Dick Parsons' Misleading Remarks In This Morning's CNBC Interview

I caught some of Citigroup chairman Dick Parsons' interview with Becky Quick this morning on CNBC. The interview seemed like an exercise in futility, as Quick lobbed softballs at Parsons, and he replied with some misleading and almost delusional responses.

Parsons' off the cuff numbers on Citi's TARP bailout made light of the real risk undertaken by taxpayers. Of course, now, it looks like a great profit- something like $12B on $48B. But this obscures the capital flows and sources of the profit. That is, existing shareholders were just about wiped out, while subsequent "profit" to the government came from the markets. It's very difficult to assess a proper risk-adjusted return for the deal, since the government has unique characteristics as an investor, including the ability to rig market and economic conditions to favor its investments.

Further, Parsons delusionally claimed that the government never interfered with the firm's operation. What was the special compensation czar's job? Did I miss something over the past few years when Ken Feinberg  was fighting with commercial banks over compensation levels? Does anyone really believe there wasn't behind-the-scenes arm twisting of banks which had taken TARP funds?

Then, in a completely surreal moment, Parsons began to lecture Quick on how banking works. How banks intermediate savers and borrowers. I guess this stuff is news to Dick, and he assumes nobody else watching CNBC knew these important details, either. But he then went on to claim, on that basis, that banks were 'special,' at the 'heart of the economy,' and could not be allowed to fail!

Wow. How convenient, Dick. Your predecessor, Bob Rubin, helped leverage and direct Citi into the mortgage-backed mess, it should have gone bankrupt, its parts sold to other banks, and you claim that your, and, by extension, all large, globally-connected banks must be saved.

Anna Kagan Schwartz correctly noted over two years ago that the problems with the US financial sector in late 2008 were solvency-based, not liquidity-based. Closing losers like Citi would have improved counterparty trust throughout the sector. Propping it up with printed government liquidity simply prolonged and rewarded incompetent bank managements and their boards.

So now, we have faulty, inept managements continuing to function along with better banks, when we had an opportunity to weed out the bad managers and allocate, by market mechanisms, their salvageable businesses to better-managed competitors.

But, of course, Parsons is in a delusional, self-serving mode now. As chairman of Citigroup, he has to distort and misrepresent that bank's and the meltdown's realities, in order to justify the firm's current existence.

J Crew Goes Private: More Self-Dealing & Unethical Corporate Governance

The story emerging around J. Crew Group's sale of itself to private equity groups TPG Capital and Leonard Green & Partners, and CEO Mickey Drexler, is distinctly unpleasant. How it portrays corporate governance and unethical behavior of certain parties is another black eye for corporate America.

According to the latest Wall Street Journal piece on the subject,

"The details of the J. Crew deal show how top management kept a number of key details from the company's board, while a TPG executive serving on that board eventually engaged in direct purchase negotiations with the company.

TPG, Leonard Green and J. Crew declined to comment."

As if this wasn't bad enough, Goldman Sachs, which originally advised J. Crew on,

"management's review of strategic alternatives other than a sale....had switched sides, working as a financial adviser for the TPG group that included Mr. Drexler. Goldeman declined to comment."

The private equity groups and Drexler discussed a buyout "for about seven weeks" before notifying J. Crew's board. During that time, the Journal article states that senior managers were brought in to make board presentations about the company's condition. This means the private equity bidders for the company were essentially being given all of the company's confidential information, unbeknownst to the directors not involved in the buyout.

Upon reading, in the Journal, and hearing, on CNBC, these various details, I immediately thought of the similar case of Kinder Morgan's buyout a few years ago. And at least one other pundit made the same connection.

The Journal article provided further details of how Drexler wouldn't work with any other buyer, and the buyout group's intimate knowledge of J. Crew's situation allowed it to make an offer calculated to satisfy the board, meaning, that the offer wouldn't be unnecessarily high.

Obviously, the big losers in this situation are the shareholders.

The nearby chart shows J. Crew's recent performance versus that of the S&P500 Index. The retailer has done better than the index over the period. It isn't completely clear why the firm's management or board would consider it to be so in need of a private equity rescue.

But what is pretty clear is that the private equity groups who ultimately agreed on a $43.50/share deal felt they were getting a bargain. So shareholders were implicitly being roughly handled.

Why? It seems that, with Drexler unwilling to work for other buyers, and having allied himself with the TPG-Green  bid, he was acting against the interests of the shareholders in whose interest he allegedly served as CEO and a board member of J. Crew. Depriving shareholders of his services, after having been compensated for learning the details of the firm, seems unethical. If Drexler did such a bad job that the firm had to be sold to a private buyout group, why was he necessary if the firm wished to remain public? If he was so key and successful, why was it being sold to a private group?

The logic is neither clear, nor sensible. Instead, about the only way it seems plausible is because Drexler and the TPG representative on J. Crew's board gained sufficient knowledge of the firm's operation and prospects, coupled with Drexler's alliance with that buyout group, to give them leverage over future prospects of the firm as a publicly-held entity.

Like the Kinder Morgan deal, it smacks of insider, self-interested dealing at the expense of shareholders. This undermines long term faith by investors in the publicly-held firm model. Perhaps investors would be wise to note whether private equity firms have representatives on boards.

One also wonders why and how the board of J. Crew let itself be put in this position? And if there were not other remedies available, such as removing the TPG-affiliated board member, and Drexler. Instead, they were evidently rewarded for their questionable ethics and behavior by being awarded a buyout price based on insider knowledge and unique leverage over the firm.

The Fed's Rescue Details

Many pundits and media personalities are expressing outrage after reading details of the Fed's assistance to various private entities during the 2008-09 financial meltdown.

Of particular mention in a Wall Street Journal article was the Fed's aid to money-market funds, while a CNBC discussion highlighted the otherwise-frozen commercial paper market.

It's disconcerting to read of Goldman Sachs borrowing a total of $600B from the Fed. Obviously, loan totals over the period would be staggering.

Since, as the Journal article notes, "it is tough to see how the Fed will ever convince investors it won't again ride to the rescue when required," can we not at least expect the Fed, Treasury, and perhaps Congress, in concert with financial sector players, to devise better ways of providing said insurance during financial crises?

Is it not feasible for the Fed to sell insurance, rather than simply lend trillions? Can't some market-oriented solution utilize risk-pricing so that institutions may acquire protection, but at prices related to their risk and in consequence of their mistakes?

Or perhaps, through significant rewriting of the deeply-flawed Dodd-Frank bill, provide clear, objective, quantitative tests, failing which will send a firm immediately into Chapter 11, while passing would allow it access to temporary federal aid, though priced according to risks measured in said tests?

Anna Kagan Schwartz went on record first, back in 2008, noting that the crisis was, in reality, one of solvency, not liquidity. But Paulson and Bernanke provided a solution to a liquidity crisis.

What would the proper solution have been for a solvency crisis? Wouldn't it have been, as Schwartz suggested, more orderly closing of insolvent institutions, thereby relieving counterparty pressure on the remaining institutions, which then would be judged safe and solvent? Wouldn't that take far less capital from the Fed, and create far less panic in the first place?

