KKR, TPG & The TXU Private Buyout Fiasco

Tuesday's Wall Street Journal featured an article on the mess that's become of KKR's and TPG's private buyout of TXU.

When you think of private equity, you often think of wealthy, savvy private capitalists buying underappreciated companies and assets, sprucing them up, then spinning them back out to the public, coining money in the process.

Sometimes, of course, we read about one of the leveraged buyouts which essentially just looted the firm of value by loading it up with debt, paying a 'special dividend' to the buyout firms, then letting it go under or stagger under the onerous debt service costs.

But one paragraph of the Journal story gave me pause.  It contained this passage,

"The biggest leveraged buyout of all time has boiled down to an expensive bet on the price of a commodity. Natural gas has fallen 43% since TXU's buyout, and settled at $3.927 a million British themral units on Monday."

Makes you think twice about how smart some of these private equity guys are, doesn't it? Like Cerebrus' purchase of GMAC and Chrysler just before the mortgage-backed mess collapsed in 2008.

Somehow, one is left feeling that TXU should have been left alone, and these private equity guys could have just gone long natural gas futures, if that's really all they were effectively trying to do.

CNBC's On-Air Staff & Yesterday's Equity Market Sell-Off

US equity markets sold off yesterday. We got that.

But if you watched CNBC after 3PM that afternoon, you saw some priceless comedy featuring Maria Bartiromo's breathlessly asking a guest, to paraphrase,

'We've had a two-year bull market during which some have been calling for this pullback. Calling for it for years. Now we finally get it.'

Two years? Are you kidding me? Someone's been predicting an equity market drop for two years, and yesterday they were suddenly heroes? I'd like to see one of those anchors or reporters try to manage a live portfolio where you weren't allowed to just guess that sometime during the next few years the market may decline. You had to go long or short for real.

Around 3:45PM, the network shifted into high gear with a multi-camera'd navel-gazing session that looked, onscreen, like the old Brady Bunch intro. Among the cognoscenti were the network's own David Faber, Sue Herrera, ex-anchor Ron Insana, a few other staffers I can't recall, and one or two guests. The first few participants, of course, were CNBC talking heads.

Why do you suppose a crew of people whose job is to make every day in the markets seem like the most important day ever would have a clue as to what yesterday's equity market decline implied? Didn't occur to any of the CNBC production staff to arrange participation by some respected portfolio managers or equity strategists, rather than their own largely credential-less crew of reporters and talking heads?

Here's a test. Bartiromo wrung her hands over the day's losses. Others decried the rise in volatility.

Since the market's post-2008 crisis bottom on 9 March, 2009, how many days has the S&P500 Index experienced a loss greater than yesterday's?

The answer appears below, in a table of the 50 worst daily percentage declines since the market's bottom. I've highlighted yesterday in red. It's only the 32nd worst day in two years.

The champ? April 1, 2009, at -4.28%

At -1.89%, yesterday's Index decline didn't even make it into the -2% range, of which there 18 days of such magnitude.

       Date      Level      Return


1 4/20/2009 832.39 -4.28%


2 5/20/2010 1071.59 -3.90%


3 3/30/2009 787.53 -3.48%


4 6/4/2010 1064.88 -3.44%


5 5/6/2010 1128.15 -3.24%


6 2/4/2010 1063.11 -3.11%


7 6/29/2010 1041.24 -3.10%


8 6/22/2009 893.04 -3.06%


9 7/2/2009 896.42 -2.91%


10 7/16/2010 1064.88 -2.88%


11 8/11/2010 1089.47 -2.82%


12 10/30/2009 1036.19 -2.81%


13 5/13/2009 883.92 -2.69%


14 10/1/2009 1029.85 -2.58%


15 8/17/2009 979.73 -2.43%


16 4/7/2009 815.55 -2.39%


17 5/4/2010 1173.6 -2.38%


18 6/15/2009 923.72 -2.38%


19 4/27/2010 1183.71 -2.34%


20 1/22/2010 1091.76 -2.21%


21 9/1/2009 998.04 -2.21%


22 5/11/2009 909.24 -2.15%


23 2/22/2011 1315.44 -2.05%


24 3/27/2009 815.94 -2.03%


25 3/24/2009 806.33 -2.02%


26 4/14/2009 841.5 -2.01%


27 3/20/2009 768.54 -1.98%


28 7/7/2009 881.03 -1.97%


29 10/28/2009 1042.63 -1.95%


30 5/27/2009 893.06 -1.90%


31 1/21/2010 1116.48 -1.89%


32 3/10/2011 1295.11 -1.89%


33 5/14/2010 1135.68 -1.88%


34 1/28/2011 1276.34 -1.79%


35 11/27/2009 1091.49 -1.72%


36 6/1/2010 1070.71 -1.72%


37 8/19/2010 1075.63 -1.69%


38 6/24/2010 1073.69 -1.68%


39 5/21/2009 888.33 -1.68%


40 4/30/2010 1186.68 -1.67%


41 11/16/2010 1178.34 -1.62%


42 4/16/2010 1192.13 -1.61%


43 6/22/2010 1095.31 -1.61%


44 10/19/2010 1165.9 -1.59%


45 3/1/2011 1306.33 -1.57%


46 5/7/2010 1110.88 -1.53%


47 8/30/2010 1048.92 -1.47%


48 8/24/2010 1051.87 -1.45%


49 11/23/2010 1180.73 -1.43%


50 5/18/2010 1120.8 -1.42%

What about volatility? Well, everyone has their favorite measure. By mine, yesterday's volatility value isn't even close to levels that should worry you about a significant, short-selling type of market sell-off. In fact, volatility was more than twice as great while the market rebounded in March of 2009. There were at least two more periods of higher volatility since then.
So before you get all shook up by Bartiromo's breathy rhetoric and anxious tone, never mind her typical loss for words and inability to get her sentences enunciated properly, check the facts.
 
As market hurricanes go, this isn't even a tropical storm yet.

A Twitter-Based Hedge Fund

I saw one of the most unusual segments on CNBC a few days ago involving a hedge fund announcing it will use Twitter-based inputs for trading.


