The Divagator

Mitt and the fire eaters

2012-01-12T18:50:00.000-05:00

The famously Unionist South Carolina native James Petigru once opined to a visitor that his home state was too small to be a republic, but too large to be an insane asylum. The notion that South Carolina is kind of wacky persists, but its reputation for wackiness depends less on outright corruption and more on the defiant, unreconstructed nastiness of the prevailing ideologies. South Carolina tends toward extremes, and tempers can get hot quickly.

So when correspondent Jim Rutenberg of the New York Times writes that South Carolina is “a place famous for surfacing the dark undercurrents of American politics,” there is some historical validity to the assertion, although Mr. Rutenberg’s construction of things strikes me as little more than a dog whistle for the average Manhattanite who might happen on to his news analysis. After gently touching on the things that make South Carolina what it is, at least, in his telling of it, Mr. Rutenberg does end up defaulting to the economy as the most likely driver of sentiment. After all, the state is an economic mess with no obvious catalyst for growth. It has one of the highest unemployment rates in the U.S., and despite some recent good news, like the establishment of a new Boeing facility in North Charleston, large swathes of the state are poor and getting poorer.

Despite Mr. Rutenberg’s “dark undercurrents,” South Carolina’s Republican primary will turn on perceptions concerning the economy and the unusually focused concentration that Republicans in the state have on putting forth someone “electable.” The fire eaters are willing to swill Mitt’s tonic for fear of having four more years of taking Mr. Obama’s medicine, and those who prefer a different flavor aren't sure which bottle to pull down from the shelf, thus dividing the remaining vote among three or four candidates.

Given that the average man on the street in Columbia or Charleston would be hard pressed to describe what it is that a private equity firm does, I suspect Mitt is all but assured of winning the election in South Carolina. It won’t be as sweeping a victory as New Hampshire, but he will avoid the fate that befell John McCain in 2000, when the state’s party machinery smashed his front-running campaign to bits in favor of a candidate (George W. Bush) whose conservative Republican bona fides were purportedly more established. Mitt is not a shoo-in for the nomination yet, but South Carolina won't be the undoing of his campaign.

The Divagator's brush with cybercrime

2012-01-03T20:00:00.001-05:00

Over the Christmas holiday, business news and intelligence website Stratfor joined the ranks of a club no company wishes to be a part of – those who have been hacked. In Stratfor’s case, the deed was carried out (reportedly) by hacker group Anonymous, which infiltrated the company’s servers and then publicized sensitive customer information on the internet. I should know. My credit card number was among those stolen, and I have already experienced the fallout. I was contacted last night by a scam artist cleverly disguised as an India-based call center for Amazon.com.

Luckily, my habit is not to answer any phone call from a number I don’t recognize. The call went to voicemail, and I was somewhat skeptical of the ostensible purpose of the call (to query me about “suspicious” card activity). I called Amazon (not the number given to me over the phone) and quickly ascertained that the previous call was a phishing expedition. Needless to say, I canceled the card.

The reason provided by Anonymous for hacking Stratfor had nothing to do with taking credit card information but rather to gain access to Stratfor’s emails. It seems my credit card account and the $200 already charged in illicit purchases were but collateral damage due to Stratfor’s carelessness in placing such information in relatively open areas of their server environment. As Bloomberg’s Michael Riley reported at the end of the year, such thievery is big business. In totaling up the value of the cyberheists, Riley cited a figure from Symantec: $118 billion per year.

The hacker group Anonymous fancies itself as something of a cross between Robin Hood, whistleblower, and anarchist. I’m not sure what Anonymous – or those operating in its name – believes is so cool and secretive that Stratfor might have in its emails. I’ve always imagined Stratfor as something like the Council on Foreign Relations but with a small publishing function for news and views and a security consulting business mixed in. Yes, they probably know a lot about the way the world works, but so do a lot of people.

Besides, who believes that the world is screwed up due to a lack of information? Corporate thieves – the ones Anonymous claims to target – have the audacity to do their work in broad daylight. I fail to see how a few emails squirreled away on Stratfor’s servers will motivate people to seek out political change to end corruption and self-dealing. If the financial crisis and its unsatisfactory wind-down weren’t enough to wake folks up, I doubt Anonymous’s daring heists will do much in that respect. Unless, of course, Anonymous is merely using political rectitude or activism as a cover to grab a slice of that $118 billion pie for itself.

And there are much bigger fish out there than the small fry of stealing credit card numbers from an online vendor. Writing for the Financial Times, Joseph Menn has a big page-long spread in today’s paper detailing the cybersecurity of U.S. banks and, more tellingly, their clients. He tells the story of Experi-Metal, a U.S.-based auto parts maker that lost $560,000 in a matter of hours once a skilled thief had ascertained the vital information needed via a fraudulent “customer service” email form. Experi-Metal was able to pin the losses on its bank, Comerica, whom it felt could have done more to stop the fraudulent transfer out of its accounts. Experi-Metal was lucky. Many companies that suffer fraud and lose a bundle lose, according to FT, lack the protections that individuals enjoy vis-à-vis cybercrime. As Menn writes:

“Individual Americans are protected by Regulation E of the federal banking code and are liable for a maximum $500 if a cyberthief strikes. Companies – even those owned by a single person – have no such guarantees.”

And:

“Most businesses are unaware that they do not have the same protection as consumers. Just 18 per cent of 1,000 small companies knew the truth in one recent survey by Actimize, a banking security company. Analysts say that those unaware of the risks are less likely to insist on precautions, such as mandatory phone calls to confirm every wire.

“Often, companies find out that they are liable only when they have been robbed.”

Being inconvenienced personally is always a consciousness-raising experience, but after doing some cursory reading and seeing the volume of recent news items detailing cybercrime, I think I’m not being a complete narcissist in saying that cybercrime will be a big trend line to watch in 2012. Data published by the Financial Times show that losses to the banking industry due to cybercrime (this includes identity theft, check-related fraud, credit card fraud, computer intrusion, and wire transfers) have fallen by over half since peaking in 2006. That’s the good news. The bad news is that the banks tend to cover a greater percentage of the losses for large corporate clients, leaving small businesses relatively exposed when it happens to them, and these are precisely the folks who feel such losses the most. For some, cybercrime can end up being an enterprise-changing event.

Fifty years after Gann’s Fate

2012-01-01T19:01:00.000-05:00

Who knows what prompts a programming director to air a seldom-seen movie from nearly half a century ago? In this case, it might have been the 50th anniversary of the publication of Ernest K. Gann’s Fate Is the Hunter that so moved Turner Classic Movies to screen the movie inspired by the book. How many times had this movie been screened on television in the last decade or so? Hard to know, but it can’t have been very often. Once upon a time, it must have been a staple of television programmers, at least, enough to make Mr. Gann regretful about disassociating himself from the movie. He was piqued at the final product and didn’t like it, but admitted in later years that he would have liked the royalties from the frequent airings on TV. But at some point, probably the 1980s, the movie receded into the mists of time, called forth less and less each year to take up space in a station schedule.

It was last spring or thereabouts, and I chanced upon the movie just as the opening credits were rolling. At that time, I had never heard of the book or the movie it inspired, and I say “inspired” because the book is an episodic memoir not especially reducible to the formula of a Hollywood screenplay. But there I was, watching some screenwriter’s best effort at transforming Gann’s book into a Hollywood production.

I found the film intriguing for a number of reasons, but it was most certainly not a great film and perhaps not even a good film. I always liked actor Glenn Ford, so seeing him in a dramatic role that wasn’t a western or film noir was enjoyable. In the middle of the movie, there is a weird flashback scene in which Jane Russell appears in a cameo as herself. Well into her 40s and semi-retirement when the movie was made, she still looked absolutely stunning and was totally believable as the World War II pin-up girl version of herself. The movie also featured young Suzanne Pleshette and Nancy Kwan in supporting roles.

Ultimately, the movie typifies some elements of Hollywood moviemaking in the early to mid-1960s. The Production Code was almost history, and films were already subverting it in ways large and small. Such a frank treatment of an airline disaster could be viewed from this forward-leaning perspective that embraced cinematic naturalism; however, the acting itself was fairly traditional and stiff, and it is not uncommon to see movies of the period host a curious collision of old and new in this manner. Such is the art of transitions. It was 1964, but the sixties were not yet The Sixties.

I’ve focused so much attention on a mediocre film from a mediocre era because it did me the service of introducing me to Mr. Gann and his book, if only in sideways fashion. The movie might be nickel-plated, but the book is pure gold, and I encourage one and all to give it a read.

I had never counted myself an aviation enthusiast…and still don’t. Luckily, one needn’t be to appreciate Mr. Gann’s memoir. There is so much clear thinking, wisdom, and humanity on each page – I found it ennobling to read.

Principally, the book serves as a great canvas on which Mr. Gann paints the particulars of his idiosyncratic view of the world. He is forever pondering the ineluctable workings of chance, or as he had it, “fate’s nefarious and beneficial doings.” He relates stories where his survival depended upon seemingly inconsequential occurrences – there was the icing incident where flying a DC-2 (a last-minute replacement for the scheduled DC-3) was the difference between life and death or where the need of a chart from the passenger compartment led to the discovery of a near-fatal oil leak. There are stories of colleagues whose demise, much to the consternation of the author, cannot be squared with the facts (or just as often, the lack of facts). Gann’s long career as a pilot, inevitably perhaps, leads him to consider: Why them and not me?

As to the art and craft of flying an airplane, Mr. Gann’s descriptive flourishes come rather like the sudden banks of air he describes. His prose is flat, laser sharp, and precise in its descriptions until, often, erupting into a pleasant and strange figuration often as jolting as the things he describes. For instance, a sudden and violent mid-air squall is unleashed thusly: “Some preposterous genie turns a fire hose on the windshield.” But just as often, Mr. Gann had a gift for description that didn’t rely on antics, and in any event, both his fidelity and ostentation was a pleasure.

He also had a gift for clear-headedness. For instance, in the chapter titled “Gypsies” (my favorite in the book), Gann describes where he was and what he was doing when he learned that Pearl Harbor had been attacked. He was in San Juan, refueling for the next leg of a trip to Brazil. In the next chapter (“Rule Books Are Paper”), his reflections on Pearl Harbor struck me as incredibly true and honest and rarer still for their lack of sentimentality. He wrote:

“The hysteria of Pearl Harbor had yet to evaporate and the echoing cry of indignation from the American people now sounded like a traumatic screech rather than a determined roar of anger. The true leaders did not yet have their bearings. The still-unyoked multitude milled in Babylonian turmoil as their pundits cast them adrift between selfish opportunism and impossible visions of nobility. The paradox affected every endeavor and it paraded in brash nudity through the erupting complex of aviation.”