Given the immense scale of the Fed's bailouts of 2008, and the increasing indebtedness of the US, and possible pushback by global investors the next time the Fed tries to blithely expand its balance sheet so quickly and to such a large extent, it seems prudent to develop less capital-intensive, more discerning methods of avoiding financial panic and complete breakdowns short of simply lending out hundreds of billions, to trillions of dollars to one and all without any regard to the riskiness of the situation at each institution.

We have some time, hopefully, before the next incident of such widespread financial catastrophe. Surely there are suitably-capable minds available. Can't we expect our government's institutions to engineer better financial crisis solutions pre-emptively, rather than simply repeat the awkward and questionable practices of the Fed and Treasury during the recent financial crisis?

New Directions In Econometric Modeling

Last Tuesday's Wall Street Journal featured a lengthy news story discussing the work of many new arrivals to the econometric modeling scene. Some of the recent entrants into the field use distinctly atypical approaches.

At first, some of what I read struck me as silly. Indeed, the story quotes NYU economics professor Mark Gertler as saying,

"It strikes me as not productive to say that all we have done is a complete waste. The profession is extremely competitive. If you have a better idea, it's going to win out."

Well, yes, but only over other equally-flawed and potentially limited-in-scope approaches which are all developed by economists who studied the same historic approaches.

One of the things I found distasteful about the prospect of taking a PhD in Marketing at Penn years ago was the requirement to take various econometric modeling courses. The Journal piece notes one of the new modelers, one Mr. Farmer, observing that modern "dynamic stochastic general equilibrium" models have become so complex and over-specified that convergent solutions are often impossible to satisfy all conditions and variables.

One engaging newer approach is that of using 'agents' to describe economic activity, rather than reduce all economic activity to equations of various Keynesian-era variables. Other ideas borrow from psychology and lean toward the work of Amos Tversky and Daniel Kahneman, a Nobel Laureate for his work on risk.

Another suggests approaches used for weather, traffic and epidemics, focusing on many discrete inputs, rather than a few simplifying equations and variables.

Gertler's comment brings to mind the entire question of what such models are built to do, and how they perform in terms of prediction errors. So long as one can explain a logical trail from inputs to predictions, does it really matter, other than to Gertler's sensibilities, and those of his kind, that the models aren't conventional econometrics?

I should think not. Speaking from experience, taking a fresh approach to a problem, using tools and perspectives from another field, can allow one to capture aspects of a the problem that conventional, existing approaches simply miss, out of ignorance. I've found this to be the case in my equity strategy work. Coming from a marketing and strategy background, my modeling approach to equity performance and selection is quite different than those of typical finance-trained people. And has resulted in better performance than most similar, publicly-tracked funds.

Reading the Journal story provides some shocking insights regarding what isn't included in many of the current models, e.g., central bank actions and the finance sector, generally.

After rereading the piece and reflecting on it, I think I'm more inclined to be welcoming and excited by the arrival of a group of new and varied modeling techniques onto the econometric scene.

Certainly the past several years of ineffective retreaded Keynesian-type models have produced nothing impressive.

GM's Misleading Volt Launch

There was a fair amount of media hype over GM's launch, earlier this week, of its Volt automobile. Coverage ranged from the expected to the ridiculous.

The latter, of course, featured former GM exec Bob Lutz crowing about how wonderful the Volt was to drive, and how profitable it would be. When asked about the latter topic, Lutz first cited his lack of current information about it, then proceeded to assure the reporter that he was sure that all the key component costs would decline with volume, and the vehicle would make tons of money for GM.

Bob curiously- or not so- failed to mention those hefty federal government subsidies for buying a Volt. Without which, demand would likely slow to a trickle.

Seeing videos of the car, I'm struck by its ugliness, if not plain design. Like so many GM vehicles, it fails to excite. Nobody, including Lutz, has discussed various features or interior details which are always the subject of reviews of other new cars. I have this sense that the Volt is a sort of electrically-powered equivalent of a Volkswagen, i.e., simple and relatively spare. Nothing to write home about.

Except the currently-chic electric power thing.

On that note, a pundit on CNBC weighed in on how poorly-prepared the US electrical grid is in the major cities in which the Volt might actually make some sense. With a fully-charged range of about 40 miles before resorting to the gasoline engine to charge the electric batteries to run the motor, the guy pointed out that the car is truly practical only in the larger US cities with fairly dense populations. As such, he noted that few had power grids and capacities which could take a hefty dose of Volt users.

And, of course, there's the embarrassing fact  that most of that juice comes from coal. So all that good feeling of avoiding burning gasoline is offset by the reality that the Volt owner is causing more emissions-creating coal to be fed into power plants in his city.

Lastly, the GM CEO who gave a CNBC interview was largely incapable of explaining his rather stratospheric claims of something north of 200 MPG for the car on a cross-country road trip. He boasted that you could drive the car across the US like any conventional gasoline-powered vehicle, then botched a simple explanation of how, with an 8-gallon gas tank, that would work. I'm still a bit unclear myself.

So much for marketing. But, then, this is GM. They haven't done effective marketing since Alfred P. Sloan left the company, have they?

Distributing Starbucks Coffee: Kraft Vs. SBUX

At last there's a terrific marketing story in the news. Starbucks and Kraft are wrangling over the control and value of the distribution channel for the former's ground coffee through grocery stores.

According to an article in Monday's Wall Street Journal, the two parties inked a deal back in 1998, renewed in 2004, which has no expiration date, and puts Kraft in charge of distributing Starbucks' packaged coffee products through grocery channels. Kraft pays Starbucks fees related, in part, to sales, but essentially keeps the rest of the profits, in consideration for its doing the work of selling and distributing the coffee.

Now, like many vendors who began with weak distribution capabilities, for which they paid stronger distributors or retailers, Starbucks wants to take control of the channel back. But that pesky, perpetual agreement with Kraft stands in the way.

So Starbucks has begun to exercise its rights under the agreement to accuse Kraft of some fairly groundless- no pun intended- damages. The coffee roaster is criticizing how Kraft has done its marketing and claims it hasn't been included in discussion about the channel's management. Then the Seattle giant told Kraft that its earlier breach of contract accusations hadn't been remedied, so it was ending the agreement.

The Journal article notes that Starbucks' claim that Kraft has harmed it is belied by the strong sales growth- rising ten-fold since 1998. Causing further confusion, senior Starbucks executives are on record complimenting Kraft for its successful efforts on the coffee roaster's behalf.

Apparently, one remedy would be for Starbucks to buy the Kraft operations at a "market" price plus some premium.

Estimates of the channel's value, of course, vary. But they include one of around $1.5B. Then, the piece observes, Starbucks would have to replace Kraft's channel investments and efforts with its own, costing even more money.

This is, at heart, an old marketing conundrum. Producers give away large amounts of control and sweet terms when initiating various activities. Channels of distribution are risky, expensive and difficult to create from scratch. When a large, successful company like Kraft has a functioning channel, it makes sense to rent it, albeit at a high cost.

