Saturday, January 31, 2009

I Second That Evasion: Tom Underpays Tim

"Kleptocracy is a term applied to a government that extends the personal wealth and political power of government officials and the ruling class (collectively, kleptocrats) at the expense of the population" (Wikipedia)

The motto of this blog is "In Equity, Veritas". The term "equity" refers both to fairness and ownership.

Bill Clinton and Al Gore each built up personal net worths of about $100 Million within about 7 years of leaving public service. Nice work if you can get it, n'est ce pas? Tom Daschle was not quite in their league, but he apparently learned that a penny of tax avoided is better than a penny earned (because a penny of tax avoided has no tax on it!).

Former Democratic Majority Leader Daschle is Mr. Obama's nominee to be Secretary of Health and Human Services. The importance of this post is tipped to be greater than usual, because of Mr. Obama's plans to make the health system fairer and more universal.

Here is the Times' headline:

"Use of Free Car Lands Tom Daschle in Tax Trouble"

DoctoRx here: Doesn't sound too bad, does it? Perhaps just a forgotten couple of limo rides?

President Obama's pick for health and human services secretary, Tom Daschle, failed to pay more than $128,000 in taxes, partly for free use of a car and driver that had been provided to him by a prominent businessman and Democratic fund-raiser, administration officials said Friday.

Note the word "partly", whichindicates that the headline of the article was too easy on Mr. Daschle, and also note that $128,000 far exceeds Treasury Secretary Tim Geithner's tax underpayments.

Mr. Daschle, concluding that he owed the taxes, filed amended returns and paid more than $140,000 in back taxes and interest on Jan. 2, the officials said.

The car and driver were provided by Leo Hindery Jr., a media and telecommunications executive who had been chairman of YES, the New York Yankees regional sports network. In 2005, Mr. Hindery founded a private equity firm known as InterMedia Advisors. Mr. Daschle was chairman of InterMedia’s advisory board.

In a financial disclosure statement filed this month with the Office of Government Ethics, Mr. Daschle reported that he had received large amounts of income from InterMedia, including more than $2 million in consulting fees and $182,520 in the form of “company-provided transportation.”

Under his consulting arrangement with InterMedia, the report said, Mr. Daschle received $1 million a year, or $83,333 a month. The payment to Mr. Daschle for May 2007 was omitted from the annual statement of income sent to him by InterMedia. Ms. Backus said the omission resulted from “a clerical error by InterMedia.”

The White House and the Senate majority leader, Harry Reid, Democrat of Nevada, affirmed their support for Mr. Daschle.

It's nice to know that Mr. Obama opposes high pay for financial industry types. Lawyers who lobby under the guise of "consulting", however, can earn the big bucks and retain his "support".

The committee report said Mr. Daschle had told the committee staff that “in June 2008, something made him think that the car service might be taxable, and he disclosed the arrangement to his accountant.”

“Under Section 132 of the Internal Revenue Code, the value of transportation services provided for personal use must be included in income,” the report said. “Senator Daschle estimated that he used the car and driver 80 percent for personal use and 20 percent for business.”

"Something made him think" that his personal use of a free car "might" be taxable?

Good for him! A deep thinker, obviously . . . but an honest one? The article points out that he did not pay his back taxes until January 2009, when he knew he was going to enter the public eye. Yet he cleverly suspected that personal use of a company car and driver was in fact a taxable service seven months earlier, and even consulted with an accountant about it?

An administration official said Mr. Daschle’s failure to pay the taxes was “a stupid mistake.” But, the official said, Mr. Daschle should not be penalized because he had discovered the tax liability himself, paid up and brought it to the committee’s attention.

DoctoRx here: Res ipsa loquitur, as the lawyers say ( usually translated as, "the thing speaks for itself"). Don't you really, really want people who make "stupid mistakes" performing surgery on the health care system!

That opinion from the please-don't-name-me administration official, besides being dubious, is not even accurate. If people can really think that not being Secretary of HHS is a "penalty", then perhaps Mr. Daschle and Mr. Obama can take a meeting together and review their horn books to recall what a penalty under the tax and other law really can be. Is returning to a multi-million dollar a year "consulting" business really a penalty?

There's more (the Times again):

The car and driver were not Mr. Daschle’s only problems. The Finance Committee said he failed to report consulting income of $83,333 on his 2007 tax return and overstated the deductions to which he was entitled for charitable contributions from 2005 to 2007. In his amended tax returns, he reduced the deductions by $14,963.


Had enough yet? There's still more:

Members of the committee staff from both parties have been examining a number of other issues, including his relationship with EduCap, a student loan company.

Some members of the staff have also been asking whether Mr. Daschle should have registered as a lobbyist while working at the law firm Alston & Bird, which itself was registered as a lobbyist for EduCap and for many health care companies.

In his financial disclosure report, Mr. Daschle said he received compensation of more than $5,000 for providing “policy advice” to EduCap. The exact amount was not disclosed.

In its report, the Finance Committee said its staff was still reviewing “whether travel and entertainment services provided to the Daschles by EduCap Inc., Catherine B. Reynolds Foundation” and the Academy of Achievement “should be reported as income.”

In his financial disclosure statement, Mr. Daschle said he had received $2.1 million in “wages and bonuses” from Alston & Bird and more than $390,000 for speeches to groups like America’s Health Insurance Plans. He also said he had received more than $5,000 for giving “policy advice” to the insurer UnitedHealth.


So here we have it. Mr. Daschle is voted out of office by the good people of South Dakota (median household income in 2004 was $39,000). He goes not for public service or an academic post, but rather for the big bucks as a "consultant".

Here are the two clients listed here and their descriptions:

"Intermedia is a leading international research and consulting organization specializing in media and communications".

Educap: "Student loans to help you succeed in life".

Quite some healthcare-related activities. Well, apparently Barack Obama and Harry Reid believe that consulting in those fields is a great qualification to lead the reshaping of healthcare (back to the Times article):

The White House and the Senate majority leader, Harry Reid, Democrat of Nevada, affirmed their support for Mr. Daschle.

James P. Manley, a spokesman for Mr. Reid, said: “Senator Daschle will be confirmed as secretary of health and human services. He has a long and distinguished career in public service and is the best person to help reform health care in this country.”

DoctoRx here. Public service? Do they expect us to believe that while earning millions a year "consulting" for a media company and a student loan company, he was burning the midnight oil at his own expense studying the intracacies of health care policy? Is there no one in the entire US of A who actually has spent a career in health care policy?

The best person?

Copyright (C) Long Lake LLC 2009

Friday, January 30, 2009

A proposal to prevent wholesale financial failure: A critique

Yesterday, Drs. Roubini and Pederson of the NYU Stern School of Business published "A proposal to prevent wholesale financial failure" in the Financial Times. This post would like to examine their thoughts in detail. Their core proposal "is to impose a new systemic capital requirement and systemic insurance programme".

They go on to make the following points.

The root of the problem is that banks have little incentive to take into account the costs they impose on the wider economy if their failure prompts a systemic liquidity spiral. This is akin to when a company pollutes as part of its production without incurring the full costs of this pollution. To prevent this, pollution is regulated and taxed.

DoctoRx here. The core assertion here is questionable on the following grounds:
1. Any systemically important institution does in fact take into account the systemic ramifications of its actions. After all, if its error can bring down its house, it won't smoke in bed (to mix metaphors).
2. There is fuzzy thinking in comparing an error or bad luck caused by decisions a financial company makes with pollution. Pollution is a "bad thing" on its face. Financial companies may simply take too much risk, such as loading up on mortgages to the exclusion of, say, lending to AAA corporations. If in fact a financial company is producing pollution, that product should be banned. So the analogy fails.

There are two challenges associated with reducing the risk of a liquidity crisis. Systemic risk must be first measured and then managed. We propose to define a bank’s systemic risk as the extent to which it is likely to contribute to a general financial crisis. This measure can be estimated using standard risk-management techniques already used inside banks – but not across banks, as we propose – to weigh how much each trading desk or division contributes to the overall risk of a bank.

DoctoRx here. The questionable assertion here is the term "standard risk-management techniques already used". This is scary. Dr. Nassim Nicholas Taleb ("Black Swan" author and philosopher; prior options trader) correctly predicted the demise of Fannie Mae and the horror in the financial markets because he saw that the risk model, such as "Value at Risk", was fatally flawed.

With this measure of systemic risk in hand, a regulator can manage it. We propose two ways to manage systemic risk. First, the regulator would assess each bank’s systemic risk. The higher it is, the more capital the bank should hold.

DoctoRx here. Several objections:
1. Dr. Taleb teaches that is really impossible to "measure" risk, no matter what it is.
2. Even if risk could somehow be even approximated, trusting a regulator to correctly assess both a bank's inherent risk and its importance to the riskiness of the system as a whole represents a leap of faith that this blogger, for one, is unwilling to make.
3. Of course, the greater the risk, the greater the capital requirement. But there will always be the issue of whether the capital set aside for damage to the system is sufficient.

