US Commercial Banking, Evolution & Commoditization

My years with the Chase Manhattan Bank were spent under the tutelage of Gerry Weiss, SVP of Corporate Planning & Development. It was a privilege to work for such a bright, secure and gifted strategist.

Gerry didn't win a lot of new friends among his senior executive colleagues at the bank for holding the view that banking was one of the most commodity-like businesses in existence. With a few exceptions, most of the businesses at Chase were extremely difficult to differentiate because, at the end of the day, you were either borrowing, lending or processing money. Not exactly a patentable good.

Further, as technology became more important in more banking businesses, any single bank's ability to maintain a competitive edge for very long became increasingly difficult.

With all this in mind, I read a piece in the Wall Street Journal last week regarding federal arm-twisting of the major US banks on mortgage foreclosures. Leaving aside the subject of that article, which was the unwise attempt to force banks to forgive negative equity for borrowers, I was struck by the pedigrees of the few banks mentioned- Chase, Wells Fargo and BofA, and the one absent bank- Citicorp.

I realized, as pondered these names, how few people today probably recall that these, including Citi, are no longer the banks which originally had those names.

For example, Wells Fargo is really just the name of a former San Francisco-based bank acquired by what was once a staid Midwestern outfit- Norwest Bank of Minnesota. If I'm not mistaken, Norwest itself was acquired by a one-time rival, First Bank System. Along the way, it hoovered up the crippled Wachovia during the recent financial crisis, giving it, ironically, the old Golden West S&L, too. That was a product of Ken Thompson's wrong-headed mortgage bank acquisition at the peak of the real estate bubble. It cost him his job.

Meanwhile, BofA is just the surviving name of another San Francisco-based bank that took too many risks and became the prey of another regional US bank- Nationsbank, the renamed North Carolina National Bank. Hugh McColl busily assembled a large group of basic banking franchises beginning in the 1980s. The drive to aggregate assets and relationships culminated in the takeover of the once-proud BofA. McColl's successor, Ken Lewis, overreached when he bought Countrywide and Merrill Lynch during the recent financial crisis. That latter deal's murky details sent Lewis packing early from his CEO job at BofA.

Chase, as we know it today, is simply the name hung on the agglomeration of assets of most of the old money center banks of New York City, except for Citi and Bankers Trust. Back when I worked for Gerry Weiss, he once referred to Chase Manhattan, Chemical and Manufacturers Hanover Trust as three fairly interchangeable, mediocre banks. When asked about merging them, he snorted derisively,

'All you'd get is a much bigger mediocre bank that would be even more difficult to manage than what we've already got.'

Never the less, Chemical took over MannyHanny, then the two picked off Chase after its CEO, Tom Labrecque, finally ran the latter into the ground and attracted the unwanted attentions of fund manager Michael Price. In time, the CEO job went to Jamie Dimon, who had fled New York City to run the remaining Midwest regional commercial bank, Banc One- by then a product of a merger of the Ohio company of that name and the old First Chicago.

Citicorp wasn't mentioned among those in the foreclosure-related article because it essentially died, only to be resuscitated as a ward of the federal government after 2008. Before that, however, it was taken over from outside banking, when Sandy Weill prevailed upon then-Treasury Secretary Bob Rubin to allow him to 'merge' with John Reed's Citibank. Weill then hip-checked Reed out of the C-suite, hired Bob Rubin, and proceeded to build the most unwieldy, unmanageable financial supermarket ever attempted in the US.




My point is that if you were to have surveyed the national and regional banking field in the mid-1980s, as my colleagues and I did as part of our jobs as corporate and business strategists at Chase Manhattan, you'd have classified BofA, Chase Manhattan and Citicorp as the nation's three most important international money center banks. Chicago had just lost Continental Bank, but still had First Chicago. Bankers Trust and JP Morgan were smaller, more focused money center banks. All of these had senior management which felt and behaved as if their banks were special, different, and able to take risks which other US banks couldn't handle.

Fast forward almost 30 years, and you can see how wrong they were. The three premier US money center banks all lost their managements via takeovers.

In truth, the managements of what we now know as the leading US banks are products of duller, less-ambitious banks. Less ambitious in terms of scope, though, rather than size. And the businesses which are now part of these banking companies which aren't historic mainline banking units- brokerage, underwriting and merger and acquisition advisory- have become, as my old boss Gerry Weiss predicted, less lucrative due to the commoditization of them by the large commercial bank entrants.

In true Schumpeterian form, most of large commercial banking has become commoditized amidst growing competition. Thus, their equity price performances are, for the most part, anemic. Only Wells Fargo has a 35-year price performance which eclipses the S&P500 Index. Chase, BofA and Citi all trail it substantially.

What's different about Wells? Notice, first, that its outperformance slackened significantly around 2000. So it's not a function of recent management skill.

More likely, its earlier outperforming of the S&P resulted from its having avoided combining with any of the leading money center banks- ever. A host of old mid-sized California banking franchises- First Interstate, Crocker, and Security Pacific- if I recall, comprised the Wells Fargo that Norwest snared. As such, while predecessor banks got into some troubles, they tended not to be on the gigantic scale of the messes into which the three largest US money centers stepped throughout the past three decades.

Of the other banks, Chase managed to about match the S&P, while the Citi and BofA plunged noticeably.

So, from a perspective of over thirty years of large US commercial bank performance, it's evident that the risk-taking of the old international money center banking companies didn't result in their consistently superior performance. Rather, to the contrary, that strategy failed, as evidenced by the managements of more cautious, smaller commercial banks ultimately owning the marquees previously associated with their larger one-time rivals.

Now, no matter what you hear on CNBC or read in the Wall Street Journal, for the most part, the four major US commercial banks have become financial utilities which will, for the most part, fail to consistently outperform the S&P500 for any significant period of time. They've become large, slow-moving purveyors of financial commodities.

The Good, The Bad & The Ugly: CNBC Reporters & Anchors

Over the past few weeks, it's dawned on me that there are three types of business reporters or anchors. Being a prominent business/financial cable network, CNBC offers examples of all three.

The Good: Michelle Caruso Cabrera
Ms. Caruso Cabrera is one of the only, if not the only, CNBC on-air anchor with an economics or business degree. Her questions are typically well-reasoned and germane. She is well-informed and isn't afraid to ask tough questions of her guests and let them ensnare themselves in hypocritical positions.


The Bad: Tyler Mathisen, Bob Pisani
These two epitomize bad anchoring and reporting.

Consider Tyler Mathisen. I wrote here of his incredible naivete during his special grocery sector program. I think that's the signature characteristic of what I mean by bad anchors and reporters. They are surprised by everything. Their curiosity is, sadly, born of ignorance and cluelessness. In his grocery store special, Mathisen actually asked a store design expert why milk and dairy are always located at a rear corner of the store.

Honestly, if I were a senior executive at CNBC and saw/heard that, I'd immediately fire Mathisen. Can anyone past the age of 25 with a college education really be that stupid?

