Boeing's & McNerney's Continuing Bad "Dream"

Today's Wall Street Journal reported the story which broke on cable news networks yesterday. Boeing announced more delays for the Dreamliner, its newest jet. It seems that delays continue to plague this plane, whose delivery has now been pushed into 2009.

Is McNerney up to this job?

He arrived at Boeing in late 2005, as noted in this post on various former GE executives now heading other companies. As I wrote in that post, last September,

"But McNerney got there after Alan Mulally, now Ford CEO, had put the company back on track to success. The firm McNerney left GE to head, 3M, hasn't exactly set the world on fire.

And now, after McNerney's been at Boeing long enough to make an impression, the company falters. As the Yahoo-sourced price chart nearby reveals, Boeing's performance since late 2005 has begun to stall, as the S&P closes in on it."

Somewhere in the Detroit area, Alan Mulally must be laughing. The nearby chart shows Boeing's and the S&P500 Index's prices for the past five years. Mulally's efforts on the commercial side of Boeing had contributed to its nicely-rising stock price from 2003 through when McNerney arrived. Passed over for the top job, Mulally was vulnerable to the offer to be Ford CEO.

Now that Mulally, a genuine airplane guy, is gone, Boeing seems to have gradually wound down, performance-wise.

The nearby two-year price chart for Boeing and the S&P shows that the former no longer steadily outpaces the index. Instead, the index has ended the last two years handsomely up, and positive, relative to Boeing's roughly 5% price decline.

For just the past 12 months, it's similar. Though the S&P is also negative, it still comfortably beats Boeing's loss of more than 10%.

It's tempting to conclude that Boeing simply moves with the index, but, judging from the first chart, I don't think that's necessarily the case. The company had a solid path of outperformance through the middle of this decade.

Now, that's clearly gone.

Maybe McNerney should be, too.

As I discussed this post with my business partner last night, I thought about the logic Boeing used to recruit McNerney from 3M, where he had a similarly-lackluster, though very brief, tenure, to Boeing.

I wrote this post in June of 2006 concerning 3M and McNerney. In it, I wrote,

"All in all, an ironic track record for McNerney. It appears that under his leadership, 3M's stock price path remained pretty consistent, suggesting that investors didn't really see much difference with McNerney running the company. The only significant changes were bad ones- the dips in price in this decade."

3M's price trajectory hasn't really changed much since McNerney's departure in 2005. So he didn't appear to have markedly improved, or damaged the firm.

But in bringing McNerney to Boeing, the company's board cited his longtime experience heading GE's aircraft engine business.

On first blush, that sounds really relevant, doesn't it? That a guy who builds your engines can come run your company?

Then you stop and think....wait a minute!

That's sort of like saying the guy who runs Goodyear could run companies that used tires.

Or maybe Starbucks could be run by the guy, or woman, who heads up the paper cup supplier that the coffee maker uses.

Ford hired Mulally because they respected three things:

-his reinvigoration of Boeing's commercial plane marketing

-his leading the turnaround of that unit

-his long experience with a maker of complex large moving objects, i.e., airplanes.

I'm not sure that I see how Boeing's reasons for hiring McNerney were as valid.

As always, time will tell. But right now, I don't see McNerney having had a positive impact on keeping the Dreamliner and/or its program mangers performing up to expectations and promises.

Greenspan Answers His Critics

Tuesday's Wall Street Journal contained a long piece focusing on Alan Greenspan's recent, continuing efforts to defend himself against mounting criticism of his reign as Fed Chairman.


Of course, last fall, it was a different story. Back then, I wrote two posts, here and here, which included this passage,


"Grant pulls no punches in questioning Greenspan's consistency as a libertarian, and acolyte of Ayn Rand, by ending up as the sole determiner of the economy's key interest rate. He makes clear Greenspan's lack of significant accomplishment as an economist or equity savant, prior to his role as Fed Chairman, and his misunderstanding of housing finance, after he took the position.


As Joe Kernen, an anchor on CNBC, articulated, Grant also seems to question Greenspan's motive in writing this book. Whereas Kernen opined that Greenspan wants back in the limelight, Grant suggests it's about trying to write his own legacy, before someone else writes a less flattering one."


And, in fact, Jim Grant, of Grant's Interest Rate Observer, was entirely correct. But it seems that Greenspan's pre-emptive effort has failed.


According to the Journal article,


"The criticisms that get under his skin are those from friends and former colleagues, many of them respected economists who backed his policies at the time but now say, in hindsight, that the calls were wrong. "I do take it seriously if my peers think I have misstated the facts," he says. "But where's the evidence? Too many people make accusations by assertion. I think it's improper." "


Which, as I noted last September in that second post, is true. There was insufficient objectivity about Greenspan back in the day. Too many people put him on a pedestal to begin with.


One subject on which I agree with Greenspan, which is vitally important right now, is the genesis of asset bubbles. The Journal article continues with,


"Mr. Greenspan now admits he was wrong about the improbability of a housing bubble. Yet he has long maintained that bubbles are an unavoidable feature of a dynamic economy. He pulls out a 1999 speech and shows, underlined in green marker, passages in which he warned of recurring but unpredictable patterns of overconfidence followed by investor panic. He does not share some foreign central bankers' belief that their job is to defend against excessive asset-price inflation: No sensible policy, he maintains, could have prevented the housing bubble.

"I am reasonably certain that I am right here," Mr. Greenspan says. If proved wrong, he says, "I will change. I do not have a vested interest in holding wrong ideas." "


But with Greenspan's last statement, I disagree. Obviously the former Fed Chairman has a very great, vested interest in having his actions sustained and generally regarded as correct. Who, after such adulation as Greenspan achieved, would not be worried that his image would be sullied afterward?


Greenspan's book and subsequent consulting deals smack of someone a lot less secure in his actions at the Fed than, say, Paul Volcker.


For instance, consider this passage from the Journal piece,


"Mr. Greenspan says many of the criticisms against him are unjust. He is particularly perturbed by attacks over a 2004 speech in which he suggested that more borrowers would benefit from adjustable-rate mortgages. Interest rates were at a historical low at the time, which means that those who held on to the mortgages would have seen rates adjusted upward.