Years later, then the brand is established, the producer typically attempts to wrest control back from the distributor.

Manufacturers' reps face this situation all the time. As a result, they charge high margins for their efforts, knowing they will lose the successful brands down the road, while the failures won't pay them very much.

In this case, Kraft didn't plan to lose the brand franchise. Starbucks evidently only came to realize later what it had ceded to the food giant. It seems rather short-sighted for Starbucks to pick this particular fight, when it probably could have engineered a smoother transfer of the channel ownership over time. But that doesn't seem to be Howard Schultz' way.

I'm going to be very interested to see how this one develops. No doubt much of the case will turn on the exact wording of the written agreement between Kraft and Starbucks which, of course, is not currently public. From what I've read, though, so far, I'd put my money on Kraft in this fight.

Netflix's Growing Effect On Video Consumption

CNBC's David Faber presented a nice little report on Netflix yesterday morning. In it, he provided some details related to the company's service and its effects on various internet-related phenomena.

For example, HBO, according to Faber, has recently lost more than one million subscribers to Netflix's instant video content viewing. With so many titles available to stream to computers and/or download to DVRs, HBO's value as a separate paid service is dimming.

Netflix is reputed to be responsible for as much as 25% of web traffic during prime hours, as vast amounts of video content is viewed via streaming.

I can't recall the datum, but Faber mentioned the mix of online vs. mailed video content currently being consumed on Netflix, and it's heavily tilted toward the former.

Faber noted all of the above as distinct from the firm's impressive stock price performance.

The nearby price chart for Netflix and the S&P500 Index confirms this. It puts the S&P to shame and has easily transitioned to its new, more heavily-online distribution model while its total returns have remained attractive. Meanwhile, Blockbuster struggles with its legacy stores under Chapter 11 protection.

Faber mentioned that those who have dared to short the stock have paid dearly for their mistake.

I'm guessing that, if Netflix were part of the S&P500, It would have made appearances in my equity portfolios by now.

Price Comparison Mobile Phone Apps vs. Websites

Sometime early last week I heard or read a news story concerning Amazon offering a free mobile phone shopping application. If I understood it correctly, the online store released the app so that shoppers could take a cell phone picture of an item or its barcode, or type in its name, and Amazon would provide price comparisions from other retailers or sources. The app was available prior to Black Thursday.

I don't use my cell phone for shopping or finance, but I quickly considered how this technological development would affect various web-based comparison shopping services. Again, I don't use them, but I have a pretty good idea what they are. A quick Google of the topic produces results including PriceGrabber, Bizrate, Nextag, Smarter, and more. It doesn't take much intelligence to realize that maintaining such a website is expensive and provides revenues and profits to someone.

Thus, Amazon's new cell phone comparison shopping app represents a Schumpeterian type of technological and retail structural advance which could well doom those websites.

I'm assuming Amazon's app disintermediates those other websites. But even if it used them, as well, Amazon's position as a retailer makes it different. Very much like a financial broker filling orders from its securities inventory before going to the markets. Or the original Sabre airline reservation system.

When a vendor offers a comprehensive service involving comparison shopping, it is slipping customers into a closed system of its own design. That can't be comforting to the owners of those older comparison shopping websites.

Will they gradually lose traffic and value? I haven't seen a business story about this phenomenon. Perhaps it's too early to assess the behavioral changes of shoppers and the effect of those changes on the older comparison sites. But it's hard to believe that they won't now be in some trouble or, at least, have significantly more competition with Amazon's entry into the fray.

Malkiel On "Buy & Hold" Equity Strategies

Earlier this month, Burton Malkiel wrote a persuasive editorial in the Wall Street Journal entitled 'Buy and Hold' Is Still a Winner. He begins by writing,

"Many obituaries have been written for the investment strategy of buy and hold. Of course, investors would be better off if they could avoid being in the stock market during periods when it declines. But no one—either professional or amateur—has ever been able to time the market consistently. And when they try, the evidence shows that both individual and institutional investors buy at market tops and sell at market bottoms."



It's a useful reminder. Many investors, including professionals, panic in a sharply-falling market and exit, only returning after the bottom has been touched and significant gains have already begun to be seen in the equity market indices. Malkiel goes on to assess some of the facets of equity markets of the past decade,

"Stocks and mutual funds were liquidated in unprecedented amounts at market bottoms in 2002 and 2008. Professional investors had large cash holdings at market bottoms but tended to be fully invested during market tops. Buy and hold investors in the U.S. stock market made an average annual return of 8% during the 15 years from 1995 through 2009. But if they had missed the 30 best days in the market over that period, their return would have been negative. Market strategists called for a sharp market decline in late August 2010 as technical indicators were uniformly bearish. The market responded with its best September in decades.



While no one can time the market, two timeless techniques can help. "Dollar-cost averaging," putting the same amount of money into the market at regular intervals, implies investing some money when stocks are high, but also ensures some buying at market bottoms. More shares are bought when prices are low, thus lowering average costs.


The other useful technique is "rebalancing," keeping the portfolio asset allocation consistent with the investor's risk tolerance. For example, suppose an investor was most comfortable choosing an initial allocation of 60% equities, 40% bonds. As stock and bond prices change, these proportions will change as well. Rebalancing involves selling some of the asset class whose share is above the desired allocation and putting the money into the other asset class. From 1996 through 1999, annually rebalancing such a portfolio improved its return by 1 and 1/3 percentage points per year versus a strategy of making no changes."


I can vouch for Malkiel's basic concepts. My own research has confirmed what anyone can find who closely examines the S&P500 Index. It rises in roughly 2/3 of months, with significantly long and deep losses only rarely. Thus, it pays to usually be invested long in equities. Dollar-cost averaging, combined with rebalancing,
allows an investor to amass more assets/dollar, and take profits in a regular, disciplined manner, to spread out among all the other assets.

Further, it's a little-known truth that most actively-managed funds don't beat the S&P500. Malkiel observes,


"As Jack Bogle, founder of the Vanguard Group, says: "In the investment fund business, you get what you don't pay for."



The evidence is clear. Low-cost index funds regularly outperform two-thirds of actively managed funds, and the one-third of actively managed funds that outperform changes from period to period. Even the very few professional investors who have beaten the market over long periods of time—Berkshire Hathaway's Warren Buffett and Yale University's David Swensen, for instance—are quick to advise that investors are likely to be much better off with simple low-cost index funds than with expensive actively managed funds.


The chart nearby illustrates how someone who invested $100,000 at the start of 2000 and, following my advice, used index funds, stayed the course and rebalanced once a year, would have seen that investment grow to $191,859 by the end of 2009. At the same time, someone buying only U.S. stocks would have seen that same investment decline to $93,717."


The above is sadly accurate. For most investors, disciplined, frequent asset purchases and rebalancing of inexpensive, available index products will deliver a much higher expected return than chasing the last year's hot actively-managed funds. The latter strategy pretty much guarantees buying at the tops of those funds, then selling at the bottom to buy the next year's winners.
 
