Odds & Ends

I found it amusing to hear Roger Altman, erstwhile Clinton advisor, sing the praises of Warren Buffett on CNBC yesterday morning, despite the recent Lubrizol/Sokol front running/insider trading flap.

The network, I guess to curry more favor with selected guests, and coincide with a golf tournament, has been plastering the title "Market Master" on all manner of financial oldsters for the past week, regardless of whether they ever managed a live portfolio.

Altman was interviewed yesterday, and, when asked, fairly leaped to the defense of Buffett that characterized him as angelic. The superlatives tripping out of the investment banker's mouth made it crystal clear that, by doing business in circles which intersect with Buffett, Altman was not going to say a single negative thing about him. In a business where contacts are everything, you could see Altman had become a shill.

So charming.

In an unconnected story, Netflix, which entered the S&P500 last December, replacing the New York Times, has finally entered my equity portfolio.

For the past few months, I've been hearing CNBC's Herb Greenberg criticize Netflix's accounting practices and equity price. While not recalling all of the specifics, Greenberg's attacks largely centered on content acquisition costs and cash flows. Here's what he wrote a couple of days ago,

"So far this year, Netflix has committed to spend between $300 million and $400 million on new content, including "Mad Men".



If you just look at their balance sheet and cash flow statements you might say: “Not so bad.”


They have about $350 million in cash and about $230 million in debt.


Even cash flow positive, with reported free cash flow of $82 million.


Here’s the problem: In their 10-K, they disclose $1.3 billion in content obligations spread over a number of years, and that’s before these recent deals.


That gets us to their payables, which have been rising to levels not ever seen: $222.8 million last quarter, up from $92.5 million a year earlier. Another way of looking at it: Payables to revenue are 9.35 percent — the high end of its range; it was 5.2 percent in the fourth quarter of 2009.


Adjust the cash flow to reflect the payables and suddenly cash flow isn’t quite what it appears. Len Brecken of Brecken Capital, who has been short Netflix, says that if 2010 operating cash flow of $276.4 million were adjusted for the ballooning accounts payables it would fall below 2005 levels of $157.5 million.


(And this is before getting into his argument that net income is inflated by artificially low amortization of cash content costs.)


My take: Netflix has done an exceedingly excellent job capturing mind share and market share and building a seemingly unbeatable brand."


With the equity now among my selections, I'm no longer a disinterested observer. But Greenberg's arguments are not time-dimensioned. You don't get a sense of when he believes the stock's price will go into free fall.

Meanwhile, Netflix seems to continue to enjoy wide consumer appeal, thanks to its instant viewing capabilities. Yes, I know Facebook and Amazon are competing with Netflix. But there's still the ability with the latter to obtain physical DVDs for viewing material that isn't on demand anywhere. For a fixed price.

If Netflix had more of an opaque profile in terms of what it sold, and to whom, I would take Greenberg's concerns more seriously. As it is, he and other, like-minded critics have been vocally objecting to Netflix's valuation and accounting for several months. That ought to be sufficient time for investors to have factored these stories into their buy or sell decisions. And the firm's equity price has continued to strengthen.

In the past, my equity selections have included Tyco and a few home builders. In each case, my selection process had exited the equity in question long before its price cratered.

I'm not a long term holder of equities. There's a potential for a portfolio to turn over quite significantly after six months. That doesn't mean an equity won't continue to be selected monthly for some time. But each month's decision to include an equity is different than the prior month's. Just last year, Intuitive Surgical and McAfee proved to be disappointments. But  that didn't prevent the strategy from nearly doubling the S&P's gross returns.

So while Netflix is now in a portfolio, its weight isn't out sized. And, honestly, I don't care, presently, where its price is in two years. Or even a year, for that matter. It takes a lot of investors with varied valuation models to make a market. Sometimes, despite a firm's flawed long term strategy, you can make money in the meantime.

About Last Week's Employment Numbers

Last week's BLS employment number for March was 216,000 net non-farm payroll additions.


I was discussing this with a friend over the weekend. She's not a business person or economist, so it was an opportunity for me to explain the overall job loss and recent growth dynamics since 2008.

At this point, I can't find a single reliable number for how many jobs have been lost since the recession began in 2007, but it's certainly at least 6 million. In this post from February, discussing Brad Schiller's outlook for unemployment and job growth. He had written, as I quoted in that post,

"The latest employment reports have not been encouraging. At the rate of 36,000 new jobs a month—the number gained in January—we will never get back to full employment. Even if we keep adding jobs at the December rate of 121,000 new jobs, we wouldn't achieve full employment in this millennium.



At the trend growth rate of 1.2% annually, we get another 1.8 million labor force participants a year, and with them, the need for another 1.8 million new jobs.


To get back to full employment tomorrow, we could get by with another seven million new jobs. To reach full employment by the end of this year, we would need at least nine million new jobs (some 750,000 a month). There's simply no way we will experience that kind of job creation.


Each year brings another two million-plus workers to the labor force (new workers plus the re-entry of discouraged workers). Thus we would need monthly job gains of 460,000 to achieve full employment in time for the 2012 presidential elections.


We created that many jobs one time in the last four years (May 2010)."

So let's use the 9 million number. I looked back at last year's posts on monthly employment numbers, and saw that April's was much like last month's.

So despite all the positive comments last year over a few months of 100,000+ job growth, here it is, a year later, and we're only at 216,000.

If job growth doubled to around 400,000/month, we'd still need 22 months to absorb 9 million new jobs. Obviously, at half that rate, you're talking about 4 years. Writing in the wake of January's anemic number, Schiller's math showed it taking forever, because job growth was being outstripped by new entrants into the labor market. We need at least 150,000 net new jobs/month to soak up the incoming flow to the base of job-seekers each year. Right now, we're at 65,000 more than that, in an economy that has rising inflation, increasing regulation and serious government fiscal and monetary challenges.

Explaining this to my friend, I found myself reacquainted with the truth about the current unemployment situation. That is, while the administration and various pundits are cheering the erratic but mostly rising series of monthly BLS employment numbers, the rate of increase and current levels are just too low to support a serious economic recovery anytime soon.

Schiller's focus on the basic math of the challenge is sobering. And March's employment numbers do not, in the larger picture, really constitute sufficiently good news to celebrate much of anything yet.

The Economics of Electric Vehicles

Margo Thorning's editorial in an edition of last month's Wall Street Journal, entitled Pull the Plug on Electric Car Subsidies, assembled a useful set of data concerning the economics of electric vehicles.

Going back to 1832, Ms. Thorning noted the invention of the first electric car in Scotland by Robert Anderson. She mentions the first American electric vehicle making its appearance in 1907, then writes,

"Since that time Americans have seen tremendous innovations in everything from air travel to microwaves, yet there has been little progress converting consumers to vehicles powered by rechargeable batteries."

She begins by quoting Consumer Reports reviews which trashed Chevy's Volt as inefficient as both an electric and gasoline car. In terms of cost, she reveals that the Nisan Leaf's battery costs $20,000, yet still only provides an 80-mile range under optimal, which is to say, temperate weather conditions. Drive it in hot or cold weather, and that range shrinks dramatically. The charging unit for such a vehicle varies between $1-2,000. Of course, using an electric vehicle merely transfers energy usage from gasoline to our mostly coal-fired power grid.

