Mike Jackson Flacks For US Automakers

Autonation's CEO, Mike Jackson, a guest host on CNBC yesterday morning, spent his time flacking for the US auto sector.

It's exasperating to me to listen to Jackson recount a history that never was as he extols US automakers to the detriment of those overseas. What one has to remember is that Jackson, whose company is in the business of selling cars, is a ceaseless promoter of all things automotive.


Thus, to hear Jackson's version of history, the only way America's automakers could be saved was by government rescue. And that was necessary to preserve jobs and technology.


Well, as I've written in several prior posts, a conventional Chapter 11 filing by GM and Chrysler would have provided both with the time and opportunity to reorganize, group healthy units together and refloat them independently, or sell them to bidders. Further, neither company had to cease operations to do this.


Why Jackson seems ignorant of this fact is beyond me. I guess he's either not creative or simply not well-versed in the very real and frequent occurrence of business death or dismemberment.


So, to hear Jackson sing the praises of GM and Ford and the coming high volume vehicle unit sales years is to listen to someone tell half of a story. Give any business free government help to an extreme and you'll get the same happy ending. Jackson failed to discuss government-mandated purchases of hybrids and other unholy consequences of the excessive intervention.


The one- and only- thing which Jackson got right in this morning's auto fairy tale is that Alan Mulally rescued Ford by better leadership, focus and management, not wholesale reinvention- yet. Because it's way too soon, despite the views of many sector cheerleaders with agendas, to declare Ford a medium- to long-term shareholder winner.


The chart above displays the lone US automaker with a continuous price history, Ford, and, for good measure, Jackson's Autonation, along with the S&P500 Index.

If you have a technical inclination, you might notice that both firms' recent rapid price gains don't have long term sustainable precedents. In Ford's case, it's pretty clearly just a function of the rebound from the nadir of the 2008-2009 market bottom. Of the three series, anemic as its last decade has been, the S&P is the least volatile, ending with a much better performance than either company.

Of perhaps more import is how both Ford and Autonation have current share prices below their 1990s-era tops. Autonation peaked a few years before Ford, but both had either a flattening or multi-year decline for most of the past 12+ years. Jackson became CEO of Autonation in 1999, so he owns most of that performance.

What Jackson chooses not to explain, or perhaps genuinely doesn't realize, is that automaking is, for the most part, an unattractive commodity business over the long term. He railed about how China is the real 'Government Motors,' but, if true, this simply proves my point. It's hardly the sort of industry in which you'd invest a billion dollar fortune, if you had one to invest.

For what it's worth, you don't hear this analysis on CNBC during the day, either, when they prominently showcase all those analysts singing GM's praise. There wouldn't be any agenda there, either, would there? Say, for pieces of future underwriting?

Holman Jenkins, Jr., of the Wall Street Journal, has written many times how US auto manufacturing, especially of small cars, has been legislated onshore to appease unions, thus hurting profitability of the assemblers. When you consider where most of the so-called innovations in vehicles originate, it's typically with vendor-supplied assemblies or devices, e.g., anti-lock brakes, airbags, and, now, so famously touted by Ford's Mulally, all manner of wireless communications devices. Thus, most of the profit for the automakers would seem to be sourced in design, rather than manufacture. Otherwise, the smart, value-adding components are available from sector vendors to any assembler.

Doesn't sound very attractive as an investible sector to me. Rather, it sounds more like a case of advanced Schumpeterian dynamics, wherein the value-added growth has long since left the sector's auto assemblers. The entry of Korean and Chinese automakers, and near-exits of GM and Chrysler fits the description of an industry with low barriers to entry and exit.

Hardly your choicest sector for long term investing.

Another Perspective On Facebook's non-IPO

I recently wrote this post in light of the publicity surrounding Facebook's recent private equity offering, ending with this passage,


"Facebook continues to confound. Is global social networking truly a value-added proposition and business model on a par with Google's search and related ad businesses? Is online gaming via social networking really so novel and profitable?

Or is Zuckerberg merely enjoying the latest, most profitable round of social networking hype?
One thing may be a positive, however. That is, Facebook, Twitter and Groupon, at present, are not public. So any frothiness that subsequently deflates, with concomitant value destruction, will be absorbed by wealthy, so-called 'sophisticated' investors, rather than the general public."
 
Then there's another side, presented in a Wall Street Journal editorial in Monday's edition. Gordon Crovitz asks if the real issue is that wealthy private investors who are clients of Goldman Sachs are getting the benefit of early price appreciation in Facebook, while the average investor has to wait for an IPO that will enrich those early private investors?

What Crovitz contends is that my last sentence needn't even be true, and, at least each investor should determine the suitability of a Facebook-like equity for her/himself.

On further reflection, I agree with him. Mostly because the current system results in the wealthy having access to so many issues which the average retail investor never sees. An example comes to mind: then-vibrant Microsoft.

And I suppose one can contend that retail investors don't need hot IPOs to lose money. They can do that in individual brokerage accounts already. But as Crovitz notes, issues like Facebook, regardless of their long term viability, tend to have short term gains which now belong exclusively to sophisticated, already-wealthy investors.

So I guess I don't mind that retail investors would be exposed to risks from investing in a less-mature Facebook's IPO. Because at least that company would have audited financial statements allowing investors to easily assess, for themselves, the wisdom of buying and/or holding the shares. But on the positive side, average investors would have the opportunity to participate in some of the genuinely value-adding investing successes much earlier, thus sharing much more of the early gains.

To be clear, I'm not advocating investing in Facebook, Groupon or Twitter. Certainly not Twitter. But I am in favor of the SEC putting these into public markets earlier, allowing for public availability of their financials in real time at a much earlier phase of their corporate life.

Investing In US Financial Companies

I continue to find remarks on CNBC regarding investing in the equities of US banks to be suspect.

Consider, for example, the nearby price chart for BankAmerica, Chase, Citi, Wells Fargo, Goldman Sachs, Morgan Stanley and the S&P500 Index.

Despite what you may believe from the daily cheerleading by CNBC equities reporter Bob Pisani, simply holding a basket of these largest six (surviving) equities for the past five years was worse than holding the anemic S&P index.

Yes, Pisani is largely valueless as a reporter, because he's really just an equity markets shill. But it's a deeper issue than that.

First, as I noted, there's the survivor bias. Wachovia acquired itself out of business, while Bear Stearns just imploded. Merrill Lynch and Countrywide are gone, now part of BofA.

Even if you knew in advance which large financial institutions would survive, you'd have to be pretty fortunate to randomly pick the winner- Goldman Sachs. Chase and Wells Fargo basically tied the S&P with no price appreciation over the period. It's difficult to credit those latter two CEOs with being paid handsomely for simply tying the index. If they were hedge fund managers, they'd be pilloried on Capitol Hill.

Citi and BofA remain, of course, unholy messes. The former should have been allowed to fail, so that better management could have gained access to that large asset base. Morgan Stanley continues to limp along, performing like a badly-managed commercial bank, but with the business mix of Goldman Sachs.