Instead, as Malkiel concludes,
"The diversified portfolio, annually rebalanced, produced a satisfactory return even during one of the worst decades investors have ever experienced. And if the investor also used dollar-cost averaging to add small amounts to the portfolio consistently over time, the results would have been even better."
 
Even in the past decade, according to Malkiel's findings, investors would have enjoyed positive returns which would have outearned investments made and left in the S&P500 at the decade's beginning.
 
'Buy and hold' isn't a totally passive approach. But it's disciplined, limited activity, using only index products, can pretty easily outperform most active funds and an unmanaged use of those indices.

The Latest European Bank Disasters

US Equity markets faltered last week due, in part, to more problems among European banks. This time it was Irish banks, but the Spanish ones are on everyone's mind.

Between last April's Greek bank crisis and the current concerns, pundits are now calling into question the ECB's bank stress tests. A recent Wall Street Journal article noted how much country-specific latitude exists for bank capital requirement determination. Differences in housing markets, for example, allows banks in different countries to allocate capital differently for mortgage loans.

On the face of it, this sounds problematic. It seems that, as with US banks, the Basel required capital determination methodologies are sufficiently pliable to allow for under-capitalization.

Another important criticism of capital regulations, generally, is that they are pro-cyclical. Typically backward-looking, using past volatilities as inputs, capital requirements penalize recently-troubled asset classes, while leaving those potentially ready to cause a problem with lesser capital allocations.

But, more generally, it's useful to consider what several decades of attention by global financial regulators have achieved in terms of preventative bank capitalization.

That is to say, not much. In fact, the CDO mess occurred under full implementation of the best regulatory capital approaches that wealthy countries could muster over the years since the LTCM meltdown of 1998.

Doesn't inspire investor confidence in our global financial systems, does it?

Humphrey-Hawkins On The Chopping Block

Back almost a year ago, in February of 2009, I wrote this post mentioning the ill-conceived Humphrey-Hawkins Bill regarding the Fed's mandate. In it, I noted,

"To fully understand this, one has to go back to Paul Volcker's tenure to understand that Congress routinely has threatened the independence of the Federal Reserve System, which it created as a populist alternative to a single central bank, when and if it does not seem to be sufficiently lubricating national finance with the growth of the money supply.



"Thanks to William Jennings Bryant's advocacy of American farmers' cry for coinage of silver, to devalue dollar-denominated debts by inflating the money supply at the turn of the century, the Fed system was designed to give each of the country's regions a Reserve bank, and, thus, a say in money supply management. It was a populist solution which would lessen the chances of another J. Pierpont Morgan-led rescue of the US financial system as occurred in the Panic of 1907.


Much later, in the waning days of Hubert Humphrey's life, the hapless liberal Democrat's misguided Humphrey-Hawkins Full Employment (and Balanced Growth) Bill (Act) was passed, mandating that the Fed maintain equal focus on two objectives: appropriate money supply growth consistent with low inflation, and full employment. The former, of course, is often at odds with the latter.


And it was this issue to which Greenspan was referring, by implication. If he had tried to rein in subprime lending by more vigorous bank examination and quashing of these activities, Congress would have hauled him up before some committee to explain his actions, which would have dampened economic growth, particularly at the expense of home ownership by lower-income groups.


This Greenspan was unwilling to do."


There are two points which are important to understand from this passage, the CNBC program about which it was written, and Humphrey-Hawkins, generally.

The Act was a grotesque mistake passed at a time when America had become somewhat indolent and expectant. Acknowledging harsh economic realities wasn't in vogue. The reality that there are periods in which tradeoffs must be made between monetary policy and employment was simply ignored, to be legislatively banished like some sort of King Canute ordering the tides to recede.

The dual mandate idea was an idiotic mistake of epic proportions, foisted upon the American economy by uninformed political hacks.

It was yet another example of a constant theme in American politics since the 1913 creation of the Fed, i.e., Congressional threats to restructure, limit or abolish the Fed, should the latter pursue its price stability mandate too zealously.
Now, thanks to the recent election outcomes, QE2 and failed fiscal stimulus spending of the past two years, there's serious talk of repealing Humphrey-Hawkins.
Until I read the recent Wall Street Journal lead staff editorial in last weekend's edition, The Fed's Bipolar Mandate, I hadn't really considered how much economic damage occurred in the years following the Act's passage. In a sense, H-H legislatively institutionalized what had become a 1960s-era trick. The Fed chairman would goose the money supply prior to presidential elections, in hopes of being reappointed in exchange for providing favorable, expansionary monetary policy.
 
The editorial notes how frequently current Fed officials have referred to the Fed's employment mandate as a basis for QE2. Yet, Fed Governor Kevin Warsh recently wrote a Journal editorial in which he dismissed the Fed's ability to even affect such economic ends with purely monetary policy.
 
Now, as the recent Journal staff editorial observes,
 
"The irony is that critics of QE2 are being portrayed as enemies of Fed independence, when the truth is the opposite. Ending the dual mandate would liberate the central bank to focus on the single task of stable prices, which is hard enough in a world of fiat money and no formal price rule."
 
Congress created the Fed, and it constantly harasses the bank's chairman, threatening intervention if politically-popular monetary policy isn't provided. This is old news, and really has to simply be ignored.
 
The only chance the US has of regaining some monetary self-discipline is for Congress to repeal its own prior stupidity, leaving the Fed the simpler, more achievable aim of providing price stability for the US dollar.

CNBC's Ford Turnaround Special

I remain unconvinced that Ford has effected a true, long-lasting "turnaround." As I discussed in this recent post concerning CNBC's special program on the topic, it's much too early to declare victory on that dimension.

Accidentally still awake early this morning, I saw some of the aforementioned special. I was unimpressed.

To be clear, Mulally deserves credit for doing some things which were necessary to stop Ford's death spiral. These included no-brainers like selling or shutting marginal brands, some of which had been foolishly purchased within the prior decade or so. And, yes, Mulally accelerated development of various new models.

But what struck me as I listened to all of these actions was how, well, obvious they were.

I have a high regard for Mulally's managerial skill. I believe I expressed this for his performance at Boeing, which foolishly failed to adequately reward him. So he was ripe for recruitment to Ford.

However, there probably are 5-10 good US senior executives who could have done most, if not all of what Mulally did at Ford. I suspect much of what Mulally was able to do was a function of Bill Ford and his family's realization at how badly they had run Ford into near-bankruptcy. They had, to use a phrase from Saul Alinsky's playbook, become unfrozen.

What were once-unthinkable measures had become acceptable, given that the alternative was corporate death.

Mulally was fortunate to be given so much latitude. I really doubt that, had he arrived five years earlier, he would have been so successful in halting Ford's slide.

This doesn't detract from what Mulally accomplished, but it does suggest others could have done the same, given his opportunity.

And it still doesn't mean Ford, and Mulally, have accomplished what would be a first- a long term, lasting ability to earn consistently superior total returns for shareholders. Which, to me, would constitute a true, enduring turnaround of Ford.