If I recall correctly, a psychology professor and his grad student played with data and found an alleged leading indicator of Tweets, classified by sentiment, to the Dow's performance 3-4 days later.


Then a British guy with money from some other, distinctly non-financial venture, the exact nature of which I've forgotten, but think it had something to do with hair care, together with his colleague or brother, is investing some millions of pounds in a hedge fund- and promptly arranged to use the Twitter-based approach. The investor was presented in a brief clip extolling the importance of jumping on such a hot, 'leading edge' concept as Tweet-based trading.


This is almost too funny for words, isn't it? If it were three weeks from now, I'd think it was an April Fool's Day joke.


There are so many things about this story that don't make sense that it makes you wonder how it even made it onto CNBC a few afternoons ago.


First, it's clearly a high-frequency trading strategy. That means it's expensive. We learned nothing about how much and how rigorous was the backtesting the creators did on the strategy.


Of course, being psychologists, selling or licensing their technique to novice hedge fund owners, one wonders if any of them- concept originators or hedge fund owners- actually have any idea how professionals actually test these things?


Then there's the rather non-trivial question of just how it works. Believe it or not, most sophisticated investors don't want to invest with novice fund managers who operate a total black box investing strategy. Think, well, Bernie Madoff.

Especially one which relies, we are told, on the daily attitudes of the tweets of samples of several million users. Which are then, we're told, classified into one or more of six sentiment buckets, the disposition of which apparently creates a signal to buy or sell the Dow in anticipation of its level 3-4 days hence.

The actual example given in the interview on CNBC was a Tweet by a person stating that they were going to their gym to work off some excess weight. The psychologist sagely intoned that this was a negative market indicator.


Then there's the ease with which this could probably be cloned, with the market inefficiencies beaten out of it within a year- or less.


Or perhaps a competitor will clone it, then go one step further and poison the general Twitter feeds, while retaining their own pristine stream, the better to confuse others trying to trade on such sentiment.

Having been introduced to adapting what a novice equity strategist thinks is an investment-ready approach to actual operational status by experienced fund managers, I speak from experience when I say that I am sceptical of the Twitter-based fund concept. There just don't seem to be any experienced adults in sight to vet the idea.

But I guess time will tell whether we'll hear more about this one.

BofA's Moynihan Proves My Point

You have to laugh at BofA's CEO, Brian Moynihan, trying to make a virtue out of a vice.

As the chart in this recent post illustrated, BofA has performance problems. It has no business even thinking about expansion and acquisitions. And Moynihan, being a lawyer, is probably over-matched as it is trying to run such a large, diverse company. Remember the last time a lawyer ran a large US commercial bank?

That's right- Chuck Prince tanked Citicorp so badly the government had to step in and buy part of it to keep it from dissolution.

Anyway, back to our story. Moynihan gave a carefully-timed interview to CNBC the other afternoon, echoing a recent Wall Street Journal article announcing his "peace dividend." That's Moynihan's term for the value he plans to return to shareholders by not pursuing acquisitions. Considering the last two large BofA acquisitions cost Moynihan's predecessor, Ken Lewis, his job, you can understand his attitude toward expansion.

Laughably, according to the article, BofA thinks it will break new ground trying the oldest large commecial bank trick of all- cross-selling.

The short story on this vain attempt is that the customers with money know better than to give all their business to one giant mediocre banking firm, while the customers who want to do this aren't profitable enough to make it worthwhile.

Of course, being new to managing a bank, Moynihan probably doesn't realize this yet.......

Meanwhile, the firm is buying back its equity and closing branches. That sounds like a bank that acknowledges the over-banked nature of the US market.

Hardly a reason to invest, is it? I stand by my conclusions of the prior, linked post.

Groupon & Its Competitors

I was very intrigued by a recent Wall Street Journal article discussing competitive risks for Groupon, the company that combines couponing, social networking and local business.


The article cites Groupon as potentially earning $1B in revenue for 2011, but then notes that the online couponing business has low barriers to entry. The trick, it contends, is pairing large pools of email addresses/subscribers with large pools of merchants. For that, it names Google and Amazon as the two most obvious potential competitors to Groupon.


Google's $6B offer wasn't sufficient to buy Groupon, but it does have the necessary pools of potential customers, as well as existing merchant relationships. Amazon, the Journal piece notes, currently backs LivingSocial, Groupon's most significant existing competitor, with 20 million subscribers to Groupon's 60 million.


The article mentions a national coupon deal LivingSocial did for movie tickets through the online service Fandango. It drew a million responses as of noon of the day the article went to press. It also cited Groupon's largest offer, which was with Barnes & Noble, garnering 700,000 respondents.


What struck me about this was just how low the barriers to entry may well be in this product/market. I hadn't really given the business a whole lot of thought until I read this piece. Frankly, it just seems to be a tactic- couponing- that no business can afford to do too much of, without suffering serious pricing policy challenges for the long term. There's something about teaching customers to expect discounts that becomes corrosive over time.


Regardless, it's clear that by starting with national vendors, an online coupon competitor can rapidly build a subscriber base, then slowly move, locale by locale, into individual markets. Of course, once you have even three competitors, the revenue split becomes a weapon to be used to lure vendors to a specific competitor.

As the Journal article noted in closing, perhaps the Groupon owners should hurry along on an IPO, while they still have such a high market value. Once large competitors really get rolling, that value could shrink surprisingly quickly.

Starbucks Again- Still Trying To Talk Itself Back To Growth

I read Starbucks CEO Howard Schultz' Wall Street Journal interview in the Monday edition and immediately headed for a price chart of the firm and the S&P500 Index. Two, actually.

The first shows the two series for the past five years. The second covers a period from the early 1990s, when Starbucks went public. The two charts provide some interesting perspectives on the firm's recent performance.

In the Journal piece, much is made of revenue and profit growth from 2009, as well as even more recent growth statistics. That's all well and good if you are a prescient market timer. Few investors- even professionals- are successful at that.

What the first chart actually reveals is that Starbucks' performance collapsed much more deeply than the Index during the recent recession. It's pretty clearly become highly correlated with economic activity.

Schultz, in the interview, admits that "we were growing the company with such speed and aggression that we lost sight of the customer experience."