Surprisingly, Thorning contends that you'd need $300/bbl oil, along with an electric car battery costing 25% of the current $20,000, to make an electric vehicle cost-competitive.

Thorning then ticks off the various government subsidies to try to sway consumers to buy electrics. There's the $7,500 tax credit, as well as credits for "installing charging stations in homes and businesses and for building battery factories and upgrading the electric grid."

Citing the current administration's goal of one million electric vehicles driven by 2015, she estimates this will result in a $7.5B federal subsidy.

Having read this piece last month, then reading Paul Ryan's editorial in yesterday's Wall Street Journal in support of the House GOP's 2012 budget, I have to wonder whether these subsidies will survive the next two years of federal spending fights.

And, in that environment, with such reliance by Ford, GM, Nissan et.al. on federal largess to market these cars, whether those auto makers are due for a nasty surprise, having sunk so much capital into designing and producing electric vehicles.

I saw Alan Mulally show a new Ford Explorer on CNBC's morning program yesterday. The amount of digital technology in a new car, including various remote cameras and warning systems, certainly distinguishes such a car from one that is just five years old. But those systems are hardly so novel as to be a barrier to competition.

That means all the major car makers will be designing and selling better cars with more useful safety/electronics systems without prices for them rising out of control.

So where will the payoff ultimately come for Ford, GM and the other competitors for electric vehicle design and production that ultimately makes no economic sense? Wages aren't rising, and unemployment is still high. Federal spending is now under more scrutiny than at any time that I can recall in my life.

With Thorning's informative editorial as evidence, does anyone really think the money being poured into electric vehicles is actually going to make an adequate return for these firms any time soon?

Government Employment vs. Private Sectors

Stephen Moore wrote an interesting piece in Friday's Wall Street Journal regarding the balance between government/public sector and private sector employment.

Here are some of his statistics,

"Today in America there are nearly twice as many people working for the government (22.5 million) than in all of manufacturing (11.5 million)....More Americans work for the government than work in construction, farming, fishing, forestry, manufacturing, mining and utilities combined.....Nearly half of the $2.2 trillion cost of state and local governments is the $1 trillion-a-year tab for pay and benefits of state and local employees.....Surveys of college graduates are finding that more and more of our top minds want to work for the government."

Moore goes on to note that employment in teaching has doubled, per student, from 1970-2005, while test scores remained flat. Similarly, mass transit spending is up, while usage is a smaller share of transportation than in the past.

Now, I find some fault with Moore's simplistic presentation of data. For example, manufacturing value in America has remained high and stable for decades, but, thanks to productivity, employment has declined. Low-complexity, low-wage manufacturing goes overseas, now to Southeast Asia and China, while more difficult manufacturing remains onshore and pays well, albeit to fewer workers. More automation and mechanization ensures higher quality and more consistency of output.

So griping about a reversal of government and manufacturing employment from 1960 to the present isn't completely fair or representative of what's going on.

That said, it's stunning to simply read that there are 22.5 million government workers in America. How do we measure the value they create for our society? We can't and we don't. That is troubling.

Here's the way I prefer to consider Moore's numbers.

Jobs should entail adding value. When numbers of jobs, and total wages, increase, that should mean that the sector involved is creating more value. Thus, while private sector jobs typically follow that route, government does not. Or, more importantly, we can't tell.

The teaching and transportation statistics are troubling, because, as Moore puts it, they are backward. When we don't like results in those sectors, we do not, as in business, cut resources. Instead, we spend more. It becomes a case of buying service levels at any price.

That's why the average voter should ask why government ever does anything through its own employees, short of military and policing, rather than contract it out every 3-5 years? We don't want to employ people in government, because that's tax money. We want productivity, which is best bought via competitive contracting over the relevant time period to get the most out of facilities and the productivity gains of a contractor's operations.

I wish Moore had noted the total private sector US employment versus government employment, and those numbers over time. And, then, total wages and benefits for both over time.

Now that would be revealing.

Research On Oil Shocks & The US Economy

Don Luskin wrote an interesting editorial in last Tuesday's Wall Street Journal which contained some valuable empirical information on the effects of oil prices on US economic activity.

One of the pieces of research cited by Luskin "suggests that oil prices imperil the economy when they reach a new three-year high."

Another "says the overall economy is threatened when the 12-month average oil price exceeds the year-ago 12-month average price by more than half. Below those levels consumer and investor expectations aren't sufficiently disrupted to make a difference."

Luskin then observed that "both conditions are very far from being triggered at today's prices."

I don't follow the oil markets specifically, so I'll have to take Luskin's word for that conclusion. After all, there are various grades of oil priced at various places, and Cushing, Oklahoma, the standard US pricing nexus, has, I am aware, some capacity issues which can distort prices there.

However, it's pretty clear that today's trailing 12-month average price of oil isn't very high above the prior year-ago 12-month average, although, just typing that reminds me of how much specific price information is required for that determination. Information I don't typically have at my fingertips.

But I do find coherence between the oil effect researchers' approaches to comparing recent prices with year-ago averages or prior peak prices. I've observed similar equity-market-related effects using not entirely dissimilar lagged point-in-time average comparisons. The notion of modeling human behavior regarding surprise or accommodation is not new, and it makes a lot of sense. If changes aren't too drastic over a year's time, people can often adjust to them and, thus, attenuate their impact.

Luskin goes on to cite some more interesting statistics which build upon the US economy's improved energy efficiencies since the first Arab oil embargo of 1973-74. He writes,

"It may come as a surprise to many, but today in the U.S. we're consuming the same amount of crude oil that we did 12 years ago and real output is more than 25% higher. For all the talk of our being the planet's most villainous energy hog, we've become remarkably oil efficient."

Wow. Imagine that! No subsidies for cutting oil usage, and it's become more efficient all on its own. Why, that sounds like a market that responds to price signals, economizing on that which is becoming more expensive, doesn't it?

Maybe oil's price trend and the uncertainty of its level has affected US oil efficiency on its own, without the dubiously-effective subsidies to wind, solar and other ostensible replacement sources.

It is a constant source of comforting amazement to me that US energy efficiency improves over time, on its own, while critics point to simpler, less-useful numbers such as total oil usage. After all, if you have a large economy that creates much economic value, it will tend to use lots of inputs to do so. That doesn't make it bad nor inefficient solely on the basis of scale.

Luskin's piece is valuable, therefore, for two reasons. He highlights some important empirical research suggesting what sorts of oil price increases will be necessary to really cripple the US economy due to consumer behavioral changes, and reminds us that, meanwhile, the country's natural economic behavior has increased the efficiency with which we use this expensive energy input.

EBay's Belated Challenge To Amazon

I read with some small interest that EBay bought GSI Commerce earlier this week. The title of one Wall Street Journal piece on the acquisition was entitled EBay Buys Allies For Amazon War.

If only. Didn't that ship sail years ago?

As I noted on a recent Groupon post, EBay has a particular market segment. It's good if you find what you are looking for, but it's not a good place to simply buy what you may need, because there's no guarantee that you'll find it.

Granted, Amazon's book selling facility has lots of used book merchants to fill demand, but, beyond that, I can't personally vouch for product availability across a wide spectrum.

From what I read about GSI, EBay seems to be committing the old sin of buying something to which it adds little or no value with its own business. Take a look at the nearby five year price chart for EBay and the S&P500 Index. EBay has been stalled for the past five years, unable to out-perform the index. So why is it now going to ignite shareholder value by buying a business it isn't actually already in? Especially when it's paying a 51% premium for the privilege?

