I just finished watching more than half of CNBC's special program, "House of Cards," written by, I believe, and starring David Faber.
The program was extremely well done. It captured various elements of the financial and real estate systems, regulators, their interactions, and the consequences of all of their actions over the past eight years.
Of particular effect, and interest, was the inclusion of European municipal investors in CDOs, the mortgage- and other debt-backed structured finance instruments, as well as lenders and borrowers of mortgage money fueling the manufacture of such instruments.
As I listened to the mayor of Narvik, Norway, accuse American banks, European financial products salesmen, and ratings agencies of misleading her, and her town council, so that they bought CDOs, I could not help but detect a strong odor of denial.
The woman clearly admitted that the financial products vendor told the town's council that CDO yields would be higher than that of safer instruments. They bought this lie, and even admitted, after the fact, that they had no idea what they actually had purchased. Neither did their banker, nor, the banker thought, did the salesman of the products.
If you're like me, by now, you are asking yourself how anybody can protect these clueless municipalities from buying instruments they don't understand. Or even actually know, in detail.
It's one thing to buy a AAA-rated American municipal or corporate bond. It's quite another to buy a newly-issued, untested structured finance instrument, also AAA-rated, the yield on which is higher than expected.
Several California home buyers admitted they neither understood, nor could afford their mortgages. Yet they still accused their lenders of guilt in lending them the money for their house.
A mortgage banker solemnly asserted that, although he knew low-doc and no-doc mortgages would blow up, he had to lend, or else he'd have to close down, as other lenders made such loans.
Of course, he had to close eventually, because the few low-doc subprime loans he made, when in default, wiped out his firm.
Even Alan Greenspan impassively claimed that he could not have popped the housing finance bubble if he'd wanted to, because Congress would have been unhappy with the resulting halt in low-income housing sales, as well as the consequential economic recession.
It seems everyone has someone else to blame.
But nobody seems to really take responsibility for their own part. Greenspan blames Congress. Congress blames mortgage bankers, securitizers, and regulators. Regulators blame a lack of funding from Congress. Investors blame rating agencies. Congress blames rating agencies. Rating agencies claim they did nothing wrong. Lenders blame borrowers and securitizers.
When Faber ends the program asking each person what they learned, and if they feel guilty of any wrongdoing, they all claim to simply be a part of a chain of players and events which, together, caused the problem. Nobody took responsibility for his or her part.
Even the mayor of Narvik somewhat disingenuously claimed that she had learned two things; not to trust financiers in Armani suits, and; if something seems to good to be true, it probably is.
The sad thing is, that second lesson is the very first lesson in finance. And why was the Narvik town council borrowing against the municipal power generation plant's future revenues to buy CDOs without professional advice in the first place?
But perhaps the most searing and revealing moment in the entire program, during the time I watched, was the last scene. Faber is closing his interview with the guy, whose name escapes me, who was head of structured financial product creation for Bear Stearns. The man wisely and propitiously left the firm just weeks before its demise, and now pursues photography. He clearly was not ruined in the aftermath of the failed investment bank.
When Faber asks him if he feels guilty for his role in the mess, the man moves to speak. But cannot. He looks away, snorts, shrugs, but Faber and the camera will not be denied.
Eventually, holding back obvious grief, guilt, and shame, trying desperately to decide, in an instant, whether to admit the truth on global television, or not, the man sniffs and says he was just part of a larger chain....yada....yada....yada......
It's a very poignant and sad moment. You can actually see this man choose denial, lying, and a loss of ethics in favor of avoiding responsibility for his and his firm's actions in the overall financial markets excess of the past decade.
There were and are many guilty parties. There's no doubt about that. But at the end of the day, I can't help but focus on two types of parties in particular.
Those who borrowed money to buy houses using mortgages they both did not understand, and could not afford. And those institutional investors, including small town mayors and councils in Europe and America, who bought what they believed to be high yielding structured securities, for less money than was expected, as I wrote about here, thinking they were getting extra yield for free.
Granted, those in the middle of the chain, between these two types of parties, committed fraud, excess, and errors of judgment. But none of it would have been sustainable without the uncoerced behavior of mortgage borrowers and structured financial instrument buyers. These parties received what they asked for.
What happened to them was, truly, just. They simply don't want to admit that, and take responsibility now for their prior actions. It's easier for them to blame somebody else.
Friday, February 13, 2009
Recalling Milton Friedman When We Need Him More Than Ever
These days, I'm probably not alone in missing the recently deceased economist Milton Friedman.
With so much seeming to go wrong in our economy, his voice of calmness, stability and personal responsibility is sorely missed.
For example, Friedman would have clucked at Alan Greenspan's ill-advised pumping of the money supply early in this decade, as well as the seemingly ad hoc flooding of more money via ever-lower rates under Bernanke for the past 15 months.
Instead, Milton would have counseled a steady growth in money supply at an automatic rate. This would have mitigated much of the housing boom excess and, thus, probably indirectly avoided the consequent real estate and mortgage-backed structured finance market collapses.
Along with his co-author, Anna Schwartz, it's quite likely Friedman would have correctly noted that liquidity was not the problem in our economy for the past year and a half. Rather, it was bank asset quality and solvency.
Finally, the Nobel laureate would doubtless have publicized the flaws in thinking behind the latest trillion-dollar "stimulus" package. Having close acquaintance with the economic facts of the Great Depression, Friedman would have argued for permanent tax cuts to affect the permanent incomes of taxpayers, rather than excessive government spending and temporary fiddling with tax rebates.
Further, he would have continued to champion government actions promoting individual freedoms, rather than mega-spending programs drawing even more power to politicians, and away from average citizens.
Maybe somebody can channel his spirit, pending his reincarnation.
With so much seeming to go wrong in our economy, his voice of calmness, stability and personal responsibility is sorely missed.
For example, Friedman would have clucked at Alan Greenspan's ill-advised pumping of the money supply early in this decade, as well as the seemingly ad hoc flooding of more money via ever-lower rates under Bernanke for the past 15 months.
Instead, Milton would have counseled a steady growth in money supply at an automatic rate. This would have mitigated much of the housing boom excess and, thus, probably indirectly avoided the consequent real estate and mortgage-backed structured finance market collapses.
Along with his co-author, Anna Schwartz, it's quite likely Friedman would have correctly noted that liquidity was not the problem in our economy for the past year and a half. Rather, it was bank asset quality and solvency.
Finally, the Nobel laureate would doubtless have publicized the flaws in thinking behind the latest trillion-dollar "stimulus" package. Having close acquaintance with the economic facts of the Great Depression, Friedman would have argued for permanent tax cuts to affect the permanent incomes of taxpayers, rather than excessive government spending and temporary fiddling with tax rebates.
Further, he would have continued to champion government actions promoting individual freedoms, rather than mega-spending programs drawing even more power to politicians, and away from average citizens.
Maybe somebody can channel his spirit, pending his reincarnation.
Thursday, February 12, 2009
Readers "Express" Outrage At AmEx
On rare occasions, I follow up one of my posts due to reader comments. When a post is over a week old, the odds of comments on it being read by others declines markedly, absent the piece being found by direct searches.
Thus I found it interesting to draw attention back to this late January post concerning American Express' recent results and less-obvious actions regarding its customers.
Here are two comments on the anecdote concerning a colleague who was badly-treated by the credit card firm. The first comment contains an absolutely stunning account of credit management,
"Anonymous said...
Well they just did it to me. My credit line went from $13,000 to $1,800. It left one of my drivers stranded at a gas station out of town. Thank you Un-American Express."
And this one is on a par with the story in my post,
"Anonymous said...
My credit line was cut 40% for no reason. I haven't missed any payments and my business is growing. Bad leadership. Bad business."
Evidently, the credit limit shrinkage at AmEx is both real and widespread. Chances are good this will lead to even lower revenues and profits at the firm.
Anyone for shorting AmEx?
Thus I found it interesting to draw attention back to this late January post concerning American Express' recent results and less-obvious actions regarding its customers.
Here are two comments on the anecdote concerning a colleague who was badly-treated by the credit card firm. The first comment contains an absolutely stunning account of credit management,
"Anonymous said...
Well they just did it to me. My credit line went from $13,000 to $1,800. It left one of my drivers stranded at a gas station out of town. Thank you Un-American Express."
And this one is on a par with the story in my post,
"Anonymous said...
My credit line was cut 40% for no reason. I haven't missed any payments and my business is growing. Bad leadership. Bad business."
Evidently, the credit limit shrinkage at AmEx is both real and widespread. Chances are good this will lead to even lower revenues and profits at the firm.
Anyone for shorting AmEx?
Carl Icahn On Boards, Governance & Compensation
Activist investor and former corporate raider Carl Icahn weighed in on executive compensation, boards and corporate governance again in this past weekend's edition of the Wall Street Journal. Building on the recent government-mandated restrictions on compensation for executives of banks receiving Federal investment, Icahn renewed his calls for corporate governance reform.
As he did in the editorial on which I commented in this post only a few weeks ago, Mr. Icahn writes scathingly of entrenched boards and executives. This time, he highlights his own organization, United Shareholders of America, urging readers to join it and him.
While I respect Mr. Icahn's accomplishments, attitudes and actions, the problem I continue to have remains what I wrote in the prior, linked post,
"It all sounds good, and very patriotic. But, really, just how do thousands of individual shareholders mount an attack upon a few members of the board of a large corporation?
Why isn't plain old share price the best investor weapon? Sell shares of companies you don't want. If enough shareholders do this, and other investors short the stock, the price will fall to a level that makes current management vulnerable; to creditors, predators, or simple liquidation, at which point some better management team swoops in to recover any salvageable value.
What's wrong with this scenario? Isn't it the ultimate in capitalist retribution? A poorly-run company simply loses value, until it no longer has capital with which to operate?"
I just don't see how shareholder maneuvering accomplishes anything, unless you happen to be able, like Mr. Icahn, to buy sufficient shares to challenge the board, gain a seat, etc.
But isn't this just exchanging one small group of controlling people for another? What if you don't happen to agree with Mr. Icahn on his choice of targets?
It just seems to me that really pure capitalism uses price- and little else- as the signal and weapon with which to discipline companies and their executives.
Isn't this process how it should work?