Pisani spends too much of each weekday looking astonished or surprised by some move in equities. That's when he isn't anthropomorphizing the market and cheering it onward to new heights, rather than simply reporting the facts.

Anchors and reporters who can't add value beyond restating the obvious or bringing some level of knowledge to a topic, so that they can at least ask questions you would, or hadn't considered, are just a waste.


The Ugly: Steve Liesman
I've reserved this category for those anchors and reporters who, far from adding value to interviews or segments with their knowledge, or adding no value by being ignorant or clueless, actually spread misinformation and falsehoods.

There's no doubt the posterchild for this category is CNBC's senior economic idiot, Steve Liesman. You can search my blog by his name to get a list of posts which will give you a fair sampling of his daily antics on the network.

Whether he's attempting to lecture actual, degreed economists- Liesman is a journalist with no economics or business education- or pontificating on economics statistics and/or patterns about which he has no formal training, Liesman typically spreads suspect 'knowledge.'

Fortunately for CNBC viewers, Chicago-based Rick Santelli is often on hand to counter, de-bunk and generally demolish whatever Liesman has just said.

Unfortunately for viewers, however, CNBC has far too many bad and ugly reporters, and too few good ones. Among the last, though, I think you can count, in addition to Santelli and Caruso Cabrera, Trish Regan, Melissa Frances, Joe Kernen and, often, Larry Kudlow.

And Another Thing......

In today's earlier post, I described some of the blather which comprised David Faber's noontime half hour on CNBC this past Wednesday. As I listened to the program again today, while multi-tasking, an on-air conversation reminded me of one more verbal blunder on Wednesday's edition of the program which had slipped my mind.

Somewhere in the middle-late portion of that program, Kaminsky was on his anti-technology jag again. At some point, a guest, either the Evercore guy or some portfolio manager- I think the latter- was asked about, I believe, Twitter. It was something estimated to be worth about $4B, and it wasn't Facebook.

In any case, the $4B number was tossed out, and this guy says, to paraphrase,

'Well, it probably will be worth $4B at some point, just not now.....maybe in a few years....'

He went on to essentially advocate holding the issue.

Kaminksy, meanwhile, was silent. I was incredulous.

Yes, and in a few years, what, maybe Yahoo will turnaround? Wal-Mart will come up with a strategy that works during economic expansions?

Isn't this sort of thinking about future large market caps the way the original technology bubble grew? Yes, it is.

There's a fine line between buying something before it's generally recognized to be as excellent performing as it may be, and buying something years in advance of a big total return payday. Kaminsky, of all people, with his fund management background, should know this. I expected him to excoriate the guest.

Instead, he was mute.

You can't make this stuff up.

Inanity on CNBC Wednesday At Noon

Just when I favorably mentioned David Faber's noon CNBC program, it turned inane on Wednesday afternoon.

Gary Kaminsky led off the nonsense purporting to prove that 'slow and steady' wins, by showing a price chart of three companies over 10 or 20 years- McDonalds, Colgate-Palmolive and Dwight & Church. All three had average annual total returns of 13+%, with low betas, which I guess Kaminskly judged acceptable.

He made some derisive remarks about technology stocks, although I didn't see comparable charts, returns or betas. Maybe I missed them. But Kaminsky actually concluded by judging low beta stocks to be preferable to those with high betas.

The problem is, equity selection is just not that simple. And if it really were, tens of billions of hedge fund dollars would have erased any such performance difference.

The truth is, Kaminsky, you or I could choose 3 equities with any one attribute to prove pretty much anything we wished.

For example, I would guess GE has a pretty tame beta, but it's been a complete turkey for a decade.

Moreover, Colgate-Palmolive is a rather special company. Years ago, when I first undertook my proprietary equity performance research, I found Colgate, then run by deservedly-legendary CEO Ruben Mark, to be the longest-running example of a firm whose total return had outperformed the S&P annually. And it is a slow-growth firm. Thus, it's by no means an accidental choice of Kaminsky. But I can assure you that it would be very easy for me to find a handful of similar slow-growth firms whose total returns have under-run the S&P for most of one or two decades.
Further, beta is debatable as the proper measure of volatility.

Given Kaminsky's years as a big-time portfolio manager with Neuberger Berman, you wonder if this really represents how he thinks about and manages equity portfolios. If not, what was this little demonstration for?

You don't present a seemingly-random, or worse, contrived sample of 3 companies' performance as proof of anything. Rather, you state hypotheses, build multi-factor models, construct hold-out samples, then use some data and periods to estimate parameters, and others to test the models.

After that farce, a guest from Evercore Partners appeared to opine on whether another 1990s-style technology issues bubble is building. I don't recall the guy's name, but he was introduced as having been instrumental in four of the largest telecom M&A deals of the past decades, including the sale of MCI to Worldcom.

I'm not making this up. You'd think with an introduction like that, well, Faber would think twice about even having the guy on his program.

If there were ever a case of expedient deal-making without concern for the fundamentals, not to mention the veracity of the financial conditions of the parties involved, this deal would be it.

Once again demonstrating how so much of CNBC's lineup is business and financial entertainment, not solid analysis or useful information.

Foreclosures: Pro & Con

Last week brought a pleasant surprise to David Faber's CNBC program. Former Salomon Brothers Vice-Chairman and mortgage-backed securities pioneer Lew Ranieri gave his first live televised interview.


Ranieri is a seriously smart and sophisticated guy, so I hung around within range of a television after I'd finished what I was doing, just to listen to his entire set of comments.


His version of how the late 2000s mortgage lending bubble occurred is objective and credible. He gives weight to both so-called Wall Street houses for securitizing questionable mortgages, and to the GSEs for accepting them to back their own securities, too. He cited some numbers regarding GSE explosion of pass-throughs which were simply incredible.


To his credit, Ranieri personally apologized for not having screamed louder and longer as the bubble grew beyond any sustainable size. He identified poor underwriting standards and an over-reliance on FICO scores, rather than prior, more involved and often qualitative mortgage lending standards.


When the conversation turned to foreclosures, Ranieri cited a stunningly large supply of unsold or foreclosed housing. I don't recall the exact numbers, but I believe he said several months supply had been the historical norm, but today's supply was something like almost two years' worth, if not more.


Never the less, he came out against massive foreclosures. He said that foreclosures destroy neighborhoods and cause them to rapidly degenerate into ghettos. He also cited a lack of government programs to promote and assist local entrepreneurs in buying foreclosed properties, repairing/renovating them and putting them back up for sale at new, lower, market-clearing prices.


Separately, Joseph Mason, a professor of banking at Louisiana State University, wrote an editorial in the Wall Street Journal last week entitled Why Regulators Should Let Banks Foreclose.


 Mason  providing evidence that foreclosure delays don't help


"On Capitol Hill last week, federal banking regulators suggested that the government may soon reach a comprehensive settlement with banks on foreclosure procedures and servicing. In theory such a settlement could unlock housing markets and boost the economy. But recent statements by Comptroller of the Currency John Walsh and FDIC Chair Sheila Bair suggest that they remain focused on using the settlement to extend, rather than end, ongoing foreclosure delays.



