Early this month, Princeton economics professor and one-time financial markets savant Burton Malkiel wrote an editorial in the Wall Street Journal, Entitlement Reform and the Global Budget Crisis.
In contrast to Paul Krugman's recent cries of despair that anybody should throttle back any governmental spending, Malkiel argued for serious reform of expensive social entitlement programs, such as Social Security, in order to cut government deficits and calm financial markets.
Granted, Malkiel didn't expressly recommend cutting current spending budgets. But his tone and attitude were clearly in favor of a "return to fiscal sanity," as he put it.
More specifically, though Malkiel counseled against growing federal budget deficits and unsustainable spending.
In the final analysis, a dollar spent is a dollar spent, so Malkiel's advice for global social pension reforms would seem to be at odds with Krugman's desire for full-tilt spending by governments around the globe.
Pretty interesting contrast of approaches, isn't it?
Wednesday, June 30, 2010
Tuesday, June 29, 2010
Krugman's Global Depression Hysteria
I got around to reading liberal economist Paul Krugman's recent NY Times editorial of last Sunday. It's a real scary piece calculated to frighten anyone reading it into believing that only large-scale government spending can possibly save the world.
If only Krugman were more accepting of the facts of the world's first major Keynesian intervention in America in the 1930s. That is, the fact of the failure of FDR's massive borrowing and spending economic regime.
I've read Amity Schlaes' excellent work on the subject, The Forgotten Man. Not only does Schlaes use economic data to refute the commonly-held belief, obviously shared by Krugman, that FDR's massive spending did little, if anything, to facilitate new job growth. She also describes perhaps better than anyone else has how massive government spending, borrowing and money printing naturally accompanies a loss of individual freedoms and a gradual growth in power of the state. Power which never completely recedes.
But, back to Krugman. He contends,
"And this third depression will be primarily a failure of policy. Around the world — most recently at last weekend’s deeply discouraging G-20 meeting — governments are obsessing about inflation when the real threat is deflation, preaching the need for belt-tightening when the real problem is inadequate spending.
In the face of this grim picture, you might have expected policy makers to realize that they haven’t yet done enough to promote recovery. But no: over the last few months there has been a stunning resurgence of hard-money and balanced-budget orthodoxy.
As far as rhetoric is concerned, the revival of the old-time religion is most evident in Europe, where officials seem to be getting their talking points from the collected speeches of Herbert Hoover, up to and including the claim that raising taxes and cutting spending will actually expand the economy, by improving business confidence. As a practical matter, however, America isn’t doing much better. The Fed seems aware of the deflationary risks — but what it proposes to do about these risks is, well, nothing. The Obama administration understands the dangers of premature fiscal austerity — but because Republicans and conservative Democrats in Congress won’t authorize additional aid to state governments, that austerity is coming anyway, in the form of budget cuts at the state and local levels."
Perhaps if this were 1930s, governments could fool capital markets. But, since this is 80 years later, and deficits have not really declined in that time, investors realize that governments don't really ever stop excessive spending. And programs, once in place, don't end.
Krugman seems to live in a fantasy world of theoretical economics, rather than the real one which, in Adam Smith's time, was more correctly named political economics.
Krugman never addresses what would occur if government simply cut taxes and let people choose to spend or invest. It's not as if money the government spends doesn't ever exist otherwise. Sure, some of the borrowing wouldn't. Certainly the purely printed money doesn't, although some would argue it doesn't truly exist, in that that manner of its creation reduces the value of existing money, thus making the sum remain equal in value.
But, more importantly, Krugman's assumption, going in, is that only government can remedy shortfalls of demand. And that economic cycles are to tamed, not accepted.
Well, we've been trying that recipe, with the exception of the Reagan years, for essentially the 80 years since FDR's massive, ineffective economic tonics.
Krugman ends with a notional nod to global investors,
"It’s almost as if the financial markets understand what policy makers seemingly don’t: that while long-term fiscal responsibility is important, slashing spending in the midst of a depression, which deepens that depression and paves the way for deflation, is actually self-defeating.
So I don’t think this is really about Greece, or indeed about any realistic appreciation of the tradeoffs between deficits and jobs. It is, instead, the victory of an orthodoxy that has little to do with rational analysis, whose main tenet is that imposing suffering on other people is how you show leadership in tough times.
And who will pay the price for this triumph of orthodoxy? The answer is, tens of millions of unemployed workers, many of whom will go jobless for years, and some of whom will never work again."
It's hard to understand the analytical basis for Krugman's contention in that first paragraph. It's as if he chooses to credit private sector markets when it suits him, i.e., that they appreciate long term fiscal rectitude, but currently punish 'bad policy.'
Could it be, instead, that investors are punishing the obvious fiscal messes that governments around the globe have created? Too much hard-to-service debt, the money from which went to pure consumption by early retirees, universal health care consumers, and so on?
Perhaps that, rather than discount Greece, Greece is the example investors now fear being a global reality?
Let's face it- Krugman simply refuses to acknowledge reality. Spending with borrowed and printed money by governments worldwide, not for lasting investments in infrastructure, but for social welfare consumptions, have hit a wall of unwilling investors. Debts are coming due without matching appetites, at acceptable interest rates, to simply roll those debts over.
The good news is that, ultimately, markets discipline governments. Regardless of Krugman's ignorance of that fact. And we are now seeing that dynamic in play in capital markets' responses to sovereign monetary and fiscal policies.
If only Krugman were more accepting of the facts of the world's first major Keynesian intervention in America in the 1930s. That is, the fact of the failure of FDR's massive borrowing and spending economic regime.
I've read Amity Schlaes' excellent work on the subject, The Forgotten Man. Not only does Schlaes use economic data to refute the commonly-held belief, obviously shared by Krugman, that FDR's massive spending did little, if anything, to facilitate new job growth. She also describes perhaps better than anyone else has how massive government spending, borrowing and money printing naturally accompanies a loss of individual freedoms and a gradual growth in power of the state. Power which never completely recedes.
But, back to Krugman. He contends,
"And this third depression will be primarily a failure of policy. Around the world — most recently at last weekend’s deeply discouraging G-20 meeting — governments are obsessing about inflation when the real threat is deflation, preaching the need for belt-tightening when the real problem is inadequate spending.
In the face of this grim picture, you might have expected policy makers to realize that they haven’t yet done enough to promote recovery. But no: over the last few months there has been a stunning resurgence of hard-money and balanced-budget orthodoxy.
As far as rhetoric is concerned, the revival of the old-time religion is most evident in Europe, where officials seem to be getting their talking points from the collected speeches of Herbert Hoover, up to and including the claim that raising taxes and cutting spending will actually expand the economy, by improving business confidence. As a practical matter, however, America isn’t doing much better. The Fed seems aware of the deflationary risks — but what it proposes to do about these risks is, well, nothing. The Obama administration understands the dangers of premature fiscal austerity — but because Republicans and conservative Democrats in Congress won’t authorize additional aid to state governments, that austerity is coming anyway, in the form of budget cuts at the state and local levels."
Perhaps if this were 1930s, governments could fool capital markets. But, since this is 80 years later, and deficits have not really declined in that time, investors realize that governments don't really ever stop excessive spending. And programs, once in place, don't end.
Krugman seems to live in a fantasy world of theoretical economics, rather than the real one which, in Adam Smith's time, was more correctly named political economics.
Krugman never addresses what would occur if government simply cut taxes and let people choose to spend or invest. It's not as if money the government spends doesn't ever exist otherwise. Sure, some of the borrowing wouldn't. Certainly the purely printed money doesn't, although some would argue it doesn't truly exist, in that that manner of its creation reduces the value of existing money, thus making the sum remain equal in value.
But, more importantly, Krugman's assumption, going in, is that only government can remedy shortfalls of demand. And that economic cycles are to tamed, not accepted.
Well, we've been trying that recipe, with the exception of the Reagan years, for essentially the 80 years since FDR's massive, ineffective economic tonics.
Krugman ends with a notional nod to global investors,
"It’s almost as if the financial markets understand what policy makers seemingly don’t: that while long-term fiscal responsibility is important, slashing spending in the midst of a depression, which deepens that depression and paves the way for deflation, is actually self-defeating.
So I don’t think this is really about Greece, or indeed about any realistic appreciation of the tradeoffs between deficits and jobs. It is, instead, the victory of an orthodoxy that has little to do with rational analysis, whose main tenet is that imposing suffering on other people is how you show leadership in tough times.
And who will pay the price for this triumph of orthodoxy? The answer is, tens of millions of unemployed workers, many of whom will go jobless for years, and some of whom will never work again."
It's hard to understand the analytical basis for Krugman's contention in that first paragraph. It's as if he chooses to credit private sector markets when it suits him, i.e., that they appreciate long term fiscal rectitude, but currently punish 'bad policy.'
Could it be, instead, that investors are punishing the obvious fiscal messes that governments around the globe have created? Too much hard-to-service debt, the money from which went to pure consumption by early retirees, universal health care consumers, and so on?
Perhaps that, rather than discount Greece, Greece is the example investors now fear being a global reality?
Let's face it- Krugman simply refuses to acknowledge reality. Spending with borrowed and printed money by governments worldwide, not for lasting investments in infrastructure, but for social welfare consumptions, have hit a wall of unwilling investors. Debts are coming due without matching appetites, at acceptable interest rates, to simply roll those debts over.
The good news is that, ultimately, markets discipline governments. Regardless of Krugman's ignorance of that fact. And we are now seeing that dynamic in play in capital markets' responses to sovereign monetary and fiscal policies.
Monday, June 28, 2010
US Hypocrisy In Toronto
Remember back nine years ago, in the wake of the 9/11 attacks on the United States, when then-Fed chairman Alan Greenspan began to hold rates down to assist US economic recovery?
