A few days ago, on CNBC, guest Steve Crawford, late of Morgan Stanley, advanced the notion that current Senate regulatory efforts to shove risky trading out of regulated banks and into a "shadow banking system" won't keep the federal government from bailing out that sector, too.
This seemed to be an unsubstantiated claim.
Crawford didn't name names, but alleged that "shadow banks" had already been bailed out in the recent crisis, so there was no real discrimination, new legislation, or not.
I wonder which companies he considered to be shadow banks which were saved?
To me, any publicly-held, private sector entity which has material regulation of some sort is not a "shadow bank."
For example, I'd say that hedge funds and private equity groups are "shadow banks." Private equity lends, does leveraged buyouts and, at the upper end, can engage in significant proprietary trading.
Hedge funds clearly meet the trading units of heavily-regulated banks in the marketplace. But the hedge funds enjoy notoriously lighter regulatory burdens than their publicly-held competitors.
I'm not aware of any private equity or hedge fund groups being rescued in late 2008, are you? In fact, a few hedge funds went under, though I can't recall specific names. Other than LTCM, in 1998, no hedge fund, to my knowledge, has been the subject of a coordinated, government-led action to preserve markets.
Even in the case of LTCM, the firm wasn't saved. Rather, there was concern for counterparty losses due to the lack of bids for assets held by the firm, causing financial markets to crater as a by-product.
Counterparties and other large institutions contributed to the orderly unwinding of LTCM positions, but the firm's owners lost everything.
So I confess to not really understanding why Crawford is so worried about shadow banks. Existing hedge funds and private equity firms would pose risks due to unwise levels of leverage. But surely their lenders are capable of judging for themselves what those balance sheets can handle. At least better than an army of civil servants who have yet to forestall a financial crisis due to their exercise of their lawful supervisory powers.
Thursday, May 20, 2010
Wednesday, May 19, 2010
Doug Dachille on CNBC This Morning
I caught a fair amount of Doug Dachille's appearance for, I think, an hour this morning on CNBC.
As always, his comments were lucid, powerful and candid.
Dachille crystallized something which has always bothered me about the creation of the Euro.
In effect, Dachille, more clearly than anyone else whom I've heard on the subject, noted that the EU chose to create a currency, but no centralized taxing authority. Thus, unlike the US, the countries share a currency, and some loose federation policies, but have no effective means to back the Euro as a currency.
It really brings to mind something I said just yesterday to a colleague about Alexander Hamilton. Our first Treasury Secretary was truly brilliant. He had the federal government assume the debts of the states and created the dollar, thus seamlessly unifying the nation fiscally and monetarily.
Pity the Eurozone. As Dachille so succinctly put it, they can't take unified measures to support the Euro because there is no federal taxing power. Everything has to be a country-by-country vote to fund actions in support of their shared currency.
This addresses what I had misgivings about so many years ago, i.e., that the Euro countries weren't sufficiently unified in both fiscal and monetary policies. As such, at some point, their lack of federal authority to coordinate the monetary and fiscal aspects of the Euro would come back to bite them. In effect, Germany, with the most stable currency and strongest economy of the EU, had not ceded its fiscal authority to the EU.
You might not be able to clearly define how the monetary and fiscal aspects of a nation's currency interact, but you know it's an important phenomenon. In the Eurozone, it's now clear they just don't have that linkage in a manner that global investors trust or believe.
As always, his comments were lucid, powerful and candid.
Dachille crystallized something which has always bothered me about the creation of the Euro.
In effect, Dachille, more clearly than anyone else whom I've heard on the subject, noted that the EU chose to create a currency, but no centralized taxing authority. Thus, unlike the US, the countries share a currency, and some loose federation policies, but have no effective means to back the Euro as a currency.
It really brings to mind something I said just yesterday to a colleague about Alexander Hamilton. Our first Treasury Secretary was truly brilliant. He had the federal government assume the debts of the states and created the dollar, thus seamlessly unifying the nation fiscally and monetarily.
Pity the Eurozone. As Dachille so succinctly put it, they can't take unified measures to support the Euro because there is no federal taxing power. Everything has to be a country-by-country vote to fund actions in support of their shared currency.
This addresses what I had misgivings about so many years ago, i.e., that the Euro countries weren't sufficiently unified in both fiscal and monetary policies. As such, at some point, their lack of federal authority to coordinate the monetary and fiscal aspects of the Euro would come back to bite them. In effect, Germany, with the most stable currency and strongest economy of the EU, had not ceded its fiscal authority to the EU.
You might not be able to clearly define how the monetary and fiscal aspects of a nation's currency interact, but you know it's an important phenomenon. In the Eurozone, it's now clear they just don't have that linkage in a manner that global investors trust or believe.
Taxes & GDP
David Ranson, the head of research for H.C. Wainright & Co. Economics, wrote in Monday's Wall Street Journal on the relationship between US GDP and tax revenues.
The graph from his article appears nearby. It shows real US tax receipts (Y axis) plotted against US GDP (X axis), with the dotted red line representing Y-values equal to 20% of the X-values at each point.Ranson observes, in his editorial,
"The feds assume a relationship between the economy and tax revenue that is divorced from reality. Six decades of history have established one far-reaching fact that needs to be built into fiscal calculations: Increases in federal tax rates, particularly if targeted at the higher brackets, produce no additional revenue. For politicians this is truly an inconvenient truth.
The nearby chart shows how tax revenue has grown over the past eight decades along with the size of the economy. It illustrates the empirical relationship first introduced on this page 20 years ago by the Hoover Institution's W. Kurt Hauser—a close proportionality between revenue and GDP since World War II, despite big changes in marginal tax rates in both directions. "Hauser's Law," as I call this formula, reveals a kind of capacity ceiling for federal tax receipts at about 19% of GDP."
I confess to being completely surprised at the incredible consistency of this chart. There aren't the kind of significant swings above and below a regressed curve fitted through the actual data.
Rather, it's clear, assuming Ranson's numbers, as sources in his chart footer, are correct, that this relationship is very tight and dependable.
Why is this so? Ranson opines,
"What's the origin of this limit beyond which it is impossible to extract any more revenue from tax payers? The tax base is not something that the government can kick around at will. It represents a living economic system that makes its own collective choices. In a tax code of 70,000 pages there are innumerable ways for high-income earners to seek out and use ambiguities and loopholes. The more they are incentivized to make an effort to game the system, the less the federal government will get to collect. That would explain why, as Mr. Hauser has shown, conventional methods of forecasting tax receipts from increases in future tax rates are prone to over-predict revenue."
You can guess what the contemporary application of Ranson's version of "Hauser's Law" would be. Ranson considers current federal tax revenue and GDP projections,
"In this form, Hauser's Law provides a simple basis for testing the validity of any government's revenue projections. Today, since the economy already suffers from a large output gap that is expected to take many years to close, 18.3% must be a realistic upper limit on the ratio of budget revenues to GDP for years to come. Any major tax increase will reduce GDP and therefore revenues too.
But CBO projections based on the current budget show this ratio reaching 18.3% as early as 2013 and rising to 19.6% in 2020. Such numbers implicitly assume that the U.S. labor market will get back to sustainable "full employment" by 2013 and that GDP will exceed its potential thereafter. Not likely. When the projections are tempered by the constraints of Hauser's Law, it's clear that deficit spending will grow faster than the official estimates show."
What provides me with some odd comfort is that, no matter how heavily the government taxes us, jointly, we only pay up to about 18-19% of GDP. Thus, recent deficit-financed spending is not going to be repaid out of near-term taxes which rise precipitously.
Rather, it's pretty clear that the only way it will be repaid is through economic growth. And that's going to take a much different economic climate than our current federal government seems to be capable of delivering.
Another Perspective on Financial "Reform"
Harvey Pitt, the one-time SEC chairman, wrote an editorial in Monday's Wall Street Journal discussing how the ability to learn, or not learn, from history, informs the deeply-flawed Dodd bill.
Thought Pitt was never my favorite SEC chief, his recent article reminds us of some inconvenient facts.
For example, he notes that the S&L crisis of the late 1980s didn't feature any one or few large institutions. Never the less, it required Bill Siedman to create the RTC and took many years and billions of dollars to process and ultimately dispose of foreclosed properties.
Another point Pitt makes is that, once again, Congress seeks to add to layers of existing regulatory authority. This has been the trend since, well, anyone can recall. It seems no agency is ever destroyed. At worst, it morphs into something else. Rather like the principle of conservation of energy.
When is the last time you remember an entire federal agency and its workers being simply eliminated?
No, instead we'll get more oversight boards and agencies with more civil servants in lifetime jobs. Does this sound like the crew that will catch the next explicit, deliberate financial excess perpetrated by groups of very bright financial executives with masters degrees in finance and associated quantitative disciplines?
Congress' own FCIC hasn't even finished its job yet, and both Congress and the administration are pushing for immediate passage of a 1,400 page bill.
Where is the sense in that?
Finally, Pitt sagely observes that, almost certainly in any case, and certainly in this case, whatever legislation is rushed through Congress and signed into law will "assure that we will experience anew the law of unintended consequences."
To me, this last is perhaps the most troubling element of the current rush to over- and re-regulated the financial sector.
For once, could someone just assemble a practically-sized group of reasonably-objective experts, sift through the last 50 years of financial disasters, and consider what type of regulatory bodies and rules would have effectively and efficiently minimized said crisis?
Certainly, one aspect involves credit and leverage standards. The S&L's came to ruin from mismatching durations of liabilities and assets. So, for that matter, did Bear Stearns and Lehman. And, very nearly, Goldman Sachs and Morgan Stanley.
On the exchange front, regulatory authorities have allowed, for some time, the NYSE and the NASDAQ to run under vastly different rules concerning circuit-breakers at the level of individual equities. Promises or expectations of liquidity vanish when they are most wanted, triggering sudden elevator-rides down in equity prices.
We know this happens. Do we want to prevent it, or simply make everyone aware of its possibility? Because, right now, we do neither.
Harvey Pitt did a good job exposing several important truths which currently-proposed regulations do not fix.
I regret to conclude that, as usual, we'll end up with more, more expensive, cumbersome and unwieldy regulatory authorities and processes, but no greater protection from the financial excesses which we deem unacceptable.
Thought Pitt was never my favorite SEC chief, his recent article reminds us of some inconvenient facts.
For example, he notes that the S&L crisis of the late 1980s didn't feature any one or few large institutions. Never the less, it required Bill Siedman to create the RTC and took many years and billions of dollars to process and ultimately dispose of foreclosed properties.
Another point Pitt makes is that, once again, Congress seeks to add to layers of existing regulatory authority. This has been the trend since, well, anyone can recall. It seems no agency is ever destroyed. At worst, it morphs into something else. Rather like the principle of conservation of energy.
When is the last time you remember an entire federal agency and its workers being simply eliminated?
No, instead we'll get more oversight boards and agencies with more civil servants in lifetime jobs. Does this sound like the crew that will catch the next explicit, deliberate financial excess perpetrated by groups of very bright financial executives with masters degrees in finance and associated quantitative disciplines?
Congress' own FCIC hasn't even finished its job yet, and both Congress and the administration are pushing for immediate passage of a 1,400 page bill.
Where is the sense in that?
Finally, Pitt sagely observes that, almost certainly in any case, and certainly in this case, whatever legislation is rushed through Congress and signed into law will "assure that we will experience anew the law of unintended consequences."