Mr. Greenspan says the speech merely pointed out that many people who get a 30-year mortgage move or refinance long before it matures. Eight days after giving the speech, he says, he clarified his comments to say he didn't mean to disparage 30-year fixed-rate mortgages. "I find it profoundly disturbing" that critics cite the recommendation and not the retraction, he says, tapping his fingers on the table in front of him. "In all seriousness, this is really quite unfair." "


You can't say that Greenspan is unfamiliar with how the media treat public pronouncements by him. To complain that the headline got all the attention, and a minor clarification didn't, is to believe Greenspan is naive. But he's not. He was a longtime power player in Washington, and well knows how quotes can be misused.


Further, it's hard for Greenspan to now duck his explicit hesitancy to conduct closer supervision of specific, mortgage-related bank and bank-subsidiary lending practices.


For what it's worth, I don't really think we should rely on Federal regulators to take the place of commercial bank risk managers when it comes to lending practices, once guidelines are set. However, would it have been so bad for Greenspan to observe the rush to no-money-down mortgages and insist on 10% or 20% downpayments, instead?


This way, the Fed wouldn't have second-guessed bank risk management, so much as simply aligned housing purchases with those of financial assets, which the US long ago put on a higher-margin basis.


Reviewing the history of Greenspan's tenure as Fed Chairman, it's probably fair to say that he handled specific crises well. He showed flexibility with rate movements in response to various challenges to the economy, but was probably slow to return low interest rate levels to more appropriate ones consistent with a stronger dollar. And, finally, he didn't exercise as much influence over safe lending terms for mortgages as he could have, given the Fed's inherent ability to do so.


It's too bad that Greenspan is pouting about the changing sentiment regarding his Fed reign. It's not like he is being viewed as a failure. But, after last fall's public coronation of the man as the 'best central banker' of all time, it's understandable that he's suffering from a reduction in public esteem.


It may well be that, with more time, either Volcker or Bernanke will more fittingly be judged worthy of the title that Greenspan so clearly wants to keep.

Starbucks' Howard Schultz On CNBC Today

By chance, I happened to catch Maria Bartiromo's softball interview with Starbucks' recycled CEO, Howard Schultz. Schultz was all a twitter about today's introduction of the firm's latest beverage- a specially-designed, basic brewed cup of coffee.


As the nearby, Yahoo-sourced five-year price chart for Starbucks, McDonald's and the S&P500 Index illustrates, Schultz had better hope it delivers something big for his shareholders.


I've written at least six labeled posts about the company, and probably a few more prior to those. My most significant recent piece was this one, in January, regarding the marketing battle heating up between Starbucks and McDonalds, with Dunkin Donuts also in the mix.


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


'Competition- they're just noise,'



or words very close to those.



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



"She says she hasn't been focused on competitors in developing the new plans. "I think we'd all readily admit that a lot of the situation we're in is self-induced."


Sounds familiar, right? At least Gass and Schultz are reading from the same page in the same playbook.



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

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

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

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



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

While McDonalds has not, historically, been a competitor of Starbucks, it is now. Looking at the three Yahoo-sourced charts in this post- the five-year, two-year and one-year timeframes of Starbucks', McDonalds', and the S&P's price performances- it's clear that the fast food giant has been resurgent for the entire five year period just past.


Starbucks peaked two years ago, and is now struggling to find a way to rekindle its total return performance. Viewing the two firms' looming battle, and now learning that Schultz' latest weapon is a simple, brewed cup of coffee, I really wonder if Starbucks 'gets it.'


They are in the fight of their lives. They no longer own the premium coffee product/market. At least with espresso-based coffees, they had a lot of room to innovate and maneuver.


But brewed coffee? Lower priced, I would guess. And how long will it take Dunkin Donuts or McDonald's to emulate the new flavor, if it's warranted? Dunkin already wins taste tests with its signature coffee.


The shorter time period charts show Starbucks losing 50% of its price over two years, and 40% in just the past twelve months.


In contrast, McDonalds has racked up more than 20% in price appreciation, while the S&P was slightly negative.


My point is not that Schultz and Starbucks have to perform exactly like McDonald's, but that the latter is newly-focused and on a roll, with upscale coffee targeted as one of several important new product/markets.


The end of Bartiromo's interview with Schultz saw him fumbling to handle her question about how investors should view his new brewed coffee initiative. He spat out some tired lines about returning to the firm's roots and values while pursuing international growth, all calculated to


'Return Starbucks to its traditional place in this segment,'


or something close to that statement, which is not an exact quote.


It seems, per my prior posts, that Schultz and his chief strategy lieutenant, Gass, think that all of their company's troubles have been simply a matter of self-inflicted loss of focus and failure to refresh their brand.


In fact, again, per my prior pieces on Starbucks, the truth is more complicated than that. McDonalds is certainly much more dangerous than 'just some noise.'


So is Dunkin Donuts. Starbucks' most recent target segment, lower socio-economic groups, are currently hurting economically. The firm's success has attracted two large, capable competitors.


Are we to believe that one brewed coffee blend is going to reverse a 40% slide in the firm's stock price? With two hungry competitors active in the same market?


I think it's fair to say that the bloom is long off Starbucks' rose.

AMD's Sagging Fortunes

How the world has changed in the semiconductor sector!

Just about two years ago, I wrote this post in observance of AMD's successful revenue and profit growth, while Intel struggled.

This morning, however, the Wall Street Journal published an article detailing AMD's recent woes, including a 10% cut in its workforce.

What went wrong?

Nearby is a Yahoo-sourced five-year price chart of AMD, Intel and the S&P500 Index. It seems that my post from May of two years ago, based upon another Journal article, from that time, caught AMD just past its stock price apogee.

Today's Journal article notes,

"The company has been coping with a series of problems, including a heavy debt load from its 2006 acquisition of ATI Technologies Inc. and a stronger line of competing products from Intel. AMD counterattacked in September by announcing a new line of chips that pack the equivalent of four electronic brains on a single piece of silicon.

In December, AMD disclosed technical defects that affect models of the chip for server systems and desktop PCs. It has now introduced versions without those bugs, but computer makers held up purchases in the meantime, said JoAnne Feeney, an analyst at FTN Midwest Securities Corp.

She added that demand has been softening for desktop PCs, a field where AMD has been the strongest lately. "They were gaining share in desktops, which paradoxically exposed them more" to the demand problem, Ms. Feeney said.

John Lau, an analyst at Jefferies & Co., estimated that the total PC market declined about 10% from the fourth period, with AMD's 15% drop also reflecting losses in market share."

So, putting the pieces together, it seems that AMD's acquisition of ATI, Intel's own counterstrikes, and then AMD's management troubles combined to push its stock price down ever since that brief window of triumph.

