launched Exxon Enterprises. EE was a holding entity which oversaw startup planning for all sorts of non-oil businesses, including solar energy panels, a fax machine business, and various other electronic office products initiatives. The thinking was to use Exxon's enormous revenues to fund so-called replacement technologies, such as electronic office equipment, to replace oil used in commuting and travel, and solar, to replace depleting and expensive oil.

I consulted to one of the EE businesses as part of the Wharton Applied Research Center when I was a graduate student. In a hilarious activity straight out of Joseph Heller's Catch-22, our mission was to help the management of Exxon Solar Energy to forecast a developing market of sufficient size to secure follow-on budgetary funding to continue the business effort. The furthest thing from our charter was to actually create any product. We were brought in to simply play a paper-shuffling game of justifying the unit's existence to corporate for a few more years. The stories we heard of oil executives jumping ship from the New York headquarters to work out in Florham Park, NJ, were many and rich. Suffice to say, there was a whole lot of ticket-punching going on, but nobody believed in the longevity of the businesses.

As it happened, a year later, I was working at AT&T in Morristown, just a stone's throw from EE. In short order, Lee Raymond, the now-retired CEO of Exxon, was brought in to wind down the whole mess and stanch the incredible losses emanating from Florham Park.

Raymond observed that oil wasn't going away, while Exxon would never amount to much in these new areas. He presided over the selling off or closing of all the EE business efforts.

In truth, EE had served its purpose. During a period of hysteria over high oil prices and Arab control over much of the world's crude, Exxon had successfully deflected some public criticism, and appeared to be spending money on diversification in order to seem to be 'solving' the problems associated with high oil costs.

Once Reagan was in office and the publicity crisis had passed, Raymond, a rising 'go to' guy at the firm, was brought in to restore sanity.

I think that's what's occurring now, too.

Rex Tillerson is no fool. I loved the Journals reference to Tillerson's snide remark about alternative energy, i.e., that he expected to be driven to his funeral in a car powered by gasoline or diesel fuel. And he will be.

But, for now, it's once again time to show public humility at being in the oil business.

Who better with whom to partner than noted scientist Venter, on a project that sounds like something out of pure science fiction.

Imagine- an algae that consumes greenhouse gases and spews out usable energy. Can it get any wilder, more perfect, or safe?

I can just see Tillerson and other senior Exxon execs around a conference room table one-upping each other on what the alternative energy project should have as its aim, and roaring with laughter at the final result.

How many years will it be before any real progress is made on this wild-algae chase? Well, Daniel Nocera's work on fuel cells has consumed about a decade, and he figures he has at least half that time, again, to go before perfecting his work.

Who knows how long Exxon can manage to make this tilt at an enormous windmill take? Most likely, long enough to see a return of either the Oval Office or at least one chamber of Congress to Republican control.

In the meantime, this far-fetched, impossible-sounding quest will soldier on, consuming a trickle of Exxon profits, while reaping huge publicity gains.

Don't ever underestimate Exxon management.

The Dial-a-Mattress Case

Yesterday's post discussed Goldman Sach's recent blowout earnings announcement. For what it's worth, a Wall Street Journal column on the back page of today's Money & Investing Section echoed my own note of caution regarding Goldman as a bellwether. More on that in a later post.

Going from the sublime to the ridiculous, yesterday's Journal featured a piece which my business partner and I thought had vanished. It was a rather in-depth story on the bankruptcy filing of New York-based Dial-a-Mattress.

As successful and 'together' as Goldman's management team has always been, Dial-a-Mattress' was home-grown and sort of 'seat of the pants.'

Founder Napoleon Barragan got his idea from a local business that once sold steaks over the phone, and began a similar one for bedding in 1976. After some twenty-five years of solid and profitable growth, the company's downfall began in 2001, according to Barragan. Specifically, the article notes,

"Mr. Barragan said two major changes in his business were largely to blame: an expansion into bricks-and-mortar sales and a culture clash brought on by new management."

In effect, the business cratered due to totally controllable mistakes, not market or consumer trends.

In brief, the Journal piece describes Dial-a-Mattress' haphazard, inept expansion into physical stores right after the 9/11 economic pullback. It's clear from the article that the company stumbled its way into this strategy, mistakenly opening stores in literally "low rent" areas to which people would not drive to shop.