1. Company management entrenches itself while the board cooperates.
2. Management begins to enrich itself at shareholder expense, while business falters.
3. Business continues to weaken while executives continue to become wealthy.
4. Non-shareholders don't bid the company's equity up, while disgusted shareholders sell.
5. Equity price gradually, then more quickly, falls.
6. Executives can't raise fresh capital, losses mount, and firm becomes target for takeover.
7. Eventually, another company buys the ailing firm, or it files Chapter 11.
Short-circuiting this process via some sort of shareholder action seems, to me, beside the point. First, you're asking thousands of shareholders who don't know each other to agree on a common action.
It's one thing to want current management out. But what next? How do thousands of unacquainted company owners do this? They don't trust the board, but how do these thousands of individual owners assemble a workable new slate of directors?
It's feasible for Carl Icahn to do these things himself. He can amass large positions in target companies, assemble board candidates, and even articulate solutions for the company's ills. But that's not mass shareholder action. That's one wealthy activist or large fund manager behaving like Eddie Lampert.
How well is Sears doing since his takeover of the retailer?
Call me simple, but in my book, a liquid market with very low barriers to buying and selling shares is the best form of corporate governance.
Let equity prices do their work, and skip the heated arguments over more legislation and regulation over corporate boards and their actions.
As he did in the editorial on which I commented in this post only a few weeks ago, Mr. Icahn writes scathingly of entrenched boards and executives. This time, he highlights his own organization, United Shareholders of America, urging readers to join it and him.
While I respect Mr. Icahn's accomplishments, attitudes and actions, the problem I continue to have remains what I wrote in the prior, linked post,
"It all sounds good, and very patriotic. But, really, just how do thousands of individual shareholders mount an attack upon a few members of the board of a large corporation?
Why isn't plain old share price the best investor weapon? Sell shares of companies you don't want. If enough shareholders do this, and other investors short the stock, the price will fall to a level that makes current management vulnerable; to creditors, predators, or simple liquidation, at which point some better management team swoops in to recover any salvageable value.
What's wrong with this scenario? Isn't it the ultimate in capitalist retribution? A poorly-run company simply loses value, until it no longer has capital with which to operate?"
I just don't see how shareholder maneuvering accomplishes anything, unless you happen to be able, like Mr. Icahn, to buy sufficient shares to challenge the board, gain a seat, etc.
But isn't this just exchanging one small group of controlling people for another? What if you don't happen to agree with Mr. Icahn on his choice of targets?
It just seems to me that really pure capitalism uses price- and little else- as the signal and weapon with which to discipline companies and their executives.
Isn't this process how it should work?
1. Company management entrenches itself while the board cooperates.
2. Management begins to enrich itself at shareholder expense, while business falters.
3. Business continues to weaken while executives continue to become wealthy.
4. Non-shareholders don't bid the company's equity up, while disgusted shareholders sell.
5. Equity price gradually, then more quickly, falls.
6. Executives can't raise fresh capital, losses mount, and firm becomes target for takeover.
7. Eventually, another company buys the ailing firm, or it files Chapter 11.
Short-circuiting this process via some sort of shareholder action seems, to me, beside the point. First, you're asking thousands of shareholders who don't know each other to agree on a common action.
It's one thing to want current management out. But what next? How do thousands of unacquainted company owners do this? They don't trust the board, but how do these thousands of individual owners assemble a workable new slate of directors?
It's feasible for Carl Icahn to do these things himself. He can amass large positions in target companies, assemble board candidates, and even articulate solutions for the company's ills. But that's not mass shareholder action. That's one wealthy activist or large fund manager behaving like Eddie Lampert.
How well is Sears doing since his takeover of the retailer?
Call me simple, but in my book, a liquid market with very low barriers to buying and selling shares is the best form of corporate governance.
Let equity prices do their work, and skip the heated arguments over more legislation and regulation over corporate boards and their actions.
Wednesday, February 11, 2009
Roy Smith On Investment Banking, Compensation & Greed
Former Goldman Sachs partner and current NYU finance professor Roy C. Smith wrote a lengthy piece in the weekend edition of the Wall Street Journal entitled, "Greed Is Good."
In his extensive piece, Smith paints the more complete and fair picture of the old Wall Street, a/k/a investment banks, compensation structure, in order to raise some warnings about the effects of the recent compensation caps, and predict some structural changes.
Among other points, Smith notes that many- perhaps thousands- of well-paid investment bankers at Bear Stearns and Lehman lost assets, jobs and companies. This, too, is part of the risk-taking environment which produced such lavish bonuses over the past few decades.
Smith also does a great job tracing the evolution of investment banking from when all of the firms were private partnerships. He, as I have done, notes the entry of commercial banks into traditional investment banking turf as the beginning of the end of the sector.
My mentor at Chase, Gerry Weiss, had predicted this years in advance. As the less-adept, more ham-handed commercial banks began to underwrite securities, margins shrank, volumes had to increase and instruments had to become more opaque in order to justify spreads and maintain revenues and profits.
Eventually, everybody levered up, and the once-private investment banks, having mostly gone public with the deregulatory "Big Bang" of the 1970s, mostly used other people's money to run much more risky businesses, while paying themselves healthy bonuses in good years.
Smith points out, with which I agree and have also stated, that the logical consequence of the recent vaporization of publicly-held investment banks, is a return to boutique, private partnership investment banking. The compensation caps really won't, by themselves, cause talent to leave the commercial banks for the private investment banks.
But they will set a tone that will probably trickle down. And, anyway, investment banking at a commercial bank simply isn't the same as doing it at a pure investment bank, even with the abolition of Glass-Steagal.
Smith endorses the practice of making large compensation payments vest over some years, in order to make them conditioned on continued profitability. Again, a topic on which I have written, in one form or another, for years. Specifically, I've recommended that large components of senior executive compensation be tied to outperforming the S&P500 over a five year period, in arrears. Thus, if performance lags, the payment in any given year for the prior five-year period shrinks. This is the sort of idea now gaining currency in the remaining publicly-held institutions having to grapple with this dilemma.
I like Smith's sense of history. He notes how the regulatory backlash to the 1920s and market crash of '29 resulted in relatively low financial services compensation until the 1980s. Which, by the way, was about the time the previously-privately-held investment bank partnerships began to swell with public money and pay more lavishly.
On the subject of the systemic risks taken by most, if not all, of these banks, which eventually came home to roost via mortgage-backed CDOs and such, Smith and I agree that, in the future, it's likely that such risk will be minimized only by the existence of many smaller investment banks, rather than a few large ones.
Even now, as I discussed with a Morgan Stanley employee at a social function this past Sunday, quite a few large hedge funds and private equity shops, not to mention the explicitly-identified boutique investment banks, stand ready to re-enter the riskier areas of underwriting and trading in the coming months and years. As private firms, they have no shareholders ranting at annual meetings, need justify their compensation to no external parties, and can only grow at the rate at which their private capital allows, plus judicious borrowing.
As Smith notes, the industry will reinvent itself, and, in fact, already has. My various posts about Blackstone and other private equity shops noted this as far back as the 2007 IPO of that large private equity enterprise.
In truth, as usual, what we see happening with compensation, regulation and risk management of the remaining former-investment banks-cum-commercial banks, Goldman and Morgan Stanley, and the crumbling commercial banks, Citigroup and BofA, is simply the tidying up of the worst-performing, hind-end of the sector. The better players and their capital departed those publicly-held firms over a decade ago, the better to ply their trade in stealth and away from excessive governmental intervention.
Though he didn't write that, I believe Mr. Smith would agree with me on that last point.
In his extensive piece, Smith paints the more complete and fair picture of the old Wall Street, a/k/a investment banks, compensation structure, in order to raise some warnings about the effects of the recent compensation caps, and predict some structural changes.
Among other points, Smith notes that many- perhaps thousands- of well-paid investment bankers at Bear Stearns and Lehman lost assets, jobs and companies. This, too, is part of the risk-taking environment which produced such lavish bonuses over the past few decades.
Smith also does a great job tracing the evolution of investment banking from when all of the firms were private partnerships. He, as I have done, notes the entry of commercial banks into traditional investment banking turf as the beginning of the end of the sector.
My mentor at Chase, Gerry Weiss, had predicted this years in advance. As the less-adept, more ham-handed commercial banks began to underwrite securities, margins shrank, volumes had to increase and instruments had to become more opaque in order to justify spreads and maintain revenues and profits.
Eventually, everybody levered up, and the once-private investment banks, having mostly gone public with the deregulatory "Big Bang" of the 1970s, mostly used other people's money to run much more risky businesses, while paying themselves healthy bonuses in good years.
Smith points out, with which I agree and have also stated, that the logical consequence of the recent vaporization of publicly-held investment banks, is a return to boutique, private partnership investment banking. The compensation caps really won't, by themselves, cause talent to leave the commercial banks for the private investment banks.
But they will set a tone that will probably trickle down. And, anyway, investment banking at a commercial bank simply isn't the same as doing it at a pure investment bank, even with the abolition of Glass-Steagal.
Smith endorses the practice of making large compensation payments vest over some years, in order to make them conditioned on continued profitability. Again, a topic on which I have written, in one form or another, for years. Specifically, I've recommended that large components of senior executive compensation be tied to outperforming the S&P500 over a five year period, in arrears. Thus, if performance lags, the payment in any given year for the prior five-year period shrinks. This is the sort of idea now gaining currency in the remaining publicly-held institutions having to grapple with this dilemma.
I like Smith's sense of history. He notes how the regulatory backlash to the 1920s and market crash of '29 resulted in relatively low financial services compensation until the 1980s. Which, by the way, was about the time the previously-privately-held investment bank partnerships began to swell with public money and pay more lavishly.
On the subject of the systemic risks taken by most, if not all, of these banks, which eventually came home to roost via mortgage-backed CDOs and such, Smith and I agree that, in the future, it's likely that such risk will be minimized only by the existence of many smaller investment banks, rather than a few large ones.
Even now, as I discussed with a Morgan Stanley employee at a social function this past Sunday, quite a few large hedge funds and private equity shops, not to mention the explicitly-identified boutique investment banks, stand ready to re-enter the riskier areas of underwriting and trading in the coming months and years. As private firms, they have no shareholders ranting at annual meetings, need justify their compensation to no external parties, and can only grow at the rate at which their private capital allows, plus judicious borrowing.
As Smith notes, the industry will reinvent itself, and, in fact, already has. My various posts about Blackstone and other private equity shops noted this as far back as the 2007 IPO of that large private equity enterprise.
In truth, as usual, what we see happening with compensation, regulation and risk management of the remaining former-investment banks-cum-commercial banks, Goldman and Morgan Stanley, and the crumbling commercial banks, Citigroup and BofA, is simply the tidying up of the worst-performing, hind-end of the sector. The better players and their capital departed those publicly-held firms over a decade ago, the better to ply their trade in stealth and away from excessive governmental intervention.