Since that brief, two-year period of outperformance of the index and Intel, AMD has had a pretty much monotonic decline, as depicted by the nearby Yahoo-sourced price chart for the past two years.

Even so, as the first chart clearly shows, AMD is still not tremendously far below Intel over the longer timeframe. After its rollercoaster ride up and down, AMD looks to have returned to the same overall neighborhood of performance that Intel has shown by its nearly-flat trajectory over the period.

Both have underperformed the index for five years, indicating why neither shows up on the list of equity selections for my portfolios.

Lehman's Structural Issues

Tuesday's WSJ covering Lehman's $4B preferred stock placement.

The Wall Street Journal carried an article last Tuesday describing Lehman Brothers' recapitalization with $3B of preferred equity. Scared by Bear Stearns' collapse after a run by counterparties and customers, Lehman elected to shore up its capital and cut its leverage.

Perhaps Lehman isn't Bear Stearns. Perhaps it's a bit more diversified and- now- more conservatively funded.


But that's not the entire question, is it? That is, we don't really need to know about just the necessity of Lehman's funding. Sufficiency is the real issue.


Is it possible that only one, perhaps two investment banks- Goldman Sachs and Merrill Lynch- are now sufficiently diversely funded and large to avoid the ultimate negative consequence of their leverage- insolvency?


Maybe Lehman, for all its efforts, just still isn't sufficiently diverse, large, and long term funded. Maybe Morgan Stanley isn't, either.


Oh, yes. Lehman had the Fed window now, as does Morgan Stanley. Then why the new preferred issue?

Well, later last week, Fed Chairman Ben Bernanke did confirm that the window for investment banks is an emergency step. It will be closed when Ben and his colleagues judge the emergency to have passed.

You have to wonder if this is about to be an opportune time for Dick Fuld, Lehman's hardnosed CEO, to exit via a sale of his firm to a commercial bank.

Once Fed funding is off-limits again, what will Lehman's stock price do? For how long will investors really believe that an investment bank is safe, now that SEC Chairman Chris Cox noted that Bear Stearns lost slightly less than 90% of its liquid assets in one day last month?

Lehman still has significant exposure to mortgage loans. And Bear's experience demonstrates how quickly the loans from commercial banks, on which all brokers/investment banks depend, can be pulled.

Per my recent posts in the wake of the Fed's window opening to investment banks, I just don't see, long term, why any but perhaps the very best one or two investment banks can remain independent.

Congress Determines There Were No Buyers of Toxic Structured Finance Instruments- Only Sellers!

This week's appearance by Bernanke in front of a joint Congressional committee provided another pathetic example of Ted Kennedy's failing grasp of reality. To be fair, not only Teddy, but many of his Democratic and Republican fellow Senators and Representatives, too.


Brow beating the Fed Chairman, Ted repeatedly asked Bernanke why the Fed didn't 'remove harmful financial products' from the 'shelves' of America's banks, just like the Congress forced toy retailers to clear their shelves of lead-contaminated painted toys. Judging from Kennedy's assault on Bernanke, it is clear that Ted thinks there were no buyers of structured finance instruments, only sellers.


Here's a little piece of information you evidently missed, Ted.


Wall Street's investment banks, and commercial banks, too, wouldn't have securitized toxic loans if there weren't informed, willing adult institutional buyers.


That's right. Nobody actually put a gun to anybody's head to make them buy CDOs or auction-rate securities.


As I wrote in this post last year, every institutional investor who bought CDOs, shares of an SIV, or other structured finance instruments surely believed they were receiving excess returns for no commensurate additional risk.


Without willing buyers, none of the risky, opaque structured instruments now so roundly criticized and reviled by regulators and Congressional pooh bahs would have ever been created and sold.


Further, very few retail investors seem to have bought CDOs. Those were mostly institutional investors including your typical local county or state pension or sinking funds. Those people are paid to make informed investment decisions. They can't blame the rating agencies or their investment bank advisers for decisions for which they are handsomely paid.


These investment professionals, the ones who willingly bought CDOs, SIV shares, and similar structured finance instruments, are, it seems to me, the real source of the financial market excesses. These people, whoever and wherever they are to be found, failed to exercise due diligence in understanding what they were buying on behalf of their investing organizations.


How does Senator Kennedy propose to stop this consensual buying behavior?


Maybe we should be realistic and stop denying the obvious. We have financial market turmoil because a lot of institutional investors failed to do their jobs, became greedy, and believed excess returns could be had for no added risk.


It turns out that they were, as usual in every financial cycle, wrong on all counts.


Don't blame the sellers of these instruments. Or at least, not them alone.


Blame the buyers who provided the market demand for the toxic financial paper that lies at the root of the credit market mess.

Thursday's Senate Financial Regulator Witchhunt

Yesterday provided some free comedy theatre. The Senate banking committee grilled Chris Cox, Bob Steele, Tim Geithner and Ben Bernanke, respectively, SEC Chairman, Treasury Undersecretary, NY Fed President and Fed Chairman.

As usual, the spectacle was both amusing and frightening. Among other adults who understand financial markets who were at my fitness club in the afternoon, the universal sentiment was something like,

'These clowns barely understand what they are overseeing/regulating, and they've been on this committee for years!'

Of course, between this being an election year, a year with a more slowly-growing economy, and in the wake of the subprime mortgage and fixed income markets debacles, all of the Democratic Senators are attempting to hang all possible blame and responsibility on the administration of the opposing party. The Republican Senators, predictably, ask the respondents helpfully leading questions to elicit explanations that depict and impossible situation which could not be managed ahead of time.

If I were giving awards for this comedy show, without question the award for Most Witless Statements and Questions would go to Jim Bunning of Kentucky. The always-irascible former pitcher thinks he knows much, much more than he does. This time, he castigated the Fed for not knowing all about the brewing subprime lending debacle years in advance.

I'm guessing Jim still doesn't realize that, as Michelle Caruso-Cabrera so ably stated recently, in America, we let innovation work in free markets, until they don't. We don't generally regulate a priori with a heavy hand.

The award for Narrow-minded Agenda and corresponding Witchhunting Questions would go to.... Chuckie Schumer of NY.

This perennially partisan Democratic Senator focused with laser-like precision on a sort of 'what did you know and when did you know it?' line of questioning in an attempt to make all of the regulators present look stupid and slow. Of course, it didn't work because Chuck is actually the slow one, showing no grasp of the rapidity with which modern financial markets can move liquid assets away from a financial institution. As Chris Cox explained- many times, due to the Senate panel's stupidity- Bear Stearns lost $10B of its $12B of liquid assets during the Thursday before the weekend during which it effectively ceased to exist independently.