Commodity Prices & Government Assurances

In last Thursday's Wall Street Journal, Agriculture Secretary Tom Vilsack was reported to have said,

"I'm not sure that commodity prices necessarily translate directly and proportionately into food costs. They go up and down all the time."

If you Google Vilsack's bio, you'll see he has zero experience as a commodities trader, farmer or economist. His profession should not surprise you, since he's a professional politician. He graduated from law school, and plied that trade.

So how can Tom be so sure commodities just go "up and down all the time?"

Later in the Journal article, General Mills is cited as ending consumer promotions for cereals which have kept a lid on prices.

Nowhere in Vilsack's reported comments was there an acknowledgement that global demands for agricultural commodities are booming as other nations become richer and exhibit higher growth rates than the US.

With the article's title "Vilsack: Food Costs Won't Surge," and subtitle, "USDA Chief Says Consumers Won't Fell Jump in Futures," you get a sick feeling in your stomach, don't you? And not- yet- from hunger?

The YouTube Viral Quantitative Easing Video

Perhaps you've heard of this video by now. It appeared on YouTube on November 10th. As of the morning of November 18th, as I'm writing this post, it has had just over 1.5MM views.

The creator of the video appeared on CNBC's early afternoon program yesterday. He is a former commodities trader who produced the clip to explain QE & QE2 to his economically-challenged friends. On air, he deferred his specific thoughts about QE2 to the video, but, later, agreed that, in a word, he does not agree with the Fed's policy.

For some clarification before you watch the clip, I noted a few factual errors. Ben Bernanke has prior monetary policy experience. He is generally regarded as a leading expert on the economic history of the Great Depression, and served on the Fed prior to his being named as Chairman.

I also think that the video is a bit unfair in characterizing Goldman Sach's mission as 'ripping off the American people.' Prior posts under that label will reveal that I feel the firm is rapacious and dangerous with which to do business. If you interact with Goldman on a professional basis, even as a so-called client, prepare to be dealt with sharply and without undue concern for your welfare. You are well-advised to look after your own interests, because the firm will certainly look after its own equally with, if not before yours, even if you are their client.

But, that said, it has certain expertise which may be used on its clients' behalf's. And you can, if you wish, always share in their alleged ill-gotten gains through purchase of their publicly-traded stock.

In case the embedded video doesn't play, you can go to the clip here.

More Confusion On Inflation

Kelly Evans writes a typically-interesting daily column, Ahead of the Tape, in the Wall Street Journal's Money & Investing section.

Wednesday's piece focused on inflation, with the declarative title Why an Inflationary Outbreak Isn't Likely.

Arguing from  Keynesian demand-based, capacity-oriented bases, Evans wrote,

"U.S. consumers, in other words, are hardly better-equipped today to handle higher prices. That is no small matter. It limits the risk of an inflationary outbreak. If consumers don't have rising incomes or savings to pay for higher food and energy costs, for example, they will have to adjust by pulling back on spending elsewhere. That is a deflationary, not an inflationary, outcome."

That's true, from a purely Keynesian perspective. Evans went on to cite comparisons to the 1970s and quote an economist for further proof of slack labor demand.

The problem is, this approach ignores the Austrian school's definition and conception of inflation as a monetary phenomenon. Milton Friedman, of course, agreed, with his now famous quote,

"Inflation is always and everywhere a monetary phenomenon."

Isn't that why we had stagflation in the 1970s, and may be creating it again now, as I argued in this recent post? Back then, one commodity, oil, drove the US inflation rate up into the teens. Arthur Okun's misery index skyrocketed, as interest rates soared to cover inflation expectations. Yet, curiously, Evan's doesn't touch on those aspects of the late 1970s US stagflation experience.

The reason stagflation can occur is because slow economic growth can be divorced from inflation caused by commodity prices and foreign trade flows which can depreciate the dollar.

Only by focusing on Keynesian production-factor supply and demand as the source of inflation can you ignore the monetary sources of the phenomenon.

I'm frankly a bit surprised that the Journal is printing this sort of nonsense.

GM & It's IPO

We've been bombarded with GM IPOmania this week. Today is the big show.

Predictably, CNBC has been hauling anyone with a word to say about this onto their network to comment. A favorite has been one-time GM, Ford and Chrysler senior executive Bob Lutz. He was recently paired with Paul Ingrassia to debate various aspects of the IPO.

Lutz, of course, is a big cheerleader for the re-emergence of GM as a publicly-held entity, playing down the remaining 25% government stake in the firm. Ingrassia was more balanced.

Whereas Lutz crowed about the great Rattner-led government reorganization of the firm under Chapter 11, Ingrassia noted that it was GM's management that refused to do so when it would still have saved the firm from its ultimate failure.

Elsewhere, on yesterday's noontime program, former hedge fund manager Michael Steinhardt replied with an immediate, unequivocal "no" when asked if he would buy/hold the GM IPO. Steinhardt cited industry and competitive factors which offered more downside than upside potential in the years ahead.

CNBC's resident auto sector reporter, Phil LeBeau, was popping up distressingly frequently, backed by big electronic displays of data and analytics to stump for the GM deal. He ranted incessantly about how all GM needed was for the industry to return to some higher annual vehicle sales rates, and GM was just sure to coin money. In a November 3rd Wall Street Journal article entitled GM Could Be Free of Taxes for Years, the paper reported,

"General Motors Co. will drive away from its U.S.-government-financed restructuring with a final gift in its trunk: a tax break that could be worth as much as $45 billion.



Now it turns out, according to documents filed with federal regulators, the revamping left the car maker with another boost as it prepares to return to the stock market. It won't have to pay $45.4 billion in taxes on future profits.



The tax benefit stems from so-called tax-loss carry-forwards and other provisions, which allow companies to use losses in prior years and costs related to pensions and other expenses to shield profits from U.S. taxes for up to 20 years. In GM's case, the losses stem from years prior to when GM entered bankruptcy.


Usually, companies that undergo a significant change in ownership risk having major restrictions put on their tax benefits. The U.S. bailout of GM, in which the Treasury took a 61% stake in the company, ordinarily would have resulted in GM having such limits put on its tax benefits, according to tax experts.


But the federal government, in a little-noticed ruling last year, decided that companies that received U.S. bailout money under the Troubled Asset Relief Program won't fall under that rule.


The government's rationale, said people familiar with the situation, is that the profit-shielding tax credit makes the bailed-out companies more attractive to investors, and that the value of the benefit is greater than the lost tax payments, especially since the tax payments would not exist if the companies fail."


This extra sweetheart deal for the firm is yet another reason it should have gone through conventional bankruptcy. Then some other firm, seeing this special TARP-related benefit, might have paid up handsomely to acquire GM assets and the special tax treatment. As it is, the crony capitalism under which GM was "rescued" insulated the firm from outside pressures, other than the government, and unfairly penalized Ford by essentially rewriting the tax code for a newly-public GM.
 
