The Wall Street Journal has recently published a spate of editorials and columns regarding the official FCIC final report. One of those editorials was by the authors of a minority report- Messrs. Thomas, Hennessey and Holtz-Eakin. Mr. Thomas is a former Republican congressman from California. Mr. Hennessey served as director of the White House National Economic Council in 2008. Mr. Holtz-Eakin is a former director of the Congressional Budget Office.
Here are some key passages from their Journal editorial synopsizing their report,
"Today, six members of the Financial Crisis Inquiry Commission—created by the last Congress to investigate the causes of the financial crisis—are releasing their final report. Although the three of us served on the commission, we were unable to support the majority's conclusions and have issued a dissenting statement.
In a November 2009 article, Brookings Institution economists Martin Baily and Douglas Elliott describe the three common narratives about the financial crisis. The first argues that the primary cause was government intervention in the housing market. This intervention, principally through Fannie Mae and Freddie Mac, inflated a housing bubble that triggered the crisis. This is the view expressed by one of our co-commissioners in a separate dissent.
The second narrative blames Wall Street and its influence in Washington. According to this narrative, greedy bankers knowingly manipulated the financial system and politicians in Washington to take advantage of homeowners and mortgage investors alike, intentionally jeopardizing the financial system while enjoying huge personal gains. That's the view of the six majority commissioners.
We subscribe to a third narrative—a messier story that emphasizes both global economic forces and failures in U.S. policy and supervision. Though our explanation of the crisis doesn't fit conveniently into the political order of Washington, we believe that it is far superior to the other two.
We recognize that the other two narratives have popular appeal: They each blame a clear entity, and thus outline a clear set of reform proposals. Had the government not supported housing subsidies (the first narrative) or had policy makers implemented more restrictive financial regulations (the second) there would have been no calamity.
Both of these views are incomplete and misleading. The existence of housing bubbles in a number of large countries, each with vastly different systems of housing finance, severely undercuts the thesis that the housing bubble was a phenomenon driven solely by the U.S. government. Likewise, the multitude of financial-firm failures, spanning varied organizational forms and differing regulatory regimes across the U.S. and Europe, makes it implausible that the crisis was the product of a small coterie of Wall Street bankers and their Washington bedfellows.
We believe the crisis was the product of 10 factors. Only when taken together can they offer a sufficient explanation of what happened:
Starting in the late 1990s, there was a broad credit bubble in the U.S. and Europe and a sustained housing bubble in the U.S. (factors 1 and 2). Excess liquidity, combined with rising house prices and an ineffectively regulated primary mortgage market, led to an increase in nontraditional mortgages (factor 3) that were in some cases deceptive, in many cases confusing, and often beyond borrowers' ability to pay.
Losses from the housing downturn were concentrated in highly leveraged financial institutions. Which raises the essential question: Why were these firms so exposed?
Failures in credit-rating and securitization transformed bad mortgages into toxic financial assets (factor 4). Securitizers lowered the credit quality of the mortgages they securitized, credit-rating agencies erroneously rated these securities as safe investments, and buyers failed to look behind the ratings and do their own due diligence. Managers of many large and midsize financial institutions amassed enormous concentrations of highly correlated housing risk (factor 5), and they amplified this risk by holding too little capital relative to the risks and funded these exposures with short-term debt (factor 6). They assumed such funds would always be available. Both turned out to be bad bets.
These risks within highly leveraged, short-funded financial firms with concentrated exposure to a collapsing asset class led to a cascade of firm failures. Some firms had large counterparty credit risk exposures, and the sudden and disorderly failure of one firm risked triggering losses elsewhere. We call this the risk of contagion (factor 7). In other cases, the problem was a common shock (factor 8). A number of firms had made similar bad bets on housing, and thus unconnected firms failed for the same reason and at roughly the same time.
A rapid succession of 10 firm failures, mergers and restructurings in September 2008 caused a financial shock and panic (factor 9). Confidence and trust in the financial system evaporated, as the health of almost every large and midsize financial institution in the U.S. and Europe was questioned. The financial shock and panic caused a severe contraction in the real economy (factor 10).
We agree with our colleagues that individuals across the financial sector pursued their self-interest first, sometimes to the detriment of borrowers, investors, taxpayers and even their own firms. We also agree that the mountain of government programs supporting the housing market produced distorted investment incentives, and that the government's implicit support of Fannie Mae and Freddie Mac was a ticking time bomb.
But it is dangerous to conclude that the crisis would have been avoided if only we had regulated everything a lot more, had fewer housing subsidies, and had more responsible bankers. Simple narratives like these ignore the global nature of this crisis, and promote a simplistic explanation of a complex problem. Though tempting politically, they will ultimately lead to mistaken policies."
The Journal's Holman Jenkins, Jr., a regular columnist, wrote his own piece commenting on the FCIC's various reports. He concurred with these three, and others, in decrying the commission's chairman's politically convenient tactic of simply blaming "Wall Street." But he also criticized Thomas, Hennessey and Holtz-Eakins for not concluding a simple, actionable source of the crisis.
To me, this minority explanation most closely approximates what is probably the truth. It addresses elements of the crisis that other explanations do not, i.e., its global nature, the different types of firms which failed, and the related, but not identical sources of mortgage-lending-sourced and -related factors which spread throughout the global financial system.
I think these authors stretched to arrive at the memorable round number of 10 factors. But, given a choice between competing explanations, I'd go for this one over all the others I've read.
Which leads to a conclusion I've expressed in prior posts on this topic. There were plenty of regulations and regulators already in existence to observe and act upon dangerous behaviors by various sector players. So rewriting regulations, adding more, or reshuffling regulators, won't likely change anything.
Moreover, consumer borrowers, investors, and various financial entities all behaved in ways which exacerbated the crisis, because that's human nature. Borrowers took sweet mortgage deals they couldn't likely afford under most scenarios. Lenders bet that they could pass their mortgage trash to investors before the stuff imploded. Too much greed and belief that creating and circulating mortgage-related assets of questionable value would not result in a systemic disaster.
In an earlier post, I likened it to too many people dumping toxic waste into a common sewer that drained into a drinking water supply. Like actually occurred in London before its modern sewer system, this will cause contagious diseases to spread.
So long as people are allowed to generate and circulate toxic waste with no regard for the systemic consequences, we'll see more of these crises in the future. If you don't believe regulators can effectively stop another crisis, then you should monitor the financial system for simple signs of building asset bubbles and make sure your assets are not in those instruments. Protection from broader equity market consequences and the progression of the shock to the real economy are more difficult effects from which to insulate or isolate oneself.
That appears to be an undiversifiable risk of modern financial systems and economies.
Tuesday, February 01, 2011
Monday, January 31, 2011
CNBC's Tyler Mathisen Exhibits His Naivete Of The Grocery Sector
CNBC seems to have developed a style of tossing co-anchors a bone in the form of their own subject-specific one-hour specials. They've done programs on airlines, McDonald's, Goldman Sachs, high-end prostitution, growing marijuana, the video porn industry, garbage and, now, Tyler Mathisen's piece on grocery stores.
I will admit at the outset that I have yet to see the entire hour-long program, but I did see most of the second half of it last night.
However, all last week, Mathisen related anecdotes from the program and introduced brief clips.
You don't really need to see the grocery documentary to grasp what struck me about it, or, more specifically, Mathisen. He seems to be incredulous about everything.
Over and over the guy keeps announcing into a camera, horrified, that these food chains are trying to make money! Oh, the shame! The danger! The horror!
He confides a secret- grocery managers place wine next to fish, hoping you'll buy both. Shocking!
Oh, the evils of this sector! Trying to make a profit by selling food to you. Knowing you must eat to live.
From the shape of mayonnaise bottles (svelte rather than bulbous) to the size of shopping carts (larger than in the past, so you won't think twice about buying more items), it's all just a trap to make money on your need to eat.
For all that, however, the average checkout ticket is remarkably small- under $20. Even in this era of food price inflation.
I have two marketing degrees, so I cut my business education teeth on reading marketing research articles about consumer buying behavior and was taught how attention to many details have a major effect on the profitability of grocery stores. They typically operate on sales margins of 1-2%. Not much room for mistakes. Turnover, of course, is, ideally, quite high, if a competitive ROI is to be earned.
What surprised me, though, was that Mathisen is either completely lacking in curiosity, or just really not at all intelligent. He looks to be at least in his 50s, yet it seems that he's gone his entire life unaware of how supermarkets use location and point-of-purchase displays to stimulate consumer buying. Since purchasing food is probably one of the two most basic recurring buying behaviors for most Americans that doesn't involve immediate total consumption- the other I'd guess being gasoline- grocery store marketing has been the subject of countless newspaper articles for decades.
How could Mathisen be so dense as to have learned nothing about the sector during his entire life? The look on his face as he apparently discovers for the first time that people respond to package design is over the top.
On the larger subject of the documentary, I'd have to say it was decidedly underwhelming. As I contended earlier in this piece, anyone who's middle-aged and remotely curious has, by now, learned some of the basics of supermarket marketing. Higher margin items around the outside of the store, frequently-purchased staples (milk, bread and juice) typically in the corner diagonally furthest from the main entrance, less-expensive, lower-margin items (processed foods) typically in the cluttered middle aisles. Shelf facings paradoxically reflect market share or fees paid to the grocer, and eye-level facings are choicest.
It's one thing to learn a lot about fairly hidden business sectors like growing marijuana, video pornography or ultra-high end prostitution/escort services. But you'd have to live under a rock to be surprised by much in Mathisen's supermarket piece.
I will admit at the outset that I have yet to see the entire hour-long program, but I did see most of the second half of it last night.
However, all last week, Mathisen related anecdotes from the program and introduced brief clips.