Translation: Starbucks won't be even attempting such levels of growth, apart from riding economic cycles, again.

Over the past five years, owning Starbucks basically got you a return not significantly different from the S&P, but with far more risk.

The second chart provides a larger view of just how volatile the firm's returns have become. Looked at since inception, we see the predictable rocket-like trajectory as the firm grew across the nation, changing coffee consumption habits during some periods of economic growth. But 2005 clearly marked a watershed year.

After that, monotonic share price growth ended. Volatility arrived on an unheard of scale, making the stock a much different type of issue than it had been. Prior price declines were nothing, in retrospect, compared to the cliff off of which the stock price fell for about three years.

Thus, the recent rebounds in fundamentals which have powered a seeming-comeback may mislead investors. Perhaps even Schultz, too.

Wilbur Ross vs. Liesman on CNBC This Morning

This morning, on CNBC, viewers were treated yet another example of why the network must fire Steve Liesman.

Under discussion was the proposition that the Dodd-Frank law has solved nothing, and only added to regulatory costs and uncertainties. Wilbur Ross opined that nothing in Dodd-Frank that was new would have prevented any of the of the recent mortgage-related financial excesses. Another guest echoed Ross' comments.

Leave it the networks senior economic idiot, Liesman, to begin yelling over and at Ross, claiming that he disagreed. Not once, but two or three times, did Liesman interrupt or shout over guests with actual, successful experience in the sector, to object to their opinions and tell them they were wrong.

When he finally sputtered to a stop, the uncredentialed reporter uttered some barely-comprehensible, feeble and, frankly, unbelievable reason that he felt Dodd-Frank would have improved upon prior regulatory schemes. I seem to recall him repeatedly yelling,

'but Fannie and Freddie......,'

so it's likely his mistaken belief had something to do with safeguards involving the GSEs.

You had to see this exchange, though, to truly appreciate just how clueless and pompous Liesman has become. It would have been one thing for him to ask Ross and the other guest a question focused on what he believed was a feature of the recent regulatory law that may have had a positive effect on the crisis. But without any credible basis for his comments, to simply try to shout down two more involved and experienced businessmen on the topic, was just deplorable.

Liesman has become a glaring liability for CNBC. It would not surprise me if Ross conditioned his next appearance upon Liesman being banned from the set for the duration of his visit.

Evolution of Equity Portfolio Selections

I recently had the opportunity to focus on how my quantitatively-driven portfolio selection process has captured current trends in business.

It began when I noticed a former business partner using selections from a prior month for which he had not compensated me. Without going into the details of the situation, suffice to say he continued to buy equities and options, in January, based upon two-month old portfolio selections.


With his old portfolios, and using only some of the prior selections, for comparison, I have noted how the February and March portfolio selections have, in just those several months, begun to shift into new areas.


For example, one new holding is a cloud computing firm. Another is in solar energy.


Since its inception in 1997, the selection process has included various energy firms- Royal Dutch Shell at the outset, and, over time, natural gas, oil exploration and service firms. Now, reflecting the economy and government subsidies to alternative energy production, a solar-related firm has performed well enough to become part of the portfolio.


Similarly, my very first portfolio included Intel and Microsoft. Over time, the selection process moved to PC manufacturers, other software providers, security firms, network gear providers, then online-oriented firms. Now, with so much content stored off-site and so many programs which are net-based, a cloud computing firm has demonstrated sufficient strength on the necessary attributes to be included in the latest portfolio.


I don't think I could ever make such changes subjectively. Just the other morning, on CNBC, I listened to a portfolio manager bemoan having owned Microsoft, instead of Apple, for several years. I suspect that when one subjectively analyzes forecasts, it becomes very difficult to reshuffle one's portfolio. So much of the decisions become based on quality of estimates or forecasts, or simply emotions concerning old favorites.

Along the lines of that last point, I found it hard to believe a conversation I heard last Friday on CNBC regarding Wal-Mart.

The hapless Maria Bartiromo was asking a guest- either a portfolio manager or buy-side analyst- why Wal-Mart's size and market shares didn't guarantee that it exhibit excellent equity price performance.

I don't really recall the guest's reply. I know what he didn't say. What Bartiromo, with all her presumed experience covering financial markets didn't already understand.

Simply put, Wal-Mart has lost its potential to surprise investors and markets.

Firms like Apple which design and manufacture products can develop radically new, innovative items- then enhance them. But retailers must typically on just store growth. Perhaps occasionally the addition of a new product line or fighting brand. But, for the most part, once they gain lots of attention, are followed by a hundred analysts, and saturate their primary markets, it's hard for them to surprise with results on a consistent basis.

Wal-Mart reach that point about a decade ago, as the nearby price chart indicates. After several decades of torrid total returns which massively outpaced the index, it has settled into maturity. Probably never to regain the performance characteristics of its earlier days. That's why the firm hasn't been among my portfolio selections for over a decade.

How is it that this fairly common phenomenon escaped the understanding of the veteran CNBC anchor and her presumably experienced guest?

US Commercial Banking, Evolution & Commoditization

My years with the Chase Manhattan Bank were spent under the tutelage of Gerry Weiss, SVP of Corporate Planning & Development. It was a privilege to work for such a bright, secure and gifted strategist.

Gerry didn't win a lot of new friends among his senior executive colleagues at the bank for holding the view that banking was one of the most commodity-like businesses in existence. With a few exceptions, most of the businesses at Chase were extremely difficult to differentiate because, at the end of the day, you were either borrowing, lending or processing money. Not exactly a patentable good.

Further, as technology became more important in more banking businesses, any single bank's ability to maintain a competitive edge for very long became increasingly difficult.

With all this in mind, I read a piece in the Wall Street Journal last week regarding federal arm-twisting of the major US banks on mortgage foreclosures. Leaving aside the subject of that article, which was the unwise attempt to force banks to forgive negative equity for borrowers, I was struck by the pedigrees of the few banks mentioned- Chase, Wells Fargo and BofA, and the one absent bank- Citicorp.

I realized, as pondered these names, how few people today probably recall that these, including Citi, are no longer the banks which originally had those names.