So brilliant and rare is this passage, it reverberates even today and in no small manner could be applied to much of what we have just lived through after 9/11.

Clear-headed and unsentimental, yes, but Gann was also capable of tender musings on a number of beloved things. My last example is drawn from “Gypsies.” While surveying the pleasures of his aviator’s charts, Gann spares a few thoughts for art, reflecting:

“Someday we would chart the heavens for actual penetration. The positions of the stars and planets will be plotted within a fractional second of arc. But I pray that the representation of stellar bodies will be more than mere blobs signaling to the leanness of purely scientific minds. There are other hungers. Let there be true artists involved who will color a blue star blue, and one that is amber, amber, and pink, pink – accordingly.”

Indeed.

Best of The Divagator, 2006-2011

2011-12-29T20:11:00.000-05:00

Before I relaunch this blog, I thought I'd rummage through the hundreds of posts I've made over the past few years and try to put together a little anthology of posts that might provide some reading pleasure. My posting schedule was always erratic, even when the blog was more or less active, so the results of this exercise are a little clumpy, with several posts from some months and then long stretches of nothing. Such is life. When I resume posting next week, I don't foresee that changing. I'm aiming for one substantive, longer-form piece per week or ten days with some shorter, less demanding stuff sprinkled about.

What you'll find below is this site's Best Of list in reverse chron order; the contents are true to the blog's name, meaning, these essays are all over the place as to topic, theme, or what have you. I hope you choose to invest a little time to skim through a few of them and that you'll find the effort worthwhile. Here's to a prosperous and fruitful 2012!

“Why Personhood Matters,” January 28, 2010

http://divagator.blogspot.com/2010/01/why-personhood-matters.html

“More on Google’s Chinese Buh-Bye,” January 15, 2010

http://divagator.blogspot.com/2010/01/more-on-googles-chinese-buh-bye.html

“Tiger’s Fall and Race,” December 20, 2009

http://divagator.blogspot.com/2009/12/tigers-fall-and-race.html

“A Different Kind of Market Polarization,” December 11,2009

http://divagator.blogspot.com/2009/12/different-kind-of-market-polarization.html

“Of Eggheads and Good Eggs,” November 24, 2009

http://divagator.blogspot.com/2009/11/of-eggheads-and-good-eggs.html

“Wall at Main: TheDisconnect,” October 13, 2009

http://divagator.blogspot.com/2009/10/wall-at-main-disconnect.html

“Two Americas,” August 29, 2009

http://divagator.blogspot.com/2009/08/two-americas.html

“From We to Wii,” July 29, 2009

http://divagator.blogspot.com/2009/07/from-we-to-wii.html

“Of Tea Parties and Sunshine Patriots,” March 7, 2009

http://divagator.blogspot.com/2009/03/of-tea-parties-and-sunshine-patriots.html

“The Great Stakeholder Society,” February 3, 2009

http://divagator.blogspot.com/2009/02/great-stakeholder-society.html

“Thirteen Ways of Looking at Philoktêtês,”January 9, 2009

http://divagator.blogspot.com/2009/01/thirteen-ways-of-looking-at-philoktts.html

“The Coming Monetary Mess,” December 20, 2008

http://divagator.blogspot.com/2008/12/coming-monetary-mess.html

“Toward Reconstituting the Republican Party,” November 6,2008

http://divagator.blogspot.com/2008/11/toward-reconstituting-republican-party.html

“The End of Liberalization,” October 15, 2008

http://divagator.blogspot.com/2008/10/end-of-liberalization.html

“The Free-Market Straw Man,” October 14, 2008

http://divagator.blogspot.com/2008/10/free-market-straw-man.html

“Solzhenitsyn and the West,” August 6, 2008

http://divagator.blogspot.com/2008/08/solzhenitsyn-and-west.html

“Look Away, Look Away, Look Away,” July 25, 2008

http://divagator.blogspot.com/2008/07/look-away-look-away-look-away.html

“Healer Heal Thyself,” March 11, 2008

http://divagator.blogspot.com/2008/03/healer-heal-thyself.html

“Who Lost Russia?” February 24, 2008

http://divagator.blogspot.com/2008/02/two-recent-articles-on-russia-appearing.html

“The ‘post-war’ revival,” August 8, 2007

http://divagator.blogspot.com/2007/08/postwar-revival.html

“Catholicism and Chinese Stability,” January 21, 2007

http://divagator.blogspot.com/2007/01/catholicism-and-chinese-stability.html

“Quiddity is Job One,” January 20, 2007

http://divagator.blogspot.com/2007/01/quiddity-in-global-marketplace.html

“Our Sad, Rich Anglosphere,” January 20, 2007

http://divagator.blogspot.com/2007/01/our-sad-rich-anglosphere.html

“The Rhetoric of Schism,” January 14, 2007

http://divagator.blogspot.com/2007/01/rhetoric-of-schism.html

“Mirror, Mirror,” December 13, 2006

http://divagator.blogspot.com/2006/12/mirror-mirror.html

“Darkness, Darkness,” November 25, 2006

http://divagator.blogspot.com/2006/11/darkness-darkness.html

“Farewell, Mr. Friedman,” November 19, 2006

http://divagator.blogspot.com/2006/11/farewell-mr-friedman.html

“Millions of Pepys,” August 21, 2006

http://divagator.blogspot.com/2006/08/millions-of-pepys.html

“Apocalypse Now and Then,” August 18, 2006

http://divagator.blogspot.com/2006/08/apocalypse-now-and-then.html

“History’s Long Arc, “August 15, 2006

http://divagator.blogspot.com/2006/08/historys-long-arc.html

“Asymmetry and Jus In Bello,” August 6, 2006

http://divagator.blogspot.com/2006/08/asymmetry-and-jus-in-bello.html

“The Other Conservatism,” August 4, 2006

http://divagator.blogspot.com/2006/08/other-conservatism.html

“What Centrism Is and Isn’t,” July 17, 2006

http://divagator.blogspot.com/2006/07/what-centrism-is-and-isnt.html

“Tenured Lapdogs,” May 21, 2006

http://divagator.blogspot.com/2006/05/tenured-lapdogs.html

“He Ain’t Heavy…He’s My Brother in Christ,” May 8, 2006

http://divagator.blogspot.com/2006/05/he-aint-heavyhes-my-brother-in-christ.html

“Mutually Assured Proliferation,” March 31, 2006

http://divagator.blogspot.com/2006/03/mutually-assured-proliferation.html

“Gaming the System,” February 10, 2006

http://divagator.blogspot.com/2006/02/gaming-system.html

How the sausage got made

2010-03-11T11:43:00.001-05:00

The Federal Reserve Bank of New York’s Tobias Adrian and Hyun Song Shin have published a new report – “The Changing Nature of Financial Intermediation and the Financial Crisis of 2007-09” – in which there is a very clear explanation of the intermediary steps taken by market actors in creating many of the toxic mortgage securities that so palsied the financial system. The excerpt is below, but I’d encourage you to read the whole report, which is surprisingly accessible for a Fed Staff Report.

“In this illustration, mortgages are originated by financial institutions such as banks who sell individual mortgages into a mortgage pool such as a conduit. The mortgage pool is a passive firm (sometimes called a warehouse) whose only role is to hold mortgage assets. The mortgage is then packaged into another pool of mortgages to form mortgage-backed securities (MBSs), which are liabilities issued against the mortgage assets. The MBSs might then be owned by an asset-backed security (ABS) issuer who pools and tranches them into another layer of claims, such as collateralized debt obligations (CDOs). Then, a securities firm (e.g., a Wall Street investment bank) might hold CDOs on their own books for their yield, but finance such assets by collateralized borrowing through repurchase agreements (repos) with a larger commercial bank. In turn, the commercial bank would fund its lending to the securities firm by issuing short-term liabilities, such as financial commercial paper. Money market mutual funds would be natural buyers of such short-term paper, and, ultimately, the money market fund would complete the circle as household savers would own shares of these funds.”

Should fraud victims be made whole?

2010-03-10T13:05:00.000-05:00

I read this morning from Bloomberg a report I find disturbing regarding a lobbying effort underway by Bernard Madoff and R. Allen Stanford fraud victims. It seems the victims have teamed up to request that Congress look into levying a tax on financial institutions in order to pay the victims back.

Talk about a bad precedent to set.

I don’t quite understand why these folks get a special hearing in the halls of Congress. We have laws on the books to deal with frauds like Madoff and Stanford, and much like FDIC, which protects bank depositors from losing everything, SIPC, or the Securities Investor Protection Corporation fund, is supposed to step in to protect investors from fraud, up to a $500,000 maximum per person. It’s a paltry amount when compared to the $65 billion that Madoff swindled from his clients, but that’s what the law states, and we should stick to it rather than retroactively applying a new standard.

It’s bad enough that the government’s inability to enforce its own laws led to this mess, but playing fast and loose with the law after the fact only compounds the problem. If we are going to levy a new tax on Wall Street to fund SIPC, the effort should be motivated by future funding considerations, not past frauds operating under past rules. And we certainly should not be playing around with the kinds of losses that SIPC will compensate. For instance, Bloomberg reports that the Madoff victims have already sued SIPC (and lost) in an attempt to compel the fund to base its payouts to victims on “fictional” statements issued by Madoff in his Ponzi scheme. And after all, why should SIPC pay investors phony profits?

If this is the direction we are going to go with SIPC, then we are creating large, unknowable exposure for the U.S. government in connection with securities fraud. Today’s fraud victims would have the banking industry pick up the tab, but as one professor noted in the Bloomberg story, this is just a back-door means of socializing the losses, because those bank taxes will get passed directly on to the consumer in the form of higher fees, and even then, it doesn’t help SIPC project future liabilities.

And just think, if the SEC had done its job, we wouldn’t be having this conversation. If anything, the revenues from any new bank tax should go to the SEC. It makes no sense to maintain a shitty securities law enforcement agency, yet lavishly fund the government “insurer” against fraud.

The fleecing continues…

2010-03-03T11:28:00.001-05:00

Bloomberg has reported on compensation figures for the executive team over at the bailed-out, loss-making lender GMAC, Inc. The company hasn’t seen profitability since 2008, yet former CEO Alvaro de Molina received $3.7 million last year. The new guy, former Citigroup executive Michael Carpenter, made an annualized $9.5 million for the month and a half he was on the job. Four other c-suite executives at GMAC made a combined $22 million in 2009, despite losing money every quarter.