Only shortly after the bursting of the late-1990s technology sector bubble, Greenspan began pumping liquidity into the US economy again.
The result, as we came to realize by mid-2007, was a housing finance disaster of epic proportions. Too much borrowing and securitizing of loans to unfit, un- or marginally-qualified buyers.
In short, for the past decade, the US's economic troubles have largely been due to borrowing and spending money which did not really exist. It was borrowed or printed, rather than saved in advance.
Now we turn to the recent Toronto G-20 summit. Having infected the world's economies with debt instruments of questionable quality, the US is now lecturing the other nations to join it in another borrowing, printing and spending spree.
Our delegation pressed more cautious European leaders to throw caution to the wind and enact even more stimulus programs in their own economies.
I purposely didn't watch any summit-closing grandstanding speeches, but I'm fairly optimistic that the European leaders held firm. Perhaps the US Congress' defeat of the latest Democratic stimulus bill added stiffening to their collective spines.
Judging from the joint statement's alleged compromise on making growth a primary concern, but extracting a promise on deficit reduction over the next few years, I'd say the Europeans managed to subdue our own out of control federal representatives to the meeting.
How long must the US economy endure more silly, impractical, expensive and pointless Keynesian spending? When will the US government finally realize that the only lasting, valuable spending in an economy is by the private sector, which creates private sector jobs.
All federal spending must borrow or tax, now or later, thus diminishing private capital and savings. Government spending is always politically motivated, not economically driven.
It makes no sense to believe that excessive government spending will create lasting employment or economic activity. If that were so, endless deficits would be a good thing. But they aren't.
Perhaps now that the Toronto summit is finished, and no major economic events are scheduled before the US November Congressional elections, excessive spending will abate, and, then, if there is a change in party leadership in at least one House of Congress, be stopped for the next two years.
We can only hope.
Only shortly after the bursting of the late-1990s technology sector bubble, Greenspan began pumping liquidity into the US economy again.
The result, as we came to realize by mid-2007, was a housing finance disaster of epic proportions. Too much borrowing and securitizing of loans to unfit, un- or marginally-qualified buyers.
In short, for the past decade, the US's economic troubles have largely been due to borrowing and spending money which did not really exist. It was borrowed or printed, rather than saved in advance.
Now we turn to the recent Toronto G-20 summit. Having infected the world's economies with debt instruments of questionable quality, the US is now lecturing the other nations to join it in another borrowing, printing and spending spree.
Our delegation pressed more cautious European leaders to throw caution to the wind and enact even more stimulus programs in their own economies.
I purposely didn't watch any summit-closing grandstanding speeches, but I'm fairly optimistic that the European leaders held firm. Perhaps the US Congress' defeat of the latest Democratic stimulus bill added stiffening to their collective spines.
Judging from the joint statement's alleged compromise on making growth a primary concern, but extracting a promise on deficit reduction over the next few years, I'd say the Europeans managed to subdue our own out of control federal representatives to the meeting.
How long must the US economy endure more silly, impractical, expensive and pointless Keynesian spending? When will the US government finally realize that the only lasting, valuable spending in an economy is by the private sector, which creates private sector jobs.
All federal spending must borrow or tax, now or later, thus diminishing private capital and savings. Government spending is always politically motivated, not economically driven.
It makes no sense to believe that excessive government spending will create lasting employment or economic activity. If that were so, endless deficits would be a good thing. But they aren't.
Perhaps now that the Toronto summit is finished, and no major economic events are scheduled before the US November Congressional elections, excessive spending will abate, and, then, if there is a change in party leadership in at least one House of Congress, be stopped for the next two years.
We can only hope.
Friday, June 25, 2010
The FINREG Bill Disaster
Well, as we awake to the last day of this week, we can all thank a clueless Democratic Congress and a spineless Republican one for passing the most misguided and ineffectual financial regulatory "reform" in years.
As I've written in prior posts on either this or my companion political blog, a country that allows bribe-taking, retiring Senator Chris Dodd (D-CT), in collaboration with Barney Frank (D-MA), the Congressman who rewrites history in an attempt to hide his gross failure to oversee Fannie and Freddie, to author such sweeping, flawed legislation gets what it deserves.
First, the regulation omits any mention of the two most egregious sources of financial excess in the past few decades, Fannie Mae and Freddie Mac. Prior posts have spoken to their immense lobbying clout, which has bought these two horrors the votes of hundreds of elected members of Congress.
Second, nothing in the FINREG bill will or can prevent yet another financial crisis of the type experienced a few years ago. Larding up ineffectual regulation of commercial and investment banking and consumer lending with yet more layers of ineffectual and confusing regulation won't solve anything.
Third, the so-called Volcker Rule got watered down and loopholed, so that deposit-insured commercial banks can still do some derivatives activity on their books.
There was a long discussion of the technical aspects of the loophole this morning on CNBC. In short, the law is vague on how and when a commercial bank's derivatives positions are part of servicing a customer's position, or part of its proprietary book.
The on-air anchors and reports argued that this is a tough call to make.
It's not.
In reality, it's incredibly simple. Put any derivatives activity in a separate subsidiary which is 100% equity-financed and unable to be "bailed out."
This notion that somehow a bank can't figure out if its derivative position is on behalf of a client, or not, is nonsense. Client funds and positions are in client accounts. Bank positions aren't.
Got it?
Once again, Congress gave in to big banks and let them have a loophole through which they will, in time, exploit subsidized risk-taking in proprietary derivatives activity.
The larger issue here, however, is that the US economy and nation has been, once more, ill-served by a supine Republican party in Congress that is afraid to take the real issues to the public and stop bad legislation, while the Democratic party in Congress continues to believe that the same inept regulators, given more pages of obscure law to interpret, will do any better in the future without a fundamental reform of the GSEs and the belief that the federal government will bail out excessive risk taking by sufficiently large private sector financial companies.
This legislation will only harm the financial sector and the US economy over time, if for no other reason than it continues the state of denial by government concerning what really drives financial crises.
As I've written in prior posts on either this or my companion political blog, a country that allows bribe-taking, retiring Senator Chris Dodd (D-CT), in collaboration with Barney Frank (D-MA), the Congressman who rewrites history in an attempt to hide his gross failure to oversee Fannie and Freddie, to author such sweeping, flawed legislation gets what it deserves.
First, the regulation omits any mention of the two most egregious sources of financial excess in the past few decades, Fannie Mae and Freddie Mac. Prior posts have spoken to their immense lobbying clout, which has bought these two horrors the votes of hundreds of elected members of Congress.
Second, nothing in the FINREG bill will or can prevent yet another financial crisis of the type experienced a few years ago. Larding up ineffectual regulation of commercial and investment banking and consumer lending with yet more layers of ineffectual and confusing regulation won't solve anything.
Third, the so-called Volcker Rule got watered down and loopholed, so that deposit-insured commercial banks can still do some derivatives activity on their books.
There was a long discussion of the technical aspects of the loophole this morning on CNBC. In short, the law is vague on how and when a commercial bank's derivatives positions are part of servicing a customer's position, or part of its proprietary book.
The on-air anchors and reports argued that this is a tough call to make.
It's not.
In reality, it's incredibly simple. Put any derivatives activity in a separate subsidiary which is 100% equity-financed and unable to be "bailed out."
This notion that somehow a bank can't figure out if its derivative position is on behalf of a client, or not, is nonsense. Client funds and positions are in client accounts. Bank positions aren't.
Got it?
Once again, Congress gave in to big banks and let them have a loophole through which they will, in time, exploit subsidized risk-taking in proprietary derivatives activity.
The larger issue here, however, is that the US economy and nation has been, once more, ill-served by a supine Republican party in Congress that is afraid to take the real issues to the public and stop bad legislation, while the Democratic party in Congress continues to believe that the same inept regulators, given more pages of obscure law to interpret, will do any better in the future without a fundamental reform of the GSEs and the belief that the federal government will bail out excessive risk taking by sufficiently large private sector financial companies.
This legislation will only harm the financial sector and the US economy over time, if for no other reason than it continues the state of denial by government concerning what really drives financial crises.
GM's Continuing Mistakes
I read with disbelief a headline in yesterday's Wall Street Journal, GM Is Seeking Partners for Car Loans.
Since selling off half of it's old GMAC unit, stuffed with subprime housing loans, GM has had to focus on actually making cars people want to buy.
The second paragraph of the article brought a chill to me. It read,
"The car maker has had trouble providing loans to more consumers, particularly those with weaker credit history, and views this as a barrier to winning back U.S. market share."
Have we, as a nation, and GM, as a company, learned nothing from the past few years of financial excess?
HOw is anyone well-served by GM seeking weaker, less capable borrowers to buy cars they cannot truly afford?
Sure, a car that can't be afforded doesn't represent quite the same amount of resources as an unaffordable house. But it's still a misallocation of societal resources.
Further, it's yet another clear example, after so many of the past few years, of a company deliberately pursuing marginal business which isn't sustainable.
This time, however, US taxpayers own this problem. Literally.
Not only is GM government-owned, so we own the losses that will come from this unsustainable strategy. We own the economic seeds of damage such a strategy is sowing. Spreading unaffordable cars throughout the country, creating bad loans and over-stretched consumers.
Have we learned nothing from the financial excesses of earlier this decade?
Evidently not.
Since selling off half of it's old GMAC unit, stuffed with subprime housing loans, GM has had to focus on actually making cars people want to buy.
The second paragraph of the article brought a chill to me. It read,
"The car maker has had trouble providing loans to more consumers, particularly those with weaker credit history, and views this as a barrier to winning back U.S. market share."
Have we, as a nation, and GM, as a company, learned nothing from the past few years of financial excess?
HOw is anyone well-served by GM seeking weaker, less capable borrowers to buy cars they cannot truly afford?