To me, this last is perhaps the most troubling element of the current rush to over- and re-regulated the financial sector.
For once, could someone just assemble a practically-sized group of reasonably-objective experts, sift through the last 50 years of financial disasters, and consider what type of regulatory bodies and rules would have effectively and efficiently minimized said crisis?
Certainly, one aspect involves credit and leverage standards. The S&L's came to ruin from mismatching durations of liabilities and assets. So, for that matter, did Bear Stearns and Lehman. And, very nearly, Goldman Sachs and Morgan Stanley.
On the exchange front, regulatory authorities have allowed, for some time, the NYSE and the NASDAQ to run under vastly different rules concerning circuit-breakers at the level of individual equities. Promises or expectations of liquidity vanish when they are most wanted, triggering sudden elevator-rides down in equity prices.
We know this happens. Do we want to prevent it, or simply make everyone aware of its possibility? Because, right now, we do neither.
Harvey Pitt did a good job exposing several important truths which currently-proposed regulations do not fix.
I regret to conclude that, as usual, we'll end up with more, more expensive, cumbersome and unwieldy regulatory authorities and processes, but no greater protection from the financial excesses which we deem unacceptable.
Tuesday, May 18, 2010
Meredith Whitney On Financial "Reform," Small Businesses & State&Local Governments
Meredith Whitney wrote a simple, elegant editorial yesterday in the Wall Street Journal entitled The Small Business Credit Crunch.
In it, she drew a fairly short, straight line from the current Senate financial sector regulation bill to higher-cost or even unavailable consumer credit for use by small businesses. Added to that, Whitney noted how lower housing values have wiped out their use as a traditional small business financing source.
Thus, in her opinion, small business-based job creation, a traditional source of US economic expansion, will be crippled, as the small businesses face financing difficulties, as and should they desire to expand or be created.
To this already dark picture, Whitney added her prior views on municipal and state government budget shortfalls and, eventually, job cuts.
Whitney and former Merrill economist David Rosenberg each shared these views last winter on CNBC, from which I wrote the two linked posts.
Now, it seems that at least Whitney sees evidence of her predictions coming true and having meaningful consequences.
The punchline of her article is that the government job cuts will result in up to two million newly-unemployed at a time when Congressional legislative action will help dampen small business formation and/or growth.
Whitney believes it unlikely that large US businesses will turn around and hire nearly the same number of workers- three million- they just got finished laying off in the past three years.
Missing from the picture will be small businesses growing to take up the five million jobs they have cut in the recent recession.
Putting the pieces of the picture together, Whitney sees continuing jobless 'recovery,' with large businesses continuing to enjoy jobless productivity gains, small businesses crippled by consumer credit contraction, while municipal and state governments finally shed workers larded on in earlier expansions.
Hardly cause for optimism for a robust, high-employment recovery, is it?
In it, she drew a fairly short, straight line from the current Senate financial sector regulation bill to higher-cost or even unavailable consumer credit for use by small businesses. Added to that, Whitney noted how lower housing values have wiped out their use as a traditional small business financing source.
Thus, in her opinion, small business-based job creation, a traditional source of US economic expansion, will be crippled, as the small businesses face financing difficulties, as and should they desire to expand or be created.
To this already dark picture, Whitney added her prior views on municipal and state government budget shortfalls and, eventually, job cuts.
Whitney and former Merrill economist David Rosenberg each shared these views last winter on CNBC, from which I wrote the two linked posts.
Now, it seems that at least Whitney sees evidence of her predictions coming true and having meaningful consequences.
The punchline of her article is that the government job cuts will result in up to two million newly-unemployed at a time when Congressional legislative action will help dampen small business formation and/or growth.
Whitney believes it unlikely that large US businesses will turn around and hire nearly the same number of workers- three million- they just got finished laying off in the past three years.
Missing from the picture will be small businesses growing to take up the five million jobs they have cut in the recent recession.
Putting the pieces of the picture together, Whitney sees continuing jobless 'recovery,' with large businesses continuing to enjoy jobless productivity gains, small businesses crippled by consumer credit contraction, while municipal and state governments finally shed workers larded on in earlier expansions.
Hardly cause for optimism for a robust, high-employment recovery, is it?
Monday, May 17, 2010
The Ratings Agencies' Turn "In The Barrell"
With Moody's being assailed for misleading statements in a regulatory filing, and two opposing amendments to a Senate financial 'reform' bill dealing with the rating agencies, it looks like Moodys, Fitch and S&P are finally getting their turn for scrutiny from the fallout of the mortgage-backed securities-induced financial sector meltdown.
One of the amendments to Dodd's disastrous regulatory "reform" bill would strip the rating agencies of their special, government-designated status. Another amendment, by comedian, now Senator Al Franken, would wrap even more red tape around the ratings agencies, cocooning them under yet another special oversight board.
Guess Franken hasn't left the comedy field just yet.
Paradoxically, both amendments have passed votes to attach them to the Senate bill.
If you have much exposure to the financial sector, then you probably will be rooting for the 'less is more' approach that removes the agencies from any federal imprimatur of credibility. S&P, for the record, backs this step.
Back in the days of little information and poor communications, ratings agencies provided low-cost, widely-disseminated creditworthiness judgements when most investors lacked the resources to undertake their own due diligence.
That's no longer the case. The ratings agencies enjoy monopolies from a long-ago era, much like the airlines before Alfred Kahn liberated them from their anti-competitive industry structure.
It's high time institutional investors quit hiding behind the rating agencies, yet also taking money for allegedly making hard choices concerning investment instruments.
It's not clear there's even a role for the agencies anymore. If so, it's probably not going to be rating instruments for pay from the originators.
Something else will have to replace that now-tainted model.
It's long overdue.
One of the amendments to Dodd's disastrous regulatory "reform" bill would strip the rating agencies of their special, government-designated status. Another amendment, by comedian, now Senator Al Franken, would wrap even more red tape around the ratings agencies, cocooning them under yet another special oversight board.
Guess Franken hasn't left the comedy field just yet.
Paradoxically, both amendments have passed votes to attach them to the Senate bill.
If you have much exposure to the financial sector, then you probably will be rooting for the 'less is more' approach that removes the agencies from any federal imprimatur of credibility. S&P, for the record, backs this step.
Back in the days of little information and poor communications, ratings agencies provided low-cost, widely-disseminated creditworthiness judgements when most investors lacked the resources to undertake their own due diligence.
That's no longer the case. The ratings agencies enjoy monopolies from a long-ago era, much like the airlines before Alfred Kahn liberated them from their anti-competitive industry structure.
It's high time institutional investors quit hiding behind the rating agencies, yet also taking money for allegedly making hard choices concerning investment instruments.
It's not clear there's even a role for the agencies anymore. If so, it's probably not going to be rating instruments for pay from the originators.
Something else will have to replace that now-tainted model.
It's long overdue.
Wealth In China
I read the details of a story in the Wall Street Journal concerning the murder of many young school children in the small provincial town of Lincheng.
The story is heartbreaking. An embittered man who had leased a building for the local school was angry at not being able to recover use of the house. In spite, he attacked the children and school teacher, hacking them to death, then killed himself.
What struck me, however, was the Journal piece's description of the town as "one of the poorer villages in China."
I can't locate the article, published last Thursday, in the Journal's online site. But it seems, at least to me, to belie the notion of what now constitutes the one of the poorer villages in China.
Centered in the image accompanying the article is a decently-dressed woman chatting on a cellphone. To the right, in the back of the photo, sits a man in a dark blazer, well-coiffed, in a collared shirt and loafers, his face grim. Next to him is a casually dressed woman, her face buried in her hand, in a tasteful, slim pair of jeans and dark top with metal buttons.
Other grieving parents, all waiting in a hospital or medical clinic, are surprisingly well-dressed, -groomed and modern-looking.
They'd put the people in the poorer sections of New York City or Chicago to shame.
I guess economic welfare in China is truly widespread and rising.
The story is heartbreaking. An embittered man who had leased a building for the local school was angry at not being able to recover use of the house. In spite, he attacked the children and school teacher, hacking them to death, then killed himself.
What struck me, however, was the Journal piece's description of the town as "one of the poorer villages in China."
I can't locate the article, published last Thursday, in the Journal's online site. But it seems, at least to me, to belie the notion of what now constitutes the one of the poorer villages in China.
Centered in the image accompanying the article is a decently-dressed woman chatting on a cellphone. To the right, in the back of the photo, sits a man in a dark blazer, well-coiffed, in a collared shirt and loafers, his face grim. Next to him is a casually dressed woman, her face buried in her hand, in a tasteful, slim pair of jeans and dark top with metal buttons.
Other grieving parents, all waiting in a hospital or medical clinic, are surprisingly well-dressed, -groomed and modern-looking.
They'd put the people in the poorer sections of New York City or Chicago to shame.
I guess economic welfare in China is truly widespread and rising.
Friday, May 14, 2010
Congress Plans To Ration Consumer Credit
This morning and afternoon, CNBC has had fairly extensive coverage of the new and expanded consumer finance regulations making their way through the Senate and headed for the House.
Among other features, the bill cuts debit card usage fees. The general effects of the bill are for Congress to exercise price controls over consumer credit providers. This will, of course, result in the rationing of credit to consumers.
Imagine lower-income consumers finally getting to the point of affording credit or debit cards, only to discover that they are no longer available to them, on prior terms, due to increased costs of regulation.
Yesterday's Wall Street Journal carried an editorial co-authored by Cliff Asness, founder of hedge fund AQR. His piece called attention to the very many vague and unspecified instances of language in the horribly-written Dodd financial 'reform' bill. Language making it unclear what is illegal and how penalties will be assessed.
Bill Isaacs, the former FDIC head, was on CNBC expressing his hope that more insane and unworkable concepts get added to the bill, thus making it completely incapable of being passed during this session of Congress.
Between the badly-written, so-called 'reforms,' public and legal attacks on investment banks, and, now, new attempts to curtail, proscribe and limit profitability of consumer lending, the recent federal government actions aimed at the financial sector point to less available capital or credit, higher costs of capital, and the effective rationing of credit and capital on non-price bases.
None of which are good things for our nation or its future economic growth.
Among other features, the bill cuts debit card usage fees. The general effects of the bill are for Congress to exercise price controls over consumer credit providers. This will, of course, result in the rationing of credit to consumers.
Imagine lower-income consumers finally getting to the point of affording credit or debit cards, only to discover that they are no longer available to them, on prior terms, due to increased costs of regulation.
Yesterday's Wall Street Journal carried an editorial co-authored by Cliff Asness, founder of hedge fund AQR. His piece called attention to the very many vague and unspecified instances of language in the horribly-written Dodd financial 'reform' bill. Language making it unclear what is illegal and how penalties will be assessed.
Bill Isaacs, the former FDIC head, was on CNBC expressing his hope that more insane and unworkable concepts get added to the bill, thus making it completely incapable of being passed during this session of Congress.
Between the badly-written, so-called 'reforms,' public and legal attacks on investment banks, and, now, new attempts to curtail, proscribe and limit profitability of consumer lending, the recent federal government actions aimed at the financial sector point to less available capital or credit, higher costs of capital, and the effective rationing of credit and capital on non-price bases.
None of which are good things for our nation or its future economic growth.