Because GMAC received taxpayer assistance, Obama administration “pay czar” Kenneth Feinberg had to sign off on these compensation figures, in effect, giving the administration’s imprimatur to the comp, just as it did with last month’s banker bonuses.

To illustrate how our mindset about such things is miles away from where it needs to be, Mr. Carpenter sat on the GMAC board of directors (albeit just for six month or so) prior to being named CEO. As I discussed yesterday, it is the board of directors who are chiefly responsible for runaway compensation. Why even consider a current board member to run the company when, often, they’re part of the problem?

As more and more ordinary people learn how corporations work, the outrage over compensation will continue to grow. Corporate governance – long the preserve of academics and specialized lawyers – is about to become the next big thing, and yet, neither major political party seems very interested in it. That should tell you something about how the bread gets buttered.

Corporate directors under the microscope

2010-03-02T11:12:00.003-05:00

Over the years, one of my biggest gripes concerning corporate America has been the lack of accountability on corporate boards of directors. While golden parachutes and bonus payments to executives are well publicized – and rightly so – often those targets of public anger, I feel, are misplaced. After all, those executives negotiated and signed contracts. Through repeated – and often, bombastic – news accounts, the average Joe on the street can probably name a few executives that have received the payouts, but I would wager that none of them can name the directors sitting on those companies’ compensation committees that granted the payouts in the first place, and therein lies the problem: directors work in relative anonymity, and outside of a few big shareholders, they are largely unaccountable to the numerous stakeholders in the business.

So I cheer this morning’s New York Times article, written by Graham Bowley, profiling Ruth J. Simmons, Brown University’s president, who sits on the board of Goldman Sachs. After her ten-year run on the Goldman board, it seems students and faculty at Brown have finally cottoned on to how the wheels get greased in corporate circles, and she has come under increasing criticism, particularly in the wake of the massive bonuses paid out by Goldman.

I won’t recount here her compensation from Goldman for her services – it’s all in the Times article – and I certainly don’t have a beef with paying directors well. After all, it’s a big job. My issue is that many of the folks who sit on the boards of companies across the country don’t really do anything. Most provide neither oversight nor strategic thinking. I can’t accuse Goldman’s Simmons of being a corporate slacker; I have no direct knowledge of her or her aptitude for corporate board work. But let’s consider her work schedule, and you tell me how much quality time she spends as a board member. According to the New York Times, Simmons is the president of an Ivy League institution, in and of itself a pretty demanding job. Then there’s the Goldman directorship, another huge undertaking. And then, if I’m reading the Times correctly, she has held concurrent directorships at both Texas Instruments and Pfizer Inc. I’m sure Simmons is a real peach, but let’s face it, there’s no way a person can do all four of these jobs well. It would be a real stretch to do just two of them.

Simmons’ multiple directorships are not at all an outlier in corporate America; many folks take on multiple assignments, but I can’t imagine that there is a truer barometer demonstrating what little is expected of these people.

Extra kudos should go to the Times for delving into director-level reporting. In terms of compensation and corporate culture, the board is omni-important, and yet, directors are hardly ever called to account for themselves by the press or by government bureaucrats. Instead of congressional committees that drag executives into the halls of Congress for tongue-lashings, more attention should be thrown on the awful track record boards of directors have in minding the store, and this attention should come from regulators, not a bunch of petulant undergraduates and their academic handlers.

Greece’s great alibi

2010-02-24T11:40:00.003-05:00

Upon the centennial of the American Civil War, Life magazine commissioned author and poet Robert Penn Warren to write an essay marking the moment in time. Warren complied with The Legacy of the Civil War, a brilliant work that analyzed the long tentacles that the conflict extended into 20th century attitudes in both the North and the South. Warren characterized the South, because of its defeat in the war, as possessing The Great Alibi, which, crudely rendered, could be reduced to “Yankees stealing the family silver,” a meme I heard more than once in my Southern childhood from the older folks. There had never been much silver in my family to steal, but no matter – this is what generations of Southerners had blamed their actual or borderline penury on for years. Having such a pet explanation is handy in fending off personal, family, or regional criticisms. How convenient it is never having to submit one’s failures to the harsh light of self-criticism.

I can’t help but feel much the same kind of mental operation is being performed today by the Greeks, who are enduring heavy criticism from other countries – particularly Germany – for being so lax in managing their financial affairs. These criticisms are prompting some truly unbelievable reactions. For instance, Reuters reported this morning on an interview given by the Greek Deputy Prime Minister on BBC Radio that completely jumps the shark in terms of ministerial idiocy. After employing a kind of everybody-else-was-doing-it excuse for Greek financial woes, the Deputy PM then turned his vitriol upon the Germans, basically proclaiming that they had no right to criticize – because of World War Two! Yes, you read that right. The choicest quotations:

“They took away the Greek gold that was at the Bank of Greece, they took away the Greek money and they never gave it back. This is an issue that has to be faced sometime in the future. I don’t say they have to give back the money necessarily but they have at least to say ‘thanks’. And they shouldn’t complain so much about stealing and not being very specific about economic dealings.”

Welcome to the Greek version of The Great Alibi.

Putting antitrust into high definition

2010-02-19T11:54:00.002-05:00

There is an interesting article in The Economist this week discussing antitrust and competition regulation in Europe. Occasioned by a changing of the guard at the European Union’s competition commission, where Joaquín Almunia is replacing Neelie Kroes, the article makes some strong recommendations concerning the direction of EU antitrust. After lauding the commission for its active and robust enforcement, it then suggests that the EU should reconfigure its process for prosecuting price fixing, cartelization, monopolization, and the like. The biggest complaint stems from the concentration of authority – “prosecutor, judge and jury,” The Economist calls it – within the case teams that spearhead enforcement actions. The newspaper feels greater justice would be served by having enforcement teams make their cases before judges in open court, as we do in the United States.

It seems slightly disingenuous to laud the EU for its antitrust enforcement on the one hand, and then urge it to be more like the U.S. on the other, but luckily for the EU, it could probably introduce much of what The Economist suggests without compromising the vigor of its antitrust enforcement. That’s because, at least to date, the EU has invested the commission with real power and a certain independence. These are qualities that wax and wane in U.S. antitrust enforcement, depending upon the priorities and ideology of the president.

Personally, I admire the commission’s chutzpah in bringing big, commercially important enforcement actions against market leaders, something rarely seen in the U.S., and I think it would be a shame to have a convergence of the two systems. Much like state-level laws and regulations in the U.S., competition and variety among regulators is a positive thing. It is often remarked how the individual states act as laboratories for policy in the U.S., and I see the quirks of EU competition policy in much the same light. It doesn’t hurt to have a slightly different system in place policing the global market, even though that system seems to disproportionately prosecute big American technology firms.

Often times, the big American tech firms deserve the scrutiny.

For instance, I was recently made aware of a rather silly problem a friend of mine encountered when trying to display high-definition content that he bought online. My friend just purchased a new MacBook Pro and visited the iTunes Store to buy some HD movies and TV shows. The MacBook has a very nice display, but my friend wanted to view the content on his television, so he connected his Mac to his large TV, such that the TV would function as a secondary monitor. It worked fine…except for when he went to view the HD content, whereupon he received an error message that read “This movie cannot be displayed because a display that is not authorized to play protected movies is connected.” The standard-definition content played fine, only the HD stuff caused the error.

At first, we thought it was a lame attempt by Apple to force people to buy Apple TV or Apple’s home theater system, both of which display the HD content without a problem. Not so. It appears the culprit here is the content owners – movie studios, television studios, and the like – which have flagged their online HD video content using something called high-bandwidth digital content protection (HDCP). Devised by Intel, HDCP basically prevents the viewing of HD video content by encrypting video and audio as it travels across peripheral connections (i.e., monitor cables and ports). I’m not alleging anti-competitive behavior by relating this story, but instead, merely want to point out how easy it would be to form cartels in consumer electronics and technology, industries that rely on technical standards and harmonization in order to commercialize their products. Given the plethora of new technologies out there – and the speed at which they proliferate – the opportunity for mischief is quite high.

This argues for greater antitrust regulation and consumer protection, not less. When the Obama administration arrived on the scene, people assumed that heightened antitrust regulation would accompany it. And it has, of a sort. But as I noted late last year, if greater antitrust vigilance is going to ramp up regulation on trifling matters – like pretzels – and exclude enforcement actions against companies and industries that really matter – like high technology, consumer electronics, and telecommunications – then that’s something I can’t support. As the foregoing example demonstrates, we need strong antitrust enforcement, but the regulators also need the independence and funding to go after the biggest companies, something they already do in Europe, sometimes for less than saintly reasons, but at least the current EU competition regime has shown that it is stronger than the corporate interests it is supposed to be policing.

The kids are not alright

2010-02-16T23:35:00.004-05:00

Is it just me, or does it seem we can’t staff a high-level ad hoc commission in Washington without exhuming pre-Baby Boomers to lead it?

The latest example appears to be the Obama administration’s choices to lead the so-called ‘deficit panel.’ The first spry youngster is Alan Simpson, who retired from a two-decade career in the U.S. Senate about the time today’s eighth-graders were being conceived. Simpson, a Republican who turns 79 in September, was a fairly moderate voice in the Senate who served as whip before being ousted from that position by Trent Lott and the cantankerous, southern-fried conservatism that has come to characterize the Republican Party.

Erskine Bowles, the second fellow named to lead the commission, is a mere swaddling babe. Bowles, a Democrat, will turn 65 this summer and is known primarily for his work as Bill Clinton’s Chief of Staff, especially his work in twisting congressional arms in budget negotiations.

This practice of naming senior citizens to chair important ad hoc commissions is becoming rote in D.C. The last such exercise was in 2006 when Congress created the Iraq Study Group, chaired by James Baker, who was 76 at the time, and Lee Hamilton, who was 75. The Iraq Study Group lived up to its name – it did a lot of studying. Unfortunately for it, the advice it had to give was not what the Bush administration wanted to hear, which eschewed it in favor of General Petraeus’ “surge” strategy the following year. Given that experience, one would expect a similar outcome for the fiscal commission. Without any binding authority, its advice will be discarded should it ask politicians to do things that are not politically expedient or ideologically acceptable, becoming little more than a make-work program for retired bureaucrats.

But that aside, I am struck by another facet of this, namely the personalities of the folks who are chosen for these positions. Most of them are known for a certain degree of moderation and have demonstrated bipartisanship throughout their careers. And by moderation, I mean a practical, problem-solving moderation, not the mealy-mouthed, go-along-to-get-along variety. After all, for all the talk of the lack of bipartisanship today, there is a unique degree of unanimity in the halls of Congress when it comes issues like congressional pay raises and increased travel stipends. What I mean to say is that these folks are often people who have garnered the respect – or tolerance – of the Left and the Right. It seems like these folks are in short supply and getting older each year. I mean, who is going to chair such committees 20 years from now? Will we haul out the 99-year-old Alan Simpson or will we be stuck with the Rahm Emanuels and Lisa Murkowskis of the world?