If you look back just about a year, you see that, in general, prices have either flattened or actually dropped. So timing didn't really get you much in a year when the S&P rose 15%.

Then there's the sector's prospects for 2011. Here, Goldman is again probably the best-advantaged of a mediocre bunch. With no asset base like a true commercial bank, it doesn't own mortgage portfolio valuation risks and, if it behaves as it has in the past, may even bet on further declines in related assets. For the commercial banks, recent housing price weakness, noted recently in posts here and here, portend another round of punishing valuation plunges reminiscent of late 2007.

Between that imminent risk, and the uncertainty of rebuilding fee income in the wake of the Dodd-Frank bill, commercial bank revenues are not so, well, bankable. Plus there's the reality that bank profitability historically rises with rates...which are ultra-low and show no particular sign of rising.

Unless you feel lucky about timing financial equities, there's not really much positive in the outlook for financial equities.

All of which leaves me critical of CNBC's ceaseless pumping of financial equities. At least Kelly Evan's recent Journal piece on the upcoming earnings season cautions on financial sector equities.

Regarding Amazon & Growth

This morning's Wall Street Journal's Heard On The Street column is a cautionary note regarding Amazon. Martin Peers warns that Amazon's slipping DVD sales will undermine its stock price performance. The article is filled with all sorts of micro-analysis of media consumption and data on Apple's video downloads.

Like other analysts observing Apple, about which I wrote as an investment in this recent post, I believe Peers is underestimating Amazon.


Back when the online retailer was a profitless favorite of investors, my equity selection process avoided it. As the first price chart for Amazon, Apple and the S&P500 Index, going back to 1998 illustrates, I didn't miss much. Amazon pancaked in the tech bubble crash, then began a much more measured, sustained growth, along with Apple.

However, at present, every equity portfolio selected by my process which is active contains Amazon. It's actually more prevalent than Apple, and outperforming the S&P in every active portfolio in my strategy.

The second chart focuses on the last five years of performance for the three entities. Amazon and Apple share a very close performance path, both handsomely outpacing the index.

While Peers cites DVD sales growth as the reason to doubt Amazon's continued outperformance, I prefer to see the company's equity in the context of the broader market. While, as I mentioned, my process did not find Amazon acceptable in prior years, lately, it has become one of the most consistent performers in the S&P.

Peers writes,

"But Amazon looks to have lost the music battle......Given Amazon's success elsewhere, losing in video may only reduce its red-hot growth rate by a few percentage points. But given its sky-high valuation, that isn't something investors could ignore."

I guess that's one way to view Amazon.

Here's another. In recent years, the firm's growth rate is the 14th best in the S&P 500, while it's P/E ratio is 19th best. Taken together, the firm's valuation for its growth rate is quite reasonable. Much as Dell's was in 1998, when I owned it, contrary to the advice of most Dell-watchers. As I mentioned in the prior linked post, Dell went on to be one of the S&P's top ten total return performers that year.

As I also noted in the linked post, analysts who get totally focused on the internal mechanics of the companies they follow tend to lose, if they ever had it, perspective on the companies' performances among the broader market.

In this case, Amazon's general management of its businesses has sustained its performance for years. I would suspect that it's going to take a lot more than being an also-ran in just one particular product segment for Amazon's outperformance to end imminently.

Is The Online Social Network Sector Another Investment Bubble?

You know a trend is becoming important when both the Wall Street Journal and the Economist mention it within the same month.

In this case, the trend is a resurgence of bubble-like valuations in online social networking companies.

Back in September of 2007, the Journal's Dennis Berman wrote an excellent piece concerning the online communities business, about which I posted here. Berman's piece covered a lot of territory, but my concluding observations and quotes from his piece (in blue) were,

"At some point, the questions about Facebook the business will eclipse the praise of Facebook the social phenomenon. And once that point hits, Mr. Zuckerberg will be less able to dictate the terms of how fresh capital is put to use."



Mr. Berman pulls no punches. From his initial description of the now-essentially-defunct GeoCities, to the likely fate of Facebook, his superb writing uncovers a wonderful, timeless story of business innovation, absorption, mismanagement, the rise of new competitors, and the continuing weakness of the underlying business model.


Aside from the marvelous business strategy expose, Mr. Berman makes it hard for the reader to avoid asking the question,


"If no other, larger firm, had bought, or bought stakes in, GeoCities, or was trying to buy or invest in Facebook, would Bohnett and Zuckerberger realize millions in wealth simply from the profitability of their businesses and business model? Or would they become, like Amazon, long on initial market value gains, but short on realized profits?"


That last passage came to mind immediately as I read the Economist's piece on the current frothiness of social networking site valuations. It referenced Groupon rebuffing a $6B offer from Google, Twitter being valued at $3.7B, and Facebook's private offerings valuations rising 77% in just three months. Of course, the big recent news is Goldman's funding a private offering for Facebook, with the shares to be allocated among its most-favored clientele.

Holman Jenkins, Jr., of the Journal, made the Facebook private offering the subject of his column last week, supporting Zuckerberg's choice to remain private and take time to mature before going public.

Perhaps Berman's observations of three years ago are outdated and no longer germane. Then, again, the collapse of the late 1990s technology valuation bubble came after many pundits disregarded the need for profits. Facebook is reputed to have annual revenue in the low billions thanks to ad revenue and a share of sales from games through its site. Still, I wonder if they really have solved the challenges about which Berman wrote so eloquently.

An older veteran CEO with whom I spoke recently was dismissive of Facebook and other online businesses as genuinely value-creating. I'm not quite so sweeping in my scepticism. For example, it's clear what value Amazon and Google have managed to create. I can sort of comprehend Groupon's appeal, although I continue to wonder how profitable it is, and/or what its growth prospects are, or what the long-run financial costs are to the businesses granting the discounts. Twitter doesn't seem to be a viable business.

Facebook continues to confound. Is global social networking truly a value-added proposition and business model on a par with Google's search and related ad businesses? Is online gaming via social networking really so novel and profitable?

Or is Zuckerberg merely enjoying the latest, most profitable round of social networking hype?

One thing may be a positive, however. That is, Facebook, Twitter and Groupon, at present, are not public. So any frothiness that subsequently deflates, with concomitant value destruction, will be absorbed by wealthy, so-called 'sophisticated' investors, rather than the general public.

Ken Lewis' BofA Tab for Countrywide Up 50% Over 2008's Price

Three years ago next week, I wrote this post discussing Ken Lewis' purchase of the part of Countrywide which BofA, of which he was CEO, didn't already own, for some $4B.

Yesterday's Wall Street Journals Money & Investing section headline read 'BofA Pays for Soured Loans,' with the subheading 'Lender Gives Nearly $3 Billion to Fannie, Freddie Over Countrywide Mortgages.'

So that makes the running tab for Countrywide $9B, when you include the $18/share purchase of Countrywide equity in August of 2007 for a total of about $2B. By the way, when Lewis made the January purchase, Countrywide's stock was less than half its August price, or $8/share.