You don't really need to see the grocery documentary to grasp what struck me about it, or, more specifically, Mathisen. He seems to be incredulous about everything.
Over and over the guy keeps announcing into a camera, horrified, that these food chains are trying to make money! Oh, the shame! The danger! The horror!
He confides a secret- grocery managers place wine next to fish, hoping you'll buy both. Shocking!
Oh, the evils of this sector! Trying to make a profit by selling food to you. Knowing you must eat to live.
From the shape of mayonnaise bottles (svelte rather than bulbous) to the size of shopping carts (larger than in the past, so you won't think twice about buying more items), it's all just a trap to make money on your need to eat.
For all that, however, the average checkout ticket is remarkably small- under $20. Even in this era of food price inflation.
I have two marketing degrees, so I cut my business education teeth on reading marketing research articles about consumer buying behavior and was taught how attention to many details have a major effect on the profitability of grocery stores. They typically operate on sales margins of 1-2%. Not much room for mistakes. Turnover, of course, is, ideally, quite high, if a competitive ROI is to be earned.
What surprised me, though, was that Mathisen is either completely lacking in curiosity, or just really not at all intelligent. He looks to be at least in his 50s, yet it seems that he's gone his entire life unaware of how supermarkets use location and point-of-purchase displays to stimulate consumer buying. Since purchasing food is probably one of the two most basic recurring buying behaviors for most Americans that doesn't involve immediate total consumption- the other I'd guess being gasoline- grocery store marketing has been the subject of countless newspaper articles for decades.
How could Mathisen be so dense as to have learned nothing about the sector during his entire life? The look on his face as he apparently discovers for the first time that people respond to package design is over the top.
On the larger subject of the documentary, I'd have to say it was decidedly underwhelming. As I contended earlier in this piece, anyone who's middle-aged and remotely curious has, by now, learned some of the basics of supermarket marketing. Higher margin items around the outside of the store, frequently-purchased staples (milk, bread and juice) typically in the corner diagonally furthest from the main entrance, less-expensive, lower-margin items (processed foods) typically in the cluttered middle aisles. Shelf facings paradoxically reflect market share or fees paid to the grocer, and eye-level facings are choicest.
It's one thing to learn a lot about fairly hidden business sectors like growing marijuana, video pornography or ultra-high end prostitution/escort services. But you'd have to live under a rock to be surprised by much in Mathisen's supermarket piece.
Friday, January 28, 2011
Recalling Basic Economics
I had an interesting conversation at my fitness club the other day with an acquaintance who is in the accounting/consulting field. We were discussing the current economic situation, and he asked me, to paraphrase,
'What do you think of the notion being circulated that Bernanke is pursuing QE2 and low rates in order to drive equity market prices up, to make businesses and investors feel better, so to better spark a real economic recovery?'
I replied that, if true, it's a misguided approach. I noted that, for those who recall their basic economics, we're now in a classic Keynesian liquidity trap. Rates aren't driving investment and, if anything, as I've written in some prior posts, are likely to fund marginal, unwise projects, because of the ultra-low rates and their inability to include adequate risk pricing.
We discussed the wasted so-called stimulus spending and added deficits, neither of which have really affected the unemployment rate.
It was then that, in answer to my colleague's question concerning what should have been done, I repeated my belief that banks and other firms, e.g., GM, contrary to auto czar Rattner's contentions, in need of capital should have been allowed to properly enter a formal Chapter 11 process. Profitable operations would have been protected and either spun off or sold. Unprofitable operations would have been liquidated, which is what Citigroup and GM subsequently did. Merging failed banks is no longer a major issue, given FDIC deposit insurance. This myth that large-scale bank failures cripple the economy persist only so long as government and industry officials allow it to perpetuate.
Once you've insured depositors, what's the risk? Loans are transferred or sold. Operations are transferred and merged. Shareholders lose, which is appropriate. Bondholders line up in order of seniority, according to bankruptcy law.
Where's the problem? We're overbanked in the US as it is.
Then I touched on the inequity of government's enforcement of a mortgage foreclosure moratorium. How unfair it has been for existing owners to be given breaks, while equally-deserving buyers at the true, lower market-clearing housing prices are denied the opportunity to do so. Which only delays a true housing recovery.
Anyway, my colleague agreed with my suggestions. But, further, I recalled for both of us some more basic economics, i.e., you can't have recoveries without real recessions. You can't have the release of resources- capital and labor- without the liquidation of failed firms. If firms aren't allowed to fail, resources don't experience the necessary Schumpeterian recycling into new uses.
We can't experience robust economic recoveries without full economic recessions. Despite politically-originated attempts to chop off the downside phases of economic cycles, we can't always be in an expansion. Real capitalistic economies have expansions and contractions.
King Canute couldn't stem the tides, and our government can't rewrite economic laws to eliminate periods of economic contraction.
'What do you think of the notion being circulated that Bernanke is pursuing QE2 and low rates in order to drive equity market prices up, to make businesses and investors feel better, so to better spark a real economic recovery?'
I replied that, if true, it's a misguided approach. I noted that, for those who recall their basic economics, we're now in a classic Keynesian liquidity trap. Rates aren't driving investment and, if anything, as I've written in some prior posts, are likely to fund marginal, unwise projects, because of the ultra-low rates and their inability to include adequate risk pricing.
We discussed the wasted so-called stimulus spending and added deficits, neither of which have really affected the unemployment rate.
It was then that, in answer to my colleague's question concerning what should have been done, I repeated my belief that banks and other firms, e.g., GM, contrary to auto czar Rattner's contentions, in need of capital should have been allowed to properly enter a formal Chapter 11 process. Profitable operations would have been protected and either spun off or sold. Unprofitable operations would have been liquidated, which is what Citigroup and GM subsequently did. Merging failed banks is no longer a major issue, given FDIC deposit insurance. This myth that large-scale bank failures cripple the economy persist only so long as government and industry officials allow it to perpetuate.
Once you've insured depositors, what's the risk? Loans are transferred or sold. Operations are transferred and merged. Shareholders lose, which is appropriate. Bondholders line up in order of seniority, according to bankruptcy law.
Where's the problem? We're overbanked in the US as it is.
Then I touched on the inequity of government's enforcement of a mortgage foreclosure moratorium. How unfair it has been for existing owners to be given breaks, while equally-deserving buyers at the true, lower market-clearing housing prices are denied the opportunity to do so. Which only delays a true housing recovery.
Anyway, my colleague agreed with my suggestions. But, further, I recalled for both of us some more basic economics, i.e., you can't have recoveries without real recessions. You can't have the release of resources- capital and labor- without the liquidation of failed firms. If firms aren't allowed to fail, resources don't experience the necessary Schumpeterian recycling into new uses.
We can't experience robust economic recoveries without full economic recessions. Despite politically-originated attempts to chop off the downside phases of economic cycles, we can't always be in an expansion. Real capitalistic economies have expansions and contractions.
King Canute couldn't stem the tides, and our government can't rewrite economic laws to eliminate periods of economic contraction.
Disappointment On CNBC This Morning
It was with great disappointment that I learned that Steve Rattner would be a guest host on CNBC this morning.
Here's some information pertaining to Rattner's recent settling of an SEC charge by paying a $6.2MM fine and agreeing to a suspension from activity involving broker/dealers or investment advisers for two years.
Why is CNBC even going near this guy? Is this the best they can do? A guy who has pretty clearly been caught violating SEC regs in a pay-to-play scheme involving pension fund management?
I turned to Fox News for the duration, rather than watch this egotistical guest host. The few words I caught emanating from him were the usual scare stories about how if he hadn't saved GM, the US would have sunk into another Depression and 2-3 million more jobs would have been lost.
Please, spare me this unsubstantiated drivel.
Here's some information pertaining to Rattner's recent settling of an SEC charge by paying a $6.2MM fine and agreeing to a suspension from activity involving broker/dealers or investment advisers for two years.
Why is CNBC even going near this guy? Is this the best they can do? A guy who has pretty clearly been caught violating SEC regs in a pay-to-play scheme involving pension fund management?
I turned to Fox News for the duration, rather than watch this egotistical guest host. The few words I caught emanating from him were the usual scare stories about how if he hadn't saved GM, the US would have sunk into another Depression and 2-3 million more jobs would have been lost.
Please, spare me this unsubstantiated drivel.
Thursday, January 27, 2011
GE, Morgan Stanley & Sustainable Growth
GE's revenues for the quarter were up 51% from the year-earlier period. The Journal piece noted that the firm,
"posted its first revenue increase in more than two years and its highest level of new orders since 2007."
Morgan Stanley reported a 35% rise in profits versus the fourth quarter of 2009. However, one observer was quoted as saying,
"They need consistent revenue growth. That's where they've let investors down."
Ah, yes. Consistency.
Well, here's a look at the two firms' price charts, along with the S&P500, over the past five years.
Looks quite a bit different, doesn't it?Over that period, the Index easily outperformed the two firms.
What do you suppose are the chances that both firms have suddenly changed the character of their enterprises? That they will continue to consistently report such revenue and income changes in the year ahead?
My guess is that the 51% GE sales growth is a one-time event. Morgan Stanley was lauded as having outperformed Goldman Sachs for the period, but one wonders how likely that will be in the next year.
Elsewhere, some pundits are calling for GE's Immelt to step down from his CEO job if he is to lead the government's new jobs creation initiative. They note that Immelt misled the firm to require a multi-billion dollar capital infusion from the federal government, suggesting he's not exactly a managerial icon.
A Wall Street Journal lead staff editorial on Wednesday charitably excused his mismanagement of the GE Capital unit for seven years, from 2001-08. The piece firmly placed the outsized reliance of the industrial conglomerate on outgoing CEO Jack Welch, but failed to properly hold Immelt accountable for continuing to rely on financial services revenues and incomes to prop up the troubled firm.