Bob Menendez, the corruption-tinged Democratic Senator from my own state of New Jersey would be the runner-up for witless questions. He embarked on some will o' the wisp search for 'quantitative' measures of the ultimate value of securities the Fed took as collateral for its $29B loan in the matter of the Bear Stearns collapse.

If Menendez had a real grasp of finance, which shouldn't be too much to ask after his years on this committee, he'd understand that the incredible complexity and fluidity of the financial situation surrounding Bear Stearns prohibits firm dollar amounts to be known for various risks and valuation of securities. Unfortunately, asking Bob to actually learn something about the industry overseen by the committe on which he sits is apparently too much.

"Doddering" Chris Dodd, chairman of the committee and Democratic Senator from Connecticut, also postured and blustered about the situation, with little in the way of any insightful questions. Preening from CNBC's Jim Cramer's fawning adoration earlier in the morning, Dodd behaved with that all-too-familiar Senatorial gravitas, as if he and his fellow committee Democrats were the last protective barrier between Americans and their financial assets.

As I noted earlier, the only real message that came through to me from the morning's, and, for that matter, afternoon's questioning of various financial markets regulators and players, was how little grasp of modern financial markets and the plumbing that allows them to function smoothly these Senators have, after so many years allegedly making acquaintance with the sector.

It's really tempting to believe that no Congressional oversight whatsoever wouldn't be much worse than oversight by a collection of preening, pompous, self-aggrandizing fools and idiots.

More on Auction Rate Securities

The Wall Street Journal published an article this past Tuesday on auction-rate securities, with another one this morning. Recently, I've been getting a large number of readers coming to my blog for this post from mid-February.

Probably the best that can be said is that nothing has improved about this situation.

In Tuesday's article, the Journal reported that UBS has begun writedowns of retail account holders' auction-rate assets. Today's article noted that, by contrast, Merrill Lynch is still recording them at a higher value to its retail customers, although they note that the firm itself has reduced the values at which it carries comparable auction-rate securities.

To attempt to end the mess involving these notes, some issuers either calling their own notes or simply refunding with conventional long term debt.

But it's noteworthy that nearly two months after the Journal's first mention of this market failure, the only 'solutions' in sight are the same as those originally mentioned- lending to customers on the collateral of a reduced value of the auction-rate securities, and calling/reissuance of the auction-rate securities as conventional longer term securities.

Is this not essentially indicative of an instrument which has no further use in current markets?

Like a hot-house flower, it seems that auction-rate securities could only exist and thrive in a rather narrowly-defined financial market condition. A condition of fairly easy and low-risk credit which has now vanished from current credit markets.

At this point, it is probably fair to say that the word 'fix' doesn't really apply to the auction-rate securities dilemma. A word like 'end' or 'terminate' seems more applicable. In time, one suspects that these securities will simply disappear as they are replaced by less-volatile, truly more cash-equivalent securities.

Hopefully, both issuers and buyers will now be more sanguine and suspect when Wall Street securities salespeople insist that some abstruse, complex instrument is 'as safe and liquid' as cash.

The Uptick Rule & Recent Market Volatility

Yesterday's Wall Street Journal piece on the effects of the removal of the 'uptick rule' provided some fascinating information on recent changes in the securities markets.


As background, the article began with the passage,


"With the stock market posting its worst quarter in six years, an obscure change in how stocks are traded is the subject of a nasty debate on Wall Street, with one side blaming the switch for everything from increased volatility to the collapse of Bear Stearns and the other side dismissing those critics as fools and worse.
The subject of this rancor is the "uptick" rule. Until July, investors typically had to wait until a stock was rising before they could wager on its decline. Under this rule, adopted in response to the stock market's crash in 1929 to inhibit bearish traders, there had to be an "uptick" in a stock's price before traders could short the shares. In other words, investors could borrow shares and sell them, hoping for the price to fall, only after a trade that pushed up the stock's price.

After years of academic research suggested that the rule was hindering trading without protecting prices, regulators eliminated the rule last summer, giving a green light to those eager to sell a stock short, even as it was falling."

So last summer, just as the Bear Stearns mortgage-backed mutual funds were experiencing losses, the uptick rule disappeared. Accordingly, the article notes,

"Some argue that the move unleashed a new era of volatility. Consider the drastic drop in Bear Stearns stock, which tumbled to $4.81 a share March 17 from $57 just two days earlier. When groups of traders short a stock they effectively flood the market with shares they are selling -- even though they don't actually own them -- which can drive down prices and sometimes even cause a panic, critics say. Some investors maintain that groups of hedge funds and others conspired to knock down Bear's stock price, hoping to profit by forcing the big brokerage to seek bankruptcy protection.

"Traders are in hog heaven -- they keep banging and banging a stock [down] -- but investors find it hideous," argues Mario Gabelli, chairman of Gamco Investors, who wants the rule re-instated. "The increased volatility causes investors to want higher returns, so there will be a higher cost of capital for companies, putting our markets at a competitive disadvantage."

Adds Martin J. Whitman, founder and co-chief investment officer of Third Avenue Management: "In my 58 years in the market, it's never been easier to conduct bear raids." His funds sustained losses when shares of companies such as CIT Group and bond-insurance companies, such as MBIA and Ambac Financial Group, fell significantly, declines he blames on short-sellers.

And, just over a week ago, CNBC's James Cramer encouraged his viewers to contact the Securities and Exchange Commission and Congress to complain about the change, saying that "tens of billions of dollars" have been lost because of the change, and that SEC officials "are total morons" about the issue.

Thus we have a number of industry pundits complaining that the sky is falling, and all because of this one minor change. But there are other views, as well. For example, as the Journal piece continues,

Hogwash, say others. They argue that a debt crisis and economic weakness are at the root of the market's problem.


"Anyone who thinks the removal of this rule is somehow causing havoc in the financial markets is hopelessly lost in the bark of one tree and may never be able to see the forest," says James Bianco, who runs Bianco Research in Chicago. He notes that there were ways around the uptick rule, such as using options strategies and exchange-traded funds, or simply violating it and paying a small fine. "To suggest that the removal of this rule is causing the markets to go down is to loudly announce 'I don't understand the credit crisis, and I am incapable of ever understanding it.'"