Will the amateurs who make a living selling chachkas and other assorted items actually process orders and ship via GSI? Well, wouldn't that mean they'd have to send all their merchandise there? It's simply not the same model.

 Meanwhile, here's a picture of the same five years, with Amazon added. EBay and Amazon aren't remotely in the same performance league.  So there's the added problem for EBay of taking on a more successful, well-capitalized competitor.

Put another way, this isn't like Apple or Google is coming into a new product space. EBay has had problems for years, including the over-priced Skype acquisition. I reread my posts under the "EBay" label, and they weren't good omens for EBay's success with this acquisition.

I would bet it's another case of a CEO and his senior management hanging on for dear life to high-paying jobs at a has-been company. Well, hanging on by using shareholder equity to overpay for an acquisition that isn't going to change the true owners' fortunes very much at all.

Post Script: Here's a very interesting blog post that my reader and commenter, Henrietta, sent me regarding Meg Whitman's early blunders, both pre- and while at EBay. Worth following the link.

More On Groupon

I wrote this initial post regarding Groupon early in March. From a marketing perspective, I observed,

"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."

My subsequent joining of the service didn't result in any particularly positive added information or experiences.

It was then with some relish I read another Wall Street Journal article last week reinforcing my observations about Groupon in that first linked post.

Specifically, the piece more fully divulged the deal economics. It was worse than I'd imagined. A typical Groupon deal has the retailer giving customers a half-price deal, from which Groupon then receives half of the actual revenue. That means the retailer is giving a 75% discount off of list price for the Groupon customers.

Furthermore, many of the anecdotes related in the article portrayed the couponing services, not necessarily Groupon, as offering deals with fine print or overlooked details which cost the retailers dearly.

Finally, in the last story in the Journal piece, a retailer contrasted her experience with two different online networking-related couponing services. In one, the customers were very narrowly chosen and proved to be repeat customers. In the other, a horde of discount-seeking buyers took the deal, with very few returning for full price products.

About the same time as the article appeared, there was a rash of stories reported on CNBC of various institutional investors and pundits worrying that another internet business bubble is building. Twitter and Groupon are among the businesses cited as having valuations that seem unsubstantiated by long term profitability dynamics.

Groupon and its ilk just aren't businesses which I see as capable of delivering long term consistently superior shareholder returns, when they are public. There seem too few barriers to entry, too little in the way of proprietary, defensible competitive advantages, and an evolving sense by many customers, i.e., retail merchants, that what these services provide is, in the end, not really all that different than conventional couponing, and not necessarily loyal, full-price customers, either.

Sokol, Buffett & Becky Quick

By now you've probably read, heard or seen more about David Sokol's conflict of interest investment in Lubrizol, ahead of his recommending it to Warren Buffett for Berkshire Hathaway to buy, then you wanted to. It's been all over CNBC throughout the day.

That written, I won't add my own view about the propriety of Sokol's actions. He spent about ten minutes on CNBC this morning attempting to defend his actions as above question. The network had panels of various people appear on almost every program to debate Sokol's actions and defense.

But to me, there's a single glaring question you should ask, in light of Buffett's lavish, frequent use of CNBC when it suits him:

Where is Becky Quick's in-person investigative interview with the so-called Oracle of Omaha on this one?

Sure, Quick accompanies Buffett on those photo- and video-op tours of China, India, and Korea. She's with him before every annual meeting, and several more times per year. All good press for Buffett- on his terms.

What about now? Because everyone agrees that Buffett sent Sokol out to do damage control on his own. Many is the pundit who contends that Buffett is worried that this incident might finally pierce his folksy, aw shucks veil of privacy and land him in front of an SEC inquiry.

I've written many posts suggesting that Buffett's recent performance hasn't been nearly as good in recent years as it was a decade ago. Buffett gets a pass on borderline unethical or illegal takeover moves, such as Burlington Northern, that would raise eyebrows were others to attempt to use the same tactics.

Don't you wonder why, with her tight connection to Buffett, CNBC's producers didn't have Becky Quick on the line to Buffett this morning, or explaining why not?

Well, okay, that's a rhetorical question. The reason why not is that Warren obviously didn't want to be spotlighted on the Sokol-Lubrizol front-running scandal. And if Becky Quick had pushed on this, it likely would have been the last time her call would be taken or returned by Buffett.

So much for hard-hitting, investigative business news on CNBC, huh? Better to preserve marquee relationships, avoid asking embarrassing questions, and leave Buffett alone when viewers would have liked to know what he knew, what he said, etc.

That's why CNBC is a business entertainment network, not a business news network.

The True Costs of TARP

Yesterday afternoon, just before the close of the market, CNBC gave itself over to propaganda by allowing a Treasury official to appear and declare that TARP had officially been repaid more than it lent, allegedly making it profitable.

I write allegedly because of the following editorial from the March 17, 2011 edition of the Wall Street Journal, entitled TARP Was No Win for the Taxpayers. Subtitled "Treasury's claim that the bank bailouts will return a profit ignores the other, more costly programs enabling the banks to repay their TARP funds," it was co-written by Paul Atkins, Mark McWatters and Kenneth Troske. Regarding their credentials, Mr. Atkins was a member of the Congressional Oversight Panel from 2009-2010. Messrs. McWatters and Troske are current members of the panel.




I made a reference to it in this post last week,

"...then moved on to exhibit his complete misunderstanding of a recent Wall Street Journal editorial which ingeniously put the lie to Treasury Secretary Geithner's claim that TARP had 'made money' for taxpayers. The Journal piece provided the broader context of various Fed asset purchases, GSE takeovers, etc., which allowed bank-held structured finance assets to be valued at higher levels than they would have otherwise been, thus allowing them to repay TARP funds. In short, the editorial correctly noted that TARP was simply the named tip of a very large federal iceberg of self-dealing and non-market-based asset valuations calculated to let banks appear solvent and, thus, capable of repaying government funds. Liesman apparently failed to understand the article, gasping and sputtering that the authors, and anyone who believed them, were just ungrateful for the federal government's profitable rescue of the banking system."



Here's the editorial in its entirety, so you may follow all the numeric trails within it,
Today the Senate Banking Committee will explore the Troubled Asset Relief Program (TARP). Almost 30 months after its birth, TARP is far from dead. More than 550 banks, AIG, GM, Chrysler and others still have approximately $160 billion of taxpayer money outstanding.


Even so, the administration would have us believe that TARP has been a success because it supposedly alleviated the financial crisis and is (so far) being paid back at an apparent profit for taxpayers. Perhaps because he helped invent TARP before he joined the Obama administration, Treasury Secretary Timothy Geithner has called TARP the "most effective government program in recent memory."


Treasury's view is misleading. First, it hides the full story of the government's financial crisis effort, of which TARP is but a minor part. Moreover, Treasury has not been content using rhetoric alone to try to put TARP in the best light. The Special Inspector General for TARP criticized Treasury in October for inadequately disclosing a change in its valuation methodology that reduced a $45 billion loss in AIG to $5 billion, making TARP losses appear smaller than they really are. This data manipulation is only part of a much larger problem with Treasury's representations regarding the supposed success of the bank bailout payments that lie at the heart of TARP.


