More Bad Research On Corporate Performance From Deloitte

I read a reference in a recent Wall Street Journal column by Holman Jenkins to a recently-popular piece of research by two Deloitte consultants, Michael Raynor and Mumtaz Ahmed, along with a "researcher" from the University of Texas, Andrew Henderson.

The book they wrote is described here, and the paper from which it sprang, may be found here in a Deloitte website post, and downloaded/read.

Whenever I read of a reference to some new empirically-based work purporting to diagnose the bases of corporate performance that is desirable to emulate or duplicate, I naturally am curious to learn who did the work, the methodology employed, and their conclusions.

In this case, it appears that Raynor is the leader of the group. His bio can easily be found, as well as his own website. From what I've gathered, he is clearly an intelligent individual, but doesn't seem to be described as having any significant working experience in business, outside of his academic pursuits at Harvard (DBA) and as a consultant at Deloitte. Deloitte, it should be noted, is not exactly in the vanguard of management consulting. Neither is Harvard known as a source for the best empirical approaches to business performance analysis. And it would appear that Raynor is in a sort of 'of counsel' role at Deloitte, as he has his own speaker's bureau representative and website.

In the beginning of their article, the authors state that they believe most prior studies of excellent US businesses have, in fact, been portraits of lucky, rather than skillful firms.

It's also not all that surprising, to me, at least, to learn that Raynor's methodology has little relationship to the real world in which most businesses operate, i.e., a need to produce results that create wealth for business owners. The most easily-accessible data for this, which, conveniently, also is the business form which accounts for the bulk of US business activity, is total returns of publicly-held corporations.

Because I linked to the authors' original article, I won't duplicate their text with reposted passages here.


In their piece, the authors essentially put down total returns as too reflective of future performance, as anticipated by investors, than actual management skill.

Instead, they chose ROA as their preferred measure.

As I mentioned to a colleague, this choice, alone, virtually guarantees the uselessness of all of their efforts.

Yes, they got their article in HBR, won a prize, expanded it to a book. Fine. Tom Peters got a lot of accolades, too, at first. But his work sunk like a stone into the vast sea of strategy and management 'how to' tomes. As, I would expect, will this latest effort by Raynor, Ahmed and Henderson.

Their description of what total returns are is wrong. It's not simply a measure of future "surprises" to investors. Taken as a pattern, over time, total return measures, in a presumably reasonably efficient market of investors and analysts, the ability of a firm's performance to exceed expectations. It does involve expectations, but it also involves expectations based upon prior and evolving performance.

And, more importantly, it is the measure of wealth created by management of the firm, regardless of the exact source of that wealth. It may have been a fortuitous purchase of a patent, a discovery in the research labs, a marketing edge, the discovery of some mineral deposit, or other unpredictable competitive advantage.

In fact, the very unpredictability of the advantage is what generates surprises and wealth. If all gains or excellent performance stemmed from reproducible methods, then those methods would quickly be copied, implemented, and all competitive advantage due to them would vanish.

Such performance can't, won't, and doesn't typically last for very long. But that timeframe can be years, not days or months.

In fact, my own research began with my simple quest to learn what the distribution of company performances was on the basis of being able to consistently outperform the equity markets averages on total return. From that knowledge, I was able to discern a range which constitutes an average length of time of outperformance.

In the same research, I tested ROA's association with patterns and levels of market outperformance, and found it absent for firms which grew revenues at above-average rates. Simply put, ROA is a point estimate of little value in deducing ongoing behavior of firms that are growing at a healthy pace.

And ROA doesn't automatically or tautologically translate into shareholder wealth. So it's going to be of passing interest to both investors and CEOs.

Thus, for all their extensive, hard quantitative work, the authors of the Deloitte study have pretty much doomed it to insignificance because it doesn't generate operable conclusions which directly lead to increased wealth for shareholders or their CEOs.

Then there's the matter of choice of patterns of outperformance.

In my research, I first reviewed real corporate performance over time. From these analyses, I constructed patterning variables which grouped companies by the pattern which their performance exhibited.

By contrast, the Deloitte study authors began by arbitrarily deciding to set a threshold of occurrence of 9 out of 10 years for a variety of unspecified fundamental performance measures.

Why should 9 out of 10 be the appropriate screening value? Why impose a value on the date a priori, instead of simply letting the data describe the true situation?

Thus, the authors proceeded down a path which features their own subjectively-chosen patterns for outperformance on a measure, ROA, which has no direct relationship to the growth of shareholder value in most companies.

As I read their paper, I reflected on my own background being a curious confluence of several important streams of influence. Over many years and with different companies, as a marketing and strategy professional, internal consultant, external consultant and research director, in several different sectors, including financial services, I happened to absorb several key lessons for this type of research.

Being in consulting at Oliver, Wyman & Co., I didn't approach research on the sources of consistently superior shareholder wealth creation with the scepticism that a true believer in efficient financial markets. When I produced my financial services sector results and presented them to retiring Chairman Alex Oliver, he exclaimed, to paraphrase,

'For years we've been saying we had knowledge of what drives superior performance, but we never really did. Now, with this, we do. This is a strategy consultant's ultimate tool.'

Alex was a lot of things, including cheap and petty, but he was arguably one of the best strategy consultants of his time. In his day, he headed Booz Allen Hamilton's strategy practice, leaving to co-found Oliver, Wyman. I took his praise as justifiable proof that my research approach was unique, effective and applicable in a very pragmatic manner.

When I extended the research, on my own, to the entire S&P 500, the results were even more powerful and applicable.

What Raynor, Ahmed and Henderson have produced has no real applicability other than a sort of minor confirmation that what can be easily duplicated is of little lasting value. And that what typically creates significant shareholder wealth can't be reduced to easily-duplicated management dicta.

So, there you have it. The Deloitte study authors and I agree that unexpected innovation can't be easily duplicated as a management style.

But I already knew that, and, if you read this blog regularly, so did you.

Is Bigger Really Better In Banking?

As I mentioned in this recent post, Charles Calomiris of the Columbia Business School wrote an editorial defending 'too big to fail' banks in last Tuesday's Wall Street Journal.

Calomiris clearly states his contention thus,

"Yet the challenge of coordinating the efforts among different countries' regulators can be met through prearranged, loss-sharing arrangements that assign assets to particular subsidiaries based on clear rules. This would make it possible to transfer control over the assets and operations of a large international financial institution in an orderly fashion, in case of its failure. This process could be handled by the courts for nonbank failures and the Federal Deposit Insurance Corp. for banks. With such arrangements in place, governments will have no reason (or excuse) to bail out large, international institutions.

