The Misleading US Housing "Recovery"

Last Wednesday's Wall Street Journal carried a prominent lead article trumpeting the recent news concerning increases in housing starts and home prices "across U.S." Home prices were described as having "first gain in three years."

Yet, details in the long article were somewhat contradictory to this headline's implications, if not its limited scope.

No less an authority than Yale housing economist Robert Shiller was cited as saying,

"The change in momentum here is very significant."

Yet, the article also noted of Shiller,

"He said he expects home prices to remain near current levels for the next five years."

Elsewhere in the Journal piece, the ability of housing prices to rise was credited to banks delaying the remarketing of foreclosed homes. This deliberate constriction of supply tends to, of course, firm up prices.

Ivy Zelman, CEO of Zelman & Associates, a housing-research concern, was quoted as saying,

"We think (the sales index) will look like a "W," where prices go up until the foreclosures at the higher end translate into another leg lower."

The article also noted that larger down-payments are being required on buyers trading up to larger, more expensive houses, while jumbo mortgages typically carry higher rates. Both these factors will tend to retard housing sales.

These comments put an entirely different spin on the recent, small and brief upward blip in housing prices and sales.

Seen from 2005, both measures are still very low. And now we learn this positive news might be so only because an undetermined stock of foreclosed homes has yet to reach the market, thus further depressing housing prices, and, probably, new home starts.

Hardly what you'd use to underpin your hopes for a widespread US economic recovery, is it?

More Boeing Dreamliner Headaches

Last Thursday's Wall Street Journal reported Boeing's latest troubles with its Dreamliner 787 airplane program.

Now running over two years behind schedule, the plane is running into sagging demand and affordability issues by customers.

In these two posts last year, here and here, I commented on Boeing CEO James McNerney's continuing inability to manage the Dreamliner problem. Essentially, Boeing's board bet that a guy who ran the unit that built engines for airplanes could...run an airplane company.

So far, that's not working out too well. As the nearby 5-year price chart for Boeing and the S&P500 Index shows, the airplane company hasn't outperformed the index over the period.

Figure that you need some extra return from a single issue to adjust for risk, and Boeing's actually behind the index's performance.

What, exactly, has McNerney done for the company? Right now, shareholders would have been no worse off by simply holding the index.

Meanwhile, the gaffes which have become public in Boeing's Dreamliner program would make one ask just how competent the company has been with its vaunted new production and assembly concepts?

Somebody has to take responsibility for Boeing's lackluster total return performance and the Dreamliner's continual launch date. It would seem, after about four years, McNerney would be that person.

Kodak: How The Mighty Have Fallen

Friday's Wall Street Journal reported on Kodak's recent quarterly performance.

It wasn't pretty. The headline for the article proclaims "sales fall 29%." The firm lost $189MM in the quarter.

There were all sorts of the usual verbiage from the company's earnings report explaining expense cuts, revenue declines, etc. Kodak announced that it expects this year's total revenue to fall by 12-18% from the prior year's $9.42B.

As it happened, I saw a Kodak infommercial the next day for one of its printers. All I could think of was,

"Has it really come to this? Kodak is hawking printers with an ex-sitcom co-star on weekend cable television? Complete with the requisite "studio audience" and cutesy comments from the faux-production personnel?"

Yes, it has.

Schumpeterian dynamics have struck, and struck hard, at Kodak. Image capture, distribution, storage and, if you want, printing, in the digital world are finally nearly free, and very easy.

Long gone are the days, when I was a teen-ager, of buying film, taking it to the local drug store for developing, and then hiding the pictures in their bags for decades.

As Schumpeter correctly described, expensive products like film photography spurred radical technological replacements that, first, erode, then just eviscerate revenues and profits of the old-line producers. So low are the new prices that old competitors are crushed and their business models simply disintegrate to mere fractions of the old revenues and profits.

That's basically Kodak today. There really isn't enough of a business left to sustain an entire company with consistently superior profitability. What does still make money at Kodak could be just a copier or printer division at Dell, HP, Ricoh, Canon or Lexmark.

If you had a few billion dollars today, and Kodak's technologies, you probably would not waste the money to found the firm in its current incarnation. What you now see is a snapshot of a firm in the process of dissolving, apparently at an accelerating pace.

As the nearby 5- and 1-year price charts for Kodak and the S&P500 Index display, the company has not experienced prolonged positive returns in five years. It's had roughly -80% price drops over both the 5- and 1- year periods, suggesting it's on a sort of constant rate of decline on an ever-shrinking base, far underperforming the S&P over both periods.

I can't imagine who would still be an owner, besides those unfortunate enough to work at Kodak and have it in their 401Ks. Who wouldn't just dump this company's stock as it plummets toward no value at all, having lost almost any uniquely advantageous business attributes with which to stave off death by digital imaging?