Consistency is a curious quality, because you can observe it over time. It isn't created instantaneously. Thus, recent performances notwithstanding, I doubt either Morgan Stanley or GE has suddenly changed its striped and become a new company in the past quarter, or even 12 months.
Wednesday, January 26, 2011
CNBC's Incomplete Economics Lesson
Monday's Wall Street Journal contained a front page headline regarding global commodity inflation. This evidently spurred CNBC to do some in-depth contrarian segments alleging that commodity inflation won't really be all that bad.
Tasked with this effort was the network's under-equipped economic's report Steve Liesman. Using a single commodity, wheat, and a single product, bread, the hapless reporter attempted to track the effects on bread prices for a given increase in wheat prices. Further, he confided that he'd checked with a Harvard economist who told him that component cost increases were more likely to be passed along in highly competitive product markets.
Funny thing was, nowhere did the economically untrained Liesman utter the words inelastic or elastic. As in demand.
Most economists would differentiate the inflationary impacts of component costs according to the demand elasticity of the good. Goods with highly inelastic demands will tend to accommodate price increases without offsetting declines in volume, while goods with elastic demands will not.
But, of course, Liesman, not having an economics background, didn't bother with the fundamental analyses taught in basic economics courses.
What occurred to me was to ask questions like:
-Which commodities are components of food products with what shares of dollar volume of US food spending?
-Which of those products tend to have inelastic demands? Elastic demands?
-What would this mix of inflating commodities' share of consumer food spending by products, and the relevant demand elasticities, suggest for the average food price inflation that US consumers may expect in the year ahead?
None of that was forthcoming from Liesman. Just a pithy little example of wheat and bread costs, without a word concerning demand elasticities. Yet another reason to only listen for news on CNBC, and skip the network's home-grown economic 'analysis.'
Tasked with this effort was the network's under-equipped economic's report Steve Liesman. Using a single commodity, wheat, and a single product, bread, the hapless reporter attempted to track the effects on bread prices for a given increase in wheat prices. Further, he confided that he'd checked with a Harvard economist who told him that component cost increases were more likely to be passed along in highly competitive product markets.
Funny thing was, nowhere did the economically untrained Liesman utter the words inelastic or elastic. As in demand.
Most economists would differentiate the inflationary impacts of component costs according to the demand elasticity of the good. Goods with highly inelastic demands will tend to accommodate price increases without offsetting declines in volume, while goods with elastic demands will not.
But, of course, Liesman, not having an economics background, didn't bother with the fundamental analyses taught in basic economics courses.
What occurred to me was to ask questions like:
-Which commodities are components of food products with what shares of dollar volume of US food spending?
-Which of those products tend to have inelastic demands? Elastic demands?
-What would this mix of inflating commodities' share of consumer food spending by products, and the relevant demand elasticities, suggest for the average food price inflation that US consumers may expect in the year ahead?
None of that was forthcoming from Liesman. Just a pithy little example of wheat and bread costs, without a word concerning demand elasticities. Yet another reason to only listen for news on CNBC, and skip the network's home-grown economic 'analysis.'
Tuesday, January 25, 2011
Airlines Bid To Reverse Commoditization
Holman Jenkins, Jr., wrote a very good piece this past weekend in the Wall Street Journal concerning airlines' use of the internet to try to reverse the commoditization of their service.
In particular, he points out how American, Bob Crandall's old airline, withdrew its listings from some online intermediators, including Orbitz and Expedia. Southwest and Jet Blue have blocked access by intermediaries to their ticketing, as well. Six other airlines are working with AA to establish Open Axis to wrest control of ticketing and related extras back from the brokers.
Jenkins notes,
"Too, the carriers have shrewdly held back most of their ancillary goodies, allowing them to be sold only at their own websites, ticket kiosks or on the plane itself. Because the booking networks fear they will become irrelevant if they can't display the optional services along with basic fares and schedules, airlines see a ripe moment to negotiate a new business model with the online ticket sellers.
The bottom line for travelers, though, is not nearly as profound as some make out. The shopping experience is likely to change a bit, with more targeted freebies, upgrades and "upsells" aimed at individual passengers by airlines hoping to nourish customer loyalty. But the idea (or hope) that airlines will now be able to mint anticompetitive fares is unrealistic."
Fair enough, no homonym pun intended. But Jenkins misses the larger picture, which is simply the only swing of the strategic relationship control pendulum back towards airlines in decades. Crandall said, at the end of this career with AA, that, given a choice, he'd prefer to run Sabre, the spun off ticketing business, because it was much more profitable.
With one URL pretty much as good and accessible as the next, why shouldn't airlines begin to foster customer loyalty by tying more services and benefits to patronage, albeit in legally-defensible ways? Its' the sine qua non of marketing, i.e., get away from price competition and focus the customer on the total product/service experience.
No, it doesn't mean complete price freedom for the airlines. At some point, price ranges will become too great to sustain, but some latitude will be available as flyers are drawn into loyalty webs and, with the less pleasant environment for commercial flight, the ability to enjoy better overall treatment while traveling in exchange for choosing a preferred air carrier.
Sounds like a partial return to the 1960s that my late father knew, only with immediate mobile access.
In particular, he points out how American, Bob Crandall's old airline, withdrew its listings from some online intermediators, including Orbitz and Expedia. Southwest and Jet Blue have blocked access by intermediaries to their ticketing, as well. Six other airlines are working with AA to establish Open Axis to wrest control of ticketing and related extras back from the brokers.
Jenkins notes,
"Too, the carriers have shrewdly held back most of their ancillary goodies, allowing them to be sold only at their own websites, ticket kiosks or on the plane itself. Because the booking networks fear they will become irrelevant if they can't display the optional services along with basic fares and schedules, airlines see a ripe moment to negotiate a new business model with the online ticket sellers.
The bottom line for travelers, though, is not nearly as profound as some make out. The shopping experience is likely to change a bit, with more targeted freebies, upgrades and "upsells" aimed at individual passengers by airlines hoping to nourish customer loyalty. But the idea (or hope) that airlines will now be able to mint anticompetitive fares is unrealistic."
Fair enough, no homonym pun intended. But Jenkins misses the larger picture, which is simply the only swing of the strategic relationship control pendulum back towards airlines in decades. Crandall said, at the end of this career with AA, that, given a choice, he'd prefer to run Sabre, the spun off ticketing business, because it was much more profitable.
With one URL pretty much as good and accessible as the next, why shouldn't airlines begin to foster customer loyalty by tying more services and benefits to patronage, albeit in legally-defensible ways? Its' the sine qua non of marketing, i.e., get away from price competition and focus the customer on the total product/service experience.
No, it doesn't mean complete price freedom for the airlines. At some point, price ranges will become too great to sustain, but some latitude will be available as flyers are drawn into loyalty webs and, with the less pleasant environment for commercial flight, the ability to enjoy better overall treatment while traveling in exchange for choosing a preferred air carrier.
Sounds like a partial return to the 1960s that my late father knew, only with immediate mobile access.
Monday, January 24, 2011
GE's Immelt Gets A Political Sop for His Support
All his political ass-kissing and support for the administration's uneconomic green, alternative energy initiatives paid off in his being named as head of a new jobs & competitiveness council.
Funny, isn't it, how a guy who ran his company so badly that it had to be rescued by the Fed's cheap funding, with no questions asked, is rewarded with a job telling others how to do what he couldn't, i.e., compete effectively?
Because Immelt would have run GE out of business, but for a generous federal government. It's difficult to figure out just what he's supposed to know about competition that he could teach anyone else.
Wouldn't it have made more sense, provided more inspiration, for the administration to have selected the CEO of a firm that didn't have to be bailed out in order to avoid bankruptcy?
Take a look at the nearby price chart of GE and the S&P500 Index. From late 2001, when Immelt took the helm of GE, until now, the company's relative price to the index has fallen precipitously. Even Friday's earnings announcement and price rise couldn't save nearly a decade of mediocre misleadership by Immelt. At GE's recent 2009 lows, Immelt had destroyed cumulative value stretching back 13 years, to 1996. That takes talent!
Meanwhile, with NBC/Universal being taken over, for managerial purposes, next week, Immelt was treated to one last softball interview on his company's CNBC network this afternoon. What will happen when Immelt doesn't have the power to hire and fire in order to command such creampuff scenes?
Friday, January 21, 2011
Chesapeake Energy's Derivatives Strategy
Aubrey McClendon, Chesapeake Energy's CEO, made news this week for an audacious move to juice Chesapeake's net income.
His bet on natural gas over the last few years turned bad, causing him personal losses on margined positions. Now, with gas prices looking soft for the near term, he's moving the firm into oil drilling. Sensing weakness, activist investor Carl Icahn has bought into Chesapeake.
Meanwhile, McClendon has Chesapeake aggressively hedging natural gas prices forward, with some positions allegedly not expiring until 2020.
Some analysts and fellow traders argue that Chesapeake is playing with fire. The company has already bet on gas prices as far into the future as 2020—a date so far ahead, some skeptics say, that the markets are too tough to pinpoint. CNBC reporter Kate Kelly wrote a piece yesterday which noted,
“I don’t really like the idea of selling out call options on gas prices and oil prices—mostly gas prices for the long-dated options—10 years out so that I can get more revenue today,” says Phil Weiss, a energy analyst who recently downgraded Chesapeake to a sell rating. “It’s just another way the company is mortgaging its future.”
McClendon counters that “90 percent” of Chesapeake’s hedging activity is focused on the “next eighteen months.” The trades dating to 2020, he said, are “basis hedges” intended to mitigate risk events in regional markets.