For example, Wells Fargo is really just the name of a former San Francisco-based bank acquired by what was once a staid Midwestern outfit- Norwest Bank of Minnesota. If I'm not mistaken, Norwest itself was acquired by a one-time rival, First Bank System. Along the way, it hoovered up the crippled Wachovia during the recent financial crisis, giving it, ironically, the old Golden West S&L, too. That was a product of Ken Thompson's wrong-headed mortgage bank acquisition at the peak of the real estate bubble. It cost him his job.

Meanwhile, BofA is just the surviving name of another San Francisco-based bank that took too many risks and became the prey of another regional US bank- Nationsbank, the renamed North Carolina National Bank. Hugh McColl busily assembled a large group of basic banking franchises beginning in the 1980s. The drive to aggregate assets and relationships culminated in the takeover of the once-proud BofA. McColl's successor, Ken Lewis, overreached when he bought Countrywide and Merrill Lynch during the recent financial crisis. That latter deal's murky details sent Lewis packing early from his CEO job at BofA.

Chase, as we know it today, is simply the name hung on the agglomeration of assets of most of the old money center banks of New York City, except for Citi and Bankers Trust. Back when I worked for Gerry Weiss, he once referred to Chase Manhattan, Chemical and Manufacturers Hanover Trust as three fairly interchangeable, mediocre banks. When asked about merging them, he snorted derisively,

'All you'd get is a much bigger mediocre bank that would be even more difficult to manage than what we've already got.'

Never the less, Chemical took over MannyHanny, then the two picked off Chase after its CEO, Tom Labrecque, finally ran the latter into the ground and attracted the unwanted attentions of fund manager Michael Price. In time, the CEO job went to Jamie Dimon, who had fled New York City to run the remaining Midwest regional commercial bank, Banc One- by then a product of a merger of the Ohio company of that name and the old First Chicago.

Citicorp wasn't mentioned among those in the foreclosure-related article because it essentially died, only to be resuscitated as a ward of the federal government after 2008. Before that, however, it was taken over from outside banking, when Sandy Weill prevailed upon then-Treasury Secretary Bob Rubin to allow him to 'merge' with John Reed's Citibank. Weill then hip-checked Reed out of the C-suite, hired Bob Rubin, and proceeded to build the most unwieldy, unmanageable financial supermarket ever attempted in the US.




My point is that if you were to have surveyed the national and regional banking field in the mid-1980s, as my colleagues and I did as part of our jobs as corporate and business strategists at Chase Manhattan, you'd have classified BofA, Chase Manhattan and Citicorp as the nation's three most important international money center banks. Chicago had just lost Continental Bank, but still had First Chicago. Bankers Trust and JP Morgan were smaller, more focused money center banks. All of these had senior management which felt and behaved as if their banks were special, different, and able to take risks which other US banks couldn't handle.

Fast forward almost 30 years, and you can see how wrong they were. The three premier US money center banks all lost their managements via takeovers.

In truth, the managements of what we now know as the leading US banks are products of duller, less-ambitious banks. Less ambitious in terms of scope, though, rather than size. And the businesses which are now part of these banking companies which aren't historic mainline banking units- brokerage, underwriting and merger and acquisition advisory- have become, as my old boss Gerry Weiss predicted, less lucrative due to the commoditization of them by the large commercial bank entrants.

In true Schumpeterian form, most of large commercial banking has become commoditized amidst growing competition. Thus, their equity price performances are, for the most part, anemic. Only Wells Fargo has a 35-year price performance which eclipses the S&P500 Index. Chase, BofA and Citi all trail it substantially.

What's different about Wells? Notice, first, that its outperformance slackened significantly around 2000. So it's not a function of recent management skill.

More likely, its earlier outperforming of the S&P resulted from its having avoided combining with any of the leading money center banks- ever. A host of old mid-sized California banking franchises- First Interstate, Crocker, and Security Pacific- if I recall, comprised the Wells Fargo that Norwest snared. As such, while predecessor banks got into some troubles, they tended not to be on the gigantic scale of the messes into which the three largest US money centers stepped throughout the past three decades.

Of the other banks, Chase managed to about match the S&P, while the Citi and BofA plunged noticeably.

So, from a perspective of over thirty years of large US commercial bank performance, it's evident that the risk-taking of the old international money center banking companies didn't result in their consistently superior performance. Rather, to the contrary, that strategy failed, as evidenced by the managements of more cautious, smaller commercial banks ultimately owning the marquees previously associated with their larger one-time rivals.

Now, no matter what you hear on CNBC or read in the Wall Street Journal, for the most part, the four major US commercial banks have become financial utilities which will, for the most part, fail to consistently outperform the S&P500 for any significant period of time. They've become large, slow-moving purveyors of financial commodities.

The Good, The Bad & The Ugly: CNBC Reporters & Anchors

Over the past few weeks, it's dawned on me that there are three types of business reporters or anchors. Being a prominent business/financial cable network, CNBC offers examples of all three.

The Good: Michelle Caruso Cabrera
Ms. Caruso Cabrera is one of the only, if not the only, CNBC on-air anchor with an economics or business degree. Her questions are typically well-reasoned and germane. She is well-informed and isn't afraid to ask tough questions of her guests and let them ensnare themselves in hypocritical positions.


The Bad: Tyler Mathisen, Bob Pisani
These two epitomize bad anchoring and reporting.

Consider Tyler Mathisen. I wrote here of his incredible naivete during his special grocery sector program. I think that's the signature characteristic of what I mean by bad anchors and reporters. They are surprised by everything. Their curiosity is, sadly, born of ignorance and cluelessness. In his grocery store special, Mathisen actually asked a store design expert why milk and dairy are always located at a rear corner of the store.

Honestly, if I were a senior executive at CNBC and saw/heard that, I'd immediately fire Mathisen. Can anyone past the age of 25 with a college education really be that stupid?

Pisani spends too much of each weekday looking astonished or surprised by some move in equities. That's when he isn't anthropomorphizing the market and cheering it onward to new heights, rather than simply reporting the facts.

Anchors and reporters who can't add value beyond restating the obvious or bringing some level of knowledge to a topic, so that they can at least ask questions you would, or hadn't considered, are just a waste.


