After Bear Stearns, Is Lehman Next To Collapse?

This week's hot investment banking story is the vulnerability of one of the remaining weak sisters among publicly-owned investment bank/brokerages, Lehman Brothers. I last wrote about this issue here in April.

Nearby is a price chart of Lehman, Goldman Sachs, Morgan Stanley, Merrill Lynch and the S&P500 Index for the past five years.

Goldman is clearly the class of the class, especially distinguishing itself since late 2006- months before last summer's mortgage finance-fueled fixed income markets crisis.

Of the other three investment banks, Lehman has the relatively 'best' performance. Of course, that's not saying very much, since none of the three could give an investor a better return than the S&P500 did over the period.

As I read yesterday's Wall Street Journal piece about Lehman's new difficulties, I noticed the article making a really big deal about how Lehman's leverage has recently been lowered from 31.7 to 27.3. Today's Journal has a lead piece in the Money & Investing section about Lehman looking abroad for capital.

In my opinion, this completely misses the point. As I wrote here in late March,

"Looking beyond simply Bear Stearns, can anyone truly justify the existence of all four of Goldman Sachs, Merrill, Lehman and Morgan Stanley? Especially in the modern world of large private equity firms and hedge funds? The former provide additional underwriting, M&A advisory and asset management, while the latter focus on providing trading capacity and investment management.

Other than emotional reaction of former employees seeing their old firm's name vanish, what would be different if one or more of those names were bought by or merged with a commercial bank?

Contrary to Andy Kessler's view, in the Wall Street Journal this past January, about which I wrote here, it's unlikely now that an investment bank will do the buying. With their high leverage and dependence upon commercial banks for funding, I suspect the investment banks are the more vulnerable. Now having access to the Fed discount window, it's only a matter of time before the regulators get around to levying a new regulatory framework on the investment banks."

It's not whether Lehman reduces their leverage right now by a pithy 4 or 5 percentage points. That's going to be irrelevant if/when their big meltdown comes. Bear Stearns saw billions of dollars of client assets, and customer business, vanish in days.

Quite simply, as I wrote in that prior post, Lehman exists at the pleasure of its commercial bank Broker Loan divisions to fund them beyond the current maturity of outstanding liabilities. Whether the leverage is 30, or 25, 20, 15, won't matter when customers leave within two days.

At that point, anything above 1:1 spells dissolution. The mechanics of profitability, risk management and leverage have simply changed for long term survival of most publicly-held investment banks.

A plethora of hedge funds and private equity shops have trimmed profit margins in virtually every investment banking business except asset management. There, the best managers head for private firms ASAP anyway. Meaning the publicly-held investment banks, with the exception, still, for now, of Goldman, are largely the province of the lesser-skilled bankers at the mercy of commercial bank funding and the need to take ever-larger risks to offset declining profit margins.

A recipe for long term death of these firms? You bet.

As I wrote later in that March post,

"A natural consequence to this will probably be even more smart financial services people migrating back to the privately-financed arena. Just like consumer goods merchandising has the 'wheel of retailing,' whereby new entrants compete at the low-cost end of the market, as existing players migrate upwards in terms of quality, service, selection and price, so, too, it seems, will financial services now have its own version of this 'wheel.'

Only in financial services, the 'wheel' is between publicly- and privately-held concentrations of capital and risk management. Again, viewed from afar over decades, the story of commercial and investment banking for the past forty years has been a gradual selling of transactions, asset and risk management businesses at their 'tops,' as formerly-private banks of both stripes went public, followed by managerial ineptitude, decline in risk management, and excesses in pursuit of growth via more risk."

And, as I wrote in my recent post on Wachovia CEO Ken Thompson's demise,

"To me, the pecking order of smart management in financial services begins with the best private equity and hedge funds. After them would come Goldman Sachs. Then.....well..I don't know if there is anyone else thereafter."

So to me, this breathless watch over Lehman's viability is sort of misplaced. As soon as confidence begins to erode, it's 'game over.' Bear's situation proves this. As I wrote in the earlier linked post, why doesn't Fuld just take the opportunity to sell to a commercial bank and retire gracefully, while his image is still in good shape?

The Folly of Corporate Diversification

I've written a handful of posts about diversification. Perhaps the two that I find most important in conveying my core philosophy about diversified companies are found here and here.

Not surprisingly, because it is probably the best known American diversified conglomerate, GE has been the primary subject of those two posts.

However, GE isn't the only American company that is probably overly-diversified. Consider yesterday's sacking of Wachovia's CEO, Ken Thompson. One of Thompson's mistakes, in his rush to make Wachovia larger and faster-growing, was the unwise purchase of Golden West Financial at the top of the real estate boom in 2006.

Now, it appears that Wachovia, like its Charlotte rival, BofA, would have done better simply remaining a large commercial bank without trying to become a major presence in the now-national business of mortgage lending.

Over the past decades, auto makers have bought, then sold: EDS, Hughes, and several financial service companies.

Who knows how much better-managed and -positioned for today's changing, challenging environment GM, Ford and Chrysler would have been, had they not frittered away precious capital and management attention on these diversifications?

Or consider TimeWarner's disastrous merger with AOL. Eventually it destroyed huge amounts of shareholder value. A needless diversification that never truly worked.

Microsoft has grown cumbersome and complicated to understand and manage, judging by their total return performance over the past decade.

When I consider both Microsoft and GE, it seems pretty obvious to me that too broad an assortment of businesses, especially when their commonality is eclipsed by their differences, leads to mediocre total return performances for shareholders.

Who really believes that Microsoft's applications businesses need to share a corporate structure with the games division?

Or that GE's aircraft engine business has a lot of interdependence with its Universal/NBC unit?

What are the odds that executives overseeing these unlikely combinations actually add value that exceeds the costs of their administration?

Look at the nearby price charts for five companies and the S&P500 Index for the past five years.

The monoline companies- Google and Apple- far outperform the diversified ones- GE and Microsoft.

I know there are many reasons to assail this comparison. What I want to show is the huge performance gap between operating models. The focused, largely single-business firms have created far more value for their shareholders in the last half decade than have the two diversified ones.

How can Gates, Ballmer and Immelt possibly excuse such lackluster performance for so long?