Still, just because I don't like that treatment doesn't mean it doesn't have economic value. It does. The question is, how much of GM's attraction rests on special, one-time tricks and deals? Like the five-year union no-strike deal? Or the tax-loss carry-forwards? It's one thing to spin GM out with all these special deals, but it's another for the firm to make consistent progress on cost controls, revenue growth and total returns for shareholders.
 
The sector in which GM operates is still highly competitive. Many of its more effective competitors produce their US vehicles in Southern right to work states without unions. Any rise in annual US vehicle sales will result in GM's competitors fighting for the added share. It's not like AutoNation's Mike Jackson and CNBC's Lebeau suggest, which is that GM will somehow be assured of a healthy share of US sales growth. We still don't know that the firm can produce a full line of saleable, profitable vehicles for several consecutive years.
 
Does anyone really think GM's competitors will be standing still, so that the newly-public firm can just walk in and take new share?
 
Like Lucent when it was spun off from ATT, I prefer to wait a few years for the new firm to demonstrate its ability to perform in a consistently superior manner. And to do so in a sector that offers sustainable strength, thus making the firm attractive among a wide range of other equities one might buy.

Microsoft's Refusal To Consider Splitting Itself Into Separate Units

Imagine my surprise in finding yesterday's Wall Street Journal's Marketplace section's lead headline to be Microsoft Breakup Not in Cards.

Back in August of 2007, I wrote this post, in which I explicitly suggested,

"As I wrote nearly two years ago, what Microsoft needs to do is think and behave like a venture capitalist, and spin out various smaller entities to work on the areas in which it wishes to lead. By retaining a stake in the firms, seats on their boards, Microsoft, the parent, will share in the innovation-based value that these startups will create. In time, these startups could become the next Googles, etc.



But so long as senior Microsoft executives respond to Mundie's efforts with comments like Tom Gibbons, VP for various non-computer software efforts,


"I need to think of this as a completely new effort,"


in response to Mundie's stimuli involving mulicore processors, I think Microsoft is doomed to remain a large, hulking, mediocre giant whose best days of consistently superior total return performance are way, way behind it."

Another posts discussing this may be found here. Suffice to say, others have publicly echoed my thoughts in the last few years.

For Ballmer and Gates to audaciously dismiss shareholder questions about this is really over the top, isn't it?

Last time I looked, neither of those two Microsoft board members and billionaires are valuation experts. Gates didn't even finish college.

That's not to take anything away from how Gates originally built Microsoft. I wouldn't go so far as Julian Robertson did, calling Gates the most important innovator or inventor, or whatever he called him, of last or this century. But I do acknowledge his early success in providing consumers with powerful, inexpensive, fairly useful, if not elegant and bulletproof applications and operating system software.

Ballmer's only stock in trade, of which I am aware, was bullying customers like Dell and HP to pre-load Windows and, at one point, Explorer, on PCs, or else.

Neither earned his spurs as either an investment banker or valuation consultant. So wouldn't it have been a reasonable, even defensible response to the investor's question for Ballmer to agree to have the board consider retaining one or two outside, objective experts to opine on the answer to his question? The Journal article even references a Goldman analyst's public suggestion that spinning off the businesses "could potentially unlock hidden value."

Sure it would. But the wrong way to answer was what Ballmer and Gates did, which was to simply dismiss the question out of hand, citing their own personal beliefs in a preference for a monolithic Microsoft.
I don't care what Gates or Ballmer babble about imagined "synergies." Ballmer's public acknowledgement of the company's dismal share price performance over the past decade, combined with a refusal to think broadly about how to remedy that failing, tells you all you need to know about the firm's closed-minded management.
 
A few weeks ago, I heard one of those inane pro-con CNBC debates on the occasion of Gates' birthday. In that post, I wrote,
 
"In the CNBC discussion, two fund managers with opposing views were pitted against one another on the occasion of Bill Gates' birthday.



What amazed me is that, despite the admission of a decade of non-performance, the CNBC anchors refrained from criticism of the company. Instead, they seemed to want to favor the opinions of a fund manager who claims that the firm's cashflow will now rise, and the XBox proves the company is still innovative.


I can't think of many companies with a flat ten-year equity price performance that roughly apes the S&P which would enjoy this sort of media treatment."


For some reason, Microsoft, and Gates, seem to provoke irrational responses by analysts, fund managers and the media. They get a pass for poor performance, where other firms would be flayed for the same failures.

It's probably another example of a corporate failure having too much influence and spending power to warrant being treated honestly in the media, fund management and brokerage communities. Heaven forbid one of them should lose their place at Microsoft's spending or information trough for being candid about the firm's lackluster performance and mistreatment of its non-billionaire or -millionaire outside shareholders.

CNBC Showcases Senator Debbie Stabenow's Misleading Untruths Re: GM

On the eve of tomorrow's much-ballyhooed GM IPO, CNBC is trotting out all manner of political and business people who want to bask in the limelight of the topic.

This morning, Michigan Senator Debbie Stabenow got her turn. Trouble is, the bulk of Stabenow's statements were either grossly misinformed, or lies.

This sort of segment is the reason I only watch/listen to CNBC for actual market news and the occasional bona fide pundit. For the most part, the network's morning programming has managed to sink to the level of Pravda before perestroika.

Before I discuss Stabenow's comments, let me quote the relevant lines from her own biography concerning her credibility and aptitude on matters concerning GM, macroeconomics and energy. If you scroll down to the very end of Stabenow's bio page, you will find this extensive description of her pre-government experience,

"She attended Michigan State University, where she received her Bachelor's (1972) and Masters (1975) degrees. She worked with youth in the public schools before running for public office."

That's it. She was either a teacher or counselor in the Michigan public school system. She won her first elected post in 1974, which suggests she did a part-time MSU masters while commencing her real career- politics. Wikipedia lists her graduate degree as an MSW. I don't typically rely on that source, but in this case, it's ostensibly more detailed than the Senator's own bio page.

My point is, Stabenow doesn't appear to have any economics or business background. Like so many in Congress, of either party, she had a brief, post-college career in public education, followed by a quick exit into a 30+ year career in politics. So I think it's safe to say that the bulk of what Stabenow voiced this morning was probably collected and prepared by her staff. She is, in effect, a mouthpiece.

For contrast, recall that Phill Gramm and Dick Armey were PhDs and professors of economics. Newt Gingrich was a history professor and PhD. Even New Jersey's geriatric Democratic Senator, Frank Lautenberg, once, long ago founded and successfully built payroll processing giant ADP.

Stabenow isn't close to being in a league with any of those other past or present Congressional members.

Never the less, Stabenow assured one and all that a failure of the government to bail out GM two years ago would have brought down the economy, wrecked all its suppliers and, with them, our defense sector. Additionally, she contended that the only way we can have a viable American middle class is to preserve GM-like 'manufacturing' jobs.

Stabenow next assured viewers that GM's workers sacrificed so much to keep the failed auto maker alive. Yes, the UAW was a force for good, and never was a factor in the firm's demise.