Starbucks Expands Its "Fighting Brand"- Seattle's Best Coffee
Wednesday's Wall Street Journal called attention to Starbucks' plans to push its lower-priced brand, Seattle's Best Coffee, through various distribution channels. The wholly-owned unit, once a Starbucks competitor, is now headed by Michelle Gass, the parent's CEO's one-time strategy aide.
Essentially, rather than repeat its mistake of the past few years by taking the Starbucks brand down-market, causing temporary sales growth but diluting the brand's image, the company is tapping its lower-priced coffee brand to implement this strategy.
One pundit likens it to the Gap's Old Navy brand, but I'm not so sure that comparison works. After all, style, quality of material and price all serve to differentiate Old Navy, while, in the end, moderate-priced coffee is moderate-priced coffee.
Seattle's Best is to be marketed through franchisees, sales of beans in grocers, and the like. I suppose that, if done successfully, this Starbucks division can earn a respectable return. Perhaps, at first, it will add some growth to the parent's income statement and total return through raw revenue growth.
But, over time, what's the likelihood that a middle-market coffee roaster, competing with Dunkin' Donuts and McDonalds, will somehow break out in the segment and prove to dominate a segment known more for its very lack of distinguished flavor?
More than anything, isn't the plan to push growth at Seattle's Best Coffee an implicit admission by Howard Schultz that the Starbucks brand isn't as capable of delivering profitable growth which will enhance shareholder value and consistent total returns in the near future? That the main Starbucks brand is essentially devoid of significant opportunities for growth, having saturated its markets in recent years?
Essentially, rather than repeat its mistake of the past few years by taking the Starbucks brand down-market, causing temporary sales growth but diluting the brand's image, the company is tapping its lower-priced coffee brand to implement this strategy.
One pundit likens it to the Gap's Old Navy brand, but I'm not so sure that comparison works. After all, style, quality of material and price all serve to differentiate Old Navy, while, in the end, moderate-priced coffee is moderate-priced coffee.
Seattle's Best is to be marketed through franchisees, sales of beans in grocers, and the like. I suppose that, if done successfully, this Starbucks division can earn a respectable return. Perhaps, at first, it will add some growth to the parent's income statement and total return through raw revenue growth.
But, over time, what's the likelihood that a middle-market coffee roaster, competing with Dunkin' Donuts and McDonalds, will somehow break out in the segment and prove to dominate a segment known more for its very lack of distinguished flavor?
More than anything, isn't the plan to push growth at Seattle's Best Coffee an implicit admission by Howard Schultz that the Starbucks brand isn't as capable of delivering profitable growth which will enhance shareholder value and consistent total returns in the near future? That the main Starbucks brand is essentially devoid of significant opportunities for growth, having saturated its markets in recent years?
Thursday, May 13, 2010
GM Wants A New Captive Finance Unit
The headline in yesterday's Wall Street Journal, "GM Looks At Return To Auto Lending," caught me completely off guard when I saw it.
Is Ed Whitacre nuts?
The lead paragraph in the Journal article stated,
"General Motors Co. is weighing an attempt to buy back its old auto-lending arm or start a new finance company in a bid to become more competitive and bolster the company's appeal ahead of an initial public stock offering...."
This is surely among the more wrong-headed, disastrous moves I've read regarding the failed auto maker.
If the 'core competence' notion has any value, this is one stupendously dumb idea. GM has shown over several decades that it couldn't even build attractive, competitively priced gasoline-engine cars.
Its financing arm, GMAC, eventually grew to be its own entity, pursuing profitability through....sigh.....residential finance. Where it went fabulously wrong and lost billions.
True, an equally-naive Cerberus bought into the unit before the implosion. But my point is that finance is, or should be, a related but non-core function for making and selling vehicles.
The temptation has been, in past decades, for US auto makers to cut price through finance terms, making their financing arms the repository of losses while their vehicle operations look healthier.
Granted, the Journal piece went on to note,
"GMAC, which recently renamed itself Ally Financial, made $653 million on its North American automotive operations in 2010's first quarter."
Of course, operational profit on auto lending may, and probably does not address the balance sheet risks for Ally of holding, selling or hedging its portfolio of auto loans.
Like any financial institution which has borrowed in the credit markets, is highly leveraged, and makes loans, Ally and, thus, GM, when it either repurchases part of Ally or starts its own new finance unit, has to manage asset/liability risks.
How is Ally doing on that score right now? If GM owned Ally, and continued its infamous 0% rate financing programs, to which it has seemed to always turn when tempted by slow sales or share erosion, how would it manage borrowing money at positive interest rates and lending it at lower ones?
Sounds to me like yet another recipe for disaster at GM.
My proprietary research has shown that financial services firms which concentrate on just one, or a few businesses, tend to have higher, more consistent total returns over time. Broadening a firm's business mix, especially when the businesses don't share many fundamental functions, tends to overtax management and promote the lack of attention to the core businesses.
In GM's case, the only link between the two businesses is that the finance arm would be making loans whose collateral was the cars GM made and sold. Aside from that, the real question is whether auto financing, as a standalone business, can generate long term superior returns relative to GM's auto making business.
If so, shouldn't any US investor, who, by definition, as a taxpayer, is already long GM, have the option of buying equity in the finance company that services GM, rather than be forced to own that, too?
Is Ed Whitacre nuts?
The lead paragraph in the Journal article stated,
"General Motors Co. is weighing an attempt to buy back its old auto-lending arm or start a new finance company in a bid to become more competitive and bolster the company's appeal ahead of an initial public stock offering...."
This is surely among the more wrong-headed, disastrous moves I've read regarding the failed auto maker.
If the 'core competence' notion has any value, this is one stupendously dumb idea. GM has shown over several decades that it couldn't even build attractive, competitively priced gasoline-engine cars.
Its financing arm, GMAC, eventually grew to be its own entity, pursuing profitability through....sigh.....residential finance. Where it went fabulously wrong and lost billions.
True, an equally-naive Cerberus bought into the unit before the implosion. But my point is that finance is, or should be, a related but non-core function for making and selling vehicles.
The temptation has been, in past decades, for US auto makers to cut price through finance terms, making their financing arms the repository of losses while their vehicle operations look healthier.
Granted, the Journal piece went on to note,
"GMAC, which recently renamed itself Ally Financial, made $653 million on its North American automotive operations in 2010's first quarter."
Of course, operational profit on auto lending may, and probably does not address the balance sheet risks for Ally of holding, selling or hedging its portfolio of auto loans.
Like any financial institution which has borrowed in the credit markets, is highly leveraged, and makes loans, Ally and, thus, GM, when it either repurchases part of Ally or starts its own new finance unit, has to manage asset/liability risks.
How is Ally doing on that score right now? If GM owned Ally, and continued its infamous 0% rate financing programs, to which it has seemed to always turn when tempted by slow sales or share erosion, how would it manage borrowing money at positive interest rates and lending it at lower ones?
Sounds to me like yet another recipe for disaster at GM.
My proprietary research has shown that financial services firms which concentrate on just one, or a few businesses, tend to have higher, more consistent total returns over time. Broadening a firm's business mix, especially when the businesses don't share many fundamental functions, tends to overtax management and promote the lack of attention to the core businesses.
In GM's case, the only link between the two businesses is that the finance arm would be making loans whose collateral was the cars GM made and sold. Aside from that, the real question is whether auto financing, as a standalone business, can generate long term superior returns relative to GM's auto making business.
If so, shouldn't any US investor, who, by definition, as a taxpayer, is already long GM, have the option of buying equity in the finance company that services GM, rather than be forced to own that, too?
TARP Oversight Chief Scold Elizabeth Warren Whines On CNBC This Morning
It was my unfortunate fate to sit through more whining this morning from the head of the Congressional panel looking into the financial crisis, Elizabeth Warren, on CNBC.
Every time I hear this woman talk, my sense that there is nothing she says that is new is reinforced. As well as my sense of how much she doesn't understand about the financial sector.
She began her typical rant by excoriating large US banks for not lending out the TARP money they had been "given." Never mind much has been repaid.
Warren then added the usual pundit's rant about small businesses. Small businesses, she insisted, were being hurt at the expense of larger businesses by the failure of those big, bad banks to lend to the bedrock of the US economy....blah blah blah....small businesses.
Several other guests on the CNBC set countered Warren on two issues. Bob Barbera, chief economist at ITG, noted that small businesses had been disproportionately hurt by the drop in real estate values and, thus, were in no position to borrow any more money. Another guest, perhaps Rich Bernstein, a former Merrill Lynch senior strategist, noted that there wasn't really any real loan demand by small business, just based on economic conditions of late 2008 through late 2009. Further, they were absolutely not hiring anyone.
Nobody on the panel offered another key piece of evidence, i.e., at Fed-induced ultra-low interest rates, how could any bank possibly justify, in hindsight, throwing money given them by the Treasury into risky, low-rate loans to small businesses?
If those banks charged appropriate, higher rates, they would no doubt by garroted by Warren at a later date for daring to profit unfairly on the gift of Federal largess. If they lost money on low-interest loans, they'd be lectured for more foolish lending, just like their original real estate finance excesses.
Warren would have none of the panel's contrary views, insisting she was correct.
Then someone asked if the FCIC was investigating the potential for securitizing small business loans.
I have to say, at this point, I nearly spit out my coffee from shock. What the hell is anyone doing wanting securitization of small business loans when we still are cleaning up the mess from subprime and Alt-A home loans and their securitized offspring?
Warren charged ahead, though, informing everyone that, gosh, small businesses are very unique and require a different kind of lending than simply marking up prime and opening a credit facility for, say, Boeing or Cisco. Only she didn't say it that elegantly. So they are difficult to package up and sell in securities.
Liz Warren is 61 years old, born in 1949, according to her bio. So in 1974-75, when, as a freshmant at Saint Louis University, I was learning the basics of corporate finance in Dr. Fred Yeager's Introduction to Finance 100 course, Warren would have, I guess, been in law school, or already practicing.
Over thirty years ago, I learned in Dr. Yeager's course that conventional business lending was a very qualitative affair. Back then, the standard Brigham & Weston text referred to the "five Cs" of credit: character, capacity to pay, collateral, capital and conditions.
Now, an excited Liz Warren informs CNBC's viewers all about how individualistic is the nature of each small business loan.
Give me a break!
Hundreds of thousands of trained business school graduates working in the financial services sector already know this, Liz. You're only about, what, a few decades late to the party?
Why is it that the head of Congress' vaunted TARP Oversight panel is a liberal lawyer with obviously no practical understanding of finance? How useful are her 'insights' ever going to be? She doesn't even understand how the business works.
To be fair, for all of us, regardless of political persuasion, the challenge of staffing a Congressionally-appointed, outside panel is going to be finding informed but objective members.
The informed experts could well have an industry bias. Financial academics are a potential hybrid which could hold promise, but even some of the more revered theoreticians aren't all that steeped in the reality of fast-moving markets and real instruments, like CDOs.
The more objective candidates from outside the sector, like Warren, simply look clueless and naive. Further, their conclusions are likely to be wrong because they don't fully understand the issues with which they are charged to resolve.
It's hard for me to take seriously anything Warren says from her soapbox perch. When it's an informed comment, which is rare, it's not news. When it's not informed, Warren is just wrong.
Every time I hear this woman talk, my sense that there is nothing she says that is new is reinforced. As well as my sense of how much she doesn't understand about the financial sector.