Meanwhile, states including New Jersey and Hawaii are considering imposing their own moratoriums on foreclosure that, if they conflict with federal policy, may lead to protracted litigation. This approach is the wrong medicine for our ailing economy.


For borrowers, delaying foreclosure only provides false hope. Today, a borrower faces a foreclosure sale only after failing to make a payment for more than a year. There is no reason to believe a brief additional time-out will allow such borrowers to become current. To the contrary, data from the Mortgage Brokers Association indicate that loans reaching the foreclosure stage almost never avoid default, and that borrowers who become 90 days delinquent cure their default only about 1% of the time.


Similarly, recent research done for the National Bureau of Economic Research demonstrates that loan-modification programs have mixed effectiveness. Data suggest that many delinquent borrowers have the means to afford their mortgage payments, but are so deeply "under water" on their mortgages that they are simply no longer willing to pay. Others have insufficient income to afford any reasonable mortgage payment.


For those who do obtain modifications, roughly half become delinquent again within six months. Thus, while modification efforts are laudable, they are not the solution.



The unfortunate reality is that efforts to lengthen the foreclosure process will not substantially alter borrower outcomes. They will only extend a painful time for borrowers and the economy. During that time, uncertainty will prevent borrowers from moving on with their lives, including starting to pay rent and make purchases that would inject money into the economy.


For neighborhoods, every day without foreclosures means another day of deteriorating home values. A recent study of the Cleveland area published in Urban Affairs Review found that neighborhood home values are largely unaffected by foreclosures that take less than a year. But foreclosures that take longer than a year have a negative impact on home values as the effects of neglect and vandalism mount.



One of the root causes of the economic crisis was a deterioration of underwriting standards: We stopped focusing on whether people could afford the homes they were buying. Continuing to delay foreclosures reflects the same kind of wishful thinking. California's 90-day moratorium in 2009 did not improve the state's economic performance, and moratoriums in other states would only prove again that a delay can't turn an unaffordable mortgage into an affordable one.



Kicking the foreclosure problem down the road creates uncertainty that discourages investment—and delays our desperately needed economic recovery."


Mason seems to provide evidence contradicting Ranieri on foreclosures. Rather than worry about allowing them, Mason suggests getting them over quickly is the better alternative. And his end-game is Ranieri's, too- repurchase of foreclosed properties at lower, market-clearing prices.

Personally, I believe it's foolish to delay foreclosures, especially when it's governmentally-coerced. It unfairly penalizes some while allowing others to evade the proper consequences of their failure to fulfill financial contracts, as well as discriminating against all those who behaved properly and did not buy an unaffordable home, only to see such behavior rewarded.

More Warren Buffett Cornpone on CNBC This Morning

This morning was a good one to skip watching CNBC. I don't know how often they do this each year, but it's one of those marathon Buffett chuckle-manias from Omaha. Becky Quick sits there with him and he pontificates on lots of subjects about which he knows little more than anyone else. Given the setting and someone's recent reference to Buffett's annual shareholders' letter, I assume Berkshire Hathaway's annual meeting is the occasion.

Much of the time is wasted by Buffett saying things which are patently obvious, e.g., Steve Jobs is a uniquely-talented and successsful entrepreneur with a gift for "knowing what we want before we know we wanted it."

That's when he's not contradicting actual experts in a field, such as mortgage banking. Last week, on David Faber's noontime program, industry veteran and CMO pioneer, one-time Salomon Brother's Vice-Chairman Lew Ranieri cited a market overhang of unsold homes which, I believe, was far larger than the one year cited by Buffett as the date by which said inventory will be gone.

And, of course, it's all done with that annoying aw shucks guffaw. I don't know which would drive me insane faster, constantly being subjected to Buffett's trademark country guffaw or Maria Bartiromo's lisp.

But on one subject, Buffett is positively misleading.

Only about 15 minutes ago, he railed against perceived income inequality in the US. His evidence?

Buffett pulled out some apparently IRS-sourced document, and had Becky Quick read off some numbers. Buffett alleged that in the past few years, the 400th largest AGI on a tax return soared from about $43MM to $340MM or so. Buffett then contended that the associated tax rate on that 400th return fell over time, too.

Unfortunately, as you may read here, the subject is much more complex than Buffett either understands or acknowledges. Add to Reynolds' arguments the fact that many private enterprises show up for tax purposes as schedules on an individual 1040 return, and you blow Buffett's contention out of the water.

But this is CNBC, so Buffett's every aside or chuckle must be fawned over. No matter how misinformed or misguided it may be.

The Ben Bernanke On Capitol Hill Yesterday

I caught some of The Ben Bernanke's testimony on the Hill yesterday, and let me tell you, it was nauseating.

But for me, the two low points were Ben insisting:

- the Fed needs to retain its dual mandate of managing the money supply and targeting full employment.

- there's no risk of US economic inflation.

The first must have Milton Friedman spinning in his grave. And perhaps Paul Volcker spit out his cigar when/if he heard it. Ever since dim-witted Hubert Humphrey championed the added full employment mandate, the Fed has been hampered in its ability to do focus on the one thing that nobody else can do- manage the US money supply. To finally face a friendly House and possibly ambivalent Senate and refuse the chance to formally escape this monstrosity is unforgivable.

The second certainly had Milton spinning. Not to mention tons of pundits laughing at Ben's sophistry.

It got so bad that later, on CNBC, senior economic idiot Steve Liesman made up a whole spiel to explain why Ben was right.

Between excessive money creation over the past two and a half years, and easy dollar-induced rises in commodity prices, we certainly have inflation. The fact that it's not conventional labor-sector cost-push doesn't mean it isn't happening.

Friedman was right. Get rid of the Fed and use a Taylor-style rule to manage the money supply.

Unfunded Liabilities: Pensions & Entitlements

Karl Rove wrote in a recent Wall Street Journal weekly column, regarding the Wisconsin public sector union protests and Governor Walker's bill to repeal collective bargaining rights,


"Union demands have helped produce an estimated $3.5 trillion in unfunded liabilities for state and local government pension and health-care plans. They've also led to personnel practices that tie the hands of local elected officials, often resulting in perverse outcomes. For example, union insistence on "Last In, First Out" often means the best and brightest teachers are let go when districts downsize or schools close."

I had a long talk recently with a close friend who is a political conservative and, as a New Jersey school teacher, a member of their union.

As we discussed the Wisconsin situation, and she dutifully, but reluctantly, read the related posts on my companion political blog, she bluntly told me this had become a painful topic for her, with me. But she also admitted that her union's members needed to pay for their health care and pension benefits.

She then returned to a topic she'd ranted on in previous conversations with me, i.e., going back several administrations, the New Jersey state government had emptied her union's pension fund by 'borrowing' from it and then failing to maintain promised annual funding. In short, the State of New Jersey has already brazenly failed to fund the promised lavish retirement benefits for the teachers' union.