Carol Bartz Finally Ties Yahoo Up With Microsoft

The big news in the technology sector this week was Yahoo's deal with Microsoft. Ever since the latter launched its semi-hostile takeover bid for the former, some sort of alliance has been talked about.

With Carol Bartz' recent assumption of the CEO position at Yahoo, investors' hopes brightened. Yet, after reading the reports on the actual deal, and various pundits' reactions to it, it seems many of those investors headed out of Yahoo positions, causing a one-day 12% drop in its stock price after the Microsoft deal was announced.

Meanwhile, an article in the Wall Street Journal this week extolled Microsoft's Ballmer for finally getting a few things right, e.g., Windows 7, improved XBox revenues, and the Yahoo deal.

As the nearby two-year stock price chart for Microsoft, Yahoo and the S&P500 Index shows, there wasn't a huge difference between the three. Certainly, after applying some risk premium for the two companies, they would both have underperformed the index.

The second chart, a five-year view, reinforces that conclusion.

I don't think Ballmer is by any means out of the woods yet.Microsoft has not convincingly outperformed the S&P for years, and I don't really think it's about to start now.

As for Bartz and Yahoo, I'm inclined to be a little less critical than most published pundits.

Unless you think she simply lost her mind last week and got snookered by Ballmer, the odds are that, despite her upbeat remarks to the media since she took over the helm at Yahoo, Bartz found things much, much worse than she feared.

To have gone from forecasting a 'boatload of cash' to come Yahoo's way from Microsoft for any tie-up, to getting very little, clearly disappointed a lot of shareholders. Even Ballmer chimed in with helpful comments like, 'people don't understand how good this deal is for Yahoo,' or some similar quote.

I think Bartz got the best deal she could for a firm, the very existence of which, prior to her arrival, was in doubt. She managed to outsource development for search, keep a lot of ad revenue, and get breathing room to pursue her objective of pumping up Yahoo's content.

If you revisit Bartz' remarks about the future she envisions for Yahoo, it's all about content, not search. She has managed to narrow the management focus of the firm and get continued search technology for free.

Not too bad. My guess is Bartz saw things as much worse than outsiders, and just couldn't drive a bargain that would effectively pay Yahoo up front for the Microsoft deal. But she still got what she wanted, and probably the best result among several not so stellar ones available.

While I would be unlikely to own Yahoo anymore, and don't forsee it entering our equity portfolio anytime soon, Bartz seems to have done a lot in a short time to begin reversing the damage done over many years by Terry Semel and Jerry Yang. Investors who want to own Yahoo should at least be thankful for that.

The Myth of "High Paying Manufacturing Jobs"

Earlier this week, I saw a surrealistic debate on CNBC between an SEIU representative and Wharton's Professor Jeremy Siegel.


Siegel cited economic theory that advanced economies typically lose lower-paying jobs, including simpler manufacturing, to lesser-developed, lower-wage countries. He cited, over the past several decades, the loss of comparatively few US manufacturing jobs, in the tens of thousands, in comparison to the addition of millions of service jobs. Siegel also asked the SEIU rep if he truly wanted his union members to be paid wages on a par with those of lesser-skilled Asians?

Somehow, all of this was lost on the SEIU guy, including the irony of Siegel pointing out how his own sector benefited.


The SEIU rep kept babbling about how we "need to create high-paying manufacturing jobs," as if they are simply devised out of thin air. And, that by saying that phrase, tautologically, such jobs must exist in a long run, profitable US manufacturer.


He then continued by ticking off various guarantees that workers should have- pensions, high pay, health care. Michele Caruso-Cabrera replied that there are no guarantees now, anyway. Unions price their workers out of the market, so continued employment with such lush packages as the SEIU rep listed was often in jeopardy.

Such as at GM and Chrsyler.

The SEIU guy went nuts.


What was evident, though, was his inability to understand Siegel's first, simplest point, i.e., you really don't want US workers being paid Chinese rates for manufacturing.


Missing, too, was an understanding by the union member that advanced manufacture requires education and training. If workers can't cut it, they're destined for lower-paying jobs. Period.


There just are no guarantees with global competition.


Along the way, GE CEO Jeff Immelt's dopey speech calling for more US manufacturing was cited, and Siegel sort of laughed and implied Immelt is an idiot. That's when he began to describe the low-paying type of work that manufacturing now typically is which has been sent overseas. That we are a service and IP giant, not really destined to grow manufacturing in a world with cheaper labor overseas.

It's understandable, sadly, that the SEIU representative continues to believe in the myth of "high paying manufacturing jobs" in the US, with no thought of how they would possibly be globally competitive.