The Ugly: Steve Liesman
I've reserved this category for those anchors and reporters who, far from adding value to interviews or segments with their knowledge, or adding no value by being ignorant or clueless, actually spread misinformation and falsehoods.

There's no doubt the posterchild for this category is CNBC's senior economic idiot, Steve Liesman. You can search my blog by his name to get a list of posts which will give you a fair sampling of his daily antics on the network.

Whether he's attempting to lecture actual, degreed economists- Liesman is a journalist with no economics or business education- or pontificating on economics statistics and/or patterns about which he has no formal training, Liesman typically spreads suspect 'knowledge.'

Fortunately for CNBC viewers, Chicago-based Rick Santelli is often on hand to counter, de-bunk and generally demolish whatever Liesman has just said.

Unfortunately for viewers, however, CNBC has far too many bad and ugly reporters, and too few good ones. Among the last, though, I think you can count, in addition to Santelli and Caruso Cabrera, Trish Regan, Melissa Frances, Joe Kernen and, often, Larry Kudlow.

And Another Thing......

In today's earlier post, I described some of the blather which comprised David Faber's noontime half hour on CNBC this past Wednesday. As I listened to the program again today, while multi-tasking, an on-air conversation reminded me of one more verbal blunder on Wednesday's edition of the program which had slipped my mind.

Somewhere in the middle-late portion of that program, Kaminsky was on his anti-technology jag again. At some point, a guest, either the Evercore guy or some portfolio manager- I think the latter- was asked about, I believe, Twitter. It was something estimated to be worth about $4B, and it wasn't Facebook.

In any case, the $4B number was tossed out, and this guy says, to paraphrase,

'Well, it probably will be worth $4B at some point, just not now.....maybe in a few years....'

He went on to essentially advocate holding the issue.

Kaminksy, meanwhile, was silent. I was incredulous.

Yes, and in a few years, what, maybe Yahoo will turnaround? Wal-Mart will come up with a strategy that works during economic expansions?

Isn't this sort of thinking about future large market caps the way the original technology bubble grew? Yes, it is.

There's a fine line between buying something before it's generally recognized to be as excellent performing as it may be, and buying something years in advance of a big total return payday. Kaminsky, of all people, with his fund management background, should know this. I expected him to excoriate the guest.

Instead, he was mute.

You can't make this stuff up.

Inanity on CNBC Wednesday At Noon

Just when I favorably mentioned David Faber's noon CNBC program, it turned inane on Wednesday afternoon.

Gary Kaminsky led off the nonsense purporting to prove that 'slow and steady' wins, by showing a price chart of three companies over 10 or 20 years- McDonalds, Colgate-Palmolive and Dwight & Church. All three had average annual total returns of 13+%, with low betas, which I guess Kaminskly judged acceptable.

He made some derisive remarks about technology stocks, although I didn't see comparable charts, returns or betas. Maybe I missed them. But Kaminsky actually concluded by judging low beta stocks to be preferable to those with high betas.

The problem is, equity selection is just not that simple. And if it really were, tens of billions of hedge fund dollars would have erased any such performance difference.

The truth is, Kaminsky, you or I could choose 3 equities with any one attribute to prove pretty much anything we wished.

For example, I would guess GE has a pretty tame beta, but it's been a complete turkey for a decade.

Moreover, Colgate-Palmolive is a rather special company. Years ago, when I first undertook my proprietary equity performance research, I found Colgate, then run by deservedly-legendary CEO Ruben Mark, to be the longest-running example of a firm whose total return had outperformed the S&P annually. And it is a slow-growth firm. Thus, it's by no means an accidental choice of Kaminsky. But I can assure you that it would be very easy for me to find a handful of similar slow-growth firms whose total returns have under-run the S&P for most of one or two decades.
Further, beta is debatable as the proper measure of volatility.

Given Kaminsky's years as a big-time portfolio manager with Neuberger Berman, you wonder if this really represents how he thinks about and manages equity portfolios. If not, what was this little demonstration for?

You don't present a seemingly-random, or worse, contrived sample of 3 companies' performance as proof of anything. Rather, you state hypotheses, build multi-factor models, construct hold-out samples, then use some data and periods to estimate parameters, and others to test the models.

After that farce, a guest from Evercore Partners appeared to opine on whether another 1990s-style technology issues bubble is building. I don't recall the guy's name, but he was introduced as having been instrumental in four of the largest telecom M&A deals of the past decades, including the sale of MCI to Worldcom.

I'm not making this up. You'd think with an introduction like that, well, Faber would think twice about even having the guy on his program.

If there were ever a case of expedient deal-making without concern for the fundamentals, not to mention the veracity of the financial conditions of the parties involved, this deal would be it.

Once again demonstrating how so much of CNBC's lineup is business and financial entertainment, not solid analysis or useful information.

Foreclosures: Pro & Con

Last week brought a pleasant surprise to David Faber's CNBC program. Former Salomon Brothers Vice-Chairman and mortgage-backed securities pioneer Lew Ranieri gave his first live televised interview.


Ranieri is a seriously smart and sophisticated guy, so I hung around within range of a television after I'd finished what I was doing, just to listen to his entire set of comments.


His version of how the late 2000s mortgage lending bubble occurred is objective and credible. He gives weight to both so-called Wall Street houses for securitizing questionable mortgages, and to the GSEs for accepting them to back their own securities, too. He cited some numbers regarding GSE explosion of pass-throughs which were simply incredible.


To his credit, Ranieri personally apologized for not having screamed louder and longer as the bubble grew beyond any sustainable size. He identified poor underwriting standards and an over-reliance on FICO scores, rather than prior, more involved and often qualitative mortgage lending standards.


When the conversation turned to foreclosures, Ranieri cited a stunningly large supply of unsold or foreclosed housing. I don't recall the exact numbers, but I believe he said several months supply had been the historical norm, but today's supply was something like almost two years' worth, if not more.


Never the less, he came out against massive foreclosures. He said that foreclosures destroy neighborhoods and cause them to rapidly degenerate into ghettos. He also cited a lack of government programs to promote and assist local entrepreneurs in buying foreclosed properties, repairing/renovating them and putting them back up for sale at new, lower, market-clearing prices.