She began her typical rant by excoriating large US banks for not lending out the TARP money they had been "given." Never mind much has been repaid.
Warren then added the usual pundit's rant about small businesses. Small businesses, she insisted, were being hurt at the expense of larger businesses by the failure of those big, bad banks to lend to the bedrock of the US economy....blah blah blah....small businesses.
Several other guests on the CNBC set countered Warren on two issues. Bob Barbera, chief economist at ITG, noted that small businesses had been disproportionately hurt by the drop in real estate values and, thus, were in no position to borrow any more money. Another guest, perhaps Rich Bernstein, a former Merrill Lynch senior strategist, noted that there wasn't really any real loan demand by small business, just based on economic conditions of late 2008 through late 2009. Further, they were absolutely not hiring anyone.
Nobody on the panel offered another key piece of evidence, i.e., at Fed-induced ultra-low interest rates, how could any bank possibly justify, in hindsight, throwing money given them by the Treasury into risky, low-rate loans to small businesses?
If those banks charged appropriate, higher rates, they would no doubt by garroted by Warren at a later date for daring to profit unfairly on the gift of Federal largess. If they lost money on low-interest loans, they'd be lectured for more foolish lending, just like their original real estate finance excesses.
Warren would have none of the panel's contrary views, insisting she was correct.
Then someone asked if the FCIC was investigating the potential for securitizing small business loans.
I have to say, at this point, I nearly spit out my coffee from shock. What the hell is anyone doing wanting securitization of small business loans when we still are cleaning up the mess from subprime and Alt-A home loans and their securitized offspring?
Warren charged ahead, though, informing everyone that, gosh, small businesses are very unique and require a different kind of lending than simply marking up prime and opening a credit facility for, say, Boeing or Cisco. Only she didn't say it that elegantly. So they are difficult to package up and sell in securities.
Liz Warren is 61 years old, born in 1949, according to her bio. So in 1974-75, when, as a freshmant at Saint Louis University, I was learning the basics of corporate finance in Dr. Fred Yeager's Introduction to Finance 100 course, Warren would have, I guess, been in law school, or already practicing.
Over thirty years ago, I learned in Dr. Yeager's course that conventional business lending was a very qualitative affair. Back then, the standard Brigham & Weston text referred to the "five Cs" of credit: character, capacity to pay, collateral, capital and conditions.
Now, an excited Liz Warren informs CNBC's viewers all about how individualistic is the nature of each small business loan.
Give me a break!
Hundreds of thousands of trained business school graduates working in the financial services sector already know this, Liz. You're only about, what, a few decades late to the party?
Why is it that the head of Congress' vaunted TARP Oversight panel is a liberal lawyer with obviously no practical understanding of finance? How useful are her 'insights' ever going to be? She doesn't even understand how the business works.
To be fair, for all of us, regardless of political persuasion, the challenge of staffing a Congressionally-appointed, outside panel is going to be finding informed but objective members.
The informed experts could well have an industry bias. Financial academics are a potential hybrid which could hold promise, but even some of the more revered theoreticians aren't all that steeped in the reality of fast-moving markets and real instruments, like CDOs.
The more objective candidates from outside the sector, like Warren, simply look clueless and naive. Further, their conclusions are likely to be wrong because they don't fully understand the issues with which they are charged to resolve.
It's hard for me to take seriously anything Warren says from her soapbox perch. When it's an informed comment, which is rare, it's not news. When it's not informed, Warren is just wrong.
Wednesday, May 12, 2010
The FCC Puts US Communications Technology Growth In Jeopardy
Nothing scares off investment capital like uncertainty. Whether measured by higher required rates of return or lower 'certainty equivalents,' uncertainty of return of capital makes projects less attractive.
Thus, the FCC's recent second attempt to regulate the internet is likely to slow or halt growth of that important communications tool and the economic benefits it would otherwise create.
Having watched Congress rebuff 'net neutrality' earlier this year, the FCC is trying again by unilaterally declaring that the internet may be regulated under the 1996 Telecommunications Act.
Noting the year of that act, one already realizes that the Act came just at the dawn of the internet's rapid growth in the late 1990s. The notorious "dot com" bubble.
So, not only did the Act not even foresee developments only a few years hence, but, now, over ten years later, it is most assuredly out of date, drafted, as it was, with the intent of regulating telephony.
Having worked for ATT years ago, in the early years of my business career, I can attest that the last ten years of growth of internet-related services is beyond all comparison to growth in telephony for the last thirty. Once telephony went to wireless, the rest of the changes were of magnitude, more than type.
Other than that, companies like Verizon have only introduced innovation by expanding outside of voice communications to look more like cable companies.
The FCC's unilateral power play is sure to have very negative consequences for one vibrant sector of the US economy.
Think of how many new initiatives, perhaps along the lines of Facebook, Google, or the thousands of apps for iPhones, will now be choked off by uncertain returns to capital as the FCC clouds the business operating environment for such services.
It's bad enough that our government uses taxpayer money to prop up old, antiquated and unproductive sectors like auto manufacture. To now turn to the other end of the spectrum and move to limit growth in new economic sectors will surely lead to a moribund US economy in the not too distant future.
Thus, the FCC's recent second attempt to regulate the internet is likely to slow or halt growth of that important communications tool and the economic benefits it would otherwise create.
Having watched Congress rebuff 'net neutrality' earlier this year, the FCC is trying again by unilaterally declaring that the internet may be regulated under the 1996 Telecommunications Act.
Noting the year of that act, one already realizes that the Act came just at the dawn of the internet's rapid growth in the late 1990s. The notorious "dot com" bubble.
So, not only did the Act not even foresee developments only a few years hence, but, now, over ten years later, it is most assuredly out of date, drafted, as it was, with the intent of regulating telephony.
Having worked for ATT years ago, in the early years of my business career, I can attest that the last ten years of growth of internet-related services is beyond all comparison to growth in telephony for the last thirty. Once telephony went to wireless, the rest of the changes were of magnitude, more than type.
Other than that, companies like Verizon have only introduced innovation by expanding outside of voice communications to look more like cable companies.
The FCC's unilateral power play is sure to have very negative consequences for one vibrant sector of the US economy.
Think of how many new initiatives, perhaps along the lines of Facebook, Google, or the thousands of apps for iPhones, will now be choked off by uncertain returns to capital as the FCC clouds the business operating environment for such services.
It's bad enough that our government uses taxpayer money to prop up old, antiquated and unproductive sectors like auto manufacture. To now turn to the other end of the spectrum and move to limit growth in new economic sectors will surely lead to a moribund US economy in the not too distant future.
Tuesday, May 11, 2010
Rick Santelli v. Paul Kanjorski
If you enjoy Rick Santelli, here's a clip of the exchange between him and this morning's CNBC guest host Rep. Paul Kanjorski, about whom I wrote here earlier today. Once again, thanks to a reader's search, this time for the video of the exchange, I was alerted to go find it.
In my earlier post, I wrote, in part,
"And, as I'm writing this, Kanjorski is lampooning voters who blame CRAs, Fannie and Freddie for causing much of the recent mortgage-backed financial meltdown. That, alone, should tell you that Kanjorski is living in an alternative universe where Congress has never done anything to damage our financial system."
This exchange occurred right after I wrote that.....
In my earlier post, I wrote, in part,
"And, as I'm writing this, Kanjorski is lampooning voters who blame CRAs, Fannie and Freddie for causing much of the recent mortgage-backed financial meltdown. That, alone, should tell you that Kanjorski is living in an alternative universe where Congress has never done anything to damage our financial system."
This exchange occurred right after I wrote that.....
More Reflections On The ECB Greek Bailout
The big news in US equity markets this week continues to be the weekend announcement of the ECB bailout of Greece and, prospectively, Spain and Portugal.
The US pre-market open S&P futures were down to 1141 at one point this morning, from yesterday's close of nearly 1160. As of 10AM, the S&P index is around 1154, still down slightly.
Already, before the open of the US equity markets, pundits were warning of the potential risks and negative consequences, for equities, of the ECB's bailout.
One, of course, is that the Euro isn't a reserve currency. Thus, the relatively benign effects, so far, on the dollar, of the late-2008 massive printing and borrowing of dollars, may not accrue to the Euro or the Eurozone economies.
Second, the austerity measures called for in the bailout will probably result in real economic slowing for the Eurozone economies. That isn't good for short term GDP growth and, by extension, will affect those companies doing much business there.
Third, there's some non-trivial political uncertainty accompanying the ECB actions. The British still don't know the shape of their new government, in the wake of Brown's defeat. And Angela Merkel's party lost an important state election, which will result in her party's loss of control of Germany's upper legislative chamber. Simply put, it's too early to tell if most Germans really approve of using their economic strength and savings to pay off the debts of their relatively less hard-working and less prudent Greek Euro-neighbors.
And Spain is still to come.
All of which means that, after the predictable one-day jump in equities, the longer-term consequences of the ECB action may be quite different.
According to my measures, equity market volatility has not yet abated, and returns are by no means assuredly back to a long, steady march upwards. Seeing just what sort of market dynamics predominate in the days and weeks ahead is still unclear.
The US pre-market open S&P futures were down to 1141 at one point this morning, from yesterday's close of nearly 1160. As of 10AM, the S&P index is around 1154, still down slightly.
Already, before the open of the US equity markets, pundits were warning of the potential risks and negative consequences, for equities, of the ECB's bailout.
One, of course, is that the Euro isn't a reserve currency. Thus, the relatively benign effects, so far, on the dollar, of the late-2008 massive printing and borrowing of dollars, may not accrue to the Euro or the Eurozone economies.
Second, the austerity measures called for in the bailout will probably result in real economic slowing for the Eurozone economies. That isn't good for short term GDP growth and, by extension, will affect those companies doing much business there.
Third, there's some non-trivial political uncertainty accompanying the ECB actions. The British still don't know the shape of their new government, in the wake of Brown's defeat. And Angela Merkel's party lost an important state election, which will result in her party's loss of control of Germany's upper legislative chamber. Simply put, it's too early to tell if most Germans really approve of using their economic strength and savings to pay off the debts of their relatively less hard-working and less prudent Greek Euro-neighbors.
And Spain is still to come.
All of which means that, after the predictable one-day jump in equities, the longer-term consequences of the ECB action may be quite different.
According to my measures, equity market volatility has not yet abated, and returns are by no means assuredly back to a long, steady march upwards. Seeing just what sort of market dynamics predominate in the days and weeks ahead is still unclear.
Who's Minding Our Markets?
This morning, CNBC's morning program is still beating a loud drum regarding the sudden drop in equity prices on Thursday afternoon. To facilitate the process, they invited Pennsylvania Democrat Representative Paul Kanjorski to be a guest host. Kanjorski is a member of the House Financial Services Committee, thus, his attraction for CNBC. Talk about one hand washing the other......
It's ironic for CNBC to have Kanjorski guest host to discuss Thursday's alleged trading scandal, because Kanjorski is actually a scandal-tainted legislator, himself. I found this out due to an accident a month or so ago. At the time, I had written a post on one of my blogs involving Kanjorski. Reading through my Sitemeter details of visits, I found that one reader had found my post from a search for 'Kanjorski scandal.'