Unbelievably, Barragan states that the company never did standard store-based profitability analysis which could have caught the losses early on and perhaps mitigated the damage.

Around the same time, Barragan hired a fairly large number of new senior executives, thus diluting the culture with which Dial-a-Mattress had succeeded for years. In a scenario straight out of some made-for-television movie about rich, inept businessmen, the new hires ignored the operating processes which had accounted for much of the firm's nimbleness, and, instead, devoted much time and energy to infighting.

Apparently, according to the Journal's piece, nobody bothered to analyze profit margins by channel, store, or any other basis. Thus, rising sales were seen as validation of new strategies, including a successful move to internet-based sales, while profits languished, then fell.

The final chapter is that the firm's competitor, Sleepy's, is purchasing the phone and online portion of the business, as well as hiring Barragan at $500,000/year.

As I read this story, I was struck by how difficult building and maintaining a successful business is. And how often successful companies fail for the most basic, fundamental reasons.

In Goldman's case, it was forced to become a commercial bank, and take federal funding, not so much for its own mistakes, but for the tenuousness of the financial system in which it operated. The mere hint of counterparty failures sent Goldman to the brink. Though it seemed never to skate so close to failure as Bear Stearns did, the same forces were about to bear down on the formerly premier investment bank.

In the case of Dial-a-Mattress, the business model was simpler. Yet the mistakes which sank the firm were simpler, too. And, unlike Goldman's, totally under management's control.

How fleeting is business success. How many ways there are for it to go "poof."

No matter how smart, or uneducated the management at the helm.

I guess, as I read this post, one has to ask the unrelated question,

'Was it fair for Goldman's mistakes in operating in an environment in which it was so vulnerable to counterparty and funding risk to be assumed by the federal government, thus saving the firm and most of its employees, while Napoleon Barragan's mistakes led to his firm's failure?'

Goldman's Earnings Announcement

Yesterday's 2.5% rise in the S&P500 has been attributed to Meredith Whitney's 'buy' rating on Goldman Sachs, just in advance of its earnings announcement.

Various superlatives have been used to describe the firm's quarterly earnings. And, coming on the heels of the prior 6 months of financial sector turmoil, in which Goldman had to give up being an investment bank, and become a commercial bank, the performance is somewhat surprising.

Then again, much of the gains were from trading- an old Goldman strength. And it's not clear how the Fed will continue to oversee and/or allow Goldman's current mix of business.

Frankly, I think the investor reaction which propelled the S&P to such a daily gain is misplaced. It's asking a lot to pin hopes on just one, and arguably the best bank's results.

Furthermore, it's not just Goldman's quarterly performance, but, allegedly, Whitney's stamp of approval with a 'buy' rating on the firm.

It's troubling when any single analyst has this type of power over companies with their recommendations. Additionally, while Goldman may be poised to continue its superior performance, that, in my opinion, is precisely why it is not a bellwether for either the sector or the economy in general.

Fresh Evidence on Housing Foreclosures

This past weekend's Wall Street Journal had an editorial by Stan Liebowitz, a professor of economics at the University of Texas in Dallas. He writes a very compelling piece demonstrating that current policy makers are wrong in both their beliefs as to what brought about the mortgage default crisis and what will resolve it.

He wrote,

"Many policy makers and ordinary people blame the rise of foreclosures squarely on subprime mortgage lenders who presumably misled borrowers into taking out complex loans at low initial interest rates. Those hapless individuals were then supposedly unable to make the higher monthly payments when their mortgage rates reset upwards.

But the focus on subprimes ignores the widely available industry facts (reported by the Mortgage Bankers Association) that 51% of all foreclosed homes had prime loans, not subprime, and that the foreclosure rate for prime loans grew by 488% compared to a growth rate of 200% for subprime foreclosures. (These percentages are based on the period since the steep ascent in foreclosures began -- the third quarter of 2006 -- during which more than 4.3 million homes went into foreclosure.)

Sharing the blame in the popular imagination are other loans where lenders were largely at fault -- such as "liar loans," where lenders never attempted to validate a borrower's income or assets.