I contend that CEOs who collect and 'manage' businesses too many in number, with little inter dependencies, are ineffectively constructing mini-indices of their own. As Microsoft's and GE's performances so clearly demonstrate, at best, they might perform like an index..but with much higher risk.

That's why I have written for years that both GE and Microsoft would benefit their shareholders by splitting their companies into their logical constituent parts. In both cases, their business units are sufficiently large to operate as independent corporations, and would have much more transparency and focus if they did so.

With total return performances like GE's and Microsoft's, it's hard for anyone to argue I'm wrong.

Does any reader know of a legitimate exception to my position? That diversification of corporations is, in today's environment, with deep, broad equity pools, needless and counterproductive for shareholders and managements?

Synfuel & Energy Security

Back on May 21st, the Wall Street Journal ran an interesting article describing efforts by the US Air Force to test the use of synfuels in its bombers and fighters.

As the Journal article explained,

"Despite its high-tech connotations, synthetic fuel -- often dubbed "synfuel" for short within the industry -- has been around for decades. The basic technology for transforming coal or natural gas into synthetic fuel was invented by a pair of German researchers, Franz Fischer and Hans Tropsch, in the 1920s. The Nazis later used the Fischer-Tropsch process to mass-produce synthetic diesel fuel. During the apartheid-era embargo against South Africa, scientists there tweaked the technology so it could also produce synthetic jet fuel.

The Fischer-Tropsch process transforms a synthetic gas derived from coal or other material into liquid gas. The resulting synthetic fuel is different from biofuel, commonly produced from corn, sugar or other plants. Continental Airlines Inc. has announced plans for an experimental flight using biofuel this spring, which would be the first by a U.S. carrier; Virgin Atlantic also has done some testing."

I have had a vague awareness of this process for some time. Originally, I thought it converted coal into liquid hydrocarbons, then I later thought that was mistaken, and it only 'gassified' coal to burn like natural gas. In fact, it does produce liquid fuel. Sounds too good to be true, right?

Well, in a sense, it might be, as the Journal piece noted,

"The pure synthetic fuel Syntroleum sold the Air Force for the B-52 test flight in 2006 cost almost $20 a gallon. Its price since has come down sharply, but the synthetic product used in the B-1 supersonic test in March still cost $4.62 a gallon. It was mixed with petroleum fuel costing $3.04 a gallon, according to government officials."

You can guess, and the article confirms, that if large refiners knew that the US government stood ready to buy their output at some reasonable minimum price, the cost and, subsequently, price of synfuel would fall dramatically.

But then there's this aspect to the synfuel solution,

"Military use of synthetic fuel faces significant obstacles. The energy bill signed into law by President Bush last year included a clause preventing the government from buying the fuel if it emits more pollution than petroleum. Manufacturers have promised to meet that target by recapturing carbon dioxide and other greenhouse gasses produced in refining. Without those efforts, synthetic fuel can emit up to twice as much pollution in refining as conventional petroleum."

Here is where common sense would hopefully prevail. Seeing the US, as Boone Pickens believes, spend $500B per year buying oil from external suppliers, isn't it worth something to avoid that import bill?

Screw the greenhouse gases for now, we're talking energy security. Military energy security. As the Journal article states,

"The problems are particularly acute for the Air Force, which uses about 2.6 billion gallons of jet fuel a year, or 10% of the entire domestic market in aviation fuel. The Air Force's fuel costs neared $6 billion last year, up from $2 billion in 2003, even as its consumption fell by more than 10% over the same period because of energy-savings measures, including a campaign to shut off lights and lower thermostats at bases.

The Air Force wants to be able to purchase 400 million gallons of synthetic jet fuel a year by 2016, an amount equal to 25% of its total fuel needs for missions in the continental U.S. This year, it expects to buy slightly more than 300,000 gallons."

With all the handwringing about US energy security, surely it's worth first reducing our dependence on overseas petroleum, then working on the emissions issues.

Here we have a clear, proven, even old technology which will make good use of coal, the fuel which America has in such abundance that we are sometimes called the 'Saudi Arabia of coal.' And yet in the midst of tight petroleum supplies and dwindling non-sovereign control of the energy source, we needlessly hamper our own ability to convert coal into synthetic oil and gasoline.

And the Air Force tests? The Journal had this to report,

"On a clear day in March, the three men took off for New Mexico with a reporter aboard. When the B-1 crossed into the closed airspace above the White Sands Missile Range, Capt. Fournier yanked back his throttle and sent the plane climbing almost straight up, throwing the bomber's occupants back into their seats. He then pitched into a steep dive. Pens and other small objects hovered around the cabin, weightless, until the plane leveled off again.

Capt. Fournier fired the plane's afterburners and sent the bomber roaring over the range. A small dial in the cockpit showed that the bomber was flying faster than Mach 1.

Back at Dyess, the crew packed into a small conference room to analyze the flight with a crew of military and civilian officials, including a pair of engineers from GE, which makes the bomber's engines. Capt. Fournier said the plane handled normally at high speeds and on sharp turns. The only difference he noticed was that the synthetic fuel had a different smell than conventional jet fuel. "So it didn't give you the normal buzz?" one of the engineers joked.

With the B-1 certified to fly on the synthetic mix, Maj. Donald Rhymer, the deputy director of the Air Force's alternative-fuels certification office, said the Air Force would soon test fighters such as its workhorse F-16.

"Our biggest litmus test was Capt. Fournier coming out of the B-1 and saying that it was an unremarkable flight," Maj. Rhymer said as the meeting ended. "That's the subjective endorsement we're looking for with all of the planes.""

Ken Thompson Fired At Wachovia

Well, it's official. At least one commercial banker has gotten the axe for his boneheaded 'leadership.'

CEO of Wachovia Kennedy "Ken" Thompson's forcible resignation was announced this morning.

As the nearby Yahoo price chart illustrates, Thompson's Wachovia (WB) hasn't really delivered for shareholders for the past five years.

Wachovia barely tracked the S&P until early last year, when the bank's stock price went flat, while the index rose, and then plunged precipitously while the index flattened.

Guess buying Golden West, the California mortgage bank, in 2006, at the top of its value, wasn't so smart after all, eh, Ken?