Sure enough, Kanjorski, a Representative since 1984, has a big earmarking scandal in his past apparently involving using millions of dollars of federal money to enrich his family. Wasn't Kanjorski's regionally-close, Pennsylvania Democratic House colleague John Murtha, also known for excessive, often self-serving earmarks, too? Must be something in the water up in Northeast Pennsylvania.
Anyway, knowing this makes Kanjorski's earnest-looking, solemn attitude regarding finding and punishing equity market traders and 'insiders' much more of a joke. After all, it seems Kanjorski is a veteran 'insider' himself.
But, back to the issue. Kanjorski has been spewing all manner of hot air this morning, no doubt to make ideal campaign sound bites and video clips. Particularly, he went to great lengths to extol the current financial market regulatory personnel as just the best "in 25 years." Really. Honestly.
No matter that a Democratic administration staffed those agencies. And Democratically-controlled committees are taking a 'hands off' approach with Mary Shapiro in the wake of the incident.
And, as I'm writing this, Kanjorski is lampooning voters who blame CRAs, Fannie and Freddie for causing much of the recent mortgage-backed financial meltdown. That, alone, should tell you that Kanjorski is living in an alternative universe where Congress has never done anything to damage our financial system.
By now, though, it's pretty clear what happened on Thursday. The NYSE used its human specialists to engage a trading slowdown. Claiming that a two minute pause in trading does not constitute 'stepping away' from the market, the NYSE chief and his colleagues and defenders all claim they were merely bringing 'order' to markets run amok from too much electronics.
When the NYSE's specialists essentially took a hike on selected equities, the order flow immediately went to the NASDAQ, which, because of the NYSE's absence, had to order match in a less-liquid market. With more sell orders than buy orders, the 'real,' instant market prices fell.
I really don't think what happened is much more complicated than that.
You can conjure up all manner of conspiracy theories, but, in reality, it does seem to be a case of the regulatory authorities allowing for one exchange to engage equity-specific trading halts, while allowing another exchange to trade through.
What do you think will happen in cases where this differential treatment of individual equities occurs? In down markets, prices will gap down. If Thursday had been an up day, prices would have been skipping up discontinuously, and buyers would have complained about missing bids and being filled at what they considered to be ridiculously high prices.
The truth is, the definition of a "market" involves several dimensions. No one buyer or seller can set prices. Prices must be continuous. Price discovery has to be ubiquitous.
If any of these tenets are violated, it's not a 'market' anymore. Therefore, 'market' orders aren't really going to have their desired effect.
Funny how it's become pretty obvious that the cause of Thursday's ultra-sharp sell-off is a regulatory mistake of keeping exchanges in step with each other. But, because it was a regulatory lapse, the party in power is looking elsewhere for someone to blame.
It's ironic for CNBC to have Kanjorski guest host to discuss Thursday's alleged trading scandal, because Kanjorski is actually a scandal-tainted legislator, himself. I found this out due to an accident a month or so ago. At the time, I had written a post on one of my blogs involving Kanjorski. Reading through my Sitemeter details of visits, I found that one reader had found my post from a search for 'Kanjorski scandal.'
Sure enough, Kanjorski, a Representative since 1984, has a big earmarking scandal in his past apparently involving using millions of dollars of federal money to enrich his family. Wasn't Kanjorski's regionally-close, Pennsylvania Democratic House colleague John Murtha, also known for excessive, often self-serving earmarks, too? Must be something in the water up in Northeast Pennsylvania.
Anyway, knowing this makes Kanjorski's earnest-looking, solemn attitude regarding finding and punishing equity market traders and 'insiders' much more of a joke. After all, it seems Kanjorski is a veteran 'insider' himself.
But, back to the issue. Kanjorski has been spewing all manner of hot air this morning, no doubt to make ideal campaign sound bites and video clips. Particularly, he went to great lengths to extol the current financial market regulatory personnel as just the best "in 25 years." Really. Honestly.
No matter that a Democratic administration staffed those agencies. And Democratically-controlled committees are taking a 'hands off' approach with Mary Shapiro in the wake of the incident.
And, as I'm writing this, Kanjorski is lampooning voters who blame CRAs, Fannie and Freddie for causing much of the recent mortgage-backed financial meltdown. That, alone, should tell you that Kanjorski is living in an alternative universe where Congress has never done anything to damage our financial system.
By now, though, it's pretty clear what happened on Thursday. The NYSE used its human specialists to engage a trading slowdown. Claiming that a two minute pause in trading does not constitute 'stepping away' from the market, the NYSE chief and his colleagues and defenders all claim they were merely bringing 'order' to markets run amok from too much electronics.
When the NYSE's specialists essentially took a hike on selected equities, the order flow immediately went to the NASDAQ, which, because of the NYSE's absence, had to order match in a less-liquid market. With more sell orders than buy orders, the 'real,' instant market prices fell.
I really don't think what happened is much more complicated than that.
You can conjure up all manner of conspiracy theories, but, in reality, it does seem to be a case of the regulatory authorities allowing for one exchange to engage equity-specific trading halts, while allowing another exchange to trade through.
What do you think will happen in cases where this differential treatment of individual equities occurs? In down markets, prices will gap down. If Thursday had been an up day, prices would have been skipping up discontinuously, and buyers would have complained about missing bids and being filled at what they considered to be ridiculously high prices.
The truth is, the definition of a "market" involves several dimensions. No one buyer or seller can set prices. Prices must be continuous. Price discovery has to be ubiquitous.
If any of these tenets are violated, it's not a 'market' anymore. Therefore, 'market' orders aren't really going to have their desired effect.
Funny how it's become pretty obvious that the cause of Thursday's ultra-sharp sell-off is a regulatory mistake of keeping exchanges in step with each other. But, because it was a regulatory lapse, the party in power is looking elsewhere for someone to blame.
Monday, May 10, 2010
The ECB Bailout
The business media airwaves are still filled with arguments about the cause of the Thursday elevator-shaft ride of US equity markets late in the afternoon.
No real news there. This morning's CNBC "debate" with the usual regulatory suspects, including Ned Reilly, Elizabeth Nowicki and Jacob Frenkel, got nowhere. Ms. Nowicki was decidedly more informed and credible on this topic than the last one on which I saw her opine on CNBC.
Together, though, the various pundits shed no real new light on the existing gulf between the NYSE human, stock-specific 'circuit breakers,' and the NASDAQ's lack of human intervention. It doesn't take a genius to realize that if one exchange, with most of the liquidity, takes "breaks" at its own discretion, while other markets trade on, then discontinuities are going to occur. Nobody has yet provided justification for breaking those NASDAQ trades. And there are none. If you elected to trade during a market downdraft, you should get that for which you asked. The arbitrary trade-breaking after the fact is unconscionable. No matter that the NYSE, which caused the problem, is finger-pointing at the NASDAQ for breaking trades.
At this point, you can assail Congress and the SEC for allowing this situation to even occur.
But the real news is the spectacular rebound of the S&P, up to 1155 in pre-trading futures at 9:20, on the strength of the ECB bailout of the Euro and all the potential Eurozone countries requiring help.
The US equities market will no doubt open on an upward tear for the morning.
Of course, the longer term consequences of the ECB $1T bailout fund is much more sobering, and hardly cause for this bounce.
First, the ECB isn't the Fed. Europe's economy isn't the same as the US economy.
Just where is the value to be found underpinning this sudden materialization of one trillion Euros?
Sure, we hear that there will be Euro-quantitative easing, just like in the US in late 2008. Greek bonds are trading up and spreads are down.
Everyone feels that the bottom has been put in, once again, by a financial regulatory authority.
Hooray!
Where is all this money actually coming from? Is it real, or just a printed, time-shifted value play by sovereign governments, and their agents, to cover sovereign shortfalls for a few years?
By the way, in case you hadn't noticed, between the IMF and the Fed's own promise to join the party on quantitative easing, this means the US sovereign balance sheet, already stuffed with subprime mortgages and other financial toxic waste, is going to get some more.
Funny, weren't we just debating how overstretched the US balance sheet is? How much debt we'e created and excess money we've printed?
Maybe investor confidence has returned relative to last Thursday and Friday, which, together, accounted for a loss of 4.7% on the S&P.
Can it last?
Already this morning, before the open, many pundits were looking to today's close and warning of a false rally and more equity declines ahead.
No real news there. This morning's CNBC "debate" with the usual regulatory suspects, including Ned Reilly, Elizabeth Nowicki and Jacob Frenkel, got nowhere. Ms. Nowicki was decidedly more informed and credible on this topic than the last one on which I saw her opine on CNBC.
Together, though, the various pundits shed no real new light on the existing gulf between the NYSE human, stock-specific 'circuit breakers,' and the NASDAQ's lack of human intervention. It doesn't take a genius to realize that if one exchange, with most of the liquidity, takes "breaks" at its own discretion, while other markets trade on, then discontinuities are going to occur. Nobody has yet provided justification for breaking those NASDAQ trades. And there are none. If you elected to trade during a market downdraft, you should get that for which you asked. The arbitrary trade-breaking after the fact is unconscionable. No matter that the NYSE, which caused the problem, is finger-pointing at the NASDAQ for breaking trades.
At this point, you can assail Congress and the SEC for allowing this situation to even occur.
But the real news is the spectacular rebound of the S&P, up to 1155 in pre-trading futures at 9:20, on the strength of the ECB bailout of the Euro and all the potential Eurozone countries requiring help.
The US equities market will no doubt open on an upward tear for the morning.
Of course, the longer term consequences of the ECB $1T bailout fund is much more sobering, and hardly cause for this bounce.
First, the ECB isn't the Fed. Europe's economy isn't the same as the US economy.
Just where is the value to be found underpinning this sudden materialization of one trillion Euros?
Sure, we hear that there will be Euro-quantitative easing, just like in the US in late 2008. Greek bonds are trading up and spreads are down.
Everyone feels that the bottom has been put in, once again, by a financial regulatory authority.
Hooray!
Where is all this money actually coming from? Is it real, or just a printed, time-shifted value play by sovereign governments, and their agents, to cover sovereign shortfalls for a few years?
By the way, in case you hadn't noticed, between the IMF and the Fed's own promise to join the party on quantitative easing, this means the US sovereign balance sheet, already stuffed with subprime mortgages and other financial toxic waste, is going to get some more.
Funny, weren't we just debating how overstretched the US balance sheet is? How much debt we'e created and excess money we've printed?
Maybe investor confidence has returned relative to last Thursday and Friday, which, together, accounted for a loss of 4.7% on the S&P.
Can it last?
Already this morning, before the open, many pundits were looking to today's close and warning of a false rally and more equity declines ahead.
Friday, May 07, 2010
The NYSE vs. NASDAQ
Quite the interesting remote boxing match this morning on CNBC between the heads of the NYSE and NASDAQ.
Distilled to its essence, the mudslinging between the two chiefs consisted of Duncan Niederauer claiming that the "other exchange," i.e., NASDAQ, had insufficient liquidity to support market orders, while NASDAQ's Bob Greifield accused the NYSE's specialists of, once again, stepping away from filling orders for 90 seconds in an already-plunging market.
Who's right?
It matters, because the NYSE is voiding many trades which rewarded buyers at the very-low prices available once the NYSE's specialists abdicated their role.
Worse, as various pundits noted, many of the institutional buyers brave enough to step in at the bottom and buy, sold out before 4PM for nice gains. Now, they entered this morning short and had to cover.