She railed over the likelihood that her contributions would probably be in vain, with her promised pension never to actually be paid in full.

Welcome to the club.

I vividly recall learning in Professor Peter Kundsen's 'Great Moments in Balance Sheet Accounting' course in graduate school, back in the late 1970s, how unfunded pension liabilities were confined to footnotes. The midterm for that course was a list of questions attached to the Bethlehem Steel 10K. Needless to say, one of the questions was, I am sure, related to the firm's unfunded pension obligations.

Within a few years of graduating, I saw bankruptcies roll through the steel and airline sectors. And Chrysler require a government bailout.

With the rise of hostile takeovers and raiders taking their targets private, or into Chapter 11, many more businessmen learned about the PBGC. The Pension Benefit Guaranty Corporation is the federal agency which is charged with administering the failed, under-funded pensions of bankrupt firms.

The truth is, the private sector has seen, for some thirty years, a series of sectors experience bankruptcies which dumped underfunded pension plans onto the PBGC. At the same time, many other companies switched to defined-contribution plans, terminating their defined-benefit plans and putting the resulting lump sum into the former.

In short, private industry has learned, over the past three decades, that the defined-benefit pensions are, for the most part, illusory and unworkable.

What's happening now is that public sector employees are discovering the same truth. The major difference, however, is that because state and local governments foolishly agreed to these plans, the public sector unions have, as a counterparty, an entity that cannot, as easily as a private sector company, declare bankruptcy and subsequently renegotiate the pension obligations.

It goes without saying that Social Security, Medicare and Medicaid are all federal programs which share the same foolish defined-benefit mentality. And we've all been aware for decades of the chronic insolvency of the first, and the obscene growth of the second and third.

How is it that what business people have understood for thirty years as infeasible, i.e., the defined-benefit approach to any long run pension or health care obligations,has only now come to be seen as unworkable in the public sector?

Economic Growth vs. Jobs

Sometimes, well, actually, many times, those without any economic background or education run at the mouth about related topics, getting relationships all wrong.

Such was the case earlier this morning, when I heard the first few minutes of the president's remarks about from where new jobs would come.

So often, we hear people with no economics training whatsoever harp on job growth, as if they can magically wave a wand or fund a program, and paying jobs will appear.

That's just not true. In fact, the whole point of a market economy is for government to enact stable, lasting policies which promote business and capital formation, which leads to economic growth, which then creates jobs.

A related common complaint by some pundits is the oft-proclaimed death of US manufacturing.

In a well-written editorial entitled The Truth About U.S. Manufacturing, in last Friday's Wall Street Journal, economics professor Mark Perry (University of Michigan at Flint) debunks that complaint.

Perry observes,

"In every year since 2004, manufacturing output has exceeded $2 trillion (in constant 2005 dollars), twice the output produced in America's factories in the early 1970s. Taken on its own, U.S. manufacturing would rank today as the sixth largest economy in the world, just behind France and head of the United Kingdom, Italy and Brazil. Despite recent gains in China and elsewhere, the U.S. still produced more than 20% of global manufacturing output in 2009.

The truth is that America still makes a lot of stuff, and we're making more of it than ever before. We're merely able to do it with a fraction of the workers needed in the past.

The average U.S. factory worker is responsible today for more than $180,000 of annual manufacturing output, triple the $60,000 in 1972.

These increases are a direct result of capital investments in productivity-enhancing technology, which last year helped boost output to record levels in industries like computers and semiconductors, medical equipment and supplies, pharmaceuticals and medicine, and oil and natural-gas equipment."

It's the productivity and volume of economic activity that drive further growth. And productivity is enhanced when more capital is provided. Sure, there are eventually diminishing returns. But it's simply wrong to try to force-feed an economy the jobs government thinks ought to exist.

Haven't we learned from Russia's failed 50+ year experiment with a centrally-planned economy that such efforts are pointless?

With capital availability, mobil labor resources and high productivity, and low barriers to new businesses and innovation, an economy is poised to grow, thus leading to new jobs as a consequence.

Jobs aren't the ultimate objective of economic policy, per se. They are important, but follow economic activity. Not vice versa.

GM's Misleading Results

I read this headline, GM Rebounds With Best Year Since 1999, in a section of this morning's Wall Street Journal, with great amusement.

Does anyone really believe the concept implied by this headline? That it's the same GM? Or that, if you think it is the same company, these results are either comparable or real, in the sense of being the result of completely normal business and accounting practices?

Because of course, they are not.

First, this GM exited a federally-distorted bankruptcy. It's not relevant to compare any of this GM's performances to the company with that name which existed prior to 2009.

Second, this GM is the beneficiary of some significant liability restructuring, as well as purchasing preferences by the federal government. From union concessions, related capital structure changes, and federally-mandated dealership closings to atypical tax loss carry-forwards, this bankruptcy was one for the record books. In an ideal capitalist world, GM wouldn't even exist anymore, unless someone bought the right to use the name again. Which would be unlikely, since it had become a symbol of corporate ineptitude, failure, and union excess.

Third, one year does not a turnaround make. Even the Journal article disclosed that the fourth quarter performance was relatively weak.

Sadly, the new GM seems to be just the latest example of the concept that everybody wins. Even a bankrupt corporate failure like GM is given special dispensations, favors and a tilted playing field so that its latest results may be celebrated as a record.

Don't be confused by this accounting magic and think it portends a healthy future in which GM earns consistently superior total returns for years to come.

Amazon Enters Subscription Video On Demand To Challenge Netflix

This post from last December concerning Netflix. In it, I wrote,


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



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


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


Earlier this week, Amazon announced a subscription service for video on demand for its best customers.

This is not surprising. I find that successful firms which earn consistently superior total returns for a certain periods tend to fail to do so anymore for one or more of three reasons: competitive reactions, inability to continue to surprise investors, or regulatory reactions.

In Netflix's case, it's the first. Amazon has seen the effects of Netflix on Blockbuster, HBO, and probably Amazon's own business of selling DVDs. After arranging the logistics of offering a similar service to their best customers, Amazon is now moving to limit Netflix' inroads into its business.

It's a natural response to a very successful business model. Just like we see competing tablet products coming forth to compete with the iPad.

I'll watch with interest to see if Amazon can actually dent Netflix' volumes, profits and stock price. Chances are, it can. Plus there are some critics of Netflix' accounting, including CNBC contributor Herb Greenberg. The details escape me, but he disagrees with the firm's capitalizing some expenses. If their growth rate falters due to Amazon's moves, and profits are squeezed, then we might see an even faster decline due to an inability to continue whatever aggressive accounting practices are in place.

Regarding Endangered Jobs

Andy Kessler wrote another one of his quirky, mostly off-target editorials in the Wall Street Journal last Thursday, entitled Is Your Job an Endangered Species? Once again, I'm left wondering why the Journal gives this guy so much space so frequently? Compromising pictures of whom does he have?