Sure, a car that can't be afforded doesn't represent quite the same amount of resources as an unaffordable house. But it's still a misallocation of societal resources.
Further, it's yet another clear example, after so many of the past few years, of a company deliberately pursuing marginal business which isn't sustainable.
This time, however, US taxpayers own this problem. Literally.
Not only is GM government-owned, so we own the losses that will come from this unsustainable strategy. We own the economic seeds of damage such a strategy is sowing. Spreading unaffordable cars throughout the country, creating bad loans and over-stretched consumers.
Have we learned nothing from the financial excesses of earlier this decade?
Evidently not.
Thursday, June 24, 2010
The iPad's Success Affects Amazon's Kindle
"I don't think there's any question that the iPad will be significant in its category. Some claim that, at least initially, it will also increase volume of ebook sales at Amazon. Perhaps so. But I continue to believe it will marginalize the Kindle, relative to its prior market position."
How much more marginal can Kindle get, than to have to cut its price from $259 to $189, as it did earlier this week?
The e-reader functionality is quickly moving toward a razor-razor blade sort of dynamic. Much more quickly, one suspects, than Amazon expected.
Perhaps, in time, an e-reader will be priced and marketed like a cell phone, with an upgrade included if you buy some sort of volume purchase contract from the vendor's site.
Of course, the gorilla in the room that isn't just an e-reader, the iPad, will continue to affect the lesser-functioned competitive offerings. And as I have written in a prior post, the fact that Apple controls the design and manufacture of the iPad gives it a tremendous advantage.Over the past five years, as the nearby price chart for Apple, Amazon and the S&P500 Index displays, Apple has outperformed Amazon.
Currently, both firms are in my equity portfolio. They are two of the very few S&P500 firms which have consistently outperformed in the past years. As well as Amazon has done, it pales in comparison to Apple.
The two firms are structurally very different. Apple is essentially a producer of a family of specialized digital applications devices and associated content and advertising systems. Amazon is an online general merchandiser, book and music seller, and vendor of cloud computer.
Still, whether it's due to growth rates or business mix, Apple has been viewed for some time as more valuable than Amazon. You have to wonder, with Amazon having so much less control over its Kindle development than Apple does over the iPad, if that difference will have ramifications for its content sales in the years to come.
One thing is sure. The Kindle is in a direct fight with the Nook and other e-reader-only devices, while Apple's iPad floats above them, offering a different set of features which clearly differentiates it and commands the typical premium Apple price.
Wednesday, June 23, 2010
David Faber's Program- Another New Low: Steve Liesman
I wrote here yesterday that David Faber's newish CNBC noontime program, Strategy Session, seems to be losing momentum. Its guest list has declined considerably in quality.
Now I know Faber's new program, and, sadly, Faber himself, is in trouble. Real trouble.
Today, as Faber and co-host Gary Kaminsky discussed this morning's new housing sales slump, the worst monthly numbers, they contended, since 1963, guess who they turned to for 'expert' economic commentary?
None other than CNBC senior economic idiot, Steve Liesman.
As if that wasn't enough, Faber introduced Liesman as a sage on economics and the bond market!
News to me, and all the other CNBC viewers who thought that the network's anointed bond market guru is the guy who reports from the Chicago pits on a daily basis, Rick Santelli.
Liesman is only a reporter. He's got no background in economics and, according to his bio, has no operating experience in the fixed income markets.
Has Faber lost his mind? It's bad enough that Faber is stuck with colleague and notable idiot Liesman as a 'guest' on his program.
David Faber didn't have to compound this unfortunate development by attributing knowledge to the CNBC economic moron that he clearly does not possess.
Now I know Faber's new program, and, sadly, Faber himself, is in trouble. Real trouble.
Today, as Faber and co-host Gary Kaminsky discussed this morning's new housing sales slump, the worst monthly numbers, they contended, since 1963, guess who they turned to for 'expert' economic commentary?
None other than CNBC senior economic idiot, Steve Liesman.
As if that wasn't enough, Faber introduced Liesman as a sage on economics and the bond market!
News to me, and all the other CNBC viewers who thought that the network's anointed bond market guru is the guy who reports from the Chicago pits on a daily basis, Rick Santelli.
Liesman is only a reporter. He's got no background in economics and, according to his bio, has no operating experience in the fixed income markets.
Has Faber lost his mind? It's bad enough that Faber is stuck with colleague and notable idiot Liesman as a 'guest' on his program.
David Faber didn't have to compound this unfortunate development by attributing knowledge to the CNBC economic moron that he clearly does not possess.
Housing & The Infamous "Double Dip" Recession
Kelly Evans wrote her usual interesting piece in the Wall Street Journal yesterday. The topic was housing, published before the dismal existing home sales data which came out a little later in the morning.
Evans points out that new home sales declines, after some earlier increases, are less troubling than they might seem at first glance. She mentions the now infamous "double dip" term, applying it to housing, but suggests that a dearth of new home sales isn't a bad thing, as it will help trim inventories, leading more quickly to eventual price firming.
That term, "double dip," is about as overused and nauseating these days as "green shoots" was last year at this time.
The other day, on CNBC, Maria Bartiromo, with that distinctive, distracting lisp of hers, was yammering away at everyone in sight about "a double dip," as well.
To me, whether there's a technical negative quarter or two of negative GDP growth in the near future, or not, is probably less relevant than whether the best quarterly rates of growth will ever get to the levels typically associated with vibrant, robust recoveries of prior decades.
Then you have Art Laffer, in a Journal editorial about which I wrote this post two weeks ago, predicting an outright US economic collapse next year, thanks to tax rate increases and additional taxes, too.
One thing Evans did mention, toward the end of her piece, was the role employment and wages play in a housing recovery. How's that going, do you suppose?
Last I recall, the president was in front of cameras after the latest jobs report, trying to explain why a pathetic 41,000 new private sector jobs in the prior month was a good thing.
Let's be honest. We don't want housing and housing finance to ever return to the level of economic importance it possessed during the 2002-2007 period. In the wake of that disastrous period and the excesses which drove it, lenders will understandably be focused on more verifiable, dependable employment in order to judge housing loans as of reasonable quality. I don't think we can count on home loans to temporary census workers or newly-minted federal government hires to drive US economic growth for the next five years.
If private sector employment isn't picking up, housing isn't going to, either. And yesterday's data suggests as much.
As it is, a CNBC report described how some homeowners are simply choosing not to pay their mortgages anymore, thus driving retail clothing, appliance and dining sector growth.
Housing growth depends on employment growth. Employment still isn't growing sufficiently to suggest a robust, healthy US economic recovery right now.
Meddling with housing finance assistance programs may paper over short term valuation issues, but it can't make the US economy grow in the absence of the growth of well-paying, long term private sector job growth.
Double dip or just anemic economic growth, it sure doesn't look, yet, like the US is in the process of enjoying a snappy, sharp economic upturn.
Evans points out that new home sales declines, after some earlier increases, are less troubling than they might seem at first glance. She mentions the now infamous "double dip" term, applying it to housing, but suggests that a dearth of new home sales isn't a bad thing, as it will help trim inventories, leading more quickly to eventual price firming.
That term, "double dip," is about as overused and nauseating these days as "green shoots" was last year at this time.
The other day, on CNBC, Maria Bartiromo, with that distinctive, distracting lisp of hers, was yammering away at everyone in sight about "a double dip," as well.
To me, whether there's a technical negative quarter or two of negative GDP growth in the near future, or not, is probably less relevant than whether the best quarterly rates of growth will ever get to the levels typically associated with vibrant, robust recoveries of prior decades.
Then you have Art Laffer, in a Journal editorial about which I wrote this post two weeks ago, predicting an outright US economic collapse next year, thanks to tax rate increases and additional taxes, too.
One thing Evans did mention, toward the end of her piece, was the role employment and wages play in a housing recovery. How's that going, do you suppose?
Last I recall, the president was in front of cameras after the latest jobs report, trying to explain why a pathetic 41,000 new private sector jobs in the prior month was a good thing.
Let's be honest. We don't want housing and housing finance to ever return to the level of economic importance it possessed during the 2002-2007 period. In the wake of that disastrous period and the excesses which drove it, lenders will understandably be focused on more verifiable, dependable employment in order to judge housing loans as of reasonable quality. I don't think we can count on home loans to temporary census workers or newly-minted federal government hires to drive US economic growth for the next five years.
If private sector employment isn't picking up, housing isn't going to, either. And yesterday's data suggests as much.
As it is, a CNBC report described how some homeowners are simply choosing not to pay their mortgages anymore, thus driving retail clothing, appliance and dining sector growth.
Housing growth depends on employment growth. Employment still isn't growing sufficiently to suggest a robust, healthy US economic recovery right now.
Meddling with housing finance assistance programs may paper over short term valuation issues, but it can't make the US economy grow in the absence of the growth of well-paying, long term private sector job growth.
Double dip or just anemic economic growth, it sure doesn't look, yet, like the US is in the process of enjoying a snappy, sharp economic upturn.
Tuesday, June 22, 2010
David Faber's Program Running Out of Gas
I happened to catch today's edition of David Faber's noontime CNBC program, Strategy Session. The effort to present Faber, begun a few weeks ago, seems to be losing steam.
For example, one of today's special guests was a guy named Rob Cox. Cox used to co-write a daily piece on the back of the Wall Street Journal's Money & Investing section, as part of a feature called, I believe, Breaking Views. At the time, Cox and his colleagues were part of a boutique analyst group in which the Journal had a minority interest.
I've written some posts on a few of Cox's pieces from that period. His work seemed to be uneven, at best. Certainly not extraordinary.
Today's topic was GM's imminent IPO. Cox was there to tell us that the company isn't really healthy yet, so the only way the government can sell this pig is to underprice it, thus losing taxpayers even more money.