But is it worth the trouble to preserve large financial institutions? Emphatically, it is."

It's worth noting that Calomiris postulates an entirely new, trans-national financial regulatory and accounting structure, after and on which he then bases his contention.

Realistically, what he envisions would be a good decade away from implementation, never mind that the sorts of accounting data supporting it would be gamed to high heaven by the smart financiers who would have time to discover and exploit the inevitable loopholes.

And, ironically, last year Calomiris claimed, in the Journal piece on which I wrote a post which is linked in that recent post, that the Basel accords' risk management prescriptions were the reason for the recent meltdown!

So, prior international financial regulatory attempts were bad. But now, Calomiris believes, they will magically become good.

Remember, modestly-paid civil servants write these sorts of regulations and procedures, while much smarter, better-educated sector practitioners, with plenty of capital behind them, immediately begin working to subvert, avoid and evade these same regulations.

Calomiris' vision will never be created, much less work as planned.

"This underlying reality is the background factor that helps explain why some financial firms also need to be large.

First and foremost, they need to be large to operate on a global scale—and they need to do so because their clients are large and operate globally.

Second, there are economies of scope when financial firms combine different products within the same firm (lending and foreign-exchange swaps, for example). A financial firm able to offer multiple products to a customer means savings in marketing costs and in the costs of information production (about the creditworthiness of clients, for example). Economies of scope among products also imply economies of scale within finance suppliers, since small financial firms cannot afford the overhead costs of building platforms with many complex products."

This is a rather common fairy tale in banking. The truth is, until the mid-1970s, the business of correspondent banking was alive and well. I didn't happen to include Calomiris' cite of Ollie Williamson's recent Nobel for his work on networks among businesses, but correspondent banking was the original implementation of this notion.

Simply described, regional and local banks across the US would use New York- or California-based money center banks for various financial markets activities, such as securities lending, upstreaming loans for risk layoffs, taking part in large loans from the money center, institutional trust, letters of credit, and so forth. There was no particular need for a regional bank to be everywhere, when it could basically share customer activities with a money center bank.

However, as money centers grew more complex, there was no accompanying increase in the skills of senior management in those banks, and the increased risks began to result in heavy losses. For example, recall Chase Manhattan's Drysdale Securities fiasco in securities lending, and the Penn Square energy lending debacle in the correspondent banking division.

If anything, finance has proven to be a sector where focused execution of fewer functions tends to result in greater wealth creation per invested dollar. Old line investment banks and brokerages were partnerships which only went public when the allure of cashing out to an unwitting public proved too great a temptation for the older partners.

Third, many of the gains of consolidation accrued to customers, not banks, in the form of cheaper and better financial services. For example, my research shows that from 1980 to 1999, after controlling for changes in the mix of firms, the underwriting costs of accessing the public equity market fell by more than 20%. These declining costs encouraged an expanded use of the market particularly by young, growing firms.

One study of bank productivity growth during the heart of the merger wave (1991-1997), by Kevin Stiroh, an economist at the New York Federal Reserve, found that it rose more than 0.4% per year.

This is hilarious. I would just love to know how the Fed's economist's study defined "bank productivity." I worked at Chase Manhattan for quite a few years, in many areas of the bank, including IT. One thing which is nearly impossible to do is provide a meaningful, cross-bank measure of productivity that has any sort of functional meaning.

As for Calomiris' finding of lower equity underwriting costs, this is precisely what my old boss at Chase, Gerry Weiss, predicted. However, Calomiris separates that cause from the effect it triggered on Wall Street, meaning investment banks. This loss of profitability in underwriting is what drove Merrill Lynch, Morgan Stanley, Bear Stearns, Lehman and the capital markets portion of Citibank to pile into mortgage banking and securitization. Thus, the causes of the ensuing bubble of poorly-originated and securitized mortgages by 'too big to fail' investment and commercial banks stemming from the ability of diversified financial institutions to move into product/markets with which they were not well acquainted. And whose risks with which they were inexperienced.

Fourth, global financial institutions also have made stock, bond and foreign exchange markets globally integrated and more efficient. Global financial institutions are the institutions that provide the funds for arbitrage across markets, which ensure global market integration.

But such "integrated and more efficient" "stock, bond and foreign exchange markets" can be accessed by smaller, single- or limited-product line firms, just as well as by financial utilities of unimaginable size and scope. That's the point of exchanges. They require counterparties to post collateral and stand between the counterparties, allowing small and large entities to safely trade with each other.

It was the old telephone markets which allowed large firms, in their day, like the old Salomon Brothers, to dominate specific markets, such as fixed income trading and origination, to the detriment of smaller rivals.

Today, we see thriving privately-owned M&A, hedge fund and private equity concerns. All primarily focused on specific niches in the financial services markets.

Until large commercial banks embarked on their buying spree, of dubious value, of standalone credit card issuers, that segment, too, had its own focused, skilled competitors.

Limiting the size, complexity and global reach of financial institutions is fraught with downsides for the international economy. We can solve the too-big-to-fail problem without destroying global finance. It certainly is worth a try."

As in his piece in October of last year, Calomiris avoids providing empirical evidence for his sweeping contentions. By contrast, merely observing which firms went under last year tells you a lot about how wrong Calomiris' positions are.

Merrill Lynch, Wachovia, WaMu, Bear Stearns and Lehman were all large financial institutions. They were either needlessly diversified, or growing into new areas at their peril. Citigroup and AIG came near dissolution, but were "saved" by government intervention. Morgan Stanley nearly failed, but found a gullible Asian savior just before the feds closed and merged them, as well.

One of the most memorable lessons I took away from my Chase Manhattan Bank experience was the manner in which executives in businesses that are part of a large, diversified financial institution lose a sense of individual risk-taking, assuming that poor performance or outright losses will be borne by the institution and its shareholders, while the near-term profits of risky and/or ill-conceived strategies will drive bonuses for the unit's management.

Financial services skills tend to be focused on and in particular products. Very few senior managers, CFOs and CEOs actually understand the intricacies of all of the businesses which report to them, and for which they are responsible and accountable. Notice how unprepared Vik Pandit was as he was given the CEO job at Citigroup, and how many months he took before claiming to have the slightest idea of what to do with the collection of businesses he inherited from Chuck Prince.

Among the most admired financial service firms, for their ability to generate consistently superior total returns, do not appear large, publicly-owned diversified banks. More often, firms such as Goldman Sachs, Blackstone, Blackrock, and a few hedge funds, are mentioned. Those firms operate in fewer, more focused collections of businesses.