According to the Journal article, a Sanford Bernstein analyst assesses the additional put back risk to BofA at as much as $4B.

I'd love to see Ken Lewis questioned now by someone with good data on the August, 2007 and January, 2008 final Countrywide equity purchases. With the $6B paid for Countrywide by three years ago, $1B of which had already vanished as loss between mid-2007 and early-2008, this week's $3B, and up to $4B more in givebacks over the next two years to private investors, Lewis' Countrywide deal might ultimately cost BofA over double it's 'final' price three years ago.

It's difficult to believe that would still make the Countrywide acquisition by BofA the profitable masterstroke Lewis contended it was.

Oddly, the Journal article didn't seem to mention any of this. But a glance at the nearby price chart for BofA and the S&P500 Index shows how far the former's stock price has collapsed since Lewis closed the Countrywide deal.

While the S&P has lost a few percentage points of value, BofA has dropped by more than 60%!

What do you suppose was BofA's manner of assessing risks of the Countrywide portfolio and its upstreamed mortgages? Could they really have assumed no or minimal losses, when Countrywide was collapsing due to a general residential real estate value meltdown?

Perhaps the Countrywide deal will serve commercial bankers as a cautionary tale of buying badly-damaged financial institutions with far-flung liabilities in the form of loan sales.

Mort Zuckerman On Commercial & Residential Real Estate In 2011

On the afternoon of yesterday's post regarding housing prices, Mortimer Zuckerman, the Chairman of Boston Properties, as well as US News & World Report, weighed in with similar views to Peter Schiff's in an interview on CNBC.

It was interesting to observe Zuckerman carefully avoiding agreeing with CNBC co-anchors that commercial real estate would henceforth escape a serious crisis. What he did say was that his Boston Properties firm, which just purchased the Hancock Center in Boston, concentrates on high-end commercial properties, which do better in downturns. He implied that he expected a further softening of the market, but didn't explicitly say that.

However, he did reinforce Schiff's contentions, in the latter's recent Wall Street Journal piece. He went on to observe that with continued high unemployment and probable declines in residential real estate prices, there could well be an economic softening later this year. Further, he railed against continued excessive government spending, even in the guise of the recent tax rate extension bill.

Zuckerman isn't infallible, but he's a very shrewd guy. It seems that evidence continues to mount for worrisome, real estate-led economic developments later this year.

Housing Price Trends

Despite dire warnings for the just-finished year 2010, the S&P500, according to today's Wall Street Journal, posted a 15.06% return for the year.

Yet home prices continue to be a sobering economic backdrop for the US economy in 2011. Thursday's Journal featured an editorial by Peter Schiff entitled Home Prices Are Still Too High.

Schiff details the meteoric rise of the Case-Shiller 10-City Index gains of an average of 19.2% per year from January, 1998 to June, 2006. Schiff contrasts this with the index's co-creator, Robert Shiller's calculation that the average US home price increase for 1900-2000 was only 3.35% per year. Using this datapoint, Schiff's Big Point is that the current Case-Shiller Index "remains well above the long-term trend."

Doing the math, Schiff contends that "this would suggest that the index would need to decline an additional 20.3% from current levels just to get back to the trend line."

Ouch!

Schiff adds these observations,

"From my perspective, homes are still overvalued not just because of these long-term price trends, but from a sober analysis of the current economy. The country is overly indebted, savings-depleted and underemployed. Without government guarantees no private lenders would be active in the mortgage market, and without ridiculously low interest rates from the Federal Reserve any available credit would cost home buyers much more. These are not conditions that inspire confidence for a recovery in prices.

In trying to maintain artificial prices, government policies are keeping new buyers from entering the market, exposing taxpayers to untold trillions in liabilities and delaying a real recovery. We should recognize this reality and not pin our hopes on a return to price normalcy that never was that normal to begin with."

Listening to quite a few economists, one is reminded that, while sectors like technology have continued to grow, housing in the US remains mired in recession, or at least a doldrums. Schiff makes reasonable points concerning the government's continued actions to unrealistically prop up housing values and (unfairly)discriminate in favor of current homeowners, rather than prospective ones, at lower prices.

That 20.3% further decline, even if only in the once-hottest real estate growth markets, would seem to portend some economic pain for 2011. And just a few weeks ago, pundits, including S&P's David Blitzer, have warned of the second part of the notorious 'double-dip' recession.

Sometimes equity markets feast on short-term trends, amidst larger, longer and more painful economic trends. There was at least one equity bull market during the Great Depression of the 1930s.

With an allegedly more fiscally conservative Republican House majority and the US at record levels of foreign-held debt, it's unclear how much longer the federal government can mask the true weakness of the housing markets. We know that the nation's large commercial banks continue to sit on many properties which should be foreclosed and resold on public markets, which will almost certainly drive prices down again across many areas in the US, thus causing more damage to household net worths and, probably, spending.

Whether this purported housing sector weakness, as Schiff suggests, will spill over into the general economy in 2011, is something to seriously consider.

Confusion Over Apple As An Investment

I've noted with interest this past week's flurry of comments about Apple as an investment for 2011.

In my own equity strategy, which is outperforming the S&P for the year by roughly 25% to 11%, Apple would now be a holding in four of the currently active six portfolios. Apple trails the index slightly in two recently-formed portfolios, and outperforms in the other two.

While I can't predict with certainty, I'd expect that Apple will be part of the January 2011 equity portfolio, as well.

The nearby price chart for Apple, Google, Microsoft and the S&P500 Index reveals how dominantly the former has outperformed the latter three entities, Google and Microsoft being two of the more popular alternates in the technology sector.

What surprised me somewhat is how comparatively anemic Google's performance has been, when viewed with Apple's. The S&P's and Microsoft's track records for the past five years isn't all that unexpected.

Listening to many pundits, it's tempting to believe that Apple's performance is a purely technical feat, with a parabolic curve that must descend soon.

However, on the several bases in my quantitative equity portfolio selection process, Apple probably has some life left in it. Moreover, I've seen broad consensus on prior growth equities be wrong. For example, in 1998, Dell was viewed as overpriced and unable to sustain its then-torrid fundamental growth. It ended the year as one of the S&P500's top ten total return issues, so I was thrilled to have followed my portfolio selection process and held Dell for the entire year.

Ironically, as I observed back in the late 1990s, the bulk of the analyst community views equities in aggregates, often with some technical perspective. Thus, the individual merits of many attractive equities are lost amidst broad comparisons and conventional 'rules of thumb.'

Thank God for that.

As I consider why Apple, with its lofty share price and steady march upwards in price since January of 2009, may continue to outperform the S&P500, several reasons come to mind.

One, of course, is the firm's clear, successful focus on consistent innovation and evolution of well-received products. Those products have achieved high brand preference status. Additionally, they are typically in price ranges that have made them less vulnerable during the recent US recession and continuing economic weakness. With Steve Jobs' continued leadership, the firm may outperform expectations for a little while longer still.