Thanks, Rob. I couldn't ever figure that one out for myself. Thanks, David, for underestimating your audience- such as it may be.
Faber began his inaugural week with John Mack, among others whom I can't even now recall. I know I saw Sirius' Mel Karmazin on one episode.
Today's marquee guest was some housing guy who I confess to not recognizing.
Of course, Faber's challenge is identical to that of, say, Jay Leno or another David, Letterman. His bookers have to run a full court press every day to line up guests whom people will feel compelled to see. That's got to be easier in the general entertainment field than in the business world. Especially when the show's set wants you to think it's primarily financial in nature, although the program's title leads you to think otherwise.
As I mentioned in my earlier post, I like Faber. He's a capable, intelligent, likable analyst. More candid and direct with his interviewees than many others on CNBC.
I don't know what his ratings numbers are looking like without the first week's A-list guests. It would be unfortunate for him if his network once again showcased him in an unworkable format.
For example, one of today's special guests was a guy named Rob Cox. Cox used to co-write a daily piece on the back of the Wall Street Journal's Money & Investing section, as part of a feature called, I believe, Breaking Views. At the time, Cox and his colleagues were part of a boutique analyst group in which the Journal had a minority interest.
I've written some posts on a few of Cox's pieces from that period. His work seemed to be uneven, at best. Certainly not extraordinary.
Today's topic was GM's imminent IPO. Cox was there to tell us that the company isn't really healthy yet, so the only way the government can sell this pig is to underprice it, thus losing taxpayers even more money.
Thanks, Rob. I couldn't ever figure that one out for myself. Thanks, David, for underestimating your audience- such as it may be.
Faber began his inaugural week with John Mack, among others whom I can't even now recall. I know I saw Sirius' Mel Karmazin on one episode.
Today's marquee guest was some housing guy who I confess to not recognizing.
Of course, Faber's challenge is identical to that of, say, Jay Leno or another David, Letterman. His bookers have to run a full court press every day to line up guests whom people will feel compelled to see. That's got to be easier in the general entertainment field than in the business world. Especially when the show's set wants you to think it's primarily financial in nature, although the program's title leads you to think otherwise.
As I mentioned in my earlier post, I like Faber. He's a capable, intelligent, likable analyst. More candid and direct with his interviewees than many others on CNBC.
I don't know what his ratings numbers are looking like without the first week's A-list guests. It would be unfortunate for him if his network once again showcased him in an unworkable format.
New-Style Regulations' Effects On Business
Gerald O'Driscoll, a senior fellow at the conservative Cato Institute, wrote an editorial in an issue of last week's Wall Street Journal entitled The Gulf Spill, the Financial Crisis and Government Failure. The theme of O'Driscoll's piece was government regulatory failure.
He wrote,
"There are two major reasons such efforts fail. I have already discussed the first: regulatory capture.
The second source of regulatory failure is the knowledge problem identified by Nobel Laureate Friedrich Hayek. The knowledge required by regulators is dispersed throughout the industry and broader economy. For regulation to work, that dispersed knowledge must be centralized in the regulatory agency. To successfully accomplish this requires central planning of the industry, if not the economy. But the local knowledge of specific circumstances of time and place cannot be aggregated in one mind or agency. We know that is impossible, and that impossibility was the reason for the collapse of the Soviet Empire and the transformation of the Chinese economy."
The rest of the article provides more detail in how the increasingly granular and detailed regulation of industries such as financial services and oil exploration have only led to more regulatory failure.
O'Driscoll ends the piece citing University of Chicago law professor Richard Epstein, who has noted that
"we need simple rules for a complex world. The complexity of rules is self-defeating because that complexity requires more knowledge than can be acquired."
Thus, the current FINREG bill, which will be a disaster the moment it ever becomes law. Much like the vaunted omnibus healthcare overhaul bill.
Along with these increasingly microscopically-controlling regulatory bills/laws is another new approach to regulation/law that I suspect will chill economic activity in the US.
It is the open-ended nature of these laws which leave the actual details of regulation to various commissions, boards and agencies to be established and operated later.
As bad as some of the 1930s-era regulations were, at least they actually specified what rules and regulations were to be. ERISA legislation was very specific, too.
Now, however, we have healthcare, energy and climate, and financial so-called "reform" legislation which each run into thousands of pages, without definitive rules. Instead, industry players are invited to lobby and bribe various agency and commission officials to write detailed regulations in their favor.
Of course, what an agency write today, it can rewrite tomorrow. Witness the current FCC chairman trying to singlehandedly overrule Congress, the courts and public opinion, never mind his fellow commissioners, by subjecting the internet to the restrictions of the telephone industry in the Communications Act of 1934.
Is any of this even Constitutional?
Whether it is, or not, it must be chilling for businesses and investors to contemplate risking their capital under rules which may be changed at the literal stroke of an unelected, bribeable Washington bureaucrat's laptop.
Vigorous, robust capital markets and economies like as much certainty of environment and frameworks of rules and regulations as possible, in order to leave the remaining business operation uncertainties as the major ones.
Instead, we are now embarking on an era of explicitly-vague federal regulation and legislation, leaving businesses to wonder just what the rules are, or will be, and for how long.
This cannot be good for the US economy going forward.
He wrote,
"There are two major reasons such efforts fail. I have already discussed the first: regulatory capture.
The second source of regulatory failure is the knowledge problem identified by Nobel Laureate Friedrich Hayek. The knowledge required by regulators is dispersed throughout the industry and broader economy. For regulation to work, that dispersed knowledge must be centralized in the regulatory agency. To successfully accomplish this requires central planning of the industry, if not the economy. But the local knowledge of specific circumstances of time and place cannot be aggregated in one mind or agency. We know that is impossible, and that impossibility was the reason for the collapse of the Soviet Empire and the transformation of the Chinese economy."
The rest of the article provides more detail in how the increasingly granular and detailed regulation of industries such as financial services and oil exploration have only led to more regulatory failure.
O'Driscoll ends the piece citing University of Chicago law professor Richard Epstein, who has noted that
"we need simple rules for a complex world. The complexity of rules is self-defeating because that complexity requires more knowledge than can be acquired."
Thus, the current FINREG bill, which will be a disaster the moment it ever becomes law. Much like the vaunted omnibus healthcare overhaul bill.
Along with these increasingly microscopically-controlling regulatory bills/laws is another new approach to regulation/law that I suspect will chill economic activity in the US.
It is the open-ended nature of these laws which leave the actual details of regulation to various commissions, boards and agencies to be established and operated later.
As bad as some of the 1930s-era regulations were, at least they actually specified what rules and regulations were to be. ERISA legislation was very specific, too.
Now, however, we have healthcare, energy and climate, and financial so-called "reform" legislation which each run into thousands of pages, without definitive rules. Instead, industry players are invited to lobby and bribe various agency and commission officials to write detailed regulations in their favor.
Of course, what an agency write today, it can rewrite tomorrow. Witness the current FCC chairman trying to singlehandedly overrule Congress, the courts and public opinion, never mind his fellow commissioners, by subjecting the internet to the restrictions of the telephone industry in the Communications Act of 1934.
Is any of this even Constitutional?
Whether it is, or not, it must be chilling for businesses and investors to contemplate risking their capital under rules which may be changed at the literal stroke of an unelected, bribeable Washington bureaucrat's laptop.
Vigorous, robust capital markets and economies like as much certainty of environment and frameworks of rules and regulations as possible, in order to leave the remaining business operation uncertainties as the major ones.
Instead, we are now embarking on an era of explicitly-vague federal regulation and legislation, leaving businesses to wonder just what the rules are, or will be, and for how long.
This cannot be good for the US economy going forward.
Monday, June 21, 2010
New Growth At Starbucks?
Last Monday's Wall Street Journal featured an upbeat article concerning Starbucks.
According to the piece's author, John Jannarone, writing for Heard on the Street, the Seattle-based coffee giant is poised to display strong sales growth in the near future.
Jannarone provided a sketchy analysis to demonstrate that Starbucks has already successfully fought upscale coffee competition from McDonalds. Rereading the evidence, I'm personally not convinced of the conclusions. More likely than stealing Starbucks customers, as Jannarone seems to believe was the point of McDonalds' efforts, I suspect McDonalds is enjoying coffee sales growth that just won't now accrue to Starbucks.
The article concludes by observing that Starbucks has a 19 P/E multiple, which, while judged expensive, is teasingly hinted at being too low considering the potential ahead for Starbucks.
The article concludes by observing that Starbucks has a 19 P/E multiple, which, while judged expensive, is teasingly hinted at being too low considering the potential ahead for Starbucks.
Being inquisitive, I constructed price charts for Starbucks and the S&P500 Index for the past 5 
years and the term of Starbucks' public listing. They appear nearby.
years and the term of Starbucks' public listing. They appear nearby.Not surprisingly, the past five years have been tough on the coffee roaster. Exhibiting more volatility than the index, which isn't news, it ended up about flat with the index for the period. So the recent past doesn't suggest Starbucks is poised for a breakout due to suddenly-inspired management.
I've written a handful of posts since Howard Schultz returned to the firm as its CEO. Overall, he hasn't had much impact on the firm's performance in terms of leading it to consistently superior gains over the index.
Looking at the two price curves from Starbucks' public trading debut in 1993, the recent five years looks even more significant.
Prior to that time, the firm displayed consistent superiority over the index. I personally held it in equity portfolios in the past, so exceptional were the firm's fundamental and technical performances.
Viewing the firm's share price over such a long period, the recent stall looks more telling, at least to me. It fell precipitously during the recent economic turmoil. Weakening in a time of economic trouble is one thing, but Starbucks' share price did much worse than just that.