Of course, the other Charlotte-based "Ken," Lewis, about whose bank I wrote here recently, has had his share of problems, as well, as depicted in the chart.

While Thompson's Wachovia actually lost about 25% of its value in five years, Lewis' BofA barely managed to stay above the flat line. Neither, at their best in the past half-decade, ever showed signs of out-performing the S&P.

In Lewis' case, the purchase of Countrywide, another California-based mortgage lender, hasn't helped BofA. The early purchase of an interest in the real estate financial firm, to help shore it up, looked expensive by the time Countrywide collapsed and offered the rest of itself to BofA at a much lower price.

Isn't it ironic that the two one-time North Carolina regional powerhouses, NCNB and First Union, by virtue of astute risk management in the 1990s, managed to scoop up the west coast money center titan, BankAmerica, and assorted other US bank chains. Then, in the latter half of this decade, squandered their shareholders' value by returning to..where else?....California to buy mortgage lenders which subsequently caused large loan losses.

Almost seems like some sort of revenge of California finance on the North Carolina banks worthy of a Greek tragedy, doesn't it?

Now Thompson's out, and Lewis is looking less and less effective.

This morning, on CNBC, Dick Bove, a long-time commercial bank analyst, opined that both franchises lost their focus and moved out of basic deposit-taking and lending, thus damaging themselves with mortgage banking.

As I wrote here last October,

"Quite simply, as a group, US commercial bank CEOs are typically less-broadly experienced and, frankly, less 'smart,' in a business sense, than their investment banking CEO counterparts.

Stretching back to the 1970s, I think only David Rockefeller and Walter Wriston were, among commercial bank CEOs, possibly on a par with their investment bank peers in terms of vision and business acumen. Even then, these two were encumbered by the inherent obligation, as leaders of large US banks, to act to protect the banking system, rather than focus primarily on their shareholders' interests."

Further on in that post, I noted,

"As I consider the M-LEC and its supporters, I can't help but see it as essentially an attempt by the less-savvy commercial bank CEOs to stave off a fire sale of fixed income assets which they abetted by their operation of various SIVs. Meanwhile, the savvier investment bank, hedge fund and private equity CEOs circle, like sharks in the water, waiting for the inevitable disgorgement of SIV assets to begin. They will wait for near-bottom prices, buy and hold and, eventually, realize tremendous profits for their risk taking."

Among the investment banks operating when I wrote that post, Bear Stearns is gone. Lehman is teetering, as it attempts to outlast liquidity concerns amidst weak performance. Merrill has been run for decades more akin to a money center bank than an investment bank.

To me, the pecking order of smart management in financial services begins with the best private equity and hedge funds. After them would come Goldman Sachs. Then.....well..I don't know if there is anyone else thereafter.

What Thompson, Lewis, and perhaps even Dimon, seem to forget is that commercial banking really only grows without excessive risk in two ways: with market demand, or by expanding geographically without overpaying for acquisitions. Typically, moving into new businesses, such as mortgage banking and capital markets, brings disaster.

It has for Wachovia and Thomson via Golden West. Lewis has capital markets losses and the specter of Countrywide's losses with which to contend.

It's too early yet to discern whether Chase has really bought anything worthwhile by scooping up the remains of Bear Stearns.

Commercial bank CEO's rarely learn the lesson of long term risk management vis a vis growth. Each large bank CEO wants their bank to be the largest, their asset and income growth to be the fastest.

To their shareholders continuing regret.

Bear Stearns' Management's Naivete

Earlier this week, I read the second part of the Wall Street Journal's retrospective series concerning the demise of Bear Stearns. The piece ended with the following passage,

"At about 6:45 a.m., Bear Stearns officials received an email from Stephen Cutler, J.P. Morgan's general counsel. It was the draft of a news release announcing that the bank had agreed to provide Bear Stearns with financing "as necessary" for up to 28 days.

The money underwriting the rescue was coming from the Fed, which was also bearing the risk of the loan. It was the first time since the Great Depression that the Fed had made a loan like this to an entity other than a bank. It would provide the bailout through J.P. Morgan, because as a commercial bank the firm already had access to the Fed's discount window and was under the central bank's supervision.

Inside the sixth-floor conference room where Messrs. Molinaro, Upton and others had huddled, executives cheered and exchanged high-fives. They thought they had four weeks to sort out their problems."

When I read that last paragraph, I just shook my head. Those guys must be idiots.

The bulk of the article described the steady drain of customer assets and counterparty business fleeing Bear Stearns that week. Anyone with as much experience in financial services as Cayne and Schwartz should have remembered how quickly Continental Illinois Bank went from healthy to shuttered.

Once customers and counterparties smell weakness in a leveraged financial institution, it's over. Nobody will risk their cash with a counterparty or custodian who might, on any day, suddenly become insolvent. It's more than just 'staying away until the dust settles,' as one institutional customer told their Bear contact.

With sufficient numbers of other trading houses in the sector, who needs to do business with a cripple what might collapse in the next day's market decline?

What were those guys thinking? Did they really believe that the 11th-hour loan, brokered by the Fed and run through Chase, would actually save them? They didn't have a month to 'sort out their problems.'

They never had more than that weekend, because as soon as Monday morning's market open, every remaining customer would flee the obviously-weakened firm, and counterparties would step back, too.

You don't have to be a rocket scientist to understand that the Thursday night loan simply got Bear through one last day before a weekend deal to arrange the transfer of positions to whomever became the new owner of what remained of Bear Stearns.

I haven't read part three of the series yet, but the end of part two just left me incredulous that the guys at the top of Bear Stearns could have been so naive and clueless. Truly, they did not deserve to continue their corporate existence.

GE, Immelt, O'Reilly & Olbermann...And Corporate Governance Again

It seems that every time Bill O'Reilly mentions GE, Jeff Immelt and Iran on his Fox News program, my blog visits skyrocket. When people Google any two, or all three, of the words 'Iran GE/Immelt O'Reilly,' one of the top results is one of my blog posts regarding my appearance on O'Reilly's program last month discussing the business aspects of GE's dismal performance under CEO Immelt.

This morning, however, I received a visit from a reader who found my blog from this referring post. I don't really follow the O'Reilly-Olbermann feud, although I have friends who keep me abreast of it from time to time.