As I wrote in that recent post concerning Mervyn King's and Paul Volcker's calls for the effective rebuilding of the Glass-Steagall wall between deposit-taking institutions and risk-taking investment banking institutions, it's simply unwise to allow large, diversified banking concerns to have a conduit into government-insured deposits. This allows them to essentially take risks with taxpayer-insured money, knowing that this will also prevent the firms from failing without some form of government-directed intervention or rescue.

In short, until and unless such insured activities are split from risk-taking ones, the moral hazard against which the two central bankers warn will continue to loom large.

Calomiris simply ignores this fact, provides no persuasive empirical evidence for his contentions, and then dreams up a non-existent international regulatory regime on which to base his conclusion that we need gigantic financial utilities.

Business Odds & Ends

Quite a bit of flap has arisen in business circles over the administrations "pay czar" slapping 90% salary cuts on a number of executives at firms which requested or took government aid, e.g., GM, Citigroup, AIG, BofA.

If anything, this illustrates the point of this post back in April about a lack of boundaries between government and business. I wrote,

"In my opinion, as well as others, such as William McGurn of the Wall Street Journal and even liberal Nobel Economics Laureate Joseph Stiglitz, the bankruptcy option has been avoided far too much in the past twelve months.

Bear Stearns, Lehman, BofA, AIG and Citigroup, upon appealing to the federal government for assistance, should all have been referred to bankruptcy court or the FDIC for closure. GM and Chrysler, too, should be in Chapter 11.

Somehow, corporate executives have come to expect their government to play favorites, pick winners, and temporarily prop up failing companies, rather than admit their own mistakes and close up shop.

By failing to observe the boundaries of responsible corporate behavior, boards of directors and CEOs unwisely opened a Pandora's Box of problems by requesting government financial aid.

This left them open to having their operations and decisions overseen and scrutinized by political officials who have used the excuse of looking after taxpayer money in order to move our economy down the road of fascism.

At the same time, government officials, beginning with the Bush administration, and continuing into the current one, have unwisely consented to helping private corporations, rather than declining, and sending them to their fate in the financial markets or bankruptcy courts.

By failing to observe the clear line between private and public spheres of activity, our government officials have compromised our economic system and given into the temptation to begin manipulating companies for political purposes and pet political agendas."

Right now, the political agenda on display is liberal America's desire to limit executive compensation. And, frankly, the companies involved right now deserve this treatment.

They ran themselves into a condition worthy of bankruptcy court. They begged for government aid. Now, having availed themselves of taxpayer funding, they have no excuse for having compensation become a political weapon to be used against their employees.

But I don't think there is any room for such government intervention in the rest of business.

You don't see the administration suggesting that entertainment or sports figures have their compensation limited, do you?

On another topic, I saw a laughable little piece on CNBC the other day. The topic was women in business, featuring some female MD from Deutsche Bank's derivatives unit.

Hilariously, the woman, whose name I cannot recall, blathered on about how a woman can now take time out of her career to have children, return to the workforce, and still reap substantial corporate success.

Michelle Caruso-Cabrera, a CNBC co-anchor, laughed and retorted that the only truly successful executives of either gender of whom she knew basically slaved like dogs, worked unending hours for years, sacrificed their family lives in order to climb to the top of the executive ladder at an investment bank. The other CNBC on-air personnel bobbed their heads in agreement.

The Deutsche Bank woman protested that this was wrong, and here she was, an MD at DB, to prove them wrong.

Look, let's be honest. DB is no Goldman Sachs, Morgan Stanley, or Blackstone. It's simply not a first-rank US investment bank or asset manager. DB is one of those second-rate-at-best, large European universal banks which bought a US bank, usually in distress. In DB's case, that would be the old, self-crippled Bankers Trust.

I don't think anyone equates rising to MD rank at DB with being a senior executive at Goldman, a first-rate private equity shop, or a hedge fund.

It's not clear just why CNBC even aired this segment. I guess they really wanted to focus on the notion that women can now rise to the top of an investment bank while happily and successfully juggling a family, too.

Unfortunately, I don't think women in senior management at truly first-rate investment banks, private equity groups or hedge funds would waste their time appearing on CNBC to crow about how much time they didn't work while rising to the top.

It seems to be very much a Groucho Marx sort of topic. Anyone foolish enough to self-identify as a successful female financial services exec who has it all probably either a) doesn't have it all, b) isn't that successful, or c) is about to have her career limited by appearing on CNBC to state that she has it all and is successful.

More Regulatory Pressure To Separate Commercial & Investment Banking

Way back in 1996, my friend B predicted that, going forward, US banks would become increasingly like utilities, with core lending and deposit-taking functions eventually separated from riskier investment banking. The former would become federally-insured activities, with lending subject to fairly rigorous standards in order to qualify for federal guarantees.

Otherwise, he noted, the few, large deposit-taking banks would subsidize risky investment banking with insured deposits and a "too big to fail" condition that would only lead to increasingly riskier trading and underwriting activities.

This week, Mervyn King, Governor of the Bank of England, and Paul Volcker, former US Fed chairman, once again called for separation of investment and commercial banking. For pretty much the same reasons B prophesied over a decade ago.

Both central bankers identified the increasingly risky behavior of commercial banks which have bulked up proprietary trading and underwriting activities.

Yet, one only has to look at this week's mortgage loan delinquencies at Wells Fargo to see that my old Chase Manhattan boss, Gerry Weiss, was prescient when he observed that money center banks didn't need to enter investment banking to lose money. They could do that in their regular businesses through the usual abandonment of credit standards in pursuit of market share as various product/markets exhibited strong growth in demand.

Is a return to an era of a Glass-Steagall type of separation of investment and commercial banking possible?

If the current administration and Congress have their way, quite possibly.

Given the quick return to risky trading activities at Chase this past quarter, it's clear that the combination of the two types of banking is going to once again, in time, lead to risk-based profits for shareholders and compensation for employees, while heavy losses will once again tax the FDIC and result in federal rescues.

Just a few days ago, on Tuesday, Columbia finance professor Charles Calomiris authored another flawed editorial in the Wall Street Journal, on the subject of universal banks combining investment and commercial banking. The last one one which I posted, here, was exactly a year ago.

Because Calomiris' piece was so long, and contains a number of fallacies, I'll touch on it in a subsequent post.

But, for me, King and Volcker represent far more objective, reasoned positions on the subject of separating riskier banking activities from those of insured deposit-taking institutions.