Kessler began well enough, observing,

"Technology is eating jobs- and not just obvious ones like toll takers. Tellers, phone operators, stock brokers, stock traders: These jobs are nearly extinct. Since 2007, the New York Stock Exchange has eliminated 1,000 jobs. And when was the last time you spoke to a travel agent?"

It's hardly a novel observation, but a fair way to commence discussing the topic. But then he veers into the surreal with the following nonsequitor,

"So which jobs will be destroyed next? Figure that out and you'll solve the puzzle of where new jobs will appear."

Kessler goes on to sensibly divide jobs into "creators and servers." The latter basically do the non-intellectual things that implement innovators' (sorry- creators') solutions. Then he goes off the rails and sub-divides the servers into sloppers, sponges, supersloppers, slimers and thieves.

Supersloppers, by the way, are marketers who offer consumers features which may carry no economic value, but appeal to psychological or other bases of desire. Slimers are financial sector workers.

Then Kessler returns to his trademark of (re)stating the obvious,

"Like it or not, we are at the beginning of a decades-long trend."

Really? Beginning? How about, oh, 110 years into it? Ask buggy whip manufacturers.

"Watch the divergence in stock performance between companies that actually create and those that are in transition- just look at Apple, Netflix and Google over the last five years as compared to retailers and media."

Fair enough- there you have it in the nearby chart. Along with the S&P500 Index and online retailer Amazon.

Wait, how'd Amazon get in there? It's supposed to be tanking. And, for what it's worth, Andy, Netflix is an online and direct retailer, too.

So much for rigid, mutually exclusive taxonomies. Kessler seems better at selective recall and comparison, the better to make his narrow, but unfortunately for him, indefensible point.

You see, Netflix and Amazon have done well for the past five years, and they are retailers.

Google is the worst of the bunch, underrun only by the Index. Truth is, as Amazon and Netflix demonstrate, there are times when distribution of goods or services is valuable. It's not always just about production or even design.

Kessler finishes his perplexing piece with this passage,

"But be warned that this economy is incredibly dynamic, and there is no quick fix for job creation when so much technology-driven job destruction is taking place. Ultimately the economic growth created by new jobs always overwhelms the drag from jobs destroyed- if policy makers let it happen."

Kessler offers no statistics or empirical evidence of that last, bold assertion. I'm not at all sure it's even true.

That's the real point of this post. Not just to critique Kessler's weak, obvious and otherwise wrong-headed editorial. But to use it to make the following point.

It does little good to simply add up jobs lost and jobs created, and assume all is well when the latter is larger than the former. Wouldn't it be more informative to understand the life-cycle earnings and job types of workers from several different strata of US businesses over the past century? To have a set of benchmarks of life-cycle earnings relative to each worker's average? To see what normative patterns were, by era and job type, education, over the past century or more?

We don't know if Kessler's contentions are true without empirical data.

But I do think this much is true. There is a stronger, multi-lateral global economic competitiveness at higher levels of value-added now than for probably the last 90 years. As such, economies with, on balance, better-educated work forces will probably be able to create higher value-added goods and services. Certainly design them. Maybe produce them.

However, since populations are stratified by intellect and education, this means the US will continue to experience the challenge of employing the lower echelons of its labor force, by skill and education, as more of these jobs go overseas to more productive, cheaper workers in other countries.

Hopefully, America's entrepreneurs and innovators will create business ideas, solutions to consumer needs and wants, which also, with growth, create jobs that can be filled by not only well-educated, highly-skilled people, but the lower rungs of the US labor force, as well.

What Is Productivity? What Is Efficiency?

Back in 1997, I wrote a 15-page white paper synthesizing concepts I'd read in various publications on economics, including some of Joseph Schumpeter's seminal papers from the 1920s. The short version of the paper enabled my mentor, Gerry Weiss, to get me a meeting with an influential, well-known former money center bank CEO to discuss the concepts and my resulting research as it applied to corporate performance, both internally for resource allocation, and externally for equity portfolio management.

I found that prior economic literature had, for the most part, failed to distinguish between productivity and efficiency. So I wrote, in part,

"The critical difference between efficiency measures (called “volume efficiencies” in this paper instead of the popular term “productivity”) and productivity measures (called “resource value productivities” in this paper) is that the numerator of the latter are value-denominated, whereas the former are unit-denominated. Thus, volume efficiency measures can’t provide any information regarding the value of what was done more or less efficiently. By splitting what has come to be misnamed productivity into two properly different concepts, some of the confusion regarding the modern behavior of volume efficiency can be better understood."

Imagine my surprise, therefore, that 12 years later, the Wall Street Journal published an editorial in last Wednesday's edition by two McKinsey consultants addressing some of the same concepts. Except that they still didn't get it quite right.

Here's what James Manyika and Vikram Malhotra wrote in their editorial Productivity and Growth: The Enduring Connection,

"Productivity can come either from efficiency gains (i.e., reducing inputs for given output) or by increasing the volume and value of outputs for any given input (for which innovation is a vital driver.)"

The McKinsey guys are close to getting it right, but they still fail to properly split volume efficiency phenomena from the very different notion of creating more value for a level of output.

Further, from reading their article, it's clear that they still mistakenly deal in averages across an economy. They also misleadingly connect productivity and growth, as if one will drive the other.

Truth is, as I found in my proprietary research over a decade ago, the highest resource productivity gains aren't typically associated with raw growth in value for shareholders.

The actual relationships are much more complicated, but I can't discuss them here. It's proprietary.

But I can tell you this. McKinsey's contention that productivity is some amorphous concept which can be grown or driven higher across an economy to spur economic growth is wrong. That's not how Schumpeterian dynamics works. It has more to do with higher value-added solutions displacing older ones in an economy, not simply flogging older competitors' operations to somehow run leaner and faster. Those activities won't create more consumer value.

You might be able to measure these concepts across an economy. But that doesn't mean they are managed or occur at that level.

However, I'm quite sure Manyika's and Malhotra's puff piece in the Journal is just the public facet of a well-orchestrated push, complete with Powerpoint presentations, that's being delivered to every potential client. It makes for good face time and high-spot meetings with CEOs to suggest some new project for, naturally, McKinsey, to measure various aspects of the firm's efficiency and productivity.

For those CEOs and senior executives who can't think for themselves, it will sound very seductive. It reminds me of something Bob Gach, a partner at Andersen Consulting years ago when I worked there, used to say. He didn't like Morgan Stanley, his lead client, very much. He said they were a bad client because they knew too much. Ideally, he contended, a client had to be smart enough to know they needed help, but, unlike the old Salomon, Goldman or Morgan Stanley, not so smart as to know they could do most of the job themselves. That probably also describes the ideal McKinsey client.

From that perspective, this new spin on productivity sounds good, doesn't it? Won't actually help the companies, but it should help the McKinsey partners.

Wither Yahoo Now?

This past Tuesday's edition of the Wall Street Journal contained a long piece on Yahoo's coming to terms, as it were, with Facebook, entitled Yahoo Decides to Friend Facebook.

The piece chronicled the firm's changing attitudes toward it's most recent nemesis, Facebook. Nothing has changed since my last Yahoo post only a few weeks ago.