I love Bianco's comment. And the Journal article clearly set up the sequence in order to imply that Bianco thinks anyone who thinks and behaves like Cramer is 'incapable of ever understanding' the credit crisis.

Which I think is pretty much true, in Cramer's case. He railed for lower Fed rates and bailouts for his hedge fund and trading desk friends. But the credit crisis, as I've since written, has always been more about counterparty risk than it has about a need for lower costs of funds.

The article goes on to describe some of the other, confounding changes in the markets which occurred with the disappearance of the uptick rule. To wit,

"But lots of bad things have gone on in the market since July, making it difficult to isolate the impact of the dissolution of the uptick rule. And volatility eased when the market rebounded in October, though it remained somewhat above pre-July levels.

A representative of the SEC, which made the rule change, notes that since 2001, stocks have traded in decimals, rather than fractions. So even before the July change, a bearish-minded investor easily could have pushed a stock even just a penny higher with a little buying and then come back with a big short sale, effectively skirting the intent of the rule. He notes that some foreign markets also have seen a volatility spike, even though there were no similar changes in how stocks can be shorted."

Decimalization alone is very important. So, of course, is the usage of puts to do what shorting does, without any uptick complications.

I think it's pretty hard to view the relevant market changes since last summer and lay all of the damage on one rule involving upticks.

Michelle Caruso-Cabrera's Sound Thoughts On Our Financial System

Michelle Caruso-Cabrera, one of the brightest on-air personalities on CNBC, and one of perhaps only two with a business or economics degree, had some choice words yesterday afternoon about the US financial markets.

As Steve Liesman whined about market failure, and Dennis Kneale made some fairly forgettable remarks, She conveyed eloquently in just two minutes several complex but important sentiments.

Among the salient points Caruso-Cabrera made in her brief comment were:

-Our financial system is all about risk and innovation, not control.

-Unless it's prohibited, you can do it.

-By contrast, in other countries, like France, if it's new, you must obtain explicit permission.

-Financial service firms will abuse leverage in every cycle. It is, she said, 'addictive- it's their cocaine.'

-So we have to expect some blow-ups in financial markets every few years.

-Regulation won't ever stop this, because we favor innovation and growth over control.


Could anyone capture the essences of US financial markets any better or more succinctly? I doubt it.

In the process of explaining these points, Ms. Caruso-Cabrera implicitly provided the rationale for why there will always be a tendency toward US financial market excesses. Innovation and risk taking lead to the marginal service provider taking the imprudent, marginal risk, in search of excess returns.

The key is not to smother innovation, but to attempt to provide sufficient safeguards, in the manner of clearing exchanges with collateral, margin and settlement rules, to make any one party's downfall less cataclysmic to the entire financial system.

And that is something Treasury Secretary Paulson clearly understands and is moving to do, per my post on his recently released blueprint for regulatory reform of the US financial service markets.

Secretary Paulson's New Financial Markets Regulatory Blueprint

Hank Paulson's speech last Wednesday to the US Chamber of Commerce on financial markets regulatory redesign, about which I wrote here, was, in retrospect, a warning about today's release of the Secretary's 'blueprint' for a new scheme.

You can read all about it in today's Wall Street Journal. The details would be many, I am sure. The executive summary was reported to be some 22 pages, the full report running to something in excess of 200.

However, to me, three facets of the recommendations stand out.

The first is one on which I picked up during Paulson's speech on Wednesday- forming exchanges for current OTC instruments such as credit default swaps. When he referred to this on Wednesday, I found it telling.

When Paulson mentioned it twice today- once in his speech, and another in an interview on CNBC- it told me that Paulson correctly understands that these unregulated instruments, whose settlement and clearing has become problematic, are going to be reined in hard.

This is a good thing. Leaving them roaming in OTC land has become a dangerously destabilizing feature of today's financial markets. It may end up as one of Paulson's two best legacy achievements.

The other would be Federalizing the insurance markets. Paulson took the politically difficult, but economically- and regulatorialy-necessary step of calling for Federal supervision of insurance to supersede any existing state-level regulations. Citing national and international scale of providers and a need for competitive developments in the industry, Paulson's recommendation may finally force loose a major stumbling block which has helped delay meaningful progress on affordable healthcare insurance plans in this country. It would be his other monumental legacy to accomplish this particular Federalization.

The third noteworthy aspect of Paulson's recommendations is the near-term formation of a Federal mortgage certification board. The intended consequence of this board would ostensibly create a body of Federally licensed mortgage industry professionals.

Are there no bad practitioners of law or medicine? Plumbing, electrical work or carpentry?

Licensing alone will not prevent the shoddy lending practices or improper mortgage broker activity which played their parts in the home lending debacles now being sorted out.

A recent Wall Street Journal editorial noted that requiring licensing for a profession typically raises prices, but offers no guarantees of better products or services. This will, sadly, be true for the mortgage business, as well.

Rather, as my partner suggested over a month ago, the more obvious and simple solution is to require a 20% cash downpayment for any mortgage made in the US. Period.

No exceptions. A borrower's balance sheet must be frozen and clean, and on that balance sheet must he sufficient cash to constitute 20% of the purchase price of the home.

Most of the problems with subprime mortgages or shady brokers would have been mitigated simply by requiring the borrowers to qualify with 20% of the purchase price in cash.

It is very similar to the original installment credit regulations in place in the US in the 1950s, before the growth of installment lending via bank credit cards.

Other than overloading the Fed with excess supervision duties, as I noted in my earlier, linked post, and this bad idea for mortgage banking licensing, Paulson's recommended blueprint for newly-regulated US financial markets holds great promise, and is long overdue.

Carl Icahn & Motorola: Are Big Changes Afoot?

Last May, I wrote this post when the Wall Street Journal's minority-owned 'breakingviews.com' group castigated Carl Icahn for trying to gain seats on Motorola's board.

The post contains two interviews with Icahn at that time, plus some then-current price charts of Motorola and the S&P500 Index.

This past Thursday, the Journal carried an article discussing Motorola's partial surrender to Icahn, in the form of their announcement to spin off the handset unit, though not necessarily until 2009.

Here's an updated five-year price chart for the company and the S&P500.

Clearly, things have only gotten worse since last spring.

On the face of it, Motorola's decision to simplify its business by ridding itself of the ailing handset business is sensible.

But Carl Icahn wants more assurances that things will change. For example, in the Journal article, he noted that the company's promise to spin off its handset business is not the same as actually getting it done expeditiously.