The focus on repayment fails to consider the huge taxpayer costs from non-TARP programs that directly and indirectly enabled many of the large banks to repay their TARP funds. These intertwined programs, operated by the Treasury and the Federal Reserve, dwarf the size of TARP and lack its accountability.


The financial crisis was born in the housing bubble caused by the policies of Fannie Mae and Freddie Mac, the two bankrupt government-sponsored entities (GSEs) charged with buying and packaging mortgages into mortgage-backed securities (MBS). TARP banks own billions of dollars worth of MBS and have remained liquid in part because the Federal Reserve has bought more than $1.1 trillion of these GSE-guaranteed MBS in the securities markets—all outside TARP.


The Fed purchased the MBS at fair market value, but this value reflects Treasury's bailout and continued support of the GSEs—also done outside of TARP with taxpayer money. Had the GSEs failed, TARP recipients probably would have been stuck with these MBS, writing them down at significant loss. Their ability to pay back TARP funding would have been hurt, and they might have had to obtain more TARP funds or go bust.


So the taxpayer-backed GSE guarantee enables the Fed to prop up the market with taxpayer funds, in turn allowing the TARP banks to "repay" their TARP funds. The bailout of the GSEs by Treasury thus shifts potential losses from TARP to other programs that have less oversight and public scrutiny. Any evaluation of TARP's success must take into account the interaction among all government programs designed to prop-up the financial system, and the shifting of costs among these programs.


The Congressional Budget Office estimates that Treasury's bailout of the GSEs will cost the taxpayers approximately $380 billion through fiscal year 2021. If only one-fourth of CBO's estimate ultimately benefits TARP recipients and other financial institutions, taxpayers will have provided a subsidy to these institutions of approximately $100 billion, which is not accounted for under TARP.


Also seldom mentioned are future costs resulting from using TARP funds to rescue "systemically important" financial and other firms. TARP exacerbates the "too big to fail" phenomenon by targeting much of its funding toward large banks and automobile firms, solidifying the market's belief in an implicit guarantee from the government for these firms. As credit-rating agencies have recognized, these large firms can borrow much more cheaply than their small-enough-to-fail competitors, which will lead to less competition, a more concentrated financial sector, and higher prices paid by consumers.


In addition, creating larger, more systemically important financial firms increases the likelihood of future financial crises because these firms have an incentive to invest in riskier projects as a result of the implicit government guarantee. The additional costs borne by consumers in the form of higher prices for financial services and the additional costs that result from future financial crises need to be included in any accounting of the costs of the TARP.


TARP was never where the real action was happening. In fact, other Fed and FDIC programs added another $2 trillion of taxpayer money at risk to the 19 stress-tested banks alone, on top of the $1.1 trillion of MBS purchased by the Fed. TARP is but one-eighth of that total.


The government's efforts inside and outside of TARP have sown the seeds for the next crisis and, unfortunately, last year's 2,319-page Dodd-Frank Act does nothing to fix these problems. Treasury must be more transparent regarding TARP. The real myth that the Treasury secretary should dispel is that TARP is a big win for the taxpayer.


So there you have it. Whether TARP is notionally repaid, or not, and whether correct accounting for the funds was performed, or not, it really doesn't matter. As the editorial's authors convincingly demonstrate, "other Fed and FDIC programs added another $2 trillion of taxpayer money at risk...on top of the $1.1 trillion of MBS purchased by the Fed. TARP is but one-eighth of that total."

Too bad CNBC didn't have anyone challenge the gloating Treasury official yesterday afternoon, and, instead, behaved like the government lapdog it has become.

Larry Page's New, Speedier, Leaner Google- Will It Really Recapture The Old Magic?

This past weekend Wall Street Journal edition had a page-one article concerning Lary Page, Google co-founder's aim "to clear red tape." Good luck with that!


Will Google return to the good old days? For some perspective, take a look at the firm's equity price history as compared to the S&P500 Index.

Google, according to the Journal article, had 200 employees in 2001, when Eric Schmidt became CEO. Ten years later, it employs some 24,000, or two orders of magnitude greater.

No, Larry, you're not in Kansas anymore. And trying to get an idea-themed internet sofware and services behemoth to be as prolific and successful a decade and so many more employees later is, truthfully, likely to be a futile task.

Page is doing what sound like sensible things, i.e., requiring short project descriptions from each manager, making himself and other senior managers physically available during afternoons "on small couches outside a board room in Building 43 at Google's headquarters."

However, a member of a leadership consulting firm is cited in the Journal piece observing that Page is attempting to foster more innovation by adding controlling processes to a very large organization. She describes it as "antithetical."

I agree.

In terms of the average amount of time during which companies' total returns can consistently outperform the S&P, Google may well have already seen its time in the sun come to an end. Let's be candid. Page and Brin are late 30-something engineers who, as far as I'm aware, have zero managerial education or background. Originally exploiting some technological search innovations and combining them with ad sales, the two spawned a successful startup and profited handsomely.

Now, however, Google is in a very different place as a company. The firm's ability to succeed, as evidenced by its recruiting Eric Schmidt ten years ago, will be more a function of management than sheer innovation. Its size dictates that, because the sheer weight of people and activity means that the few breakthrough ideas which occur at Google may not be seen in time to matter or, if they are, may not be capable of carrying the overhead of the rest of the firm.

Management is as much art as it is a discipline or science. That a 37-year-old software engineer, albeit a billionaire, now thinks he can, without any training in the field, simply step in and recreate Google's early days of success is sort of laughable. Chances are better the firm has simply grown and morphed into something that's never going to be capable of recapturing the early days and successes which made it into what it now is.

Breaking News: Maria Bartiromo's Stupid Comment of the Day

As I was working and listening to CNBC just before the 4PM close, I heard Maria Bartiromo making a hash out of an interview with some trader or fund manager.

The guy was talking about volatility, and how he was hoping to make money selling volatility as it fell.

Bartiromo, grasping at straws and, as usual, having no sensible follow-up question prepared blurted out a question paraphrased as,

'So can viewers use that declining volatility to bet on market direction?'

Just read that line again.

With all the smart hedge fund quants beavering away around the US, do you- does anyone....even Maria Bartiromo- really think that such a simple relationship could actually work?

How dense can someone be to ask such a pointless and obviously silly question?

Dense enough to be featured on CNBC commercials claiming that the network's being 'first to report from the floor of the NYSE' had anything to do with reporting from 'where decisions are made?'

Last I looked, the trading floor is empty now, because trading is electronic. Decisions were always made in trading rooms of investment banks and fund management firms.

But, then, someone who thinks volatility alone predicts market direction might also think that traders make decisions for their clients from the floor of the NYSE.

LLBean Offers Permanent Free Shipping

I recently received an email from LLBean announcing the end of shipping charges. Permanently. No minimum order value.


Of course, the first thing which occurred to me was- will their prices now build in shipping costs? Or will they attempt to absorb them in margins? Or hope for growth to offset the shipping? From the outside, without examining a lot of prices before and after the offer, it's difficult to tell. However, I'm guessing it's perhaps modest relative price movements that will be stickier or higher than otherwise, combined with some margin loss.


That said, the change is an interesting commentary on at least two phenomena.


One, for competitive posturing, offering 'free' shipping may be a powerful inducement to buy. I don't follow other online retailers closely, but it's quite possible that economic pressures on the middle class are driving online retailing, generally, to absorb shipping. In either case, competitively, it certainly removes a potential negative for Bean.