Second, each institution would be required to buy insurance against its systemic risk – that is, against its own losses in a scenario in which the whole financial sector is doing poorly. In the event of a pay-off on the insurance, the payment should not go to the company, but to the regulator in charge of stabilising the financial sector.

DoctoRx here. Again, some points regarding this proposal.
1. Who reinsures the insurer? What if the insurer fails? What if the reinsurer fails?
2. Who sets the insurance rate?
3. This situation sets up a perverse incentive in which the regulator brings in funds if the bank does poorly. Perhaps what would be better would be for the regulator to be compensated if the bank does well. Well . . .wouldn't that be similar to the current situation in which insiders were compensated if their institution reported good numbers for the short term, no matter the intermediate or long-term results?

DoctoRx: Summary

In interviews at Davos and pre-Davos, Dr. Taleb called for banks to be treated as regulated utilities, perhaps owned by governments. This point of view has been propounded in this blog, as well ("What Does Reform of the Banking System Have to do with the Internet?") That post also discussed the NYU Stern white paper, "Restoring Financial Stability: How to Repair a Failed System"). In that post I argued against the very existence of what the white paper called "large complex financial institutions" if they were systemically threatening. I also stated that private money could do what it wants, with appropriate regulation, with the understanding that it would not be bailed out and could not threaten the system; e.g., no more Long Term Credit messes, no more Lehman Brothers, etc. Dr. Taleb expressed the same thought, as well.

Dr. Roubini has been prescient as a prognosticator. However, as a physician, I am aware that a genius diagnostician may yet not come up with the optimal treatment plan for a patient. In this case, Dr. Roubini has entered what might be called the statist quo. In this situation, systemic risk would exist but allegedly, better regulation (read, government) would alleviate the problem.

In the Taleb (and DoctoRx) model, systemic risk from banks that are depository institutions would not be allowed to exist, period.

In this view, the functioning of basic banking is akin to a utility. Just as the lights must stay on, toilets must flush, etc., so must basic banking functions go on and on and on. In this model, Glass-Steagall would come back into being with appropriate updates, nationwide banking could occur, but the banks would be small and competitive, and financial gamblers could gamble and use leverage if they could obtain it, but they could not threaten the utility-like banking system.

Copyright (C) Long Lake LLC 2009

Economic Update: Weekly Leading Indicators

It was reported very recently that the Conference Board's Leading Economic Indicators were up slightly for December. This helped trigger a rally in stocks. However, the LEI was created by Dr. Geoffrey Moore, who found an improved methodology, which is now used by the successor enterprise he then founded, ECRI. ECRI has a superior track record to the LEI, in my humble opinion.

The ECRI (Economic Cycle Research Institute) has released its Weekly Leading Indicator figure for the week ending Jan. 23. The W.L.I. clocked in at 107.3, down marginally from the prior week and down 24% year on year. The absolute number of 107.3 is about where this index was in the 1994-5 time frame. Considering that companies have been reinvesting in their own stocks, paying dividends, making acquisitions, and the like, it may be reasonable to ask the question of whether the absolute number of the Dow Jones Industrial Average also belongs at the level of the mid-1990s. FYI That might put it at 4000.

Let's hope not, but the action of seemingly solid companies over the past year teaches humility in ruling anything in or out.

Copyright (C) Long Lake LLC 2009

Morning Update: Procter and Gamble

Procter & Gamble announced second quarter earnings today. Here is the link and highlights:

P&G Delivers Second Quarter EPS and Organic Sales in Line with Expectations

"Volume declined three percent for the quarter driven primarily by trade inventory reductions and consumption declines.

Gross margin declined by 70 basis points to 51.6 percent as higher commodity and energy costs of about 300 basis points were largely offset by the impact of price increases and manufacturing cost savings.

For the 2009 fiscal year, the Company expects organic sales to grow by two to five percent. The combination of pricing and product mix is expected to impact sales growth by a positive four to five percent. Organic volume is expected to be flat to down two percent. (emph added)

For the January - March quarter, organic sales are expected to grow two to five percent. The combination of pricing and product mix is expected to contribute between five and seven percent to sales growth. Organic volume is expected to decline two to three percent. . . Total sales are expected to be down two to seven percent."

DoctoRx here. The balance sheet continues to show a large working capital deficit and about $27 B in negative tangible net worth.

Commentary: The Company appears to believe that in the worst global consumer economic environment in decades, it will be able to "up-sell" products via price increases and by selling higher-priced/higher-margined goods in the 5-7% range to offset projected volume shrinkage. Good luck to P&G!

(The alert reader will note that there is no discussion of earnings here. In this brutal bear, they don't much matter. Undue attention to earnings is what has destroyed many an investor's capital over the past 1 1/2 years.)

Unlike with a company that has oodles of unrestricted cash, all P&G has is its trade names, distribution system, etc. as its asset value. If times stay bad, there is no upside to its current sales and earnings projection, but there is lots of downside. The stock has reacted badly to the news today (currently down 4%), despite S&P reiterating how much it likes the stock. On a long term chart, this defensive company's stock is at a 2 1/2 year low and is less than 5 points (less than 10%) above a 5-year low. Watch out below.

Copyright (C) Long Lake LLC 2009

Thursday, January 29, 2009

Market Update

First, the good news. At Calculated Risk, CR summarizes the Credit Crisis Indicators this evening. The short-term financials are getting better.

The bad news is that all this was the run-up to and of course one of the causations of a vicious global economic downturn. While every recession is scary, the current one is setting various records. Simply scour CR's posts this week, and you will find records ranging from the known housing issues to obscure ones such as trucking tonnage and air cargo volumes. And of course the world is experiencing the lowest short-term rates in multiple countries at least in the past 300+ years. Lots of major bear markets have not had much credit crisis. But we'll take any improvement where we can get it.

That said, the markets are at a most interesting juncture. Here's a summary of the 3 major markets covered here.

1. Treasuries. Currently they are in a correction. The 10-year yield bottomed near 2%. This was a historic breakout in price of the continuous bond. In the last cycle, the 10-year bottomed intra-day around 3.1%. It is now around 2.8%. If it hits 3.1%, that would represent a 50% increase in rates from the bottom. That's about as much as a short-term jump as one ever sees and could represent an attractive purchase, especially considering that this is a seasonally weak time of years for Treasuries and the talk is of an oversupply of Treasuries.

In the meantime, TIPS continue to price in deflation, there is excess capacity everywhere except in gold mining and the only real hiring anywhere is for people to handle unemployment claims.

Long Treasury yields did not bottom until about 19 years after the Crash of 1929.

Treasuries are in a primary bull market. There is near-universal belief that rates are way, way too low. Thus there is every possibility that the correct approach for at least a while longer is to buy a 5-10 year Treasury, make a real return against deflation or minimal inflation, and sell the bond in a year or two at a profit; or at the worst hold till maturity. Unlike the NASDAQ that paid no interest and considering the opportunity cost, is down much more than the raw numbers (from 5100 to 1500), Treasuries really do pay one to own them (remember, it's a bond!). So, all the talk of a bond bubble strikes me as incongruous. Overpriced, perhaps; a bubble: not quite.

2. Gold. The most intriguing market of them all. The gold bull Jesse of Jesse's Cafe Americain links to a Times online article titled "Gold price could treble if China divests dollars, warns mining boss". The article quotes Barrick Gold's chairman as scaring us that "there was even a possibility that central banks, including China’s, might start to switch from dollar holdings to gold, which could cause the price of the metal to treble." It seems that every time that chestnut is trotted out, a peak in the gold price is nigh.

The article goes on to point out that:

"Gold has been one of the best-performing assets of recent months, rising in value by nearly 17 per cent since late October even as the price of other commodities, such as oil and copper, has dropped sharply."

"Investors have bought heavily into physical bullion in the form of coins and bars, and physically backed assets, such as exchange-traded funds, as a safe store of value at a time of increased volatility in other asset prices."

Technically, gold is fairly strong, but its 200 day moving average is pointing down and has not crossed yet but an up-sloping 50 day ma. Gold has had an interesting correlation with the stock market during this bear: it has peaked out of phase with the stock market but made important bottoms with it (gold stayed up in October 2008 but crashed as the stock market made its November bottom). This pattern will continue until one day it will not.

So with the short-to-intermediate technicals inconclusive, the take here is that there is too much optimism in the gold price to suit us. Its outperformance vs. essentially all other physical commodities is breathtaking. India is in or near a recession, as is China, and these locales are huge buyers of gold, and are very price-sensitive. Most gold use remains for jewelry, and no one anywhere on the face of the earth is buying gold jewelry anymore (well, that's a slight exaggeration, but you get the point). So the most likely fundamental direction for the price of gold is to go straight down. Numerous nervous people have already placed their orders; the worst timer of the gold price, Barrick, is a raging bull; and its chairman, who should be in the background quietly accumulating gold or his company's stock, is out in public touting his wares.

Caveat emptor on Au. Adventurous sorts could look at purchasing puts, as this market could fall fast. However, gold is in a long-term bull market, so it's most interesting and most people should be on the sidelines unless they want to own physical gold as a true hedge.