Further, Icahn reminded investors and the public that he complained last year when management badly missed quarterly performance targets. He still believes the company is poorly-managed, handset business or not. That's why he is still seeking four seats on the company's board.

Will any of this help the troubled communications equipment maker?

Spinning off or selling the handset business will be a good first step, as it seems, as run by Motorola, to be more like a fashion business than a solid equipment business. Having missed with customers after the now years-old, 'must have' Razr line, it is probably better off letting others manage the quixotic unit.

That will leave it with a clearer focus on networking equipment. The good news might be that most of the firm's awful performance since early 2006 has been handsets, and it will now right itself in short order.

Or, the bad news may be that Icahn was right to demand a large cash dividend, because the firm's core communications network business is also now hopelessly behind competitors.

Either way, I know I wouldn't be investing in the firm for some time to come.

Secretary Paulson Speaks To The Chamber of Commerce

Wednesday morning's speech by Treasury Secretary Henry Paulson to the US Chamber of Commerce contained several important points. But of all of the things he mentioned in his address, three stand out in my mind as crucial.


First, he explicitly spoke of the need to begin work on replacing today's crazy-quilt US financial regulatory scheme with a more simplified, streamlined, single-entity model.




Predictably, he began hinting that the Fed should assume this mantle. My own feeling is that it's unwise to overload the Fed with three missions. It should, ideally, still only have one, anyway- price stability/inflation.

Humphrey-Hawkins was a bad idea that has already brought the Fed under Congress' intimidation.


Assigning the Fed more regulatory duties in excess of what it has now is probably a bad idea. Should it be aware of a single regulator's findings and actions? Yes.


Second, he explicitly stated that he thought investment bank access to the Fed window was not meant to be permanent.


Nice try, Hank, but that's probably now irrelevant. Who among us, or, more importantly, investment bank CEOs, doesn't believe the Fed will do it again, when 'necessary?'


So much for enforcing moral hazard.

However, putting the first and second comments together, you can see the investment banks which want continued access to Fed funding being told they must look and act like a commercial bank, i.e., conform to the Basle accords on capital adequacy.

Oh dear. You mean de-lever an investment bank from 30x to a mere 12x capital? How will they ever make money that way? Underwriting commodity instruments, trading run-of-the-mill markets and doing some M&A advisory alone aren't going to make investors sit up and take notice of profits and growth.

As I contended in this recent post, I think you are looking at profound sector consolidation if the Fed window remains open to investment banks.


But to me, the most interesting and heartening message Paulson enunciated was on over-the-counter instruments, i.e., credit derivatives swaps. He called for an 'association' to be established with counterparty safeguards for clearing and settling.

That is, he means an exchange! He wants more transparency, counterparty capital adequacy, and fewer surprises among the participants in such markets.

As I suggested in two prior posts, including the one already linked, and this one, this month's action by the Fed concerning funding investment banks is an historic moment in our financial markets.

Every bit as significant and structure-altering as FDR's bank holiday and the 1914 establishment of our Federal Reserve System.

Ethan Penner's Misunderstanding of Mortgage Lending

Yesterday's Wall Street Journal featured an editorial by Ethan Penner, one-time head of Nomura's mortgage business, entitled "Of Markets and Mortgages."

Penner begins his defense of securitization, which is what his editorial really stresses, with this passage,

"Yet today we see the search for quick fixes and for villains, with securitization being identified as the chief culprit. Securitization is not the cause of the massive problems in our credit markets. The problems are due to basic mistakes that even the most unsophisticated among us can grasp. Lenders loaned too much money on too easy terms to borrowers who did not have the capacity to make their payments. No alchemy by even the brightest minds on Wall Street could turn bad loans into good assets. Sound simple? It really is."

What Penner writes is true. Unsound lending was and is at the core of the mortgage-related finance troubles. But he fails to note that much of the worst of the lending, the 'no money down' mortgages, were not intended to be held in portfolio, but securitized ASAP.

Penner continues in this vein a few paragraphs on, stating,

"The underwriting of risk in the past few years has, of course, not been so good, and securities backed by poorly underwritten loans are losing value daily. Yet the cry for systemic fixes from various constituencies has been dangerously off the mark. One common fix advocated is to abandon or de-emphasize mark-to-market accounting in favor of allowing companies to estimate an asset's "true" long-term intrinsic value. Another is to move away from securitization and return to a portfolio lending model -- where, for example, the bank originating a mortgage keeps it (in its own portfolio of assets), rather than selling it to a third party (as in securitization). Both fixes are tempting. Both are mistaken."

So Penner is about to disabuse us of the two major notions for repairing the current damage from bad lending and exotic structured finance instruments.

First, he deals with mark-to-market, opining,

"The desire to abandon or deemphasize the mark-to-market model is based upon the logic that, if the public didn't know how bad things were, then the all-important confidence in the system would not be at risk and we would be safer. The price to be paid -- the complete obfuscation of the truth -- is simply way too large."

That's it! Penner simply states, without any supporting statistical or other quantitative, descriptive evidence, that the reason we can't modify or adapt 'mark-to-market' is because it would result in 'complete obfuscation of the truth.'

But is that really true? What about the commercial bank investment account? We've lived with that for decades, and still do. Has that brought down our financial system? No.

Sometimes, when an instrument is truly held for income, to perpetuity, or for a long time, the current market value does not represent the value of the instrument to the holder. This could well be true for many institutional investors, especially pension funds, who hold structured finance instruments.

There are provisions for accounting for the value of such instruments by banks when the no longer perform, i.e., become delinquent or in default. But performing instruments thus benefit from a lack of pressure by markets to affect valuation decisions on performing instruments.

Penner then moves to defend his special co-contribution to our current finance system, the securitized mortgage,

"The argument in favor of portfolio lending is based upon the notion that, unlike securitization, portfolio lending incorporates the discipline of "skin in the game." Since, in the portfolio lending model, the loan's risk is not being transferred from the originator/lender, underwriters will therefore be more careful. But the anecdotal evidence just does not support this thesis. In the last major credit correction, it was portfolio lenders who violated prudent credit standards. And in this correction, many of the world's portfolio lenders are suffering the largest writedowns because of their bad credit decisions. Simply put, human nature exploits both models -- securitization and portfolio lending."

I believe Penner's 'analysis,' again, woefully devoid of any quantitative descriptions or statistics to support his weighty contentions, falls short on two counts.

First, I take issue with the 'fact' that 'many of the world's portfolio lenders are suffering the largest writedowns because of their bad credit decisions.' That rings false to me.