Though he didn't write that, I believe Mr. Smith would agree with me on that last point.
Tuesday, February 10, 2009
Starbucks Muddled Marketing Messages
Yesterday's Wall Street Journal carried a rather surprising article about Starbucks. It seems they have actually been offering some marketing promotions as long ago as last summer, wherein the purchase of a morning coffee led to a discount on an afternoon beverage purchase.
Who knew? As I noted in this post from last April, CEO Howard Schultz and his marketing chief, Michelle Gass, seemed rather confused about what was ailing their firm. They thought it was only their own strategies, and not competition. Somehow, Dunkin' Donuts' and McDonalds' explicit targeting of premium coffee drinkers escaped Schultz' and Gass' notices.
I was amazed to read in yesterday's piece that prices between Starbucks and its two main competitors, McDonalds and Dunkin' Donuts, have narrowed. That, in some instances, on a per-ounce basis, Starbucks is actually less expensive than Dunkin'.
Further, in a total about-face from removing food from their menu, Starbucks is now offering a food-and-coffee combo at a discount. But when asked about simply cutting coffee prices, Gass replied,
"Today, no. But never say never."
I guess the food reversal proves this out. But what I wonder is whether Schultz, Gass and their colleagues actually have any sort of larger marketing and product strategy in mind? Or are they just making these tactics up as they go along?
My own guess is the latter. How could they have reversed on providing food if they had done research and looked at their own customer buying information in the first place? It's not the sort of misstep you typically make if you are a data-driven marketer.
But it does smack of a sort of image- and mission-oriented marketing and business philosophy for which Howard Schultz is well known.
Unfortunately, that sort of business focus can lead to tragic mistakes, as market, customer and competitive realities are tuned out, in favor of 'the mission.'I suppose a shareholder could be grateful that, as the nearby chart indicates, the company's equity price has pretty much tracked the S&P500 Index for the past six months. After all, this must have been a rocky period for the coffee giant, what with consumer luxury spending declining.
The question would seem to be, though, can Starbucks really manage to breakout above the index, and for a long time- several years? Because if it can't, then it has simply become another fallen star whose prospects for consistent, profitable growth are gone, and for whom competition and a saturated market spell mediocrity for the foreseeable future.
Sad to say, statistics and Schumpeterian dynamics suggest that it will be the latter.
Monday, February 09, 2009
Paul Romer's "New" Bank Scheme
Stanford Institute for Economic Policy Research senior fellow Paul Romer wrote a succinct piece in Friday's Wall Street Journal arguing for the the creation of new banks, rather than allocating Federal assets to shore up existing, crippled banks. It is reminscent of the Journal's similar article by Dennis Berman back in November, about which I posted here.
I didn't think much of Berman's idea then, and I don't feel Romer's prescription is actually any better. Or different, for that matter.
But Romer points out why a new bank might be better than Federal support for a crippled one, i.e., no messy valuation problems going forward.
That brought me to Anna Schwartz' comments in the interview with her in the Journal back in October, which elicited this post.
Schwartz asserted, correctly, I believe, that the current problem, unlike the Depression, is not liquidity, but discerning which banks are healthy. Investors won't buy into banks whose assets are of questionable value.
Thus, putting the two streams of thought together, one arrives at the unmistakable conclusion that, whether by straightforward write-offs, or modified mark-to-market policies reflecting actual economc value, impaired assets should be properly valued, insolvent banks closed and/or merged, and the results allowed to either decrease excess banking capacity, or allow existing, healthy banks to take up the slack.
Either way, it's really unclear now why we need Federal investment in banks, short of an explicit nationalization policy. Having had time, since September's bank panics, to see that the largest US commercial banks now fall into one of two groups.Citi and BofA sell at as much as a 70% discount to their values back in September of last year. Wachovia and WaMu don't even exist now.
Chase and Wells Fargo track the S&P fairly closely, indicating less concern over their viability and asset valuations.
Doesn't this indicate that banking, in general, is not at risk. Just the two most problematic commercial banks.
If the Feds simply enforced sensible valuation at Citi and BofA, then determined capital adequacy, and closed either or both, if necessary, we'd probably be out of the woods, with respect to commercial banking stability, right now.
If more capacity is required in the sector, we'll know by growing loan profit margins and growth rates. And fresh capital will naturally seek out these businesses and compete the excess profits away. Without undue goverment manipulation and interference.
Friday, February 06, 2009
Uncle Sam Outdoes The Mob
I read yesterday's Wall Street Journal piece detailing how the US government, primarily in the form of Fed Chairman Ben Bernanke, muscled BofA CEO Ken Lewis into a bad deal for his shareholders.
From the article, it's clear that Uncle Sam has rapidly replaced organized crime as a businessman's worst nightmare.
How in the world have we gone from a democracy of relatively freely-operating businesses, to a nation in which our own government coerces businessmen to behave against the best interest of their owners, in only a few months?
This is why I oppose continuing heavy Federal intervention in the private sector, under the excuse of a recession.
It's one thing to nationalize commercial banking in the long term interest of a more stable monetary and economic environment. But that doesn't require government purchase of those banks. Simply new operating rules, to which the affected firms' owners will adapt. As the value of commercial banking declines, so, too, will compensation, returns, profits, etc.
But to have government buy into firms, and then coerce their decisions with threats of replacing executives, withholding further funding, and who knows what else, is hardly how we, in America, have seemed to want to conduct private enterprise.
I found the article chilling in its description of how Bernanke and his colleagues rode roughshod over private property rights in the name of the 'public good.'
Perhaps better, further-seeing monetary supply management by the Fed, and more reasoned, less panicked reactions by Treasury and the Fed during 2007 & 2008 would have resulted in a smaller, but healthier financial services sector.
Anna Schwartz was right. The problem isn't liquidity, it's not knowing the long term solvency of commercial banks.
If affected shareholders and institutions had been allowed to fail, healthy banks allowed to assume the remnants, and bad loans written off, then there would now be room for whatever new capital is appropriate for the commercial banking sector.
Instead, we have a mess on our hands. We have the nation's money supply authority muscling private institutions to do the government's bidding, or else.
A very sad state of affairs.
From the article, it's clear that Uncle Sam has rapidly replaced organized crime as a businessman's worst nightmare.
How in the world have we gone from a democracy of relatively freely-operating businesses, to a nation in which our own government coerces businessmen to behave against the best interest of their owners, in only a few months?
This is why I oppose continuing heavy Federal intervention in the private sector, under the excuse of a recession.
It's one thing to nationalize commercial banking in the long term interest of a more stable monetary and economic environment. But that doesn't require government purchase of those banks. Simply new operating rules, to which the affected firms' owners will adapt. As the value of commercial banking declines, so, too, will compensation, returns, profits, etc.
But to have government buy into firms, and then coerce their decisions with threats of replacing executives, withholding further funding, and who knows what else, is hardly how we, in America, have seemed to want to conduct private enterprise.
I found the article chilling in its description of how Bernanke and his colleagues rode roughshod over private property rights in the name of the 'public good.'
Perhaps better, further-seeing monetary supply management by the Fed, and more reasoned, less panicked reactions by Treasury and the Fed during 2007 & 2008 would have resulted in a smaller, but healthier financial services sector.
Anna Schwartz was right. The problem isn't liquidity, it's not knowing the long term solvency of commercial banks.
If affected shareholders and institutions had been allowed to fail, healthy banks allowed to assume the remnants, and bad loans written off, then there would now be room for whatever new capital is appropriate for the commercial banking sector.
Instead, we have a mess on our hands. We have the nation's money supply authority muscling private institutions to do the government's bidding, or else.
A very sad state of affairs.
Harry Markopolos' 15 Minutes of Fame
I caught the Congressional testimony of self-designated Madoff investigator and portfolio manager Harry Markopolos this past Wednesday. It was quite a show. In effect, Harry got his 15 minutes of Warholian fame, and, boy, did he make the most of it.
It's hard to decide which was more stomach-churning; the sight of Markopolos puffed up with self-importance, pontificating on all sorts of matters about which he has little knowledge, or; various Congressional members hanging on his every word, as if he receives Truth directly from God.
Perhaps the most chilling moment was when Markopolos, in response to a question, solemnly recommended that SEC personnel be compensated by bounties from pursuing investigations. Imagine the world which that would create. Numerous Inspector Javerts accusing many investment managers, rightly or wrongly, since they would pay no penalty for an erroneous accusation.
If SEC personnel made money by successful prosecutions, it logically follows that they would simply charge as many managers as possible, figuring that some would either pay or confess to a lesser crime, just to be rid of the investigation.
With sensibility like this, do you really want Congress listening to Markopolos?
Among other comments the manager made, he personally gave himself credit for several unnamed, large funds not having invested with Madoff. We don't know, of course, if any of that is true. Much of Markopolos' energy and verve seems to stem from being ignored by many people, including SEC regulators, for several years.
Having happened to turn his anger against Madoff into a lucky strike, Markopolos isn't about to go quietly into the night, say, like Sully Sullenberger, the skilled US Air pilot who made the safe landing of his commercial passenger jet into the Hudson River a few weeks ago, without loss of life.
No, Markopolos is going to make this Congressional appearance pay, and pay big. He served notice that he would be filing a formal accusation of another 'mini-Madoff' the next day with the SEC, in order to claim the bounty on the case.
The thrust of Markopolos' testimony, and that of the questions of the mock-shocked members of Congress in front of whom he appeared, was that every one of Madoff's 'victims' should have been better-protected by the SEC. As if the SEC can, and should, prevent every single investor from hurting themselves by throwing caution to the wind, ignoring obvious signs of deceit, and violating prudent investment principles.
We'll never have enough money or people at the SEC to personally hold the hand of every retail, or institutional investor.
The truth is, as I've written several times, here, here and here, for example, the so-called victims in the Madoff case were greedy, blind, and chose to ignore obvious signs of trouble, such as custody reports from an independent, reputable custodian. Neither the SEC, nor the government, will ever successfully protect investors from their own stupidity.
Let's hope Congress doesn't listen to carefully to this self-obsessed and self-congratulatory investment manager.
It's hard to decide which was more stomach-churning; the sight of Markopolos puffed up with self-importance, pontificating on all sorts of matters about which he has little knowledge, or; various Congressional members hanging on his every word, as if he receives Truth directly from God.