My own suspicion is that, like other growth firms, such as Dell and Intel, Starbucks has experienced its days of steady, long periods of consistently superior growth. I think investor expectations and competitions have both affected the firm's share price for the foreseeable future.
Being priced so apparently richly for such average recent performance suggests more wishful thinking than good sense. Sort of like those investors that still feel obliged to stuff Microsoft or GE in their portfolios, in the vain hope that, somehow, those aged, overly-diversified firms will somehow recapture the performances of their much earlier years.
Friday, June 18, 2010
Oil Drilling Leases, Liability & US Government Thuggery
I wrote this post earlier this week discussing Congress' and the administration's implicit roles in the BP undersea gusher disaster.
I wrote, in part,
"How is it that the same administration and Congress that looks elsewhere for the cause of the recent financial crisis, while overlooking their own complicated regulatory schemes and agencies, can repeat the act in the energy arena?
Whatever regulatory processes exist would seem to have been deemed appropriate by Congress. If the MMS was 'captured' by industry participants, then Congress' legislation pertaining to the agency must have allowed for that.
If we are to believe the president, nobody has ever tried to find alternative, renewable energy sources, despite the immense payoff which would accrue to the first person or company to patent such discoveries.
How is the US supposed to remain competitive if the only way to bring new energy sources to market is to subsidize them with government money? By definition, they'll be uncompetitive on a cost basis. Otherwise, those discoveries would already be providing said energy.
It's disappointing to see an administration and Congress so totally ignorant of economics that they believe that nobody has tried to find profitable renewable energy sources, and, thus, are only awaiting government handouts to make such ideas a profitable reality."
Throughout the past few days, as I've listened to dozens of pundits exclaim on various aspects of the Gulf oil disaster, I've formulated some questions and thoughts of my own.
Suppose the US were starting from scratch in the area of extracting minerals, metals and valuable liquids and gases, e.g., oil and natural gas, from our land and the sea and seabed which we control. What questions would we, as a nation, confront as we sought to enjoy economic benefits from the extraction of said natural resources?
Certainly we would seek to sell leases and licenses to explore for valuable resources and extract them. We'd probably want to hold said lessees liable for any damage they caused through their operations, and to return the land, water or seabeds to acceptable, near-original condition.
To assure ourselves that any lessee could fulfill his obligations not to cause unwarranted external costs to others, including our nation, by failing to finish restoring sites and removing unwanted structures, etc., we'd probably require some sort of bond or insurance in an amount considered adequate by knowledgeable professionals.
So far, this seems reasonable, doesn't it?
But what about that liability clause? If a lessee encounters some situation, whether accidental or by poor management, that creates a disaster on the scale of BP's Gulf rig gusher, do we seriously expect to hold that company totally responsible for every penny of expense related to the problem?
The US does not exist in a vacuum. There are deposits of virtually all of our natural resources located in other countries, on other continents. Many other countries offer far less onerous regulatory environments than those which currently exist in the US.
As tempting as it would be for the US to insist on carte blanche, unlimited liability assumption by its natural resource lessees, competitive realities could easily cause such a policy to result in no lessees whatsoever.
Even an honest, scrupulous adherence to a rule of law that mandated unlimited liability could leave the US with no firms interested in the assumption of such unlimited liability, against very limited revenues and profits from such leases.
But in reality, it's much worse than that.
Our country's president has just mugged BP, shaking it down, as Representative Joe Barton correctly observed, for $20B. Completely abrogating the rule of law in the process.
What global energy or mining company will now wish to risk its solvency by bidding for and operating under a US lease to explore and exploit natural resources?
Against the unlimited, company-killing risks now apparent for operating in the US, any company would be considering much higher tangible exploration and production costs anywhere else in the world.
It's all well and good to want a pristine environment. It sounds reasonable to expect a natural resources exploration and production firm to pay for every dime of damage they cause to the environment.
But in a competitive global economy, it's foolish and naive to actually demand that.
The result is far more likely to be an exodus of global mining and energy firms, and the jobs and capital that accompany them.
The administration's recent extortion of BP to the current- not necessarily final- tune of $20B, and Congress' vilification of BP and its CEO, before final conclusions regarding the rig failure are known, seem to be at odds with a desire to foster economic expansion, job creation and risk taking in America.
And it doesn't stop at extractive industries. If one administration is capable of illegally shaking down a private company for cash, outside or due process channels, who's to say that administration, or another one, won't trample due process rights on any matter of business operation? Perhaps, next, it will be a food processor. Or a trucking firm. Maybe, again, finance?
Nobody really knows. Once extortion becomes an established, accepted practice by government, no business is safe.
Those of us who are citizens may not wish to move overseas to ply our trades. But others who live overseas may think seriously about continuing to do business here, or commencing operations on US shores.
The effects of the recent treatment of BP on long term US economic health could be truly enormous, unanticipated and unintended consequences.
Before I finish this post, consider one other dimension- global political-financial issues. For example, this hypothetical.
Suppose next Monday morning, you read that financially crippled, value-depressed BP has sold itself to a consortium of Chinese banks, a Chinese sovereign fund, and Chinese mining interests. Later in the week, you read that the Chinese foreign ministry, at the behest of BP's new owners, have announced that they will renege on the $20B fund, and, further, demand US cessation of all criminal and civil penalties against the BP operations, on penalty of China selling its US debt obligations?
What would be the US response to such actions?
The recent trend toward sovereign control of minerals and metals production is a fact. The Chinese have been engaged in a battle over control of iron ore production for the past year. This hypothetical would simply be an extension of that trend. But the implications would be staggering.
Dealing with private firms in the area of unexpected environmental disasters is one thing. The prospect of facing a major sovereign creditor which owns a major oil firm with substantial interests in the US, with global economic and military ambitions which are at odds with ours would be catastrophic.
I wrote, in part,
"How is it that the same administration and Congress that looks elsewhere for the cause of the recent financial crisis, while overlooking their own complicated regulatory schemes and agencies, can repeat the act in the energy arena?
Whatever regulatory processes exist would seem to have been deemed appropriate by Congress. If the MMS was 'captured' by industry participants, then Congress' legislation pertaining to the agency must have allowed for that.
If we are to believe the president, nobody has ever tried to find alternative, renewable energy sources, despite the immense payoff which would accrue to the first person or company to patent such discoveries.
How is the US supposed to remain competitive if the only way to bring new energy sources to market is to subsidize them with government money? By definition, they'll be uncompetitive on a cost basis. Otherwise, those discoveries would already be providing said energy.
It's disappointing to see an administration and Congress so totally ignorant of economics that they believe that nobody has tried to find profitable renewable energy sources, and, thus, are only awaiting government handouts to make such ideas a profitable reality."
Throughout the past few days, as I've listened to dozens of pundits exclaim on various aspects of the Gulf oil disaster, I've formulated some questions and thoughts of my own.
Suppose the US were starting from scratch in the area of extracting minerals, metals and valuable liquids and gases, e.g., oil and natural gas, from our land and the sea and seabed which we control. What questions would we, as a nation, confront as we sought to enjoy economic benefits from the extraction of said natural resources?
Certainly we would seek to sell leases and licenses to explore for valuable resources and extract them. We'd probably want to hold said lessees liable for any damage they caused through their operations, and to return the land, water or seabeds to acceptable, near-original condition.
To assure ourselves that any lessee could fulfill his obligations not to cause unwarranted external costs to others, including our nation, by failing to finish restoring sites and removing unwanted structures, etc., we'd probably require some sort of bond or insurance in an amount considered adequate by knowledgeable professionals.
So far, this seems reasonable, doesn't it?
But what about that liability clause? If a lessee encounters some situation, whether accidental or by poor management, that creates a disaster on the scale of BP's Gulf rig gusher, do we seriously expect to hold that company totally responsible for every penny of expense related to the problem?
The US does not exist in a vacuum. There are deposits of virtually all of our natural resources located in other countries, on other continents. Many other countries offer far less onerous regulatory environments than those which currently exist in the US.
As tempting as it would be for the US to insist on carte blanche, unlimited liability assumption by its natural resource lessees, competitive realities could easily cause such a policy to result in no lessees whatsoever.
Even an honest, scrupulous adherence to a rule of law that mandated unlimited liability could leave the US with no firms interested in the assumption of such unlimited liability, against very limited revenues and profits from such leases.
But in reality, it's much worse than that.
Our country's president has just mugged BP, shaking it down, as Representative Joe Barton correctly observed, for $20B. Completely abrogating the rule of law in the process.
What global energy or mining company will now wish to risk its solvency by bidding for and operating under a US lease to explore and exploit natural resources?
Against the unlimited, company-killing risks now apparent for operating in the US, any company would be considering much higher tangible exploration and production costs anywhere else in the world.
It's all well and good to want a pristine environment. It sounds reasonable to expect a natural resources exploration and production firm to pay for every dime of damage they cause to the environment.
But in a competitive global economy, it's foolish and naive to actually demand that.
The result is far more likely to be an exodus of global mining and energy firms, and the jobs and capital that accompany them.
The administration's recent extortion of BP to the current- not necessarily final- tune of $20B, and Congress' vilification of BP and its CEO, before final conclusions regarding the rig failure are known, seem to be at odds with a desire to foster economic expansion, job creation and risk taking in America.
And it doesn't stop at extractive industries. If one administration is capable of illegally shaking down a private company for cash, outside or due process channels, who's to say that administration, or another one, won't trample due process rights on any matter of business operation? Perhaps, next, it will be a food processor. Or a trucking firm. Maybe, again, finance?
Nobody really knows. Once extortion becomes an established, accepted practice by government, no business is safe.
Those of us who are citizens may not wish to move overseas to ply our trades. But others who live overseas may think seriously about continuing to do business here, or commencing operations on US shores.