Other critics argue that Chesapeake’s hedges, while likely to succeed in the immediate future, will be tough to replicate longer-term.
“In 2011 they’re going to have material hedge gains,” said one energy trader whose company policy prevents him from speaking on the record, “but they’re not going to have that luxury going forward. Because if prices go up, they’re in great shape. But if prices stay depressed, they don’t have the flexibility they did in the past.
Chesapeake officials acknowledge that if gas prices rise far above the strike prices of the calls they sold—$5.84 and $6.19 for the next two years respectively—they could lose some money. But in that case, say officials, they’d be happy because produced gas could be sold at a higher price.
McClendon himself takes offense at the notion Chesapeake has become a hedge fund—a label Weiss and some traders have recently slapped on the company. “We don’t gamble. We don’t bet. We’re physically long gas,” McClendon says. “All we’re doing is mitigating risk.”
Unlike other gas and drillers, some of whom employ hundreds of dedicated traders, Chesapeake’s hedging team is a party of three: McClendon, newly-appointed chief financial officer Domenic Dell’Osso, and Jeffrey Mobley, the company’s senior vice president of investor relations. Before the team makes a move, its members say, their decision must be unanimous.”
Regardless of McClendon's remarks, doesn't this basically turn Chesapeake from a natural gas producer to a closed-ended natural gas options fund? Being naturally long due to their ostensibly main business doesn't make Chesapeake not a hedge fund. They could have just as easily bought options on production instead, and be just as long.
I'm not an energy sector analyst, but most pundits appearing on CNBC yesterday seemed to be shocked at McClendon's recent strategy moves.
I don't quite get how, if the firm has sold calls on current production, they can then claim that rising prices benefit them. Unless, of course, they didn't sell calls on much production capacity. It wouldn't seem that they can have it both ways.
From a larger perspective, McClendon can't both be able to profit more in the future if he's smoothing income now through the use of derivatives. Using derivatives either caps profits and/or losses, or is a one-way bet.
As I read McClendon's comments, and those attributed to the firm's executives, it's not clear which Chesapeake has really done. Which ought to give investors pause.
His bet on natural gas over the last few years turned bad, causing him personal losses on margined positions. Now, with gas prices looking soft for the near term, he's moving the firm into oil drilling. Sensing weakness, activist investor Carl Icahn has bought into Chesapeake.
Meanwhile, McClendon has Chesapeake aggressively hedging natural gas prices forward, with some positions allegedly not expiring until 2020.
Some analysts and fellow traders argue that Chesapeake is playing with fire. The company has already bet on gas prices as far into the future as 2020—a date so far ahead, some skeptics say, that the markets are too tough to pinpoint. CNBC reporter Kate Kelly wrote a piece yesterday which noted,
“I don’t really like the idea of selling out call options on gas prices and oil prices—mostly gas prices for the long-dated options—10 years out so that I can get more revenue today,” says Phil Weiss, a energy analyst who recently downgraded Chesapeake to a sell rating. “It’s just another way the company is mortgaging its future.”
McClendon counters that “90 percent” of Chesapeake’s hedging activity is focused on the “next eighteen months.” The trades dating to 2020, he said, are “basis hedges” intended to mitigate risk events in regional markets.
Other critics argue that Chesapeake’s hedges, while likely to succeed in the immediate future, will be tough to replicate longer-term.
“In 2011 they’re going to have material hedge gains,” said one energy trader whose company policy prevents him from speaking on the record, “but they’re not going to have that luxury going forward. Because if prices go up, they’re in great shape. But if prices stay depressed, they don’t have the flexibility they did in the past.
Chesapeake officials acknowledge that if gas prices rise far above the strike prices of the calls they sold—$5.84 and $6.19 for the next two years respectively—they could lose some money. But in that case, say officials, they’d be happy because produced gas could be sold at a higher price.
McClendon himself takes offense at the notion Chesapeake has become a hedge fund—a label Weiss and some traders have recently slapped on the company. “We don’t gamble. We don’t bet. We’re physically long gas,” McClendon says. “All we’re doing is mitigating risk.”
Unlike other gas and drillers, some of whom employ hundreds of dedicated traders, Chesapeake’s hedging team is a party of three: McClendon, newly-appointed chief financial officer Domenic Dell’Osso, and Jeffrey Mobley, the company’s senior vice president of investor relations. Before the team makes a move, its members say, their decision must be unanimous.”
Regardless of McClendon's remarks, doesn't this basically turn Chesapeake from a natural gas producer to a closed-ended natural gas options fund? Being naturally long due to their ostensibly main business doesn't make Chesapeake not a hedge fund. They could have just as easily bought options on production instead, and be just as long.
I'm not an energy sector analyst, but most pundits appearing on CNBC yesterday seemed to be shocked at McClendon's recent strategy moves.
I don't quite get how, if the firm has sold calls on current production, they can then claim that rising prices benefit them. Unless, of course, they didn't sell calls on much production capacity. It wouldn't seem that they can have it both ways.
From a larger perspective, McClendon can't both be able to profit more in the future if he's smoothing income now through the use of derivatives. Using derivatives either caps profits and/or losses, or is a one-way bet.
As I read McClendon's comments, and those attributed to the firm's executives, it's not clear which Chesapeake has really done. Which ought to give investors pause.
Repercussions of Meredith Whitney's Muni Bond Default Warnings
Only Monday I was writing of Meredith Whitney's warnings on impending muni bond defaults, putting her publicly at odds with PIMCO's Bill Gross. Further, Whitney explicitly called Gross on the motivations behind his rosy view of such fixed income instruments.
Yesterday on CNBC, Doug Dachille provided his usual scintillating and informative remarks on the fixed income market.
For starters, he agreed with both Gross and Whitney that there will probably not any US state defaults. Dachille then launched into a unique analytic description of how state tax-exempt munis play a part in financing vis a vis tax increases and defaults. Specifically, he noted that most holders of a state's bonds are wealthy state residents, because of the tax exemption. Thus, Dachille noted, a default was as good, or bad, as a tax increase, because, either way, it came out of the same pocket. However, he explained, when a state cut services to fund bond payments, that was essentially regressive, as the state's lower-income residents probably got disproportionately hurt, while the wealthier households continued to enjoy their interest payments without tax increases.
Very interesting insights on income redistribution, taxes, budget cutting and public finance bonds.
Then Dachille told a story that reinforces my belief that retail investors should never, ever, directly purchase bonds. He described a NY city waste treatment plant bond which provided for interest payments before the city was paid its operating expenses. Thus, he noted, the bond was doing nicely at 5+% and had a nearly zero chance of default. But, he cautioned, you had to do your homework to know this. Not all bonds are equal.
Exactly. Which is why when friends talk to me of building bond ladders, I cringe. Unless you are talking very plain vanilla corporates or Treasuries, you're playing with fire. Not to mention the brokerage fees hidden in the spreads when buying individual bonds.
Then Dachille pointed out another important feature of bonds, i.e., with rates so low, and nowhere to go but up, a non-defaulting muni has only its total cash flow as its maximal value. Thus, he said, investors have to realize that muni bonds aren't going to be growth instruments yielding 12% return rates, as equities might.
In sum, he painted what I think is an accurate, often missing picture of fixed income investing as much more risky for retail investors than is generally realized. And why well-managed bond funds serve an important function.
Yesterday on CNBC, Doug Dachille provided his usual scintillating and informative remarks on the fixed income market.
For starters, he agreed with both Gross and Whitney that there will probably not any US state defaults. Dachille then launched into a unique analytic description of how state tax-exempt munis play a part in financing vis a vis tax increases and defaults. Specifically, he noted that most holders of a state's bonds are wealthy state residents, because of the tax exemption. Thus, Dachille noted, a default was as good, or bad, as a tax increase, because, either way, it came out of the same pocket. However, he explained, when a state cut services to fund bond payments, that was essentially regressive, as the state's lower-income residents probably got disproportionately hurt, while the wealthier households continued to enjoy their interest payments without tax increases.
Very interesting insights on income redistribution, taxes, budget cutting and public finance bonds.
Then Dachille told a story that reinforces my belief that retail investors should never, ever, directly purchase bonds. He described a NY city waste treatment plant bond which provided for interest payments before the city was paid its operating expenses. Thus, he noted, the bond was doing nicely at 5+% and had a nearly zero chance of default. But, he cautioned, you had to do your homework to know this. Not all bonds are equal.
Exactly. Which is why when friends talk to me of building bond ladders, I cringe. Unless you are talking very plain vanilla corporates or Treasuries, you're playing with fire. Not to mention the brokerage fees hidden in the spreads when buying individual bonds.
Then Dachille pointed out another important feature of bonds, i.e., with rates so low, and nowhere to go but up, a non-defaulting muni has only its total cash flow as its maximal value. Thus, he said, investors have to realize that muni bonds aren't going to be growth instruments yielding 12% return rates, as equities might.
In sum, he painted what I think is an accurate, often missing picture of fixed income investing as much more risky for retail investors than is generally realized. And why well-managed bond funds serve an important function.
Thursday, January 20, 2011
Holman Jenkins On Apple, Goldman & Facebook
Holman Jenkins, Jr.'s editorial in yesterday's Wall Street Journal dealt with the uselessness of the SEC. He approached the topic rather ingeniously, using the recent news concerning Apple and Facebook.
Regarding Apple, Jenkins simply noted that the firm has disclosed what it felt was sufficient regarding the health of its iconic CEO, Steve Jobs. After that, shareholders are free to buy, sell, or hold the stock, as they wish.
For what it's worth, I believe Jenkins is the first major pundit whom I've read that has explicitly stated the same sentiment I share on this topic, i.e., shareholders have the ability to exit their position in a stock, at nominal cost, if they don't like something about the way the firm is managed. Period. Stop whining.