And, finally, there's something which many investors fail to grasp. That is, even broadly-followed, popular firms can outperform. What is required is unexpected excellent performance. Firms like Microsoft, Dell, Kolhs, in the past, and, currently, Apple, have achieved this. It can never last forever, but it can often outlast ill-informed, generically-based expectations.

What Google does seems to be less unique with time, while Microsoft has been mismanaged for over a decade, with no sign of significant change in that important parameter.

The bottom line for me is that I don't subjectively select equities. But I can and often do interpret why my quantitative approach selects those equities which appear in portfolios. And from post hoc, informal inspection, it's easy for me to see why none of the recent portfolios have held Google or Microsoft, while many have included Apple.

Is Case-Shiller Now Portending The Dreaded "Double-Dip" Recession?

After months of being informed by many economists and pundits that risks of the much-feared "double dip" recession were nil, S&P's David Blitzer now states otherwise.

"There is no good news in October's report," said David Blitzer, chairman of the committee that released the Standard & Poor's/Case-Shiller home-price index. Citing expired tax credits for homebuyers and a lackluster national economy among the causes, Blitzer said "on a year-over-year basis, sales are down more than 25 percent and the month's supply of unsold homes is about 50 percent above where it was during the same months of last year."



The Case-Shiller index plunged unexpectedly, posting some price declines. Spinning this trend out, property values are set to slide, with more foreclosures to add to the backlog currently residing on the balance sheets of major commercial banks.

Slice it any way you wish, housing price declines mean less household net asset value and potentially lower spending levels.

Thus, the feared recessionary impact of the recent Case-Shiller data.

It adds more complexity to the already murky economic picture for early 2011.

On one hand, you have robust S&P500 earnings and balance sheets heavy with spendable, investible liquid assets, coupled with newly-legislated, extended tax rates.

Then, again, you have high unemployment, a continued bloated federal deficit, and state and municipal financial woes.

With that uncertain backdrop of conflicting influences, this week's Case-Shiller Index news landed with a worrying thud. It's hard to believe it bodes well for the US economy in the months ahead.

So much for all the Pollyanna pundits of 2010 assuring us that residential real estate woes were in the rear view mirror.

Scepticism On Tax Data

Yesterday I wrote this post concerning how sceptical one must be when listening to private sector supporters of administration alternative-energy policies.

Thanks to an excellent Wall Street Journal editorial last Thursday, 23 December, by Alan Reynolds, entitled Taxes and the Top Percentile Myth, we now know that similar scepticism must be exercised concerning taxpayer data, as well.

Specifically, Reynolds debunks an oft-cited study purporting to reveal that the wealthiest US taxpayers also earn a disproportionate share of "income." The term "income," Reynolds notes, is the Achilles Heel of the study.

Reynolds begins,

"Despite the deficit commission's call for tax reform with fewer tax credits and lower marginal tax rates, the left wing of the Democratic Party remains passionate about making the U.S. tax system more and more progressive. They claim this is all about payback—that raising the highest tax rates is the fair thing to do because top income groups supposedly received huge windfalls from the Bush tax cuts. As the headline of a Robert Creamer column in the Huffington Post put it: "The Crowd that Had the Party Should Pick up the Tab."



Arguments for these retaliatory tax penalties invariably begin with estimates by economists Thomas Piketty of the Paris School of Economics and Emmanuel Saez of U.C. Berkeley that the wealthiest 1% of U.S. households now take home more than 20% of all household income.


This estimate suffers two obvious and fatal flaws. The first is that the "more than 20%" figure does not refer to "take home" income at all. It refers to income before taxes (including capital gains) as a share of income before transfers. Such figures tell us nothing about whether the top percentile pays too much or too little in income taxes.



In The Journal of Economic Perspectives (Winter 2007), Messrs. Piketty and Saez estimated that "the upper 1% of the income distribution earned 19.6% of total income before tax [in 2004], and paid 41% of the individual federal income tax." No other major country is so dependent on so few taxpayers."


Reynolds has pointed out a critical problem with the Piketty and Saez study, i.e., they don't use appropriate measures. Instead, they use inflated, pre-tax income for the wealthy, while using pre-transfer payments income for those at the other income extreme. He continues,
"A second fatal flaw is that the large share of income reported by the upper 1% is largely a consequence of lower tax rates. In a 2010 paper on top incomes co-authored with Anthony Atkinson of Nuffield College, Messrs. Piketty and Saez note that "higher top marginal tax rates can reduce top reported earnings." They say "all studies" agree that higher "top marginal tax rates do seem to negatively affect top income shares."


What appears to be an increase in top incomes reported on individual tax returns is often just a predictable taxpayer reaction to lower tax rates. That should be readily apparent from the nearby table, which uses data from Messrs. Piketty and Saez to break down the real incomes of the top 1% by source (excluding interest income and rent).


The first column ("salaries") shows average labor income among the top 1% reported on W2 forms—from salaries, bonuses and exercised stock options. A Dec. 13 New York Times article, citing Messrs. Piketty and Saez, claims, "A big reason for the huge gains at the top is the outsize pay of executives, bankers and traders." On the contrary, the table shows that average real pay among the top 1% was no higher at the 2007 peak than it had been in 1999.


In a January 2008 New York Times article, Austan Goolsbee (now chairman of the President's Council of Economic Advisers) claimed that "average real salaries (subtracting inflation) for the top 1% of earners . . . have been growing rapidly regardless of what happened to tax rates." On the contrary, the top 1% did report higher salaries after the mid-2003 reduction in top tax rates, but not by enough to offset losses of the previous three years. By examining the sources of income Mr. Goolsbee chose to ignore—dividends, capital gains and business income—a powerful taxpayer response to changing tax rates becomes quite clear.

The second column, for example, shows real capital gains reported in taxable accounts. President Obama proposes raising the capital gains tax to 20% on top incomes after the two-year reprieve is over. Yet the chart shows that the top 1% reported fewer capital gains in the tech-stock euphoria of 1999-2000 (when the tax rate was 20%) than during the middling market of 2006-2007. It is doubtful so many gains would have been reported in 2006-2007 if the tax rate had been 20%. Lower tax rates on capital gains increase the frequency of asset sales and thus result in more taxable capital gains on tax returns.


The third column shows a near tripling of average dividend income from 2002 to 2007. That can only be explained as a behavioral response to the sharp reduction in top tax rates on dividends, to 15% from 38.6%. Raising the dividend tax to 20% could easily yield no additional revenue if it resulted in high-income investors holding fewer dividend- paying stocks and more corporations using stock buybacks rather than dividends to reward stockholders.


The last column of the table shows average business income reported on the top 1% of individual tax returns by subchapter S corporations, partnerships, proprietorships and many limited liability companies. After the individual tax rate was brought down to the level of the corporate tax rate in 2003, business income reported on individual tax returns became quite large. For the Obama team to argue that higher taxes on individual incomes would have little impact on business denies these facts.