3. Stocks. The single worst-looking of the three major markets remains general stocks. Stocks remain in a major bear market, with aggressive supply meeting every jump in prices. Wednesday's move up looks like one of many panicky short-covering rallies, with no follow-through, and with financial stocks continuing to erode. Most depressing is the action of McDonald's, the Dow leader and the only Dow stock to be at a higher price than 1 year ago. It recently "beat" the Street, which however was unimpressed. The technicals are deteriorating. There have been a series of lower highs since the early August high, though as well there have been higher lows. McDonald's almost has to lead a break-out of the general stock market higher. 14 months into a recession, even meeting expectations should ordinarily let a strong company with a high dividend yield squeeze the shorts and pop higher, but instead the stock acts a bit too "heavy" despite the "beat". If MCD goes the way of Wal-Mart and collapses, this would be very, very bad for the market as a whole. Traders and investors should watch MCD carefully.

There is no leadership anywhere. ConocoPhillips wiped out 2 years of earnings with a "one-time" charge of about 32 billion dollars (real money even for a bank), and happily its otherwise OK quarter was not rewarded, and the stock collapsed today.

GlaxoSmithKline, one of the original roll-ups in the pharmaceutical arena, is back to 1997 stock prices. In the last boom, its stock price never got near its 1999 high. Worse, it is trading as if it were a growth company at 12X tangible book value. Pfizer is being taken apart for its multiple sins of halving the dividend and perhaps going to the well one time too many with its emulation of GSK by becoming another roll-up (see Econblog Review's take on the merger, Pfizer Buys Wyeth: Layoffs Financed by You and Me).

Other medical stocks are providing little leadership, even on good news.

The education stocks that the unemployed go to in a recession are, too predictably to suit us here, strong; the quality of the rally off the November low has been poor.

"Defensive" consumer stocks such as Procter & Gamble have cyclically high operating and net profit margins, which have nowhere to go but down, as well as multi-year low tax rates, which can hardly go lower and therefore should have nowhere to go but up in a world where governments have higher priorities than some marginal extra profits accruing to sellers of staples.

The real geniuses such as Drs. Roubini and Taleb remain bearish, along with most others who "got it right".

And while stocks and headlines can move in quite opposite ways, the stock market is made up of companies which are, for the most part, quietly or not-so-quietly withering on the vine.

Under the earnings/price momentum Value Line-type system that has served this blogger so well over 3 decades of investing, if the stock market were a stock, it would be a 5 (lowest on a 1-5 scale) for "Timeliness". If the bottom has been seen, that would be great news. There's no need to risk your money on that hope.

Where does that leave an individual with new money to put to work?

Consult your financial advisor . . .

Copyright (C) Long Lake LLC 2009

Being Really, Really Rich Means You Can Say Whatever You Want to Whenever You Want to, Especially in Davos

A Bloomberg special report may have been fun in a way to write. One can only wonder at some of what was edited out.

"Davos Delegates in ‘Denial’ as $25 Trillion of Wealth Vanishes"

Denial wouldn't be so bad. For example, here's David Rubenstein (Carlyle Group):

"One Davos regular, Washington-based Carlyle Group’s managing director David Rubenstein, said he thinks a key issues at this year’s gathering is “who is at fault.” Yet Rubenstein, who was saying at Davos two years ago that the outlook for leveraged buyouts was “very robust,” says responsibility shouldn’t be tied only to him or his industry.

“There are six billion people on the face of the earth, and probably about five billion participated in what went on,” Rubenstein said in an interview. “Everybody participated in some way or shape or form.'"

What on earth does he mean that 5 billion people "participated"? Excuse me, they went to work, breathed (creating carbon pollution by exhaling?), farmed, went to bed hungry, etc. This is not exactly the meaning that Marie Antoinette had when she said that if they were hungry, they could eat cake, but it could not be any more out of touch (to be polite). No, Mr. Rubenstein, your crowd was at fault. Don't try to pass the billion dollar buck, please, Mr. R.

Then there is the 21st Century Leo Tolstoy:

"Ruben Vardanian, CEO of Russian investment bank Troika Dialog Group, said just saying sorry is not enough."

“'Our values became miserable,” Vardanian said. “We are all guilty, and the scope of attrition is large.'”

How many dollars is this penitent giving to charity?

"Davos has no time for redemption, says Barry Gosin, CEO of Miami-based global real estate firm Newmark Knight Frank."

“'If a shark bites your leg off while swimming in the ocean, can you condemn the shark? This was not an intentioned plan to destroy the world. Wall Street was designed to make money.'”

Wait a minute. This man is from my home region. We really have sharks in the water. Is he really saying that it's not our/their fault, they were just born that way, as sharks actually are?
He and his cohorts perhaps were like Florida Tarzans, and were reared underwater with their shark parents, one would think.

No, Mr. Gosin, we can condemn those responsible for the past decade's orgy of greed and insider deals, culminating in the TARP looting and its aftermath, which continues (see prior post "Up Jesse, Down Goldman) with no end in sight. They were not really brought up by sharks. They may even have been brought up by men of the cloth, or have become them:

"Stephen Green, chairman of London-based HSBC Holdings Plc, also criticized regulators at a panel about capitalism on Wednesday. Green, 60, a Church of England lay minister who has written a book about reconciling a life in banking with his belief in God, called for “an overhaul of the regulatory environment.” He also talked about the need for self-regulation, saying that “no amount of rules is going to enforce good behavior.'”

"‘Everybody Participated’"

"At a press conference on Jan. 28, he dodged the question of personal responsibility, saying only that “the banking industry” has “something to apologize for.'”

Good for you, Mr. Green. Perhaps you could apologize like your brethren at UBS, who did not put much of a fight when most of their ill-gotten prior compensation was taken away. Or at least give a tithe or two to ye olde Banke of Englande.

"At a panel on leadership yesterday morning before hosting a reception with champagne and canapés at the Hotel Europe Piano Bar, JPMorgan Chase & Co. Chief Executive Officer Jamie Dimon expressed frustration at those who seek to pin all the blame on bankers."

"Regulators, he said, should share some of the blame."

“'God knows, some really stupid things were done by American banks,” Dimon said. “To policy makers, I say where were they? They approved all these banks.'”

OK. That's more than enough. These men have no idea how incensed the public is about the behavior of his bank and the other "too-big-to-fail" crowd. And those of us who are following the whole tawdry situation more closely than those who really work for a living are aware that JPMorgan Chase has been favored more than any other money center bank. For him to say that
it's the fault of the lowly-paid regulators and their ilk when his guys have been making the big, big, big bucks is horrifying.

These comments make completely believable the summary comment from a PR man:

“'Nobody in Davos wants to get near a negative like redemption,” said Robert Dilenschneider, chief executive officer of the Dilenschneider Group, a public relations firm in New York. “But the truth is that everyone here is part of the problem, and the public will soon begin demanding a pound of flesh.'”

“'No banker or businessman wants to take responsibility,” said Dilenschneider, who counts 40 Davos delegates as clients, their identities shielded by confidentiality agreements. “It’s their view that everybody else did something wrong.'”

There's another excuse: there were too many guilty parties to punish:

If atonement is difficult, retribution may prove “brutally difficult,” Starwood Capital Group CEO Barry Sternlicht said in an interview in Davos. As Sternlicht sees it, “everyone wants a head, and that’s not reasonable. To do that, you’d need to take out the top 20 executives at the 300 biggest financial firms.'”

No, Mr. Sternlicht. It is your statement that is not "reasonable". Not everybody "wants a head". And none of you were St. John the Baptist. And no one's talking death penalty, anyway.

And the blame really does not involve the 300 biggest financial firms. Maybe not even the 30 biggest. It really does involve the biggest investment banks and money center banks. So far as I know, there is not one Asian bank amongst them and not one bank located in Canada or any country south of Texas. The entirety of Africa may also be in the clear. The fact that many plain-vanilla mid-sized mid-Western banks are in trouble does not mean that anyone in the public or Congress wants any retribution, if they are suffering due to plain old economic problems in their regions. Of course, many made too many residential real estate loans at the top of the market, but they did not create, package, distribute, tout, etc. products such as junk CDOs; and they did not crowd their balance sheets with junk and off-load it into "Tier 3" inventory.

Davos man? Or beast?

Copyright (C) Long Lake LLC 2009

Up, Jesse; Down, Goldman

The ever-trenchant commentator Jesse sums it up in the latest post at Jesse's Cafe Americain:

29 January 2009

Goldman Sachs Says the Banks Now Need At Least $4 Trillion in Bailouts

"Can we get an estimate that assumes we nationalize Goldman Sachs, Morgan Stanley, Citigroup, and J.P. Morgan, place them in receivership, selectively default on their derivatives, sell all their assets, and criminally prosecute their executive management from the year 2000 under the RICO statutes?"

DoctoRx here. My guess is that Goldman floated the $4 T number with Mr. Geithner's approval so that a smaller number will look "responsible".