It's totally baffling, at first, why GE's Immelt would be similarly ill-informed. But, then, as readers of this blog know, I have never believed that Immelt has been a worthy successor to Welch, or, for that matter, that the former has shown any ability to merit his current position and compensation.

Housing Starts From A Fresh Perspective

Tuesday's Wall Street Journal had a great little article by staff writer Mark Gongloff, entitled "Pyrrhic Victory in June Housing Data," about the June housing starts. It was tucked away on the back page of the Money & Investing section.

It's fairly short, so I've pasted it below:

Many investors celebrated Monday after June's "surge" in U.S. new-home sales. Alas, it was largely wishful thinking.

True, the Census Bureau reported sales up 11% from May. That is a big number, at first glance justifying Monday's 4.5% leap in the Dow Jones U.S. Home Construction Total Stock Market Index. But it fails a close inspection.

First, home sales quite often jump in June, the height of the spring selling season. When trying to gauge the strength of home sales, then, it makes more sense to compare them with the same month a year ago. That comparison is less kind -- sales were down 21.3% from June of 2008.

Seasonally unadjusted data show a total of 36,000 new homes were sold last month, the lowest June total since 1982, notes Richard Moody, chief economist at Forward Capital.

And the Census Bureau warns against assuming too much precision in these numbers, which are based on a sample survey. Accounting for a 13.2% margin of error -- at a 90% confidence level, suggesting the actual error could be higher -- new-home sales enjoyed somewhere between a 24.2% gain or a 2.2% decline from May.

New-home inventories are falling, an encouraging development. But inventories are still higher than their historical norm, and there remains an avalanche of distressed sales.

Little wonder, then, that June's "surging" sales were driven by heavy discounting. The median new-home price -- not seasonally adjusted -- fell 12% in June from a year ago, to $206,200, the lowest June sales price since 2003. And it was down 5.8% month on month.

To paraphrase Pyrrhus, if sales keep soaring like this, then home builders will be utterly undone.

That sounds more like it. Sales are down, year-over-year. And prices were discounted to get that.

Hardly a housing boom, is it? Or even a 'recovery.'

Yes, inventories of unsold houses are being sold off, but at lower prices. Which is a good thing.

But don't kid yourself that this is going to turn around next quarter....or the one after that.

The Economy: Recovering, Or Ready To Plunge Again?

Alan Blinder's recent editorial in the Wall Street Journal extolled the imminent blast-off for the US economy of Samuelson's accelerator-multiplier effect.

Blinder didn't credit the retired MIT Nobel Economist in his editorial, but he provided the math to explain how housing and autos, having plunged so low, will kick-start the US economy in the next quarter just by being non-negative.

Dick Hoey, whom I knew briefly at EF Hutton many years ago, was saying the same things on CNBC yesterday afternoon.

Then we have a very detailed, persuasive editorial in last Tuesday's Journal, written by Mort Zuckerman. In his piece, the chairman of US News & World Report, and head of Boston Properties, dwells almost exclusively on the under-representative current unemployment rate of 9.5%.

Zuckerman lists 10 separate, but related points, all of which provide evidence that the demand side of the economy, via consumer spending, will almost certainly be much lower in the next few years than most pundits, analysts and economists realize.

Among his points, Zuckerman cites: underemployed, those no longer even looking for work, workers 'employed' but on unpaid leave, part-time workers who were once full-time, shorter work weeks among the employed, a 65% capacity utilization at US factories, and, finally, the longest average length of official unemployment- 24.5 weeks- since this data item has been tracked back in 1948.

For good measure, Zuckerman adds that low consumer confidence and high debt levels have increased the savings rate which will, of course, dampen any subsequent recovery, as the consumer's 'marginal propensity to consume' will be much lower than in recent years. He laments that now, when a truly job-creating, infrastructure-building federal spending bill would help, it's too late. That's because $787B was allocated for what has been, to date, largely increases in Medicare and other state-based transfer payment programs.

In effect, Zuckerman would conclude that people like Bank of New York's Hoey mistakenly believe that there will be sufficient consumer demand to justify rebuilding inventories, building new cars and houses.

Who's right?

Personally, I'd put my money on Zuckerman. Leaving aside that Dick Hoey was a fixed income manager back in the day, and his BONY/Mellon/Dreyfus bio doesn't exactly laud him as an economic Nobel Laureate, I don't think Hoey is sufficiently observant of the real differences in the effects of the recent recession on the US labor force from those of recessions prior to 1992.

That so-called 'jobless recovery' may well have marked a turning point for the US economy which has not yet been captured in various models and adequately observed by pundits-cum-economists like Hoey. Or even Alan Blinder.