The effects of the recent treatment of BP on long term US economic health could be truly enormous, unanticipated and unintended consequences.
Before I finish this post, consider one other dimension- global political-financial issues. For example, this hypothetical.
Suppose next Monday morning, you read that financially crippled, value-depressed BP has sold itself to a consortium of Chinese banks, a Chinese sovereign fund, and Chinese mining interests. Later in the week, you read that the Chinese foreign ministry, at the behest of BP's new owners, have announced that they will renege on the $20B fund, and, further, demand US cessation of all criminal and civil penalties against the BP operations, on penalty of China selling its US debt obligations?
What would be the US response to such actions?
The recent trend toward sovereign control of minerals and metals production is a fact. The Chinese have been engaged in a battle over control of iron ore production for the past year. This hypothetical would simply be an extension of that trend. But the implications would be staggering.
Dealing with private firms in the area of unexpected environmental disasters is one thing. The prospect of facing a major sovereign creditor which owns a major oil firm with substantial interests in the US, with global economic and military ambitions which are at odds with ours would be catastrophic.
Thursday, June 17, 2010
Congressional "Fact Finding": Today's BP Hearing
I've watched a fair amount of today's Congressional hearing featuring BP CEO Tony Hayward, and I must admit that both Hayward and most of the members of Congress have behaved dreadfully.
It started yesterday, when retiring Michigan Democrat Bart Stupak apparently said Hayward would be "sliced" up by the Congress' members during the hearing. The absence of fairness and decorum in the House is truly stunning. It's living down to our Founding Fathers' view of the chamber as filled with mannerless rabble.
One Texas Republican Representative, in his opening statement, correctly characterized the $20B fund which BP was coerced by the administration into offering as a "shakedown." Every single other member whom I've heard speak has basically used the hearing to grandstand, bully and embarrass Hayward, while admitting absolutely no culpability on the part of federal regulators or the Congress' own legislation which has required deep water drilling in the first place.
Hayward, for his part, is about the worst guy BP could possibly have as its public face. When a demonstrator was forcibly removed from the proceedings, Hayward sported a grin from ear to ear that looked remarkably inappropriate.
Michigan Democrat "Tailpipe Johnny" Dingell repeated the performance he crafted for the Goldman Sachs CDO hearing, requiring "yes" or "no" replies to questions he knew that Hayward could not answer, because they were operationally-oriented and applied to lower-level BP or contractor employees engaged in managing the actually drilling on the rig which exploded.
Hayward looked totally out of touch with the operations of his company during that exchange. It's sort of hard to believe that he wouldn't have brought either documentation concerning the rig's operation, or a lieutenant with more direct knowledge of the decisions about which questions were asked. Additionally, he gave needlessly vague, circuitous replies to many questions, which did give the distinct impression that he desired to be evasive. His expression was often disdainful, which doesn't come across as either sympathetic or empathetic. In the situation at hand, that's a mistake.
Never the less, Dingell made a telling point. He homed in on whether BP had made decisions based on saving money and time. The overall impression left by Hayward is that BP saved, at best, less than $20MM and maybe a few weeks' of time by apparently skipping on steps which would have resulted in safer drilling and perhaps the avoidance of the deep water blowout.
I've noticed in Hayward a disturbing trait. Maybe it's because he's British, or maybe because he is of the particular class he is, but his answers impart a decidedly distant, uncaring tone. He seems profoundly detached from the incident, offering only an annoyingly repetitive "very sorry" at every turn.
Combined with his chairman's gaffe yesterday referring to the "small people" along the affected Gulf Coast, Hayward didn't help BP's cause or image today.
Truth be told, in its zeal to roast BP's CEO, the members of Congress apparently failed to understand that, by the necessity of operation of a large company, Hayward couldn't answer, under oath, most of the detailed rig operation questions put to him. Anyone watching for more than ten minutes would have, I think, like me, quickly deduced that the Congressmen were simply piling on an easy target with ludicrous questions, given that Hayward wasn't the supervising manager of the failed rig.
In short, a lot of wasted time.
But, additionally, as I'll discuss tomorrow, like the Goldman hearings on CDOs, and earlier bank CEO grillings, yet another example of why global businesses should think twice now before choosing to enter the US market.
It started yesterday, when retiring Michigan Democrat Bart Stupak apparently said Hayward would be "sliced" up by the Congress' members during the hearing. The absence of fairness and decorum in the House is truly stunning. It's living down to our Founding Fathers' view of the chamber as filled with mannerless rabble.
One Texas Republican Representative, in his opening statement, correctly characterized the $20B fund which BP was coerced by the administration into offering as a "shakedown." Every single other member whom I've heard speak has basically used the hearing to grandstand, bully and embarrass Hayward, while admitting absolutely no culpability on the part of federal regulators or the Congress' own legislation which has required deep water drilling in the first place.
Hayward, for his part, is about the worst guy BP could possibly have as its public face. When a demonstrator was forcibly removed from the proceedings, Hayward sported a grin from ear to ear that looked remarkably inappropriate.
Michigan Democrat "Tailpipe Johnny" Dingell repeated the performance he crafted for the Goldman Sachs CDO hearing, requiring "yes" or "no" replies to questions he knew that Hayward could not answer, because they were operationally-oriented and applied to lower-level BP or contractor employees engaged in managing the actually drilling on the rig which exploded.
Hayward looked totally out of touch with the operations of his company during that exchange. It's sort of hard to believe that he wouldn't have brought either documentation concerning the rig's operation, or a lieutenant with more direct knowledge of the decisions about which questions were asked. Additionally, he gave needlessly vague, circuitous replies to many questions, which did give the distinct impression that he desired to be evasive. His expression was often disdainful, which doesn't come across as either sympathetic or empathetic. In the situation at hand, that's a mistake.
Never the less, Dingell made a telling point. He homed in on whether BP had made decisions based on saving money and time. The overall impression left by Hayward is that BP saved, at best, less than $20MM and maybe a few weeks' of time by apparently skipping on steps which would have resulted in safer drilling and perhaps the avoidance of the deep water blowout.
I've noticed in Hayward a disturbing trait. Maybe it's because he's British, or maybe because he is of the particular class he is, but his answers impart a decidedly distant, uncaring tone. He seems profoundly detached from the incident, offering only an annoyingly repetitive "very sorry" at every turn.
Combined with his chairman's gaffe yesterday referring to the "small people" along the affected Gulf Coast, Hayward didn't help BP's cause or image today.
Truth be told, in its zeal to roast BP's CEO, the members of Congress apparently failed to understand that, by the necessity of operation of a large company, Hayward couldn't answer, under oath, most of the detailed rig operation questions put to him. Anyone watching for more than ten minutes would have, I think, like me, quickly deduced that the Congressmen were simply piling on an easy target with ludicrous questions, given that Hayward wasn't the supervising manager of the failed rig.
In short, a lot of wasted time.
But, additionally, as I'll discuss tomorrow, like the Goldman hearings on CDOs, and earlier bank CEO grillings, yet another example of why global businesses should think twice now before choosing to enter the US market.
Federal Government Lies & Fantasies Concerning Regulations & The Oil Industry
One of the aspects of the recent BP undersea oil gusher is a sudden flurry of lies from Congress and the administration regarding regulation in the sector.
To hear the president and selected members of Congress tell it, the oil industry has been unregulated for, oh, just about a decade. Sound convenient in terms of presidential terms?
Yet, I vividly recall then-CEO of ExxonMobil, Lee Raymond, caustically observing all the sudden experts in oil refining, when gasoline prices hit new highs several years ago amidst shortages. Raymond, among others, replied to the accusation by government that no new refineries had been built in the US since about 1968, by pointing to the complex, expensive and time-consuming permitting process.
Sounds like regulation to me.
Raymond explained that it was far easier, faster and cheaper to expand an existing refinery than to build a new one from scratch. Nobody, at least until they can't buy a gallon of gasoline, seems to want a refinery in their backyard.
How is it that the same administration and Congress that looks elsewhere for the cause of the recent financial crisis, while overlooking their own complicated regulatory schemes and agencies, can repeat the act in the energy arena?
Whatever regulatory processes exist would seem to have been deemed appropriate by Congress. If the MMS was 'captured' by industry participants, then Congress' legislation pertaining to the agency must have allowed for that.
Who's fault is that? Not BP's.
Perhaps regulations were inadequate. But it's a joke to suggest there are none, or they are totally unenforced. And then blame industry firms for that.
Last time I looked, only Congress could pass legislation in this country, not publicly-held companies.
Taking this travesty a step further, it's simply ludicrous to ignore Congress' legislative culpability in the oil gusher mess, then use the disaster as a reason to swear off of oil and nuclear.
If we are to believe the president, nobody has ever tried to find alternative, renewable energy sources, despite the immense payoff which would accrue to the first person or company to patent such discoveries.
As no less than, I believe, Jack Welch intoned on CNBC yesterday morning, if technology and ideas existed to build functioning, profitable alternative energy markets and businesses, someone would have done so already.
Having a president use a crisis of oil exploration to declare an end to our use of oil is just plain stupid. It's even more stupid to then propose to throw more unaffordable federal dollars into subsidies for non-existent replacement energy sources.
How is the US supposed to remain competitive if the only way to bring new energy sources to market is to subsidize them with government money? By definition, they'll be uncompetitive on a cost basis. Otherwise, those discoveries would already be providing said energy.
It's disappointing to see an administration and Congress so totally ignorant of economics that they believe that nobody has tried to find profitable renewable energy sources, and, thus, are only awaiting government handouts to make such ideas a profitable reality.
Now, that's a fantasy.
To hear the president and selected members of Congress tell it, the oil industry has been unregulated for, oh, just about a decade. Sound convenient in terms of presidential terms?