Then the Senator swung to the 'green jobs' front, alleging that the US must lead the world in this job-creating sector. And, of course, Michigan is going to lead in that. With, did she mention- no- overly-generous helpings of federal subsidies. And state investments. No, the way in which Stabenow couched these subsidies was government-private sector 'partnerships.'

There may have been more whoppers, but I don't recall them. I'm sure you could see them for yourself over on CNBC's website this morning, before the video disappears behind a paid subscription wall.

So much for Stabenow's tall tales. Here are more truthful versions of her contentions.

The alternative to the manner in which the federal government, under both presidents Bush and Obama, assisted GM, was not to do nothing. Thus, the alternative outcome for the economy, GM's UAW members, vendors, and auto- and defense-related competitors was not bankruptcy, dissolution and widespread economic ruin.

As I have written in many posts, found under the labels 'GM,' and 'Government Intervention,' a well-managed, conventional, Constitutionally-provided Chapter 11 filing by GM, without government ownership or coercion of the firm's legitimate bondholders, could have easily avoided all of the catastrophic consequences mentioned by Stabenow and others. I won't go into the same detail here as in prior posts, but merely sketch the alternative scenario.

Rather than pump tens of billions into a failed management structure, the federal government could have, for much less money, sent direct payments to idled workers. A conventional bankruptcy would have allowed GM's operations to continue under court protection, while they were reorganized. Some operations would have been closed, and some may have been sold or spun back out separately. If private sector banks declined to fund the interim operations, the federal government could have provided loan guarantees, rather than direct aid, in order to facilitate those private loans.

Further, by not strong-arming bondholders to rescind their rightful status, in favor of the politically-connected UAW, needless uncertainty for future fixed income investors regarding bankruptcy actions would have been avoided.

By maintaining some operations under bankruptcy, the process would have kept the various suppliers and the competitors which also relied on those suppliers in business.

The US economy need not have collapsed simply because the federal government declined to pump upwards of $50B into a failed GM.

The UAW, far from making noble sacrifices, was bailed out by a Democratic administration, to the detriment of legal bondholders. Stabenow is not telling the truth when she paints the union's GM workers as saints who gave unstintingly in a worthy cause. In fact, they came away far better thanks to the federal bailout of GM than they would have in a conventional bankruptcy, under which their labor agreements could have been suspended and forcibly renegotiated.

On the subject of electric cars and other 'green' business initiatives, one only has to read this week's excellent Wall Street Journal editorial by George Gilder to understand how wrong-headed and false Stabenow's contentions on this topic are. By deliberately reducing energy efficiency and requiring cumbersome new energy networks to move from gasoline to electric vehicular propulsion, we will be lowering US living standards. Even Boone Pickens' vehicular natural gas plans make better economic sense than Stabenow's simple-minded regurgitation of false, ill-conceived and misleading left-wing green energy platitudes.

Further, Stabenow blithely blesses the unholy strategy of extreme reliance on subsidies by the green energy sector. Gilder skewered Silicon Valley venture funds for turning from private sector-financed computer- and information-technology businesses, to favor investments in green energy startups whose major revenue sources are government loans, grants and subsidies. You cannot hide the fact that the green energy push is not market economics at work, but merely old-fashioned government-directed and funded economics using taxpayer money to subsidize politically-popular technologies and pet projects.

Almost nothing Stabenow said this morning was true on its face.

Shame on CNBC for allowing such political grandstanding without serious challenges to any or all of her contentions.

Regarding Alan Blinder's Defense of Bernanke

I do not possess a PhD in economics. Not even a BA in the subject. However, I do hold two business degrees, the completion of which provided me with a substantial amount of both micro and macro economic education, plus a healthy dose of anti-trust law and economics.

Thus, when I read Alan Blinder's In Defense of Ben Bernanke in Monday's Wall Street Journal, my initial reaction was one of potential academic inadequacy to question or critique Blinder's contentions. But, upon rereading his editorial, I realized that many of what I see as his errors are not those of abstruse higher-level economics, so much as those of reasoning and logic. On those bases, I feel quite comfortable discussing his piece.

Blinder begins by claiming "one current catchphrase is "job-killing spending.""

Really? Alan gives no cite on this. So much for PhD-level work, eh? His opening salvo is an unsourced complaint. Even so, it's not government spending that is killing jobs. It's over-regulation, erratic government takeovers of portions of the economy, and vague taxation policies. The spending, by the way, didn't go for infrastructure, as promised, but mostly for transfer payments. Which didn't create jobs, but allegedly saved some. Hardly the same thing.

He then uses an ad hominum argument by calling his friend's detractors "the economic equivalent of the Flat Earth Society." Again, hardly academic-quality reasoning. Or, maybe it is.

Only at the end, by the way, does Blinder tell you what his current position already should. As a Princeton economics professor, he would be well-acquainted with Bernanke. This isn't an objective defense of the Fed chairman. It's somehow personal.

But, back to Blinder's editorial.

Blinder then writes,

"Yet critics are branding QE2 a radical departure from past practices and a dangerous experiment."



He counters that QE2 is really just a big ol' open market operation like the Fed constantly performs. Nothing to be scared of.

But in this recent post, I discussed the Wall Street Journal's lead staff editorial which expressed concerned for QE2's heretofore unheard of effects on the Fed's balance sheet. It is, actually, a dangerous experiment. Blinder's attempt to gloss over type and maturity of assets is misleading.

He continues in his editorial,

"The next charge is that QE2 will be inflationary. Partly true. The Fed actually wants a bit more inflation because, now and for the foreseeable future, inflation is running below its informal 1.5% to 2% target. In fact, there's some concern that inflation will dip below zero—into deflation. The Fed, thank goodness, is determined to stop that. We don't want to be the next Japan now, do we?"

For a counter argument to this, read posts here, here, here and here regarding recent, true inflation rates among commodities and other economic inputs. Virtually every knowledgeable observer realizes that the Fed has switched inflationary measures in order to avoid admitting how commodities in everyday use, e.g., food, energy, metals, are skyrocketing thanks to two phenomena. One is dollar weakness, the other is increased demand by newly-enriched nations. Blinder is just wrong on this argument, following the Fed's lead and choosing convenient measures of inflation which aren't practical, but allow him to claim we're closer to deflation than inflation.

Blinder finishes his item-by-item defense with this passage,
"The final major charge, levied especially by a number of foreign officials, is that the Fed's new policy amounts to currency manipulation: deliberately lowering the international value of the dollar to gain competitive advantage for U.S. exporters. Is there any truth to this? Not if words have any meaning."



Blinder follows with a conventional description of interest-rate effects on capital inflows versus trade-related inflows thanks to a cheaper dollar, claiming nobody knows which will dominate, so Ben is innocent. I don't think that's an adequate or even relevant defense. Just because Ben isn't sure if the trade flows will win out doesn't mean he's not hoping they will.
 
Then there was Blinder's attempt to clean up various other troubling comments about QE2,
 
"More important, the U.S. is a sovereign nation with a right to its own monetary policy. So I was stunned when a top aide to the Russian president suggested that the Fed should consult with other countries before making major policy decisions. Come again? An independent central bank doesn't even consult with its own government.