Prior to the 1991-92 recession and recovery, you are looking back to 1982-83, the early Reagan years, now very nearly thirty years ago. For perspective, was the 1960 economy different from that of 1930? Very much so. And the 1980 economy was so radically different from that of 1950, thanks to electronics and technological advances in communications as to make forecasting the former with models of the latter seem laughable.

I suspect that's what is happening now. Those analysts and economists harking back to the early 1980s and using conventional models with estimates of consumer spending and labor growth have missed some important transformations in the US economy of 2009.

I don't think Zuckerman is one of them.

Barnes & Noble Enters The Electronic Reader Business

Last Tuesday's Wall Street Journal reported on Barnes & Noble's entry into the electronic book market. In a direct challenge to Amazon and its Kindle e-reader, the bookstore chain is seeking to extend its business into providing e-books across a range of readers. And, the Journal report states, probably enter the e-reader market, as well, with its own proprietary device, to be developed by Plastic Logic.

I find this very exciting.

Up to now, Amazon has had a lock on this market, although nobody knows just how lucrative it has been. Whatever that profitability level has been, watch it shrink.

Credit Barnes & Noble, too, with not waiting around to be cannibalized by a potentially growing market in electronic readers and content.

The nearby, Yahoo-sourced price chart of Barnes & Noble and the S&P500 Index shows that the bookseller has held its own with the market over the past five years, but dipped lower during the turmoil of the past 18 months.

If you think about it, there's little about Amazon's book and e-reader business that B&N can't duplicate. It has a well-known brand, and its website ought to be able to hold its own, as well.

If this boils down to a battle of pricing and features of e-readers, Amazon could be in a lot of trouble. In fact, per classic marketing theory, Amazon could actually end up paying a price for being the 'first mover' in this new publishing area.

Often, early entrants into a new field eventually suffer by becoming the target of later, better-focused and technologically-superior competing products.

Given that neither Amazon, nor B&N are doing in-house development of e-readers, it could well come down to the delivery of content. On that basis, too, B&N should be able to remain competitive.

I wonder if Jeff Bezos is worried. My guess is he should be. Not because B&N could become the market share leader in e-readers and e-books, but because it could slow Amazon's own growth, dragging the online merchant back to parity among other competitors in this new publishing area.

The Myth of Consumer Over-Spending

Last week, I caught a few minutes of CNBC's morning program, Squawkbox, when a market strategist for, I believe, Citibank, Tobias Levkovich, made a clear and succinct statement regarding US consumer debt and spending.

Levkovich unequivocally stated that he had studied data over some longish period, perhaps the past 7-8 years, and concluded that the wealth created among consumers over that time vastly outweighed what had been borrowed against housing equity and on credit cards.

David Malpas, once the chief economist of Bear Stearns, is the only other prominent analyst to have noticed this.

Levkovich then addressed the many who consistently claim that US consumers simply 'used their houses as piggybanks,' and said they are wrong. That this is a myth and it's simply, clearly, wrong.

Ford's Big Quarter

I saw in Friday's Wall Street Journal that Ford finally posted a profitable quarter. Granted, much of it was due to various restructuring-related, non-comparable income statement items. But evidently analysts and investors are whooping it up.

Pardon my lack of interest.

Truth is, Ford is unlikely to ever appear on my equity and option strategy's list of investments.

There are several reasons why Ford's quarterly performance is probably not the beginning of a pattern of consistently superior total returns which would truly reward investors.

For some perspective, observe the nearby 6-month, 2-year and 5-year performances of the price of Ford, compared with the S&P500 Index.

Ford is up 200%, meaning it's price quadrupled in the past six months, but is down 20% over the past two years. Over the past five years, Ford is down about 50%, while the S&P is just below flat.

Much of Ford's recent gains are simply the snap-back after the entire sector was in trouble at the end of last year. Like many other companies, values in the first quarter of this year were often far below longer term values, if the company survived. Thus, the six-month Ford stock price performance isn't really due to operating improvements.

It's not at all clear, and, actually, is pretty unlikely that this phenomenon can continue into the future.

Granted, Ford borrowed heavily while it could, during Mulally's early tenure, and generally cleaned up its balance sheet, thus avoiding GM's need to file for bankruptcy. But it still has the UAW with which to contend, and, now, is competing with two government-assisted auto makers, GM and Chrysler.

Finally, auto making just isn't the sort of business in which a has-been, ailing competitor like Ford is likely to suddenly surge forward and become a consistently superior total-return performer.

Barriers to entry are so low that Chinese cities are building cars. Newer vendors of alternative energy cars, such as electric, stand ready to compete Ford back to the point of merely average profits and growth.

Vehicle production just isn't the sort of business that has characteristics of defensible advantages, low union involvement, and high growth that are so often found in the best companies.