Wells Fargo's Mortgage Woes

My friend B predicted this at lunch late this summer.

As we discussed the expected continuing bank loan losses, he mused that Wells had bought a truckload of trouble via Wachovia's purchase of Golden West Financial some years ago.

You may recall that the Golden West acquisition was a material cause of Wachovia's slide into insolvency, leading to Ken Thompson's ouster.

When Wells swooped in to take Wachovia out of the arms of failing Citigroup last year, many thought it to be a clever purchase.

However, Wells' own California-focused mortgage business, coupled with the Golden West loans, is now stressing Well's loan loss reserves. California was certainly among the most over-priced areas in the US during the mortgage finance excesses of the past few yeas, and Well's mortgage portfolio's delinquencies are now reflecting that.

As the unemployment rate continues to remain high and probably go higher, expectations for these delinquencies to not become defaults are low.

And just this morning, the Boston Fed's president expressed his view, on CNBC, that the economy is still very fragile, and interest rates will have to remain low for some time.

This doesn't look like economic recovery to me.

FHA Mortgages: Buckle Your Seatbelts For More Defaults

In yesterday's Wall Street Journal, Nick Timiraos wrote,


"Some 59% of new home buyers are using government-backed loans from the FHA and other agencies, according to a survey of home builders by John Burns Real Estate Consulting, an Irvine, Calif.-based consultancy. The FHA accounts for nearly half of all mortgages, while loans from the Department of Agriculture and the Department of Veterans’ Affairs account for another 10% of all loans for new homes.

The government’s share of the market rises even higher in certain areas. In Northern California, for example, builders said that the government accounted for 76% of all mortgages, while the government share stood at 65% in the Midwest and 62% in South Florida."


Further, FHA mortgages may be had with as little as a 3% downpayment!


Mind you, FHA was originally intended to be the government-backed housing finance program for lower-income Americans. How in the world did it morph into accounting for more than half of new home loans? With the VA coming in for another 10%?

A few days earlier, on last Friday, to be precise, Peter Wallison of the American Enterprise Institute wrote a piece in the Journal entitled, "Barney Frank, Predatory Lender."

Wallison details Frank's push for governmental support of questionable mortgage lending, including requiring the GSEs to make 55% of their mortgage purchases "affordable," meaning lower-quality.

He notes, regarding the presumption that Wall Street firms cavalierly originated and securitized bad mortgages of their own volition,

"There was always a problem with this theory. Mortgage brokers had to be able to sell their mortgages to someone. They could only produce what those above them in the distribution chain wanted to buy. In other words, they could only respond to demand, not create it themselves. Who wanted these dicey loans? The data shows that the principal buyers were insured banks, government sponsored enterprises (GSEs) such as Fannie Mae and Freddie Mac, and the FHA- all government agencies or private companies forced to comply with government mandates about mortgage lending."

Wallison's last sentence is a clear warning about a rerun of the past few years' mortgage mess,

"If the financial crisis was caused by subprime mortgages and predatory lending, the government's own policies made it happen."

Buckle up!

Amazon's Kindle's Coming Competition

Yesterday I wrote a post concerning the coming, unanticipated and unintended consequences of high volumes of high-bandwidth multi-media wireless communications applications.

Along the same lines, the colleague with whom I discussed that topic has led me through the logic behind another coming unanticipated consequence of a recent technological development.

Amazon's Kindle ereader is on its second or third version by now. And other entities are hot on their heels with competing products. It's clearly another opportunity for an iPod and iTunes sort of system competition.

My colleague then observed that, now, about the least-used and simplest of iPhone applications is voice communication. The screen, fonts, and apps on the iPhone are all superior to other multi-media phones and communications appliances. In fact, it appears that Steve Jobs' relentless focus on special fonts for his products is bearing fruit on the current generation of small, hard-to-read screens.

But my colleague noted that, soon, all Apple has to do is put the iPhone on steroids and produce it as a tablet-sized reader.

When that arrives, Amazon's Kindle is toast. It will be a one-app device in a new, multi-app world.

How attractive will a Kindle be in a world in which an iPhone and its competitors, with rich communications applications, including voice, text, video store and messaging, cameras, all contain ereader apps, too?

My colleague showed me how reasonably clear the type and presentation of a current iPhone are. Apparently, the Kindle still has clarity issues. It's weak on actual readability, but alone, for now, in providing electronic access to material.

That is probably going to change in a few years.

Jeff Bezos might well be enjoying the halcyon years of his firm's ereader right now. Because once Apple arrives with a competitive product, I don't think Amazon's core skills will allow it to keep pace with the dominant US consumer technology firm.

Unanticipated Consequences of Wireless Multi-Media

I recently had a long talk with a colleague on the subject of the evolving world of wireless multi-media communications and devices.

Of particular interest to us was the relatively new wireless cellular modem card for use in laptops. Verizon has been advertising its MiFi service and gear relentlessly in past weeks.

Essentially, this device allows a user to take 4-5 users through one cellular router up to a cell system, bypassing an initial wireless step into a conventional WiFi hotspot router and onto the wired internet.

Instead, internet connectivity is totally wireless through the cellular carrier, until it accesses the internet backbone.

Pricing, of course, can quickly reach hefty levels if more than one person is using this in a full-blown multi-media mode. But the capability never the less now exists, practically, for several people located in the middle of nowhere, in terms of wired internet access, to have reasonably high-speed wireless access to the internet.

A recent article in the Wall Street Journal noted iPhones and similar non-Apple devices being used for this sort of multi-media application, consuming huge amounts of wireless capacity. So much, it contended, that two local wireless slingbox users could effectively consume a neighborhood's total wireless bandwidth capacity.

Thus, pricing is probably going to move, rapidly, to a bandwidth-usage basis. After the initial pricing plans incenting large volumes of text messaging for fixed prices, the subsidizing of larger-bandwidth hogging video viewing is finally exhausting existing wireless system capacity.

The logical consequence is to move to usage-based pricing in order to both effectively ration bandwidth usage and fund further capacity increases in existing wireless systems.

Ironically, this might actually overshadow any similar move to wired internet usage pricing, as that begins to look like a comparative backwater.

As I'll mention in an imminent post about coming generations of wireless reader devices, this is just the tip of the iceberg for wireless usage, pricing and capacity issues. It's going to get much more interesting, as the Journal piece noted, for companies like Google.