Separately, Joseph Mason, a professor of banking at Louisiana State University, wrote an editorial in the Wall Street Journal last week entitled Why Regulators Should Let Banks Foreclose.


 Mason  providing evidence that foreclosure delays don't help


"On Capitol Hill last week, federal banking regulators suggested that the government may soon reach a comprehensive settlement with banks on foreclosure procedures and servicing. In theory such a settlement could unlock housing markets and boost the economy. But recent statements by Comptroller of the Currency John Walsh and FDIC Chair Sheila Bair suggest that they remain focused on using the settlement to extend, rather than end, ongoing foreclosure delays.



Meanwhile, states including New Jersey and Hawaii are considering imposing their own moratoriums on foreclosure that, if they conflict with federal policy, may lead to protracted litigation. This approach is the wrong medicine for our ailing economy.


For borrowers, delaying foreclosure only provides false hope. Today, a borrower faces a foreclosure sale only after failing to make a payment for more than a year. There is no reason to believe a brief additional time-out will allow such borrowers to become current. To the contrary, data from the Mortgage Brokers Association indicate that loans reaching the foreclosure stage almost never avoid default, and that borrowers who become 90 days delinquent cure their default only about 1% of the time.


Similarly, recent research done for the National Bureau of Economic Research demonstrates that loan-modification programs have mixed effectiveness. Data suggest that many delinquent borrowers have the means to afford their mortgage payments, but are so deeply "under water" on their mortgages that they are simply no longer willing to pay. Others have insufficient income to afford any reasonable mortgage payment.


For those who do obtain modifications, roughly half become delinquent again within six months. Thus, while modification efforts are laudable, they are not the solution.



The unfortunate reality is that efforts to lengthen the foreclosure process will not substantially alter borrower outcomes. They will only extend a painful time for borrowers and the economy. During that time, uncertainty will prevent borrowers from moving on with their lives, including starting to pay rent and make purchases that would inject money into the economy.


For neighborhoods, every day without foreclosures means another day of deteriorating home values. A recent study of the Cleveland area published in Urban Affairs Review found that neighborhood home values are largely unaffected by foreclosures that take less than a year. But foreclosures that take longer than a year have a negative impact on home values as the effects of neglect and vandalism mount.



One of the root causes of the economic crisis was a deterioration of underwriting standards: We stopped focusing on whether people could afford the homes they were buying. Continuing to delay foreclosures reflects the same kind of wishful thinking. California's 90-day moratorium in 2009 did not improve the state's economic performance, and moratoriums in other states would only prove again that a delay can't turn an unaffordable mortgage into an affordable one.



Kicking the foreclosure problem down the road creates uncertainty that discourages investment—and delays our desperately needed economic recovery."


Mason seems to provide evidence contradicting Ranieri on foreclosures. Rather than worry about allowing them, Mason suggests getting them over quickly is the better alternative. And his end-game is Ranieri's, too- repurchase of foreclosed properties at lower, market-clearing prices.

Personally, I believe it's foolish to delay foreclosures, especially when it's governmentally-coerced. It unfairly penalizes some while allowing others to evade the proper consequences of their failure to fulfill financial contracts, as well as discriminating against all those who behaved properly and did not buy an unaffordable home, only to see such behavior rewarded.

More Warren Buffett Cornpone on CNBC This Morning

This morning was a good one to skip watching CNBC. I don't know how often they do this each year, but it's one of those marathon Buffett chuckle-manias from Omaha. Becky Quick sits there with him and he pontificates on lots of subjects about which he knows little more than anyone else. Given the setting and someone's recent reference to Buffett's annual shareholders' letter, I assume Berkshire Hathaway's annual meeting is the occasion.

Much of the time is wasted by Buffett saying things which are patently obvious, e.g., Steve Jobs is a uniquely-talented and successsful entrepreneur with a gift for "knowing what we want before we know we wanted it."

That's when he's not contradicting actual experts in a field, such as mortgage banking. Last week, on David Faber's noontime program, industry veteran and CMO pioneer, one-time Salomon Brother's Vice-Chairman Lew Ranieri cited a market overhang of unsold homes which, I believe, was far larger than the one year cited by Buffett as the date by which said inventory will be gone.

And, of course, it's all done with that annoying aw shucks guffaw. I don't know which would drive me insane faster, constantly being subjected to Buffett's trademark country guffaw or Maria Bartiromo's lisp.

But on one subject, Buffett is positively misleading.

Only about 15 minutes ago, he railed against perceived income inequality in the US. His evidence?

Buffett pulled out some apparently IRS-sourced document, and had Becky Quick read off some numbers. Buffett alleged that in the past few years, the 400th largest AGI on a tax return soared from about $43MM to $340MM or so. Buffett then contended that the associated tax rate on that 400th return fell over time, too.

Unfortunately, as you may read here, the subject is much more complex than Buffett either understands or acknowledges. Add to Reynolds' arguments the fact that many private enterprises show up for tax purposes as schedules on an individual 1040 return, and you blow Buffett's contention out of the water.

But this is CNBC, so Buffett's every aside or chuckle must be fawned over. No matter how misinformed or misguided it may be.

The Ben Bernanke On Capitol Hill Yesterday

I caught some of The Ben Bernanke's testimony on the Hill yesterday, and let me tell you, it was nauseating.

But for me, the two low points were Ben insisting:

- the Fed needs to retain its dual mandate of managing the money supply and targeting full employment.

- there's no risk of US economic inflation.

The first must have Milton Friedman spinning in his grave. And perhaps Paul Volcker spit out his cigar when/if he heard it. Ever since dim-witted Hubert Humphrey championed the added full employment mandate, the Fed has been hampered in its ability to do focus on the one thing that nobody else can do- manage the US money supply. To finally face a friendly House and possibly ambivalent Senate and refuse the chance to formally escape this monstrosity is unforgivable.

The second certainly had Milton spinning. Not to mention tons of pundits laughing at Ben's sophistry.

It got so bad that later, on CNBC, senior economic idiot Steve Liesman made up a whole spiel to explain why Ben was right.