The first nearby, two-year price chart, compares Yahoo, Google, Microsoft and the S&P500 Index.

Begun near the market's spring lows of 2009, shortly after Carol Bartz took the helm at Yahoo, it depicts just how badly Yahoo has lagged even the moribund Microsoft. Both trail the Index by significant margins.

Here's another view. Since the late 1990s, Yahoo's absolute stock price peaked, as expected, during the bubble, then collapsed. But what's more interesting is that it was already flat to down by 2005, well before the latest equity market crisis.

Reading that Yahoo is now desperately trying to put links to Facebook on its own pages seems rather pathetic. Thanks to Terry Semel's inept choices while CEO of the firm, and Jerry Yang's subsequent incompetence in the role after Semel's departure, Yahoo just marked time with no particular strategy or mission in sight.

Now, it's too late. Even the typically-competent Bartz can't seem to do more than get a few dollars for using Bing and doing an ad deal with Microsoft. But Yahoo isn't lighting the world on fire with free content anymore, and missed its chance, long ago, to be a profitable, earlier version of Facebook.

To have seen its stock price fall from over $100 to under $18 in 11 years makes me wonder just who still owns this turkey? Back in mid-2008, Carl Icahn briefly ignited interest, amidst Microsoft's attempt to do some sort of deal with the firm. In retrospect, Yang missed a chance to let Ballmer make a huge blunder and give his own shareholders a way out of Yahoo's long, slow decline.

Where to now? With no clear mission for the firm going forward, what would a current investor do? I'd say sell. The risks of further erosion are probably at least as great, if not moreso, than Bartz magically getting a higher value now for selling the firm to someone who would, by some stretch, need whatever it is of value that Yahoo still offers.

There seems to be no solo act for Bartz at Yahoo which will do shareholders any good. Continuing to operate the firm will probably just result in a declining share price. Shutting it down would destroy value. I suppose, at some price above zero, some other tech firm will see some kind of value in the firm's assets, if only its internet traffic.

It's truly been sad watching the firm manage to evade natural exit strategies over the past few years, now to languish behind even the moribund Microsoft, watching upstart Facebook move on without even noticing Yahoo in the same general product/market space.

What Lesson Did the Phone Wars Provide for Energy Policy?

Holman Jenkins, Jr. in last Wednesday's edition of the Wall Street Journal, provided a very concise view of the evolution of mobile telephony in the US and Europe. He discussed how the US eschewed the unified, monolithic European GSM mobile standard. And how Nokia, one of the originators of that standard, is nearly dead, while Apple and Google, thanks to the US indecision on such a standard, flourished with new approaches.


Isn't this a commentary on government's unwanted, unnecessary intrusion in sectors where competing private solutions drive better ultimate solutions?


Jenkins describes the process as messy and inefficient, but, in the end, delivering superior results. Nokia has run into the arms of Microsoft, having fallen on hard times after initially leading in the GSM standards setting process. Jenkins ended his piece,

"The lesson for the new Nokia and everyone else is an old one: Nobody knows anything, and there's no substitute for messy, wasteful competition as a finder of solutions to problems we didn't even kow we needed solutions for. Whether the mobile world will settle into one proprietary or many proprietary ecosystems is far from decided."

Interestingly, from my reading of Amity Schlaes' The Forgotten Man several summers ago, those cries of how competition is so messy and wasteful are the very same arguments that FDR and his minions used to seize control of so much of American business. They decried the waste and inefficiency of free market competition, only to stifle innovation and mismanage the economy for most of the 1930s.


There's a larger lesson here. Right now, and in a technologically intensive sector- energy.

Doesn't Jenkins' illustrative tale of the mobile phone sector over the past few years suggest that we are making a horrific mistake by acceding to demands for monolithic, command-economy directives to subsidize and produce certain energy- wind, solar, ethanol- without subjecting them all to real, fair economic forces?

What ever happened to price as a market signal? As gasoline prices rise, largely silently, above $3/gallon, pundits predict a weakening of the US economy. So be it.

I wrote this post back in the summer of 2008 after reading a WSJ piece on Air Force experimentation with synfuel for jet aircraft. We have lots of coal and a known, reliable process to liquify that energy source to burn instead of gasoline or jet fuel.

If you worry about sending dollars abroad to buy oil, then promote synfuels. If you're simply worried about carbon emissions, then admit that you want to turn the US standard of living back about 110 years.

But this government system of choosing energy source winners is going to end badly. Market forces may entail some initial waste and inefficiency, but the result is the best solution, with much less long term waste and inefficiency, while satisfying consumer needs and desires. The latter of which is the point.

Not to have government dictate what consumers want, and how they'll get it.

Kelly Evans Gets It Right On US Standards of Living vs. Inflation

Kelly Evans' Ahead Of The Tape column in yesterday's Wall Street Journal contained a concise, distilled read on the US economy over the past 25+ years.

Evans began,

"The threat of inflation is real. It is just a different threat than many realize."

She then reminded readers that much of the price pressure on commodities comes from smaller, faster-growing economies. It's a demand-push phenomenon.

Then she noted that "median income for men was actually higher, in real terms, in 1973 than in 2009."

But the best, punchiest passage was,

"The globalization of the labor force, meanwhile, continues to exert pressure on the U.S. job market even as it pushes up commodity prices by expanding the middle class world-wide.

This vulnerability was highlighted in mid-2008 when oil prices soared and consumer spending promptly tanked. That was before the worst of the recession. Households are hardly better able to handle such a run-up now."

Thus, the more we look backward, protect union jobs at defunct auto makers and such, the more we pour scarce economic resources into the wrong opportunities. And you wonder why the US is a slowing economic power, relative to some other nations?

Evans then delivers an apolitical shot of truth in her last sentence,

"The real risk is that the U.S. faces a poverty cycle rather than an inflationary one."

That word, poverty, should rivet you. It did me. But that's what happens when your economy no longer focuses on ever higher value-adding opportunities, seeking, instead, to subsidize less robust value-adding economic situations.

Kyle Bass On CNBC Yesterday

Occasionally David Faber has a worthwhile guest on his noontime CNBC program, Strategy Session. Yesterday was one such occasion.

Kyle Bass, a hedge fund manager who scored big by correctly betting against the residential finance boom in its latter years, was on to give his opinions on a variety of market topics.

You can probably find his appearance in a video on the CNBC website. But here, in brief, is what he said.

On municipal defaults, he agrees with Meredith Whitney.

On equity markets, he's swearing off of them, because he believes what we are now seeing is mostly just a result of QE2 and too easy money. He believes it's a global phenomenon which will end very badly. I don't recall his measure of choice, but he mentioned a particular rate which one could watch to discern when the top in equities had been reached, and the fall would begin.

One interesting anecdote he told was being at a conference of alleged observers of credit markets or some such relevant group. He asked how many of the several hundred people in the room in which he was speaking new the weighted average cost of the Greek government's debt? Nobody did. Bass said it was about 4.3%. He expressed shock and amazement at the faulty, shoddy, poor quality of basic analysis by people whose job it was to know that type of data.