In addition to RICO, what about Sarbox and general fraud statutes? Were all those P&L's truly accurate, and if they were not, should not the CEO have known?

Copyright (C) Long Lake LLC 2009

Bad Bank: Afternoon Update

Meredith Whitney, the esteemed financial analyst and a Cassandra over the past 2 years, has added her voice to the anti-"bad bank" proposal, saying, as reported on, that:

"A U.S. proposal to create a “bad bank” to buy troubled assets won’t cause banks to increase lending, Oppenheimer & Co. analyst Meredith Whitney said."

“Simply removing ‘toxic’ assets from bank balance sheets will not directly cause banks to increase lending,” Whitney wrote in a note today.

The banks likely won’t participate in selling assets if the Obama administration wants to pay fair market value for the assets “as capital hits would be too dear,” Whitney said.

The Obama administration is moving closer to setting up a so-called bad bank in its effort to break the back of the credit crisis and may use the Federal Deposit Insurance Corp. to manage it, two people familiar with the matter said yesterday.

Whitney is in favor of banks selling “crown jewel” assets to cover their own losses, she wrote.
“We believe private capital will readily invest in businesses that make money and grow,” Whitney wrote. “However, the banks do not fit this description.”

“If a bank were to sell its ‘bad’ assets into a ‘bad bank,’ it would still be left with lower earnings power from higher losses on ‘good loans’ and the requirements to build reserves, lower earnings power from lower assets and a higher legacy expense structure, or both,” Whitney wrote."

I have authorized entree to view Ms. Whitney's comments on-line via the Oppenheimer website. She has been so right for so long, it's almost scary. Roubini level of prescience, almost.

In addition, I heard an anecdote from someone who knows her. Because she has told the truth about Wall Street, she actually is physically attacked with fruit thrown at her when she visits the Stock Exchange. Really. A man accompanying her returned to his office with his suit bearing the proof. Lovely people, those Wall Streeters. Masters of the Universe? Hardly. Not even masters of their own domain.

In any case, opposition to the bad bank includes from Mr. Soros, Nassim Taleb, Nouriel Roubini, Meredith Whitney . . . all people who called for a financial crack-up before it happened. Against this are Robert Rubin and Tim Geithner, amongst others. Might this opposition give the Obama Administration pause?

We can hope for a course change, can't we?

Copyright (C) Long Lake LLC 2009

Morning Comments: Bad Banks and Stock Risk

The blogosphere is full of commentary relating to the banks, the "bad bank" situation, and the like. For those who can't enough of this stuff, here are several links to commentary. In no special order, there are the following:

"Taleb Says Nationalize Banks, You Can’t Trust Them" ( note-Roubini agrees with nationalizaton);

"Op-Ed: Recession Turns Japanese"(Minyanville- note- reprises this blogs "Land of the Setting Sun" post);

"Geithner Discusses Nationalization in $2 Trillion Bailout Proposal" (Mish).

The above are of a piece. There appears to be real resistance to and anger about further giveaways to the same financial institutions that "goofed".

Switching gears, a number of Dow "Industrials" have reported earnings. Having learned from the collapses of AIG, Lehman, Fannie and Freddie, etc., I am ignoring headline earnings (of historical interest only and different from what they tell the IRS they earned) and focusing only on the balance sheet. Things are not pretty.

In addition, to show how out of touch some companies are, even a relatively straight shooter such as Boeing has tried to show that it is getting real by downgrading its prospective pension returns. To what yearly level has it downgraded them? To 8%. In this environment, I would say that 3-4% is more realistic if they want any stock exposure (to account for losses on stocks; and if the stocks outperform, they can book the gains), and 5-6% if they want to stick only with high-quality corporate bonds.

As an example of what can happen to a large and seemingly solid company, the unthinkable has happened to AIG. A year ago it was about a $56 stock. Now it is at $1.41 only because of the bailout. Otherwise it would be at $0.00. A look at the balance sheets of Boeing, AT&T, GE, P&G, etc., gives pause. Financial fortresses these companies are not. With estimates of U.S. and world growth heading down, estimates of financial firms' write-offs increasing on a rapid and regular basis, and growing resentment of governmental and Fed policy regarding financial companies, there may be asymmetric risks skewed to the downside in common stocks. The strongest balance sheets are now seen in large tech stocks such as Cisco and Microsoft. For now, the best short-term macro news may be the recent stalling of gold's ascent.

Copyright (C) Long Lake LLC 2009

Wednesday, January 28, 2009

Bad News and Bad Banks

The IMF has issued a Global Financial Stability Report today. It is much less upbeat than the stock market's response to the news of the day. This report is more than sober. It is describing a potential Depression, or at least a Great Recession.

There is also criticism of the good/bad bank idea from a variety of sources. George Soros is one who feels it is insufficient, and argues for a new "good bank". He is interviewed both on CNBC and video.

On Naked Capitalism, there is a superb review of the issue drawing on an article today by Jeffrey Sachs and the broader issue of the thoughtfulness with with Team Obama and Congress are (not) addressing the economic and financial crisis. They are being accused of "short-term-ism".

Also from NC is a link to an even more troubling article titled "Global Banking Organization Predicts Worldwide GDP Fall for 2009":

"The Institute of International Finance, the global organisation of major banks, predicted an almost unprecedented collapse in world economic growth and capital flows.It became the first major global institution to forecast a full-scale global contraction in 2009, predicting that the economy would shrink by 1.1%

"IIF chief economist Philip Suttle said: "This is the worst period since the interwar years..."He also expects rich economies to contract by 2.1pc – the worst peacetime output since the 1930s.Private flows of capital into the emerging world are set nearly to dry up in the next year, the IIF predicted, dropping from $928.6bn in 2007 down to $465.8bn in 2008 and then to $165.3bn the following year.As a result the current account deficits in emerging Europe will more than treble in the coming year, from $30bn in 2008 to $117bn next year...Asia is likely to suffer a worse downturn than during the Asian financial crisis, the report indicated.The IIF was meeting ahead of the World Economic Forum in Davos, and Mr Rhodes warned that the growing concern this year was the rise in protectionism. He said: "There is a tremendous need to keep trade lines open. If you start seeing – with everything else we're talking about – the reduction of trade lines on top of that, then you really have a problem.'"

Please read the IMF writeup carefully. It does not use the language it uses lightly. I would have to guess that this could well be the single gloomiest report it has ever issued.

The IIF writeup (a Jan. 27 press release) is available directly at

Copyright (C) Long Lake LLC

Obama Channels Bush? Uh-Oh . . .

From, "FDIC May Run ‘Bad Bank’ in Obama Plan to Remove Toxic Assets":

"The Federal Deposit Insurance Corp. may manage the so-called bad bank that the Obama administration is likely to set up as it tries to break the back of the credit crisis, two people familiar with the matter said."

"Federal Reserve Chairman Ben S. Bernanke suggested on Sept. 23, when then Treasury Secretary Henry Paulson was initially considering buying bad assets, that the government should purchase them at values above the near fire-sale prices prevailing in the market."

Regarding the politics and economics of this matter, please consider reading the (somewhat lengthy) free post at Institutional Risk Analytics, "The Big Banks vs. America: A Roundtable with David Kotok and Josh Rosner".

One of the points of agreement that came out from this discussion was that President Obama is being heavily influenced by Robert Rubin, who helped guide Citigroup to its current state, and that the politics were appearing to favor the money-center banks over community banks.

Econblog Review believes in a level playing field and free-market capitalism. If money-center banks own assets that they wish to sell, they will have to accept the market price. If that price later rises, then perhaps they never should have sold. Or more to the point, they never should have voluntarily let themselves become so leveraged that they were forced to sell below what they think is fair value.

After all that the Federal Government has done to support housing and banks, why would it want to get in the business of owning complex assets? If it does, should it not make the best deal it can? That means paying "fire-sale" prices- a term that sugar-coats the situation for the companies selling the assets. After all, the term "fire sale" refers either to items or the facility in which they were store that were damaged by a fire. What happened to these securities the companies don't like any more is more predictable. They simply went down in value because the companies put them on their books at the peak of the boom. No out-of-the-blue fire occurred. That's life. These same companies used to boast about all their brilliant decisions that made money. Now it turns out that they were just gamblers, and like all compulsive gamblers, their luck ran out. Sorry, guys, bad quarter, bad year. What I want are clawbacks to be considered, not gifts so you can gamble again, always knowing that the house will let you keep your winnings but write off your losses if you lose.

Since it is clear that any "bad bank" will only exist to overpay for these assets, then to the (unknowable) extent it overpays, it will provide an unfair and unearned subsidy to the companies that currently own these assets. All of us who have lost money on real estate, stocks, boats, art, etc. have received no such subsidy. In fact, a prior Democratic Congress limited the deductibility of these losses to $3000/year, a number which has never been adjusted for inflation.

Yet now we are also looking at proposals for various tax benefits for corporate losers, in addition to the "bad bank" proposal being discussed here.