In fact, the article observed how quickly Apple went from fighting Verizon's possible encroachment on applications on the iPhone to a partnership to make sure iPhones can work on the latter's network. Apple is evidently seeing that getting others to pay for the infrastructure that the iPhone requires is far cheaper than being forced, through a closed system, to pay for one itself. Thus, the article mused that Google, Yahoo and other non-network-owning content providers could soon find themselves in a difficult pricing situation.

They will be using large amounts of bandwidth to serve their customers, but won't own any pipes, and, thus, will be vulnerable to applications-based pricing from their servers.

This could get quite interesting in a hurry, causing some business models to become much less profitable almost overnight.

Jamie Dimon's Chase Increases Risk To Generate Earnings

After the celebrations over JPMorgan Chase's recent revenue and earnings announcements which exceeded "expectations," more sober analysts are noting the increased risks the bank took to generate those results.

On Thursday, the Wall Street Journal's Heard On The Street column called it "J.P. Morgan's Chilling Win."

The article detailed the decline in profitability of the bank's core businesses. Loan volume was down, while loan loss provisions went up, and credit card past-due volumes were up, as well.

According to the Journal, the bank's VAR measure rose as it relied on bond trading for its juiced-up profits.

But, wait!

Isn't excessive risk-taking in trading and non-core banking business precisely what Congress, the administration, regulators and the banks themselves all swore was what caused the recent financial meltdown? That such short-term, excessive risk was to be sworn off by our "too big to fail" financial titans?

Gee, that didn't last long, did it?

Here's a memo- short term fixed income trading isn't a core retail or wholesale commercial bank business. It's what investment banks and brokerages use to boost earnings, but not without accompanying increased risk.

Of course, this country no longer has any large investment banks. They either failed, or begged for commercial bank holding company licenses last year, the better to get access to the Fed borrowing window.

So Chase is basically following Goldman Sachs' lead in relying on risky trading to generate revenue and earnings surprises. Guess how long that's going to last?

So much for anyone having learned from last year's debacle. So much for regulators being serious about oversight and risk management.

Nothing essential has changed about the US financial services sector in the past year, other than a few badly-managed firms were left to fail, while a few others were kept on government-supplied life support.

Nor has anything changed about Jamie Dimon's lack of management skill. Those surprising earnings came courtesy of some fixed income traders and the risk they were allowed to take, not from core lending businesses.

But the Journal is correct. Chase isn't making its money on conventional commercial banking. It's taking extra risks by wagering its proprietary capital at the tables in that little casino we like to call the US fixed income markets.

The BofA Ken Lewis Succession Mess

By now, BofA's board must be lamenting the day its CEO, Ken Lewis, agreed to take federal funding. And agreed to buy Countrywide Financial. And agreed to buy Merrill Lynch. And agreed not to tell shareholders of the bonus payouts to Merrill employees prior to the sale's closing.

Now the administration's "pay czar" is refusing to agree to Lewis' compensation.

Isn't this all enough to prove why it's never a good thing for government to get in bed with private, publicly-held companies?

BofA probably should have just taken its lumps from the Countrywide purchase and soldiered on, rejecting federal "help."

It could have done what it liked with the Merrill purchase, including rescinding it for material changes. It could have paid its employees what it liked, and ignored Treasury's coercive behaviors.

Instead, the board has to scramble to replace its CEO, who is girding for an extended legal battle with the New York State. And has to submit its executive compensation to some nitwit in Washington.

Federal money was the root of all of this trouble for BofA.

They should have just said "no."

Mortgage Market Pablum from Barclay's Michelle Meyer

Another wacky segment which I caught yesterday afternoon featured a woman from Barclays named Michelle Meyer. Apparently she was a rising star at...ah..... Lehman. Now she's chief economist at Barclays Capital, having been absorbed along with some other remnants of Dick Fuld's failed investment bank.

The topic of interest to me was one on which I'm planning another post, as well- a return to poor lending standards and the abrogating of current mortgage contracts.

The various talking heads on the segment were discussing rising delinquencies and, ultimately, the foreclosures which will follow. One CNBC reporter noted the story of a realtor who simply stopped paying her family's home's mortgage because their loan is so deeply underwater. This was some nine months ago, so the story went, and she hasn't been contacted by her bank yet, effectively letting the family live mortgage payment-free in their own home.

As the CNBC on-air anchor introduced the topic of mortgage forgiveness and rewrites, she polled the discussion participants regarding how this treatment of investors will affect subsequent mortgage lending in years to come.

Meyer jumped in and missed the entire point with her comment. Instead, she blurted out something about the price bottom having been reached, so it's upwards from here for the market. Nothing in her comment indicated she understood in the least what the anchor's question implied.

I watched this, and Meyer, with curiosity. Meyer appears to be, at most, in her mid-30s. Most of her mortgage-related experience has thus been in one of the most bizarre, unusual markets of all time. Rates near historic lows, negligible down payments and easily-securitized liar loans, option-rate ARMS and other strange residential finance creatures. All in a surreal market of ultra-low rates.

By contrast, my friend and sometimes business partner, B, is a residential finance veteran of some thirty years. He built at least two mortgage businesses on Wall Street, and has consulted with several others. He and I have discussed how he has supervised and managed teams of twenty-something mortgage business personnel who were stymied when confronting recurring problems B had first seen, and solved, decades ago.

It struck me as disappointing that CNBC has sunk to basically having kids on their segments as experts.

Remember when Mary Meeker and Henry Blodgett were the queen and king of internet business analysis? That didn't end so well, did it? If I remember correctly, I think Blodgett signed a consent decree to refrain from being an analyst anymore.

Lehman wasn't exactly a successful, driving force in investment banking during its last incarnation. Color me sceptical (yes, note the blog's title), but the failed bank wouldn't be a place where I'd expect to find the sector's best economic analysis or talent.

Even Bear Stearns had, in its day, Larry Kudlow and David Malpass. Both economists of much greater depth and with longer experience than Meyer.

To appear on air and assure everyone that, despite mortgage loan covenants being torn up by government programs, future housing finance will be unaffected just seems ludicrous to me.

But that's what Meyer seemed to be saying with her rather irrelevant response to the question concerning how investors will now view the safety of mortgage-backed instruments.

Misplaced Hero Worship: Morgan Stanley's John Mack on CNBC

Yesterday afternoon I happened to catch Bill Griffeth's fawning, softball interview with Morgan Stanley retiring CEO John Mack.

I find myself unable to disguise my total disgust with CNBC's continued glorification of inept CEOs, including sympathizing over how, in this case, Mack struggled to avoid his firm's demise, while carefully avoiding any question over Mack's responsibility was in leading his firm to that brink of disaster.