Two, there's the consumer behavior aspect. Perhaps Bean is seeking to entice customers to buy more frequently, albeit in smaller quantities. Perhaps changing more purchases from planned to impulse? I know I have, in the past, typically tended to combine purchases in order to save on shipping. But I've bought on impulse more frequently when I've received notices of free shipping periods. Perhaps Bean has concluded, from comparative research on its credit card-holders, who receive free shipping, and others, controlled for income, etc., that free shipping is worth the investment in subsequent revenues.


You have to wonder how Bean will manage the extremes of this cost absorption. How long can they afford customers buying some low-priced miscellaneous items for $9 or $10 when the real shipping costs might equal the product price? I spoke with a friend who, while at BCG, did some consulting for the USPS. She informed me that when Bean uses UPS, it doesn't necessarily mean you'll receive your item from Big Brown. Depending upon where you live, UPS will simply bar code your parcel for USPS shipping and drop it in a box in that mailing zone. Typically that happens in rural areas where the costs of actually sending a UPS truck are prohibitive. Maybe that's how the smaller, cheaper items will be delivered.

Still, there's real cost involved in those.

Then again, giving credit to Bean for being pretty sharp, maybe their research shows that, even with free shipping, most people simply don't deluge them with orders for $7 items.

With oil prices surging again, and gasoline prices continuing to bounce between $3.50 and $4 on average, nationally, you have to reason that Bean knows some very revealing information about its customers that would result in offering free shipping as a move to increase profits.

Carlos Slim's Track Phones: Marketing In Action

Last week's post on ATT's proposal to buy T-Mobile focused mostly on the market concentration among the top three wireless firms.

In subsequent discussion of the proposed deal, Michelle Caruso-Cabrera, a co-anchor and reporter on CNBC, made a very interesting point. Rather than focus on the two major wireless firms, ATT and Verizon, she noted that Mexican billionaire Carlos Slim's Track Phone pre-paid wireless business had the highest growth of any wireless firm.

I can't vouch for exactness, but I believe the data she cited showed Slim's firm adding more subscribers in some recent multi-year period than all three competitors who weren't ATT or Verizon. I believe MetroPCS was one of the firms, and T-Mobile may have been another.

In any case, it got me thinking about segmentation and consumer behavior, always favored topics due to my academic roots in marketing theory and practice.

I'm aware of how differently P&G and Colgate-Palmolive market in third-world countries, as opposed to higher per capita income European and US markets. Specifically, much of their volume moves through neighborhood bodegas with little product display capacity, selling to consumers with little disposable income. Thus, package quantities tend to be much smaller. Detergent might be sold by the envelope, rather than, as in the US, in a money-saving giant bottle.

That said, it makes sense to me that someone with business and cultural roots in a country like Mexico would naturally see the value of pre-paid wireless phones. Rather than take the American vendor route of replacing large monthly landline phone bills with similar-sized, or larger ones for much more feature-rich, multi-functional smart cell phones, Slim chose to offer smaller-sized bites of valuable wireless service to poorer consumers.

The result? Faster subscriber growth in a simpler market. You can bet that Slim's customers probably aren't constantly watching videos or netsurfing on their phones. They're probably happy to have such a powerful, yet inexpensive communications tool on their limited budgets.

When asked, an ATT official made some mention of possible interest in the pre-paid market. And, of course, it's no shock to observers that, for purposes of the proposed acquisition, ATT seeks to define the wireless market to include pre-paid, thus lowering the effective market share of the combined firms.

However, to me, Caruso-Cabrera's comment was eye-opening. Recalling the unsatisfying, mediocre total equity price performances of ATT and Verizon, relative to the S&P500, which appeared in last week's linked post, I can only imagine how Track Phone would look if it were public and standalone.

Just because a product aims at a lower-priced segment doesn't always mean it's lower-quality. That characteristic is, ideally, in the mind of the consumer. And Carlos Slim's people have apparently hit a very good sweet spot, offering affordable doses of a very desirable, powerful service, wireless, to lower-income consumers.

A great marketing story. I love it.

Laszlo Birinyi's Equity Markets Call On CNBC

Wednesday morning's appearance by Laszlo Birinyi on CNBC caused quite a stir. He made a stunning prediction that we are currently in a new secular bull equity market. He forecast a 2100 S&P500 Index in "2 to 3 years." By my calculations, that's a roughly 60% rise, working out to almost twice the long run Index annual average performance of around 11%.

I don't personally keep track of his record on this sort of call, but I assume it's pretty good. My sense is he is very well regarded in his field.

However, Birinyi said something that fit with my own observations. He talked about equity analysts and noted that there really are no 'stock market analysts,' but, rather, 'stock analysts.'

His own firm specializes in technical analyses of equity markets generally. For example, on the subject of the North African uprisings, Birinyi cited work that his firm has done on German equity markets after the Berlin Wall fell. Maybe it's relevant, maybe it's not. But that's the sort of thing his firm does.

I can identify with that, since my own quantitative work keeps a careful eye on basic equity market trends and behaviors. Like Birinyi, I don't presently see a market in which one wants to be solidly short. There may be increased volatility compared to a few months ago, but, despite many apparent headwinds, signals still indicate solid long positions.

Birinyi came right out and said that most investors simply have no sense of market history. Therefore, they are incapable of seeing trends or understanding how markets are likely to behave.

In light of current US federal and state government spending and debt challenges, and Fed policies, it seems heroic for Birinyi to have made his unequivocal call. However, given his focus, I am inclined to assign him more credibility than most pundits on this sort of prediction.

Lee Cooperman Talks His Book On CNBC

This earlier post described the feisty discussion between Ken Langone and one of CNBC's favorite guests, Steve Rattner.

Rattner seems to be one of those favored cronies, like Bill Ackman and Lee Cooperman, who are given air time to basically push their views in order to publicize positions and, hopefully, enhance their portfolios' values. In the second linked post, I noted,

"Cooperman clearly believes, as a result of his fund's analytical team's meetings with HD's management, that the company's stock will eventually be appreciated, even though, now, it's "undervalued." His reeling off of the many operating statistics, mostly rather abstruse numbers, sounded like he was reading from a list his analysts had prepared for him."



I hadn't reread this post in quite some time, so I was pleasantly surprised that I had noted how Cooperman seemed to be reading quickly from a script prepared by his staff.

On Wednesday, Legg Mason fund manager Bill Miller, once famous for an unbroken string of years beating the S&P500 Index return, was a co-host for a portion of CNBC's afternoon programming. He, in turn, invited Omega Advisers' Lee Cooperman to appear, via video link, as his guest.

What followed was one of the most transparent, blatant examples of self-serving, legal investment book-talking that I've seen on CNBC in quite some time. After exchanging mutually-congratulatory greetings and such with Miller, Cooperman answered some questions about market conditions and the like. He stepped through some points which were conveniently reprised on overlay text, suggesting the thing was well-prepared and coordinated long before air time. It was so pre-programmed that Cooperman evidently forgot he was on video, and began to do something annoying with his finger and his ear. I honestly don't recall what he said, as it was so fascinating, in this video age, to see him attempt to push a finger all the way through his head on camera.