The initial Bush/Paulson/Bernanke/Reid/Pelosi/Frank/ etc. scheme for the bank bailout was more or less exactly what is being floated now. But now it is in addition to TARP funds. (By the way, Nouriel Roubini has provided a fascinating story of how a group of experts, including him, persuaded Congress to morph TARP I into TARP II and use it for equity injections into the banks.)

Under the Bush-Obama/Paulson-Geithner (in chronological order) plan, the American taxpayer will overpay for various financial products of uncertain value, and will get to own stock in the companies:

"In any new rescue efforts, the Treasury is likely to continue to require banks to hand over ownership stakes to the government as a condition of receiving aid. Programs so far have sought preferred shares and warrants, which can be converted into common stock and cashed out on the government’s request."

Excuse me. This is socialism/corporatism. From a public policy standpoint, money is money. No one cares what the name of the institution is that lends money for a mortgage. So, keeping company A alive is irrelevant to us. There are numerous truly well-capitalized financial companies/banks in the U.S. that would love to grow, and that never put B-S- assets on their books. A better approach than the apparent Obama Administration approach would be the anti-Bush, not only on Guantanamo. Be a populist, not a corporatist.

Financial companies that own financial products that they wish to sell should do so. If doing so at market value means that the company is revealed to be insolvent, then the company really is insolvent. Such a company should be put into receivership, sold piecemeal or recapitalized in such a way that taxpayers' interests come first and those of the company, its owners and those who lent it money (i.e., its bondholders) come after those of you and me. In any case, regulators already know intimately what assets (Tier 3 etc.) these companies own and approximately what they would fetch if sold in the free market. So all this is a type of kabuki dance to find politically acceptable ways to transfer taxpayer assets to those of failing financial institutions, institutions which made poor decisions but rewarded insiders beyond lavishly while they were in the process of failing.

This blog has been making the point consistently that on economic/financial affairs, the Obama Administration was one of continuity with the Bush Administration; with the most political Fed head (Dr. Bernanke) since Mr. Miller of Jimmy Carter's era in cahoots with the Administration.

Change we can believe in? On the bank bailout front, sadly not.

Copyright (C) Long Lake LLC 2009

Tuesday, January 27, 2009

Boldly Go?

Is someone in the Obama Administration reading this blog?

Two days ago, we posted "On Economy, Not Obama's Style to Boldly Go Where No Man Has Gone Before". The post ended: "Be bold. Be Kirk."

Well! In checking out the proprietary Econblog Review Bloomberg Video Indicator this AM (which is neutral) with the morning cup, we see the video clip titled: "Geithner says Treasury to be Source of Bold Initiative".

Great! I won't overload the Dream Team with too many suggestions, but I will comment. Henry Paulson had a bold bazooka. Boldness in the maintenance of the status quo is no virtue.
(If you're under 50 and get that reference, good for you.) Think different (oh, I forget, Mr. Obama is into the B-berry, not the IPhone). Enough fooling around-you get the idea. If Mr. Obama wants durable approval ratings of 80%+ like Brazil's Lula, he should identify the Merchants of Debt as his ideological enemies and lead the nation forward under the banner of equity.

Moving on to the Big Boss himself, the President repeated his plea to Congress to push forward his $825 B "stimulus" plan, saying yesterday's layoffs prove the need for it to act with a "sense of urgency".

The take from this blogger is more nuanced and thoughtful (my wife always called me Spock). High-powered public Congressional hearings about this plan would be nice after TARP etc., which lacked any such thoughtfulness. Why (for example), after all the yelling by the Party now in power about the unfunded tax cuts pushed through during the last recession by the President whose name is now Mudd but whose middle initial was W (the latest possible shape of this recession), are some hundreds of billions less in receipts to the Federal Government suddenly a good idea? After all, back in the relatively sunny days pre- 9/11, U.S. Government finances were quite good (ignoring long-term entitlements); now, there is serious talk about default on the Federal debt. And while I have nothing against Caterpillar staying afloat, I remain skeptical that multi-year construction projects will do anything special about the current recession.

In that vein, DuPont, Texas Instruments and American Express have reported poor earnings and gave poor forward guidance. Yet the stocks are tipped to open higher. This continues to suggest that the market "knows" that we are in a severe recession. Recessions do end. Perhaps Mr. Obama's urgency for the Government to go into yet more debt has something to do with the fear that perhaps sooner than expected, the end of the recession will be predictable, and then America will channel its inner Perot and start wondering why the Feds are so into debt when ordinary Americans have learned the virtues of saving?

Copyright (C) Long Lake LLC 2009

Monday, January 26, 2009

Even Economists Who Are Mostly Right Still Get It Wrong

John Hussman, Ph.D., runs different mutual funds and has a superior track record. Available on the Web is his Weekly Market Comment. He is one of the best commentators. For example, he is right on with his early comments in his post today: "Okun's Law, Ockham's Razor, and Economic Stimulus". An example:

"For my part, I tend to lean away from the Keynesian view that sees recessions as times of inadequate “aggregate demand.” Rather, recessions are essentially times when there is a mismatch between the mix of goods and services demanded by individuals in the economy, and the mix of goods and services that was previously supplied. The clear area of mismatch here is in housing, as well as various sectors of the economy that have made a business of irresponsibly increasing the debt burden of the nation (including mortgage companies, investment banks, and other purveyors of leverage). Those mismatched sectors are experiencing enormous losses, as they should. The job of economic policy is to ease that transition in a way that reduces the spillover onto the broader economy."

After a discussion most of which I agree with, he concludes:

"In short, the essential problem is not “insufficient aggregate demand” but rather risk-aversion and anticipatory saving triggered by fear of financial instability."

He is correct that there is not a lack of final demand. And if there were, so what? It is not the role of government to "stimulate" any particular level of demand for goods and services. If we want to work on average 1000 hours per year rather than 2000, so be it. There will be fewer miles driven, fewer fatal car crashes, less carbon emission, fewer consumer goods sold, etc. Free
market economics at work. So far, so good.

He is dead wrong when he blames "risk-aversion" as one of the essential problems. Risk-aversion is a good thing. People took too many risks with their capital for too many years. Almost every non-professional investor and many professional money managers have no idea how highly valued common stocks are relative to long periods in the past. The same goes for commercial and residential real estate at today's prices.

Dr. Hussman is also dead wrong when he also blames as the other essential problem "anticipatory saving triggered by fear of financial instability". Most important to his major point, whether saving is "anticipatory" is an irrelevant adjective. There has been a grievous lack of saving in this country, from the Federal Government down to individuals. We need more saving, not less. Calling it "anticipatory" makes no sense. All saving is forward-looking; otherwise we would either work less hard or work as hard as we do now and spend all we earn. I would also quibble with his phrase "fear of financial instability". I suspect he didn't mean to write it the way it came out. Clearly there has been the fact of financial instability, not just a fear of it.

Brilliant economists who mostly got it right, such as John Hussman, still miss the "essential problem" (in his terminology). We need to rout the Merchants of Debt, not criticize "risk-aversion" and "fearful" savers.

Copyright (C) Long Lake LLC 2009

Pfizer Buys Wyeth: Layoffs Financed by You and Me

I have spent the last two decades working in and around the pharmaceutical industry. Having now spent the last year focusing on the worsening financial and economic conditions in the U.S. and globally, it is fascinating to see the latest useless combination of one tired pharmaceutical giant with another dovetail unexpectedly with the financial crisis.

To wit, the leaks the last few days were correct: Pfizer has agreed to purchase the former American Home Products, now called Wyeth, which got smart years ago and saw that better living through chemistry would make its shareholders richer than pots and pans could. And so it came to pass. After all, purchasing products for the kitchen lacked a direct subsidy, but drug benefits provided by employers - now there's an opportunity to jack up profit margins. This mid-course corporate life change was brilliant and has now been definitely rewarded. While matters are less clear from Pfizer's standpoint, what appears likely is that the U.S. taxpayer is indirectly subsidizing future massive layoffs in one of the "green" knowledge-based industries that we need to encourage, having just subsidized the preservation of jobs in the U.S. auto industry that has fought greenness in every way it can.

Please see the press release, "PFIZER TO ACQUIRE WYETH, CREATING THE WORLD'S PREMIER BIOPHARMACEUTICAL COMPANY" for Pfizer's take on things.

Here's my take. I'll get to the tie-in to the financial mess and TARP in points 3, 4 and especially 5.

1. Buried in the press release is the fact that Pfizer is cutting its dividend in half.

2. It is well-known in the pharmaceutical industry that Pfizer functions like the military- with unbelievable rigidity; but without the operational flexibility that battlefield commanders in the military have; and with the same creativity of the French military in preparing for WW II; and without the capacity to learn from its mistakes. That said, Pfizer has the gall to trumpet the concept that this already-stultified company will become flexible- think pre-pubescent Chinese gymnasts:

"Unique and Flexible Business Model Features Focus and Agility of Smaller Enterprises Backed by Resources and Scale of Global Company".

Excuse me. I'm going to take a 5 minute break and decide whether to have a good belly laugh or vomit.