In his questioning of Mack, all Griffeth could do was look on in reverence as Mack regaled him with tales of seeking Asian funding to avoid being closed down by the feds.

If you look at the nearby price chart of Morgan Stanley, Goldman Sachs and the S&P500 Index for the past five years, you can see that Mack had spent the better part of his tenure since mid-2005 mismanaging the investment bank onto an index-trailing path.

Much ink has been spilled over Mack's mistakes since his return to the firm at which Sears/Discover Card's Phil Purcell outmaneuvered him after the 1997 merger of the two firms.

If I recall correctly, Mack installed poor risk managers, then had the firm go for broke by diving into trading and underwriting mortgage-backed securities. Then held back in the last nine months while risk taking actually began to pay off again.

In contrast, better-led and -managed rival Goldman Sachs was performing far better even before the crisis of last fall.

So, instead of asking Mack questions about how he managed to lead his firm to the brink of insolvency and possible government takeover or enforced sale to a rival, Griffeth painted Mack as some sort of late-hour hero, beset by forces outside his control, desperately fending off Hank Paulson and Tim Geithner as he rescued Morgan Stanley with funding from new outside investors.

It makes me want to throw up when I see such shallow, gullible, misleading reportage. Much like Wall Street Journal veteran Peter Kann noted in an editorial on which I commented in this post, CNBC is rapidly heading down the road that led to the demise of printed newspapers.

Yesterday's interview of John Mack contained several aspects of that demise, e.g., shallow questions from Griffeth and a biased, flattering treatment of the subject, rather than hard-nosed questions that an intelligent, informed viewer would have posed.

Rather than champion capitalism and free markets, this sort of softball journalism at CNBC contributes to the weakening of our economic system. Griffeth breathlessly spoke about how narrowly Mack avoided Morgan Stanley going out of existence.

Guess what? Few financial service companies from thirty years ago are still around and independent. Poorly run investment banks and brokerages, such as Lehman- twice-, First Boston, Kidder Peabody and Salomon Brothers get taken over. Or perish.

Bill Griffeth needs to get a better sense of the reality of financial markets and the life-and-death cycle of those firms engaged in the rough-and-tumble world of securities underwriting and trading.

If a live televised interview on CNBC of the CEO of one of the less-well run investment banks doesn't feature questions about how Mack could have caused such massive, self-induced damage to Morgan Stanley, what will?

Holman Jenkins' Rare Mistake

I finally got around to reading Holman Jenkins' interview with Goldman Sachs CEO Lloyd Blankfein in the weekend edition of the Wall Street Journal. The colleague who urged me to read it was correct- it's primarly a public relations piece by Blankfein to try to smooth over the bank's image prior to news that it will be again paying stratospheric bonuses after being rescued by the Fed and Treasury last fall.

Of course, now, Blankfein will have none of that, as conveyed in the interview. Note, for example, these passages,

"Then there's the matter of AIG, source of snarling recriminations even among Goldman's Wall Street brethren. If AIG, a huge player in all kinds of markets, had gone down, the impact on the economy would have been incalculable. Mr. Paulson and Fed Chief Ben Bernanke wouldn't risk it. They reversed course after Lehman and bailed out the insurance giant to a tune that now has reached $180 billion. To this day, charges fly that the AIG bailout was a backdoor bailout of Goldman.

AIG had been a big issuer of guarantees on subprime-backed paper; Goldman had been a big buyer of those guarantees. Nonetheless, when government officials rang up to ask what would be the potential impact of an AIG bankruptcy on Goldman, Mr. Blankfein says his answer was: "negligible." He did not, he says, ask Washington to save AIG: "It never occurred to me, having lived through Lehman Brothers weekend, that there was government money for anything. People wanted to know how we were going to do when AIG went down. I was telling them we were fine."

Mr. Blankfein points to what he calls a fundamental aspect of Goldman culture—its risk-management discipline. AIG had been regarded on Wall Street as a gold-plated client, not just a "Street" counterparty. But Goldman had nonetheless taken the usual step of requiring AIG to post collateral nightly against any deterioration in the market value of the guaranteed assets.

Mr. Blankfein placed some of the phone calls himself. "AIG was being beastly, difficult to deal with, not responding well to our calls for collateral. And I called them up and fought with them, and it was always because they were disagreeing with our 'marks.' They never said, and I never had reason to suspect, 'We're illiquid. We don't have the money.' It never occurred to me."

Goldman, in its rigor, reinsured any shortfall with other counterparties, who were also required to post collateral nightly. "We had one day of exposure with them. It doesn't mean I can't lose $300 million if they don't pay because that's how much a market can move in a day, but basically I'm not worried about it."

These estimates, of course, have a theoretical element. The underlying assets would certainly have collapsed even further in value if Wall Street firms and AIG began dropping like nine-pins. We'll never know. In the event, AIG was rescued—though that now meant that taxpayer money, in a sense, was being shipped to Goldman to meet AIG's collateral obligations.

Some say today the government should have spurned Goldman's collateral demands. Some say it should even have forced Goldman to settle the outstanding positions at a discount.

Realistically, though, AIG faced hundreds of counterparties; and short of bankruptcy, which Washington had ruled out for AIG, no obvious formula presented itself for rewriting thousands of AIG contracts without risking the market panic Washington was trying to forestall. For its part, Goldman would have been on thin ice with its own shareholders if it had voluntarily relinquished valuable contract rights to make nice with Washington."

There's just one problem with that last paragraph. Mr. Jenkins is wrong.

In an article that appeared in the Wall Street Journal within a few months of the financial sector meltdown of last fall, one astute observer noted that there was, in fact, an existing process by which AIG's numerous counterparties could have been fairly and equally treated.

That option, of course, was bankruptcy. And it's rather curious to me that Jenkins glosses over this with a simple "Washington had ruled (that) out for AIG."

As that editorial writer noted several months ago in the Journal, putting AIG's swaps through bankruptcy, quickly, would have resulted in all counterparties taking a known, equal percentage haircut on the value of their positions. This is no different than learning that the value of your swap declined for some market reason. Swaps gain, and lose value all the time.

The source really is somewhat immaterial.

I'm surprised Jenkins gave Blankfein, Goldman and Washington all passes on this rather monumental corruption of capitalism.

AIG's takeover by the federal government is precisely the sort of unnecessary appropriation of private property, followed by draconian, confusing Congressional and administration rules impositions, that begs for more use of bankruptcy and less entanglement of Washington with private enterprise.