Yet, I vividly recall then-CEO of ExxonMobil, Lee Raymond, caustically observing all the sudden experts in oil refining, when gasoline prices hit new highs several years ago amidst shortages. Raymond, among others, replied to the accusation by government that no new refineries had been built in the US since about 1968, by pointing to the complex, expensive and time-consuming permitting process.
Sounds like regulation to me.
Raymond explained that it was far easier, faster and cheaper to expand an existing refinery than to build a new one from scratch. Nobody, at least until they can't buy a gallon of gasoline, seems to want a refinery in their backyard.
How is it that the same administration and Congress that looks elsewhere for the cause of the recent financial crisis, while overlooking their own complicated regulatory schemes and agencies, can repeat the act in the energy arena?
Whatever regulatory processes exist would seem to have been deemed appropriate by Congress. If the MMS was 'captured' by industry participants, then Congress' legislation pertaining to the agency must have allowed for that.
Who's fault is that? Not BP's.
Perhaps regulations were inadequate. But it's a joke to suggest there are none, or they are totally unenforced. And then blame industry firms for that.
Last time I looked, only Congress could pass legislation in this country, not publicly-held companies.
Taking this travesty a step further, it's simply ludicrous to ignore Congress' legislative culpability in the oil gusher mess, then use the disaster as a reason to swear off of oil and nuclear.
If we are to believe the president, nobody has ever tried to find alternative, renewable energy sources, despite the immense payoff which would accrue to the first person or company to patent such discoveries.
As no less than, I believe, Jack Welch intoned on CNBC yesterday morning, if technology and ideas existed to build functioning, profitable alternative energy markets and businesses, someone would have done so already.
Having a president use a crisis of oil exploration to declare an end to our use of oil is just plain stupid. It's even more stupid to then propose to throw more unaffordable federal dollars into subsidies for non-existent replacement energy sources.
How is the US supposed to remain competitive if the only way to bring new energy sources to market is to subsidize them with government money? By definition, they'll be uncompetitive on a cost basis. Otherwise, those discoveries would already be providing said energy.
It's disappointing to see an administration and Congress so totally ignorant of economics that they believe that nobody has tried to find profitable renewable energy sources, and, thus, are only awaiting government handouts to make such ideas a profitable reality.
Now, that's a fantasy.
Wednesday, June 16, 2010
Gary Kaminsky On ATT
I saw part of the noon time CNBC program featuring David Faber yesterday. The guest was ATT's CEO, Randy Stevenson.
I took a look at ATT's recent income statement. Let me assure you, it's no growth firm. I checked my proprietary analyses of the S&P500 for consistently superior revenue growth. ATT isn't among those firms. Not for at least the last several years. The firm simply does not exhibit the sort of revenue growth that characterizes a growth firm.
Somewhere near the end of the discussion with Stevenson, Gary Kaminsky, the program's co-host, began to rabidly insist that ATT was a growth company which wasn't appreciated as such.
While Stevenson politely attempted to deflect Kaminsky, the latter badgered the CEO about why ATT dividends out so much income, when they should be growing even more rapidly, in necessary, through acquisition.
After Stevenson's departure, Faber tried to talk some sense into Kaminsky by reminding him that ATT wasn't just a wireless firm. That it, for better or worse, still has a long distance unit and substantially more corporate business than merely running a consumer wireless unit which features the iPhone.
I took a look at ATT's recent income statement. Let me assure you, it's no growth firm. I checked my proprietary analyses of the S&P500 for consistently superior revenue growth. ATT isn't among those firms. Not for at least the last several years. The firm simply does not exhibit the sort of revenue growth that characterizes a growth firm.The nearby five year price chart for ATT and the S&P500Index illustrates that the firm certainly isn't valued, over time, as a growth firm. It barely outperforms the index over the past five years. And I'm being generous giving it that, since the difference is microscopic, and doesn't adjust for the risk of holding ATT versus a basket of 500 equities.
I wonder what Gary Kaminsky was drinking or smoking before that program? Because he ought to quit whatever it was.
Merrill Lynch's CDO Sales
I recently had the chance to read last week's Wall Street Journal article discussing Merrill Lynch's selling of CDOs to customers who were clearly not suitable for the instruments.
The piece focused on how unsophisticated some of Merrill's technically-qualifying "sophisticated" customers actually were. In particular, the article cast doubt on the notion that mere asset levels should have anything to do with sophistication in a legal or regulatory sense, as some of the Merrill customers either inherited their wealth, or made it in fields completely unrelated to financial services.
However, what drew my attention was the several cited examples in which Merrill personnel, including at least one VP, assured clients that the CDOs has "zero risk."
It seems to me that Merrill's documented actions are far more egregious than Goldman Sachs' in the matter of CDOs. Goldman had a mortgage-related synthetic CDO constructed in order that institutional market participants might buy and sell the associated risks. You may disagree on the amount of disclosure Goldman should have made, but they clearly kept the instruments among institutional investors.
Merrill, on the other hand, judging by the Journal's revealing article, pretty clearly stuffed risky CDOs into customers' accounts while deliberately and materially misleading those customers concerning the risks and nature of the CDOs.
I can't help but wonder if the BofA's purchase of Merrill will, ultimately, turn out to be a good deal, as behavior like these CDO sales comes to light.
The piece focused on how unsophisticated some of Merrill's technically-qualifying "sophisticated" customers actually were. In particular, the article cast doubt on the notion that mere asset levels should have anything to do with sophistication in a legal or regulatory sense, as some of the Merrill customers either inherited their wealth, or made it in fields completely unrelated to financial services.
However, what drew my attention was the several cited examples in which Merrill personnel, including at least one VP, assured clients that the CDOs has "zero risk."
It seems to me that Merrill's documented actions are far more egregious than Goldman Sachs' in the matter of CDOs. Goldman had a mortgage-related synthetic CDO constructed in order that institutional market participants might buy and sell the associated risks. You may disagree on the amount of disclosure Goldman should have made, but they clearly kept the instruments among institutional investors.
Merrill, on the other hand, judging by the Journal's revealing article, pretty clearly stuffed risky CDOs into customers' accounts while deliberately and materially misleading those customers concerning the risks and nature of the CDOs.
I can't help but wonder if the BofA's purchase of Merrill will, ultimately, turn out to be a good deal, as behavior like these CDO sales comes to light.
Tuesday, June 15, 2010
The Oil Industry Strikes Back- At BP!
I caught the opening statements of several oil company CEOs this morning. Most notable were those by ExxonMobil CEO Rex Tillerson and ChevronTexaco's John Watson.
Each of them took pains to criticize BP's inadequately-engineered drilling operation. It was quite clear that, in advance of a presidential address this evening focusing on the BP oil gusher, the industry and energy legislation, these two CEOs wanted to go on record, forcefully, stating that the BP mess is no accident.
From Tillerson's and Watson's comments, it was unmistakable that they view BP's operations as substandard and unsafe. They want to distance themselves from BP's approach, draw attention to their own, better safety records, and hopefully assist in heading off any damaging restrictions on deep-water drilling.
Commentators on CNBC referred to these CEOs 'throwing BP under a bus.' But that's not really quite true.
All that Tillerson and Watson did was provide their very informed opinions on the nature of the BP mess, i.e., it was the result of bad management and operations.
Even as I write this, various uninformed talking heads on CNBC are accusing the other oil CEOs as unwisely breaking ranks. One even cited Jack Welch, referring to some comment the former GE CEO was alleged to have made earlier today, or yesterday, that the execs must stick together because this is an industry problem.
No, it's not. That was Tillerson's and Watson's shared point. It's not an 'industry issue,' because nobody else in the deep-water drilling sector has managed to effect this sort of disaster.
If the Welch attribution is true, it just shows how far out of touch with reality Jack has become in recent years.
As I listened to the two prominent oil firm CEOs adamantly state their cases, it was obvious they were taking the opportunity, only hours before the scheduled presidential address, to give Congress and the viewing public their own, different view of events and reality.
Each of them took pains to criticize BP's inadequately-engineered drilling operation. It was quite clear that, in advance of a presidential address this evening focusing on the BP oil gusher, the industry and energy legislation, these two CEOs wanted to go on record, forcefully, stating that the BP mess is no accident.
From Tillerson's and Watson's comments, it was unmistakable that they view BP's operations as substandard and unsafe. They want to distance themselves from BP's approach, draw attention to their own, better safety records, and hopefully assist in heading off any damaging restrictions on deep-water drilling.
Commentators on CNBC referred to these CEOs 'throwing BP under a bus.' But that's not really quite true.
All that Tillerson and Watson did was provide their very informed opinions on the nature of the BP mess, i.e., it was the result of bad management and operations.
Even as I write this, various uninformed talking heads on CNBC are accusing the other oil CEOs as unwisely breaking ranks. One even cited Jack Welch, referring to some comment the former GE CEO was alleged to have made earlier today, or yesterday, that the execs must stick together because this is an industry problem.
No, it's not. That was Tillerson's and Watson's shared point. It's not an 'industry issue,' because nobody else in the deep-water drilling sector has managed to effect this sort of disaster.
If the Welch attribution is true, it just shows how far out of touch with reality Jack has become in recent years.
As I listened to the two prominent oil firm CEOs adamantly state their cases, it was obvious they were taking the opportunity, only hours before the scheduled presidential address, to give Congress and the viewing public their own, different view of events and reality.
Sebastian Mallaby On CNBC
Apparently Sebastian Mallaby's recent editorial, on which I commented yesterday, in the Wall Street Journal, was part of a well-orchestrated publicity campaign for his new book.
I didn't catch the book's name, but Mallaby was stumping for it on CNBC yesterday morning. When pushed, he made the same lame arguments about average hedge fund leverage on air that he did in his Journal editorial.