The overall points Reynolds so clearly makes are that the declared incomes of the wealthy are responsive to tax rates, and much corporate income flows through individual returns for many businesses. Thus it's neither fair nor correct to classify all 1040 form income as 'personal.'

Reynolds concludes his instructive piece by noting,

"The Piketty and Saez estimates are irrelevant to questions about income distribution because they exclude taxes and transfers. What those figures do show, however, is that if tax rates on high incomes, capital gains and dividends were increased in 2013, the top 1%'s reported share of before-tax income would indeed go way down. That would be partly because of reduced effort, investment and entrepreneurship. Yet simpler ways of reducing reported income can leave the after-tax income about the same (switching from dividend-paying stocks to tax-exempt bonds, or holding stocks for years).


Once higher tax rates cause the top 1% to report less income, then top taxpayers would likely pay a much smaller share of taxes, just as they do in, say, France or Sweden. That would be an ironic consequence of listening to economists and journalists who form strong opinions about tax policy on the basis of an essentially irrelevant statistic about what the top 1%'s share might be if there were not taxes or transfers."

It's almost comical how simple is Reynolds' identification of this major flaw in Piketty's and Saez' work. Yet many in the current administration apparently swear by the study. Even the president's own chief economist seems to have fallen prey to similar measurement mistakes.

It goes to show how important it is to, as a grad school professor taught me, critically read such articles to ascertain the quality of the research before giving it credibility. In the case of Piketty's and Saez' taxation-related work, it's clear that many have come to rely on the study's incorrect conclusions without even understanding how it measured the rather nebulous concept of 'income.'

Fortunately, Alan Reynolds was up to the task of deconstructing the earlier, flawed study and providing instructive guidance on how to actually interpret the phenomenon under examination.

On Scepticism & EPA Policy Support by Utilities

The lead staff editorial in one of last week's Wall Street Journal editorials teaches scepticism when one hears private sector support for EPA energy policies.

Specifically, the EPA is issuing new pollutant rulings aimed at coal-fired plants. The intended result is to force the mothballing of large amounts of comparatively inexpensive existing electricity generation capacity.

Guess who the supportive private sector utility execs are? Why, the leaders of predominantly non-coal-fired utilities, of course. Folks who have bet on other technologies, like John Rowe of Exelon. NextEra, a wind- and solar-power generator, is also lining up behind the EPA.

Clearly, one has to take private sector endorsements of government policy with a grain of salt. They are unlikely to be altruistic or without an agenda.

Instead, we see the age-old game of one group of executives getting behind a political issue and piling on those who are less-advantaged.

This is hardly the way our society should be allocating capital or choosing winners and losers in the energy generation sector.

Auditors Now Blamed for Lehman Collapse

Thursday's Wall Street Journal reported that Ernst & Young has now been charged with civil fraud in the collapse of Lehman Brothers in late 2008. As the defunct firm's auditors, E&Y is being accused of helping Lehman hide the consequences of its lethal excesses.

Observers are accusing auditing firms of going easy on valuation methodologies used by their clients. In the case of PricewaterhouseCoopers, both AIG and Goldman Sachs used the firm, yet posted differing values for the same swaps on their respective balance sheets.

Auditors, for their part, contend that they are only to assure that proper processes are in place, not that those processes are actually used correctly.

It's not a complete surprise that things have come to this. Perhaps it's more surprising that it took so long. After Arthur Andersen was improperly attacked by the US and driven to bankruptcy, the remaining large auditors know they are in government crosshairs anytime a firm goes under for reasons that have anything to do with its accounting and/or financial statements.

However, at least one hedge fund bear, which, if memory serves, was David Einhorn, was on to Lehman's financial statement problems just by analysis of those published items. It's not like any investor didn't have reason to question what was going on.

I think the larger issue is, again, expecting poorly-compensated auditors doing SEC-mandated work to surface every corporate financial impropriety. As with so much government regulation, all the SEC-required statements have done is falsely assure naive investors that audited statements which don't expressly find problems are, in fact, a clean bill of health.

How much more meaningful if no statements were required, and those that were published had to pass truly useful standards.

Boone Pickens' Wind Plans Go Horribly Awry

There have been two recent editorials in the Wall Street Journal regarding the folly of wind power as a major component of US energy policy. A lead staff editorial on 23 December discussed a number of questionable aspects of federal wind power energy policy. The 23 December piece, by Robery Bryce, entitled A Wind Power Boonedoggle, lampooned Boone Pickens' vaunted alternative energy policy, announced 30 months ago, featuring wind power.

I wrote posts here, here and here concerning Pickens' "policy." Now it seems his extensive wind farm investments have fallen afoul of the low price of natural gas.

Bryce wrote in his editorial,

"The Dallas-based entrepreneur, who has relentlessly promoted his "Pickens Plan" since July 4, 2008, announced earlier this month that he's abandoning the wind business to focus on natural gas.

Two years ago, natural gas prices were spiking and Mr. Pickens figured they'd stay high. He placed a $2 billion order for wind turbines with General Electric. Shortly afterward, he began selling the Pickens Plan. The United States, he claimed, is "the Saudi Arabia of wind," and wind energy is an essential part of the cure for the curse of imported oil.
Voters and politicians embraced the folksy billionaire's plan. Last year, Senate Majority Leader Harry Reid said he had joined "the Pickens church," and Al Gore said he wished that more business leaders would emulate Mr. Pickens and be willing to "throw themselves into the fight for the future of our country."
Alas, market forces ruined the Pickens Plan. Mr. Pickens should have shorted wind. Instead, he went long and now he's stuck holding a slew of turbines he can't use because low natural gas prices have made wind energy uneconomic in the U.S., despite federal subsidies that amount to $6.44 for every 1 million British thermal units (BTUs) produced by wind turbines. As the former corporate raider explained a few days ago, growth in the wind energy industry "just isn't gonna happen" if natural gas prices remain depressed."

So much for predicting the rise of one energy source by hoping for scarcity of another. And it's sort of funny, because, separately, Pickens has been stumping for natural gas-powered vehicles. So I guess one windfall threw another of his energy bets for a big loss.

Bryce went on to note how well-subsidized wind power has been,

"Despite wind's lousy economics, the lame duck Congress recently passed a one-year extension of the investment tax credit for renewable energy projects. That might save a few "green" jobs.

But at the same time that Congress was voting to continue the wind subsidies, Texas Comptroller Susan Combs reported that property tax breaks for wind projects in the Lone Star State cost nearly $1.6 million per job. That green job ripoff is happening in Texas, America's biggest natural gas producer.
Today's low natural gas prices are a direct result of the drilling industry's newfound ability to unlock methane from shale beds. These lower prices are great for consumers but terrible for the wind business. Through the first three quarters of 2010, only 1,600 megawatts of new wind capacity were installed in the U.S., a decline of 72% when compared to the same period in 2009, and the smallest number since 2006. Some wind industry analysts are predicting that new wind generation installations will fall again, by as much as 50%, in 2011."