What We Haven't Learned From The Reagan Recovery

Yesterday's Wall Street Journal featured an editorial by economist Judy Shelton entitled "The Message of Dollar Disdain."

Quite by accident, since I had yet to turn to that page, I had a discussion with a business colleague over lunch about the same topic that Shelton mentioned at the end of her piece. I had told my friend about this recent post, based upon another Journal editorial, as well as a cross-post from my political blog featuring two video clips of Steve Wynn on fiscal policy. Both concerned the impact of proposed, costly social programs on a federal debt already bloated by roughly six decades of deficit spending.

Ms. Shelton wrote,

"Sadly, due to our fiscal quagmire, the Federal Reserve may be forced to raise interest rates as a sop to attract foreign capital even if it hurts our domestic economy. Unfortunately, that's the price of having already succumbed to symbiotic fiscal and monetary policy. If we could forge a genuine commitment to private-sector economic growth by reducing taxes, and at the same time significantly cut future spending, it might be possible to turn things around. Under President Reagan in the 1980s, Fed Chairman Paul Volcker slashed inflation and strengthened the dollar by dramatically tightening credit. Though it was a painful process, the economy ultimately boomed."

I mused to my friend about the same scenario. That is, I suggested that, if the long term effect of the weak dollar is, as David Malpass wrote in yet another Journal editorial, a fate much like Britain, the "hollowing out" of the US economy, then the solution is to raise interest rates on US Treasuries. Combined with more prudent fiscal policy, a la Wynn's observation that 'no government spending ever increased its country's standard of living,' in the form of restrained/reduced spending and lower taxes, genuine private economic activity would be resuscitated.

Such a move would, of course, sink various marginal business activity. But it would set off a chain reaction of virtuous consequences.

Banks would cut their lending to more viable projects which would clear hurdle rates of perhaps 3-5%, plus risk premium.

New capital would flow into the US to earn decent rates on fairly low-risk Treasuries.

That capital would flow to new business activity.

Money kept by taxpayers, instead of taken and spent by government, as well as not used to pay interest on higher deficits, would also seek investment returns, resulting in greater available capital for business activity.

As Ms. Shelton points out, this is precisely what occurred under the Reagan-Volcker regime.

The essential starting point is a commitment to the future, rather than the protection of past mistakes. In a word, an economy dedicated to Schumpeterian dynamics.

From this viewpoint, the mid-late Bush and certainly current administration's actions are exactly backwards. Rather than protecting existing, failed investments and propping up their value with taxpayer funds and borrowed capital from abroad, the more robust economic path would have been to let companies like GM, Chrysler, AIG, Goldman Sachs and Citigroup fail.

As Anna Schwartz noted in an interview she gave to the Journal last fall, on which I posted here. In that interview were the following passages,

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

But perhaps this is actually Mr. Bernanke's biggest problem. Today's crisis isn't a replay of the problem in the 1930s, but our central bankers have responded by using the tools they should have used then. They are fighting the last war. The result, she argues, has been failure. "I don't see that they've achieved what they should have been trying to achieve. So my verdict on this present Fed leadership is that they have not really done their job." "

Ms. Schwartz noted that liquidity was never the issue last fall, or even two years ago, when Helicopter Ben began reducing rates in a panic. Rather, she observed, the problem has been guessing which institutions were still actually solvent, as asset values spiraled downwards.

Monetary and fiscal policy which seek to protect past actions of private capital investors, at the expense of future ones, are doomed to stultify and cement an economy in the past.

Ms. Shelton's focus, while slightly different than that of Malpass or Lawrence Kadish, is never the less chilling. Whereas Malpass focused on exchange rate consequences, and Kadish on mounting interest and rates on the national debt, Shelton concentrated her analysis on the companion measure of US debt/GDP. On that measure, she notes, we will have vaulted, on the basis of current government estimates, from 23rd last year to 7th in 2011. The result? Ms. Shelton writes,

"The U.S. is thus slated to enter the ranks of those countries—Zimbabwe, Japan, Lebanon, Singapore, Jamaica, Italy—with the highest government debt-to-GDP ratio (which measures the debt burden against a nation's capacity to generate sufficient wealth to repay its creditors)."

Economic loss brings pain somewhere in an economy. Schumpeter's genius was to identify that this is the natural order of a healthy, growing capitalist economic system. Our policymakers cannot allow themselves to be unduly affected by the plight of those in the rearward areas of economic decay.

Transfer payments for employees of yesterday's now-faded economic titans is one thing. Actually rushing to preserve those enterprises with taxpayer funds is quite another. Or, worse, with borrowed funds from abroad.

When you assemble the views of the recent Journal economics editorialists- Malpass, Kadish and Shelton- you get a truly chilling picture of US monetary and fiscal policy gone mad.

Perhaps for the same reason so few of us seem to recall the economic horrors of the Carter years, for which Reagan's and Volcker's solutions were so effective, few also realize the danger we are in today.

Or that there is a fairly simple, if painful, way out now, as well.

Design As An Essential Business Element

Last Friday's Wall Street Journal's book review section contained a nearly-hidden piece of interest. The book is entitled, "Change By Design," by Tim Brown. Mr. Brown is the CEO of IDEO, a design consultancy.

As early as perhaps four years ago, I began to take a stronger interest in the MFA degree than an MBA. There was, I believe, even an HBR article extolling the value of a Master of Fine Arts degree for its integration of design as an inherent value-adding component of products.

It is very much along this line that Mr. Brown's book is reviewed. Rather than treat product design as an afterthought, it is, with the aid of firms like IDEO, being used in the early stages of concept and product design to add features and functionality.

The review mentions a technique used by IDEO which is a direct implementation of a very old (c1975) marketing concept called Tauber's Problem Inventory Analysis. The consultancy shot video of a mock patient entering an ER facility to identify problems confronting the patient not currently addressed.

Often, breakthrough products and services are identified by this type of analysis where focus groups fail. Perhaps the most famous example of such a difference in approach is that of air travel.

It's a commonly-held tenet that air travel could never have been produced by focus groups, because it was a solution that simply did not yet exist in any form. But, as a problem analysis, the characteristics of air travel as a solution could easily be seen to fit various business problems.

As with many good management practices, the irony and disappointment is that they are the exception, rather than the norm. Otherwise, Mr. Brown wouldn't need to write a book about it, would he?

But, then, it's these type of exceptions that drive some companies to deliver consistently-superior total return performance, while most do not.

Steve Wynn On The Stimulus, Jobs & Tax Policy

I wrote this post on my companion blog today. Because of some of the political overtones and asides in Wynn's remarks, I originally put it in a political context.