On the matter of Facebook and Goldman Sachs, Jenkins concluded his brief series of pieces which have generally lauded Facebook's management and absolved Goldman of anything other than simply doing their usual job. Since I wrote this post last week, Goldman yanked its Facebook private placement from its domestic clients, ostensibly to avoid potential SEC sanctions, and, instead, turned to its overseas client base. This has reputedly resulted in a lot of angry domestic clients.
Jenkins has written several pieces extolling Facebook's Zuckerberg's right to remain private, maturity in recognizing his own not-yet-ready-for-prime-time management expertise, and the victimless nature of the firm's right to use a private offering rather than an IPO to raise more capital.
I continue to disagree, somewhat, with Jenkins on the matter of public access to such firms only after the big initial gains are locked in for the wealthy few. But I enjoyed reading his clever turn on the SEC, contending that Goldman's sudden reversal makes a mockery of the agency.
Specifically, Jenkins contends that the SEC made noises about the lack of total privacy of the Facebook private placement in part to look aggressive and tough in the wake of its lapses in the Madoff case and the implosion of the major investment banks, under its watch, during the 2007-09 financial crisis.
On both Apple and the SEC, I concur with Jenkins. He's especially astute to point out how the SEC, by its very existence, has ironically resulted in more investor risk, not less, since many believe the SEC has made investing safe.
Obviously, it hasn't, which creates an enormous and expensive unintended consequence. The core benefits of the agency, whatever they would be, could no doubt be achieved for less money and with less interference in market activities.
Regarding Apple, Jenkins simply noted that the firm has disclosed what it felt was sufficient regarding the health of its iconic CEO, Steve Jobs. After that, shareholders are free to buy, sell, or hold the stock, as they wish.
For what it's worth, I believe Jenkins is the first major pundit whom I've read that has explicitly stated the same sentiment I share on this topic, i.e., shareholders have the ability to exit their position in a stock, at nominal cost, if they don't like something about the way the firm is managed. Period. Stop whining.
On the matter of Facebook and Goldman Sachs, Jenkins concluded his brief series of pieces which have generally lauded Facebook's management and absolved Goldman of anything other than simply doing their usual job. Since I wrote this post last week, Goldman yanked its Facebook private placement from its domestic clients, ostensibly to avoid potential SEC sanctions, and, instead, turned to its overseas client base. This has reputedly resulted in a lot of angry domestic clients.
Jenkins has written several pieces extolling Facebook's Zuckerberg's right to remain private, maturity in recognizing his own not-yet-ready-for-prime-time management expertise, and the victimless nature of the firm's right to use a private offering rather than an IPO to raise more capital.
I continue to disagree, somewhat, with Jenkins on the matter of public access to such firms only after the big initial gains are locked in for the wealthy few. But I enjoyed reading his clever turn on the SEC, contending that Goldman's sudden reversal makes a mockery of the agency.
Specifically, Jenkins contends that the SEC made noises about the lack of total privacy of the Facebook private placement in part to look aggressive and tough in the wake of its lapses in the Madoff case and the implosion of the major investment banks, under its watch, during the 2007-09 financial crisis.
On both Apple and the SEC, I concur with Jenkins. He's especially astute to point out how the SEC, by its very existence, has ironically resulted in more investor risk, not less, since many believe the SEC has made investing safe.
Obviously, it hasn't, which creates an enormous and expensive unintended consequence. The core benefits of the agency, whatever they would be, could no doubt be achieved for less money and with less interference in market activities.
Wednesday, January 19, 2011
Paul Ingrassia's Success Call On "The Great Auto Restructuring"
Only a week ago, I wrote this post regarding AutoNation's CEO Mike Jackson's shameless, disingenuous cheerleading for auto stocks on CNBC. In the interests of equal time and treatment, I guess I must also discuss my one-time squash partner and friend, Pulitzer Prize-winning writer Paul Ingrassia's recent Wall Street Journal editorial entitled The Great Auto Restructuring Shows Signs of Success.
Rather than rewrite the prior post's highlights, let me quote from it,
"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 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.
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."
Here's some of Paul's glowing prose regarding the alleged success and its meaning for broader American fortunes,
"The good times are beginning to roll again, far faster than anybody expected, at General Motors, Ford and even at the weakest of the Detroit Three, Chrysler. There might be a lesson here. If the Great Restructuring has the potential to resolve the seemingly intractable problems of Detroit, perhaps bold structural overhauls can produce similar results on some broader issues facing America. Sure, that's a lot to hope for—but consider what tough love has done in the Motor City.
In 2005, General Motors lost an astounding $10.6 billion—this in a year when Americans bought nearly 17 million cars and trucks, nearly an all-time record. Last year, industry-wide sales totaled 11.6 million vehicles, historically depressed by any standard, but GM posted net income of $4.8 billion through Sept. 30. The company hasn't reported full-year results for 2010, but earnings will easily top $5 billion.
At Ford, the only Detroit company that didn't go bankrupt, the financial turnaround has been even more dramatic. Ford lost $12.6 billion in 2006 but earned $6.4 billion in the first nine months of last year. It just announced it will hire 7,000 more employees. Chrysler, meanwhile, is operating at break-even, and its cash flow is positive.
The average vehicle on American roads today is 10.2 years old, says R.L. Polk Co., which collects such data. This compares to an average age of 9.4 years five years ago and 8.8 years a decade ago. The point: Cars and trucks are getting older and will have to be replaced.
GM now makes 28 vehicles per year for each employee, calculates Goldman Sachs auto analyst Parick Archambault. That's more than double the company's productivity during the 1990s, he notes, and fully four times as high as in the 1950s, Detroit's glory years. GM's hourly labor costs now amount to just 6% of its revenue in North America. That's down from nearly 30% a few years ago, when the company was paying tens of thousands of workers to sit idle, and paying the full freight for employee health care.
GM's gains, and similar ones at Ford and Chrysler, have occurred because of the Great Restructuring, much of which came at the insistence of President Barack Obama's automotive task force.
The car companies' unlimited health-care obligations to retired workers have been replaced by a trust, funded by company contributions that are capped at a fixed amount. Active workers now pay about 5% of their health-care costs, up from nothing a few years ago.
Of course, 5% is only about one-fifth of what the average American employee contributes out of wages to his own health-care plan. That's one sign Detroit's turnaround remains fragile, threatened by the companies' traditional tendency to confuse comeback with victory. But even in labor relations there's a whiff of fresh air.
When GM's new CEO, Dan Akerson, suggested this week that workers' wages should be tied to corporate performance, the new president of the UAW, Bob King, quickly said he's willing to discuss the idea.
The United States is facing trillion-dollar federal deficits that are patently unsustainable, and the broad debate in Washington is whether tax increases or spending cuts are the proper solution. But neither approach, nor a combination of the two, will work without restructuring the vast federal entitlement programs that are the national equivalent of Detroit's Jobs Bank.
Social Security can't and shouldn't be abolished like the Jobs Bank was. But it can and should be restructured—to encourage later retirements, for example—as part of a broad entitlements reform.
States are burdened with underfunded pension plans for public employees that have destroyed their fiscal probity. It's nutty to raise taxes to plug state budget deficits, as Illinois just did, without restructuring public-employee pensions that allow workers to retire in their fifties, in some cases, with 80% of their pre-retirement incomes. Restructuring public-pension plans into 401(k) programs will spur fierce union resistance, just as key elements of the Great Restructuring did in Detroit. There's no painless way out of this problem. But further delay will only increase the pain, as Detroit's disaster of 2009 proved.
We should learn from success. Tough-love restructuring can produce renewal. With political will, resolve can produce results."
First, let me suggest reading this post from last summer. In it, I discuss Paul's review of another journalist's book about the Detroit automakers. He admits to journalists cheerleading without giving full disclosure,
"Ingrassia's opening sentences say it all,
"Many of the journalists who covered the long decline of General Motors that led to last year's bankruptcy were, in their hearts, rooting for the company. Such reporters- I among them- would seize on the occasional piece of good news about GM to write something upbeat. It would be a journalistic coup, after all, to be the first writer to call the company's turnaround. In any case, no one who grew up during GM's heyday, in the 1950s and 1960s, wanted to see an American icon self-destruct."
Together, Ingrassia's inclusion of these passages tells us a lot about why we should simply not trust most beat reporting on US companies and industries.
Reporters are not sell-side analysts. And, for that matter, we know from the last decade's dot-com bubble that sell-side analysts are, in reality, marketers for the equities which their firms underwrite and in which they make a market.
You'd ordinarily think that a reporter was more objective than an analyst whose firm clearly has conflicts of interest.
Ingrassia's review tells you different. I am not sure Paul meant to open the media kimono quite so widely, but there it is."
Let me reiterate that I like Paul Ingrassia as a person, but, thanks to that review, I can't say that I completely trust his coverage of the auto sector in the public press anymore. His own words make that a reasonable stance.
Next, I won't question Paul's many numbers involving Ford's and GM's costs, volumes, profits, etc. I simply reiterate my contention that the basic entry/exit realities of the sector suggest it's very mature and suspect for investors.
Further, Paul makes quite clear that none of this was possible without egregious government intervention. Give your local dry cleaner or restaurateur the same help, and he will eventually show promise, too. But what about years later, when the free bailouts are finished and these businesses have to prosper on their own?
Don't you think that as soon as GM or Ford book large profits, the unions and government will come screaming at management nest-feathering? Sure, it sounds good that a union official "is willing to discuss" linking wages to profits. Try getting that into a contract. The existing health care cost-sharing remains a glaring inequity for UAW members versus the rest of America.