According to Bryce, Pickens is moving his wind turbines to Canada, where mandatory alternative energy legislation requires utilities to buy power he'll generate up there with his new toys.

All of this makes you wonder just how much of Pickens' vaunted plan was a way to drive federal subsidies for his investment strategies, doesn't it?

Meanwhile, in the earlier Journal staff editorial, the writers note how much less efficient wind power is, in terms of megawatts/worker production. It "takes at least 25 times more workers to produce a kilowatt of electricity from wind as from coal."

The cost to taxpayers for each wind-related energy job was estimated at $475K in the editorial. There's no way private industry could accommodate such expensive job-creating investments. Only government, taxpayer-funded subsidies would be so foolishly squandered.

I think the larger story here is that Pickens' wind-based defeat exposes his eagerness to benefit his investors at the explicit expense of taxpayer subsidies, while never effectively responding to charges that his alarm over the US oil import bill is unjustifiable on purely economic bases.

Demographic Stress Tests

For some time now, I've been convinced that US government employee unions and various social wealth transfer schemes, e.g., Social Security, Medicare and Medicaid, will have to accept significant reductions in promised benefits due to unchecked growth in said benefits due to unrealistic contract terms and poorly-designed programs.

On the weekend after Thanksgiving, Nicholas Eberstadt of the American Enterprise Institute and Hans Groth, senior director for Healthcare Policy & Market Access for Pfizer Europe, wrote Time for 'Demographic Stress Tests,' an editorial in the Wall Street Journal which describes some of the potential consequences if my expectations are not realized.

The editorial paints a dark picture, beginning,



"Financial crises can erupt suddenly and unexpectedly. Demographic pressures, by contrast, gather slowly and predictably—but over just a generation they can transform the economic and social landscape irreversibly.

Such a transformation is already underway in the developed world. Twenty years from now, Western economies will be characterized by stagnating populations, shrinking work forces, steadily increasing pension-age populations, and ballooning social spending commitments. These demographic changes will mean major increases in public debt burdens and slower economic growth, as savings are diverted from investments and innovation that enhance productivity."


For example, they write,

"The U.S., meanwhile, can expect to see continuing population and manpower growth between now and 2030, thanks to relatively high birth rates and a robust inflow of immigrants (roughly half of them legal). America will remain the most youthful Western society, although its 65-plus population will be about 19% of the total, up from 13% today.



Nevertheless, entitlement liabilities—especially the unfunded liabilities in the health-care system—are on course to skyrocket in the decades ahead. The country's recently enacted health reform will make the burden heavier.


At present, the ratio of gross U.S. public debt to GDP is nearing 100%, and the country is running annual deficits of around 10% of GDP. The Congressional Budget Office projects gross public debt to be 200% of GDP by 2020, and the BIS sees it hitting 300% of GDP by 2030. By the BIS estimates, restoring the U.S. public debt burden to 2007 levels would require budget surpluses of 2.4% of GDP for the next 20 years.


Maintaining economic growth in the face of these demographic trends will require rethinking current approaches to work and retirement, pension and health-care policies, and government budget discipline."

Music to my ears, most assuredly. I've become certain that, for the US to avoid fiscal calamity on a society-wide scale, the 1930s- and 1960s-era social safety net programs, all sharing design flaws, must soon be seen as a temporary taking leave of economic senses by a country careening between deep despair and post-war elation. They will have to be halted, dismantled, or severely capped, to be replaced by more restrained, individually-based, defined-contribution, rather than defined-benefit approaches.

Eberstadt and Groth provide similar statistics for other countries, including Germany and Japan, which, together with the US, the authors note comprise "half of the West's output and nearly 30% of the world's GDP."

All three are projected to experience public debt/GDP ratios of over 200% in just twenty years. Japan's would hit 600%. These are stunning numbers, when you are used to the US running no more than about 50% on this ratio in past decades.

The authors suggest, in conclusion,

"Thanks to the recent financial crisis, we're now familiar with the concept of the "financial stress test" used to evaluate the soundness of banks and allied institutions. A "demographic stress test" for Western economies is now in order, so that voters and their elected representatives can cope with aging populations and declining work forces.



Such an exercise would assess how manpower availability, labor force participation rates, aging and budgetary commitments would, over the next 30 years, affect key measures of national economic well-being like growth and productivity, fiscal balances, and government debt. It would also indicate the extent to which adverse "baseline" costs and consequences could be mitigated or offset by changes in lifestyle, personal behavior and public policy. These could include, for example, later retirement thanks to healthy aging, increased attention to preventive health care, enhanced personal savings, and adjustments to health and pension schemes.


Every Western country will have to determine how to pursue a future that is grayer but healthier and more affluent. The sooner we pay serious attention to the demographic challenge, the likelier we will be to meet it successfully."


Even these pundits avoid what ought to be obvious to objective observers of these predictions. Most large Western country pension, social safety net and health care schemes will have to be radically redesigned and reduced in scope and cost. There's just no way, after several decades and generations in which expectations have been so heavily affected by citizens' knowledge of social benefits replacing their own savings, that younger, working citizens can or will sustain these obligations.

Who in their right mind expects people to work from 21-70, then live for another 15-20 years at similar standards without having saved substantial amounts of their prime years' compensation? Especially when you add in the demographics of shrinking young Western populations- except for the US- which make the burdens so much more heavy?

Reading a non-partisan, cold-eyed piece like Eberstadt's and Groth's really opens your eyes to the magnitude, across most of the West, of the size of the shortfall and drag on economic activity that old, ill-conceived social spending obligations for pensions and health care will have in a comparatively short time.

More than in past years, we are now, for many countries, on the cusp of moving irrevocably into financially dangerous territory if we continue to allow badly-designed, unsustainable social programs to remain in place.

The Euro-Based Changes In The EU

This past weekend's Wall Street Journal featured a half-page editorial by Brian Carney & Anne Jolis entitled Toward a United States of Europe. It's amazing to me how relatively little attention this major change is receiving in US business and other mainstream media.

Most of us Americans don't really understand the specific limits of the original Treaty of Lisbon which gave birth to the European Union. Among them was, with the birth of the Euro and the European Central Bank, to quote the Journal article,

"each member state would be responsible for looking after its own budgetary and borrowing needs. Going forward, the euro zone's members will stand as guarantors of each others' national debts."

Thus, the title of the editorial, because there is joint responsibility among the EU members for all sovereign liabilities. Very much the same effect as Alexander Hamilton's original plan for the United States government's assumption of all debts of the thirteen member states.

Rather troubling, however, for the Euro and the EU, is the fact that the politicians aren't giving this massive change its due, ramming it through as a "limited treaty change."

On the contrary, France's Finance Minister, Christine Lagarde, said,

"It's a major adjustment. We violated all the rules because we wanted to close ranks and really rescue the euro zone."

Further, Lagarde said that the original Treaty "was very straightforward. No bailing out."