Someone asked Cooperman a question about his 'single measure' or some similar term that he watches, and he gave a forgettable answer. Then, in a sudden burst of verbiage, he hurriedly said that his firm had just acquired a new client and/or several hundred million dollars to manage. He said he'd contacted all of his very excellent analysts for ideas, and then, in a blur of words that were nearly incomprehensible, Lee rattled off a list of investments they were making for the client.

I don't know quite why he was in such a rush, but he was, again, as some years ago with the Home Depot figures, reading from a script. The CNBC co-anchor made some joke about there being too many stocks named to do appropriate disclaimers on all of them. Cooperman didn't even grin- he was obviously pleased that he'd done the job he really wanted to do that afternoon, i.e., enunciate a list of equities, into which he'd already put client money, in hopes that viewers would rush to their terminals and follow Lee's lead.

When a floor specialist who can see trades coming does this sort of thing, it's called front-running, and is illegal. That's because the specialist knows which way orders are going, and takes additional positions in order to then sell them to fill the orders. When a portfolio manager goes on air to name his current positions, the effect is the same, though the act is not illegal. By publicizing his current positions, he reasonably expects some viewers to follow his lead. But, instead of selling anything to those subsequent investors, he enjoys a rise in his portfolio's value as new buyers push the prices of his current holdings higher.

Later in the afternoon, Jim Cramer, who, according to his own statements, engaged in his own brand of market-affecting tactics as a hedge fund manager, made the obligatory statements of adulation about Cooperman, thus adding more focus to the list.

The shame of it is that none of this is illegal. It may be unethical. It may, and, I believe, does constitute a sort of media-based crony financial capitalism. But it's all perfectly legal. Why else do you think so many lesser-known portfolio managers seem so thankful to get 3 minutes of air time? They just want a few of the names they hold in portfolios to be publicized, hoping some viewers, either retail or institutional, will take the bait and buy, pushing the price up further, enhancing the guest's portfolio values.

Much is still made of Cooperman's investing skills. I haven't seen one of  Omega's performance reports in years, so I am not personally aware of his recent performance record. I guess we'll all know, shortly, with the new fund managers' reporting requirements arriving via Dodd-Frank.

Until then, however, few will actually know how well Omega's portfolios have been performing. But you can bet they did a little better by the close of Wednesday afternoon.

Ken Langone v. Steve Rattner, George Miller On CNBC This Morning

Home Depot chain co-founder Ken Langone spent two hours as a guest host on CNBC's morning program today. As usual, it was an immensely intriguing episode marked my Langone's candor bursting the fictions being spun by other guests on the program.


The first act was Langone debunking several of the self-serving, misleading statements made by Steve Rattner. I've written about Rattner in a recent post, so I'm not pretending to be neutral about him. But the wonderful thing about this morning's discussion was that Rattner, when finally forced to spin his truth-challenged story to a smart, objective, capable opponent, clearly came off badly.

The reason for Rattner's appearance was apparently some article he wrote in a European publication claiming that his government-run bankruptcy action of GM could provide a template for European nations to follow. Langone began the debate by taking issue with the utility of comparing GM before and after the bankruptcy. Rattner had crowed about various comparative measures, and Langone called attention to the peculiar nature of the bankruptcy. In essence, Langone correctly stated that the process removed senior creditors' rights, removed health care obligations in an unusual fashion, and, generally, was run to the benefit of unions while trampling the rights of legitimate creditors.

Rattner then told his fairy tale of hypotheticals, mixed with lies. For example, he repeated the usual line that 'millions of jobs would have been lost' had the government allowed GM to be liquidated. That was the predominant line used at the time, but, of course, nobody can ever prove it to be true.

Then Rattner told a baldface lie when he claimed that, to paraphrase,

'the only choices were government-assisted restructuring of GM or liquidation.'

That's simply not true. In fact, a conventional bankruptcy would have protected GM while it considered options, such as closing some units, selling others, and, generally, reviewing alternatives prior to total liquidation. Rattner simply denies this, because it's inconvenient for him to admit there was a third, available, conventional, legal option.

Rattner also disingenuously claimed that bondholders had the right to take the company, but refused. That, too, isn't true. What really happened, as news stories of the day will inform, and about which I wrote in some of my GM-labeled posts of the time, was that the government coerced bondholders to take a lower recovery than the unions received. Rattner pretends that bondholders received a fair bankruptcy court hearing, but that's not true. The entire procedure was taken out of the usual bankruptcy channels, and federal power was used to quietly bludgeon bondholders, as they were told the government would arrange a resolution leaving them nothing, or they could take what was on offer. Period.

Because of various fiduciary laws, the various funds holding GM paper had no choice, because the third option, legitimate bankruptcy process according to established law, in an independent court, was not available.

Langone and Rattner then began to elaborate on their points, with Langone repeatedly criticizing the GM bankruptcy as abnormal and wrong, while Rattner continued to claim it saved the US economy and was nothing unusual.

From there, after a few rounds of those statements, the combatants agreed they would not change each others' opinions. Then Rattner, ever the self-interested party, chimed in that he wanted viewers to believe him. No surprise there.

Since Langone is objective, and Rattner is not, it's pretty easy to see who was telling the truth.

Next, George Miller (D-CA) appeared to beat his chest over how great a Congressman he was when his party was in the majority. Specifically, he claimed total responsibility and authorship of the dreaded 'paygo' House rule, lauded every costly piece of liberal legislation passed by the recently-ended Congressional session, and, regarding health care, said he just wanted 'change.'

His exchange with Langone, and others, was less a direct debate than a clear example of big government (Miller) vs. small government (Langone). Miller made it very clear that he had no use for market-based evolution of the health care system. Missing from his self-glorifying patter were some facts. For example, that his vaunted paygo approach was just an excuse to force every new Democratic program to trigger more taxes to pay for it. On health care, rather than mention that his party stiff-armed every Republican amendment and suggestion, he instead claimed that they 'listened to academics' and various other theoreticians, mostly of a liberal stripe. True enough, the bill that passed has already proven to be engendering dozens of unintended, unworkable and undesirable consequences. Exemptions to major coverage requirements already number over a thousand.

Toward the end of the second hour, the networks resident economic moron, Steve Liesman, showed up to spew some more bad thinking and ill-informed verbiage.He drew justifiably heavy fire from Langone, Kernen and Rick Santelli for ignoring the front-line burdens of the recent health care legislation, then moved on to exhibit his complete misunderstanding of a recent Wall Street Journal editorial which ingeniously put the lie to Treasury Secretary Geithner's claim that TARP had 'made money' for taxpayers. The Journal piece provided the broader context of various Fed asset purchases, GSE takeovers, etc., which allowed bank-held structured finance assets to be valued at higher levels than they would have otherwise been, thus allowing them to repay TARP funds. In short, the editorial correctly noted that TARP was simply the named tip of a very large federal iceberg of self-dealing and non-market-based asset valuations calculated to let banks appear solvent and, thus, capable of repaying government funds. Liesman apparently failed to understand the article, gasping and sputtering that the authors, and anyone who believed them, were just ungrateful for the federal government's profitable rescue of the banking system.

It's refreshing to see a principled, reasoned, intelligent host like Langone take on some of the dissembling guests who so routinely appear on CNBC's Squawkbox. Too bad they can't fire Carlos whathisname and replace him with Langone. But I'm sure Langone would decline the offer.

Mort Zuckerman On The Anemic Recovery

Mort Zuckerman wrote a provocative editorial in last Thursday's Wall Street Journal concerning the anemic recovery in the US. He echoed some of my concerns, but provided interesting metrics to substantiate them.