Now, I don't even agree, based upon my prior posts, including the linked one at the beginning of this post, that Ford and GM have accomplished legitimate, long term, sustainable turnarounds. But whatever improved performances have occurred would not have been so, in GM's case, without the bailout, unless the firm were put into Chapter 11 and allowed to exit the traditional way.
So I find it troubling that Ingrassia gets all googly-eyed about how what worked for Detroit could be a template for America to self-rescue on its federal entitlement programs.
Of course, as all pundits, Paul quickly disavows really scrapping Social Security or public pensions. Instead, he is in the camp of some sort of sensible discussions and negotiations with recipients to rationalize and temper the liabilities.
Well, Paul, there's a bit of a problem with that. First, GM's bailout only happened because the federal government basically printed the money for it. That has caused enough problems already. Some of the backlash by overseas investors was precisely because they watched their loans to the US government be funneled to the UAW.
However, there's nobody to bailout the US.
If anything is an object lesson in the administration's bailout of GM, it's to borrow the template used to illegally stiff legitimate senior creditors. If the US could do that to GM bondholders, why not use such tactics to cram reforms down the throats of Social Security and public pension recipients?
Works for me!
Other than that, there's nothing about the GM bailout that is really transferable to the larger public pension or federal entitlement spending mess. It's not just like a business problem. And that particular UAW benefits problem was 'solved' by our government printing and throwing money at it.
Despite Paul's best hopes, I just don't think that's going to work for the entitlements messes he believes will be resolved in that manner.
Rather than rewrite the prior post's highlights, let me quote from it,
"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 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.
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."
Here's some of Paul's glowing prose regarding the alleged success and its meaning for broader American fortunes,
"The good times are beginning to roll again, far faster than anybody expected, at General Motors, Ford and even at the weakest of the Detroit Three, Chrysler. There might be a lesson here. If the Great Restructuring has the potential to resolve the seemingly intractable problems of Detroit, perhaps bold structural overhauls can produce similar results on some broader issues facing America. Sure, that's a lot to hope for—but consider what tough love has done in the Motor City.
In 2005, General Motors lost an astounding $10.6 billion—this in a year when Americans bought nearly 17 million cars and trucks, nearly an all-time record. Last year, industry-wide sales totaled 11.6 million vehicles, historically depressed by any standard, but GM posted net income of $4.8 billion through Sept. 30. The company hasn't reported full-year results for 2010, but earnings will easily top $5 billion.
At Ford, the only Detroit company that didn't go bankrupt, the financial turnaround has been even more dramatic. Ford lost $12.6 billion in 2006 but earned $6.4 billion in the first nine months of last year. It just announced it will hire 7,000 more employees. Chrysler, meanwhile, is operating at break-even, and its cash flow is positive.
The average vehicle on American roads today is 10.2 years old, says R.L. Polk Co., which collects such data. This compares to an average age of 9.4 years five years ago and 8.8 years a decade ago. The point: Cars and trucks are getting older and will have to be replaced.
GM now makes 28 vehicles per year for each employee, calculates Goldman Sachs auto analyst Parick Archambault. That's more than double the company's productivity during the 1990s, he notes, and fully four times as high as in the 1950s, Detroit's glory years. GM's hourly labor costs now amount to just 6% of its revenue in North America. That's down from nearly 30% a few years ago, when the company was paying tens of thousands of workers to sit idle, and paying the full freight for employee health care.
GM's gains, and similar ones at Ford and Chrysler, have occurred because of the Great Restructuring, much of which came at the insistence of President Barack Obama's automotive task force.
The car companies' unlimited health-care obligations to retired workers have been replaced by a trust, funded by company contributions that are capped at a fixed amount. Active workers now pay about 5% of their health-care costs, up from nothing a few years ago.
Of course, 5% is only about one-fifth of what the average American employee contributes out of wages to his own health-care plan. That's one sign Detroit's turnaround remains fragile, threatened by the companies' traditional tendency to confuse comeback with victory. But even in labor relations there's a whiff of fresh air.
When GM's new CEO, Dan Akerson, suggested this week that workers' wages should be tied to corporate performance, the new president of the UAW, Bob King, quickly said he's willing to discuss the idea.
The United States is facing trillion-dollar federal deficits that are patently unsustainable, and the broad debate in Washington is whether tax increases or spending cuts are the proper solution. But neither approach, nor a combination of the two, will work without restructuring the vast federal entitlement programs that are the national equivalent of Detroit's Jobs Bank.
Social Security can't and shouldn't be abolished like the Jobs Bank was. But it can and should be restructured—to encourage later retirements, for example—as part of a broad entitlements reform.
States are burdened with underfunded pension plans for public employees that have destroyed their fiscal probity. It's nutty to raise taxes to plug state budget deficits, as Illinois just did, without restructuring public-employee pensions that allow workers to retire in their fifties, in some cases, with 80% of their pre-retirement incomes. Restructuring public-pension plans into 401(k) programs will spur fierce union resistance, just as key elements of the Great Restructuring did in Detroit. There's no painless way out of this problem. But further delay will only increase the pain, as Detroit's disaster of 2009 proved.
We should learn from success. Tough-love restructuring can produce renewal. With political will, resolve can produce results."
First, let me suggest reading this post from last summer. In it, I discuss Paul's review of another journalist's book about the Detroit automakers. He admits to journalists cheerleading without giving full disclosure,
"Ingrassia's opening sentences say it all,
"Many of the journalists who covered the long decline of General Motors that led to last year's bankruptcy were, in their hearts, rooting for the company. Such reporters- I among them- would seize on the occasional piece of good news about GM to write something upbeat. It would be a journalistic coup, after all, to be the first writer to call the company's turnaround. In any case, no one who grew up during GM's heyday, in the 1950s and 1960s, wanted to see an American icon self-destruct."
Together, Ingrassia's inclusion of these passages tells us a lot about why we should simply not trust most beat reporting on US companies and industries.
Reporters are not sell-side analysts. And, for that matter, we know from the last decade's dot-com bubble that sell-side analysts are, in reality, marketers for the equities which their firms underwrite and in which they make a market.
You'd ordinarily think that a reporter was more objective than an analyst whose firm clearly has conflicts of interest.
Ingrassia's review tells you different. I am not sure Paul meant to open the media kimono quite so widely, but there it is."
Let me reiterate that I like Paul Ingrassia as a person, but, thanks to that review, I can't say that I completely trust his coverage of the auto sector in the public press anymore. His own words make that a reasonable stance.
Next, I won't question Paul's many numbers involving Ford's and GM's costs, volumes, profits, etc. I simply reiterate my contention that the basic entry/exit realities of the sector suggest it's very mature and suspect for investors.
Further, Paul makes quite clear that none of this was possible without egregious government intervention. Give your local dry cleaner or restaurateur the same help, and he will eventually show promise, too. But what about years later, when the free bailouts are finished and these businesses have to prosper on their own?
Don't you think that as soon as GM or Ford book large profits, the unions and government will come screaming at management nest-feathering? Sure, it sounds good that a union official "is willing to discuss" linking wages to profits. Try getting that into a contract. The existing health care cost-sharing remains a glaring inequity for UAW members versus the rest of America.
Now, I don't even agree, based upon my prior posts, including the linked one at the beginning of this post, that Ford and GM have accomplished legitimate, long term, sustainable turnarounds. But whatever improved performances have occurred would not have been so, in GM's case, without the bailout, unless the firm were put into Chapter 11 and allowed to exit the traditional way.
So I find it troubling that Ingrassia gets all googly-eyed about how what worked for Detroit could be a template for America to self-rescue on its federal entitlement programs.
Of course, as all pundits, Paul quickly disavows really scrapping Social Security or public pensions. Instead, he is in the camp of some sort of sensible discussions and negotiations with recipients to rationalize and temper the liabilities.
Well, Paul, there's a bit of a problem with that. First, GM's bailout only happened because the federal government basically printed the money for it. That has caused enough problems already. Some of the backlash by overseas investors was precisely because they watched their loans to the US government be funneled to the UAW.
However, there's nobody to bailout the US.
If anything is an object lesson in the administration's bailout of GM, it's to borrow the template used to illegally stiff legitimate senior creditors. If the US could do that to GM bondholders, why not use such tactics to cram reforms down the throats of Social Security and public pension recipients?
Works for me!
Other than that, there's nothing about the GM bailout that is really transferable to the larger public pension or federal entitlement spending mess. It's not just like a business problem. And that particular UAW benefits problem was 'solved' by our government printing and throwing money at it.
Despite Paul's best hopes, I just don't think that's going to work for the entitlements messes he believes will be resolved in that manner.
Tuesday, January 18, 2011
Steve Jobs' Medical Leave, Cash Levels & Apple Pundits
Since I wrote this morning's post over the weekend, I didn't include the recent news of Steve Jobs' latest medical leave. Nor this morning's Wall Street Journal pieces concerning Apple. One focused on new Android devices, the other on an institutional manager's fury over the tens of billions of cash on the firm's balance sheet.
Of the three developments, I'd say that Jobs' departure will be the most critical. As expected, it knocked some value off of the equity's price this morning, causing a 3.7% drop by 11AM, as I write this post. As a growth equity, it's understandable that uncertainties over Jobs' future at the company will affect the forward-looking component of its price. So even strong quarterly performance reports will probably be overshadowed by these worries.
As to the cash concerns, I continue to be surprised by whining fund managers who can't simply make a buy/sell/hold decision. They keep wanting to push management by complaining in public, whereas simply dumping the equity if they really object to Apple's financing policies would probably have far more effect. Until these managers mount an Ed Lampert-style takeover of Apple, however, they'd be better off just voting with their trades.