This common narrative also appears to be wrong, a conclusion that is based on my analysis of loan-level data from McDash Analytics, a component of Lender Processing Services Inc. It is the largest loan-level data source available, covering more than 30 million mortgages.

The analysis indicates that, by far, the most important factor related to foreclosures is the extent to which the homeowner now has or ever had positive equity in a home. The accompanying figure shows how important negative equity or a low Loan-To-Value ratio is in explaining foreclosures (homes in foreclosure during December of 2008 generally entered foreclosure in the second half of 2008). A simple statistic can help make the point: although only 12% of homes had negative equity, they comprised 47% of all foreclosures.

Further, because it is difficult to account for second mortgages in this data, my measurement of negative equity and its impact on foreclosures is probably too low, making my estimates conservative."

Thus, according to Liebowitz' analysis of available data, people defaulted on mortgages mostly because they should never have been in those homes in the first place.

He continues,

"To be sure, many other variables -- such as FICO scores (a measure of creditworthiness), income levels, unemployment rates and whether the house was purchased for speculation -- are related to foreclosures. But liar loans and loans with initial teaser rates had virtually no impact on foreclosures, in spite of the dubious nature of these financial instruments.

Instead, the important factor is whether or not the homeowner currently has or ever had an important financial stake in the house. Yet merely because an individual has a home with negative equity does not imply that he or she cannot make mortgage payments so much as it implies that the borrower is more willing to walk away from the loan.

The difference in policy implications is enormous: A significant reduction in foreclosures will happen when and only when housing prices stop falling and unemployment stops rising (see chart nearby).

Although the government is throwing money -- almost $2 trillion and counting -- at the mortgage markets with the intent of stabilizing house prices, its methods are poorly targeted. While Federal Reserve actions have succeeded in reducing mortgage interest rates, low interest rates induce refinancings more than they do home purchases."

This is a very important point. Once again, goverment meddling in asset prices only prolongs pain and adjustments of the market to the correct price levels. The recent subsidies to promote home purchases simply represent another form of the government actions which facilitated the original mortgage default debacle, i.e., promoting purchases of housing and creating false floors under prices.

Liebowitz concludes by noting,

"Unfortunately, recent attempts by politicians such as Barney Frank (D., Mass.) to again artificially increase homeownership levels might delay this return to sustainable equilibrium prices.

Other government policies are likely to be even less effective in reducing foreclosures. The Obama administration's "Making Homes Affordable" plan focuses on having the government help lower obligation ratios (the share of income devoted to house payments) down to 31% from levels somewhat above 38%. But my analysis finds that mortgages having such obligation ratios at closing did not later experience high foreclosure rates. This suggests that reducing these ratios is not likely to significantly improve the foreclosure problem.

Understanding the causes of the foreclosure explosion is required if we wish to avoid a replay of recent painful events. The suggestions being put forward by the administration and most media outlets -- more stringent regulation of subprime lenders -- would not have prevented the mortgage meltdown regardless of their merit otherwise.

Rather, stronger underwriting standards are needed -- especially a requirement for relatively high down payments. If substantial down payments had been required, the housing price bubble would certainly have been smaller, if it occurred at all, and the incidence of negative equity would have been much smaller even as home prices fell. A further beneficial regulation would be a strengthening, or at least clarifying at a national level, of the recourse that mortgage lenders have if a borrower defaults. Many defaults could be mitigated if homeowners with financial resources know they can't just walk away.

We are at a crossroads where we can undo the damage to the housing market by strengthening underwriting standards in a reasonable way. But to do so political leaders must face up to the actual causes of the mortgage crisis, not fictitious causes that fit political agendas and election strategies."

It's sound advice as we continue to see government intervention in housing finance. Chances are it is all detrimental and distorting, just like Fannie's and Freddie's original market-distorting activities which incented lenders to make imprudent loans on too little buyer equity.

Boone Pickens' Energy "Plan" A Year Later

I saw Boone Pickens on CNBC Tuesday morning. He was there to mark the one-year anniversary of his non-plan national "energy plan."


Suffice to say, Boone was crowing about Congressional legislation including natural gas. But he begged off commenting on 'cap and trade.'