For example, consider this passage,

"Quite simply, it is because households are still carrying far too much debt on their balance sheets. Relative to income, debt today is approximately twice as high for families as it was in the 1980s. Total borrowing in relation to disposable, personal after-tax income leaped to approximately 136% in the first quarter of 2008 from 60% in the early 1980s before it began to recede. It has now declined to 117% of income compared to the pre- bubble norm of 70%. To return to that level, debt would have to be reduced by another $6 trillion. Similarly, the debt-to-asset ratio in relation to household assets is currently 20%, but the pre-bubble norm was 12.5%. The deleveraging process still has a long ways to go.

As more U.S. households pay down their debt, the slowdown in consumer spending will continue. The savings rate, which had averaged 8.6% during the 1980s and 5.5% in the 1990s, dropped to an alarming 2.8% in the 2000s. No longer are households engaging in mortgage equity cash-outs to the tune of over $80 billion per quarter, as they did in 2006. Cash-out refinancing today has dropped by 90%, contracting the available funds that helped power the pre-2007 spending binge."

In short, Zuckerman cites the data which explain why even the very slow job growth that seems to be fretfully emerging is not going to be sufficient to cure our ills. We're experiencing and witnessing continuing consumer de-leveraging after a decade of financial decline.

If you look closely at these comparative statistics, it describes how much different the decades of the 1990s and 2000s were from the 1980s. That earliest decade was, at the time, considered one of prosperity. Yet, in terms of personal financial balance sheets, it was relatively restrained.

From the perspective Zuckerman provides, the last twenty years have truly been an aberration.

Zuckerman continues by observing,

"Not surprisingly, middle-class Americans are growing increasingly leery of debt. This trend will continue as more families realize their retirement nest egg is going to be a whole lot smaller than they expected. Credit cards provide a marker. In a survey taken towards the end of last year by Javelin Strategy & Research, only 45% of households used credit cards in 2010, compared to 56% in 2009, and 87% in 2007.

Virtually every index of consumer sentiment supports this sense of consumer restraint. In a recent poll taken by the Pew Research Center, 71% of American consumers say they are buying less expensive brands, 57% say they have trimmed or eliminated vacations, 11% have postponed marriage or children, and 9% have moved in with their families, reducing spending on alcoholic beverages, clothing and restaurants. In other words, roughly 25 million unemployed or partially unemployed Americans are focusing on basic necessities. They make up a part of the 42 million Americans on food stamps.
Quite simply, American households are seeking to become net savers, not net borrowers. This is hardly surprising when real median household incomes are down over 4% from the 2000-2009 decade, according to recent research conducted by Mr. Rosenberg at Gluskin Sheff. Net worth has declined by more than $100,000 for the average household compared to just three years ago, and total household net worth is $12 trillion lower today than at the pre-recession peak—an unprecedented decline of 18.5% over three years. The bulk of this loss comes from diminished home equity, and with more than six million homes in inventory or in foreclosure, prices have been declining again for the past six months."


Here, Zuckerman has provided some of the income and spending details to identify why and how the consumer balance sheet changes he noted in the previous passage are occurring. It's stunning stuff, is it not? These are the sorts of behaviors probably last experienced forty years ago, during the Carter-era stagflation. That is, American families making sizable lifestyle changes in order to survive,

"In short, the triple whammy of weak consumer sales, a weak housing market, and a deeply anemic job market is still very much with us. There are no quick fixes to the post-bubble credit collapse. The painful process of deleveraging is far from over. Current debt loads are not sustainable either by incomes or asset values, which are falling.


That's why our economic pulse is so weak. Real GDP growth is less than half of what one would ordinarily expect to see coming out of such a deep downturn. And there has been virtually no recovery at all with respect to housing, income levels and employment."



So there you have it in a nutshell. Consumer deleveraging, by the numbers. The related income and expense consequences. I think the data are convincing and compelling. We have a signficant shift in consumer economic and financial behaviors.

In conclusion, Zuckerman wrote,


"The government's February jobs report reaped a slew of cheerful headlines. But much of the bounce came in construction, where workers were kept idle by January's snowfalls. Job gains for the past three months averaged just 135,000—we need 150,000 a month just to keep pace with population. And government figures don't take into account the two million plus discouraged workers who've dropped out of the labor force over the past year and a half and are still unemployed. If counted, the jobless rate would have been 11.5% in February."


I don't particularly agree with his final comments suggesting another federal stimulus, whether monetary or fiscal. But his analysis of the current US economic situation is, I believe, correct. The trouble is, many want government to do something. Nobody seems to be capable anymore of simply accepting the pain and consequences of prior economic mistakes.

But now, that's probably what is necessary for the US economy to fully recover to its potential.

Paul Singer On Inflation, Dodd-Frank Regulation, & The Next Financial Meltdown

This past weekend's Wall Street Journal main interview was with hedge fund manager Paul Singer. I can't say I was acquainted with his work prior to reading the interview, but I was heartened, in a way, that so much of what he espoused was similar to some of my own previously-written views.

For example, Singer was unequivocal regarding coming inflation. When a guy like this begins citing 1930s era European treatises on the Germany currency debasement, you should be worried. I already am, but, of course, Helicopter Ben keeps telling people like me to have faith and quit being concerned.

Let me put it this way. Singer has built a multi-billion hedge fund by relying on his own analyses, conclusions and instincts. Ben The Bernanke is a high-level civil servant who will probably be offered another high-level, lucrative position after being Fed Chairman, no matter how badly he messes up in that role.

Of the two, Singer or Bernanke, whom do you think has the greater risk in being wrong, and, therefore, is more likely to get the current economic situation correct? And, by the way, Bernanke, as a sitting Fed Chairman, pretty much has to cheer lead on topics like saying economic growth is coming or here, inflation won't be a problem, and the world's investors won't be concerned about continued US monetary debasement.

For once, in Singer, I've found someone who echoes my own views of large US commercial banks as totally unattractive investments. James Freeman's interview quotes him as saying,

"You don't know the financial condition of [Citigroup], JP Morgan, Bank of America, any of them. Mr. Singer believes the big banks still carry too much leverage, and he doesn't trust regulators to monitor them effectively.

The largest financial institutions, he says, are "a random collection of survivors. Almost none of the survivors exist because of their perspicacity, risk controls and sound management- even the ones that are vaunted along those lines...How and why do they exist? Mostly on accident, meaning who got bailed out first and who was saved next and how did people feel and what did people say the weekend Merrill was under pressure [in September 2008]." "

Singer goes further in the next paragraphs, citing one of my own favorite risks- counterparty. He says that his fund complex has removed itself as much as possible from having any of the large US commercial banks and "the Street" as counterparties.

Singer sees Dodd-Frank as I, and many others, do, as described in the interview thus,

"The authors of Dodd-Frank claim that the law prevents the government from bailing out any particular firm, but the Fed can still provide emergency loans to a failing giant as long as it offers similar financing to other firms.