What I find interesting about the post and its author is its apparently objective viewpoint that, based on the facts, O'Reilly is probably right on this one. And, thus, with his link to my blog, which is unabashedly critical of Immelt's inept management of GE, he also sustains my own views on the matter.

I have yet to find anyone who can counter the points I have made in my many GE- and Immelt-related posts (conveniently located by searching under those labels on the right-hand side of this page). Whatever Olbermann's faults may be, there's no denying his boss-of-bosses, Immelt, has pretty much flatlined GE after its many years of at least market-paced performance under his predecessor, Jack Welch.

Cable Gamer ends his GE-related post,

I should stop there, but I do have just one more thing on my mind: GE shareholders should be mindful that none of this controversy is doing them any good. This blogger, The Reasoned Skeptic, makes the point that GE has been hurt financially by all this ruckus. And when I see that GE stock is at 32, I think that surely somebody is going to come and rescue shareholders from this worst of both of both worlds--an amoral relationship with an American enemy, as well as poor economic performance.

In keeping with my recent rant about what shareholder democracy really means- and there will be an upcoming post exploring this in more depth- let me reprint a key passage. I wrote,

"But the investment angle of the story, as represented by Mr. O'Reilly's institutional manager/guest last night, now focuses on the wrong point.

The wonderful thing about our American economic system and environment is that you don't have to own GE! Or any other underperforming asset!

There are thousands of investing options available to both institutional and retail investors alike.

Rather than wait, like those poor souls anticipating Godot's arrival, for the seemingly-always-coming 'corporate governance' solution, investors are better off to just sell what they don't like and buy something else."

Someone come to GE's shareholders' rescue? How about they just do the sensible thing and sell the damn stock???!!!!

I spoke with my partner about this a few nights ago. Why, he asked, do people hold onto equities of companies that are such long-term poor performers.

He believes it is due to a basic element of human nature- a tendency to be in denial about the bad outcome of prior (investment) decisions. Rather than admit a mistake and sell the equity, keep it and hope someone will 'fix' it.

I don't think I can express it any better than I did in that post, so I'll just reprint the conclusion-

"There are so many opportunities for investment in the American economy that there's simply no reason to hold onto a problematic equity and either hope, yet again, that this year will bring change for the better, or, worse, lobby for 'management change' or 'board action.'

It probably makes more sense to trust the senior management and board of the firm in which you invest to do a great job with the assets under their control than to invest in a company which you think could, or wish would, do better than it has with the company's assets, and then try to change the management and/or board's behavior."

Technology's Disruptive Effects

Technology- multiplier of manpower, driving force of innovation, cutter of prices, improver of living standards

Technology- destroyer of jobs, wrecker of industries, change run amok, reducer of investment values

Technology is an awesome and typically unpredictable force in our society.

Yesterday, my partner was remarking on a factoid he read last week concerning financial services employment among large US companies. At least, I think that was the universe.

Anyway, the fact was that, before the recent purges of financial services employees, following last year's credit debacle and subsequent writedowns, financial services employment had just about reached the same level it had prior to the sector's last major cuts, following the attacks on the World Trade Center on 9/11.

He and I were frankly puzzled that the labor force in the sector had swollen by so much again. He asked whether the industry should not have become more productive, and, thus, had fewer employees at its recent peak?

That seems correct to me. We discussed productivity, and he asked how I would define that measure. I cited the method I've always used, which is value-added divided by the number of employees. Value-added, the meaning of which my partner inquired, is, classically defined, the net of revenues and purchased goods and services.

Our conversation brought me back to a similar one in the library of the then-headquarters of my former consulting employer, Oliver, Wyman & Co., in 1995. I was discussing issues of size of markets, growth, revenues and gross margins among financial services businesses with my then-colleagues John Stroughair and David Boone. We gradually came around to discussing the role of IT in the sector, beginning in the early 1960s.

This led me to conjecture that it was possible that the industry's gross margin dollars had remained relatively constant as the application of information and electronic technologies to financial services had expanded the number of customers while reducing prices. For example, credit cards, money market and mutual funds became more ubiquitous, and fees for these services fell, thus opening them up to a much larger and broader mix of customers.

Even if the gross margin dollars grew, they probably grew at a slower rate than that of revenues or customers.

My point is, the application of technology has a decidedly mixed effect, even upon industries which undertake it for its supposed benefits.

In financial services, the thinning of gross and, ultimately, net margins probably led to less cushion against risk, as ever larger customer bases were served against shrinking profitability levels.

Technology tends to lower or remove barriers to entry, which, of course, leads to lower profit margins.

Returning to my discussion this week with my business partner, I mentioned an industry with which he is familiar, and in which he has had some fairly influential contacts- recorded entertainment.

Does anyone doubt that electronic and digital technology has gradually, at first, then rapidly decimated the businesses of producing and marketing audio and video entertainment?

Prices and margins fell through the floor with each new technology- cassettes, CDs, DVDs, VCRs, MP3 & 4 players.

This is part and parcel of what Joseph Schumpeter observed and codified almost a century ago. Businesses which enjoy substantial growth, especially from technological sources, open themselves to a bargain with the devil. Technology allows for the dramatic growth in new products and services, but with the accompanying shrinking of margins and ease of competitive entry. Thus, once on a path emphasizing technology-based change and growth, businesses which pause tend to get overrun by market forces- either consumer- or competition-based.

Existing products and services, like those in entertainment and banking, become cheaper, and, thus, appear more costly to offer, in terms of gross margin. Thus, firms which fail to move forward by shifting their business mix to new, higher-margin products and services, suffer from lower profitability, even if they were initially pioneers in the technologically-based changes.

Technology is, indeed, a two-edged sword. Having initiated its use to spark growth, firms run the risk of longer-term obsolescence if they fail to appropriately continue to ride the back of this tiger. Once begun, a business' affair with technological advances can't safely be ended, or even brought to a point of just 'maintenance.' To do so is to invite an early death.

Details...Details...What's In The Boilerplate Of Those Securities?

Yesterday's Wall Street Journal's Money & Investing section featured an article discussing the putting back of bad mortgages by institutional investors to sellers of the instruments.