Finally, there's that old hobgoblin: consistency. Critics tell us that QE2 won't give the U.S. economy much of a boost but will lead to rampant inflation. Both? How does that work?


If buying Treasurys is a weak policy tool, a view with which I have some sympathy, then it shouldn't be very inflationary. There is no magic link between growth of the central bank's balance sheet and inflation. People, businesses and banks have to take actions—like spending more, investing more, and lending more—to connect the two. If they don't, we will get neither faster growth nor higher inflation, just more idle bank reserves.


But I don't run the Fed. Maybe Chairman Bernanke's ideas are better than mine and, in any case, the planned QE2 is far better than doing nothing. It is not a shot in the dark, not a radical departure from conventional monetary policy, and certainly not a form of currency manipulation."

Blinder contends QE2 is weak medicine, so, no problem. He then lambastes those who believe that QE2's effectiveness and damage must be proportional. But that's not at all true. QE2 can easily trigger inflation without doing much in the way of boosting US economic activity. I think the more relevant approach is to ask Blinder to explain why the effects should be equal?

Then Blinder switches gears, and claims that if QE2 doesn't work, all we'll have is idle bank reserves. Here, he ignores the effects of all that money creation on the perceptions of the world's investors on dollar valuation.



Finally, is QE2 really "far better than doing nothing?" This is a peculiarly Keynesian view with which Austrian school economists, including Milton Friedman, would never agree. And it is certainly not the first two of Blinder's last three descriptors. And if it's not the third, it's a pretty good facsimile of it.

A Financial Plumber Speaks In Favor of Managed Trade

At the end of last month, John Cochrane wrote a great editorial in the Wall Street Journal entitled Geithner's Global Central Planning. I wrote about it here. So Geithner & Co.'s nonsensical ideas about global trade central planning, in concert with exchange rate management, is not news.

Never the less, Geithner recently wrote another defense of these bad ideas in the Journal. It was the same basic set of themes, i.e., set balance of trade flow targets, get other countries to appreciate their currencies so the US can depreciate its dollar.

Cochrane exposed them as stupid and unfounded theories then, and nothing has changed about his critique in the past three weeks.

However, there's a deeper issue here, as well. That is the question of Geithner's credibility. As I have written in prior posts, there's nothing in Geithner's background to suggest that he is anything but a financial systems plumber. When he's had a significant policy-level position, such as running the New York Fed, he botched the job. Remember, in that capacity, he let himself be out-maneuvered by Goldman Sachs and a couple of French banks, resulting in his using taxpayer dollars to fully repay those parties for their AIG exposure.

I don't recall Geithner authoring oft-cited, learned papers concerning international trade theory. Or theories of currency policy and management.

In fact, everything about his recent articles attempting to defend his wacky notions of international trade and currency valuations smacks of expediency and, as Cochrane notes, unfounded, un-normed concepts prone to political manipulation.

Frankly, I just don't think Geithner, a guy who couldn't even do his taxes correctly, or manage to hire a competent accountant, has the mental horsepower to comprehend the current dilemma of US monetary and economic officials.

Back some years ago, I believe in the late 1980s, in a Wall Street Journal editorial, a respected economist made the insightful observation that nations had only two policy levers- monetary and fiscal- with which to attempt to affect three phenomena- domestic economic growth, domestic inflation, and international trade balances. The latter former lever, monetary policy, is typically given the double duty of governing inflation and international trade and currency policies.

Stronger currencies, following from low monetary base growth and/or higher interest rates, tend to hurt economic exports and often bring in foreign investment flows. Pro-growth monetary policies, such as our current weakening dollar and zero interest rates, aid exports but cause global investors to seek other instruments. As a reserve currency, these policies do even more damage by causing global holders of dollars, as a store of value and commonly-accepted medium of exchange, to seek more stable exchange media.

This is where, in past times, gold was used as the third lever to automatically affect international trade flows and valuation. Not coincidentally, monetary base growth, being backed by gold, was restricted from over-expansion by the knowledge that a cheaper currency would only hurt a nation when foreign holders of that currency redeemed it for now-cheaper gold.

Geithner's transparent attempts to force global investors and other countries to overlook US devaluation of the dollar and management of trade flows to our benefit haven't fooled anyone. But, then, what do you expect from a guy who, as a financial plumber, is trying to work beyond his capabilities?

The Easy Way To Defund GSEs

Emil Henry, Jr., a former assistant secretary of the Treasury in the Bush administration, wrote an insightful editorial in last Thursday's Wall Street Journal regarding Fannie and Freddie.

According to Henry, Treasury has always had the power to rein in the GSEs. Here's what he wrote,

"But the Treasury doesn't need Congress or an academic assessment in order to tackle the most important reform goal: eliminating the GSEs and moving their activities to the private sector. Mr. Geithner himself can immediately reshape the mortgage markets—by withholding his approval of new debt issuances by the GSEs. That's the best way to begin curtailing the GSEs, and it can be done unilaterally.



Congress chartered the GSEs and in their charters required that the Treasury secretary approve all of their new debt. For decades, the Treasury exercised this duty, and the GSEs submitted each new debt issuance to the department for prior approval.

But the Clinton administration found this process cumbersome and a strain on Treasury staff. It established a new process that weakened the administrative approval process for GSE securities offerings. This hands-off approach represented an abdication of Treasury's essential oversight powers.


By the mid-2000s, the GSEs' process of debt approval had devolved to a simple notification of the Treasury, without any formal process of approval. The pace of debt issuance was so rapid that such notifications came to the Treasury weekly, typically on one piece of paper that simply listed proposed issuances without supporting data (such as income statements or balance sheets) upon which to make informed judgments.
I found these to be fairly stunning revelations. First, that Treasury has a legal ability to approve GSE debt issues- or not. Second, that this power had been abdicated to the point of the GSEs simply sending non-descriptive advisories of debt issuances.

Henry thus reasons,


If the Obama administration is serious about addressing the GSEs, it should re-establish a rigorous process to review all GSE debt issuance. That process should require the GSEs to provide Treasury with full financial data and justification for issuances, including statistics that show the creditworthiness of the agencies after each offering. In addition, the Treasury secretary should have to approve all new debt issuances personally.


The administration should also announce that in 2012 the Treasury will begin to deny a portion of GSE debt issuances with the goal of reducing their debt 50% by 2015 and 100% by 2018. This eight-year period of adjustment would allow the private markets ample time to provide secondary market liquidity.

There will be a private market ready to absorb the securities currently held by the GSEs. Private companies won't be able to borrow as cheaply as the GSEs could (thanks to their implicit government guarantee), but there will still be plenty of profit left to capture in the market for mortgage securities."



This might not be expected action for the next two years. But a change in administration could bring this about, regardless of who controls Congress from 2012 onward. I think Henry is correct to believe that private conduits would re-emerge if Fannie and Freddie were limited by debt ceilings. And there certainly would be sufficient profit in private label securitization, once the GSEs are hobbled and have begun to shrink.