Between excessive money creation over the past two and a half years, and easy dollar-induced rises in commodity prices, we certainly have inflation. The fact that it's not conventional labor-sector cost-push doesn't mean it isn't happening.

Friedman was right. Get rid of the Fed and use a Taylor-style rule to manage the money supply.

Unfunded Liabilities: Pensions & Entitlements

Karl Rove wrote in a recent Wall Street Journal weekly column, regarding the Wisconsin public sector union protests and Governor Walker's bill to repeal collective bargaining rights,


"Union demands have helped produce an estimated $3.5 trillion in unfunded liabilities for state and local government pension and health-care plans. They've also led to personnel practices that tie the hands of local elected officials, often resulting in perverse outcomes. For example, union insistence on "Last In, First Out" often means the best and brightest teachers are let go when districts downsize or schools close."

I had a long talk recently with a close friend who is a political conservative and, as a New Jersey school teacher, a member of their union.

As we discussed the Wisconsin situation, and she dutifully, but reluctantly, read the related posts on my companion political blog, she bluntly told me this had become a painful topic for her, with me. But she also admitted that her union's members needed to pay for their health care and pension benefits.

She then returned to a topic she'd ranted on in previous conversations with me, i.e., going back several administrations, the New Jersey state government had emptied her union's pension fund by 'borrowing' from it and then failing to maintain promised annual funding. In short, the State of New Jersey has already brazenly failed to fund the promised lavish retirement benefits for the teachers' union.

She railed over the likelihood that her contributions would probably be in vain, with her promised pension never to actually be paid in full.

Welcome to the club.

I vividly recall learning in Professor Peter Kundsen's 'Great Moments in Balance Sheet Accounting' course in graduate school, back in the late 1970s, how unfunded pension liabilities were confined to footnotes. The midterm for that course was a list of questions attached to the Bethlehem Steel 10K. Needless to say, one of the questions was, I am sure, related to the firm's unfunded pension obligations.

Within a few years of graduating, I saw bankruptcies roll through the steel and airline sectors. And Chrysler require a government bailout.

With the rise of hostile takeovers and raiders taking their targets private, or into Chapter 11, many more businessmen learned about the PBGC. The Pension Benefit Guaranty Corporation is the federal agency which is charged with administering the failed, under-funded pensions of bankrupt firms.

The truth is, the private sector has seen, for some thirty years, a series of sectors experience bankruptcies which dumped underfunded pension plans onto the PBGC. At the same time, many other companies switched to defined-contribution plans, terminating their defined-benefit plans and putting the resulting lump sum into the former.

In short, private industry has learned, over the past three decades, that the defined-benefit pensions are, for the most part, illusory and unworkable.

What's happening now is that public sector employees are discovering the same truth. The major difference, however, is that because state and local governments foolishly agreed to these plans, the public sector unions have, as a counterparty, an entity that cannot, as easily as a private sector company, declare bankruptcy and subsequently renegotiate the pension obligations.

It goes without saying that Social Security, Medicare and Medicaid are all federal programs which share the same foolish defined-benefit mentality. And we've all been aware for decades of the chronic insolvency of the first, and the obscene growth of the second and third.

How is it that what business people have understood for thirty years as infeasible, i.e., the defined-benefit approach to any long run pension or health care obligations,has only now come to be seen as unworkable in the public sector?

Economic Growth vs. Jobs

Sometimes, well, actually, many times, those without any economic background or education run at the mouth about related topics, getting relationships all wrong.

Such was the case earlier this morning, when I heard the first few minutes of the president's remarks about from where new jobs would come.

So often, we hear people with no economics training whatsoever harp on job growth, as if they can magically wave a wand or fund a program, and paying jobs will appear.

That's just not true. In fact, the whole point of a market economy is for government to enact stable, lasting policies which promote business and capital formation, which leads to economic growth, which then creates jobs.

A related common complaint by some pundits is the oft-proclaimed death of US manufacturing.

In a well-written editorial entitled The Truth About U.S. Manufacturing, in last Friday's Wall Street Journal, economics professor Mark Perry (University of Michigan at Flint) debunks that complaint.

Perry observes,

"In every year since 2004, manufacturing output has exceeded $2 trillion (in constant 2005 dollars), twice the output produced in America's factories in the early 1970s. Taken on its own, U.S. manufacturing would rank today as the sixth largest economy in the world, just behind France and head of the United Kingdom, Italy and Brazil. Despite recent gains in China and elsewhere, the U.S. still produced more than 20% of global manufacturing output in 2009.

The truth is that America still makes a lot of stuff, and we're making more of it than ever before. We're merely able to do it with a fraction of the workers needed in the past.

The average U.S. factory worker is responsible today for more than $180,000 of annual manufacturing output, triple the $60,000 in 1972.

These increases are a direct result of capital investments in productivity-enhancing technology, which last year helped boost output to record levels in industries like computers and semiconductors, medical equipment and supplies, pharmaceuticals and medicine, and oil and natural-gas equipment."

It's the productivity and volume of economic activity that drive further growth. And productivity is enhanced when more capital is provided. Sure, there are eventually diminishing returns. But it's simply wrong to try to force-feed an economy the jobs government thinks ought to exist.

Haven't we learned from Russia's failed 50+ year experiment with a centrally-planned economy that such efforts are pointless?

With capital availability, mobil labor resources and high productivity, and low barriers to new businesses and innovation, an economy is poised to grow, thus leading to new jobs as a consequence.

Jobs aren't the ultimate objective of economic policy, per se. They are important, but follow economic activity. Not vice versa.

GM's Misleading Results

I read this headline, GM Rebounds With Best Year Since 1999, in a section of this morning's Wall Street Journal, with great amusement.

Does anyone really believe the concept implied by this headline? That it's the same GM? Or that, if you think it is the same company, these results are either comparable or real, in the sense of being the result of completely normal business and accounting practices?

Because of course, they are not.

First, this GM exited a federally-distorted bankruptcy. It's not relevant to compare any of this GM's performances to the company with that name which existed prior to 2009.