Whether retail or institutional, investors don't need this sort of game being played. I'm not talking about the plunge in prices, but the arbitrary post-hoc decision to void selective trades. The most profitable, of course.
Funny how that worked, isn't it?
My feeling is that Niederauer's NYSE is the culprit here, not Greifield's NASDAQ. People want to trade, and often allow existing routing systems to "find" the best price. If the NYSE is effectively taking a break, those orders will go to the NASDAQ. If that means lower volume, and automated programs are stepping away lower with bids to buy as sell volume builds, so be it.
Whether it's 1987 or now, using a "market order" during a panic is an invitation to disaster. You have knowingly surrendered to uncontrollable market pricing forces.
If anything, this shows, again, for the zillionth time, that NYSE specialists will violate their duty and step away rather than do their job and provide market liquidity when it goes against them.
Distilled to its essence, the mudslinging between the two chiefs consisted of Duncan Niederauer claiming that the "other exchange," i.e., NASDAQ, had insufficient liquidity to support market orders, while NASDAQ's Bob Greifield accused the NYSE's specialists of, once again, stepping away from filling orders for 90 seconds in an already-plunging market.
Who's right?
It matters, because the NYSE is voiding many trades which rewarded buyers at the very-low prices available once the NYSE's specialists abdicated their role.
Worse, as various pundits noted, many of the institutional buyers brave enough to step in at the bottom and buy, sold out before 4PM for nice gains. Now, they entered this morning short and had to cover.
Whether retail or institutional, investors don't need this sort of game being played. I'm not talking about the plunge in prices, but the arbitrary post-hoc decision to void selective trades. The most profitable, of course.
Funny how that worked, isn't it?
My feeling is that Niederauer's NYSE is the culprit here, not Greifield's NASDAQ. People want to trade, and often allow existing routing systems to "find" the best price. If the NYSE is effectively taking a break, those orders will go to the NASDAQ. If that means lower volume, and automated programs are stepping away lower with bids to buy as sell volume builds, so be it.
Whether it's 1987 or now, using a "market order" during a panic is an invitation to disaster. You have knowingly surrendered to uncontrollable market pricing forces.
If anything, this shows, again, for the zillionth time, that NYSE specialists will violate their duty and step away rather than do their job and provide market liquidity when it goes against them.
Some Eye-Opening Data On Fannie Mae
On Wednesday, I wrote this post comparing Fannie Mae and Freddie Mac to the Second Bank of the United States of the early 1800s.
Yesterday, two sources provided some absolutely eye-opening numbers on Fannie.
On CNBC, a reporter noted that the last eleven quarters resulted in, I believe, a $30B loss, which was itself equivalent to the GSE's profit of the prior 30 years. The occasion of this report was yesterday's "earnings," meaning loss announcement by Fannie, of $8B for the first quarter of 2010.
The Wall Street Journal noted, in its lead staff editorial, that Fannie and Freddie were leveraged twice as highly as Bear Stearns.
The Journal piece also stated,
"By concealing how much they (Fannie and Freddie) were gambling on risky subprime and Alt-A mortgages, these companies sent bogus signals on the size of these markets and distorted decision-making throughout the system. Their implicit government guarantee also let them sell mortgage-backed securities around the world, attracting capital to U.S. housing and thus turbocharging the mania."
No private company could sustain this behavior. It would have been bankrupt several years ago, if it looked remotely like either GSE now does.
Of course, it's also evidence of what happens when a government-underwritten entity "competes" in the economy. It drives out all private sector competitors. In the case of mortgage conduits, no private conduit could remain in the broad, mid-market space occupied by the GSEs. Only the jumbo-loan high end could support private conduits, and they dried up in the mortgage meltdown.
As it now stands, Fannie and Freddie have lost $126.9B through the end of last year, and have no limit on the amount of losses we, the taxpayers, will subsidize going forward.
It's a stunning account of horrible management being propped up, and a money-losing strategy being bankrolled with no limit.
How can any economy prosper with business models like these funded in perpetuity?
Yesterday, two sources provided some absolutely eye-opening numbers on Fannie.
On CNBC, a reporter noted that the last eleven quarters resulted in, I believe, a $30B loss, which was itself equivalent to the GSE's profit of the prior 30 years. The occasion of this report was yesterday's "earnings," meaning loss announcement by Fannie, of $8B for the first quarter of 2010.
The Wall Street Journal noted, in its lead staff editorial, that Fannie and Freddie were leveraged twice as highly as Bear Stearns.
The Journal piece also stated,
"By concealing how much they (Fannie and Freddie) were gambling on risky subprime and Alt-A mortgages, these companies sent bogus signals on the size of these markets and distorted decision-making throughout the system. Their implicit government guarantee also let them sell mortgage-backed securities around the world, attracting capital to U.S. housing and thus turbocharging the mania."
No private company could sustain this behavior. It would have been bankrupt several years ago, if it looked remotely like either GSE now does.
Of course, it's also evidence of what happens when a government-underwritten entity "competes" in the economy. It drives out all private sector competitors. In the case of mortgage conduits, no private conduit could remain in the broad, mid-market space occupied by the GSEs. Only the jumbo-loan high end could support private conduits, and they dried up in the mortgage meltdown.
As it now stands, Fannie and Freddie have lost $126.9B through the end of last year, and have no limit on the amount of losses we, the taxpayers, will subsidize going forward.
It's a stunning account of horrible management being propped up, and a money-losing strategy being bankrolled with no limit.
How can any economy prosper with business models like these funded in perpetuity?
Thursday, May 06, 2010
Bear Stearns' James Cayne Declares He Was Innocent
I didn't see all of yesterday's FCIC hearings, but I did hear/see the beginning of former Bear Stearns Chairman James Cayne's testimony.
This morning, I read the Wall Street Journal's recap of his remarks. It makes for rather sad reading, as the article noted that not one of the defunct investment bank's five former executives admitted responsibility for the firm's demise.
According to the Journal, Cayne said,
"Bear Stearns's collapse was not the result of any actions or decisions unique to Bear Stearns. Instead, it was due to overwhelming market forces that Bear Stearns, as the smallest of the independent investment banks, could not resist."
So, after admitting that Bear's 42:1 leverage was "too high," Cayne never the less avoided and evaded taking any blame for knowing that, and allowing it.
Instead, he and his crew of former high-fliers at the firm blamed the market.
It reminds me of a lesson I learned years ago at Chase Manhattan Bank.
We were investigating, at the direction of our CEO, the productivity and profitability of the bank's securities trading business. This necessitated a few meetings with the unit's manager, an SVP. At the time, this was a fairly lofty and unassailable position at the bank.
My partner and I asked what were evidently off-putting and potentially embarrassing questions of the SVP in question, who, for this post, shall remain nameless.
In particular, when we examined the relationship between the unit's trading volumes, bonuses, profits and operations costs and requirements, it became clear what was going on. The unit required expensive facilities capacity from its IT group, but felt it should pay the lowest estimated IT costs in the industry for that type of trading.
When comparing volumes and profits, it was clear that the unit's traders and managers enjoyed outsized bonuses, but didn't take any serious losses in calm or unprofitable markets.
The SVP's response was, laughably, that in good markets, he and his traders added a lot of value but, when markets were bearish, well, that was not something they could control, so losses weren't their fault.
Sound familiar? It's like all of these large bank trading execs read the same business management manual full of aphorisms designed to let them share in gains but always avoid 'market-related losses.'
This is neither a new, nor surprising contention. It's just that Cayne's and his fellow former Bear Stearns executives' explicit statement of it is particularly nauseating, in light of events.
This morning, I read the Wall Street Journal's recap of his remarks. It makes for rather sad reading, as the article noted that not one of the defunct investment bank's five former executives admitted responsibility for the firm's demise.
According to the Journal, Cayne said,
"Bear Stearns's collapse was not the result of any actions or decisions unique to Bear Stearns. Instead, it was due to overwhelming market forces that Bear Stearns, as the smallest of the independent investment banks, could not resist."
So, after admitting that Bear's 42:1 leverage was "too high," Cayne never the less avoided and evaded taking any blame for knowing that, and allowing it.
Instead, he and his crew of former high-fliers at the firm blamed the market.
It reminds me of a lesson I learned years ago at Chase Manhattan Bank.
We were investigating, at the direction of our CEO, the productivity and profitability of the bank's securities trading business. This necessitated a few meetings with the unit's manager, an SVP. At the time, this was a fairly lofty and unassailable position at the bank.
My partner and I asked what were evidently off-putting and potentially embarrassing questions of the SVP in question, who, for this post, shall remain nameless.
In particular, when we examined the relationship between the unit's trading volumes, bonuses, profits and operations costs and requirements, it became clear what was going on. The unit required expensive facilities capacity from its IT group, but felt it should pay the lowest estimated IT costs in the industry for that type of trading.
When comparing volumes and profits, it was clear that the unit's traders and managers enjoyed outsized bonuses, but didn't take any serious losses in calm or unprofitable markets.
The SVP's response was, laughably, that in good markets, he and his traders added a lot of value but, when markets were bearish, well, that was not something they could control, so losses weren't their fault.
Sound familiar? It's like all of these large bank trading execs read the same business management manual full of aphorisms designed to let them share in gains but always avoid 'market-related losses.'
This is neither a new, nor surprising contention. It's just that Cayne's and his fellow former Bear Stearns executives' explicit statement of it is particularly nauseating, in light of events.
Berkshire's Burlington Northern Deal Finally Gets Scrutiny
Last November, I wrote this post concerning Berkshire Hathaway's offer to purchase Burlington Northern railroad.
Among my observations were these,
"First, because Berkshire already owned 22% of BNI, Buffett was able to secure a private screening of the recent board presentation. As an effective insider, then, Buffett had special knowledge that you or I don't about the company's recent and prospective performance.
I don't believe such knowledge made the ultimate difference in Buffett's offer, but it does show how and why Buffett can get deals you cannot. And won't be hauled into court, either, for doing them. Like, oh, say a Sri Lankan-born hedge fund manager?
It also explains why Buffett doesn't want competition in this bid. If he had approached the BNI management publicly, and/or with an investment bank, he may have had one or more hedge funds quickly raise the price through arbitrage.
But right now is a good time to buy. While liquidity is high, M&A activity hasn't re-ignited yet on a large scale. There probably isn't a single business competitor who is positioned to take BNI without anti-trust issues. And it would take some time for even a few private equity groups to collaborate on a bid for BNI. Plus, they tend to want quicker returns than Buffett will accept.
Again, here is where Buffett gets opportunities others do not. How many investors would sit still for being told that a $44B acquisition is carrying a 30% premium and may not pay off for a decade? Most would redeem at the next quarterly window."
Well, it seems I wasn't the only one who noticed this latent unfairness. The Wall Street Journal reported this morning that the SEC is looking into Berkshire's/Buffett's possible violation of "13D," a regulation governing how and when large shareholders must inform other shareholders of the former's "plans or proposals" to take control of the firm.
In the Burlington Northern case, one could argue that Buffett triggered that when he made his oral offer to buy the shares of the firm that Berkshire didn't already own.
The Journal goes on to note that this informal, quiet approach, which Buffett so often uses, tends to depress the acquisition prices he must pay for his targets.
Hmmm....sounds sort of, well, illegal and cronyistic, doesn't it? A large firm's wealthy, influential CEO being allowed liberties with SEC regulations that ordinary investors don't get?