Perhaps the most chilling moment was when Markopolos, in response to a question, solemnly recommended that SEC personnel be compensated by bounties from pursuing investigations. Imagine the world which that would create. Numerous Inspector Javerts accusing many investment managers, rightly or wrongly, since they would pay no penalty for an erroneous accusation.
If SEC personnel made money by successful prosecutions, it logically follows that they would simply charge as many managers as possible, figuring that some would either pay or confess to a lesser crime, just to be rid of the investigation.
With sensibility like this, do you really want Congress listening to Markopolos?
Among other comments the manager made, he personally gave himself credit for several unnamed, large funds not having invested with Madoff. We don't know, of course, if any of that is true. Much of Markopolos' energy and verve seems to stem from being ignored by many people, including SEC regulators, for several years.
Having happened to turn his anger against Madoff into a lucky strike, Markopolos isn't about to go quietly into the night, say, like Sully Sullenberger, the skilled US Air pilot who made the safe landing of his commercial passenger jet into the Hudson River a few weeks ago, without loss of life.
No, Markopolos is going to make this Congressional appearance pay, and pay big. He served notice that he would be filing a formal accusation of another 'mini-Madoff' the next day with the SEC, in order to claim the bounty on the case.
The thrust of Markopolos' testimony, and that of the questions of the mock-shocked members of Congress in front of whom he appeared, was that every one of Madoff's 'victims' should have been better-protected by the SEC. As if the SEC can, and should, prevent every single investor from hurting themselves by throwing caution to the wind, ignoring obvious signs of deceit, and violating prudent investment principles.
We'll never have enough money or people at the SEC to personally hold the hand of every retail, or institutional investor.
The truth is, as I've written several times, here, here and here, for example, the so-called victims in the Madoff case were greedy, blind, and chose to ignore obvious signs of trouble, such as custody reports from an independent, reputable custodian. Neither the SEC, nor the government, will ever successfully protect investors from their own stupidity.
Let's hope Congress doesn't listen to carefully to this self-obsessed and self-congratulatory investment manager.
Thursday, February 05, 2009
Dick Armey On Hayek vs. Keynes
Former GOP House Majority Leader and economic professor Dick Armey wrote an insightful column in yesterday's Wall Street Journal. Eschewing a detailed analysis of the current mega-spending bill which the President and Democratic majorities in both Houses of Congress wish to pass, Armey instead returns to fundamentals of economics. He begins by writing,
"In the long run, we are all dead," John Maynard Keynes once quipped. An influential British economist, Keynes used the line to dodge the problematic long-term implications of his policy proposals. "
It is significant to Armey that Keynes never answered for the long term impacts of his great idea, governmental deficit spending.
Armey continues by drawing a contrast rarely made, between Keynes and his contemporary and critic, Fredrick Hayek,
"According to Nobel economist Friedrich Hayek, a contemporary of Keynes and perhaps his greatest critic, Keynes "was guided by one central idea . . . that general employment was always positively correlated with the aggregate demand for consumer goods." Keynes argued that government should intervene in the economy to maintain aggregate demand and full employment, with the goal of smoothing out business cycles. During recessions, he asserted, government should borrow money and spend it.
Keynes's thinking was a decisive departure from classical economics, because arbitrary "macro" constructs like aggregate demand had no basis in the microeconomic science of human action. As Hayek observed, "some of the most orthodox disciples of Keynes appear consistently to have thrown overboard all the traditional theory of price determination and of distribution, all that used to be the backbone of economic theory, and in consequence, in my opinion, to have ceased to understand any economics."
Classical economists up to that time had emphasized a balanced budget and government restraint as the primary goals of fiscal policy. The simplistic notion that "aggregate demand" drove investment and employment threw all of that out the window, but it had one particular convenience for policy makers. Government spending is, according to Keynes's construct, a key component in determining aggregate demand, so more spending, even to resod the Capitol Mall or distribute free contraception, drives the economy in the short run."
This is a really significant point, because Armey reminds us, or, if necessary, teaches us that, prior to Keynes entirely theoretical addition of 'macro' economics to the then-dominant microeconomics, the former was largely a definitionally equivalent of money supply, velocity and GDP, arising from the summation of microeconomic activity.
Prominent Keynesians such as Paul Samuelson, through his best-selling textbook, conveniently trotted out Say's law and gently mocked it, neglecting to ever include Hayek's contrasting views.
In the current era, however, Hayek's intellectual descendants are more numerous and vocal. Armey closely marries the political with the economy, uniting the two parts of the originally-named study of political economics by continuing,
"A father of public choice economics, Nobel laureate James Buchanan, argues that the great flaw in Keynesianism is that it ignores the obvious, self-interested incentives of government actors implementing fiscal policy and creates intellectual cover for what would otherwise be viewed as self-serving and irresponsible behavior by politicians. It is also very difficult to turn off the spigot in better economic times, and Keynes blithely ignored the long-term effects of financing an expanded deficit.
It's clear why Keynes's popularity endures in Congress. Intellectual cover for a spending spree will always be appreciated there. But it's harder to see any justification for the perverse form of fiscal child abuse that heaps massive debts on future generations."
This passage nicely captured a key, real issue in applied Keynesianism. I've noted that the effects of huge deficits, at this time, will likely cause significantly higher inflation and interest rates for Americans. Moreover, Armey, and Buchanan, address the human behavior realities of public deficit spending which Keynes ignored.
Returning to Hayek, Armey writes,
"Hayek, who famously debated Keynes in a series of articles after the release of "General Theory," gave what I believe to be the most devastating critique of government action to stimulate "aggregate demand." Hayek viewed the boom and bust of the business cycle as primarily a monetary phenomenon created by governments' artificial inflation of money and credit.
Sound money policy, conversely, allowed the disparate knowledge of millions of economic actors to be conveyed through the price system, rationally allocating capital and labor through relative prices. The problem with government attempts to manipulate the economy through fiscal policy -- spending that takes resources away from those who are productive and redistributes it to politically favored interests -- is that it is audacious. It assumes that government knows better how to spend and invest than individuals acting in their families' best interest.
"The real question," according to Hayek, "is not whether man is, or ought to be, guided by selfish motives but whether we can allow him to be guided in his actions by those immediate consequences which we can know and care for or whether he ought to be made to do what seems appropriate to somebody else who is supposed to possess a fuller comprehension of the significance of these actions to society as a whole."
Again, Hayek tackled Keynes on aspects of his theory for which the General Theory has no response. It's easy to see in Hayek's critique the brilliance he possessed in noting how Keynes casually swept away the microeconomic resource allocation mechanisms which underpin all economics, and simply assumed away the very real problem of how government would better allocate resources, sans price signals, than individuals would with the same resources, or more.
If there were ever a valid argument for preferring tax cuts for individuals and corporations over government spending, Hayek delivered it.
Armey concludes with a very common sense summation of Hayek's observations,
"In reality, no one spends someone else's money better than they spend their own. The charade of the current stimulus package, chockablock with earmarks to favored pet constituencies and virtually devoid of national policy considerations, is the logical consequence of Keynesianism in action. It is about politics and power, not sound economics, and I believe that the American people will reject it."
Let's hope Dick Armey is right, and that American voters let their Congressional members know it.
"In the long run, we are all dead," John Maynard Keynes once quipped. An influential British economist, Keynes used the line to dodge the problematic long-term implications of his policy proposals. "
It is significant to Armey that Keynes never answered for the long term impacts of his great idea, governmental deficit spending.
Armey continues by drawing a contrast rarely made, between Keynes and his contemporary and critic, Fredrick Hayek,
"According to Nobel economist Friedrich Hayek, a contemporary of Keynes and perhaps his greatest critic, Keynes "was guided by one central idea . . . that general employment was always positively correlated with the aggregate demand for consumer goods." Keynes argued that government should intervene in the economy to maintain aggregate demand and full employment, with the goal of smoothing out business cycles. During recessions, he asserted, government should borrow money and spend it.
Keynes's thinking was a decisive departure from classical economics, because arbitrary "macro" constructs like aggregate demand had no basis in the microeconomic science of human action. As Hayek observed, "some of the most orthodox disciples of Keynes appear consistently to have thrown overboard all the traditional theory of price determination and of distribution, all that used to be the backbone of economic theory, and in consequence, in my opinion, to have ceased to understand any economics."
Classical economists up to that time had emphasized a balanced budget and government restraint as the primary goals of fiscal policy. The simplistic notion that "aggregate demand" drove investment and employment threw all of that out the window, but it had one particular convenience for policy makers. Government spending is, according to Keynes's construct, a key component in determining aggregate demand, so more spending, even to resod the Capitol Mall or distribute free contraception, drives the economy in the short run."
This is a really significant point, because Armey reminds us, or, if necessary, teaches us that, prior to Keynes entirely theoretical addition of 'macro' economics to the then-dominant microeconomics, the former was largely a definitionally equivalent of money supply, velocity and GDP, arising from the summation of microeconomic activity.
Prominent Keynesians such as Paul Samuelson, through his best-selling textbook, conveniently trotted out Say's law and gently mocked it, neglecting to ever include Hayek's contrasting views.
In the current era, however, Hayek's intellectual descendants are more numerous and vocal. Armey closely marries the political with the economy, uniting the two parts of the originally-named study of political economics by continuing,
"A father of public choice economics, Nobel laureate James Buchanan, argues that the great flaw in Keynesianism is that it ignores the obvious, self-interested incentives of government actors implementing fiscal policy and creates intellectual cover for what would otherwise be viewed as self-serving and irresponsible behavior by politicians. It is also very difficult to turn off the spigot in better economic times, and Keynes blithely ignored the long-term effects of financing an expanded deficit.
It's clear why Keynes's popularity endures in Congress. Intellectual cover for a spending spree will always be appreciated there. But it's harder to see any justification for the perverse form of fiscal child abuse that heaps massive debts on future generations."
This passage nicely captured a key, real issue in applied Keynesianism. I've noted that the effects of huge deficits, at this time, will likely cause significantly higher inflation and interest rates for Americans. Moreover, Armey, and Buchanan, address the human behavior realities of public deficit spending which Keynes ignored.
Returning to Hayek, Armey writes,
"Hayek, who famously debated Keynes in a series of articles after the release of "General Theory," gave what I believe to be the most devastating critique of government action to stimulate "aggregate demand." Hayek viewed the boom and bust of the business cycle as primarily a monetary phenomenon created by governments' artificial inflation of money and credit.