This seems totally disingenuous to me. He claimed he isn't an expert on that topic, so he refused to comment whatsoever on the bill.


Personally, I don't think that dog hunts. Pickens is smart enough to judge whether or not distorting the prices of energy sources via political machinations is a wise thing.

And nobody has yet explained how we know when we spend "too much" on any one good that requires foreign exchange.

In an unrelated article, for example, I read one pundit ask why spending what the US spends on healthcare is "too much," but continuing to pump dollars into union-run schools isn't?

It's still the same with energy. While it may be unwise to leave so many dollars in the hands of unfriendly powers, that's different than buying a fairly-valued commodity input in the market, to use to create value in the US.

Lastly, if Pickens isn't smart enough to have any opinion on 'cap and tax,' why should we believe he's intelligent enough to propose a sound energy policy/plan?

He can't have it both ways. Either he has informed opinions on energy policy in general, or he doesn't. It can't be a pick and choose thing. Even for Pickens.

Morgantown Still Economically Vibrant

Last year at this time, I wrote a post about Morgantown, West Virginia. At that time, I noted that, though many talked of recession, this city certainly didn't exhibit any such signs.

I'm back here in Morgantown again, and the picture looks quite similar.

For example, on a Monday evening, a bit later than the Thursday evening last year, the same Olive Garden restaurant was still busy. Not full, though. It was about half full and we were seated immediately this time.

But there is a new Red Lobster across the parking lot, and people were waiting outside to get into that restaurant when we left after 8pm.

The Wal-Mart was still busy this year. Shopping carts were still being filled, and shelves were fully-stocked.

Traffic in Pennsylvania and Maryland was a bit lighter than last year, which fits the recent survey suggesting a 2% decline in driving over the holiday.

Never the less, the mix of activity I've seen in areas typically viewed as economically challenged, still seems vibrant.

More Stimulus?

Unbelievable as it sounds, members of Congress are pleading for another deficit-busting stimulus bill.



Apparently they are worried because the ill-designed first $787B bill didn't work. Much of the spending went to transfer payment programs, some went to temporary road-building jobs, and much is planned for out-years.



There were critics of the bill which warned of this result, but Congress passed it so fast there literally was not enough time from the bill's being written, and then voted on, for any one of them to have actually read the bill.



Meanwhile, last week's unemployment rate went to 9.6%. Far higher than the 8% this administration assumed when it pushed for the stimulus bill.



A common definition of insanity is doing the same thing again, but expecting different results. That's where we seem to be with our economy, unemployment and stimulus bills.



Perhaps, if anything were to be done, it would be to shift existing, unspent so-called stimulus funds to direct income tax rebates, in advance.



At least doing this would insure that the money is spent now, by consumers, rather than politicians.

Have Banks Been 'Too Big To Fail' Since 1975?

Holman Jenkins, Jr.'s column in last Wednesday's Wall Street Journal contended that there's really nothing new about large US banks being bailed out by Bernanke's Fed.

After arguing that if BofA shareholders had known about Merrill's worse-than-expected condition, they may have voted down the deal. As it was, Jenkins notes, BofA's Ken Lewis promptly sought Fed financial aid after the deal closed.

Fair enough. But I don't think it's correct to say that US government policy for 30-odd years has been to save all large commercial banks.

The period Jenkins references just about covers the time from when I was in college, so I have a fairly good recollection of the era.

Names which were once prominent, but are no longer with us, include: First Pennsylvania, Seattle First, Texas Commerce, Bank of New England, Continental and Bankers Trust.

In fact, it was just about the mid-1970s when technology was beginning to lead to excess capacity in banking, setting the stage for eventual consolidation.

Usually, I agree with Mr. Jenkins. But not this time.

There hasn't been a 'too big to fail' ethic in US banking for three decades. Rather, it's been more like the last ten years, dating roughly to Greenspan's Fed stage-managing Long Term Capital Management's demise.

So, oddly, I would contend that it wasn't even a commercial bank that was the first instance of the 'too big to fail' doctrine. In today's financial sector, any sufficiently large institution, even a privately-owned one, such as a hedge fund, has enough implicit influence on asset prices, and enough complicated entanglements with other firms, to cause regulatory panic at the thought of failure.