3. (I'm back. I'll keep you in suspense as to what I did.) The press release again:

"Combination Strengthens Platform for Improved, Consistent, and Stable Earnings Growth and Sustainable Shareholder Value"

However, here's Bloomberg's take on how Pfizer can struggle to keep earnings from declining, forget about growing earnings:

"The Wyeth transaction . . . could keep Pfizer’s earnings unchanged at $2.69 a share from 2010 to 2015, when patents expire on some of Pfizer’s biggest products, Anderson (a Sanford C. Bernstein analyst) said in his report. That compares to a 68 percent drop without the acquisition, to $1.40 in 2015."

"To achieve that, Pfizer would need to cut 70 percent of Wyeth’s research, marketing and administrative costs, Anderson said."

So Pfizer is going to put most of Wyeth out of business. Heck, Wyeth could have done that today on its own and basically become a free cash flow machine.

(My non-cynical take is that Big Pharma should cancel 100% of its research into new chemical entities. It should outsource all of it to those that really know how to do it, such as small companies; academia; and, surprisingly, government, which has a major public policy interest in success. Let Big Pharma stick to what it is good at, which is convincing doctors to prescribe expensive new drugs to patients, whether or not those new drugs have any advantage over others that are available for much less cost in generic form; and doing clinical trials of a drug that has already been discovered.)

4. Bloomberg again:

"Pfizer also will halve its quarterly dividend to 16 cents a share, fire 10 percent of the pre-merged workforce, or about 8,000 people, and close five factories."

In other words, Pfizer is shrinking along with cutting its dividend. Note the term "pre-merged" (I can't call it a word, as I can't find it in an on-line dictionary). The press release also ignores the fact that Pfizer has sunk so far in its own estimation of its own industry's growth prospects that has let it be known that it is now also a full-fledged generic drugs company.

5. Bloomberg once more:

"Among the banks advising Pfizer and arranging a loan package to finance part of the purchase price are Bank of America Corp., Barclays Plc, Citigroup Inc., Goldman Sachs Group Inc., and JPMorgan Chase & Co., said people with knowledge of those banks’ roles."

So here's the bottom line. The taxpayer has kept BofA, Citigroup, Goldman Sachs and JP Morgan alive with TARP money and other goodies. Now these same firms are going ahead and "arranging a loan package" that will keep Pfizer's earnings up (maybe) with mass layoffs in a transaction so large that it will of necessity be anti-competitive even if OK with Justice (which it will be).

These companies have no shame.

They will finance a mammoth deal such as this takeover that will destroy lots of jobs so that Pfizer can perhaps one day boast about raising its dividend (ignoring that it has been halved), but they won't get serious about keeping people who purchased toxic mortgage products from them or their brethren stay in the homes they never could afford.

These financial institutions deserve the death sentence if they can't support themselves absent government largesse.

Copyright (C) Long Lake LLC 2009

Sunday, January 25, 2009

Merrill, $15 Billion, and BofA

Zero Hedge blog raises the following question:

Was Merrill Casualty #3 of The Basis Trade After DB Prop and Citadel
Posted by Tyler Durden at 9:48 AM

"In a bet gone very bad, that if true would make Jerome Kerviel's $5 billion loss at Soc Gen seem like amateur hour, the WSJ reports ($$$ link with hat tip to that the main reason for Merrill's massive $15 billion Q4 loss was due to some very large basis trades gone horribly wrong. We wrote briefly about the basis trade here but now with attention turning more firmly to this topic, it is worth revisiting."

If you're a pro, you might find the entire blog interesting and comprehensible. I'm not and don't get most of it. However, here's what I think I do get. Merrill is suspected of gambling on the eve of being sold for $29/share. It had no need to risk scuttling the deal by gambling. Every gamble of this nature has a counterparty taking the other side of the gamble. That counterparty makes an equal profit to the loser, minus transaction costs if any.

In an article titled "BofA had role in Merrill bonuses", The Financial Times reports today that "In the wake of Mr Thain's dismissal last week, sales and trading chief Tom Montag, his top deputy, received a promotion. Mr Montag's department was responsible for at least half of Merrill's $15bn loss in the fourth quarter."

Why promote a loser such as Mr Montag. Did BofA make a profit as a counterparty while Merrill took huge losses?

Even Inspector Clouseau knew that every misdeed needs a motive. The motive here that makes sense is to dump on Merrill to make BofA look good.

Copyright (C) Long Lake LLC 2009

Rays of Sunlight for the Markets- and Then the Economy

The good news is that the finger-pointing has started.

The redoubtable Barry Ritholtz writes in The Big Picture, "Time to Get Swedish":

"If the behavior of these corporate executives is nothing short than egregious (sic the grammar but we get his point anyway): Their embarrassing attitudes, foolish excesses, sense of entitled greed is annoying but tolerable when its on their own shareholders dime; when the taxpayer is footing the bill, it is utterly unacceptable.

To paraphrase a Mellon, its time to liquidate the banks, liquidate capital, liquidate shareholders, liquidate bond holders . . ."

As if we didn't know that these guys spent BIG-TIME on themselves? Note that Mr. Ritholtz supported the TARP bill.

And from today comes the headline, "Biden, Summers Sound Economic Warnings, Push Stimulus (Update1)". In the article, it is reported that:

"Pressure to overhaul the program (TARP) is mounting after reports that John Thain, the former Merrill Lynch % Co. chief executive officer who was ousted last week, spent $1.2 million redecorating his downtown Manhattan office last year as the company was firing employees."

As if what should be done with our potentially insolvent financial system has anything to do with a million-dollar office renovation. Guys like Thain were actually being paid a million dollars a week.

From the time that the Pecora Commission began around the start of 1933 to investigate Wall Street of the 1929 Era, the Dow Jones Industrial Average tripled, from about 60 to about 180 at the beginning of 1937. From the time of the Enron collapse stretching into the hysteria about Dennis Kozlowski's water closet and party excesses (Tyco CEO), to revelations about Adelphia Communications (private company), Worldcom and other misdeeds, and the mostly-for-show Sarbanes-Oxley Band-Aid legislation, the stock market bottomed and approximately doubled from the 2002 bottom to the 2007 top in the U.S., but did far better in more dynamic and volatile markets.

As the blame game seeps from those who knew this stuff was going on all the time to the public at large, the markets will be healing and the assets that are going to go up in the next up-cycle for the financial markets will be under accumulation by the smart money.

Similarly to the blame game going on as detailed above, the same Bloomberg article described above has the following quotes:

"Vice President Joe Biden told the CBS program “Face the Nation” that “it’s worse, quite frankly, than everyone thought it was.” Larry Summers, Obama’s top economic adviser, said the economy faces “very difficult” months, speaking today on NBC’s “Meet the Press.'"

This also suggests that things are really not going to be so bad, though it does not prove the point. If they were really, really bad, no one would tell you. Then the public would get scared and make things worse yet, as they/we did after the messes with Fannie, Freddie, AIG and Lehman Bros.

The productive capacity of the world continues. Neither bombs nor plague are destroying significant amounts of physical or human capital. Terms of trade have shifted, for now, toward consumers of raw materials and toward the Western world, as the export economies of Asia are cutting prices like crazy to keep their factories busy. On a personal basis, I braved I-95 in South Florida today (rated the locale of the absolute rudest drivers in the entire US of A) and noted more speeders than before, a private indicator of animal spirits.

I do not know if common stocks listed on an American exchange will be especially good vehicles to play a rebound in financial markets, but absent nuclear war or another Black Swan event, or truly horrible policy mistakes by governments, then we should watch the fundamentals of the economy and the leading indicators, and when they look a lot better than the popular headlines and the rhetoric of politicians in Washington, things will in fact be getting a lot better.

Not that we're there yet.

Copyright (C) Long Lake LLC 2009

On Economy, Not Obama's Style to Boldly Go Where No Man Has Gone Before

Last night (technically early this AM), I posted a brief piece following the NY Times precis of the Obama financial oversight plan: "Little Change in Obama Reform Plan".

A similar and more detailed write-up appeared in Naked Capitalism today: "Obama's Financial Reform Proposals: Less Than Meets the Eye". Those interested in more detailed commentary that says somewhat similar things to my thumbnail critique will find it well-written, as usual.

I believe that we need real change we can believe in. That the mainstream still doesn't "get it" is evidenced by an "Economic View" article in the NY Times today by a mainstream Democratic and academic economist, the former Fed Vice Chairman Dr. Alan Blinder. In this vapid writeup, "Six Errors on the Path to the Financial Crisis", the first 4 allegedly preventable errors all relate to the over-leverage of the system that the Fed and the Feds encouraged, allowing the financial community to loot the economy. That should have been his main theme; if he wanted to mention these amongst many other mess-ups, fine. Dr. Blinder then gets specific into the alleged failure to "rescue" Lehman when Bear, Stearns had been rescued. One could turn his argument against him and ask why taxpayers should have been on the hook to rescue Bear for $29 B. He also fails to point out the multi-hundreds of billions of dollars of bail-out money for AIG and Fannie Mae and Freddie Mac. Apparently for him, it's all bail-out all the time. But with whose money coming from where? His final point criticizes "TARP's Detour". 'Nuff said on this. The whole TARP thing was a disgrace. Freedom to succeed means freedom to fail. Exactly which way a fundamentally unfair bill was to have been implemented- with the benefit of hindsight and at least disaster delayed if not averted for the financial system as a whole- misses the point.