The article cites Countrywide Financial as having reset its liability for such repurchased bad mortgages from $365Mm last year to $935MM now.

According to the Journal article,

"Additional pressure is coming from bond insurers such as Ambac Financial Group Inc. and MBIA Inc., which guaranteed investment-grade securities backed by pools of home-equity loans and lines of credit. In January...MBIA began working with forensic experts to scrutinize pools it insured that contained home-equity loans and credit lines to borrowers with good credit. "There are a significant number of loans that should not have been in these pools to begin with," says Mitch Sonkin, MBIA's head of insured portfolio management."

Further on, the article relates that WMC Mortgage, a unit of GE, made improper representations and warranties of subprime loans it pooled which PMI insured. Essentially, PMI is suing GE's unit for fraudulently describing the loans, for which PMI charged a fee to insure, because, in reality, the loans were much riskier than had been represented to PMI. PMI also wants WMC to repurchase the loans or pay damages to PMI, as the delinquency rate on the loans rose 30% within eight months.

What I find comforting, on some level, is that the legal agreements underpinning various mortgage loan and securitization instruments allow for buyers and insurers to recover for fraud and breach of contract, putting back the misrepresented instruments to the sellers.

Somewhere, in a handful of Wall Street investment banks, i.e., the few still solvent and publicly-owned, I can imagine rooms full of young financial wunderkinds being taught a lesson about the real meaning of those thick piles of documentation that accompany traded, securitized loans.

Buying a security that is what it says it is, and losing money, is one thing. Buying a fraudulently-described mortgage-backed security is quite a different matter. It's good to see that astute buyers are forcing the sellers to take back their fraudulently conveyed paper.

I wonder how much more in losses than currently expected this will bring to the larger mortgage-backed securitizers of the last few years.

Annheuser-Busch's No-Brainer Choice

This week's news in the beer industry has taken on quite the dramatic quality. European brewing giant InBev is planning a bid to buy the dominant US brewer, Annheuser-Busch.

For entertainment purposes, business media outlets, including the Wall Street Journal, are playing up the family angst angles, but it's really a no-brainer for shareholders. Vote for the acquisition, sell your AB shares, whatever.

I should probably provide a quasi-disclaimer. Although I own no AB stock, and never have, I do have some acquaintanceship with the company and family. My undergraduate alma mater is Saint Louis University in Saint Louis, Missouri. That university's student center is named the Busch Center. At the time I was completing my BS in marketing, one of the Busch children was also a student. The city reveres the first family of American brewing. The St. Louis Cardinal baseball team plays in.... Busch Stadium. At least it did. I believe the newly-built field is also named for the team's owners.

Suffice to say, I am well-acquainted with the family's identification with the company whose shares they sold to the public some time in the last century.

As CNBC co-anchor Michelle Caruso-Cabrera stated so clearly earlier this week, as I paraphrase,

'The family wanted capital and went to the public to sell shares. If they wanted full control over the company, they shouldn't have done that.'

She's right.

Further, look at the nearby five-year price chart of AB (ticker symbol BUD) and the S&P500 Index. The brewer has done its shareholders no favors. Clearly, having Busch as your last name doesn't seem to do much for achieving consistently superior returns for shareholders. Over five years, AB hasn't even made it back to a flatline performance, while the S&P has chalked up a +40% return.

The family situation of the Busch's also reads like that of the Ford family. Bloodlines thinned of talent over the generations. Divorces, underperforming sons, distant father-son relationships.

We read that the current CEO, August IV, was basically estranged from his father, by way of divorce. He, the son, went on to become a typical wealthy bad boy in his younger days.

The most chilling passage of the Journal article is its last, which reads, quotes the current CEO as saying, of his relationship with his father, August III,

"Succeeding atop Anheuser is paramount to the relationship, he says. "I honestly do believe if I failed in my professional life, it would be much harder to ever gain his respect," he says."

Meaning, I guess, that the AB shareholders are hostage to whatever it takes August IV to do to gain his father's respect.

Damn the shareholders- focus on dad!

The Journal piece does a fine job cataloguing the company's fending off Miller Brewing in the 1970s and '80s, then eschewing international expansion via mergers or acquisitions. Now, AB is the lone family brewer among large global players, and its performance is hurting.

This Yahoo-sourced price chart of the brewer and the S&P500 from the early 1980s tells an interesting story.

For nearly two decades, the brewer tracked the index, briefly declining to equal the latter's performance by 2001. At that point, the brewer's performance flattened slightly, but, relative to the bubble-bursted index's decline, posted a few years of outperformance. But by 2003, the index was rising again, while the brewer's performance dipped, then flattened.

Hardly laudatory performance by the Busch family on behalf of their public investors, is it?

It's pretty clearly time for a change. For any of the privileged Busch's to see the brewing company as a personal playground for settling family and personal issues is just wrong and unethical.

Looks like it's time for one less headquarters in Saint Louis, and a new division for InBev.

Ford's Bad News Could Be Long-Term Good News

Perhaps the biggest industrial news last week was Ford announced disappointing earnings news.



Ironically, though, this 'crisis' may be the ultimate turnaround opportunity for Detroit- or what's left of it.



The facts are these. On Thursday, Alan Mulally announced that, due to high gasoline prices, truck sales are off in a major way. Mulally used the term 'tipping point' to emphasize that gas prices have, for now, shifted consumer buying away from trucks for the foreseeable future.



The company is cutting truck and SUV production by as much as 40% in the second half of 2008, according to a Wall Street Journal lead article in Friday's edition of the business paper.



The consequence of this gasoline-price-driven change is that Mulally said it's now "extremely unlikely" that Ford will, as he had earlier predicted, return to profitability in 2009.



This is huge news, because Mulally is seen as a very capable manager. Unlike the incompetent crew across town at GM, Mulally has proven his managerial expertise at Boeing, and already made a positive difference at Ford. The unexpected, though small, profit this quarter, and the shedding of Jaguar, have demonstrated this.

The nearby Yahoo-sourced price chart for Ford and the S&P500 for the past year bears this out.

But a longer-term look at the same data, using a five-year chart, tells a different story. Seen from this perspective, it's evident what a tough job Mulally has if he ever hopes for Ford to deliver at least the S&P's returns to his shareholders. Right now, on a five-year basis, Ford is about 60 percentage points behind the index.