The lesson, of course, is that, like the anecdotes he told in the CNBC House of Cards documentary, about Wall Street mortgage finance desks, you can't really trust the so-called experts and analysts to know what they are doing, or to have proper incentives to know it and tell you.

Bass has become recently well-known for being right on US mortgage finance markets. His comments and manner convey a sensible, thorough, reasonable approach to what he does. Very credible.

On The NYSE-Deutsche Borse Merger

I saw an interesting take on the NYSE-Deutsche Borse merger from a floor broker the other day on CNBC.


A periodic guest/contributor named, I think, Peter Costas, he was livid about the merger. It shows you how far the NYSE has come from its once-cozy specialists world. The world of legal front-running, inefficient personal involvement in trades, and an avoidance of acknowledging the reality and capabilities of modern technology. For all his faults taking the Merrill Lynch CEO job and botching it, NYSE ex-CEO John Thain probably saved the place.


Yet, Costas mentioned some risks on which the Germans and current NYSE CEO Ducan Niederauer are silent. Think of it as a rerun of the Daimler-Chrysler merger.


Costas wondered aloud what would happen to the New York trading floor, should profits drop or costs rise? How committed would the merged, Germany-headquartered company really be to maintaining the current physical presences in the US?


Since so many pundits characterize the deal as really all about derivatives and other non-equity products, I suspect Costas' fears are not trivial. Nor totally misplaced.

On the other hand, also on CNBC earlier this week, Jim Chanos expressed no interest nor concern about the NYSE-Deutsche merger. But Chanos doesn't really seem all that emotional about that sort of issue to begin with. He didn't say he thought the concerns people had about the NYSE being controlled by overseas management/ownership was misplaced. He simply said he didn't really care.


Niederaur is taking pains to stress how current ownership of the NYSE and Deutsche Borse is predominantly American, by shareholders. A situation which is both fluid and uncontrollable. But his temper came out when CNBC co-anchor Mark Haines accused him of selling out Americans and repeatedly invoked the "buttonwood tree." In retaliation, Niederauer said, in a close paraphrase, while punching Haines on the arm,


'That's what I get for giving CNBC the first interview about this deal.'


Niederauer looked like he feels he needs to do all he can to convince investors, regulators and politicians to allow this merger.

Perhaps the real issues here aren't even being spotted yet. For example, listing standards. If the NYSE becomes controlled by European owners, who is to say that listing standards for what was America's largest equity market won't be controlled by Europeans?

That would indicate, however, truly global equity markets.

One thing that does make sense to me, however, is the comments of pundits regarding derivatives. Exchanges tell customers that they provide efficiency and best execution. But the truth is, profits for these entities come primarily, in a margin sense, from newer, less-well-understood, complex instruments. Like, well, derivatives.

That's why, over time, human floor specialists have declined in value. The instruments of which they allegedly facilitate the buying and selling have simply grown less profitable to intermediate.

Pepsi Joins Companies Which See Inflation Coming

My latest post concerning companies behaving differently in light of the inflation they see coming was earlier this month.

In last Friday's Wall Street Journal, Pepsi CEO Indra Nooyi defended her company's projections for lower earnings in the future,

"We have no idea what the commodity markets are going to look like in 2012 and beyond."

While one analyst was quoted in the article as chiding Nooyi and Pepsi for citing commodity price pressures, claiming that "everybody else" is facing these, as well, I think he is missing the point.

The article contends,

"At the same time, consumers are still holding back and so it will be difficult to raise prices on drinks and snacks enough to offset the higher costs."

And Nooyi is quoted, again, as saying,

"Had we not had the continued macroeconomic sluggishness and this commodity inflation, we are a solid, double-digit [percentage] player."

Simply put, commodity price inflation, at least partially induced by US monetary-policy, is affecting yet another, very large US company.

Despite Fed officials', current and former, claims to the contrary, US businesses continue to talk and behave as if inflation is coming and will affect their operations and financial results materially.

Borders' Bankruptcy & William Ackman

Back in early December- could it be that long ago?- I wrote this post regarding William Ackman's Pershing Square's attempt to have Barnes & Noble merge with Borders, one of his firm's holdings. I wrote, in part,


"It's unclear to me why Ackman has so diligently and doggedly pursued either physical book retailer over the past few years. With Amazon and Google targeting the space, and Apple's recent iPad adding to the mix, it wouldn't seem to be an easy product/market in which to earn substantial gains by maneuvering with the remaining two, damaged retailers, would it?



Ackman has a track record as a smart investor. But, then, so did Ed Lampert before his plunge into owning retailers K-Mart and Sears.


Why on earth would anyone have bought into these turkeys even as long as three years ago? Their underperformance has only increased since then.



I suppose Ackman has a very short-term, 'turnaround' sort of mentality that seeks a quick, abrupt rise in share price from an unexpected reorganization, followed by a hasty exit from his positions.


I'm just not seeing the logic to this situation for Ackman, other than desperation to rescue some value from his 1/3+ ownership of the worse-performing, lesser-sized turkey in the sector."


Perhaps I was more prophetic than I knew. This past weekend's edition of the Wall Street Journal carried the news of Borders' Chapter 11 filing. According to the article,


"Mr. LeBow, who became CEO of Borders Group last year, invested $25 million last May as Borders tried to rework its finances. Mr. Ackman's Pershiing Square Capital Management LP is expected to lose at least $125 million in its investment."


Since I don't follow Borders, I had no idea Ben LeBow had become involved. Seeing LeBow and Ackman lose at least $130MM in this turkey is surprising. Especially since LeBow's investment was so recent. Ackman's investors can't be happy to have read about this over the weekend, can they?

Why do these investors with such great reputations get involved with one of the worst companies in a market segment? Ackman is also involved with Penney's, hardly a leading retailer, either.

The Journal piece catalogued Borders' decline and fall, amidst a general shrinking of the sector. Considering its ills, I really can't comprehend why these two marquee investors got involved with the firm.

I haven't followed LeBow's moves for years, but Ackman makes generous use of CNBC, so he's much more visible.

Let's see...the failed Target deal, then Borders, now Penneys. Is he losing his touch?

Eddie Lampert & Gap

News of Ed Lampert's sizable investment in Gap, Inc sent shares of the latter up sharply yesterday.

Shares of Gap Inc. (GPS) climbed Tuesday as hedge fund billionaire and Sears Holding Corp. (SHLD) Chairman Edward Lampert reported holding a 5.8% stake in the retailer.


At midday yesterday, the Wall Street Journal reported,


"Lampert, known for large, concentrated bets on the stocks of a small number of companies, reported the stake in a 13G filing, or a filing for passive investors, with the Securities and Exchange Commission late Monday.
Lampert's ESL Partners, along with affiliates, reported beneficially holding 35 million common shares as of Monday.
Gap shares were recently trading 5.8% higher at $22.72.
Investors are "excited that he may see some value in a retailer that has been struggling with its merchandising," said Wedbush Securities analyst Betty Chen."