If mainstream economists are going to give us a more thoughtful, allegedly better-regulated version of the derivative-heavy financial system in the setting of a society that has fallen prey to over-financialization, the insiders will cheer, because their primacy is being supported, but the rest of us will remain in wait for someone with real vision. As Dr. Krugman pointed out in his TKO over President Obama (see "Krugman v. Obama: Fight Over in a Technical Knock-Out"),

Mr. Obama channeled none other than George W. Bush's First Inaugural Address in Mr. Obama's Inaugural Address.

No matter what strengths Mr. Obama has, he is presenting a picture of continuity, not major change, on economic and financial issues. (In fact, he is supporting the Bush Administration on a spy case in California, so the continuity may be surprisingly broad.) He is to date acting cautiously. Most of the "stimulus" from his plan is going to come at least a year from now, according to the Congressional Budget Office. Even "Dr. Doom", Nouriel Roubini, forecasts that the economy will be out of recession by then.

Please, Mr. Obama, tear down the Debt Society. Go after the Merchants of Debt with a vengeance. Don't legitimize credit default swaps, either treat them as insurance products and put them in that bin, or treat them as gambling. The world got on just fine in the past without them just as it got on fine without no-doc mortgages, covenant-lite corporate loans, no-down payment auto and home loans, etc. etc. Be bold.

Think Kirk.

Copyright (C) Long Lake LLC 2009

LIttle Change in Obama Reform Plan

The New York Times is reporting that "Obama Plans Fast Action to Tighten Financial Rules".

As predicted, the solution is going to be an expansion of Federal "oversight" activity, which is to say your tax money. It looks as though the incompetent Fed will be given greater power; this has it backwards. The Fed should lose power for enabling the housing bust and manipulating interest rates in chaotic fashion, almost always favoring borrowers over lenders.

Sadly, credit default swaps are going to be rewarded with a clearinghouse. They should instead be banned. Either they should be out-and-out insurance products and regulated within the existing insurance framework, or if they are between two parties neither of which has an economic interest in the loan failing, then they are gambling and are illegal depending on the jurisdiction; but in any case they then serve NO purpose.

In another disastrous trial balloon/shakedown/statist solution, "Administration officials have begun to study ways to control executive compensation".

Let us recall how the stock options craziness of the 1990s got going. The Democrats under George Mitchell (Senate Majority Leader) forced/persuaded Bush I to sign legislation eliminating deductibility of salaries over $1 M yearly. (Of course, Democratic-leaning high earners such as movie stars had their multi-million dollar salaries remained deductible.) In response, companies went to a "best practices" option-enhanced salary package. This led to an excessive effort to drive up the stock price, helping to lead to crazy stock valuations that had to fall.

Let us also recall that the non-scandal "scandal" that some wealthy people had enough tax deductions from time to time to legally pay no income tax some years led to the disgusting and widely-hated Alternative Minimum Tax.

There they go again. First the Government pushes money on banks, which either really, really needed it because they were insolvent and could have simply failed (and may yet fail), or which didn't need it and therefore were given an unnecessary and inappropriate gift from you and me; then it takes this poorly-thought out preferred stock position in these companies to propose to control what the executives earn. As with the AMT, let's think the implications of this control through. In one way or another, the Government is our partner in every legal business. Does that give it a right to control compensation? Even if the Government owns preferred stock, what right does that give it to influence salaries?

A much better solution is that companies that overcompensate their executives will pay the price in a free market.

While undoubtedly there will be positive aspects of the Obama/Democratic plan, the first quick take here is disappointment that it further legitimizes credit default swaps rather than getting rid of them or calling them insurance contracts plain and simple; that it apparently does not call for a real simplification of what derivative products can be marketed; and that it wants to be on compensation committees along with the elected directors of companies.

Saturday, January 24, 2009

What Does Reform of the Banking System Have to do with the Internet?

We have previously argued that the approach to dealing with our problems by adding a layer of regulation is a mistake. The political, financial and academic communities are enamored of this approach. If only we could watch these guys more closely!

Most recently, NYU's Stern School of Business has put out a series of 2-page discussions and recommendations called "Restoring Financial Stability: How to Repair a Failed System".

This is a good read. I would like to take exception to Chapter 5, "Enhanced Regulation of Large Complex Financial Institutions (LCFIs)".

A key part of that Chapter reads:

"We believe that regulation by function is not enough in the case of LCFIs. For these institutions, we advocate a third option - a special, dedicated regulator for LCFIs. (authors' emphasis)

Au contraire. We have had enough foxes guarding enough henhouses. The regulator comes from the same milieu as the regulated and can't wait to join the institutions he regulated, especially a "LCFI" that has lots of money to pay rather than the parsimonious regulatory agency.

The simpler solution is to prohibit any LCFI from coming into existence that has governmental subsidy or poses a systemic risk to society/government.

The Internet provides a conceptual solution. The 'Net was developed to deal with a nuclear attack on the U.S. It allowed data and communications to take a meandering path through whatever nodes for data switching happened to survive the proposed attack. When you read this blog over the Internet, the packets of information get to you not through a dedicated pathway such as a traditional phone call, but rather through whatever communications path is open at the time. The system is redundant and can survive the loss of lots of interchanges. It takes a lot to destroy all Internet potential paths.

The same should be true of a modern financial system. LCFIs have proven that the purported benefits to society they offered were really licenses to gamble with what turned out to be our money when things went really, really bad. The posturing by politicians that now they really mean to stop the big bonuses etc. are for show. The truth lies in the apparent resuscitation of the TARP 1 plan by the Obama Administration for taxpayers to buy up the bad assets on these institutions' balance sheets. Why bother doing it unless it's a massive subsidy?

If, however, the financial system had a modern series of single-state, interstate or national banks, each one small, the failure of none would be systemically important. The benefits to businesses, travelers, North-South snowbirds, etc. would be present as it is now with BofA.

In order for the financial institutions to be small, they would have to have simple functions. They should little other than take deposits and make loans. And all their assets would have to be liquid. "Tier 3 assets" is an abomination as a concept.

Regarding complex financial instruments, leveraged pools of money would in my proposal be banned from borrowing from these banks. Let various people and entities lend to one another with private, risk capital. Thus, subject to whatever regulation and/or reporting is truly necessary, let them do what they want, but essentially stay out of regulating them. It's their money, after all.

One of the underlying points comes from my background as a physician. Anything a trusted physician is associated with gets some or all of the trust the patient has in the doctor, even if it is independent of the doctor's control. Similarly, once a "bank" gets into other lines of business, the average person and even a sophisticated investor associates the presumed safety and government guarantee of a bank deposit with the other functions that the holding company that owns the bank provides. One can put forth all the disclaimers one wants, but people will both misunderstand or forget those disclaimers, or at least will be subconsciously swayed to underestimate the risks. Let's not kid ourselves. How many average people understand to this day the difference between Citigroup, the holding company, and Citibank, the depository institution?

(In fact, if you Google "Citibank", your first click will be to a web page promoting Citi, presumably meaning Citigroup, rather than Citibank, which also gets mentioned now and then on the page but less prominently.)

"Prudential regulation" of large complex financial institutions is little more than putting more and more doctors on the case of a complex diabetic patient with high blood pressure who is prone to nicotine or alcohol addiction. Keeping this patient in balance is a constant struggle. And if the doctor is a friend of the patient and is also prone to sweet foods and nicotine or alcohol himself, fuggedaboutit. And if such a patient is a systemically important person, such as the Pope or President of the U.S., then what a burden on the doctor!

Keep your vices few and simple.

Let's also keep our banks simple as well; interconnected and properly regulated; but never too big to fail.

Friday, January 23, 2009

GE Channels Sartre's No Exit; and the End of an Era

Do you want to own a stock whose CEO wears this expression?

Or a stock with a long-term chart that has broken down as this one has?

Or that has terrible earnings momentum, poor earnings quality, a shaky dividend and a likely downgrading of its credit rating?

Well, neither do I, but listen to a money manager:

"'People are going back to scratching their heads and thinking, 'How are these guys going to do it?'" said Peter Sorrentino, senior portfolio manager of Huntington Asset Advisors, which holds 4.8 million GE shares in its funds." (From AP, "GE profit drops 46 pct as finance unit struggles")

What a great quote. Think he's thrilled about his ownership of almost 5 million shares of what turned out to be a dog?