But with gasoline-driven cars finally seeing their demise due to global oil economics, it's quite possible that Ford, Toyota, Nissan, et.al. will have a golden opportunity to replace all the cars in America's vehicle fleet with hybrids of various sorts. Or even mono-fuel vehicles that don't use gasoline.



GM might not make it out of the desert of gasoline-powered cars into the promised land of hybrids. But Ford stands a decent chance.

With Kerkorian aboard as an investor, it's not hard to imagine him brokering an alliance, or even merger, between Nissan and Ford, much like he tried to arrange for GM a few years ago, before that company's CEO, Rick Wagoner, fought to prevent it.

To me, the auto industry may now be in a position akin to the recent years of television set manufacturers. Like the giant digital television replacement cycle currently underway, automakers may be able to view high gasoline prices as their salvation, not their demise.

Like it or not, I think most intelligent Americans now expect to seriously consider owning a non-gasoline-only car by the end of the next 5-7 years. I know I do.

While environmental concerns might be trumped-up, there's no missing the obvious implications of much higher oil and gasoline prices on American drivers and the cars they use.

I wrote about them in this post last December.

Just when the conventional design and production of automobiles was causing havoc for Detroit, the appearance of widespread demand for non-gasoline vehicles could change everything.

Battery makers and developers of efficient, usable hybrid drives will reap windfalls. And they should. As will clever designers of uniquely desirable vehicles incorporating various new non-gasoline power systems.

Maybe it'll be electric vehicles, or hybrids. But whatever it is, it could well mean a new lease on life for Mulally's Ford in the years ahead.

Some Perspective on Yahoo, Microsoft, Icahn & Google

On Tuesday, Dennis Berman of the Wall Street Journal wrote a wonderfully insightful and succinct assessment of the latest chapter of the Yahoo/Microsoft/Carl Icahn/Steve Ballmer/Google dance.

In the piece, entitled "Why Yahoo Should Strike as Iron Is Hot," he noted, in closing,

"But the question for Yahoo's board shouldn't be whether it can increase its cash flow. It is whether it can improve its stock price, over a reasonable period of time, greater than a Microsoft offer. A growing chorus of shareholders think it can't.

So, the basics: AOL can't succeed at being Yahoo; Yahoo can't succeed at being Google; Microsoft can't succeed at being any of them. Nonetheless, Microsoft has the fantasy it wants to be Google. How could Yahoo's board do anything but take a decent offer and bank it?"

Berman makes a key point here. Really, despite the much longer verbiage preceding these final paragraphs, the only crucial points in his article.

Yahoo is no longer an investment equity. Neither, really, is Microsoft. Forget AOL/TimeWarner entirely.

With Carl Icahn prowling about to encourage the Yahoo-Microsoft deal, you know that this is now just about short-term speculative gains. Not long-term strategy.

I haven't owned Microsoft in over a decade, or Yahoo since the 1990s. Now, both have simply become opportunities for arbitrage as Icahn maneuvers to recover the value Jerry Yang kicked away.

As the nearby Yahoo-sourced price chart of the past week illustrates, Yahoo's value has held up nicely due to continued betting that something will eventually happen to realize some of the premium of the original Microsoft offer.

But don't bet on any sort of long-term potential for consistently superior total returns from either Microsoft or Yahoo, in any sort of combination, or absent it.

Yahoo's fundamental strategy failed long ago, in terms of consistently superior total return performance. Microsoft's performance stalled before that.

I remain convinced that the only way Microsoft can re-ignite consistently superior return performance is to split itself up into an operating system business, desktop applications, online, and gaming. Then the gaming business can take off and reward shareholders for a few years.

But for now, all of this fuss is about betting that by owning Yahoo, you can benefit from Carl Icahn's ability to recover some value for its shareholders while ringing down the final curtain on Yang.

More Trouble at Howard Schultz' Starbucks

Monday's Wall Street Journal provided some additional information regarding Howard Schultz's attempt to revive the firm he founded, Starbucks.

In this recent post addressing returning CEOs, I wrote,

"In Dell's and Starbuck's cases, I question if they ever will (return to consistently superior total return performance). I believe, for reasons I've discussed in labeled posts on both CEOs and their companies, that competition, growth and simple Schumpeterian dynamics have worked to end their time of consistent outperformance."

I still feel that way. The nearby Yahoo-sourced price chart of the coffee seller and the S&P500 Index for the past five years portrays a brand that has run its course.

Typically, a firm once successful at earning consistently superior total returns will fade from either: lack of growth opportunities; competition; regulation, or; investor expectations finally catching up with performance.

Ironically, as I noted in this post, Schultz had been alleging competition had nothing to do with the firm's slumping fortunes,

Perhaps the most amazing comment Schultz uttered in the rather surreal interview this morning on CNBC was, in response to Bartiromo's question about McDonald's,

'Competition- they're just noise,'or words very close to those.

Well, as I noted in this post, regarding Schultz's recent, hand-picked strategist, Michelle Gass, contended,

"She says she hasn't been focused on competitors in developing the new plans. "I think we'd all readily admit that a lot of the situation we're in is self-induced." Sounds familiar, right? At least Gass and Schultz are reading from the same page in the same playbook.

But in that prior post, I went on to note,

"Thus, I find Ms. Gass' comment to be dangerously short-sighted and internally-focused.

Instead, she might wake up to the reality of Schumpeterian dynamics. Between Starbucks' own prior expansion into lower-income segments, and McDonalds' search for growth in kindred products, the former's market dominance was almost certainly going to come to an end, one way or another.

As it is, Starbucks is being bracketed by another coffee retailer on one side, and a fast-food giant on the other. This has less to do with Starbucks' 'self-induced' troubles than it does with recent targeting of the coffee giant's business by two very large, savvy food retailers.

I hope, for Howard Schultz' and Starbucks' sake, that Ms. Gass begins to become aware of this reality."

In this week's Journal piece, however, it reported,

"Reflecting his urgency, Mr. Schultz told workers he no longer wanted to hear about projects that would take as long as 18 months. "We have to defend our position," he said to a few hundred employees shortly after the March annual meeting. "We have lots of companies small and large who want to take a piece of our business away."