Even regarding the administration itself, many folks regardless of political party feel a hell of a lot better about things that Paul Volcker, the ancient former head of the Federal Reserve, is in tow. Granted, Volcker, 82, was basically ignored during Mr. Obama’s first year in office and has only been dragged out of solitary confinement after Obama’s plucky youngsters failed to produce anything resembling financial regulatory reform. But at least we know there is an adult in the room willing to float an uncomfortable political idea, you know, one that might potentially piss off a big campaign donor.

It is enough to lead one to nostalgia for the Church Committee, the more manageable name for the United States Senate Select Committee to Study Governmental Operations with Respect to Intelligence Activities, which commenced work in 1975 and uncovered rampant institutional abuses of power within the Federal Bureau of Investigation and the Central Intelligence Agency. It was a committee formed not as a feel-good deferral to actual decision-making, but as an adjunct to the governing process. It unearthed true ugliness, told people what they didn’t want to hear, and leaned on lawmakers to address the roots of the problem. It was also staffed by relatively youngish folks. Frank Church, the chairman, was only 51. Gary Hart, known today more as the presidential hopeful who ruined his political career for a roll in the hay, was a 38-year-old upstart.

I’m not suggesting that commissions with real teeth always need to have a younger set of principals, but it sure seems that stocking them with septuagenarians is a sure sign that nobody is serious about the business at hand.

NOTE: A friend of mine commented that the implicit comparison of the Church Committee and the various ad hoc commissions is not exactly apples to apples, the former being a Senate committee and the latter being filled with appointed individuals. The distinction is worth noting, but I think the point still stands.

“Shenzhen, we have a problem...”

2010-02-12T11:14:00.004-05:00

Back in August, I wrote a short post sardonically titled “Welcome to the recovery,” arguing that the stock market valuations of late last summer were unsustainable given the weakness of the U.S. economic recovery. Per the usual, I was early in putting my concerns down on paper – the S&P spiked another 12% between the time of that post and the end of the year. But now, aside from the fundamental weakness of demand and lending in the U.S., there are some big global events occurring that imperil whatever recovery we have experienced to date.

First, the debacle in Europe in connection with Greek government debt poses a unique problem that could offer challenges worldwide. Given the amount of Greek debt held by banking institutions throughout Europe, a default by Greece could set off a chain reaction that puts banks under pressure due to falling asset values, a kind of death by accounting such as we saw in 2008 with the failure of U.S. commercial and investment banks.

Second, the long-awaited China crash could be closer than many think. Appearing in BusinessWeek, Patrick Chovanec, an associate professor in the School of Economics and Management at Beijing’s Tsinghua University, sums things up with the problems in the Chinese real estate pretty well:

“You have state-owned enterprises using borrowed funds from the stimulus bidding up the price of land – not even desirable plots of land – in Beijing to astronomical rates. At the same time you have 30 percent-plus vacancy rates and slumping rents in commercial property so it’s just a case of when you recognize the losses – or don’t.”

This is all starting to look very familiar.

A not-so-happy anniversary

2010-02-11T17:23:00.000-05:00

Over the past three decades and change, few countries have outwardly expressed their contempt for each other as virulently as the United States and Iran. Of course, behind the bluster, there are a great many things the two countries talk about in peaceable (if not amicable) terms, the so-called “back-channel” conversations that have characterized U.S.-Iranian dialogue since this day 31 years ago when Iran’s fundamentalist Muslim clergy toppled the Shah. American policy ever since has consisted of frustrating Iran’s attempt to project power and influence throughout the region it has historically dominated as the seat of numerous Persian Empires. Over the years, this desire has led the U.S. to court strange bedfellows and make a series of minor blunders, including its toleration of Iraq’s Baathist regime, which proved to be a far more destabilizing force in the greater Middle East. But such are the trade-offs of the Great Game, a constant stream of choices between lesser and greater evils.

And, of course, U.S. history in Iran pre-dates 1979 or even the Shah. The U.S. has attempted to steer the course of events in Iran ever since the old European colonial powers retreated from the area in the immediate post-war period. This early U.S. engagement culminated in what can only be described as a very great failure of historic proportions: Operation Ajax, the 1953 CIA-sponsored coup d’etat that ejected a democratically elected government in Iran in favor of the Shah. Self-styled “realists” will remind us that Iran was nearly ungovernable and that “democracy” would have been short-lived in Iran, leaving the country vulnerable to Communist influence from the neighboring Soviet Union. Given Iran’s immense oil and gas reserves, it could not fall into the Communist bloc, or so the reasoning goes.

As is so often the case in geopolitics, attempting to solve one problem creates others. Our zeal to defeat Communism made us blind to powerful and complex historical dynamics operating in Iran and elsewhere in the former colonial lands (not to mention the Shah’s own personal failures and shortcomings). This is the legacy of the Cold War, a continuation of truly global conflict, of world war.

If this day causes the gnashing of teeth in America, it is that much worse for many Iranians, particularly those who are not Shia Muslim, those who aren’t partial to theocracy, those who long for commercial freedoms and opportunities, and those who value basic human rights.

These are the people who filled the streets after the fraudulent elections of last June, then filled them again during Ashura in late December. These so-called “Twitter Revolutions,” named after the social networking websites that have aided communications among dissidents, add up to a lot less than the name would imply. Not much has changed on the ground, and now the forces of counter-revolution have swung into action and gotten up to speed on the technology its opponents have used with gusto. The regime has dealt with the problem as it deals with so many others – it has simply shut off the grid in preparation for a larger crackdown today during the country’s observance of the anniversary of the 1979 revolution.

Buruma on China

2010-01-31T18:42:00.003-05:00

Ian Buruma has a nice short essay in the weekend Wall Street Journal exploring China’s long history of thought control and its enforcement of cultural orthodoxy. Buruma reminds us that China’s neurotic stance on the free flow of information – recently in the news thanks to Google’s decision to defy Chinese censors – is hardly a product of the country’s Communist legacy but rather pre-dates Marxism, which is itself a Western import. After all, there is a reason mandarin has made it into the English language as a word denoting a bureaucrat who is powerful, secretive, and reactionary.

Buruma’s essay is a short summary of stuff most folks already know, but it always bears repeating, and the broader historical context helps our understanding of China. One concept of note that Buruma explores is a comparison of 16th century Jesuit priests who “went native” when seeking to convert Chinese to Christianity versus today’s multinational corporate interests that seek to function as “Chinese companies” when doing business in China. Buruma writes:

“A very similar debate is going on today between those who believe that applying Western notions of human rights and democracy to China is counterproductive. Many a politician, businessman, or media tycoon has argued that adapting to special Chinese conditions is surely more effective if one wishes to have any influence in China. The fact that this argument is usually self-serving does not make it necessarily wrong, but so far it has certainly not been proven right. Chinese human rights have not been noticeably advanced because of foreign compromises with Chinese illiberalism.”

I came to a very similar conclusion in a recent post.

Why personhood matters

2010-01-28T11:43:00.003-05:00

New York magazine has a really funny cover story/essay this week written by John Homans titled “The Rise of Dog Identity Politics.” In it, Homans uses humor and overall goodnaturedness to soften what is a ultimately a stinging rebuke of contemporary culture and its confusion with something as simple as personhood, both as a practical matter and as a moral category. While we might snicker at Homans’ funny portraits of city folk and the nutty accommodations they make for their canine companions, there are some serious implications for our culture’s inability to make sense out of what makes people people.

One of these implications can be seen in the recent U.S. Supreme Court decision – Citizens United v. Federal Election Commission – that reversed precedent and granted corporations, among other entities, greater protection under the First Amendment’s promise of free speech. I have not read the decision and am not a lawyer, so I won’t venture into the territory of legal precedents and practical application, but I would point your attention to the notion that any law or legal decision that obfuscates the line between individual and corporate entities is probably a bad thing.

Appearing on SCOTUSblog, law professor Lawrence Tribe has some interesting things to say about the recent decision. Most pertinent to the discussion here, Tribe writes:

“Talking about a business corporation as merely another way that individuals might choose to organize their association with one another to pursue their common expressive aims is worse than unrealistic; it obscures the very real injustice and distortion entailed in the phenomenon of some people using other people’s money to support candidates they have made no decision to support, or to oppose candidates they have made no decision to oppose.”

While I can’t imagine that I would find myself agreeing with Tribe’s progressivism very often, I believe Tribe is right to point out what seems to be a fairly simple thing – corporations aren’t people and don’t enjoy the same kinds of protections that people do. Of course, the door swings both ways – corporations also don’t labor under the same set of responsibilities as people do, or, as Ambrose Bierce once defined it in his Devil’s Dictionary, a corporation is “[a]n ingenious device for obtaining individual profit without individual responsibility.”

You can’t crack open a newspaper without reading stories of corporate malfeasance played out on a large scale, and public anger is at a boiling point with corporations – banks, insurers, ratings agencies, et al. – in the financial industry because of their perceived ability to escape responsibility for the crisis of the past few years. In the past, one could always take some degree of solace in the implicit trade-off of corporations: less responsibility, but fewer political rights. Even folks who otherwise would be anti-corporation could appreciate the utility of the arrangement.

I fear that the Supreme Court’s recent ruling, when viewed from a big-picture perspective, has done much to muddy the water concerning individual personhood, as opposed to and distinct from a corporate entity, and perhaps even unwittingly opened corporations up to new kinds of risks. After all, if corporate political speech should be considered on par with individual political speech, one might ask in what other areas should corporate behavior be subject to standards we normally apply only to people.

FT continues to defend the indefensible

2010-01-28T00:01:00.002-05:00

On the heels of last week’s outrageous assertion that the second AIG bailout didn’t represent a “backdoor bailout” of the banking industry, the Financial Times is at it again in its reporting of Tim Geithner’s miserable day being grilled on Capitol Hill. The main article in the paper – “The hindered haircut” – is a pretty balanced piece, but the piece in the online Lex column is an abomination. The column concludes:

“Elsewhere, this autopsy has descended into minutiae – such as whether purchases required disclosure on a security-by-security basis, information for which there is a negligible public interest argument. The big picture is that in a crisis questionable decisions are made under pressure without malicious intent. Bury this corpse now.”

Wouldn’t public officials love it if all debacles were resolved thusly?