Ford reported one good quarter. Maybe it'll have one or two more. But the probabilities that Ford is going to be a long term bet for consistently beating the S&P500 just aren't very high. And that's as much a function of the sector in which the company competes as it is of the company's particulars.

CNBC's Resident Idiot Strikes Again

Earlier this week, CNBC resident idiot and economic-pretender Steve Liesman demonstrated why he loses so many debates, especially with Rick Santelli.

On the morning in question, Squawkbox had Wisconsin Republican House member Paul Ryan as guest-host.

Ryan, in response to a typical charge that conservatives/Republicans in Congress were simply 'against healthcare reform' and had no ideas of their own, quickly rattled off several bills proposed by Senate or House Republicans, but ignored by Democrats. His own proposal, he noted, covers the poor uninsured by providing a (roughly) $5,000 amount as a credit or rebate to use for health insurance.

When Liesman contended that this would cost Treasury, Ryan corrected him, explaining current treatment, taxes typically paid by these filers, i.e., not much, and the alternative of redesigning our entire healthcare finance system just to cover several million people.

Liesman then stared blankly at Ryan, mouth open, eyes dull, uttering something like,

'I'm sorry, I'm just not getting it, Congressman.'

Even I had understood Ryan's explanation, and I'm sure most viewers did, too.

Ryan smiled and patiently replied that he'd take Liesman back through the numbers- again- after the commercial break.

It was a priceless moment. CNBC's clueless economic reporter didn't have a clue about Ryan's rather straightforward manner of providing healthcare insurance for the poor, and the entire program had to stop until the staff dunce 'got it.'

As if it mattered. Or Liesman would be able to retain the explanation for more than a few minutes.

That's Why We Have Anti-Trust Laws

Holman Jenkins, Jr. wrote a curious editorial in Wednesday's Wall Street Journal.

In the piece, he spent considerable ink asking why Google and Microsoft don't figure out how to collude in staying out of each other's way. By comparing Google's relationship with Apple, on whose board Google CEO Eric Schmidt sits, Jenkins noted the animosity present between the other pair of companies.

Going through various detailed examples, such as Microsoft's new Bing search engine and Google's online office applications, Jenkins contended, probably correctly, that each has less prospect of gaining much revenue from encroaching on the other's turf than they have profit to protect by demonstrating their ability to hurt each other.

Somewhere in the piece, Jenkins noted the likely cross-ownership of Google and Microsoft by many shareholders, reasoning that, because of this, it would be a good thing if the two firms could somehow learn to back off and let each other's businesses alone.

But that is exactly why we have anti-trust laws. Microsoft is already moving to cut prices on Office applications and ready its own free internet version because Google entered the business with its own free online applications.

The two also tangle in search applications.

If Google weren't threatening several of Microsoft's businesses simply by its existence, we'd all be paying higher prices for less productive software from the Redmond giant.

Anti-trust law is a good thing. I don't quite understand Jenkins' contention that if only it were legal, gee whiz, these two large companies could save so much money by not building businesses which antagonize and threaten each other.

If that were so, the entire Schumpeterian dynamics process in the businesses in which Google and Microsoft engage would be slowed to a crawl.

The two firms' mutual pressures on each other to continue to innovate, offer more value for price, and worry about the other's encroachment all serve consumers well.

Why change that?

What Ben Bernanke Didn't Tell You In His Editorial

Fed Chairman Ben Bernanke wrote a long editorial in Tuesday's Wall Street Journal, appearing the morning of his Capitol Hill testimony, entitled "The Fed's Exit Strategy."

You see, many people, including me, doubt that the Fed can effectively avoid rampant inflation caused by its monumental explosion of the US money supply and guarantees.

Ben patiently attempted to reassure readers by listing the many ways he feels the Fed can rein in much of the liquidity it recently created.

Here's the one thing Ben never mentions in his editorial.

All of the methods he described involve raising interest rates.

Whether it's by paying higher interest rates on bank reserve deposits, selling Treasuries, or any of the other approaches he outlined, they all necessarily involve boosting interest rates.

It's fundamental economics. Money supply down, rates up. Pushing securities into investors' hands via sales pushes those prices down, thus raising effective interest rates.

You know what rising interest rates tend to do?

Yes, that's right. Choke off recoveries and slow economic growth.

Granted, rates are basically at zero for now. But they are at zero with much, much more US obligations outstanding than ever before. To move the needle on these massive obligations, interest rates will have to rise.

Oh, yes. That's right, the rate the US pays on its debt will...have to...rise.....too.

Oh, my. Doesn't that raise our cost of government and the deficit?

You betcha!

Thanks for the tutorial, Ben. Next time, maybe be more honest about the effects trying to shrink the money supply will have on the economy's effective interest rates?