Looking at the price chart for Sears Holdings, Gap, Inc. and the S&P500 Index since late 2003, it's difficult to see why Gap shareholders would cheer Lampert's control over the struggling retailer. Granted, anyone buying into it would be cause to celebrate- after dumping your shares.
 
But look at the price curve for Sears after Lampert's early-2005 takeover. It's worse than the S&P and Gap,  which tracked together over the period.
 
Just how is it that Lampert will do for Gap what he hasn't managed to do at Sears/KMart?
 
Beats me.
 
Has Lampert lost his touch, too, as I muse about William Ackman in today's next post?

Will Services Truly Go Global?

Mr. Joseph Sternberg edits the Wall Street Journal Asia's Business Asia column and recently wrote an editorial entitled Now Comes the Global Revolution in Services.

Of course this has been a feared development by many in the US economy, since our services sector is so large. The first such globally competitive service which probably comes to mind is call centers.

Sternberg wrote,

"Asia has been a big winner from the development of global manufacturing supply chains. Japan and the four tigers—Hong Kong, Singapore, South Korea and Taiwan—showed how cheaper shipping could create opportunities for factories far from the intended market. As supply chains have grown more complex, the benefits have spread. Components now travel from Thailand, the Philippines, Malaysia and Taiwan to a factory in China, where they're assembled before hitting the shelves of an Apple store in New York as a finished iPhone.


Even as the manufacturing supply chains continue their evolution, a new question confronts Asia: How to profit from increasingly sophisticated supply chains in services? Despite all the political hype in the West about the ills of outsourcing and the perceived ubiquity of overseas customer-service call centers, services supply chains are still in their infancy."

It's thought-provoking to realize how the economics of various manufactured and assembled parts of goods such as an iPhone make it affordable to ship the incomplete item around so much of the world simply to take advantage of lower labor costs. Sternberg then contends,

"We're heading for a day when a Malaysian architect will sketch out a new office tower for London, a Philippine architect will prepare detailed renderings, and a Chinese engineer will assess the structural soundness of the designs. Or a specialist firm in Bangalore will administer health benefits for a Kansas company. Indeed, such things already are happening on a modest scale.

That's particularly apparent on the infrastructure front. Ask experts what a government needs to do to develop a services- outsourcing industry, and the first answer is usually "provide more reliable electricity" or "lay fiber-optic cable." True, but more important will be the human intangibles. Educating a sufficiently skilled work force—no small task in itself—is only the start."

Sternberg's example sounds simple enough. But will it really occur? Are language barriers really so easy to overcome that complex building design will be piece-parted out as he describes?

He concluded with this passage,

"Manufacturing supply chains applied modern transportation technologies to a millennia-old principle that if someone in a neighboring village can make a good more efficiently than you can, you should buy it from him. Service supply chains derive a new principle—that you no longer need to be geographically near the person providing you a business service—from modern communications technologies. Now countries need to figure out how they fit into this trend, and how to profit from it."

Personally, I believe Sternberg is far too optimistic about the globalization of high value-added services. Especially services involving high levels of complexity.

Why?

Well, for one, globalization of product manufacture and assembly has a simple test. Does the resulting product function at a competitive price? The proof is easy to see.

Services aren't so simple. The success of a globally-designed building or other complex system using services provided in so many countries and languages might not be apparent for years. And they tend to be one-off projects, rather than, like products, things of which millions are sold and used.

Even the lowly call center has seen a reversal of outsourcing overseas from the US. Too many problems with language and basic service quality levels has resulted in some firms regaining an edge by relocating their call centers back in the US.

Then there's the recent comments of Boeing CEO Jim McNerney on CNBC. In answer to questions concerning the Dreamliner's continuing delays, McNerney confessed that the firm had overreached with its design outsourcing. He said that they won't be doing that again, focusing instead on more onshore engineering and design.

If one of the most sophisticated engineered systems we have, a modern jetliner, has failed to be reliably designed and produced globally on time, what are the prospects for equally-sophisticated systems? At least the Dreamliner results in a testable product on which quality control may be performed before it actually goes live in its initial commercial flights. And Boeing has been building such systems for decades.

I think it says a lot that they got the mix and management of global design of the various parts and subsystems of their newest jet fouled up, and are planning to move back to more centrally-sourced services in the future.

Thus, it's my guess that Sternberg's concerns and visions are very premature. And a big chunk of US exports in the service-based sector remains somewhat safe for a while.

Cisco's Continuing Woes

I recently exchanged some email missives with an old friend who escaped the collapsing financial sector for the decidedly greener fields of the California technology sector. He was glum over that day's equity price performance of his new firm, Cisco.

I didn't think much of it, until I read, later that day, of Cisco CEO John Chambers' downbeat outlook and the lackluster quarterly earnings report.

I wrote this post last November, on the occasion of the company's and Chamber's last sobering, disappointing quarterly outlook and earnings report.

"However, a much more revealing chart is the next one, spanning the public life of the firm. It produced shareholder value so fast in its early years that comparisons with the index are really pointless. But it's easy to see that, like Microsoft, Cisco has really 'enjoyed,' or, more pointedly, its shareholders have not, a lost decade. From its peak at the peak of the technology bubble in 2000, Cisco slid dramatically and really never substantially recovered.



I have checked my own records, and do not find evidence of the firm in any of my portfolios after early 2000. Between its dismal total return performance, relative to better-performing firms, and, I expect, slowed revenue growth, the firm joined the list I mentioned earlier in the post. Those technology firms whose charmed life of meteoric total return and revenue growth has slipped into history, almost certainly never to return.


Thus my amazement that pundits still put so much emphasis on the firm's every move. The information is clearly available for all to see- Cisco hasn't been a consistently superior performer worthy of long term holding for a decade. You'd have to be a market timer to have earned significant gains by owning the firm during that period. And if you simply bought and held, you'd be a big loser."



The price chart for Cisco, Dell, Intel, Microsoft and the S&P500 Index which appears at the beginning of this post bears out my contention.
 
More surprisingly, Thursday, on CNBC, one pundit was actually arguing that it's time for Chambers to find a new job. And whereas Microsoft is usually given a magical pass for its lost decade, Cisco doesn't seem to merit the same kid glove treatment.
 
A Wall Street Journal article in the Heard On The Street column matter of factly notes that the switch market, which Cisco rode to success a decade ago, has matured and become much more competitive. Revenues and margins are down. Like so many other technology firms have experienced, it appears that Cisco's main engine of profitable growth has flamed out, or settled down to a constant, slow burn, with no similar product/market to replace its earlier performance.
 
John Chambers and Cisco, meet Joseph Schumpeter's world of competitive, dynamic capitalism. Cisco hasn't been selected for my equity portfolios in at least a decade. Like the other firms I included in the price chart- Dell, Intel and Microsoft- all were once profitable contributors to earlier portfolios. But, once growth ebbed and returns came back down to earth, they were jettisoned, never to reappear.