But, on reviewing the clips, I think it deserves to be cross-posted here, as well.

Interest Expense of the US National Debt

I read a piece in the Wall Street Journal yesterday by Lawrence Kadish that left me stunned.

Kadish uses CBO and Bureau of the Public Debt figures to sketch out a horrifying scenario.

At the end of last month, the US national indebtedness stood at nearly $12 trillion. Interest expense for this year on that amount will be $383B.

Kadish then uses CBO figures to derive this year's estimated personal income tax payments as around $904B. Dividing the interest expense for this year into personal income taxes, he derives the shocking rate of more roughly 40%.

True, one could use the estimated $2 trillion government receipts for 2009 instead, making the figure a more palatable 19%. But, in reality, taxes are always and ultimately borne by people. Institutions merely collect taxes indirectly for governments.

Kadish goes on to note that the US government has run deficits constantly, except for those few years of the elusive "peace dividend" following the USSR's breakup, for decades. So, predicting to the mean, or prior behavior, it probably will try to do so going forward, as well.

Now, due in part to the recent financial meltdown and global flooding of liquidity by central banks, interest rates on Treasuries are currently around 3%. But in the Carter years, it was as high as 15%.

Now add in OMB's projections of deficits amounting to some $9 trillion over the next decade, meaning a near-doubling.

You can see the awful mathematical conclusion, can't you? If rates move up, as they most certainly will as liquidity is drained globally, and too many dollars require ever-higher rates on US Treasuries, the current nearly $400B interest tab could easily swell by a factor of at least 5- twice for the larger debt level, and 2.5 times for the interest rate effect.

Will US per capita income rise by five-fold in a decade? Unlikely. Unless you mean purely through inflation. Real incomes certainly will not. If the US economy grew at a steady 3.5% each year and it was all due to productivity, meaning the entire gain went to increase personal incomes, they would only grow by about 40%.

Kadish goes on to state,

"Eventually, most of what we spend on Social Security, Medicare, education national defense and much more may have to come from new borrowing, if such funding can be obtained."

The options, Kadish writes, will become default or hyperinflation.

In prior decades, when our debt was widely held by western powers and investors, our appetite for social programs hadn't reached its current level. Longer ago, the US dollar was a prized, stable store of value in the post-WWII era.

Now, the world's major growth economies are no longer friends, e.g., China, Brazil, India. They won't necessarily even do us the favor of lending in dollars. If so, it will be at exorbitant rates.

Kadish's final point is to cite Steve Forbes as saying that the national debt is one issue which will motivate US voters to take action on Washington's profligacy.

I believe that. But on the way there, it's going to get very scary.

Imagine explaining to the average taxpayer that his annual tax liability is nearly half-consumed for just interest on our borrowing to pay for our lush social programs. And we're adding more, by the way.

And that, in a few more years, that figure will be easily more than half. So Washington will continue to try to borrow abroad to pay for promises it is increasingly unlikely to be able to keep to all parties- citizens, investors, and other countries.

Perhaps this is why I'm finding less to write about in the corporate world these days than in the world of Washington-centric business and financial dealings.

Brian Wesbury's Punt In Today's Wall Street Journal

Brian Wesbury wrote an almost schizophrenic economic editorial in today's edition of the Wall Street Journal, entitled "The Economic Recovery Is Well Underway." It's curious to me that he has been absent from the usual venues on which I've either seen or read him for about a year. For example, these posts, here and here, date from August and December of last year.

Wesbury states early in his editorial,

"Many fear a W-shaped economy, otherwise known as a double-dip recession. These fears are overblown. The only double-dip recession of recent decades happened in the early 1980s, when the country was in the grip of "stagflation" and the Federal Reserve ran a roller-coaster monetary policy."

I won't go into all the details Wesbury presents, but simply note his high points. First, he notes that the equity market's recovery dates from about the point at which 'mark to market' valuation was suspended/modified, thus setting a floor under many financial instrument and, by extension, financial entity valuations.

He argues that housing, manufacturing, consumer spending, imports and exports are all of their recession lows. Yes, he writes, even consumer spending, excluding automobiles, is up at a 3.9% annual rate. Wesbury converts all of the quarterly or less rates into annualized rates, so the numbers are pretty compelling, if only on that basis.

On the job losses front, Wesbury cites conventional wisdom that jobs data are always lagging recessionary indicators, but he takes heart that the monthly losses have declined from the 700,000 range early in the year to just below 200,000 recently.

As others have claimed, Wesbury, too, now believes that inventory rebuilding will bring about private sector economic growth and job creation.

So far, Wesbury has kept to conventional economic data and indicators, and on these bases, he's now an optimist. It seems odd to me that he is now completely silent on the hyper-inflation which so consumed him only last December. In fact, the editorial notes, after attributing the piece to Wesbury, that he will soon have a book published entitled "It's Not as Bad as You Think: Why Capitalism Trumps Fear and the Economy Will Thrive."

Perhaps the book has consumed Wesbury's time and efforts for most of the past twelve months.

However, he then turns schizophrenic in the editorial, writing,

"The two factors that could undermine growth in the long run are bad government policy combined with global competition."

He then cites something I mentioned to a colleague recently, i.e., most of the S&P500 have significant sales and operations outside the US. Just because their revenues and profits might benefit from global growth doesn't mean jobs will be created in the US. Wesbury then goes on to note the rise in the minimum wage, a possible temporary job creation tax credit, and probable higher tax rates as bad for the US economic recovery.

He concludes his piece with this passage,

"There is no free lunch. If you take a look at the U.S. economy since 1960, the larger the government share of GDP, the higher the unemployment rate. In other words, when it comes to jobs, government spending has a multiplier of less than one- government spending destroys jobs.

Whether or not this recovery continues depends on the course of government policy. If the U.S. passes a costly bill to nationalize the health-care system, a new tax system to reduce carbon emissions, and higher marginal income tax rates, a European sclerosis will settle in with permanently higher unemployment rates. This will not happen because capitalism failed, but because government gave up on it prematurely."

I am left feeling that Wesbury is trying to have it both ways. He forecasts a recovery on existing economic data, but clearly hedges by citing pending administration and Congressional plans to do all the things about which he warns in his last paragraph. I understand why he does this, and he is attempting to convey what he sees now.

That is, an economy that could be recovering, albeit slowly from a fairly deep drop in economic activity. Combined with federal fiscal policies that could cripple the once-vibrant US economy.

It's hardly a prescription for confidence in either fundamental economic performance or the equity markets for the next few months.