The Coming Financial Sector Troubles: Commercial Real Estate

Last week, in this post, I cautioned against becoming too optimistic over Goldman Sachs' recent blowout quarterly earnings.

Sure enough, yesterday's Wall Street Journal warned that Morgan Stanley is likely to report a loss this quarter, due in large part to bad commercial real estate performances.

This is precisely the sort of thing I had in mind when I wrote about Goldman. Goldman's earnings were trading-related, something at which the firm has always excelled. And it has been rather aggressive at writing down its commercial real estate holdings.

Morgan Stanley, however, seems to be reminding investors that it is an also-ran in investment banking, and, now, commercial banking, too. It plunged into real estate late and ineptly, being burned badly enough to have to plead for a commercial banking license, and actually consider behaving like one.

But, like most investment banks, Morgan Stanley doesn't really have a great deal of successful experience with holding physical assets like real estate for long term gains. This is now becoming clearer.

In fact, the drumbeat of commercial real estate troubles, which began some months ago, are growing louder and touching more companies, including GE.

I think it's way too early to declare soundness in the banking sector, or a healthy, recovering economy.

So long as joblessness continues to grow and federal spending fuels GDP, real estate lending of both types, residential and commercial, seems destined to limp along until prices finally fall to market-clearing levels.

Morgan Stanley's imminent disclosure of more real estate losses is probably just the tip of another expensive iceberg for the financial sector.

GE's Continuing Pathetic Performance

The Wall Street Journal's headline on GE's performance results this past weekend said it all, "GE Net Falls 49% as All Units Hit."

Ouch!

Perhaps the most glaring insult to shareholders was inept CEO Jeff Immelt's quote,

"Despite a difficult overall economy, we are pleased with our results."

That sure took a lot of gall for Immelt to say, didn't it? Look at the nearby stock price charts for GE compared with the S&P500 over the past 3, 6 and 12 months.

The financial unit saw profits plunge 80%! Once again, Immelt's mismanagement and continuation of the firm's senseless, grab-bag diversification, has injured shareholders more than was necessary.

With virtually no relationship between the major components of the firm, those shareholders wishing to hold only industrial or media properties could have avoided the enormous losses of the financial unit's toxic holdings.

The same day, a Journal analytical piece in its 'Heard On The Street' column spanked GE for two weaknesses.

First, the piece noted how GE, contrary to many commercial banks, has continued to issue debt with government guarantees. Without conventional bank deposits for funding, the company has issued $68B of obligations under various federal programs, and there's no clear end in sight of the company's dependence upon, basically, all taxpayers.

The article also draws attention to GE's lower reserves for commercial and residential mortgage losses than its commercial bank competitors. This is an area on which the firm has been castigated in prior months, and there doesn't appear to be any sign that its management has seriously considered more realistic treatment of asset values in its real estate portfolios.

Take these two items together, and you conceivably have GE raising taxpayer-guaranteed debt while inaccurately leaving questionable real estate asset values inflated.

All in all, hardly a picture of competent, prudent management of the diversified conglomerate of which so much glowing press has been written in past decades. Instead, it's become a bloated, over-valued collection of unrelated, struggling businesses dependent upon government aid to fund itself.

This is a business model of which Immelt is proud, and the performance with which he is pleased?

Jack Welch must be spinning in his grave. Oh, wait, Neutron Jack's still alive!

More Signs of Schumpeterian Weakness At Microsoft

In a rather innocuous article in last Tuesday's Wall Street Journal, the paper reported that Microsoft is set to offer a free, online version of its Office software in the first half of next year.

It doesn't get much more Schumpeterian than that, does it? Google's intense pressure on Microsoft, including helping starve the former of search revenues, then offering its own free online suite of applications software, has finally caused the software titan to buckle on maintaining Office's conventional product strategies and policies.

Despite the company's insists that it will continue to grow Office revenues at a healthy rate, I'm rather more suspect about this.

My own children have learned to subsist nicely with web-based spreadsheet and text programs. Most people don't even use 80% of what Office products contain anyway. I have never bothered to upgrade from Office 2003, which has precious little advantage over my prior copy of Office2000, and contains copy limitations, too.

It's unclear to me that I'd shell out over $600 again for a private copy of the professional version of Office. There just doesn't seem to be that much comparative advantage anymore. As it is, so long as Office2003 is compatible with a next Microsoft operating system, I would have absolutely no need to upgrade.

I'm sure I'm not alone. Microsoft didn't come to be so reviled by good product management. Like many companies and other individuals, I'm always open to ways to avoid paying the Redmond giant another buck. Especially when no new significant value has been added to its products.

With their imminent admission that the web is a required distribution channel for Office, and on a free basis, at that, I think the end of Office as a main revenue growth engine at Microsoft is in sight.