Merrill Lynch, Bear Stearns and Morgan Stanley took most of their write-offs from securities, not home loans. I don't recall specifically if Merrill's housing finance unit actually originated subprimes or not, but it clearly bought the unit to securitize the loans, not hold them. After all, Merrill could never use a commercial bank's 'investment account' approach to valuation, so it's unlikely they ever expected to hold any mortgage loans, as such. Even Citigroup's large SIV losses involved securitized mortgages, not the raw material.

Penner is simply deficient on this point. Without numbers to support his positions, I find them unbelievable.

His second error is less visible, but equally important. Penner glosses over why securitization is so much worse than experiencing the same dollar losses in portfolio lending.

The obvious first reason is that, with a bad bank portfolio, you know where the damage is. It's contained to a set amount within a known institution. Usually, FDIC-insured and Fed-supervised. Thus, arrangements to handle the losses and insulate the financial system, and depositors, from the fallout, are relatively easy and conventional.

When the mortgage losses bleed through countless tranches of countless CDOs scattered among investors worldwide, it's literally impossible to know the extent of the loss for each instrument and each (counter)party.

Thus, the uncertainty of the extent of loss for each participant becomes more important than the dollar value of the losses, because, with losses presumed to be resident somewhere, counterparty risk uncertainty skyrockets.

A useful, if unappetizing analogy, involves sewage systems. Which, sadly, appropriately represent much of the material 'pumped through' our financial system for the past few years.

Portfolio lenders essentially have individual septic systems. If they toss in the wrong material and or exceed the capacity of their own system, they suffer. But relevant regulatory and municipal officials can handle the damage and supervise remedies. Nobody else suffers very much, or for long.

Securitizing mortgages, especially suspect ones like subprimes, more closely resembles a situation in which each securitizer reaps a fee for pumping effluent into a common cesspool.

However, once the effluent leaves the securitizer's effluent outflow into the cesspool, the identity of its 'product' is masked. In fact, nobody knows exactly what, in total, is in the cesspool.

And since no one securitizer 'owns' the cesspool, none of them really care about its status. They are paid for pumping the maximum amount of effluent into the cesspool that they can, not for supervising the functioning of the cesspool.

Unless the operator, if there is one, of said cesspool charges an escrow fee by monitoring the effluent feeds into it, there's no negative consequence to the securitizer's if, one day, the cesspool closes, or otherwise becomes inoperable.

Penner ignores the greater motive of humans to misuse and abuse commonly-accessible resources, i.e., the cesspool-cum-financial markets, as opposed to at least trying to risk-manage their own asset portfolios.

Thus, prior mortgage-lending related bubbles and aftermaths have been relatively more easily cleaned up than this one has been.

Because we don't have 'owners' of markets, the cleanup is vastly different. In part, too, because investors may visit a market, buy some CDO, then leave, not being really 'in' the market anymore.

The insidious nature of distributed CDOs containing bad mortgages has had the most deleterious effect on our markets, not simply the size of the delinquencies or defaults.

This lack of knowledge of who might hold bad CDO paper is what has caused the credit market seizures- the implied or suspect counterparty risk.

None of this is evident, nor mentioned, in Penner's defense of the business he says he helped create.

No surprise there, eh?

Citibank-Travelers Merger & Rubin's Board Post

A funny thing happened the other day while I was talking with my friend and sometimes business partner, B.

In discussing the current commercial bank troubles, he noted something about Citigroup that I honestly had failed to notice.

As this article confirms, the Citi-Travelers merger, fomented by then-Travelers CEO Sandy Weill, occurred in 1998. At the time, Bob Rubin was Clinton's Treasury Secretary.

Approving the merger required the effective, de facto dismantling of Glass Steagall, the law prohibiting commercial and investment banking from existing in one institution. The post-1929 crash legislation was intended to prevent the practice of commercial banks originating questionable securities, then stuffing them into investor accounts or other vehicles which they would then market off of their balance sheets.

Is it not odd that, having carefully failed to raise any warning flags about this merger, Rubin subsequently became Chairman of Citigroup's board?

And not a notional chairman. Rather, Rubin is among the three most highly-paid executives at Citi.

Talk about conflict of interest!

It's not hard to connect the dots on this one, is it?

Rubin, as Treasury Secretary, remains silent on the most significant change in financial service regulation since the 1930s, allowing the Citi-Travelers merger to sail through Federal government scrutiny without trouble. It's not certain, but one can easily imagine Rubin cajoling various other parties, such as the Fed, DOJ, and anyone else with a voice, to go along with the move.

Upon leaving Treasury, Rubin becomes Chairman of the newly combined universal bank, Citigroup. Rubin is paid far more than this typically figurehead post commands.

Seven years later, Citigroup records record losses after five years of moribund management under Weill's successor, Chuck Prince. Rubin has remained inactive in addressing Prince's failures for the half decade during which the bank languishes.

Isn't it funny how nobody in Congress has pointed a finger at Rubin's involvement in this mess? If anyone could have called a halt to Weill's rush to merge the two firms and destroy a decades-old, effective bar to the practices which, once again, led to our current credit market troubles, Rubin was probably the guy.

With his Goldman Sachs pedigree and influence over the President whom he served at Treasury, Just a few comments from Rubin would have stopped the merger cold.

Instead, Rubin's inaction led directly to the financial excesses we see today in the mortgage and securities markets.

Pandit Settles In At Citigroup With His Colleagues & Big Bonuses

To paraphrase Clint Eastwood's "Dirty" Harry Callahan's character from the 1971 movie Dirty Harry,

'Now in all the financial services excitement of the past few weeks, I can't remember if I covered Citigroup's latest indiscretions. Well, do you feel lucky, Vikram?'

You probably think I forgot all about Pandit's Citigroup. But I haven't. Right now, I'm eyeing a short stack of Wall Street Journal articles going back to early March.

The first article, from the March 5th issue of the Journal, catalogues the reasons why Citi's stock price was under assault in recent months. Without providing all the details of the now nearly month-old piece, suffice to say, Citi looked unusually exposed, going forward, to more loan losses and slowing growth.

The nearby pictures, including the smirking visage of Mr. Pandit, accompanied the article.

I found this article concerning Pandit's recent compensation numbers, since I had not saved the Journal's piece on this stunner. It reads, in part,

"Citigroup Inc.'s new chief executive Vikram Pandit received $3.16 million in total compensation during 2007 - the year that started with him running his own hedge fund and ended with him at the top of the largest U.S. bank by assets.