Wow. That's some fast reversal of strategic diagnosis, isn't it?

But what is truly disturbing is how personally Schultz is taking Starbuck's natural decline. As the Journal article describes,

But early last year, Starbucks seemed to be losing its edge, a complaint Mr. Schultz himself voiced in a leaked memo. It wasn't setting the agenda with new products but just adding drink flavors and ordinary items like breakfast sandwiches. Stores had grown cluttered with stuffed animals and other noncoffee items. Price boosts were starting to annoy customers.

"I was just depressed," Mr. Schultz says. He launched a personal turnaround routine, consisting of what are now six gym workouts a week and a daily health shake of fruit and cottage cheese.

In public, he appeared humbled. At the annual meeting in March, Mr. Schultz told the crowd to stop applauding when he walked on stage. "I thought I could start crying," he says.

Schultz is so personally invested in the attempt to reverse the age-old forces of Schumpeterian dynamics that he seems to simply deny their existence.

The article cites, through the recounting of many examples, how Schultz has gathered to himself the power to make even the most trivial decisions. It's reminiscent of Steve Jobs, with one big difference.

Jobs' Apple is in a business which creates new products. The best Schultz can now do, having already created a modern version of the old, original Dutch coffee house, is to introduce some marginal new beverage flavors each year.

Hardly the same thing.

It seems to me that people spend a certain amount of money on coffee and beverage purchases at places like Starbucks. Once the firm has penetrated sufficient markets, as I noted in this post, it really has little room for growth. Perhaps growing economies such as India and China provide some opportunities. But if that were all that was needed, the company would have already been growing with those countries' own growth rates.

No, it seems the problems for Starbucks lie more in the realm of simply having been successful long enough to have attracted competition while saturating its primary and secondary market segments.

I doubt Schultz' micromanagement of the firm he created will really change those facts.

But, as always, time will tell.

Ken Lewis' Awful Bank: Another Tale from the Frontline at BofA

Last week, I wrote this post about my recent experience with Ken Lewis' BofA. It seems they had a rather significant disclosure of sensitive account information which required them to attempt damage control in their Debit Card division.

I visited my local bank branch for more information, but learned that this form letter from one Gordon Rains, a BofA national-level executive, was news to my branch's manager and platform officers.

Fast forward to today. It's been a week, and I had heard nothing from Ms. Gonzalez, the platform officer who promised to expeditiously contact me with information last Tuesday.

As you can guess, what follows won't be pretty. After all, I'm discussing the retail bank branch customer interface of one of America's largest three banks. A sprawling, gigantic behemoth of a financial utility.

Ms. Gonzalez, upon seeing me stride to her desk, immediately registered a mixture of resignation and displeasure. With good reason.

She provided me with the explanation that my debit card, along with many, many other bank customers' cards, had been compromised by some unspecified problem "in Maine."

According to the bank officer, this 'problem' necessitated BofA replacing many ATMs, and, apparently, although this part was not explained, many debit cards, as well.

When I asked why Ms. Gonzalez had not called or emailed me last week to notify me that she was working on my issue, she simply ignored me. When I asked her why some effort was not made to convert a problem with compromised customer information into an opportunity for the local branches to get ahead of the issue and directly contact their local branch customers to explain the safety-oriented steps being taken by BofA, although those customers' data was not compromised, she gave me some nonsensical, difficult-to-understand doublespeak about it being the province of some national business unit, and each branch couldn't know the full extent of the problem.

At this point, I reminded Ms. Gonzalez of my initial request for a meeting with the branch's manager to learn more about the issue. She, in turn, informed me that she had just given me the explanation. Period.

When I politely expressed dissatisfaction with her slow, uncommunicative response to me for over a week, and that I now would probably walk down the block and re-open an account at the smallest local bank in town, of which I had been a customer in a nearby town years ago, she simply noted that I was free to do so, and that it was fine with her if I chose to do so.

As a last effort at provoking some sort of responsible customer service from Ms. Gonzalez or her branch manager, I promised her that, if I did not hear promptly from the branch manager about this issue, I would call BofA's headquarters in Charlotte, NC, in search of whatever ombudsman's office the firm's CEO, Ken Lewis, might have.

Again, Ms. Gonzalez invited me to take that action if I so chose.

By the way, I don't wish to suggest Ms. Gonzalez is a bad person or bears ill-will toward BofA customers. Judging by her change in demeanor from my first meeting with her last week, I'd say she was 'talked to' by her branch manager. She is mostly likely poorly led, rather than badly behaved on her own.

I did open that account at the other bank. And, by the way, among the benefits instantly accruing to me was free wire transfers. Imagine, in this day and age, free inbound wire transfers!

And, upon returning home and not having heard from the BofA branch manager, I called the bank's main office in Charlotte.

There, I spoke with the most gracious, helpful telephone receptionist in my memory. She asked the reason for my call, explained that Ken Lewis has no such office or assistant, but that she would like to put me on the line with the manager of her own function. This she did, and Amanda, her manager, politely and apologetically took the details of my story, which she promised to move up the bank's management hierarchy.

At least, down in Charlotte, even the frontline troops practice the region's trademark courtesy and sense of concern with regard to customer service. I honestly could not have asked for more accommodating attitudes from the two BofA employees with whom I spoke this afternoon.

Poor Ken Lewis. No wonder his bank is in such trouble. As the nearby Yahoo-sourced price chart of BofA and the S&P500 Index for the past five years illustrates, Lewis has managed to barely keep shareholders in neutral for the period. Meanwhile, simply buying the index would have netted investors about a 50% gain over the same period.

Perhaps Lewis mistakes his fellow Charlotte-based employees' attitudes and service ethics for those of his widespread retail banking empire. Believe me, they vary widely.

The staff at my local Summit, NJ BofA branch couldn't have been much less concerned with my welfare, as their customer, nor much less indifferent to whether I remained a customer or not.

We often hear of the description of America's large financial institutions 'as too big to fail.'

Now, however, I think I've discovered a more appropriate phase which described Ken Lewis' BofA and its ilk:

'too big to work.'

Moonves' CBS Buys CNET ???