Hank Paulson's Congressional Show Trial

I happened to see several minutes of Hank Paulson's Congressional show trial of last week. Specifically, I heard a Representative, from which party I honestly don't know, lambaste Paulson for having enjoyed a statutorily provided tax deferment on profits earned from premature sale of assets upon being confirmed Treasury Secretary.

Sounding like a mad dog with no common sense whatsoever, this thin, older-looking male Representative repetitively demanded to know how much in taxes Paulson had avoided paying due this provision.

This particular line of 'questioning' was quite far afield from the stated reason Paulson was appearing before the Committee, i.e., to determine whether he and/or Ben Bernanke used undue coercion on BofA CEO Ken Lewis to force him to complete the Merrill Lynch acquisition.

If we are to attract candidates of merit and suitable qualifications and accomplishments to cabinet-level offices, we can't have Congressional members behaving like Grand Inquisitors. Specifically, twisting legitimate actions of government servants to appear as something else- in this case, tax evasion by the rich.

We're all going to be much poorer, economically and otherwise, if our Congress continues to attempt to criminalize every aspect of any administration's behavior with which it disagrees.

Let CIT Die

There has been much handwringing regarding CIT's imminent demise, amidst discussions with the federal government for yet another rescue package.

According to Tuesday's Wall Street Journal, CIT has suffered heavy losses in its lending to small- and medium-sized businesses, but is not really considered a lynch-pin of the overall banking system.

Still, federal administration members worry about the signal that would be sent if a major lender to small business goes bankrupt.

Honestly, how hard is this one to figure out?

CIT has lost money doing its business. It's evidently not very good at making credit risk and/or funding decisions, which are the two most important aspects of a lending business.

If there is sufficient profitability in well-made small business loans, some other firm will enter the market as CIT vacates it with its collapse. Hopefully, doing the business better than has CIT.

But why in God's name would anyone wish to prop ups a badly-run lender that isn't crucial to the nation's financial system?

This is really a no-brainer. The loans which are outstanding will be assumed or bought by some entity. New credit will flow if it's viable and profitable.

If it's not, then these borrowers were not the ones we should want to have receiving loans in the first place.

Things generally work better when you leave market forces to figure them out. The mere fact that the administration has been discussing bailing out CIT tells you they don't really understand the dynamics involved in this matter.

Rather than clear out an incompetent source of business lending, to make room for better ones, administration officials are seriously contemplating aiding idiots who have run their own business into the ground.

This is no way to recover an ailing economy, nor, for the long run, promote efficient economic activity in the US.

Exxon Blinks On Alternative Energy

In a scene very reminiscent of the 1970s- and isn't much of our political economy these days?- Exxon announced a strategic reversal on alternative energy sources.

Yesterday's Wall Street Journal reported that Exxon is pairing with esteemed biologist J. Craig Venter to research the use of algae to clean greenhouse gases and secrete oil.

Honestly, reading that last part, it sounds like a sci-fi novel.

And maybe- just maybe, if we are lucky- it is.

Because the last time Exxon appeared to abandon its primary business, oil exploration and refining, and jumped into something else, it wasted billions of dollars. According to the Journal article, this time, it seems to be anteing up only $600MM. Truly a pittance for the oil giant.

Some historical context is required to properly understand what's happening here.

Back in the 1970s, when the Clean Air Act Extension and high oil prices put pressure on oil companies, Exxon launched Exxon Enterprises. EE was a holding entity which oversaw startup planning for all sorts of non-oil businesses, including solar energy panels, a fax machine business, and various other electronic office products initiatives. The thinking was to use Exxon's enormous revenues to fund so-called replacement technologies, such as electronic office equipment, to replace oil used in commuting and travel, and solar, to replace depleting and expensive oil.

I consulted to one of the EE businesses as part of the Wharton Applied Research Center when I was a graduate student. In a hilarious activity straight out of Joseph Heller's Catch-22, our mission was to help the management of Exxon Solar Energy to forecast a developing market of sufficient size to secure follow-on budgetary funding to continue the business effort. The furthest thing from our charter was to actually create any product. We were brought in to simply play a paper-shuffling game of justifying the unit's existence to corporate for a few more years. The stories we heard of oil executives jumping ship from the New York headquarters to work out in Florham Park, NJ, were many and rich. Suffice to say, there was a whole lot of ticket-punching going on, but nobody believed in the longevity of the businesses.

As it happened, a year later, I was working at AT&T in Morristown, just a stone's throw from EE. In short order, Lee Raymond, the now-retired CEO of Exxon, was brought in to wind down the whole mess and stanch the incredible losses emanating from Florham Park.

Raymond observed that oil wasn't going away, while Exxon would never amount to much in these new areas. He presided over the selling off or closing of all the EE business efforts.