As I have said in this space on multiple occasions, the Fed’s purchase of toxic financial instruments from AIG would not have been my choice (I think a game of brinkmanship was called for in order to secure the best deal possible); however, it’s a judgment call, and it very well may have saved the global financial system. What isn’t a judgment call is doing it all in the dark. Yes, there are congressmen lasered in on the substance of all this – way, way after the fact – but the real outrage concerns the underhanded evasion of responsibility. Remember that? That’s the thing that comes attached to power. Besides, we’re not talking about some trifling Long Term Capital Management bailout here…this is $70 billion. I know it’s easy to become inured to the money pile when you report on it every day, but you’d think the Financial Times – or any news organization – would have some appreciation for the magnitude of this. The government can’t shower money like this on private businesses in the dark. That is what the pillorying of Tim Geithner is about at the end of the day, not so much the actual decision, which is one many reasonable people would have made, even if it lacked chutzpah.

Why playoffs are wrong for college football

2010-01-26T22:49:00.001-05:00

I had a good laugh this weekend in catching the end of the Michigan-Purdue men’s basketball game. The game was long out of reach for the Wolverines, and the on-air guys, Brent Musburger and Bobby Knight, were reaching deep into the press kit by the end to keep the audience and themselves entertained. That’s when Knight, in his characteristic way, went off script and began criticizing end-of-season conference tournaments. Musburger, ever the NCAA cheerleader, quickly changed the topic, but at least Knight had his moment to break the NCAA’s sleeper hold on reality and to tell it like it is – conference tournaments are bad for college basketball. They are good for athletic department finances (in most cases), however, and therein lay the problem of extirpating this awful plague from the sport.

Last month, in my annual shout-down of college football’s playoff proponents, I utilized what is essentially the same gripe that I have with the supporters of conference basketball tournaments: they water down the regular season, rendering it practically meaningless, and drain all the drama from the regular-season schedule.

Nice to see that someone will agree, even if they might not (yet!) support eliminating conference tournaments. Wednesday’s Wall Street Journal features an article by Darren Everson exploring an upcoming match-up between Ivy League schools Harvard and Cornell. To my knowledge, the Ivy League is the only Division I conference that does not have a season-ending tournament. If you want the league’s automatic berth to the NCAA tournament, you have to do it the old-fashioned way: win the regular-season championship. You have to be good all year – not just the last weekend of the season.

Everson’s article captures the spirit my argument. He teases readers by suggesting that “[t]he game of the year in college basketball just might be in the Ivy League.” Why? Precisely because there is no tournament and the likelihood that only one team will advance to the NCAA tournament. Everson writes:

“For most of the 300-plus teams in Division I men's basketball, the regular season is a forgiving four-month exercise. Good teams play for NCAA Tournament seeding, while bad teams—which can still reach the NCAAs by winning their conference tournament—get second chances.

“But Saturday's game between Harvard (13-3) and Cornell (16-3)—and the scheduled rematch on Feb. 19 at Harvard—will bring a sense of urgency that this sport is unaccustomed to, at least before March.”

This is precisely the thing – a sense of urgency each and every week – that makes the college football regular season the most exciting competition in major American sports. It shouldn’t be trifled with.

Good news on the budget

2010-01-25T21:52:00.003-05:00

The Wall Street Journal is reporting that President Obama is planning to announce a three-year freeze “on discretionary spending unrelated to the military, veterans, homeland security and international affairs.” Medicare and Social Security are also exempt from the proposed freeze. While not huge, it is a great first step, and it also destroys the Beltway consensus against such freezes that have hogtied budget hawks from both parties over the years. Traditionally, the yearly increase in discretionary spending is as certain as sunrise and sunset. If President Obama forwards the freeze Wednesday during his State of the Union, the cultural impact on Washington’s big spenders will be much larger than the actual money saved, at least in the immediate future. That is not an unimportant consideration.

But the Republican leadership is already pooh-poohing the idea according to the Journal and much to my dismay. This is a significant step forward; I don’t understand why Republicans wouldn’t encourage further efforts in this direction with a little gesture toward conciliation. This should be a time to employ the carrot, not the stick.

As I have pointed out previously, despite its protestations, the Republican Party leadership has absolutely zero credibility on the spending issue. During the Bush presidency – especially when they controlled Congress – the Republicans passed not one significant piece of legislation freezing discretionary spending. And yet now they are clamoring that the Obama proposal is not enough? I agree that it’s not enough – even the Obama spokespeople admit as much. But when you’ve been in power and done nothing about the issue on the table, as is the case with veteran Republican congressmen, I don’t see how you can position yourself as fiscal watchdogs. And you certainly can’t afford to be petulant when someone is willing to float the idea of a spending freeze, no matter how limited it might be.

As an important aside, does this proposal essentially kill health care reform? I mean, it’s going to be difficult to argue for a massive social benefit entitlement program in the teeth of a spending freeze.

The communications coming out of Republican congressional offices should have hammered this point, not the proposed freeze itself. If you must criticize the Democrats for something, hammer them on the seeming incompatibility between the freeze and the desire to add 30 to 40 million people to the health care rolls. That’s the angle, not the lame quotations circulating in the press from House Minority Leader John Boehner’s office, which basically criticize moves in the right direction with snarky crap like, “Given Washington Democrats' unprecedented spending binge, this is like announcing you're going on a diet after winning a pie-eating contest.” Over the years, Republicans might not have won many pie-eating contests, but it sure wasn’t for lack of trying. After eight years of spectacular rises in federal spending under George Bush, Republicans can hardly paint the Democrats as the party of indiscipline.

Addendum, 10:15 p.m.: Judging from early reactions in the progressive blogosphere regarding the freeze proposal, my point about the freeze impacting health care is not lost on many folks. Nate Silver at FiveThirtyEight.com suggests as much.

Tishman Speyer: here, you take it!

2010-01-25T17:16:00.003-05:00

Back in November, I noted and discussed a nice post from Calculated Risk on so-called “strategic defaults.” I had wanted to highlight how, it seems, we hold homeowners to a higher standard of behavior than that of corporations. When homeowners walk away from a mortgage, you’d think they had just brained kittens to death, yet when corporations hand properties back over to creditors, there is hardly a peep.

Puts Tishman Speyer’s Stuyvesant Town/Peter Cooper Village debacle into perspective, no?

Some thoughts on Stratfor’s decade forecast

2010-01-24T14:37:00.004-05:00

Stratfor published last week its “Decade Forecast: 2010-2020,” a collection of regional forecasts that present one big thought: the demographic pattern of the previous half-millennium – that of expanding populations leading to greater labor, production, and economic growth – will begin reversing itself, both in developed and (some) emerging economies. I don’t want to pick at the premise overmuch. Stratfor presents the idea more as a provocation and less as a scholarly thesis.

As far as it goes, it is interesting to consider that the Turkish population in, say, Germany, is set to increase faster than that in Turkey itself. But such notions aside, the aging of what I would call middle-income countries – such as Turkey or Mexico – is likely to have knock-on effects for rich countries, too, since the rich economies depend greatly on cheap labor supplied by the middle-income countries, either migrant labor or home labor employed as part of a global supply chain. If this forecast holds true, it is definitely something to consider over the next decade.

The financial problems associated with demographic decline in rich countries are well known and have been greatly discussed. Obviously, the social safety net – from pensions to health care – in places like Europe will be altered in significant ways in the near future. For countries that wish to maintain the status quo in these areas, it makes immigration a structural economic necessity, something that current citizens of aging states might not fully appreciate. More likely, as Stratfor notes, the current social safety-net regime will change. Retirement ages will be raised; benefits lowered. These decisions will not come without significant political stress and struggle, especially given the cultural problems associated with immigrants, particularly in Europe.

On a related note, I have just ordered Cas Mudde’s Populist Radical Right Parties in Europe, an investigation of the rise of right-wing political parties in Europe. The arrival of large numbers of Muslim immigrants from North Africa and Turkey is surely one cause for the spike in right-wing parties, and I look forward to reading the book in this regard. In its forecast for Europe, Stratfor touched on this dynamic, remarking:

“A deep tension will emerge in Europe between the elite — who will see foreign pools of labor in terms of the value they bring to the economy, and whose daily contact with the immigrants will be minimal — and the broader population. The general citizenry will experience the cultural tensions with the immigrants and see the large pool of labor flowing into the country suppressing wages. This dynamic will be particularly sharp in the core states of France, Germany and Italy.”

In any event, as suggested above, the stage is set in Europe and elsewhere for a collision of two perspectives – preservation of the social safety net versus tolerance for high levels of immigration. Much of the internal politics of rich countries will be consumed with this debate in the next decade and beyond, so in this, I agree with Stratfor’s forecast. After all, the recent race riots in southern Italy illustrate somewhat the tensions associated with the current dynamic in place.

While we’re on the demographic issue, I should rectify one glaring omission in the Stratfor forecast regarding population growth rates lest folks begin to think the planet’s population is shrinking. While it is true that the population of some middle-income countries is aging, we should remember that, overall, the planet’s population continues to bulge, powered largely by Africa and Asia. For example, according to Population Reference Bureau, a nonprofit organization that focuses on population data, the population of Uganda is set to triple to 96 million between now and 2050.
As we proceed further into the new century, it is these places – sub-Saharan Africa and South Asia, particularly – that will be best able to provide labor the rich and middle-income countries need, should they want it.

Stratfor likely ignored Africa in its forecast because the region is such a non-entity in geopolitical terms, but we should remember that, along with Asia, Africa accounts for eight in ten of the planet’s youth. That’s a staggering number and will surely have some impact on geopolitics, even when one figures in the low life expectancies and extreme impoverishment of these nations. If nothing else, it gives pause to consider how easily such folks can become radicalized in the name of religion, Muslim or Christian. Witness the harrowing accounts of the Lord’s Resistance Army that operates in Uganda, and of course, we are already acquainted with the actions of a Nigerian national aboard a commercial jet around Christmastime. In the next ten years and beyond, I would expect to see Africa’s profile raised, often in a negative light, such that the plight of Africans will be hard to ignore, and yet, as before, it will be very difficult to effect change there, likely consigning us to a feeling of helplessness and frustration.

Otherwise, I would quibble here or there with Stratfor’s regional forecasts, but overall, I think the document provides a fine starting point for thinking about how long-term geopolitical trends will spill over into day-to-day events and encourage you to check it out.