Second, this GM is the beneficiary of some significant liability restructuring, as well as purchasing preferences by the federal government. From union concessions, related capital structure changes, and federally-mandated dealership closings to atypical tax loss carry-forwards, this bankruptcy was one for the record books. In an ideal capitalist world, GM wouldn't even exist anymore, unless someone bought the right to use the name again. Which would be unlikely, since it had become a symbol of corporate ineptitude, failure, and union excess.

Third, one year does not a turnaround make. Even the Journal article disclosed that the fourth quarter performance was relatively weak.

Sadly, the new GM seems to be just the latest example of the concept that everybody wins. Even a bankrupt corporate failure like GM is given special dispensations, favors and a tilted playing field so that its latest results may be celebrated as a record.

Don't be confused by this accounting magic and think it portends a healthy future in which GM earns consistently superior total returns for years to come.

Amazon Enters Subscription Video On Demand To Challenge Netflix

This post from last December concerning Netflix. In it, I wrote,


"For example, HBO, according to Faber, has recently lost more than one million subscribers to Netflix's instant video content viewing. With so many titles available to stream to computers and/or download to DVRs, HBO's value as a separate paid service is dimming.



Netflix is reputed to be responsible for as much as 25% of web traffic during prime hours, as vast amounts of video content is viewed via streaming.


I'm guessing that, if Netflix were part of the S&P500, It would have made appearances in my equity portfolios by now."


Earlier this week, Amazon announced a subscription service for video on demand for its best customers.

This is not surprising. I find that successful firms which earn consistently superior total returns for a certain periods tend to fail to do so anymore for one or more of three reasons: competitive reactions, inability to continue to surprise investors, or regulatory reactions.

In Netflix's case, it's the first. Amazon has seen the effects of Netflix on Blockbuster, HBO, and probably Amazon's own business of selling DVDs. After arranging the logistics of offering a similar service to their best customers, Amazon is now moving to limit Netflix' inroads into its business.

It's a natural response to a very successful business model. Just like we see competing tablet products coming forth to compete with the iPad.

I'll watch with interest to see if Amazon can actually dent Netflix' volumes, profits and stock price. Chances are, it can. Plus there are some critics of Netflix' accounting, including CNBC contributor Herb Greenberg. The details escape me, but he disagrees with the firm's capitalizing some expenses. If their growth rate falters due to Amazon's moves, and profits are squeezed, then we might see an even faster decline due to an inability to continue whatever aggressive accounting practices are in place.

Regarding Endangered Jobs

Andy Kessler wrote another one of his quirky, mostly off-target editorials in the Wall Street Journal last Thursday, entitled Is Your Job an Endangered Species? Once again, I'm left wondering why the Journal gives this guy so much space so frequently? Compromising pictures of whom does he have?

Kessler began well enough, observing,

"Technology is eating jobs- and not just obvious ones like toll takers. Tellers, phone operators, stock brokers, stock traders: These jobs are nearly extinct. Since 2007, the New York Stock Exchange has eliminated 1,000 jobs. And when was the last time you spoke to a travel agent?"

It's hardly a novel observation, but a fair way to commence discussing the topic. But then he veers into the surreal with the following nonsequitor,

"So which jobs will be destroyed next? Figure that out and you'll solve the puzzle of where new jobs will appear."

Kessler goes on to sensibly divide jobs into "creators and servers." The latter basically do the non-intellectual things that implement innovators' (sorry- creators') solutions. Then he goes off the rails and sub-divides the servers into sloppers, sponges, supersloppers, slimers and thieves.

Supersloppers, by the way, are marketers who offer consumers features which may carry no economic value, but appeal to psychological or other bases of desire. Slimers are financial sector workers.

Then Kessler returns to his trademark of (re)stating the obvious,

"Like it or not, we are at the beginning of a decades-long trend."

Really? Beginning? How about, oh, 110 years into it? Ask buggy whip manufacturers.

"Watch the divergence in stock performance between companies that actually create and those that are in transition- just look at Apple, Netflix and Google over the last five years as compared to retailers and media."

Fair enough- there you have it in the nearby chart. Along with the S&P500 Index and online retailer Amazon.

Wait, how'd Amazon get in there? It's supposed to be tanking. And, for what it's worth, Andy, Netflix is an online and direct retailer, too.

So much for rigid, mutually exclusive taxonomies. Kessler seems better at selective recall and comparison, the better to make his narrow, but unfortunately for him, indefensible point.

You see, Netflix and Amazon have done well for the past five years, and they are retailers.

Google is the worst of the bunch, underrun only by the Index. Truth is, as Amazon and Netflix demonstrate, there are times when distribution of goods or services is valuable. It's not always just about production or even design.

Kessler finishes his perplexing piece with this passage,

"But be warned that this economy is incredibly dynamic, and there is no quick fix for job creation when so much technology-driven job destruction is taking place. Ultimately the economic growth created by new jobs always overwhelms the drag from jobs destroyed- if policy makers let it happen."

Kessler offers no statistics or empirical evidence of that last, bold assertion. I'm not at all sure it's even true.

That's the real point of this post. Not just to critique Kessler's weak, obvious and otherwise wrong-headed editorial. But to use it to make the following point.

It does little good to simply add up jobs lost and jobs created, and assume all is well when the latter is larger than the former. Wouldn't it be more informative to understand the life-cycle earnings and job types of workers from several different strata of US businesses over the past century? To have a set of benchmarks of life-cycle earnings relative to each worker's average? To see what normative patterns were, by era and job type, education, over the past century or more?

We don't know if Kessler's contentions are true without empirical data.

But I do think this much is true. There is a stronger, multi-lateral global economic competitiveness at higher levels of value-added now than for probably the last 90 years. As such, economies with, on balance, better-educated work forces will probably be able to create higher value-added goods and services. Certainly design them. Maybe produce them.

However, since populations are stratified by intellect and education, this means the US will continue to experience the challenge of employing the lower echelons of its labor force, by skill and education, as more of these jobs go overseas to more productive, cheaper workers in other countries.

Hopefully, America's entrepreneurs and innovators will create business ideas, solutions to consumer needs and wants, which also, with growth, create jobs that can be filled by not only well-educated, highly-skilled people, but the lower rungs of the US labor force, as well.