In truth, EE had served its purpose. During a period of hysteria over high oil prices and Arab control over much of the world's crude, Exxon had successfully deflected some public criticism, and appeared to be spending money on diversification in order to seem to be 'solving' the problems associated with high oil costs.

Once Reagan was in office and the publicity crisis had passed, Raymond, a rising 'go to' guy at the firm, was brought in to restore sanity.

I think that's what's occurring now, too.

Rex Tillerson is no fool. I loved the Journals reference to Tillerson's snide remark about alternative energy, i.e., that he expected to be driven to his funeral in a car powered by gasoline or diesel fuel. And he will be.

But, for now, it's once again time to show public humility at being in the oil business.

Who better with whom to partner than noted scientist Venter, on a project that sounds like something out of pure science fiction.

Imagine- an algae that consumes greenhouse gases and spews out usable energy. Can it get any wilder, more perfect, or safe?

I can just see Tillerson and other senior Exxon execs around a conference room table one-upping each other on what the alternative energy project should have as its aim, and roaring with laughter at the final result.

How many years will it be before any real progress is made on this wild-algae chase? Well, Daniel Nocera's work on fuel cells has consumed about a decade, and he figures he has at least half that time, again, to go before perfecting his work.

Who knows how long Exxon can manage to make this tilt at an enormous windmill take? Most likely, long enough to see a return of either the Oval Office or at least one chamber of Congress to Republican control.

In the meantime, this far-fetched, impossible-sounding quest will soldier on, consuming a trickle of Exxon profits, while reaping huge publicity gains.

Don't ever underestimate Exxon management.

The Dial-a-Mattress Case

Yesterday's post discussed Goldman Sach's recent blowout earnings announcement. For what it's worth, a Wall Street Journal column on the back page of today's Money & Investing Section echoed my own note of caution regarding Goldman as a bellwether. More on that in a later post.

Going from the sublime to the ridiculous, yesterday's Journal featured a piece which my business partner and I thought had vanished. It was a rather in-depth story on the bankruptcy filing of New York-based Dial-a-Mattress.

As successful and 'together' as Goldman's management team has always been, Dial-a-Mattress' was home-grown and sort of 'seat of the pants.'

Founder Napoleon Barragan got his idea from a local business that once sold steaks over the phone, and began a similar one for bedding in 1976. After some twenty-five years of solid and profitable growth, the company's downfall began in 2001, according to Barragan. Specifically, the article notes,

"Mr. Barragan said two major changes in his business were largely to blame: an expansion into bricks-and-mortar sales and a culture clash brought on by new management."

In effect, the business cratered due to totally controllable mistakes, not market or consumer trends.

In brief, the Journal piece describes Dial-a-Mattress' haphazard, inept expansion into physical stores right after the 9/11 economic pullback. It's clear from the article that the company stumbled its way into this strategy, mistakenly opening stores in literally "low rent" areas to which people would not drive to shop.

Unbelievably, Barragan states that the company never did standard store-based profitability analysis which could have caught the losses early on and perhaps mitigated the damage.

Around the same time, Barragan hired a fairly large number of new senior executives, thus diluting the culture with which Dial-a-Mattress had succeeded for years. In a scenario straight out of some made-for-television movie about rich, inept businessmen, the new hires ignored the operating processes which had accounted for much of the firm's nimbleness, and, instead, devoted much time and energy to infighting.

Apparently, according to the Journal's piece, nobody bothered to analyze profit margins by channel, store, or any other basis. Thus, rising sales were seen as validation of new strategies, including a successful move to internet-based sales, while profits languished, then fell.

The final chapter is that the firm's competitor, Sleepy's, is purchasing the phone and online portion of the business, as well as hiring Barragan at $500,000/year.

As I read this story, I was struck by how difficult building and maintaining a successful business is. And how often successful companies fail for the most basic, fundamental reasons.

In Goldman's case, it was forced to become a commercial bank, and take federal funding, not so much for its own mistakes, but for the tenuousness of the financial system in which it operated. The mere hint of counterparty failures sent Goldman to the brink. Though it seemed never to skate so close to failure as Bear Stearns did, the same forces were about to bear down on the formerly premier investment bank.

In the case of Dial-a-Mattress, the business model was simpler. Yet the mistakes which sank the firm were simpler, too. And, unlike Goldman's, totally under management's control.

How fleeting is business success. How many ways there are for it to go "poof."

No matter how smart, or uneducated the management at the helm.

I guess, as I read this post, one has to ask the unrelated question,

'Was it fair for Goldman's mistakes in operating in an environment in which it was so vulnerable to counterparty and funding risk to be assumed by the federal government, thus saving the firm and most of its employees, while Napoleon Barragan's mistakes led to his firm's failure?'