I recalled, with interest, early on in the Euro's existence, that France and Germany were two of the first members to violate the currency union's economic guidelines regarding budget deficits and/or deficits. The rules were, as Lagarde admits, flouted from the very start.

Carney and Jolis cite Germany's one-time Bundebank head, the venerable Hans Tietmeyer, writing,

"that monetary union required 'the degree of solidarity characteristic of a nation.' "

That's a big jump for the EU member states. Unlike US states, most of which have some sort of balanced-budget requirement, however loosely-enforced or defined, formerly sovereign states in the EU were, only decades ago, issuing their own currencies, and running budget deficits even now.

The editorial's authors make the insightful point,

"Economic competition is to be replaced by consultation and cooperation. Whether that is an improvement is doubtful, but it is also, in a sense, beside the point. Europe has chosen its path. The common currency will stand or fall based on the ability of the EU to impose ever-more intrusive spending and taxation oversight on the euro zone's members. Does Europe have the necessary solidarity for that to succeed where less coercive measures have failed in the past?"

The transition from common currency to facilitate individual competitive advantages among the EU members, to its use to enforce top-down budgetary and taxation policies, is a sea-change. Even the US does not have this wrinkle in its Constitution.

The EU's members are much more ethnically distinct, and more recently, than are US states. I've always thought that this reality would prohibit a truly-shared fiscal and monetary union in the EU.

Now I guess we'll see whether I, and so many other observers, are correct. The effects of Euro failure aren't clear, but one has to suspect, if the establishment of the Euro brought so many benefits, its disappearance would reverse those, and bring new costs for the member states and businesses operating therein.

The Sudden Emergence of Contentions of 'the End of Savings Glut'

I have read two separate articles in the past week concerning a contended coming 'end of savings glut.' One piece, by David Wessel, appeared in the Wall Street Journal, while the other was in a recent edition of The Economist. Both cite McKinsey & Co.'s McKinsey Global Institute as the source of their articles.

Seeing McKinsey's institute cited twice in a week on the same topic makes me suspicious that the consulting giant is once again gearing up its media machinery to stoke demand for projects based on yet another shocking 'finding' from its 'institute.'

I recall when McKinsey created its institute many years ago. At the time, I was with Andersen Consulting, now Accenture, which, belatedly, I believe, created their own allegedly-separate research arm, as well. Back then, it was relatively easy to identify McKinsey's 'institute' concept as simply a way to refashion certain publicly-releasable elements of their confidential client work, the better to get free media attention and put forth an image of doing independent research. I said as much to senior executives at Andersen at the time, but it took quite a few years for them to come around to the McKinsey concept.

Whether this latest shocker from the consulting firm is the result of its deliberate consideration of the question, or simply an agglomeration of various client work elements, is not clear. Or even if it's mostly some deductions made from combing through available OECD information. Reading the two derivative articles suggests it could easily be the latter.

Rereading those pieces, I find myself rather unsurprised by McKinsey's alleged 'findings.' It doesn't take a genius to see that wealthier developing nation consumers will both attract more investment to build infrastructure to serve their evolving needs, as well as provide some savings from their accelerating incomes.

Are the estimates of global investment, savings, and growth from McKinsey accurate? I don't know. Why should they be any more accurate than those of other pundits, researchers and observers?

Here's a sample of Wessel's interpretation of the McKinsey report,

"The global savings glut could easily become global savings dearth. And that would mean substantially higher interest rates.

If long-term rates, adjusted for inflation, returned to the 40-year average, McKinsey estimates, they would be 1.5 percentage points higher, a big jump from the current 3% or so yield on 10-year Treasurys. And rates could go up more if emerging markets try to step up infrastructure and other investments faster than U.S. and other rich countries increase their overall saving, which could be an unwelcome brake on global growth."

Funny, I thought the US is dissaving to the tune of a trillion dollars of federal deficits per year, plus various municipal pension funding gaps in the tens of billions.

The fuzzy forecasts for various constructs- savings, investment, economic growth- combined with whether various rates rise, or fall, makes the whole notion of declaring a savings shortages a joke.

I'm not saying their won't be an 'end of savings glut,' nor that their won't be a rise in rates. But so much depends upon the movement of many inter-related factors that it's really just impossible to know, isn't it?

But, then, that's probably McKinsey's objective. To create some newly-imagined risks of uncertainty, the better, well, to go hire those supposedly-smart folks who wrote that study. Just in case there's new uncertainty.

This is classic consultant marketing. I can well-imagine the hours of conference-room sessions at McKinsey dreaming this one up. Corral a bunch of publicly-available statistics, use a lot of beach-time among under-employed junior staffers, and demonstrate the possibility of some shocking headline. Doesn't really matter what the headline is, so long as it's a shocking departure to something current. Change is news, change brings risk, and perceived new risk just might bring in some new assignments to assess various companies' risks to these new, possibly-changing facets of the global economy.

And McKinsey is doubtless counting on getting their share, or more, of those assignments. Regardless of whether there is going to be a dearth, or glut, of global savings on the horizon.

John Cochrane On The Euro & European Bank/Country Bailouts

Back on December 2nd, University of Chicago finance professor John Cochrane wrote a scintillating piece in the Wall Street Journal entitled 'Contagion' and Other Euro Myths.

I appreciate Cochrane's insightful, clear analyses of global economic and financial phenomena, and his recent piece is no exception.

I have long contended that much of the damage of the recent global financial sector crisis was a function of poor balance sheet management, evidenced by over-reliance on short-term borrowing, and Cochrane confirms this. He writes,

"The big culprit in all of this is short-term debt. There would be no crises if governments had issued long-term debt to match long-term plans to repay that debt.

Governments like to roll over short-term debt for exactly the same reasons Bear Stearns and Lehman Brothers did: It looks cheaper- at least until the crisis comes. But buying insurance is always expensive."

Cochrane correctly notes how short-term financing decisions are, in effect, a bet on an ability to rely on markets for continuing pricing and demand. Which is, of course, mistaken. Just like the pricing of mortgage-backed assets during the 2007-08 crisis, sovereign debt becomes problematic when issuers have assumed that markets will always have an appetite for roll-over issuances at affordable prices. In that crisis, you may recall, special-purpose SIVs backed by Citigroup had to be bailed out by the parent when they failed to roll over their short term borrowings due to the unexpected plunge in the assets held in the vehicles.

It's always the same. Funding decisions in low-rate environments veer dangerously short-term in nature, then become problematic as frequent trips to the market make the entity hostage to volatile investor sentiments.

Cochrane makes more excellent points in his piece. He notes that it would be better for Europe's national governments to directly and explicitly bail out their banks, rather than unnecessarily involve the currency union in bailout out an entire country. He further notes that either a blanket, "ironclad guarantee," or clear rejection of any bailout, would calm markets. By choosing the middle path, taking a case-by-case approach, the EU and IMF have magnified investor uncertainty and market volatility.