Sound money policy, conversely, allowed the disparate knowledge of millions of economic actors to be conveyed through the price system, rationally allocating capital and labor through relative prices. The problem with government attempts to manipulate the economy through fiscal policy -- spending that takes resources away from those who are productive and redistributes it to politically favored interests -- is that it is audacious. It assumes that government knows better how to spend and invest than individuals acting in their families' best interest.
"The real question," according to Hayek, "is not whether man is, or ought to be, guided by selfish motives but whether we can allow him to be guided in his actions by those immediate consequences which we can know and care for or whether he ought to be made to do what seems appropriate to somebody else who is supposed to possess a fuller comprehension of the significance of these actions to society as a whole."
Again, Hayek tackled Keynes on aspects of his theory for which the General Theory has no response. It's easy to see in Hayek's critique the brilliance he possessed in noting how Keynes casually swept away the microeconomic resource allocation mechanisms which underpin all economics, and simply assumed away the very real problem of how government would better allocate resources, sans price signals, than individuals would with the same resources, or more.
If there were ever a valid argument for preferring tax cuts for individuals and corporations over government spending, Hayek delivered it.
Armey concludes with a very common sense summation of Hayek's observations,
"In reality, no one spends someone else's money better than they spend their own. The charade of the current stimulus package, chockablock with earmarks to favored pet constituencies and virtually devoid of national policy considerations, is the logical consequence of Keynesianism in action. It is about politics and power, not sound economics, and I believe that the American people will reject it."
Let's hope Dick Armey is right, and that American voters let their Congressional members know it.
Wednesday, February 04, 2009
Mr. Citrus Opines on Chinese Imports, Gold & The Recession
I ran into a friend on Sunday with whom I had a fascinating 'catch up' conversation.
While I thought I'd first written about him almost two years ago, it seems, when I search this blog for references to him, I can't find any. So I must have only intended to write the post I imagine recalling.
For both anonymity, and appropriateness, I shall call my friend Mr. Citrus.
You see, he owns and operates the dominant fresh citrus juice-for-cooking-and-beverage business in the US. You know those little lemon- and lime-shaped plastic squeezie things you find in the produce aisle? That's him.
And of all the gyms in the world, he happens to belong to mine. Well, my old one, and, probably, soon, my new one, as well.
One day, I'll write more elaborate post about Mr. Citrus, but for now, suffice to say he's a European immigrant of more than a decade. He conceived his business- the importation of fresh, dated lemon and lime juice- shortly after arriving in the States. While it's been a long haul, he has overtaken the once-king of the market, RealLemon.
Just in case someone from a competitor finds this post via Google, I will keep the information he shared with me somewhat disguised.
Mr. Citrus told me that January sales were up at one of the highest rates ever. To him, it is logical, as he saw sales growth like this during a prior recession.
I asked about a similar-looking squeezie product I'd recently seen, and he dismissed it as a knock-off which isn't coming close to bothering his business. When I observed that I found it at a local, large grocery chain, where his products are absent, he snorted and said,
'(That chain) has the most corrupt buyers in the business. They have a supplier of lime juice who is local to their corporate headquarters, and someone is getting paid off to stock them. Therefore, they only want my lemon juice.'
Back a few years ago, when he explained the nature of his operations, which I'll share in another post, I asked him why a local premium grocery chain's fresh, soft fruit prices were double that of the other major chains. He replied that, due to a quirk in that chain's distribution process, they double-shipped those fruits to a local warehouse, then back to each store, incurring added costs.
From such small details, pricing gaps can occur.
On Sunday morning, however, our discussion turned to US macroeconomics, the recession and the 'stimulus' package. Being from Europe, still traveling there frequently, and a quintessential small, entrepreneurial businessman, I was interested in Mr. Citrus' opinions.
First, he agreed that the so-called stimulus won't work. But, thanks to global economic weakness, he doesn't think the immense added US debt will drive the price of the dollar down. Rather, he felt, it will drive up interest rates to fund the debt, as well as stoke inflation.
He continued by sharing that he had observed what asset strategies did well in the 1930s. Consequently, he's buying residential real estate in Switzerland, for use as a main residence, if necessary, as well as precious metals. This is a guy who has at least one other local business besides citrus distribution, and could easily afford to scoop up local, undervalued real estate. But he's not.
Then he launched into a well-reasoned argument, in common with some leading economists, that the US is about to foolishly rely on an unfriendly power, i.e., China, to hold and continue funding our debt. Being European, he is fairly sensitive to currents of international economics and influence.
On that subject, he began to recount a recent business event which ended with him impassioned and red-faced.
Mr. Citrus' business practices all adhere to ISO 9000 standards. As he put it, they are the international gold standard for importation. So when a Federal inspector visited his offices recently to inquire as to his various certifications for importation, Mr. Citrus greeted him by saying something like,
'I'm glad someone finally asked to see my ISO 9000 certificate. You're the first person who has done so.'
He was shocked when the government agent replied,
'Well, that's very nice. But it doesn't meet our USDA rules.'
I won't bother with the details of the apparently-heated interchange that followed, which left Mr. Citrus agitated just in retelling the story.
But he made two very interesting points.
First, he noted that by insisting on a totally separate set of import rules, the USDA risked making US businesses globally less competitive, since they would focus on a rule set unique to the US, but inappropriate for global business.
Second, as he noted to the government agent, the USDA rules allow one exception- China. If you ship anything from China, the importation rules are suspended.
Mr. Citrus then drew the obvious conclusion. China, he said, had used its financial influence with America to obtain for itself carte blanche exemptions to import regulations and standards to which all other countries are held.
In his conversation with the agent, Mr. Citrus noted the expense he incurred to comply with ISO 9000. And that, maybe now, he'd simply reroute all his shipments through China, in order to lessen costs and quality.
He doesn't really intend to do this, but the threat was ironic.
And his story was very eye-opening. If this has already happened prior to flooding global financial markets with another trillion dollars in US obligations, what other standards will Congress and the current administration relax, on the quiet, in order to fund our debt?
While I thought I'd first written about him almost two years ago, it seems, when I search this blog for references to him, I can't find any. So I must have only intended to write the post I imagine recalling.
For both anonymity, and appropriateness, I shall call my friend Mr. Citrus.
You see, he owns and operates the dominant fresh citrus juice-for-cooking-and-beverage business in the US. You know those little lemon- and lime-shaped plastic squeezie things you find in the produce aisle? That's him.
And of all the gyms in the world, he happens to belong to mine. Well, my old one, and, probably, soon, my new one, as well.
One day, I'll write more elaborate post about Mr. Citrus, but for now, suffice to say he's a European immigrant of more than a decade. He conceived his business- the importation of fresh, dated lemon and lime juice- shortly after arriving in the States. While it's been a long haul, he has overtaken the once-king of the market, RealLemon.
Just in case someone from a competitor finds this post via Google, I will keep the information he shared with me somewhat disguised.
Mr. Citrus told me that January sales were up at one of the highest rates ever. To him, it is logical, as he saw sales growth like this during a prior recession.
I asked about a similar-looking squeezie product I'd recently seen, and he dismissed it as a knock-off which isn't coming close to bothering his business. When I observed that I found it at a local, large grocery chain, where his products are absent, he snorted and said,
'(That chain) has the most corrupt buyers in the business. They have a supplier of lime juice who is local to their corporate headquarters, and someone is getting paid off to stock them. Therefore, they only want my lemon juice.'
Back a few years ago, when he explained the nature of his operations, which I'll share in another post, I asked him why a local premium grocery chain's fresh, soft fruit prices were double that of the other major chains. He replied that, due to a quirk in that chain's distribution process, they double-shipped those fruits to a local warehouse, then back to each store, incurring added costs.
From such small details, pricing gaps can occur.
On Sunday morning, however, our discussion turned to US macroeconomics, the recession and the 'stimulus' package. Being from Europe, still traveling there frequently, and a quintessential small, entrepreneurial businessman, I was interested in Mr. Citrus' opinions.
First, he agreed that the so-called stimulus won't work. But, thanks to global economic weakness, he doesn't think the immense added US debt will drive the price of the dollar down. Rather, he felt, it will drive up interest rates to fund the debt, as well as stoke inflation.
He continued by sharing that he had observed what asset strategies did well in the 1930s. Consequently, he's buying residential real estate in Switzerland, for use as a main residence, if necessary, as well as precious metals. This is a guy who has at least one other local business besides citrus distribution, and could easily afford to scoop up local, undervalued real estate. But he's not.
Then he launched into a well-reasoned argument, in common with some leading economists, that the US is about to foolishly rely on an unfriendly power, i.e., China, to hold and continue funding our debt. Being European, he is fairly sensitive to currents of international economics and influence.
On that subject, he began to recount a recent business event which ended with him impassioned and red-faced.
Mr. Citrus' business practices all adhere to ISO 9000 standards. As he put it, they are the international gold standard for importation. So when a Federal inspector visited his offices recently to inquire as to his various certifications for importation, Mr. Citrus greeted him by saying something like,
'I'm glad someone finally asked to see my ISO 9000 certificate. You're the first person who has done so.'
He was shocked when the government agent replied,
'Well, that's very nice. But it doesn't meet our USDA rules.'
I won't bother with the details of the apparently-heated interchange that followed, which left Mr. Citrus agitated just in retelling the story.
But he made two very interesting points.
First, he noted that by insisting on a totally separate set of import rules, the USDA risked making US businesses globally less competitive, since they would focus on a rule set unique to the US, but inappropriate for global business.
Second, as he noted to the government agent, the USDA rules allow one exception- China. If you ship anything from China, the importation rules are suspended.
Mr. Citrus then drew the obvious conclusion. China, he said, had used its financial influence with America to obtain for itself carte blanche exemptions to import regulations and standards to which all other countries are held.
In his conversation with the agent, Mr. Citrus noted the expense he incurred to comply with ISO 9000. And that, maybe now, he'd simply reroute all his shipments through China, in order to lessen costs and quality.
He doesn't really intend to do this, but the threat was ironic.
And his story was very eye-opening. If this has already happened prior to flooding global financial markets with another trillion dollars in US obligations, what other standards will Congress and the current administration relax, on the quiet, in order to fund our debt?
Tuesday, February 03, 2009
Tivo's Next Step: The Internet?
As my Comcast system upgraded to digital, they cleverly rendered my old VCR's multi-channel tuner useless, since anything I recorded had to come through my television's feed from the digital cable tuner.
Thus, I lost the ability to watch one program while recording another. Stripped of every American's God-given right to do this, I recently purchased a TiVo unit for simultaneous digital video recording, and all the other benefits of the service.