Back to the permanent campaign

2010-01-24T13:17:00.001-05:00

In reading this morning’s front-page New York Times spread on President Obama’s turn to campaign hack David Plouffe for greater guidance in the 2010 mid-terms, I couldn’t help but think of the outsized influence of Karl Rove in the prior administration. It was Rove’s job to rub out opponents, enforce party discipline, and further the aims of the “permanent campaign” that has come to define presidential and party politics. Fortunately, Plouffe is no Rove, but I’m sure the Obama folks wish they had a Rove at this point. When in power, a Rove-like figure is a nice asset, particularly when you’ve botched the job of governing.

Rove, Plouffe, and other political svengalis notwithstanding, it has become all but impossible for the political class to accept that policy substance, over and above mere style, causes political failure. The problems the administration has faced lately – chiefly, health care, but also the foot-dragging on financial regulation – are not ones of “positioning,” but rather the positions themselves.

Campaigns are about style; governing is about substance. For an administration that has been critically short on substance, particularly vis-à-vis the financial crisis, it can’t be a positive sign that attention is already shifting to November.

Are we finally getting serious about regulatory reform?

2010-01-22T11:55:00.003-05:00

The timing and circumstances of yesterday’s White House announcement of a new policy direction against the nation’s banking industry provide mixed signals about the underlying seriousness of the effort. First, the policy itself is just a sketch, just a rough collection of ideas that have been floating about within the administration. We need more detail. Second, I find it hard to believe that the congressional members present – Frank and Dodd – have any real interest in the White House plan after working for a year on their own plans. They are probably wondering why these proposals weren’t announced last summer, when there was more political will in Washington to act, and in Dodd’s case, I have doubts as to his ardor for reform in the first place. Third, the timing of the announcement – immediately after the stunning election loss in Massachusetts – strikes me as suspect, a mere means of giving the press something else to talk about and getting the conversation off of health care, which many conclude was the proximate cause of the electoral defeat.

These things suggest that the announcement yesterday was more photo opportunity than the introduction of substantive ideas.

Already, there are naysayers hacking into the announcement, despite the lack of substantive details. In principle, I’m onboard with the rules against proprietary trading desks, but much more is needed. After all, it wasn’t prop desks that created the problem. Indeed, there is no single-bullet theory for the financial crisis, but as Felix Salmon discussed this morning on his blog, cutting prop desks down to size will change the culture at banks, and the broader problem with Wall Street is as much cultural as structural or regulatory.

Overall, I think we’ll know we’ve entered a serious phase of the discussion when concrete ideas are floated concerning the strict regulation of derivatives contracts and stronger oversight of the mortgage industry. These things won’t prevent another financial crisis – and perhaps nothing can – but they will prevent us from having precisely the same kind of crisis.

Half-speed recovery

2010-01-21T16:15:00.002-05:00

Standard & Poor’s published an update to the company’s investment policy this morning in a note that was circulated to retail investors via brokerage houses. Of immediate interest, the company seems to be sticking with the story from late last year, which is that the so-called “recovery” doesn’t really square with the massive rally in equities seen since March.

In summarizing its longer-term outlook, S&P characterized the recovery as “half-speed,” citing the first four quarters’ 2.7% growth. This rate of growth is significantly less than that traditionally seen in the immediate aftermath of a recession. Given the amount of stimulus – both direct and indirect – thrown at the economy, I agree completely that 2.7% is nothing to write home about.

The company prefaced its policy update by noting that “sentiment [has] turned sharply bullish [in the] last six weeks, a key warning sign in our view.”

New decade forecast published

2010-01-21T11:25:00.002-05:00

I got an email this morning from Stratfor, a strategic and business forecasting company, touting the publication of its “Decade Forecast: 2010-2020.” I generally pay little attention to such forecasts, though I realize the necessity of creating such a framework for an intelligence-gathering operation. I find that decade forecasts are generally too narrow to capture truly innovative big-picture thinking, and yet too broad to be of immediate use in day-to-day decision making. Having said that, there have been notions in prior Stratfor forecasts that were, in hindsight, pretty prescient, and I’m sure the new report will have some equally thought-provoking things to say.

Of note, I was surprised to discover, in reviewing Stratfor’s 2000 forecast, the emphasis the organization placed on what it called “economic de-synchronization.” It forecasted that this, along with coordinated attempts worldwide to resist American hegemony, would characterize the first decade of the 21st century. In this, Stratfor couldn’t have been more correct. In retrospect, this de-synchronization was a very important force in the Noughties, explaining both the failure of the Doha round of trade talks as well as the rise of economic nationalism and neo-mercantilism.

It took a lot of courage in 2000 to publish such a thing, being as we were in the height of the dot-com boom and a rapidly globalizing economy.

So when the new forecast makes a claim that seems slightly outrageous – such as “the next 10 years will mark the beginning of a massive reversal in the dominant trends of the past 500 years” – we should probably stop guffawing long enough to hear them out.

When I finish the reading through the forecast, I’ll circle back and post some thoughts, but I encourage everyone to check it out (you’ll need to enter your email to receive a free copy).

What can Brown do for you?

2010-01-20T16:45:00.002-05:00

The chattering class has had a ball today telling us what the U.S. Senate special election in Massachusetts means, but unlike the off-year U.S. House election in New York last November, this time the event is worth the chatter. The result seems pretty unequivocal, unmuddied by third-party candidates and suspended campaigns. Scott Brown, the Republican challenger, decisively defeated the Democratic candidate…in Massachusetts…for Teddy Kennedy’s old Senate seat. As the polls trended away from the Democrats, I still didn’t give Brown much of a shot, but he took full advantage of a few unique factors and put away the Democrat in a stunning result that deserves a lot of notice.

As much as Democrats will downplay the result, the election was a clear rebuke. Both independents and registered Democrats (and plenty of both are needed to win in Massachusetts) cited the direction of recent policy, notably health care, as their reason for falling into Brown’s camp.

The dilemma for President Obama is clear. He campaigned and won the 2008 presidential election as a mainstream, statist liberal. His policies to date have disappointed as many liberals as conservatives. Conservatives hate Obama’s rewarding of labor unions by successive bailouts of GM and Chrysler, his lax handling of the stimulus, and, most especially, his support for Congress’s health care reform. Liberals hate Obama’s seeming acceptance of certain Bush-era doctrines that have more or less remained the same, particularly those around homeland security and the military posture. If he moves to the right, he’ll lose his base of support; if he moves to the left, he’ll lose the 2012 election in a wave of popular resentment of the kind we saw in Massachusetts yesterday.

Personally, I think Barack Obama’s biggest failing in Year One was the attempt to make good on a few pet campaign promises in the face of a financial meltdown. It has been said that presidents don’t get to choose the kind the presidencies that they have. Certainly, most presidents don’t choose to be “wartime” presidents or “depression” presidents. Mr. Obama wanted to deal with a financial crisis about as much as cats want to take baths, but that was the way the cards fell. To this point, he has shrunk into the background and allowed Tim Geithner and Ben Bernanke to do the heavy lifting, but the crisis he never wanted is going to define his presidency, whether he likes it or not. Mr. Obama royally screwed up by forcing the health care debate onto an already-full policy plate. As we continue to shed jobs and wealth, the last thing most folks wanted to consider was how to build a larger social health care regime, and as the crisis worsened early last year, I think it turned people off to divert their attention away from the slow-motion train wreck of the financial system and onto what is essentially another entitlement program.

Timing is everything. And the timing sucked for a go at health care, notwithstanding its centrality to the nation’s finances as the fastest-growing black hole of federal expenditure.

Despite Beltway thinking, most people aren’t grossly stupid. They might not understand collateralized debt obligations or credit-default swaps, but they do understand that the financial crisis has been treated with a band-aid…and they also understand that the greatest malefactors of the past cycle are still running the show…and doing so on the taxpayer dime. Introducing health care into this environment might not have been the policy equivalent of fiddling while Rome burns, but you can’t ask Americans to bail out corporations to the tune of hundreds of billions of federal dollars, and then say, “OK, now on to health care….”

FT challenges notion of “backdoor bailout”

2010-01-20T13:04:00.003-05:00

The front page of today’s Financial Times features an article (“Fed makes ‘a killing’ on AIG contracts”) discussing the Federal Reserve’s rescue of troubled insurer AIG, principally the Fed’s role in using AIG’s exposure to credit-insurance contracts as a means to funnel money to struggling banks during the height of the financial crisis, something that I and others have termed a “backdoor bailout” for much of the past year. As the FT has it:

“The Fed rescue has generated criticism because the banks received 100 cents on the dollar for credit insurance they bought from AIG on collateralised debt obligations – financial instruments that promise the buyer cash flows from pools of bonds or loans. This had led to claims that AIG’s rescue was a “backdoor bail-out” of big banks.”

In the very next paragraph, the FT claims that the Fed is “in a position to reap profits from this part of the rescue,” although the FT’s accounting of the real value of these instruments leaves a lot to be desired. My understanding is that the Fed purchased the instruments at full value – part of “making the banks whole” – even though they were worth less than half that at the time. Estimates now place the value of these instruments somewhere in between. If the FT’s “several people with direct knowledge of the portfolio” are to be believed, these instruments have risen in value by about $15 billion since the time of purchase. That’s great, but you’re still $17 billion in the hole…how is that “making a killing”?

And that assumes that you could sell the stuff and realize said gains, but the illiquidity of these instruments is part of why they’re so toxic. Nobody wants to buy them, certainly not in the quantity the Fed has them to sell. Besides, the selling of such a large quantity would surely move the price down. Naked Capitalism, the financial blog, has a pretty devastating critique of the FT’s math and their underlying editorial disingenuousness.

I’m less worried about the math. We all know that AIG is one of the costliest interventions of the financial crisis, and while we can argue in philosophical terms about it, the bailout did accomplish its immediate goal of stabilizing the system. I am more worried about the revisionist approach to the intervention, where the Fed wants us to believe (apparently) that it wasn’t really a bailout at all, which is ludicrous. Interestingly, there is a bit of text in the print edition of the FT that has been deleted from the web version of the article. The print edition reads:

“The gains in the Maiden III portfolio [the New York Fed’s AIG financing vehicle] – which came as credit markets rallied – provide ammunition for Fed officials who have argued that the central bank would be repaid.”

I’m not sure why this was deleted from the web version accessed this morning, which presumably post-dates the print version, but it would have been smarter to scupper the whole piece. It’s akin to shilling and not worthy of the Financial Times.

Nothing to bank on

2010-01-19T15:14:00.002-05:00

Last month, in penning some thoughts about the national health care reform bill, I wrote that legislation is a blunt knife, not a scalpel. There is no better example of this than the White House’s proposed “financial crisis responsibility fee,” a tax that the Obama administration would like to levy on large banks.