The chart is a year or so out of phase, but it is not much different from the chart of Fannie and Freddie, that of AIG, that of Citigroup, that of BofA, etc. etc. General Electric has lost its way. There is no business exit for it. All of its business lines except medical are in sharp down-phases, and medical is not so hot either due to constrained hospital budgets. This is at least a Great Recession and it is bringing back to earth every stock I know of that has been fundamentally overvalued, including truly great companies both large and not-so-large that really make products that power the global economy, such as Microsoft, Intel, and Intuitive Surgical. There is so little legitimate buying power on Wall Street and Main Street that high-grade muni bonds continue to trade at ridiculous yields relative to Treasuries. Who needs stocks with lots of air left in their valuations? And who needs stocks such as Alcoa with no air in their valuations but no profits either?

Every single shareholder in it who bought GE in the last thirteen years has an unrealized loss on it.

This is a sad state of affairs.

It did not develop in secret. In 1990, Ed Hyman, then the leading Wall Street economist, predicted in an interview that because going back to the 1940s, every decade had had good to very good stock returns except the 1970s, the 1990s were due, by regression to the mean, to have subpar stock returns.

What actually happened in the 1990s was the greatest stock bubble in many, many, many years, exceeding the valuations of 1929 by far. Now we are engaged in a Great Recession (or worse, heavens forfend), and it is simply bringing stock valuations back to earth in an economy that leaves "creative" companies such as GE no place to jump, no new story to try to sell investors, and most importantly no persuasive pitchman, because their enablers on Wall Street are going, going, gone.

The likely end result will be a saner, plainer economy and a saner, plainer stock market that has sufficient undervaluation that conventional valuations can be used by conservative people to say that yes, this company actually has a lot of cash, it has a lot of physical assets, and it not only has profits but it also has unused potential earnings power that can be realized if the economy just ambles along at a slow pace, and it pays a safe dividend that allows you to sit while these corporate assets get turned into increased earnings and free cash flow.

As this blog has demonstrated recently, one stock market titan after another has been failing that valuation test. The stock bubble of the 1990s, combined with an abortive recession 7-8 years ago, combined with a credit bubble and the general over-financialization of America and many other countries, have simply led to an economy and common stocks each of which have no exit to the sunlight except by going down the stairs to the basement from which some companies never escape.

If we and our Government do not panic, this cycle will turn up one of these days. I for one am going to enjoy the Florida and California sunshine as the seasons allow and not lose sleep over an economy that I can't control. And while I will root for GE to get back where it once belonged, I wouldn't want to own its stock at least till the sun shines brightly on the economy.

Copyright (C) Long Lake LLC 2009

Krugman v. Obama: Fight Over in a Technical Knock-Out

I recently posted what I thought was a brilliant analysis of a Paul Krugman op-ed in the Times, and pointed out the implicit criticisms of Mr. Obama's economic thinking, in Krugman v. Obama (Jan. 19). There were no plans to revisit this topic, till the following screed from the good doctor in his piece today, "Stuck in the Muddle":

"Like anyone who pays attention to business and financial news, I am in a state of high economic anxiety. Like everyone of good will, I hoped that President Obama’s Inaugural Address would offer some reassurance, that it would suggest that the new administration has this thing covered.

But it was not to be. I ended Tuesday less confident about the direction of economic policy than I was in the morning."

It gets harsher. What could be a more stinging insult than the following?

"Also, one wishes that the speechwriters had come up with something more inspiring than a call for an “era of responsibility” — which, not to put too fine a point on it, was the same thing former President George W. Bush called for eight years ago."

Obama as Bush? And proving it with Bush's own words? This is not a fair fight. Think of Ali v. Liston in Lewiston, Maine. (And, as a fillip, note that Dr. Krugman dissed the idea that Mr. Obama wrote his own speech: carefully note his use of the term "the speechwriters".)

The Nobel and a TKO in only two columns over the highest-achieving lawyer in the US of A? The crowd's on its feet in admiration. What can Dr. K do for an encore? We watch with bated breath.

On the economy, Krugman's hot, Obama's not.

Copyright (C) Long Lake LLC 2009

Principles for Banking Reform: Small Is Beautiful

On "fixing" the banks:

The Swedish solution, the Soros solution, the upcoming Obama solution, perhaps a different Reid and/or Pelosi solution, perhaps a "why-bother" Republican solution- all may be or will be under discussion by the same inept politicians who whooped through the TARP bill last year - enhanced in the Senate to waste more of your money - after sleepwalking through the same financial crisis that set yours truly to essentially dump all of his stocks in the summer of 2007.

The Swedish solution suffers from a number of problems. For one, the Swedes protected the bond-holders. Our current problems stem from the repeal of Glass-Steagall and the non-banking businesses of the "banks" as well as the banking businesses of the "non-bank banks".

There is no reason why bondholders should receive one penny of taxpayer money (except those who bought recently under Federal guarantee, of course). They can take their lumps like everyone else. At least, unlike the great unwashed who bought and may still own NASDAQ stocks in the bubble, they have been getting paid interest regularly. In addition, Sweden's banks were likely not run by as greedy people as ran ours.

The Soros solution calls for injecting equity, again, into these financial companies. Why- the taxpayer cries- why? Let the bondholders try to salvage their investment. Let current or prior management try to avoid Sarbanes-Oxley and other prosecution for fraudulent financial practices, misleading public statements, and the like by putting their money back into the banks- in real quantity; not the pitiful $1 M that Ken Lewis threw back into the pot at BofA.

All solutions seem to revolve against getting lending going again. But there is too much debt now. America grew via land grants and the like: owndership. Let's get to a culture and an economy based not on debt but on equity. So there is a fundamental flaw in all these plans. A more practical flaw is that the same bankers would still be in charge. And they have repeatedly proven that they don't know what they're doing. Let the functionaries at your local Department of Motor Vehicles give out home loans. They can't do worse than Countrywide or Fannie/Freddie did. And they would charge a lot less.

The G30 proposes better risk management of systemically important financial institutions. That current report is sponsored by RiskMetrics. 'Nuff said.

Here are some practical and simple principles for bank reform:

1. Ban all systemically important, "too big to fail" financial institutions. The giant banks and non-bank banks have proven they are too big, slow, stupid and/or greedy to succeed. Never allow them to get bigness back. Not ever. Put it in the Constitution.
2. Allow interstate banking, but keep the banks small. Let a thousand interstate banks bloom, all bite-sized.
3. Bring back a bill that reconstitutes the principles of Glass-Steagall. Require depository institutions to stick to their knitting. Consider mandating the 3-6-3 rule (borrow at 3%, lend at 6%, and get on the golf course at 3 PM) (that's a joke). In any case, banking can be simple. Keep it that way.
4. Do NOT give blanket, gigantic FDIC coverage such as $250,000 per depositor beyond 2009. Restrict FDIC to the little guy and get rid of all the loopholes such as different titles of accounts being considered different for FDIC purposes. Australia did without governmental bank insurance until this crisis, when they had to keep up with Ireland etc., and their banks functioned tres prudently. Depositors kept an eye on their banks and lost no money.
5. America is over-housed relative to its need for international export competitiveness. Withdraw Federal tax support for homeowners in favor of other things, such as health care, environmental initiatives, high-tech industries, export industries, etc. Let people rich and poor decide if they want a better home, better health care, a better or safer car, piano lessons for the kids, etc. It's the health and wellbeing of people who count, not the number of their bathrooms. This means letting the mortgage industry, Fannie and Freddie, the FHA, etc., shrink or go away.
6. Stop manipulating short-term interest rates to levels that penalize saving. It is borrowing that should be discouraged, not saving. The same Fed that messed up in 1929-32 messed up again and continues to mess up. Hold hearings and determine if the country really needs a Fed, and if so whether its "quasi-independence" really works.
7. Do NOT listen to the RiskMetrics crowd re risk management. Listen instead to Nassim Taleb. We can't even conceive of all the risks out there. Let private entities take whatever risks they want, but structure matters so if they lose, it's their loss, not ours.
8. Follow the rule that banking and finance should be a small part of the economy. They should for the most part function like the gears in a clock: unseen and unheard; or like WD-40, lubricating the moving parts of commerce.
9. Sweeping reform of the personal finance/credit industry are required. The current Congressional bill is a minor start. Consider limiting the amount of credit anyone can have extant absent truly exigent circumstances. Place a surcharge on all credit card solicitations. Do all that can be done to fight the Merchants of Debt.
10. Inculcate knowledge of financial literacy in all public schools, starting at young grades. Children handle money at very young ages. They should learn that a penny saved grows, whereas a penny borrowed puts one in a dependent position. As a penalty for its misdeeds, the financial industry should pay for a variety of consumer education programs.
11. Get toxic financial names with bad connotations out of use. Who needs the name, "Citi" and its various permutations? The world is surviving w/o the Bear, Stearns and Lehman Bros. names. It is doing fine w/o Wachovia. It will do fine w/o Bank of America if it truly is insolvent. What's in a name? These weeds stink. They are not roses.
12. The point of #11 is that nationalization is a ruse. It is propounded by those who are part of/wedded to/joined at the hip with the current institutions. Let the companies die if they are terminal.

Where oh where is Dr. Kevorkian now that we really need him?

Copyright (C) Long Lake LLC 2009