The Journal piece notes that enforcement of 13D
" has long fallen into a gray area. Potential buyers are loath to disclose a potential deal, fearing that it could upset their ability to complete the transaction. The SEC, meanwhile, has shown only spotty attention to this area of the law over the years, say securities attorneys."
According to one attorney quoted in the Journal article,
"Once the large shareholder decides that it plans to make an offer, that is a material change. You have a duty to amend your 13D filing promptly. There is no real dispute on this."
This would, of course, have affected several of Buffett's prior deals, but, most significantly, the recent BNI caper.
It's no doubt wildly naive and optimistic to believe that Buffett will be vigorously pursued and charged in this matter. The guy has managed to so ingratiate himself with Congress and the current administration that it would be like sending your own grandfather to jail if Buffett were appropriately dealt with in this matter.
How's that for crony capitalism?
Among my observations were these,
"First, because Berkshire already owned 22% of BNI, Buffett was able to secure a private screening of the recent board presentation. As an effective insider, then, Buffett had special knowledge that you or I don't about the company's recent and prospective performance.
I don't believe such knowledge made the ultimate difference in Buffett's offer, but it does show how and why Buffett can get deals you cannot. And won't be hauled into court, either, for doing them. Like, oh, say a Sri Lankan-born hedge fund manager?
It also explains why Buffett doesn't want competition in this bid. If he had approached the BNI management publicly, and/or with an investment bank, he may have had one or more hedge funds quickly raise the price through arbitrage.
But right now is a good time to buy. While liquidity is high, M&A activity hasn't re-ignited yet on a large scale. There probably isn't a single business competitor who is positioned to take BNI without anti-trust issues. And it would take some time for even a few private equity groups to collaborate on a bid for BNI. Plus, they tend to want quicker returns than Buffett will accept.
Again, here is where Buffett gets opportunities others do not. How many investors would sit still for being told that a $44B acquisition is carrying a 30% premium and may not pay off for a decade? Most would redeem at the next quarterly window."
Well, it seems I wasn't the only one who noticed this latent unfairness. The Wall Street Journal reported this morning that the SEC is looking into Berkshire's/Buffett's possible violation of "13D," a regulation governing how and when large shareholders must inform other shareholders of the former's "plans or proposals" to take control of the firm.
In the Burlington Northern case, one could argue that Buffett triggered that when he made his oral offer to buy the shares of the firm that Berkshire didn't already own.
The Journal goes on to note that this informal, quiet approach, which Buffett so often uses, tends to depress the acquisition prices he must pay for his targets.
Hmmm....sounds sort of, well, illegal and cronyistic, doesn't it? A large firm's wealthy, influential CEO being allowed liberties with SEC regulations that ordinary investors don't get?
The Journal piece notes that enforcement of 13D
" has long fallen into a gray area. Potential buyers are loath to disclose a potential deal, fearing that it could upset their ability to complete the transaction. The SEC, meanwhile, has shown only spotty attention to this area of the law over the years, say securities attorneys."
According to one attorney quoted in the Journal article,
"Once the large shareholder decides that it plans to make an offer, that is a material change. You have a duty to amend your 13D filing promptly. There is no real dispute on this."
This would, of course, have affected several of Buffett's prior deals, but, most significantly, the recent BNI caper.
It's no doubt wildly naive and optimistic to believe that Buffett will be vigorously pursued and charged in this matter. The guy has managed to so ingratiate himself with Congress and the current administration that it would be like sending your own grandfather to jail if Buffett were appropriately dealt with in this matter.
How's that for crony capitalism?
Wednesday, May 05, 2010
Congress Remains Silent On The Modern Bank of The United States- Fannie & Freddie
Robert Wilmers, CEO of M&T Bank Corporation, wrote a hard-hitting editorial in yesterday's Wall Street Journal entitled, bluntly, "What About Fan and Fred Reform?"
In the past few weeks, much has occurred in Congress and the administration which smacks of trying to supercharge the rush to poorly-thought, badly-drafted finance so-called "reform."
The Dodd bill is, of course, quite far from real, effective reform. And that's if we actually believed that the Congressional panel formed to investigate the recent financial crisis had completed its job. And various pundits and officials had contributed credible, objective testimony, while meaningful, measurable criteria were advanced and adopted for assessing the US financial system's health and effectiveness.
Mr. Wilmers is the CEO of a rather quotidian commercial bank. It's not a former investment bank now reborn as a commercial bank. It's not a money center bank in New York.
Thus, Mr. Wilmers' observations have some credibility and a lack of obvious bias.
He wrote, at length, about how huge and problematic Congress has allowed the two GSEs to become,
"Congress may be making progress crafting new regulations for the financial-services industry, but it has yet to begin reforming two institutions that played a key role in the 2008 credit crisis—Fannie Mae and Freddie Mac.
We cannot reform these government-sponsored enterprises unless we fully confront the extent to which their outrageous behavior and reckless business practices have affected the entire commercial banking sector and the U.S. economy as a whole.
At the end of 2009, their total debt outstanding—either held directly on their balance sheets or as guarantees on mortgage securities they'd sold to investors—was $8.1 trillion. That compares to $7.8 trillion in total marketable debt outstanding for the entire U.S. government. The debt has the implicit guarantee of the federal government but is not reflected on the national balance sheet.
To date, the federal government has been forced to pump $126 billion into Fannie and Freddie. That's far more than AIG, which absorbed $70 billion of government largess, and General Motors and Chrysler, which shared $77 billion. Banks received $205 billion, of which $136 billion has been repaid.
Fannie and Freddie continue to operate deeply in the red, with no end in sight. The Congressional Budget Office estimated that if their operating costs and subsidies were included in our accounting of the overall federal deficit—as properly they should be—the 2009 deficit would be greater by $291 billion."
Does anyone seriously doubt that any attempt at effective regulatory change of this sector will fail without addressing- and fixing- Fannie and Freddie?
Then Mr. Wilmers concludes with this knockout blow,
"According to a 2004 Congressional Budget Office study, the two GSEs enjoyed $23 billion in subsidies in 2003—primarily in the form of lower borrowing costs and exemption from state and local taxation. But they passed on only $13 billion to home buyers. Nevertheless, one former Fannie Mae CEO, Franklin Raines, received $91 million in compensation from 1998 through 2003. In 2006, the top five Fannie Mae executives shared $34 million in compensation, while their counterparts at Freddie Mac shared $35 million. In 2009, even after the financial crash and as these two GSEs fell deeper into the red, the top five executives at Fannie Mae received $19 million in compensation and the CEO earned $6 million.
This is not private enterprise—it's crony capitalism, in which public subsidies are turned into private riches. From 2001 through 2006, Fannie and Freddie spent $123 million to lobby Congress—the second-highest lobbying total (after the U.S. Chamber of Commerce) in the country. That lobbying was complemented by sizable direct political contributions to members of Congress.
Changing this terrible situation will not be easy. The mortgage market has come to be structured around Fannie and Freddie and powerful interests are allied with the status quo. I recall a personal conversation with a member of Congress who, despite saying he understood my concerns about the two GSEs, admitted he would never push for significant change because "they've done so much for me, my colleagues and my staff." "
When I read these last three paragraphs, I was instantly reminded of President Andrew Jackson's campaign against Nicholas Biddle's Second Bank of the US. A quasi-governmental entity so entwined with the federal government's officials and Congress that the two could not wean themselves from the Bank.
Biddle contributed to many Congressional campaigns, calling to mind Wilmers' reference to his member of Congress friend.
The Second Bank of the US dominated politics for four years. Fannie and Freddie could do so, now. They are that powerful, corrupt, and entangled with the nation's financial troubles and system.
In the past few weeks, much has occurred in Congress and the administration which smacks of trying to supercharge the rush to poorly-thought, badly-drafted finance so-called "reform."
The Dodd bill is, of course, quite far from real, effective reform. And that's if we actually believed that the Congressional panel formed to investigate the recent financial crisis had completed its job. And various pundits and officials had contributed credible, objective testimony, while meaningful, measurable criteria were advanced and adopted for assessing the US financial system's health and effectiveness.
Mr. Wilmers is the CEO of a rather quotidian commercial bank. It's not a former investment bank now reborn as a commercial bank. It's not a money center bank in New York.
Thus, Mr. Wilmers' observations have some credibility and a lack of obvious bias.
He wrote, at length, about how huge and problematic Congress has allowed the two GSEs to become,
"Congress may be making progress crafting new regulations for the financial-services industry, but it has yet to begin reforming two institutions that played a key role in the 2008 credit crisis—Fannie Mae and Freddie Mac.
We cannot reform these government-sponsored enterprises unless we fully confront the extent to which their outrageous behavior and reckless business practices have affected the entire commercial banking sector and the U.S. economy as a whole.
At the end of 2009, their total debt outstanding—either held directly on their balance sheets or as guarantees on mortgage securities they'd sold to investors—was $8.1 trillion. That compares to $7.8 trillion in total marketable debt outstanding for the entire U.S. government. The debt has the implicit guarantee of the federal government but is not reflected on the national balance sheet.
To date, the federal government has been forced to pump $126 billion into Fannie and Freddie. That's far more than AIG, which absorbed $70 billion of government largess, and General Motors and Chrysler, which shared $77 billion. Banks received $205 billion, of which $136 billion has been repaid.
Fannie and Freddie continue to operate deeply in the red, with no end in sight. The Congressional Budget Office estimated that if their operating costs and subsidies were included in our accounting of the overall federal deficit—as properly they should be—the 2009 deficit would be greater by $291 billion."
Does anyone seriously doubt that any attempt at effective regulatory change of this sector will fail without addressing- and fixing- Fannie and Freddie?
Then Mr. Wilmers concludes with this knockout blow,
"According to a 2004 Congressional Budget Office study, the two GSEs enjoyed $23 billion in subsidies in 2003—primarily in the form of lower borrowing costs and exemption from state and local taxation. But they passed on only $13 billion to home buyers. Nevertheless, one former Fannie Mae CEO, Franklin Raines, received $91 million in compensation from 1998 through 2003. In 2006, the top five Fannie Mae executives shared $34 million in compensation, while their counterparts at Freddie Mac shared $35 million. In 2009, even after the financial crash and as these two GSEs fell deeper into the red, the top five executives at Fannie Mae received $19 million in compensation and the CEO earned $6 million.
This is not private enterprise—it's crony capitalism, in which public subsidies are turned into private riches. From 2001 through 2006, Fannie and Freddie spent $123 million to lobby Congress—the second-highest lobbying total (after the U.S. Chamber of Commerce) in the country. That lobbying was complemented by sizable direct political contributions to members of Congress.
Changing this terrible situation will not be easy. The mortgage market has come to be structured around Fannie and Freddie and powerful interests are allied with the status quo. I recall a personal conversation with a member of Congress who, despite saying he understood my concerns about the two GSEs, admitted he would never push for significant change because "they've done so much for me, my colleagues and my staff." "
When I read these last three paragraphs, I was instantly reminded of President Andrew Jackson's campaign against Nicholas Biddle's Second Bank of the US. A quasi-governmental entity so entwined with the federal government's officials and Congress that the two could not wean themselves from the Bank.
Biddle contributed to many Congressional campaigns, calling to mind Wilmers' reference to his member of Congress friend.