Responsibility for the financial crisis is a devilishly complicated thing. The largest banks certainly have their fingerprints all over it, but they are hardly alone. Blame can also be assigned to the ratings agencies, mortgage originators, the GSEs Fannie Mae and Freddie Mac, AIG and other writers of swaps and derivatives contracts, and even regulators. Why is it that only the large banks are getting singled out for higher taxes and “responsibility” for the crisis.

Most of the reason is because that’s where the money is. If there are any winners from the financial crisis, it has to be the big banks, which are even bigger now than they were before the crisis. While problems persist in all manner of loan portfolios, many of the largest banks are making a killing, with Citigroup being the big exception. They are getting singled out because they’re making scads of money and paying large bonuses. In this time of general economic discomfort, as the American people are looking squarely at the prospect of yet another “jobless” recovery, the banks are Public Enemy #1. Nobody cares how much they get taxed.

But they should.

There are other reasons why the bankers are being asked to shell out more money to the government. Part of it is an attempt to regulate via the tax code. Because only the largest banks are being taxed – and taxed progressively on the basis of their size – the new tax is thought to do a job that regulatory authorities and Congress failed at, namely, limiting the size of “too-big-to-fail” institutions. But in all honesty, the tax is too small to affect the underlying business strategies at the banks, particularly given the advantages that size can bring. If this is a secondary strategy for the tax, it’s a poor one. We need effective regulation and oversight, not a wing, a prayer, and a new tax.

Team Obama also reasons that the tax is right and just because, without taxpayer support, the entire banking system was at risk of melting down. This is probably true, but others would point out that much of the support made available via the Troubled Asset Relief Program, or TARP, has been repaid, and of that portion, the government has made a profit. Where the government hasn’t made a profit – and never will – is the backdoor bailout given to the banks via AIG. So the government giveth, and the government taketh away. The problem is that, unless the proceeds from the new taxes go directly to paying the federal debt created by the bailout (and they won’t), the legislation merely prolongs the fantasy inside the Beltway that government can grow while everything else in the country contracts.

Unfortunately, the tax will hardly crimp the style of large banks that pay out large bonuses to its alchemists, and the costs associated with the tax will likely get passed on to bank customers. No scalpel, indeed.

More on Google’s Chinese buh-bye

2010-01-15T15:18:00.003-05:00

I should say upfront that I have a generally favorable view of Google and am a heavy user of its services. Indeed, this blog is hosted on a subdomain owned and operated by Google via its acquisition of Pyra Labs in 2003. I regularly use the company’s news reader, document applications, the now-unsupported Notebook feature (which is the best free application of its kind), and Gmail, to name a few. Having said that, since posting yesterday, I am a little perplexed regarding much of the reaction to Google’s decision to (possibly) exit China, particularly those who see this move as an unalloyed, unqualified victory for business ethics and human rights over profits.

There are some things here for ethicists and human-rights advocates to be happy about, and I am certainly pleased that Google took the opportunity to slap China’s government on the wrist in the way it chose to publicize its decision, but when you break down the decision and submit it to analysis, you discover that the business case outweighs any other consideration. That, coupled with Google’s past acceptance of China’s censorship policies, should lead one to a more restrained take on the event.

Much of the praise thrown Google’s way has centered on the enormous market that the company is exiting. It has been cited that Google is China’s #2 search engine with a steadily increasing market share. As I discussed yesterday, user adoption of the internet in China is set to rise dramatically over the next four years, from an estimated 300 million today to nearly 800 million in 2013. Pundits see these figures and reason that Google’s decision to leave China must be premised on virtue, for who would leave such a goldmine opportunity?

But dig a little deeper and Google’s China story isn’t all that. Despite the #2 ranking in a market that already sports 300 million users, China accounts for less than two percent of Google’s $21.8 billion in annual revenue, according to data from Jeffries & Co. published by BusinessWeek. Combine that with the costs of complying with Chinese government policy – policies which in effect nullify Google’s competitive advantage in search technology – and leaving China isn’t such a big deal. In fact, given the nature of the cyberattacks launched against it, Google’s exposure to risk, reputational and otherwise, in China might be greater than its upside potential.

A cynic might argue that, so long as Google thought the upside in China was enormous, it was willing to suffer any degree of nefarious interference from Chinese authorities. It might not have liked it, but why do we care what a company professes to like? Actions speak louder than words. After all, no one bothers to ask executives at General Electric whether they liked dumping polychlorinated biphenyls into the upper Hudson River. Rather than exemplifying its motto of “Don’t Be Evil,” Google for years adhered to a different motto in China – “See No Evil.”

To be fair, Google execs might have thought that the best way to change China was to engage it, rather than ignore it. This is the general approach the United States has adopted at large. The problem with this approach is that it so often and tidily overlaps with making money that the nature of the engagement never rises to the level of a provocation. Indeed, it could be argued that our engagement with China more often changes us rather than it. Google’s announcement seems to confirm this for me on a certain level.

Companies like Google – that is, companies operating in areas that the Chinese government deems “strategic” or “sensitive” – might do well to compare its experience in China with that of the Roman Catholic Church, another international organization that operates in a “sensitive” area. The Church’s experience in the People’s Republic has been riddled by duplicity, obstinacy, and alternating waves of conciliation and provocation. This almost bipolar behavior from China’s ruling party is probably the result of two competing desires. On the one hand, China seeks partners to help it maintain quiet inside the country. These could include corporations that provide jobs or religious organizations that provide spiritual succor. At the same time, the Chinese government is filled with paranoid bureaucrats who cut their teeth in a very sophisticated school for despots. This leads to an inability to trust others or share power, thus the constant vacillation which follows a fairly regular pattern: escalating displays of power that culminate in China’s authorities overplaying their hand, which is then followed by a period of conciliation, and then whole pattern starts over again. Writing for the Financial Times, David Pilling yesterday published a fine article detailing how we may be in the throes of the “overplaying” phase of the cycle on several accounts.

The cyberattacks launched by elements inside China – and perhaps elements inside the Chinese government – against Google and a score of other companies might be the proverbial last straw, at least for Google, but let’s not ascribe more to Google’s decision than need be. It’s a fine first step. Let’s see where it goes from here.

What does the Google-China fracas mean?

2010-01-14T12:20:00.003-05:00

Google made a big splash earlier this week by announcing that it may shutter its operations in China after the search engine company’s Chinese digital infrastructure suffered a sophisticated cyberattack. The apparent object of the cyberattack was to infiltrate Google’s Gmail service and raid the email accounts of Chinese political activists, which points the blame squarely at the Chinese government.

It is not an isolated incident. This morning, Business Week published a report suggesting up to 20 companies, including Yahoo and Adobe, were similarly attacked, and the WSJ Law Blog has reported that the Los Angeles-based law firm of Gibson Hoffman & Pancione was attacked as well.

What do the attacks mean?

Primarily and most immediately, it means that the Chinese government has chosen to ramp up surveillance and enforcement of the country’s censorship laws. Why now? This is the $50,000 question…or more accurately, 840 million. That is the expected number of internet users in China by 2013. Today, only 30% of China’s population use the internet. I think this user adoption growth rate is important, because it might explain why the Chinese government would risk censure with overly aggressive enforcement of its censorship policy, particularly absent any clear and present cyber threat. If you are the Chinese government, why stir the pot and piss people off when it’s not necessary? Why chase off large multinational corporations and the jobs, wealth, and prestige they bring?

Mostly because the Chinese government has no intention of making internet search a “business” or a “market.” Like many things in China, things are not what they seem, and the Chinese companies that provide internet search, like Baidu, have little independence or prerogative in setting policy. These companies “compete,” but not so much on the quality of search and information. It is akin to the government decreeing that all carbonated drinks can only have one formula. The many companies that sell soda would still “compete,” but their ability to sell soda relies on secondary things – like the color of the can or the attractiveness of the pitchman – because the drinks all taste the same.

Finally, the message got through to Google that the Chinese web search business is a sham. After all, if Google can’t leverage its considerable competitive advantages in search – primarily via advertising and new product development – the rationale for being in China withers away; therefore, at the end of the day, Google is making a commercial, not a political, decision. To its credit, Google has spun the story of its departure as a grand Fuck You to China’s authorities, but let’s not forget that Google had adopted a “see-no-evil” approach to China for a long time and had acquiesced time and again to China’s multiple affronts to civil liberties.

Will Google’s departure from China have a cascading effect where other companies rethink their China businesses?

Not likely. First of all, you have to consider the nature of Google’s business: information. It is by suppressing and manipulating information that the Chinese government maintains its grip on power. It is hardly going to allow Google a place at the table. The situation is somewhat different for other companies, like, say, electronic component manufacturers or chemical makers. They can operate without a lot of fuss from the government. And if you have spent considerable capital over the last ten years making China a key part of your supply chain, you’re hardly going to abandon that investment because Google can’t make a go of things in China.

Ultimately, the cyberattacks tell us nothing we don’t already know about China. You do business there at your own risk, as the legal and regulatory systems are sketchy, and the rights we take for granted – commercial and otherwise – are not operable. The rationale behind doing business in China has always been the ability to make stuff on the cheap. Executives would direct their people there to keep their heads low and to keep pumping out cheap products and semi-products that could command high profits in America.

In a best-case scenario, maybe Google’s decision will get people to think more carefully about the full impact of any future investment in China. After all, Google’s approach to China has mirrored that of most folks in the U.S. business class. The thinking was that China’s political rough edges, like South Korea’s and Taiwan’s, would soften as the country grew wealthier. Google no doubt banked on this, thinking that, over time, if it played the game long enough, the restrictions placed upon it would subside. But in fact, the trend has moved in the opposite direction, as China’s demands have grown in number and degree. Google is a high-profile American company operating in what the Chinese deem to be a sensitive area, so most companies don’t have the same set of concerns…at least for now.

I do believe that Google has made the right decision, now and for the future. What good is the Chinese market if you are subject to such malign and capricious authorities?

The Fed’s AIG mess

2010-01-08T15:07:00.001-05:00

It was revealed earlier this week that the New York Fed, at the time headed by current Treasury Secretary Timothy Geithner, edited out vital disclosure information from AIG’s SEC filings back in December of 2008 after the firm had received a bailout from the U.S. government. The deleted passages referred to $10 billion of indestructible swap agreements, agreements that, according to the New York Times, “could not be torn up, because they did not insure debts that could be bought by Maiden Lane III [the Fed/AIG financing vehicle] — they insured amorphous bundles of derivatives.” The Times further explained that AIG “has never found a way to cancel them, and they are still in force.” Government lawyers counseled AIG to suppress publication of information regarding these swaps.