For the most part, though, with size goes mediocrity. Most of the financial utilities- Citigroup, Chase, BofA, to name three- got that way through federally-approved mergers, not organic growth.

These super-sized financial entities are our own governmental creation, rather than that of simple business acumen.

Maybe it's appropriate, given government's permissiveness in allowing these gargantuan banks to merge themselves into existence, that government must clean up the mess when they begin to fail.

Cap & Trade Details

In reply to this recent post concerning the lack of apparent equity market reaction to Friday's stealth passage by the House of a 'cap and trade' bill, a reader wrote this note to me,

"Re your post on your Reasoned Skeptic blog on the cap and trade bill, I'd be interested in you doing a blog post on your thoughts on allowing a border tax adjustment for imports from countries with lax carbon standards. You may have noticed that the House bill includes a border adjustment provision; it was slipped in late last week, despite arguments against one from the Obama administration. If you're not familiar with border adjustment, attached are comments by Representative Inglis arguing for border adjustment, and slides by AEI on carbon border adjustment (14-18 re border adjustment and carbon; 1-13 re background on border adjustments)."

To be honest, no, I did not know this. I have yet to read the detailed article from last weekend's Wall Street Journal, and this sort of fine point isn't necessarily gleaned from televised coverage, little as there was, given the weekend news cycle and my own aversion to viewing such weekend coverage.

The reader sent me two attachments discussing how such a proposed 'carbon equalization' regime would work, which I appreciated. Suffice to say, as I expected, after quite a bit of dense, mind-numbing detail on these schemes, both documents admitted to the two things I had already guessed, prior to reading them.

First, the sheer implementational difficulties of such a regime are represent real obstacles to their successful operation. Think months'-long delays, if not years, as complicated carbon-usage forms are completed, submitted, and then overwhelm some federal department charged with administration of the whole mess.

That's the optimistic view. The reality, as with our recent experience with mortgage finance 'liar loans,' is likely to be wholesale fraud, deceit, and the employment of various 'consultants' to complete applications in such a manner as to gain favorable treatment, knowing the ability of government to investigate each application and enforce penalties for fraud will be de minimis.

Then there's the real problem- a GATT-based challenge at the WTO. This sort of issue was my first instinct in believing this importation-adjustment process to be practically unenforceable.

To get to the plainly-written crux of the matter, this will come down to a question of whether it's legal, in the context of world trade agreements, for one country to enforce its pollution penalties on producers in other countries importing into the first country.

Similar to the phenomenon of labor-intensive, low-value-added work moving to low-labor-cost countries around the world, despite various attempts of high-wage countries to stop it, it's logical to expect high-carbon-cost countries to lose employment, GDP and tax revenues from both to low-carbon-cost countries, irrespective of attempts to stop this flow.

I just don't believe a lot of complicated US law involving various carbon-usage adjustments is going to fly. Before it's sorted out, the economic uncertainty and resulting loss of jobs and economic activity from the US to poorer, 'dirtier' countries, will probably cause a serious rethink of the whole idea.

More Politicizing At The Fed

This morning's Wall Street Journal carried a fascinating piece on the selection of William Dudley as New York Fed President.

Essentially, the piece exposed the raw arm-twisting and intervention by outgoing president, now Treasury Secretary Tim Geithner, in Dudley's favor.

The article portrays Geithner and Bernanke, as well, as putting extremely heavy pressure on the NY Fed's board to choose their preferred candidate.

To the Journal's credit, the piece included some history of the Fed's design, including the regional banks and Fed boards, intended to prevent just this sort of undue influence from Washington.

The manipulation of the NY Fed's board grew so strong that Pepsico CEO Indra Nooyi resigned, using as cover her busy schedule of other duties.

I have lamented, since last fall, the continuing political flavor, content and focus of many of my business blog's posts. This article helps illustrate that it's not my choice to shift so much of my attention to political matters.

It's evident that the very fabric of American business is being heavily politicized and coerced by the federal government. This story concerning the undue influence exercised by Washington over the important regional Fed bank in New York reveals that this is a continuing theme of growing importance in our economy, and it's increasingly managed nature.