Since CBS's most recent spinoff, from Viacom, Les Moonves hasn't distinguished himself in providing superior total returns to shareholders. Granted, he's been at it just over two years. But the trend since the stock's peak in mid-2007, as the nearby Yahoo-sourced price chart for the network and the S&P500 Index, has been discouraging.

Thus, Moonves is apparently aiming to fix that with an acquisition of CNET.

Yahoo's profile of CNET portrays it as a rather widespread media content provider. On the surface, it at least seems connected to businesses which CBS ought to understand.

However, Friday's Wall Street Journal article about the proposed acquisition casts doubt on the wisdom of Moonves' latest plan.


According to the Journal,

"CBS's $1.8 billion cash acquisition of Web site operator CNET Networks Inc. is reminiscent of the tech-stock bubble. The CBS offer values CNET at a whopping 22 times Ebitda, according to Capital IQ data. CBS trades at about seven times. What's more, CBS is paying this fat premium when the advertising market is slowing.

Why is CBS overpaying for an asset with a questionable outlook? Look no further than CBS's share price. CBS shares have fallen nearly 30% from their peak last summer. (Fortunately for Mr. Moonves, who took home $36.8 million last year, his compensation has only been recently linked to CBS's share-price performance.)"

The article pulls no punches, does it? Comparing this acquisition to a tech-bubble, all-cash deal is no blessing. Further, if you look at the nearby Yahoo-sourced price chart for CBS, CNET and the S&P500 Index for the past five years, it's clear that, as mediocre as Moonves has performed with CBS, CNET has done even worse in the past 2+ years. Its peak was clearly over two years ago.

On the subject of compensation, I can readily agree with the Journal writer's sentiments. Having banked over $30MM, I would now assign Moonves no motivation whatsoever to enrich his shareholders. He's likely just in this for ego and pride.

For example, the article continues,

"To jumpstart CBS's share price Mr. Moonves wants to create some Internet buzz. He tried the same trick a few years ago, buying CSTV Networks Inc., which operates a college-sports cable channel and numerous Web sites, for $325 million. The network was supposed to complement CBS's other sports operations but was unable to get sufficient distribution and has languished.

Beyond the high price for CNET, it's difficult to see any real synergies between CNET and CBS's existing portfolio of Web properties. CNET is based in San Francisco and CBS's Web operations are concentrated in New York. So there's not much room to save on overhead. It's difficult to see why CBS, which is at its core a broadcaster, will have better luck in monetizing CNET's Web properties than CNET did."

I would concur. While the online media business, per se, is at least close to CBS's broadcast businesses, it's not quite the same thing. And, if anything, the internet argues, as I've written before, for the destruction of any broadcast value beyond local news and information. The actual value of a broadcast network like CBS is rapidly falling.

As such, Moonves seems to be engaging in the sort of game in which a CEO, seeing a dying market for his business, uses a form of sleight-of-hand to trade his shareholders' cash for other assets, the better with which to prolong his own corporate life as a CEO.

Shameful, but it happens all the time. Moonves isn't the first CEO to try this trick, and, sadly, thanks to the modern publicly-held corporation, he most assuredly won't be the last.

More Economists Recant on Recession Call

As I wrote here recently, the US is not currently in a recession.

Now we learn from last Wednesday's Wall Street Journal that more economists are retracting their earlier insistence that the US is, or shortly will be in a recession. The article begins,

"A funny thing happened to the economy on its way to recession: It's taken a detour.
That, at least, is the view of a growing number of economists -- including some who not long ago were saying a recession was all but inevitable. They note that stock and credit markets have steadily improved since the Federal Reserve intervened to keep Bear Stearns Cos. from bankruptcy in early March, while a series of economic reports have been stronger than expected."

It figures. The mass of mediocre economists, having rushed to pre-guess evolving economic data, now see that GDP growth has yet to go negative. Usually not ones to let facts get in the way of a gloomy economic story, now these less-than-first-rate economists are reversing course.

For instance, as the Journal continues,

"In February, Global Insight joined Goldman Sachs, Morgan Stanley, UBS and Merrill Lynch in declaring the U.S. to be in recession. Now, Global Insight's Brian Bethune says that while the firm is still forecasting a recession, "it's conceivable we could avoid it," thanks to "the massive policy response we've seen" since he and others began warning about the risks facing the U.S. economy.
Bruce Kasman, chief economist at J.P. Morgan, said while earlier this year it seemed like momentum was carrying the economy into a clear recession, there's only "a slightly better than even chance" of a recession now. "Even though there are meaningful drags from the credit crisis and energy costs, the economy is showing resiliency," he said.

Even Alan Greenspan, who in early April said the U.S. was in the "throes of recession" and is going through the "most wrenching" crisis since World War II, has more recently toned down the warnings, saying the U.S. is in an "awfully pale recession." George Soros, who has long argued the U.S. is headed for a major crisis, also recently remarked that the "acute phase" of the crisis has now passed."

It's beginning to look like only Brian Wesbury and perhaps David Malpas, late of Bear Stearns, got this one right. The US economy has certainly softened, but is yet to actually go into reverse.

Still, even the Journal hesitates, as the article concludes,

"The question remains open, since recessions typically aren't officially diagnosed until some time after pain hits consumers. A common definition of a recession is at least two consecutive quarters of negative GDP. But the National Bureau of Economic Research -- the nonprofit group that is the official arbiter of when recessions begin and end -- defines a recession as a period of significant decline in economic activity across GDP, income, employment and retail sales that lasts more than a few months.

John Lonski, Moody's chief economist, said recent labor market data and signs the credit crunch is easing on Wall Street have made him less gloomy than he was a few months ago. In the latest WSJ.com survey of economists, conducted in May, he said the likelihood of a recession was 60% -- down from the 90% he predicted in the April survey.

"Recent evidence suggests there's a chance the economy might stabilize before this summer," he said. On average, the 55 economists in the survey, conducted earlier this month, said the likelihood of a recession was 62.7%, down from 70%."

Maybe the mark of a good economist is that s/he doesn't change her/his mind during the period when s/he calls an economic turn, and is correct.

This whole drama regarding the forecast recession that hasn't, and probably won't, arrive, simply gives more credence to the boatload of economist jokes- like how, if laid end to end, they still wouldn't reach a conclusion......