In particular, I wanted to also stream instant NetFlix content to my television, rather than simply my desktop computer.
As I have using the TiVo unit for a month or so, I began to consider how it can and probably will morph into a general purpose web content player.
For example, within a week of setting up the TiVo unit, it underwent a few automated software upgrades, integrating the NetFlix feed more seamlessly into the menu.
My TiVo accesses NetFlix through a wireless adapter which gives it access to my home computer network. While I can't program NetFlix choices on the TiVo controller, TiVo can access my NetFlix account on its own to retrieve my selections.
Thus, it would seem only a matter of time before TiVo provides a feature on its own website that would let me either type in my preferred websites, or simply import my web browser bookmarks, so that I can access this menu on my television screen via TiVo's content menu.
Once I can do this, TiVo would let me watch various programming websites, such as HuLu, as well as NBC's own content, delayed, on its website.
As I discussed this with my business partner Sunday morning, I remarked that, once TiVo does this, I am just one step away from cancelling my cable television service.
The only missing content would be my two primary news channels, CNBC and Fox. Once I could stream these, I'd be ready to cut the cable connection, slicing my monthly content delivery bill in half.
I went exploring yesterday, and found that CNBC offers a premium content subscription of roughly $10/month which provides a video stream of their channel. So that fits the model about which I hypothesized over two years ago in a post about the eventual disintermediation of cable by individual channels offering separate internet-based viewing for a monthly fee.
Fox has some video streams, but I haven't yet found one that matches what is broadcast on their channel live. It's probably there somewhere. If not, they surely can do what CNBC is doing, at their whim.
So there you have it. Just about two and a half years after my post regarding the necessary hardware and software for television viewing of internet web content, it's basically here. One software tweak by TiVo, and it's done. I'll have TiVo for access to online weekly programming, including news programs, either free or paid, and Netflix for my movie content.
Thus, I lost the ability to watch one program while recording another. Stripped of every American's God-given right to do this, I recently purchased a TiVo unit for simultaneous digital video recording, and all the other benefits of the service.
In particular, I wanted to also stream instant NetFlix content to my television, rather than simply my desktop computer.
As I have using the TiVo unit for a month or so, I began to consider how it can and probably will morph into a general purpose web content player.
For example, within a week of setting up the TiVo unit, it underwent a few automated software upgrades, integrating the NetFlix feed more seamlessly into the menu.
My TiVo accesses NetFlix through a wireless adapter which gives it access to my home computer network. While I can't program NetFlix choices on the TiVo controller, TiVo can access my NetFlix account on its own to retrieve my selections.
Thus, it would seem only a matter of time before TiVo provides a feature on its own website that would let me either type in my preferred websites, or simply import my web browser bookmarks, so that I can access this menu on my television screen via TiVo's content menu.
Once I can do this, TiVo would let me watch various programming websites, such as HuLu, as well as NBC's own content, delayed, on its website.
As I discussed this with my business partner Sunday morning, I remarked that, once TiVo does this, I am just one step away from cancelling my cable television service.
The only missing content would be my two primary news channels, CNBC and Fox. Once I could stream these, I'd be ready to cut the cable connection, slicing my monthly content delivery bill in half.
I went exploring yesterday, and found that CNBC offers a premium content subscription of roughly $10/month which provides a video stream of their channel. So that fits the model about which I hypothesized over two years ago in a post about the eventual disintermediation of cable by individual channels offering separate internet-based viewing for a monthly fee.
Fox has some video streams, but I haven't yet found one that matches what is broadcast on their channel live. It's probably there somewhere. If not, they surely can do what CNBC is doing, at their whim.
So there you have it. Just about two and a half years after my post regarding the necessary hardware and software for television viewing of internet web content, it's basically here. One software tweak by TiVo, and it's done. I'll have TiVo for access to online weekly programming, including news programs, either free or paid, and Netflix for my movie content.
Retail Selection & The Recession: The A.T. Cross Case
After this most recent Christmas' shopping season, local malls had markdowns well into the range of 50%. My younger daughter caught onto this quickly, saying to me,
'Dad, if I had the money right now, I'd be buying a lot, because these prices are so low.'
Pondering the losses these retailers were taking, it occurred to me that we will not soon see such merchandise assortment at our local retailers. Whether its size, color, or style, you can bet that what inventory is carried will be well into the broad middle swath of sizes and styles.
In this vein, I want to relate the long search I undertook for a rather simple item- a replacement for the fine blue ink cartridge in my 20+ year old Cross pen.
A.T. Cross pens are not anywhere near the price and prestige of a Mont Blanc. Yet, try to find refills, or even the pens, in today's retail market, and you will be disappointed.
The local paper-and-gift emporia at which they were once a graduation gift staple are now gone. Our own town's retailer closed after Christmas three years ago.
Big box office suppliers don't carry them, to my knowledge. And the Staples aisle in my local Stop & Shop only had a single package of two medium black ink refills.
Despite roughly a month of visiting local drug, grocery and office supply stores, I found no fine blue ink refills.
Then it hit me where I needed to look.
In an economy where you sell a rather low-value item of medium price, through a channel that is disappearing, how do you remain viable? Assure a presence for buyers who value your brand?
I Googled "A T Cross," and immediately found their website.
Could it be that the internet is the best thing that ever happened to A.T. Cross? Perhaps so.
Their website is very well designed, with a very easy-to-find section for buying refills. On their own site, Cross can feature selected products, as well as cleanly display each and every item they offer- something my local gift store never did. They offer discounts for multi-pack refills, with low shipping costs. The refills arrived within the week.
I could go on about Cross, but my point is that I believe the pen-and-gift merchant provides a good example of what other retailers will be doing in the future.
That is, relying on internet site sales for serving customers with less mainstream tastes. It's the perfect solution.
As it is, I buy a lot of clothing for myself and my children from LL Bean, and other select online retailers.
Why not J Crew and Gap?
In a rather ironic twist, the old "bricks vs. clicks" war of retailing may have been given a huge push toward clicks because of this past Christmas' dismal retailing results.
'Dad, if I had the money right now, I'd be buying a lot, because these prices are so low.'
Pondering the losses these retailers were taking, it occurred to me that we will not soon see such merchandise assortment at our local retailers. Whether its size, color, or style, you can bet that what inventory is carried will be well into the broad middle swath of sizes and styles.
In this vein, I want to relate the long search I undertook for a rather simple item- a replacement for the fine blue ink cartridge in my 20+ year old Cross pen.
A.T. Cross pens are not anywhere near the price and prestige of a Mont Blanc. Yet, try to find refills, or even the pens, in today's retail market, and you will be disappointed.
The local paper-and-gift emporia at which they were once a graduation gift staple are now gone. Our own town's retailer closed after Christmas three years ago.
Big box office suppliers don't carry them, to my knowledge. And the Staples aisle in my local Stop & Shop only had a single package of two medium black ink refills.
Despite roughly a month of visiting local drug, grocery and office supply stores, I found no fine blue ink refills.
Then it hit me where I needed to look.
In an economy where you sell a rather low-value item of medium price, through a channel that is disappearing, how do you remain viable? Assure a presence for buyers who value your brand?
I Googled "A T Cross," and immediately found their website.
Could it be that the internet is the best thing that ever happened to A.T. Cross? Perhaps so.
Their website is very well designed, with a very easy-to-find section for buying refills. On their own site, Cross can feature selected products, as well as cleanly display each and every item they offer- something my local gift store never did. They offer discounts for multi-pack refills, with low shipping costs. The refills arrived within the week.
I could go on about Cross, but my point is that I believe the pen-and-gift merchant provides a good example of what other retailers will be doing in the future.
That is, relying on internet site sales for serving customers with less mainstream tastes. It's the perfect solution.
As it is, I buy a lot of clothing for myself and my children from LL Bean, and other select online retailers.
Why not J Crew and Gap?
In a rather ironic twist, the old "bricks vs. clicks" war of retailing may have been given a huge push toward clicks because of this past Christmas' dismal retailing results.
Monday, February 02, 2009
Robert Shiller's Wacky Spending Recommendation
Last Tuesday's Wall Street Journal featured an editorial by Yale economist Robert Shiller entitled, "Animal Spirits Depend on Trust." It may well be the wackiest, nuttiest piece yet in defense of the pork-laden "stimulus" bill now rolling through the Democratic-controlled Congress.
Shiller begins by stating,
"President Obama is urging Congress to pass an $825 billion stimulus package as soon as possible. But even that may not be enough to stabilize the economy, since it fails to take into account the downward spiral of animal spirits that is underway and may continue to worsen."
It's hard to believe that anyone could criticize this massive spending bill as being too small. But Shiller does just that. In order to justify his premise, Shiller then launches into a refresher on- what else- Keynesian economics. Referring to Keynes major work, The General Theory ..., Shiller writes,
"But lost in the economics textbooks, and all but lost in the thousands of pages of the technical economics literature, is this other message of Keynes regarding why the economy fluctuates as much as it does. Animal spirits offer an explanation for why we get into recessions in the first place -- for why the economy fluctuates as it does. It also gives some hints regarding what we need to do now to get out of the current crisis.
A critical aspect of animal spirits is trust, an emotional state that dismisses doubts about others. In talking about animal spirits, Keynes sought to convey the message that swings in confidence are not always logical. The business cycle is in good part driven by animal spirits. There are good times when people have substantial trust and associated feelings that contribute to an environment of confidence. They make decisions spontaneously. They believe instinctively that they will be successful, and they suspend their suspicions. As long as large groups of people remain trusting, people's somewhat rash, impulsive decision-making is not discovered."
What Shiller fails to note is that nobody has ever demonstrated that artificial, government-funded spending of a specialized or short-term nature, can restore 'animal spirits.' I would venture to suggest that only private capital can do that. As I wrote here recently, Paul Samuelson's genius in devising the accelerator-multiplier theory was recognizing what natural rhythms of economic cycles must occur, and how, for growth to return to an economy.
Never the less, Shiller continues,
"The danger at this point is that if the actions we take are not aggressive enough to have a substantial, visible impact on the economy, then confidence will continue to plummet. The Obama administration estimated its initial $775 billion stimulus package would shave about 1.8% off the unemployment rate from what it would otherwise be. Even so, by the time any package takes full effect the unemployment rate may be substantially higher than it is today.