The Second Bank of the US dominated politics for four years. Fannie and Freddie could do so, now. They are that powerful, corrupt, and entangled with the nation's financial troubles and system.
Tuesday, May 04, 2010
Just What Is "Proprietary Trading" Anyway?
Much has been made recently of the belief that "proprietary trading" did not actually cause the demise of Bear Stearns or Lehman Brothers, and, thus, is of no consequence in the evolving FINREG bill.
I believe this is wrong. It takes too narrow a view of just what proprietary trading actually entails.
To me, proprietary trading may technically define or describe only those as-principal activities on an investment or commercial bank's trading desks which risk the firm's own capital.
However, the broader notion meant by people like Paul Volcker, in articulating his Volcker Rule is, I believe, that of the risking of a bank's capital on any underwriting, long term investments or high-frequency trading for its own account.
The key common element isn't the duration, which could rule out proprietary trading as the culprit of some now-defunct banks' woes, but, rather, the risking of the bank's own capital in market-valued instruments and activities.
When banks which do this are also in the business of taking insured deposits, then they are implicitly being backed by the FDIC and, ultimately, taxpayers.
Lehman was brought low, in part, by the poor quality of the commercial mortgage assets it chose to hold on its books. That was proprietary investment.
Bear Stearns was believed, by its commercial bank lenders, to have asset quality problems which made those overnight loans too risky.
Were the assets the result of trading, or underwriting, or investment? Doesn't really matter.
They were owned by the firm, and lost more value than there was equity to back them.
Trading...investment.....really, what's in a word, in this case? The time dimension isn't what is important when considering the reform of financial regulations and structure regarding a bank's risk exposure while also taking insured deposits.
The source of the risk capital is.
I believe this is wrong. It takes too narrow a view of just what proprietary trading actually entails.
To me, proprietary trading may technically define or describe only those as-principal activities on an investment or commercial bank's trading desks which risk the firm's own capital.
However, the broader notion meant by people like Paul Volcker, in articulating his Volcker Rule is, I believe, that of the risking of a bank's capital on any underwriting, long term investments or high-frequency trading for its own account.
The key common element isn't the duration, which could rule out proprietary trading as the culprit of some now-defunct banks' woes, but, rather, the risking of the bank's own capital in market-valued instruments and activities.
When banks which do this are also in the business of taking insured deposits, then they are implicitly being backed by the FDIC and, ultimately, taxpayers.
Lehman was brought low, in part, by the poor quality of the commercial mortgage assets it chose to hold on its books. That was proprietary investment.
Bear Stearns was believed, by its commercial bank lenders, to have asset quality problems which made those overnight loans too risky.
Were the assets the result of trading, or underwriting, or investment? Doesn't really matter.
They were owned by the firm, and lost more value than there was equity to back them.
Trading...investment.....really, what's in a word, in this case? The time dimension isn't what is important when considering the reform of financial regulations and structure regarding a bank's risk exposure while also taking insured deposits.
The source of the risk capital is.
Monday, May 03, 2010
The Demonization Of Goldman Sachs & The Profit Motive
One of the apparent casualties of last week's unprincipled bullying of Goldman Sachs personnel by a handful of Senators was the legitimacy of the profit motive in trading and investment banking.
Once you wade through the political posturing of the Senators, and their general inability to understand that which they excoriated, you are left with a Congressional disposition against professional investors in the capital markets making money by risking capital on positions over any timeframe.
To my recollection, nobody ever believed Salomon Brothers' original CMO activities, arranged between professional investors, were altruistic. Salomon was a hard-charging, take-no-prisoners investment bank. Nobody who traded with them as a principal, or bought their underwritings, thought the fixed-income titan was doing them a favor.
Simply put, trading with investment banks isn't a sport and it's not for naive or non-professional investors. And by "trading," I mean buying from an investment bank for the purpose of holding the security.
Every professional investor, including investment committees of unions and such, knows, or should know, that no investment bank underwrites or trades securities as a principal solely for the investor's benefit. The banks do these activities to make money. So that means they expect what they sell to fall in price, or rise less than what they buy, and what they buy to rise in price, or fall less than what they sell.
What is so hard to understand about this?
Unlike selling food, cars, or vacuum cleaners, the buying and selling of securities involves making judgements on the future performance of said securities. You buy food to eat. You buy securities as a store of value.
Thus, by definition, the seller of that store of value, if it is an investment bank acting for its own account, is implicitly telling you they have better options for their own money than holding that which they sell to you.
If the Abacus deal and subsequent witch hunts into Goldman Sachs' behavior by the SEC and Justice Department demonize the business of trading, as principals, by investment banks, we have a major disconnect between our elected and appointed dummies in Washington and the realities of capital markets.
Once you wade through the political posturing of the Senators, and their general inability to understand that which they excoriated, you are left with a Congressional disposition against professional investors in the capital markets making money by risking capital on positions over any timeframe.
To my recollection, nobody ever believed Salomon Brothers' original CMO activities, arranged between professional investors, were altruistic. Salomon was a hard-charging, take-no-prisoners investment bank. Nobody who traded with them as a principal, or bought their underwritings, thought the fixed-income titan was doing them a favor.
Simply put, trading with investment banks isn't a sport and it's not for naive or non-professional investors. And by "trading," I mean buying from an investment bank for the purpose of holding the security.
Every professional investor, including investment committees of unions and such, knows, or should know, that no investment bank underwrites or trades securities as a principal solely for the investor's benefit. The banks do these activities to make money. So that means they expect what they sell to fall in price, or rise less than what they buy, and what they buy to rise in price, or fall less than what they sell.
What is so hard to understand about this?
Unlike selling food, cars, or vacuum cleaners, the buying and selling of securities involves making judgements on the future performance of said securities. You buy food to eat. You buy securities as a store of value.
Thus, by definition, the seller of that store of value, if it is an investment bank acting for its own account, is implicitly telling you they have better options for their own money than holding that which they sell to you.
If the Abacus deal and subsequent witch hunts into Goldman Sachs' behavior by the SEC and Justice Department demonize the business of trading, as principals, by investment banks, we have a major disconnect between our elected and appointed dummies in Washington and the realities of capital markets.
Warren Buffett Dances Around Conflict of Interest Questions On CNBC This Morning
I've been watching/listening to Warren Buffett on CNBC this morning. It's pretty sickening to watch the network's anchors venerate Buffett and treat him with kid gloves, while he does his grandfatherly chortling act.
Nauseating. It's just nauseating and disgusting what major business media lets this guy get away with.
This weekend, of course, was the Berkshire Hathaway annual meeting. As usual, CNBC and the Wall Street Journal covered it as the carnival it has become, with Buffett as the center of all adulation and worship.
This morning, in one of her annual personal interviews with Buffett, Becky Quick managed to at least ask Buffett if backing Goldman, as he so strongly has, is not "talking his book?"
In response, Warren employed his now-famous 'as shucks' guffaw, and only said, to paraphrase,
'I'm answering because you asked me a question.'
In effect, actually ducking the key question.
Quick, of course, declined to pursue with a tougher follow up, and let Warren skate away looking magisterial as well as simple.
The truth is, of course, that Buffett was talking his book.
The Wall Street Journal article discussing Buffett's sudden interest in derivatives regulation and defense of Goldman only noted that "to an extent" Buffett could be expected to protect his investment.
My God!
Can't even the Journal just come out and say Buffett is stumping for his investments by backing Goldman Sachs and Lloyd Blankfein to the hilt? After all, if I'm not mistaken, Buffett got warrants along with a nice coupon rate on that big loan to Goldman.
When CNBC's Joe Kernen asked Buffett if the Senate crucifixion of Goldman Sachs' personnel this past week wasn't over the top, Buffett let loose with "the chuckle," then went on to 'aw shucks they're only bein' Senators, by gum' it past any serious remarks about the unseemly spectacle.
Why?
Well, that FINREG bill isn't finished yet. Buffett isn't about to enrage all those powerful Democratic Senators who could cost Berkshire so much money in constantly-marked-to-market derivatives. So Buffett is staying the hell away from any criticism of Congress. Or the administration, for that matter.
Then there was Buffett's defense, both in the Journal and on CNBC, again, this morning, of the Moodys and S&P ratings agencies. A blind man could see these firms were atrociously derelict in the execution of their Congressionally-granted franchise. Possibly even fraudulent, as they rated some mortgage-backed issues AAA way too early, in light of subsequent performance.
Why Buffett is defending these firms is harder to understand. Perhaps it's because he is worried that, if the ratings agencies are seriously impacted by regulation changes, a lot else in Buffett's world could change- and for the worse.
Honestly, it's sickening to see all the major business media treat Buffett like this. They all want access and advertising, so nobody will call Buffett on his double standards, special treatment, use of the country boy image to deflect hard, meaningful, potentially damaging questions.
Isn't anyone ever going to expose this guy for gaming the system while getting away with actions which would get others hauled before Congress?
Nauseating. It's just nauseating and disgusting what major business media lets this guy get away with.
This weekend, of course, was the Berkshire Hathaway annual meeting. As usual, CNBC and the Wall Street Journal covered it as the carnival it has become, with Buffett as the center of all adulation and worship.
This morning, in one of her annual personal interviews with Buffett, Becky Quick managed to at least ask Buffett if backing Goldman, as he so strongly has, is not "talking his book?"
In response, Warren employed his now-famous 'as shucks' guffaw, and only said, to paraphrase,
'I'm answering because you asked me a question.'
In effect, actually ducking the key question.
Quick, of course, declined to pursue with a tougher follow up, and let Warren skate away looking magisterial as well as simple.
The truth is, of course, that Buffett was talking his book.
The Wall Street Journal article discussing Buffett's sudden interest in derivatives regulation and defense of Goldman only noted that "to an extent" Buffett could be expected to protect his investment.
My God!
Can't even the Journal just come out and say Buffett is stumping for his investments by backing Goldman Sachs and Lloyd Blankfein to the hilt? After all, if I'm not mistaken, Buffett got warrants along with a nice coupon rate on that big loan to Goldman.
When CNBC's Joe Kernen asked Buffett if the Senate crucifixion of Goldman Sachs' personnel this past week wasn't over the top, Buffett let loose with "the chuckle," then went on to 'aw shucks they're only bein' Senators, by gum' it past any serious remarks about the unseemly spectacle.
Why?
Well, that FINREG bill isn't finished yet. Buffett isn't about to enrage all those powerful Democratic Senators who could cost Berkshire so much money in constantly-marked-to-market derivatives. So Buffett is staying the hell away from any criticism of Congress. Or the administration, for that matter.
Then there was Buffett's defense, both in the Journal and on CNBC, again, this morning, of the Moodys and S&P ratings agencies. A blind man could see these firms were atrociously derelict in the execution of their Congressionally-granted franchise. Possibly even fraudulent, as they rated some mortgage-backed issues AAA way too early, in light of subsequent performance.
Why Buffett is defending these firms is harder to understand. Perhaps it's because he is worried that, if the ratings agencies are seriously impacted by regulation changes, a lot else in Buffett's world could change- and for the worse.
Honestly, it's sickening to see all the major business media treat Buffett like this. They all want access and advertising, so nobody will call Buffett on his double standards, special treatment, use of the country boy image to deflect hard, meaningful, potentially damaging questions.
Isn't anyone ever going to expose this guy for gaming the system while getting away with actions which would get others hauled before Congress?
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