"It's a very important part of this equation that a few survivors exist in this peculiar relationship with government, having to kowtow to government, make relationships with regulators," says Mr. Singer. "Are they puppets of the government? Are they cronies of the government? Will their lending be affected by the perceived whims or beliefs of the particular government regulators existing at a particular time? Yes."
If the government deems a firm not "systemically important," Mr. Singer forecasts, it could spell its doom. "Small and medium-sized financial institutions may be disadvantaged, may be sacrificed in the next crisis to protect these behemoths," he says.
It gets even worse, Mr. Singer says, if the government ever deems a financial giant "in danger of default"—a judgment that can be made without the consent of the firm or its investors. The business is then taken over by the Federal Deposit Insurance Corporation, with its Orderly Liquidation Authority.
Once in charge of the firm, the government can discriminate among similarly situated creditors and transfer assets out of the business at will. Because of this, says Mr. Singer, creditors and trading counterparties might flee even faster than they would from a firm headed toward bankruptcy, where at least there is established law instead of regulator discretion.
"You don't know how you will be treated," he says of financial institutions under the new FDIC regime. "If there are companies that are also counterparties alongside you but they've been designated systemically important, that's a clue. It's like a game of treasure hunt. It's a clue that you're going to get disadvantaged compared to them."

So maybe FDIC chairman Sheila Bair and the authors of Dodd-Frank were right about one thing: Perhaps their new process for resolving failing giants really will discourage some people from lending to the biggest banks—but only at the worst possible moment.
The problem, in Mr. Singer's view, will be the jarring shift from one day being an investor in a member of the "systemically important" club, to the next day being a creditor whose claim is determined by bureaucratic whim. This may be welcome news to government pension funds that will want to be bailed out, but certainly not for private investors.
The speed at which a firm will collapse as word gets around that it might be headed to FDIC resolution could be "amazing," says Mr. Singer. And that "speed will drive the size of the losses."
This "atmosphere of unpredictability" is harmful to America's place in the financial world, he says, and "it doesn't make the system any safer. . . . This is nuts to be identifying systemically important institutions." He views it as a poor "substitute for creating soundness and reasonable levels of leverage throughout the system."


Phrases like "bureaucratic whim" ought to make you cringe. Don't you think they have that effect on investors in, lenders and counterparties to such institutions? I do. Singer's comments confirm what many others, including me, have contended, i.e., that the comparatively predictable existing bankruptcy laws have been replaced by liquidation-by-whim and cronyism. Singer is correct to predict that funds will leave a troubled firm much faster than anyone can imagine. And, ironically, that being in a group of selectively preferred, "systematically important" designated firms lending to or investing in a large bank is actually dangerous, because you will be the least-advantaged party. The one most likely to be at the very end of any line to collect on funds due.

Thus, in Singer's view, you have government-backed large institutions continuing with risky behaviors, and counterparties like them doing the same. This, he worries, is the seed bed for the next financial meltdown. Dodd-Frank and the FDIC have replaced uncertainty with respect to government backing for large firms in the event of another financial crisis with absolute certainty that select "systematically important" banking firms will be rescued. Moral hazard is now legislatively and regulatorily banished, leading to another round of excessive risk-taking.

The final passage of Freeman's interview says a lot about Singer,

"One reason his firm has survived for 34 years, he says, is that "we try to be very respectful of the unpredictability of markets. We try to at all times at least assume that the world is not being properly run." A safe assumption. "

Sad but, in this case, so true.

ATT & T Mobile

This week's announcement of ATT's proposal to buy T Mobile's US network received copious amounts of coverage in the business press.

My first inclination, to be blunt, was to check on the equity price moves of the major US telecoms for the past five years, and more.

It isn't pretty.

The first chart displays ATT, Verizon, Sprint and the S&P500 Index for the past five years. Sprint is clearly the big loser, but the other two could only manage to match the Index.

Think about that. In such a capital intensive, advanced technological business, Verizon and ATT can, at best, only manage to give you the equity market index return, with no premium for the risk of lack of diversification.

The next chart displays the long term price moves of the same series. Sprint, again, is the big loser. But the other two haven't even matched the S&P over the longer timeframe.

Conclusion?

Before you get all amped up over this proposed deal, notice that the whole sector is an investment graveyard.

My hunch, born of my experiences with predecessor AT&T from 1979-82, was right. I can still recall, upon joining AT&T right out of graduate business school, seeing the single most riveting chart describing the company's situation. It was a Yankee Group chart showing the monotonically plunging free cash flow for AT&T. A trend that had begun a few years earlier, and was proceeding at breakneck speed. Everything about the business screamed 'value destruction,' in the classic Schumpeterian sense.

Existing prices and equipment were under attack. New products would provide incredible productivity increases for customers, while transitioning AT&T from the clunky, labor-intensive world of analog to the much more competitive, less-profitable digital world.

Everywhere I looked, I saw revenue forecasts failing to displace business lost to either competition or technology. People my age received a brutally quick introduction to deregulatory dynamics in telecommunications, airlines, and banking. It hasn't ceased yet.

Now, as to the strategies and tactics of the proposed deal.

T Mobile has the valued asset, with Sprint needing it  to remain relevant. So ATT promised a $3B breakup fee just to keep Sprint's hands off of T Mobile while the proposed merger is vetted by DOJ and God knows who else.

If ATT gets its prize, albeit at a P/E exceeding its own, it immediately increases its physical network assets and, perhaps most importantly, gets its target's valuable spectrum slots, while denying Sprint a viable means to remain competitive. If not, it's at least tied up T Mobile for a while, thus starving Sprint a little longer.

Why the putative architect of this deal, some investment banker from Chase, is so lauded is beyond me. I mean, with so few players, was this really something for which ATT and T Mobile needed a banker? Maybe for the basic funding mechanics, but nothing else.

As for the hoopla involving Chase underwriting the proposed deal with $20B of credit, so what? They're underwriting the purchase of infrastructure and spectrum, more than anything else. Not so risky. Given consumer behavior, even if the oligopolistic aspects of the deal allow some price increases, people are still going to continue to use their smart phones for data- and video-heavy apps, which will ensure the debt being paid off.

Meanwhile, according to CNBC's pundits and the Wall Street Journal, the regulatory issues are hardly trivial. For precisely that oligopoly effect of taking out one of four providers in the sector.

But, to me, win or lose, ATT's CEO, in an interview on CNBC Monday morning, said something that really gave me pause. Something right in line with this recent post.

Jenkins wrote about cloud computing, and smart phones certainly are a major contributor to the phenomenon. Stephens, ATT's CEO, noted that the firm needs more network capacity muy pronto, as even cars are now bringing apps traffic to cell phones. He mentioned some growth figure which, while I forget what it was, stunned me. After all, I, like many people, have already seen the commercial wherein a guy remotely accesses his car for his teen-aged daughter and her friend, then starts it via his cell phone app.

Far more than the old land-line engineers at the old Bell Labs and Long Lines, today's ATT network engineers must be terrified at the expected smart-phone and related device-based traffic coming their way on wireless networks. Meanwhile, nobody wants to pay much more for these conveniences.

Regardless of whether this deal is approved, or not, I doubt it will really make ATT a more attractive equity investment. Take another look at that second chart. None of the three telecom companies has a higher price today than ten years ago. It's just a lousy sector for investment, no matter how much more concentrated it gets. At least barring radical changes in regulatory-driven economics which allow a telco to become a reasonably pure play on market-based pricing for wireless bandwidth. Even then, however, the infrastructure requirements may dampen investor enthusiasm.

But, for now, I'd be surprised if this deal, if consummated, really does a whole lot for ATT's ability to earn consistently superior total returns in the years just ahead.