So what must we do to revive our animal spirits and economic growth? We must be certain that programs to solve the current financial and economic crisis are large enough, and targeted broadly enough, to impact public confidence. Not only do we need a fiscal stimulus significantly greater than the proposal that is currently on the table, government action is also needed to take the place of the credit markets that seemingly worked so well when animal spirits were high. The Treasury and the Federal Reserve not only need a fiscal target, they also need a credit target. This should not be a dollar number, but rather a target for how the credit markets should behave. The goal should be that those who would normally receive credit in times of full employment can once again find it easy to do so, at rates with realistic risk premiums."
Surely, this is very scary stuff. Can you imagine the mediocre civil servants at Treasury setting 'credit targets?' My God! This is sounding like the last Soviet 7-year plan.
Rather than such meddling in capital markets raising public confidence, it almost certainly will destroy such confidence. The current, badly-implemented and conceived TARP program, which, by the way, Shiller lauds, has caused investors to step back from bank equities, since it's not clear what will happen next with Federal intervention.
Shiller concludes his loopy editorial with this stunning piece of advice,
"In due course our animal spirits will once again turn positive, but we would rather that happen this year or the next rather than five or 10 years from now. There is only one way to speed this process: greatly expand governmental support of credit markets and pass a much larger fiscal stimulus plan than is now proposed."
Honestly, it's hard to believe someone stupid enough to write this is a professor at any major US university. If pulling out of recessions were really as simple as government spending a few hundred billions, we'd have done that in the past, and could point to it as a success.
But you can't. Because it has never happened. Economic cycles have to wait for those 'animal spirits' which so fascinated Keynes to naturally recover. Not be fooled by some trumped-up government printing press activity.
In the current situation, what we would see, were Shiller's raving to be implemented, is much higher inflation and interest rates, as buyers of US dollars and Treasuries correctly viewed the implicit devaluation of US government dollar-denominated obligations.
Let's hope nobody takes Shiller seriously, and that he visits his university's medical center to get the appropriate medication that will control this type of lunacy in the future.
Shiller begins by stating,
"President Obama is urging Congress to pass an $825 billion stimulus package as soon as possible. But even that may not be enough to stabilize the economy, since it fails to take into account the downward spiral of animal spirits that is underway and may continue to worsen."
It's hard to believe that anyone could criticize this massive spending bill as being too small. But Shiller does just that. In order to justify his premise, Shiller then launches into a refresher on- what else- Keynesian economics. Referring to Keynes major work, The General Theory ..., Shiller writes,
"But lost in the economics textbooks, and all but lost in the thousands of pages of the technical economics literature, is this other message of Keynes regarding why the economy fluctuates as much as it does. Animal spirits offer an explanation for why we get into recessions in the first place -- for why the economy fluctuates as it does. It also gives some hints regarding what we need to do now to get out of the current crisis.
A critical aspect of animal spirits is trust, an emotional state that dismisses doubts about others. In talking about animal spirits, Keynes sought to convey the message that swings in confidence are not always logical. The business cycle is in good part driven by animal spirits. There are good times when people have substantial trust and associated feelings that contribute to an environment of confidence. They make decisions spontaneously. They believe instinctively that they will be successful, and they suspend their suspicions. As long as large groups of people remain trusting, people's somewhat rash, impulsive decision-making is not discovered."
What Shiller fails to note is that nobody has ever demonstrated that artificial, government-funded spending of a specialized or short-term nature, can restore 'animal spirits.' I would venture to suggest that only private capital can do that. As I wrote here recently, Paul Samuelson's genius in devising the accelerator-multiplier theory was recognizing what natural rhythms of economic cycles must occur, and how, for growth to return to an economy.
Never the less, Shiller continues,
"The danger at this point is that if the actions we take are not aggressive enough to have a substantial, visible impact on the economy, then confidence will continue to plummet. The Obama administration estimated its initial $775 billion stimulus package would shave about 1.8% off the unemployment rate from what it would otherwise be. Even so, by the time any package takes full effect the unemployment rate may be substantially higher than it is today.
So what must we do to revive our animal spirits and economic growth? We must be certain that programs to solve the current financial and economic crisis are large enough, and targeted broadly enough, to impact public confidence. Not only do we need a fiscal stimulus significantly greater than the proposal that is currently on the table, government action is also needed to take the place of the credit markets that seemingly worked so well when animal spirits were high. The Treasury and the Federal Reserve not only need a fiscal target, they also need a credit target. This should not be a dollar number, but rather a target for how the credit markets should behave. The goal should be that those who would normally receive credit in times of full employment can once again find it easy to do so, at rates with realistic risk premiums."
Surely, this is very scary stuff. Can you imagine the mediocre civil servants at Treasury setting 'credit targets?' My God! This is sounding like the last Soviet 7-year plan.
Rather than such meddling in capital markets raising public confidence, it almost certainly will destroy such confidence. The current, badly-implemented and conceived TARP program, which, by the way, Shiller lauds, has caused investors to step back from bank equities, since it's not clear what will happen next with Federal intervention.
Shiller concludes his loopy editorial with this stunning piece of advice,
"In due course our animal spirits will once again turn positive, but we would rather that happen this year or the next rather than five or 10 years from now. There is only one way to speed this process: greatly expand governmental support of credit markets and pass a much larger fiscal stimulus plan than is now proposed."
Honestly, it's hard to believe someone stupid enough to write this is a professor at any major US university. If pulling out of recessions were really as simple as government spending a few hundred billions, we'd have done that in the past, and could point to it as a success.
But you can't. Because it has never happened. Economic cycles have to wait for those 'animal spirits' which so fascinated Keynes to naturally recover. Not be fooled by some trumped-up government printing press activity.
In the current situation, what we would see, were Shiller's raving to be implemented, is much higher inflation and interest rates, as buyers of US dollars and Treasuries correctly viewed the implicit devaluation of US government dollar-denominated obligations.
Let's hope nobody takes Shiller seriously, and that he visits his university's medical center to get the appropriate medication that will control this type of lunacy in the future.
Friday, January 30, 2009
Starbucks Shrinks!
In three posts last year- here, here and here- I discussed the failure of Starbucks' CEO Howard Schultz' growth strategy.
Finally acknowledging a slump in high-end retail sales, Schultz is cutting 6,000 store employees and 700 headquarters staff, as well as closing 300 additional stores above the 600 closures announced last year.
As I have noted in prior posts, the firm exposed itself to this sort of risk when it sought growth from lower-income customers. Those store openings and employee additions, which caused breakneck growth only a few years ago, have now had to be reversed.
The nearby price chart for Starbucks and the S&P500Index shows how the coffee roaster's equity price has fallen by some 40% since late summer, when I wrote the first post noting the beginning of its pullback. The silver lining is that it hasn't lost appreciably more than the S&P.
Meanwhile, McDonalds, which added better coffees to their menu, is running smoothly and posting gains.
Good management shows, and Starbucks clearly still doesn't have it.
Our Best Economic Sectors Remain Safe From Government "Help"
It's been a tough last two quarters for the American capitalist system.
Uncle Sam forcibly took stakes in the nation's largest commercial banks, induced the publicly-held investment banks to become chartered commercial banks, took over AIG and lent billions to GM and Chrsyler.
The good news is that these are not the engines of growth of our economy. In fact, information technology, bio-medicine and other innovation-fueled sectors have studiously avoided involvement with Washington.
You don't see Google or H-P taking government money.
In the banking sector, it may well be time to correct the country's historic vulnerability to a legion of small, poorly-run and failure-prone community and local, state-chartered institutions. As such, nationalizing the sector might well close a recurring weak spot in our nation's economic system.
The most recent bout of financial-sector induced US economic troubles stemmed from inept and jealous CEOs and senior executives in the financial sector attempting to make it a 'growth' business.
Unfortunately- for all of us- the financial services sector, being a derived business of a nation's economic activity, cannot be a growth sector over the long term. Individual products, over short timeframes, can achieve 'growth' status akin to a technology business. But, beyond that, with above-economic-growth rates come excessive risk.
Something with which we are now all familiar.
As for US-domiciled auto assemblers, they are ready for the scrap heap. Contrary to the protests of their defenders, Ford, GM and Chrysler have little role in defense production. Better cars are made by foreign-based producers in southern US plants.
Like it or not, putting all three of these firms into Chapter 11 bankruptcy was and remains the right thing to do. Profitable parts of them would be merged or acquired. The loss-making parts would be closed. Shareholders would bear the capital losses, while government could provide modest but necessary stipends to displaced employees.
Losing the corporations that are GM, Ford and Chrysler doesn't mean losing all of their products, nor all of the jobs associated with them.
I'm as sceptical of government intervention as the next person, and probably moreso. But in these cases, the damage could be much worse. As it is, some tens of billions will be lost in a last gasp to help the auto assemblers. But, fortunately, it's not as if a vital, value-creating industry is being corrupted and hijacked by Washington- yet.
Of course, time will tell whether the current administration meddles in the successful, high-growth, value-adding portions of our economy. But, for now, those parts are safe and operating without further Federal "help."
Uncle Sam forcibly took stakes in the nation's largest commercial banks, induced the publicly-held investment banks to become chartered commercial banks, took over AIG and lent billions to GM and Chrsyler.
The good news is that these are not the engines of growth of our economy. In fact, information technology, bio-medicine and other innovation-fueled sectors have studiously avoided involvement with Washington.
You don't see Google or H-P taking government money.
In the banking sector, it may well be time to correct the country's historic vulnerability to a legion of small, poorly-run and failure-prone community and local, state-chartered institutions. As such, nationalizing the sector might well close a recurring weak spot in our nation's economic system.
The most recent bout of financial-sector induced US economic troubles stemmed from inept and jealous CEOs and senior executives in the financial sector attempting to make it a 'growth' business.
Unfortunately- for all of us- the financial services sector, being a derived business of a nation's economic activity, cannot be a growth sector over the long term. Individual products, over short timeframes, can achieve 'growth' status akin to a technology business. But, beyond that, with above-economic-growth rates come excessive risk.
Something with which we are now all familiar.
As for US-domiciled auto assemblers, they are ready for the scrap heap. Contrary to the protests of their defenders, Ford, GM and Chrysler have little role in defense production. Better cars are made by foreign-based producers in southern US plants.
Like it or not, putting all three of these firms into Chapter 11 bankruptcy was and remains the right thing to do. Profitable parts of them would be merged or acquired. The loss-making parts would be closed. Shareholders would bear the capital losses, while government could provide modest but necessary stipends to displaced employees.
Losing the corporations that are GM, Ford and Chrysler doesn't mean losing all of their products, nor all of the jobs associated with them.