Finally, Cochrane draws obvious parallels between the European debt crisis and a looming potential one in the US. Specifically, he notes the financial instability of many US states, and the Fed's similarity to European banks in loading up on short-term financing, via QE2. And, similiarly to the ECB, which is buying suspect European sovereign debt, the Fed is buying questionably-valued paper, too.

Cochrane dispels the myth of contagion in Europe, replacing it with sound analysis of the true causes of the debacle, and better alternatives to resolve it.

The Latest On GE & Its Failed CEO Immelt

The Wall Street Journal featured GE's Tuesday outlook in its Ahead of the Tape column earlier this week.

Paul Glader wrote of the company's failed CEO Jeff Immelt,

"And investors are cautious about his ability to reorient the company given questionable acquisitions in areas such as homeland security, commercial real estate and subprime mortgages during his first 10 years as chief executive."

Isn't it stunning to realize that GE's board has allowed Immelt to destroy shareholder value for so long without lifting a finger to punish or replace Immelt? The nearby price chart for GE and the S&P500 Index since 1960 illustrates how atrociously bad Immelt's performance has been.

He assumed command of the firm from Jack Welch in September, 2001. Simply by observing the distance that GE's blue line was above the index's green one at that time, compared with now, one sees how much of the firm's cumulative value built over 40 years has been eliminated through Immelt's incompetence.

Glader gives a few faint compliments to Immelt in an intervening paragraph, then closes with this cautionary note,

"Still, Mr. Immelt has a long road to travel to convince investors there is more value for them in holding GE's stable of disparate businesses than directly investing in growth markets themselves."

If you read my prior posts concerning Immelt's dismal performance, under that the Immelt label, you'll see how he's already reaped so many tens of millions in cash, plus the usual options, that Immelt really no longer can be assumed to rely on current or future GE compensation for his financial needs. He's now in it mostly to salvage his reputation, if that's even now possible.

Just viewing the magnitude of Immelt's disastrous tenure at GE, and the company's board's complacency, no investor should feel safe owning GE for anything other than a timing play. In my prior posts, I've argued that GE need no longer exist as an entity, being primarily the last of a once-common breed of conglomerates which no longer have a viable financial raison d'etre in a world of ultra-low equity trading costs.

As a long run equity investment, it's been among the worst an investor could choose since Immelt took over as CEO.

Going Easy On Citi's Vik Pandit

Last weekend, according to the Wall Street Journal, was the third anniversary of Vikram Pandit's elevation to CEO of the ailing US bank Citigroup.

The nearby price chart of large US banks Citi, Chase, BofA, Wells Fargo and Goldman Sachs illustrates how miserably Pandit's institution has performed under his leadership- if you can use that word.

While all of the banks have been more or less flat for a year, Pandit's Citi plunged far lower during 2008. If you don't blame him, saying he inherited that downdraft, then you certainly can't say he did any better than any other bank since then.

In fact, it would be fair to say he essentially did nothing, and Citi benefited from a sector-wide easing of pressure on share prices.

Remember, if you will, and as I noted in posts at the time, like this one nearly two years ago, that Pandit was very slow on the trigger to change anything at Citi,

"For Vik Pandit, it's too little, too late. As the price chart for Citigroup in yesterday's post illustrated, the bank has lost nearly 80% of its equity price in the past twelve months. Surely, as others have also noted, Pandit would have gotten much more value for his shareholders had he done this early last year, rather than now.

This is precisely the sort of long term damage that results from in-denial, head-in-the-sand approaches to the actual condition of a business. By insisting on keeping Citigroup's unwieldy, difficult-to-effectively-manage business assortment intact, Pandit simply destroyed more shareholder value faster than he would have otherwise.
For this, alone, it should be time for him to go. And what more convenient time for the board, than in tandem with the guy who mistakenly hired Pandit, Bob Rubin."


The Journal, and others, are all saying Pandit has "made it," "survived," etc. Truth is, Pandit was the wrong man for the job, hand-picked by the guy who helped ruin Citigroup, Bob Rubin.

It's far from clear, from the lack of any stories concerning what Pandit ever did during the past three years, that 99 other people couldn't have "achieved," and I use that word very, very loosely, the same results at Citi to date.

It never fails to amaze me that CEOs like Pandit get time and allowances for failure or lackluster performance to which their lieutenants would never be entitled.

Next, we'll be hearing that Jeff Immelt, GE's hapless CEO, will be judged a success because, after nearly a decade of failure to perform for shareholders, he might eke out a one-time outperformance of the S&P.

From my perspective, Pandit is simply another fortunate guy who was given a job in which he hasn't done much, therefore receiving accolades for not having noticeably done more damage. However, of all the banks in that chart, only Goldman Sachs decisively outperformed the S&P for the period. None of the other banks have CEOs who were capable of delivering market-beating performance for their shareholders. But I don't believe I've read that any of those CEOs returned their large compensation packages due to those failures.

A Farm Belt Asset Bubble?

Thursday's Wall Street Journal's lead staff editorial was entitled The Farm Belt Boom.

In yet another piece of a larger inflationary mosaic, the piece detailed the recent dramatic rises in land prices in the US farm belt. For example,

"The Federal Reserve Bank of Chicago reported in November that farmland values across the upper Midwest have jumped 10% since 2009. The year-over-year increases were even more dramatic in some states- 13% in Iowa, 11% in Indiana......Land fever is running rampant."

The Journal editorial credits global crop prices, but also adds this cautionary information,

"But the price surge has been so rapid and so broad across nearly all commodities.....that it can't merely be a function of new demand for specific grains.

This is where monetary policy comes in. As the greenback declines amid easy Fed policy, commodities rise in value. Farmland booms have typically coincided with periods of Fed easing, such as the 1970s and the late 1980s. It's no accident in our view that the latest commodity price surge began this summer when the Fed's talk about another round of quantitative easing began in earnest.

The problem comes if the boom is an artificial, money-fed bubble."

Which echoes my recent post discussing the risks to banks of the low-rate environment,

"One is, obviously, the greater probability of asset bubbles, against which loans may be made, in low-rate environments. We just saw this over the last seven years. Now rates continue to hover at record lows.

The second aspect involves risks versus rates. At ultra-low rates, projects of marginal merit appear to be worthwhile and may be funded. Yet they are precisely the most vulnerable loans, once rates begin to move upwards towards more normal, sustainable levels."


Somewhere, banks are lending to buyers of this expensive farmland. At some point, if and when this commodity price boom softens or turns south, the typical outcomes will obtain, i.e., over leveraged landowners, bankrupt farmers and insolvent banks holding worthless loans on now much-less valuable farmland.

As the Journal piece concludes,

"We hope Fed Chairman Ben Bernanke is right when he says asset bubbles and price spikes in commodities are nothing to worry about. Of course, he said the same thing about housing and oil in the last decade. We're not predicting an imminent bust, but we do hope someone at the Fed is watching prices grow in farm country."
Scary, isn't it? We're not two years on from the financial meltdown caused by an overheated mortgage banking sector, exacerbated by low rates, and the Fed is still biased toward keeping them ultra-low.