And to convince Pandit to stay with the troubled bank while he works to extricate it from losing bets on mortgages and the now-frozen credit markets, Citigroup's board in January signed off on awards valued at about $102 million. That includes a $2.5 million retention equity award; nearly $27 million worth of stock, and 3 million options that in January were worth around $73 million.

For his six months at Citigroup last year, Pandit received a salary of $250,000, according to a Thursday regulatory filing. He received no cash bonus and no perks, but got stock and option awards in July worth $2.91 million."

As I wrote here in late December of last year, Pandit already had a "can't lose" proposition from the Citigroup board. About a week earlier, I wrote this spoof of a hypothetical interview with Pandit, upon his elevation to Citi CEO. As I note in the piece, Pandit and his partner, John Havens, have already received some $800MM for their underperforming hedge fund group, Old Lane Partners.

Now, in concert with the special awards to 'retain' Pandit in this already-plum job, they also elevated his erstwhile hedge fund partner, now Citi confidant, John Havens. Havens, as I recall from the Wall Street Journal article, also received a nice bonus to stay in his cushy new job, as well.

Let's be truthful here. Does anyone besides Citi's board think that Pandit and Havens are likely to bolt their new, overpaid positions running Citigroup? These guys were trying to keep an underperforming hedge fund in business less than a year ago, and now Pandit is CEO of one of the country's three largest commercial banks. His former partner is still his right-hand man at the new firm.

If we needed yet another glaring example of pay for non- or yet-to-be performance, besides Jeff Immelt's, on which I commented in this recent post, this would be it.

Then, last friday, the Wall Street Journal reported that Citigroup is to lay off an additional 2,000 staffers. The article stated,

"Mr. Pandit and other senior officials had said previously that multiple rounds of layoffs are one component of a broad cost-cutting strategy that the bank is undertaking as a result of investment losses stemming from the mortgage crisis. Citigroup has been hit particularly hard by the crisis, having written down the value of its assets by more than $20 billion in the last year."

This distinctive drawing of Pandit accompanied the article. Once again, the CEO is caught in a laughing expression.

It's almost as if he's saying,

'Ha ha, the joke is on you guys! I got the CEO job and millions in compensation, but you get the sack!'

Just a friendly aside. If I were Vikram Pandit, I'd contrive, with my public relations staff, to arrange for some better photo ops to let me show some more concerned, business-like facial expressions. Anything to dispel these grinning, smirking countenances amidst the business of firing people and presiding over record losses at Citigroup.

In the final analysis, does Citigroup's board really believe they need to further incent Pandit and Havens to keep these jobs? My earlier post about Pandit's can't lose situation suggests that he isn't going anywhere for a while. He has nothing to gain by leaving. Neither does Havens.

As the nearby, Yahoo-sourced price chart of Citi and the S&P500 Index for the past three months shows, it's a bit early to reward Pandit for any 'success.' One brief bounce does not a recovery make. So we know these awards are not for his performance of the past few months.

Yes, I know the awards are equity-based in large part. But it's the image that counts, and right now, it appears that the board is just throwing potential windfalls at Pandit.

If Citi really wants to reduce expenses, how about starting at the top?

Glass-Steagall, The Fed & Investment Bank Access- Part 2

Last week, exactly a week ago, I wrote my initial thoughts on what I consider to be the most important single US financial services event since FDR- Bernanke's Fed opening the discount window to non-commercial, investment banks.


In the week since, if anything, my conviction on how much of a watershed event this was has grown.


Paradoxically, my sense of the importance of the 'rescue' of Bear Stearns has shrunk, if it could. Yesterday, I wrote about the implied capacity in the market of various investment banking functions- underwriting, trading and M&A advice. I omitted asset management, but that is clearly a sector with nearly-unlimited capacity.

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

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

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

I suppose, in light of the new developments, Kessler might now be correct in hypothesizing that a Goldman Sachs might backward integrate, and merge with the commercial bank of its choice. But, absent the recent development with the Fed window's opening to non-commercial banks, I would not have thought that likely.

What puzzles me is how many people, when I comment on last week's watershed event, respond with,

'Oh, yes, the Bear Stearns bailout.'

It seems that the bulk of investors, institutional and retail, don't yet fully grasp the incredibly large step toward socialized finance that the Fed took on Monday of last week. Unless they can actually retract this access at some point, and close the window to investment banks, and make investors and financial service providers believe it won't ever happen again, then the industry's structure has now changed irrevocably.

From such landmark change must logically follow changes in the structure of firms and regulation. Whether a Republican or Democratic Congress and/or President, the next few years pretty much require the follow-up explicit regulatory finish to the implicit structural changes that led to this point, i.e., Sandy Weill's breach of Glass Steagall by merging Travelers with Citibank.

It's unlikely, but still possible, that a Democratic Congress would repair the breach and resurrect some version of Glass Steagall, perhaps even legislatively prohibiting the Fed's jurisdiction over non-commercial banking.

However, I think the more likely avenue, now that the breach has been widened to actually level the wall entirely, is to simplify regulation and, consequently or in tandem, see a streamlining of service providers and their composition.

Specifically, I would expect fewer separate publicly-held, regulated entities such as commercial banks, investment banks, and brokers. Instead, I think you will finally see the integration of these functions into fewer, larger and more diversified European-style universal banks, with larger shares of more financial services businesses.

Of course, with this 'bulking up' will probably come even more anemic, inconsistent total return performances. Again, just like that of European universal banks.

Seen from a more distant vantage point, does this not all make some sense? We had a concentration of financial capacity and risk taking among lightly-regulated firms specializing in peddling ever-more opaque, complex products to investors. When the value of these complex 'structured finance' instruments became difficult to discern, and the concentrated risk came home, capital shrank as losses among commercial and investment banks caught holding these instruments had to account for the newer, dramatically lower values.

It's a sad commentary on the acumen of the CEOs and senior managements running these firms: Citigroup, BofA, Merrill Lynch, Morgan Stanley, and Bear Stearns. The natural, if erratically-timed governmental response, is to save the financial system, and, thereby implicitly restructure the sector.

Risk and capacity are likely to be further concentrated, but, in exchange, more tightly overseen and regulated.

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

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

Now that the public is absorbing the brunt of the losses, via equity ownership of these firms, the logical next step is for the better executives to join the early-adopters in forming new, or joining existing private equity and hedge fund shops.

And the wheels continue to turn......