I'm as sceptical of government intervention as the next person, and probably moreso. But in these cases, the damage could be much worse. As it is, some tens of billions will be lost in a last gasp to help the auto assemblers. But, fortunately, it's not as if a vital, value-creating industry is being corrupted and hijacked by Washington- yet.
Of course, time will tell whether the current administration meddles in the successful, high-growth, value-adding portions of our economy. But, for now, those parts are safe and operating without further Federal "help."
Thursday, January 29, 2009
About Creating "Bad" Banks
There is much ado this week about a putative 'bad bank' asset disposition plan from Treasury.
Well, sort of. Despite having months to conceive his plans for the financial sector and the economy at large, Treasury Secretary Tim Geithner apparently still needs a few more months to figure all that out. Heavens knows what he was doing since November.
Regardless, let's take a step back and consider just what it means to create a 'bad bank.'
First, it's basically Bill Seidman's RTC redux. Back in the late 1980s, in the aftermath of the S&L crisis in which those institutions borrowed short, lent long and low, and largely went insolvent. The thrifts were closed, loans collected into the Resolution Trust Corporation, and sold off to investors at deep discounts, providing many of the latter healthy returns. The 1980s S&L/RTC crisis was more about stupid funding strategies than bad loans.
Now, however, the nature of the 'bad bank' is different. This time, our largest commercial banks, as well as smaller ones and specialized lenders, e.g., Golden West and Countrywide, with Federal and state regulatory tacit approval, lent mortgages on only 5%, or less, down.
Consider two banks with different approaches to loan or securities value loss recognition.
Bank A, like Merrill Lynch, promptly begins to clean up its books by writing down questionable asset values. It rapidly erodes its capital, becoming nearly insolvent. It is taken over and merged with another institution, its shareholders losing everything. There may, or may not, be Federal loss-limiting guarantees on some of the loan portfolio.
If there are such guarantees, then not only investors, but all taxpayers, have just shared the losses of the badly-managed bank.
Bank B, however, holds out and avoids writing down its losses for months. Eventually, Treasury creates a 'bad bank' to buy bad loans from commercial banks. The theory is that, once freed of the bad loans they chose to make, these ailing commercial banks are now healthy and able to make new loans.
But before we know that, we need to know at what general price level the assets were transferred to the Treasury's 'bad bank.' I wrote about this dilemma back in late September of last year, in this post, when Bernanke and Paulson first unveiled their TARP plans. Specifically,
"Further, if Treasury bids such high, close-to-maximum-economic value prices for these securities, then there is virtually no chance of the US taxpayer realizing any gain on subsequent sales. At best, they may breakeven.
At the other extreme, though, also described by Bernanke, if Treasury's bid is a little above the fire sale price, but well short of the economic, or 'hold to maturity' value, then the selling bank receives little extra capital, and not much more in the form of marking similarly-held securities up to the bid, either.
What is it that I am missing? This isn't going to work!"
In fact, it didn't work that way, and was never actually implemented as stated. Now, Geithner's Treasury faces the same dilemma in creating a 'bad bank.'
If Treasury pays face value for the loans, fully recapitalizing the banks, then Bank B's management was smart in playing for time. In effect, by gaming the regulatory system, Bank B lives to make more bad loans, while Bank A was closed for the same offenses.
If, however, Treasury buys the bad loans at economic, or lower, value, which might be as low as the 37%-or-so value Merrill accepted in its funding deal last year, then the banks aren't sufficiently recapitalized to survive. Bank B is determined to be insolvent and, like Bank A, closed and/or merged with another institution.
In the latter case, taxpayers end up owning the bad loans at distress prices, so they don't share in the losses of the inept lending institutions.
From this little mind experiment, we've learned something valuable.
If Treasury pays at or near face values for the bad loans that will fill the 'bad bank,' then taxpayers, who individually may have chosen not to own equity in the ailing lending institutions, effectively find our government buying the losses from those banks anyway. And society is penalized for the sins of a few inept lenders, while the lenders get to remain in business and, in fact, are encouraged to lend again.
If Treasury pays economic, or lower, values for the bad loans to fill the 'bad bank,' then incompetent lenders and their institutions pay a price for their mistakes, and taxpayers don't subsidize them.
Either way, however, there is a net loss of recognized value to society, in the sense that the merry-go-round of overvalued assets stops and those values are forcibly reduced.
In the case of the RTC, the private, publicly-owned financial sector was not recapitalized by the government. Instead, weak and failing thrifts were eliminated, capacity removed, and a healthier, if temporarily smaller financial sector remained.
If Treasury creates the 'bad bank' by compensating existing publicly-held, private financial institutions at or near face value for recognized 'bad loans,' this will not be at all like the 1980s RTC solution.
Instead, Treasury will, in effect, be recapitalizing shareholder-owned institutions with public money, making taxpayers effectively own the mistakes, while rewarding the incompetent management that managed to hold on long enough to get this ultra-sweet deal.
Talk about moral hazard!
This would be among the worst things to happen to capitalism that ever occurred in the US.
Private financial companies are relieved of their mistakes and given money to err again. Taxpayers are socked for the losses, despite their perhaps not having chosen to ever buy equity in the incompetent financial institutions.
And to pay for all of this, Treasury prints or borrows money, thus either devaluing the dollar or saddling the entire society with the interest and principle costs associated with the stupid lending decisions of some publicly-held, privately-owned banks.
That scenario makes no sense. The only defensible course of action is the creation of a 'bad bank' through loan purchases at lower, economic prices, resulting in bank closures, a reduction in lending capacity, and stronger resulting institutions. Which is what Anna Schwartz advocated last fall.
Well, sort of. Despite having months to conceive his plans for the financial sector and the economy at large, Treasury Secretary Tim Geithner apparently still needs a few more months to figure all that out. Heavens knows what he was doing since November.
Regardless, let's take a step back and consider just what it means to create a 'bad bank.'
First, it's basically Bill Seidman's RTC redux. Back in the late 1980s, in the aftermath of the S&L crisis in which those institutions borrowed short, lent long and low, and largely went insolvent. The thrifts were closed, loans collected into the Resolution Trust Corporation, and sold off to investors at deep discounts, providing many of the latter healthy returns. The 1980s S&L/RTC crisis was more about stupid funding strategies than bad loans.
Now, however, the nature of the 'bad bank' is different. This time, our largest commercial banks, as well as smaller ones and specialized lenders, e.g., Golden West and Countrywide, with Federal and state regulatory tacit approval, lent mortgages on only 5%, or less, down.
Consider two banks with different approaches to loan or securities value loss recognition.
Bank A, like Merrill Lynch, promptly begins to clean up its books by writing down questionable asset values. It rapidly erodes its capital, becoming nearly insolvent. It is taken over and merged with another institution, its shareholders losing everything. There may, or may not, be Federal loss-limiting guarantees on some of the loan portfolio.
If there are such guarantees, then not only investors, but all taxpayers, have just shared the losses of the badly-managed bank.
Bank B, however, holds out and avoids writing down its losses for months. Eventually, Treasury creates a 'bad bank' to buy bad loans from commercial banks. The theory is that, once freed of the bad loans they chose to make, these ailing commercial banks are now healthy and able to make new loans.
But before we know that, we need to know at what general price level the assets were transferred to the Treasury's 'bad bank.' I wrote about this dilemma back in late September of last year, in this post, when Bernanke and Paulson first unveiled their TARP plans. Specifically,
"Further, if Treasury bids such high, close-to-maximum-economic value prices for these securities, then there is virtually no chance of the US taxpayer realizing any gain on subsequent sales. At best, they may breakeven.
At the other extreme, though, also described by Bernanke, if Treasury's bid is a little above the fire sale price, but well short of the economic, or 'hold to maturity' value, then the selling bank receives little extra capital, and not much more in the form of marking similarly-held securities up to the bid, either.
What is it that I am missing? This isn't going to work!"
In fact, it didn't work that way, and was never actually implemented as stated. Now, Geithner's Treasury faces the same dilemma in creating a 'bad bank.'
If Treasury pays face value for the loans, fully recapitalizing the banks, then Bank B's management was smart in playing for time. In effect, by gaming the regulatory system, Bank B lives to make more bad loans, while Bank A was closed for the same offenses.
If, however, Treasury buys the bad loans at economic, or lower, value, which might be as low as the 37%-or-so value Merrill accepted in its funding deal last year, then the banks aren't sufficiently recapitalized to survive. Bank B is determined to be insolvent and, like Bank A, closed and/or merged with another institution.
In the latter case, taxpayers end up owning the bad loans at distress prices, so they don't share in the losses of the inept lending institutions.
From this little mind experiment, we've learned something valuable.
If Treasury pays at or near face values for the bad loans that will fill the 'bad bank,' then taxpayers, who individually may have chosen not to own equity in the ailing lending institutions, effectively find our government buying the losses from those banks anyway. And society is penalized for the sins of a few inept lenders, while the lenders get to remain in business and, in fact, are encouraged to lend again.
If Treasury pays economic, or lower, values for the bad loans to fill the 'bad bank,' then incompetent lenders and their institutions pay a price for their mistakes, and taxpayers don't subsidize them.
Either way, however, there is a net loss of recognized value to society, in the sense that the merry-go-round of overvalued assets stops and those values are forcibly reduced.
In the case of the RTC, the private, publicly-owned financial sector was not recapitalized by the government. Instead, weak and failing thrifts were eliminated, capacity removed, and a healthier, if temporarily smaller financial sector remained.
If Treasury creates the 'bad bank' by compensating existing publicly-held, private financial institutions at or near face value for recognized 'bad loans,' this will not be at all like the 1980s RTC solution.
Instead, Treasury will, in effect, be recapitalizing shareholder-owned institutions with public money, making taxpayers effectively own the mistakes, while rewarding the incompetent management that managed to hold on long enough to get this ultra-sweet deal.
Talk about moral hazard!
This would be among the worst things to happen to capitalism that ever occurred in the US.
Private financial companies are relieved of their mistakes and given money to err again. Taxpayers are socked for the losses, despite their perhaps not having chosen to ever buy equity in the incompetent financial institutions.
And to pay for all of this, Treasury prints or borrows money, thus either devaluing the dollar or saddling the entire society with the interest and principle costs associated with the stupid lending decisions of some publicly-held, privately-owned banks.
That scenario makes no sense. The only defensible course of action is the creation of a 'bad bank' through loan purchases at lower, economic prices, resulting in bank closures, a reduction in lending capacity, and stronger resulting institutions. Which is what Anna Schwartz advocated last fall.
Subscribe to:
Posts (Atom)