As to Android-based smart phones, the back page piece in the Journal's Money & Investing Section didn't really impress me all that much. The major gripe the author had was that, like its laptops, Apple commands a high price premium for its iPhone, making Android devices more attractive to carriers for discounting. But at the very end of the piece, he admits that Apple's apps are triple the current number for Android phones.
Isn't the real issue, however, growth of Apple's iPhone base, not total market share? Apple's share of PCs and laptops hasn't been dominant, but their sales certainly have continued to help fuel the firm's revenue and income growth.
I remain comfortable trusting the management that brought Apple to its path of consistently superior performance. If Steve Jobs becomes unavailable in the long term, that will probably affect the company's share price and, thus, it's implied performance for shareholders. It's a self-fulfilling prophecy that could very well remove Apple from my equity selection process' results. So be it.
But the other concerns seem, to me, pointless. Such second-guessing is akin to trying to influence the same management which has produced the results which drive investors to buy the equity in the first place.
Of the three developments, I'd say that Jobs' departure will be the most critical. As expected, it knocked some value off of the equity's price this morning, causing a 3.7% drop by 11AM, as I write this post. As a growth equity, it's understandable that uncertainties over Jobs' future at the company will affect the forward-looking component of its price. So even strong quarterly performance reports will probably be overshadowed by these worries.
As to the cash concerns, I continue to be surprised by whining fund managers who can't simply make a buy/sell/hold decision. They keep wanting to push management by complaining in public, whereas simply dumping the equity if they really object to Apple's financing policies would probably have far more effect. Until these managers mount an Ed Lampert-style takeover of Apple, however, they'd be better off just voting with their trades.
As to Android-based smart phones, the back page piece in the Journal's Money & Investing Section didn't really impress me all that much. The major gripe the author had was that, like its laptops, Apple commands a high price premium for its iPhone, making Android devices more attractive to carriers for discounting. But at the very end of the piece, he admits that Apple's apps are triple the current number for Android phones.
Isn't the real issue, however, growth of Apple's iPhone base, not total market share? Apple's share of PCs and laptops hasn't been dominant, but their sales certainly have continued to help fuel the firm's revenue and income growth.
I remain comfortable trusting the management that brought Apple to its path of consistently superior performance. If Steve Jobs becomes unavailable in the long term, that will probably affect the company's share price and, thus, it's implied performance for shareholders. It's a self-fulfilling prophecy that could very well remove Apple from my equity selection process' results. So be it.
But the other concerns seem, to me, pointless. Such second-guessing is akin to trying to influence the same management which has produced the results which drive investors to buy the equity in the first place.
More of James Stewart's Questionable Investing Advice
I have had the occasion to answer some investing questions from friends as the new year begins. Having been professionally involved in equity and options investing for nearly 15 years, and in the financial sector for much longer, my advice is typically simple.
Avoid individual equities unless it's speculative money. If investing for a longish term, stick to dollar-averaging the S&P500 from a low-cost fund complex. Any other sector bets are best made via Vanguard or comparably-priced, passive index fund complexes.
The dirty little secret of investing is that non-professionals should steer clear of individual equity, bond or option trading and, for that matter, trying to chase the, on average, 25% of actively-managed publicly-available funds which manage to beat the S&P500 Index each year, because they are usually a different 25% the next year.
So I found a recent Wall Street Journal column by its official investing guru, James Stewart, particularly disheartening. Stewart spent most of the article's ink fretting about Apple's continued dominance and growth prospects. After much 'analysis,' Stewart confided that he'd sold some options on the firm's equity recently, content with the profits. His other recommendation involved Google and the new Motorola Mobility. About Apple, Stewart concluded,
"I see only one problem: I'm not sure what worlds are left for Apple to conquer."
Then, in classic fence-sitting fashion for a market pundit, he adds,
"I haven't given up on Apple. I still own shares and another set of call options that expire in January 2012. But the market recently hit one of my selling thresholds, and I feel comfortable taking some profits."
Clear on that now? Me neither.
But here's what really stuns me. Stewart holds options expiring a year from now. That means enduring a lot of potential price volatility. And he doesn't mention any sort of time-dimensioned discipline.
The problem with the price-targeting he uses is that it isn't referenced against a market index level. It's just free-floating, as if that's adequate.
My own equity approach holds portfolios for less than a year, but more than a few months. Shorter than that is to be nearly a market-timer, which doesn't work consistently over long time periods. Longer, and you are asking for trouble due to changing company situations. I don't mind holding the same equity for over a year, so long as the decision is made month by month to do so, for the entire planned duration.
With investing technology and institutional money management having evolved as they have in recent years, the notion that you can buy and hold technology issues for the long term is misleading. Even more so when the Journal recently published an article describing how concentrated many large hedge fund holdings are in just a few equities, often in the technology sector.
But I approach this from a professional perspective, and Stewart ostensibly writes market advice columns for a living. His readers, however, presumably have day jobs.
They have no business sinking substantial amounts into individual, volatile equities. Most of his readers are probably best off dollar-averaging their way into ever-increasing S&P500 Index positions, with some diversification into perhaps one or two passive sector funds and a corporate bond fund.
Many years ago, when I was just out of graduate school, I read the chilling, sad Wall Street Journal stories of how so many retail investors lost everything on WPPS bonds. The infamous Washington Public Power Supply debt wasn't actually federally guaranteed, but had been sold as such by unscrupulous brokers.
The moral of the story for me, however, was simply this. For many investors, just keeping their capital over their investing horizon probably puts them far higher in the distribution of retail investor returns than many would care to admit. Chasing tempting returns on individual technology equities merely adds to the risk.
Which is why I think Stewart's column is inappropriate for the Journal. But, as I wrote at the beginning of this post, that's the sector's dirty little secret. Most retail investors have no business even bothering over individual equities or debt issues.
That's what low-cost, passive index fund complexes, staffed by professionals, are for.
Avoid individual equities unless it's speculative money. If investing for a longish term, stick to dollar-averaging the S&P500 from a low-cost fund complex. Any other sector bets are best made via Vanguard or comparably-priced, passive index fund complexes.
The dirty little secret of investing is that non-professionals should steer clear of individual equity, bond or option trading and, for that matter, trying to chase the, on average, 25% of actively-managed publicly-available funds which manage to beat the S&P500 Index each year, because they are usually a different 25% the next year.
So I found a recent Wall Street Journal column by its official investing guru, James Stewart, particularly disheartening. Stewart spent most of the article's ink fretting about Apple's continued dominance and growth prospects. After much 'analysis,' Stewart confided that he'd sold some options on the firm's equity recently, content with the profits. His other recommendation involved Google and the new Motorola Mobility. About Apple, Stewart concluded,
"I see only one problem: I'm not sure what worlds are left for Apple to conquer."
Then, in classic fence-sitting fashion for a market pundit, he adds,
"I haven't given up on Apple. I still own shares and another set of call options that expire in January 2012. But the market recently hit one of my selling thresholds, and I feel comfortable taking some profits."
Clear on that now? Me neither.
But here's what really stuns me. Stewart holds options expiring a year from now. That means enduring a lot of potential price volatility. And he doesn't mention any sort of time-dimensioned discipline.
The problem with the price-targeting he uses is that it isn't referenced against a market index level. It's just free-floating, as if that's adequate.
My own equity approach holds portfolios for less than a year, but more than a few months. Shorter than that is to be nearly a market-timer, which doesn't work consistently over long time periods. Longer, and you are asking for trouble due to changing company situations. I don't mind holding the same equity for over a year, so long as the decision is made month by month to do so, for the entire planned duration.
With investing technology and institutional money management having evolved as they have in recent years, the notion that you can buy and hold technology issues for the long term is misleading. Even more so when the Journal recently published an article describing how concentrated many large hedge fund holdings are in just a few equities, often in the technology sector.
But I approach this from a professional perspective, and Stewart ostensibly writes market advice columns for a living. His readers, however, presumably have day jobs.
They have no business sinking substantial amounts into individual, volatile equities. Most of his readers are probably best off dollar-averaging their way into ever-increasing S&P500 Index positions, with some diversification into perhaps one or two passive sector funds and a corporate bond fund.
Many years ago, when I was just out of graduate school, I read the chilling, sad Wall Street Journal stories of how so many retail investors lost everything on WPPS bonds. The infamous Washington Public Power Supply debt wasn't actually federally guaranteed, but had been sold as such by unscrupulous brokers.
The moral of the story for me, however, was simply this. For many investors, just keeping their capital over their investing horizon probably puts them far higher in the distribution of retail investor returns than many would care to admit. Chasing tempting returns on individual technology equities merely adds to the risk.
Which is why I think Stewart's column is inappropriate for the Journal. But, as I wrote at the beginning of this post, that's the sector's dirty little secret. Most retail investors have no business even bothering over individual equities or debt issues.
That's what low-cost, passive index fund complexes, staffed by professionals, are for.
Monday, January 17, 2011
Meredith Whitney Speaks Truth To Power a/k/a PIMCO's Bill Gross
For once, someone is speaking honestly regarding PIMCO's bond gorilla Bill Gross. MeredithWhitney accused Gross of having Pollyanna attitudes on US municipal defaults because he holds so many of their bonds.
Yes, at last, some truth about Gross' shameless pumping his own book and positions on CNBC. Whitney was on the network last week as a guest host. I believe that's where she made her comments regarding her differences of opinion with Gross on the default question. It was picked up in a weekend Wall Street Journal piece, as well.
In that latter article, Whitney is quoted as agreeing that we won't see state-level defaults. But she is clear in believing that there will be a fair number of municipal bond defaults.