Mallaby wasn't any more convincing in person than in print. I didn't hear him address the over-leveraged hedge fund disasters, such as LTCM. Nor how the highly-leveraged hedge funds' dumping of positions in 2008 contributed to the market's downward shear.
From what I saw and read, Mallaby appears to simply ignoring the evidence that doesn't fit his particular hypothesis.
I didn't catch the book's name, but Mallaby was stumping for it on CNBC yesterday morning. When pushed, he made the same lame arguments about average hedge fund leverage on air that he did in his Journal editorial.
Mallaby wasn't any more convincing in person than in print. I didn't hear him address the over-leveraged hedge fund disasters, such as LTCM. Nor how the highly-leveraged hedge funds' dumping of positions in 2008 contributed to the market's downward shear.
From what I saw and read, Mallaby appears to simply ignoring the evidence that doesn't fit his particular hypothesis.
More Findings On The Dis-Utility of Homeownership in America
Richard Florida, listed in the Wall Street Journal as "a director of the Martin Prosperity Institute at the University of Toronto,"wrote a provocative editorial a week ago in the paper entitled Homeownership Is Overrated.
Florida's central contention is that today's world of greater job mobility has made homeownership a much less valuable activity than it was in the past in America.
A few years ago, the Journal published a piece by a researcher in Washington, D.C., providing evidence for this among low-income workers. Her findings were that the lower-income group of Americans had to move to follow work, as they are semi- or unskilled. Thus, houses tie them to places that may lose work, and cause them to default on the mortgage.
Florida, however, did something a little different. He examined relationships between homeownership, local economies and incomes. What he found is, at least to me, astounding.
Here's what he wrote,
"But cities with high levels of homeownership- in the range of 75%, like Detroit, St. Louis and Pittsburgh- had on average considerably lower levels of economic activity and much lower wages and incomes. Far too many people in economically distressed communities are trapped in homes they can't sell, unable to move on to new centers of opportunity.
The cities and regions with the lowest levels of homeownership- in the range of 55% to 60% like L.A., N.Y., San Francisco and Boulder- had healthier economies and higher incomes. They also had more highly skilled and professional work forces, more high-tech industry, and according to Gallup surveys, higher levels of happiness and well-being."
Thus, Florida found not only the same downsides to homeownership among lower-income workers as the earlier researcher, but he also found associations between higher incomes and less homeownership in cities with healthier economies, as well.
Isn't it ironic that our federal government began to push homeownership so heavily, from both parties, just when our economy began to value mobility more than ever? Especially as pensions have become more portable?
Perhaps, as Florida suggests, we really should reconsider the sacred mortgage deduction and let homeownership drift down to the 55-60% range. Based upon his research, it would seem that propping up homeownership beyond that interferes with the natural mobility of labor and economic activity in America.
Yet another in the growing list of federal government-originated market-distortions in our modern economy.
Florida's central contention is that today's world of greater job mobility has made homeownership a much less valuable activity than it was in the past in America.
A few years ago, the Journal published a piece by a researcher in Washington, D.C., providing evidence for this among low-income workers. Her findings were that the lower-income group of Americans had to move to follow work, as they are semi- or unskilled. Thus, houses tie them to places that may lose work, and cause them to default on the mortgage.
Florida, however, did something a little different. He examined relationships between homeownership, local economies and incomes. What he found is, at least to me, astounding.
Here's what he wrote,
"But cities with high levels of homeownership- in the range of 75%, like Detroit, St. Louis and Pittsburgh- had on average considerably lower levels of economic activity and much lower wages and incomes. Far too many people in economically distressed communities are trapped in homes they can't sell, unable to move on to new centers of opportunity.
The cities and regions with the lowest levels of homeownership- in the range of 55% to 60% like L.A., N.Y., San Francisco and Boulder- had healthier economies and higher incomes. They also had more highly skilled and professional work forces, more high-tech industry, and according to Gallup surveys, higher levels of happiness and well-being."
Thus, Florida found not only the same downsides to homeownership among lower-income workers as the earlier researcher, but he also found associations between higher incomes and less homeownership in cities with healthier economies, as well.
Isn't it ironic that our federal government began to push homeownership so heavily, from both parties, just when our economy began to value mobility more than ever? Especially as pensions have become more portable?
Perhaps, as Florida suggests, we really should reconsider the sacred mortgage deduction and let homeownership drift down to the 55-60% range. Based upon his research, it would seem that propping up homeownership beyond that interferes with the natural mobility of labor and economic activity in America.
Yet another in the growing list of federal government-originated market-distortions in our modern economy.
Monday, June 14, 2010
In Praise of Hedge Funds?
The weekend edition of the Wall Street Journal featured a long article in defense of hedge funds as a stabilizer in our financial system.
Distilled to its essence, the article cites several features of hedge funds which contribute to healthy market dynamics and don't drain taxpayers.
Specifically, it notes that hedge funds, due to the owners/managers receiving a sizable share of the funds' profits, tend to: identify genuine profit opportunities which make positive, risk-adjusted returns; manage risk better than insured public financial entities; through their ability to short equities, contribute to pricing efficiencies; don't require nor expect public funds to rescue them from failure.
All these points are true. The one caveat comes at the end of the piece. Sebastian Mallaby, the author of the long editorial, contends that the average hedge fund is much less leveraged than the average bank. That may be true, but it's not the averages that should worry us.
Rather, as noted in my comments on Scott Patterson's recent book, The Quants, here and here, and a related post here, leverage and risk management are the Achilles Heels of these outfits.
In this later post, I describe Larry Kelly's risk management theorem, derived from Shannon's information theory. Ed Thorp, the godfather of the modern quants, mentioned so lavishly in Patterson's book, revered Kelly and his Criterion. Kelly's Criterion is absolutely crucial in its focus on risk management via bet size.
None of this made it from Thorp to his progeny, nor, really, into Patterson's book. Patterson mentions Kelly in an aside so vague it originally escaped my attention. Luckily, a retired Bell Labs colleague lent me Poundstone's tome on Kelly.
It's leverage that makes otherwise-reasonable strategies toxic. Especially when, as Patterson did emphasize, several large hedge funds are pursuing the same instruments and investing with similar strategies.
As I've written in earlier posts, blame the lenders, usually commercial banks, for not adequately supervising hedge fund positions and risks. Blame the hedge fund managers for being ignorant of Kelly's work.
Mallaby's lengthy ode to hedge funds is sensible until that last, fatal passage about leverage.
If too much capital is employed, and leveraged up, by several investors, into the same positions, that, in itself, makes for an inefficient, risky market. With today's lightning-fast trading systems, it's virtually impossible for all that capital to exit without losses. Those losses then magnify the downward price spirals in the markets for the affected instruments.
I'm not at all sure that most of the offending hedge fund managers who came so close to death prior to the TARP's rescue learned anything. In Mallaby's ideal world, they would have been wiped out, and more prudent hedge funds would have, in a Darwinian consequence, survived to expand and fill the vacant market niches.
But that's not what happened. So it's debatable whether, in even today's environment, nearly two years later, large, highly-leveraged quantitative hedge funds are a benefit to our financial system.
Mallaby didn't explicitly endorse the quants, but most of his modern examples were quantitative funds. And it is precisely this variety which is vulnerable to such large, immediate losses from over-use of leverage.
Distilled to its essence, the article cites several features of hedge funds which contribute to healthy market dynamics and don't drain taxpayers.
Specifically, it notes that hedge funds, due to the owners/managers receiving a sizable share of the funds' profits, tend to: identify genuine profit opportunities which make positive, risk-adjusted returns; manage risk better than insured public financial entities; through their ability to short equities, contribute to pricing efficiencies; don't require nor expect public funds to rescue them from failure.
All these points are true. The one caveat comes at the end of the piece. Sebastian Mallaby, the author of the long editorial, contends that the average hedge fund is much less leveraged than the average bank. That may be true, but it's not the averages that should worry us.
Rather, as noted in my comments on Scott Patterson's recent book, The Quants, here and here, and a related post here, leverage and risk management are the Achilles Heels of these outfits.
In this later post, I describe Larry Kelly's risk management theorem, derived from Shannon's information theory. Ed Thorp, the godfather of the modern quants, mentioned so lavishly in Patterson's book, revered Kelly and his Criterion. Kelly's Criterion is absolutely crucial in its focus on risk management via bet size.
None of this made it from Thorp to his progeny, nor, really, into Patterson's book. Patterson mentions Kelly in an aside so vague it originally escaped my attention. Luckily, a retired Bell Labs colleague lent me Poundstone's tome on Kelly.
It's leverage that makes otherwise-reasonable strategies toxic. Especially when, as Patterson did emphasize, several large hedge funds are pursuing the same instruments and investing with similar strategies.
As I've written in earlier posts, blame the lenders, usually commercial banks, for not adequately supervising hedge fund positions and risks. Blame the hedge fund managers for being ignorant of Kelly's work.
Mallaby's lengthy ode to hedge funds is sensible until that last, fatal passage about leverage.
If too much capital is employed, and leveraged up, by several investors, into the same positions, that, in itself, makes for an inefficient, risky market. With today's lightning-fast trading systems, it's virtually impossible for all that capital to exit without losses. Those losses then magnify the downward price spirals in the markets for the affected instruments.
I'm not at all sure that most of the offending hedge fund managers who came so close to death prior to the TARP's rescue learned anything. In Mallaby's ideal world, they would have been wiped out, and more prudent hedge funds would have, in a Darwinian consequence, survived to expand and fill the vacant market niches.
But that's not what happened. So it's debatable whether, in even today's environment, nearly two years later, large, highly-leveraged quantitative hedge funds are a benefit to our financial system.
Mallaby didn't explicitly endorse the quants, but most of his modern examples were quantitative funds. And it is precisely this variety which is vulnerable to such large, immediate losses from over-use of leverage.
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