This isn't the first time Gross has used CNBC to advance his firm's positions. A few years ago, when the Chinese were questioning US backing of Fannie Mae bonds, Gross asserted unequivocally that the bonds were explicitly backed by the US government, despite evidence to the contrary. In the event, the administration buckled and reassured the Chinese, and Gross. But in the interval before that public statement, Gross did his best to talk up the value of the bonds in question.
This time, however, he's up against a well-regarded, objective analyst. Whitney's warnings on credit card policies by banks in light of new regulations was prescient. Her work on municipal bond safety is looking pretty good, as well. And she recently intimated that her firm will initiate muni credit ratings very soon.
It's refreshing to see someone in the financial sector have the courage and ability to challenge Bill Gross' contentions. Especially when he hasn't exactly provided evidence for his views, other than a general knowledge that his firm's book drives his publicly-expressed opinions.
Yes, at last, some truth about Gross' shameless pumping his own book and positions on CNBC. Whitney was on the network last week as a guest host. I believe that's where she made her comments regarding her differences of opinion with Gross on the default question. It was picked up in a weekend Wall Street Journal piece, as well.
In that latter article, Whitney is quoted as agreeing that we won't see state-level defaults. But she is clear in believing that there will be a fair number of municipal bond defaults.
This isn't the first time Gross has used CNBC to advance his firm's positions. A few years ago, when the Chinese were questioning US backing of Fannie Mae bonds, Gross asserted unequivocally that the bonds were explicitly backed by the US government, despite evidence to the contrary. In the event, the administration buckled and reassured the Chinese, and Gross. But in the interval before that public statement, Gross did his best to talk up the value of the bonds in question.
This time, however, he's up against a well-regarded, objective analyst. Whitney's warnings on credit card policies by banks in light of new regulations was prescient. Her work on municipal bond safety is looking pretty good, as well. And she recently intimated that her firm will initiate muni credit ratings very soon.
It's refreshing to see someone in the financial sector have the courage and ability to challenge Bill Gross' contentions. Especially when he hasn't exactly provided evidence for his views, other than a general knowledge that his firm's book drives his publicly-expressed opinions.
Friday, January 14, 2011
US Drops A Rank to 9 On 2011 Index of Economic Freedom
Wednesday's Wall Street Journal contained an editorial by Terry Miller, director of the Center for International Trade and Economics at the Heritage Foundation.
The Index of Economic Freedom, jointly published by the Heritage Foundation and WSJ, recorded the lowest US rank in a decade. The UK dropped from 11th to 16th place. Leading the list of 179 countries are Hong Kong, Singapore, Australia, New Zealand and Switzerland. Canada is now 6th. Denmark is just ahead of the US.
Denmark!
What does it take for our state and federal governments to wake up to the risk of US economic atrophication? Our country's historic global diplomatic and military power have always been based upon our vibrant, leading economic power.
Now our tax rates are high by global standards, we've borrowed too much and misspent most of it. Our politicians have voted for the biggest lurch leftward toward a European social state since Medicare and Medicaid passed Congress in the late 1960s.
Even S&P and Moodys warned this week that continued US profligacy will result in debt rating downgrades.
These rankings and credit warnings will eventually serve to harm US businesses, too, after our government has lost its ability to borrow at preferential rates. The dollar, too, after decades of hollow warnings, may finally begin to lose its role as an unquestioned global reserve currency.
This recent Economic Freedom slip in rank is a warning we should all take seriously, especially when we view which countries are now outperforming the US.
The Index of Economic Freedom, jointly published by the Heritage Foundation and WSJ, recorded the lowest US rank in a decade. The UK dropped from 11th to 16th place. Leading the list of 179 countries are Hong Kong, Singapore, Australia, New Zealand and Switzerland. Canada is now 6th. Denmark is just ahead of the US.
Denmark!
What does it take for our state and federal governments to wake up to the risk of US economic atrophication? Our country's historic global diplomatic and military power have always been based upon our vibrant, leading economic power.
Now our tax rates are high by global standards, we've borrowed too much and misspent most of it. Our politicians have voted for the biggest lurch leftward toward a European social state since Medicare and Medicaid passed Congress in the late 1960s.
Even S&P and Moodys warned this week that continued US profligacy will result in debt rating downgrades.
These rankings and credit warnings will eventually serve to harm US businesses, too, after our government has lost its ability to borrow at preferential rates. The dollar, too, after decades of hollow warnings, may finally begin to lose its role as an unquestioned global reserve currency.
This recent Economic Freedom slip in rank is a warning we should all take seriously, especially when we view which countries are now outperforming the US.
Thursday, January 13, 2011
Trade Wars & Economic Statistics
Tuesday's Wall Street Journal's lead staff editorial revealed some very troubling information regarding international trade data.
Labeling the current flap over China's currency "a distraction the economy can't afford," the editorial continues,
"How much of a distraction is suggested by a paper out last month from the Asian Development Bank Institute. Economists Yuqing Xing and Neal Detert examined the supply chain of the iPhone to reach a surprising conclusion: Technically, the iPhone contributes to America's trade deficit with China.
The basic explanation is that data on bilateral trade are calculated assuming that the entire value of a traded good is created in the exporting country. If that ever made sense, it certainly doesn't in a global economy marked by increasingly complex supply chains.
In the case of the iPhone, Messrs. Xing and Detert note that the device was invented in America by an American company, Apple. The components are manufactured, either inside or out of China, by companies based in several other countries. The only part of the process that is unambiguously "Chinese" is the final assembly—a process that, in the estimation of Messrs. Xing and Detert, adds only $6.50 to the $178.96 wholesale value of an iPhone.
Yet that entire $178.96 value ends up attributed to China in official trade statistics. As a consequence, the iPhone contributed nearly $1 billion to China's bilateral trade surplus with America in 2008, and nearly $2 billion in 2009, the authors conclude. If the trade data had been based solely on the $6.50 cost of assembling each unit, the iPhone would have added only $34 million and $73 million in those years to China's surplus.
The ADBI study ought to be required reading on Capitol Hill. Most importantly, it raises the question of how much anyone really knows about what America's trade with China is. Critics of trade data, including us, have long argued that bilateral statistics are misleading. As the bilateral deficit with China grew, deficits with South Korea, Taiwan and Singapore declined, confirming that China's comparative advantage lies in the assembly into finished products of components manufactured around the region, due to its low-wage, low-skilled labor."
How about that last paragraph? Is that not insane?
For years we've been wringing our hands over trade imbalances with other nations, only to now learn that, sorry, ooops.....we don't actually account for specific value-addeds on an incremental basis.
So we really have no idea what any country's bilateral trade is with any other country? Why, because keeping track at the component or assembly level is too much trouble?
How can we realistically conduct trade policy or even correctly model the US economy if our fundamental data on international trade flows is basically wrong?
For me, this puts a huge hole in the econometric models predicting quarterly GDP growth. Back when I was in college and grad school, international trade wasn't a major component of GDP. Now, it is. Or so we think. Maybe we really don't know exactly how big it is, if we are crediting other countries with the entire cost basis of an assembled product which passes through that nation for one stage of production.
This valuable information buried in the Journal's editorial provides a big wake-up call regarding the quality of international economic trade data, does it not?
Labeling the current flap over China's currency "a distraction the economy can't afford," the editorial continues,
"How much of a distraction is suggested by a paper out last month from the Asian Development Bank Institute. Economists Yuqing Xing and Neal Detert examined the supply chain of the iPhone to reach a surprising conclusion: Technically, the iPhone contributes to America's trade deficit with China.
The basic explanation is that data on bilateral trade are calculated assuming that the entire value of a traded good is created in the exporting country. If that ever made sense, it certainly doesn't in a global economy marked by increasingly complex supply chains.
In the case of the iPhone, Messrs. Xing and Detert note that the device was invented in America by an American company, Apple. The components are manufactured, either inside or out of China, by companies based in several other countries. The only part of the process that is unambiguously "Chinese" is the final assembly—a process that, in the estimation of Messrs. Xing and Detert, adds only $6.50 to the $178.96 wholesale value of an iPhone.
Yet that entire $178.96 value ends up attributed to China in official trade statistics. As a consequence, the iPhone contributed nearly $1 billion to China's bilateral trade surplus with America in 2008, and nearly $2 billion in 2009, the authors conclude. If the trade data had been based solely on the $6.50 cost of assembling each unit, the iPhone would have added only $34 million and $73 million in those years to China's surplus.
The ADBI study ought to be required reading on Capitol Hill. Most importantly, it raises the question of how much anyone really knows about what America's trade with China is. Critics of trade data, including us, have long argued that bilateral statistics are misleading. As the bilateral deficit with China grew, deficits with South Korea, Taiwan and Singapore declined, confirming that China's comparative advantage lies in the assembly into finished products of components manufactured around the region, due to its low-wage, low-skilled labor."
How about that last paragraph? Is that not insane?
For years we've been wringing our hands over trade imbalances with other nations, only to now learn that, sorry, ooops.....we don't actually account for specific value-addeds on an incremental basis.
So we really have no idea what any country's bilateral trade is with any other country? Why, because keeping track at the component or assembly level is too much trouble?
How can we realistically conduct trade policy or even correctly model the US economy if our fundamental data on international trade flows is basically wrong?
For me, this puts a huge hole in the econometric models predicting quarterly GDP growth. Back when I was in college and grad school, international trade wasn't a major component of GDP. Now, it is. Or so we think. Maybe we really don't know exactly how big it is, if we are crediting other countries with the entire cost basis of an assembled product which passes through that nation for one stage of production.
This valuable information buried in the Journal's editorial provides a big wake-up call regarding the quality of international economic trade data, does it not?
Wednesday, January 12, 2011
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.
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.
Tuesday, January 11, 2011
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.
"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.
Monday, January 10, 2011
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.
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.
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