Fed supporters are quick to explain how disclosure of these swaps could have spooked the market and started bank runs at counterparty institutions. This position is not entirely without merit; however, for me, the fracas only highlights some of the points I made earlier this week (here and here) regarding transparency. The Fed needs to be stronger, but it must operate in the sunlight. Revelations of this kind only strengthen the hand of folks like Ron Paul who would love nothing better than to abolish the Fed, much as Andrew Jackson killed the Second Bank of the United States in 1836. In a world of fiat currency and incredibly complex global financial relationships between both sovereigns and corporations, this is would likely be a disastrous thing. The Fed must get its act together.

If not the Fed, then what?

2010-01-06T12:48:00.002-05:00

The New York Times’ David Leonhart has an excellent article on today’s front page exploring one of the central dilemmas concerning current efforts to reform financial regulations. On the one hand, as I alluded to on Monday, the central bank is the only authority currently existing that has the power and independence to referee economic disputes, such as what constitutes an “asset bubble,” but the trouble is that, in the past, the Fed has displayed a woeful level of competence at seeing the bubbles as they occur. Mr. Leonhart’s article is a rather more skillful exposition of what I was getting at earlier this week, namely, bubble-spotting is something the Fed should do, but I’m not at all sure it is up to the job.

One thing Mr. Leonhart neglects to consider is to what extent ideology and turf conditioned the responses of the Fed during the Noughties, whether under Alan Greenspan or Ben Bernanke. He quotes liberally from each to demonstrate how they basically missed seeing the housing bubble, and definitely, the choicest quotations are very damaging in terms of personal credibility; however, all quotations have a context. A sure way in Washington of getting whacked is in trying to expand your domain (ask Sheila Bair). Doing so brings unwanted attention, especially from legislators. So, with that in mind, it makes perfect sense for central bankers to keep their heads down…doubly so if the job description is merely to be an inflation watchdog. Why offer opinions on other bits of the economy when it strays from your regulatory domain and into someone else’s?

My point here is that you might have gotten different responses from the Fed if it was clear that (a) the central bank’s prerogative extended to things other than monetary policy, strictly defined, and (b) there was no regulatory ambiguity in terms of what each agency is in charge of. Lacking these things, there was a strong disincentive to central bankers becoming the kind of systemic-risk watchdogs that we needed.

A second point regarding the this morning’s article…Mr. Leonhart alludes to congressman Ron Paul (R-TX) as the sponsor of legislation that would reduce the Fed’s independence, or as Mr. Leonhart has it, “that would give Congress the power to review interest rates.” Mr. Paul is a unique figure in Washington, an outspoken hard-money enthusiast who has made no secret of his enmity towards the central bank. He has consistently called for more accountability from the Fed, which, by itself, is not a bad thing. Too often, the Fed’s definition of independence is tantamount to a lack of institutional accountability. The Fed should be politically independent, but it still must be held accountable for its actions. It is not – and has never been – an ivory tower of finance.

But we should be careful from whom we take counsel regarding the Fed. Mr. Paul’s intention is not to reform the Fed, but to abolish it, which is lunacy. Unfortunately, some folks find it impossible to separate the two issues at play concerning Mr. Paul. His calls for greater accountability are laudable – his ultimate policy goals are not. To the extent that his calls for reform are motivated by this deeper desire to do away with the Fed, he has the unfortunate potential to discredit the reform process. People will begin associating all calls for greater Fed accountability with the fringe who seek to abolish the bank, an outcome that would be bad for everyone. It is not inconsistent or mutually exclusive to want a stronger Federal Reserve, but one that is also more transparent in its decision-making. In fact, that’s precisely what is needed, if for no other reason, a lack of viable options.

The big cheese speaks out

2010-01-05T12:08:00.003-05:00

There is so much mumbo-jumbo surrounding most high-profile corporate decisions – especially mergers and acquisitions – that it gets hard to follow along without feeling a deep sadness for the injuries done to the English language. Of course, corporate types talk this way not because they’re aesthetically challenged, but because they’re usually trying to hide something.

That’s what makes today’s press release from Berkshire Hathaway, Warren Buffett’s conglomerate, so delightful to read. The statement levels a devastating critique of Kraft’s attempt to issue shares to pay for its proposed acquisition of Cadbury, the UK-based confectioner. And it does so in plain English.

According to the Berkshire release, Kraft’s management wants “to authorize the issuance of up to 370 million shares to facilitate the acquisition of Cadbury,” something that Berkshire, which owns over 9% of Kraft, is loath to do. Berkshire’s reasoning is hard to argue with – why repurchase your own shares at $33 (as Kraft did in 2007) if you’re going to issue more shares at $27 in order to use as acquisition currency?

Warren Buffett is known for picking not just great companies, but great companies with great management teams. Kraft management’s latest proposal must have left the Sage scratching his head and perhaps doubting their judgment…certainly enough to issue a public retort to the offending proposal. While the release didn’t unambiguously close the door on a future change of heart, Berkshire clearly sees the proposed deal as one that destroys value, commenting, “If we conclude [in future] that the offer does not destroy value for Kraft shareholders, we will change our vote to ‘yes.’”

It seems clear to everyone that Kraft is aiming to take a path that would lead to its overpaying for Cadbury, clear, that is, to everyone but the company’s own management. Why do executives so often destroy corporate value in M&As?

Steven M. Davidoff, who maintains The Deal Professor, a “blog within a blog” at The New York Times Dealbook site, offers some interesting reasons why corporate executives often pursue value-destroying deals. In his new book, Gods at War: Shotgun Takeovers, Government by Deal, and the Private Equity Implosion, Davidoff blames the current deal culture on two things: executive hubris and a deal industry that only profits when deals are consummated. He writes:

“This CEO hubris has been reinforced by the institutionalization of deal-making. The deal-making industry is now vast. It involves the investment banks who provide financial advice and debt financing, the law firms who structure and document these deals, the consultants who work on strategic issues, and the media who cover it all. The deal machine provides its own force toward deal-making and completion. In many circumstances, the vast proportion of the fees of these ancillary actors are based on the success of the transaction. If a deal is not completed, they are paid little. But if a deal does succeed, the deal machine reaps tens of millions, too often with little accountability for the future of the combined company. The result is that the voice heard by corporate executives is too often one that pushes their own biases toward completing and winning takeovers.”

While it is not clear that Kraft’s management is suffering from this kind of impotency, clearly, Berkshire is not impressed with its open-ended proposal to pursue Cadbury at any cost. Nor should it be. If only more shareholders (not to mention boards of directors) would throw cold water on deal-making more often, particularly when it is so patently obvious that a company is overpaying.

We often laud CEOs who pull the trigger and make the big deal. Perhaps we should devote more attention to CEOs who have wisely left the deal table when the goods have been bid up too high. But as Davidoff explains, pride goeth before destruction, and an haughty spirit before a fall.

You never give me your money

2010-01-04T20:43:00.003-05:00

Since the beginning of the last decade, I and many people like me have undergone something of a conversion experience regarding the role of the Federal Reserve in lancing asset bubbles before they grow too large. Once upon a time, I held fast to the notion that the Fed’s main job was safeguarding the economy against the ravages of inflation, but this notion is clearly too reductive, too narrow.

As early as 2002, The Economist was warning people of such a narrow view. In a survey on international finance published that year, the magazine cited the efforts of two British economists in debunking the idea that a central bank’s lone job is inflation:

“Messrs [Andrew] Smithers and [Stephen] Wright, having dispensed with market efficiency and established that asset bubbles are possible, next take issue with the Fed chairman’s belief that central bankers are supposed to control only inflation, not asset prices. They argue that the downside of a bubble bursting—possibly some combination of depression and deflation—far outweighs the cost of raising interest rates to stop the bubble forming in the first place.”

This was inflammatory stuff in 2002. In 2010, it’s perfectly benign, even acceptable. The problem, then as now, is wholly political. It comes back to taking away the proverbial punch bowl just as the economic party is getting started, which tends to piss off a lot of people. As The Economist argued, everyone agrees that too much inflation is a very bad thing for everybody; therefore, the Fed is not overly concerned with the politics of fighting inflation. When it exists, there is broad political support for getting it back under control. But if the Fed targets asset bubbles, whether they be soaring stock valuations or the market for mortgage-backed securities, the job becomes trickier. Everyone knows what hyperinflation looks like; asset bubbles, however, are in the eye of the beholder.

There may be plenty of argument concerning what constitutes a bubble, but nobody does much arguing once one has burst. People will say they “never saw it coming” or “who could’ve known.” But, more often, there are plenty of folks who see the bubbles as they form, but they are ignored because too many people are making far too much easy money during a bubble’s formation. In such a scenario, only the Fed has the power to referee the dispute and act accordingly.

The real argument today – at least, to my mind – is not whether it is possible to identify bubbles, but whether the Fed can act in a responsible and independent manner in order to head them off before they grow too large. In that same 2002 survey that I quoted from earlier, former Fed vice-chairman Alan Blinder was quoted as saying that “[f]or the US economy to go into a significant recession, never mind a depression, important policymakers would have to take leave of their senses.” Well, yeah. As we have all witnessed since 2007, that is not a far-fetched scenario.

These considerations are at the very center of U.S. economic policy in 2010. There exists a very vocal group of policymakers and pundits who see the current extended near-zero interest rate environment as providing the raw material for bubble formation. Writing for Forbes, Keith R. McCullough, Chief Executive Officer of Research Edge, an investment research firm, argues that the Fed needs to raise interest rates in order to stave off the next bubble and return to a more healthful balance between fixed-income and equity investments:

“This is where the Fed’s unscientific narrative is dead wrong: That we need more debt and credit to fix our debtor nation problem. That we silly people who save wouldn’t know what to do with a risk free rate of return if we ever see it again. That main street inflation with $81/barrel oil and $3.34/lbs copper is nowhere to be seen.

“In September of 2007, the Fed Funds Rate was 5.25%. We need to get at least half way back to that rate, over time, unless we want to become Japan. Savings build investment dollars. More investment dollars put into the hands of hard working American entrepreneurs is what builds the next Google or Nike. The Big Government Decade we just experienced failed. ‘Wide acceptance of an idea’ that we need to fear rates hikes ‘is not proof of its validity.’”

There is a lot of common sense in Mr. McCullough’s recommendation, but there are also some complicating factors that lead others to support current rate levels. Paul Krugman argues that current expectations for growth in 2010 are likely overstated, and even if one takes the rosiest prediction, it is still far below the typical post-recession growth curve. This dour outlook leads Mr. Krugman to assert that raising rates at this juncture would be tantamount to repeating the folly of the 1930s when we thought we had licked the Great Depression, only to experience prolonged economic malaise straight up to the beginning of World War Two.

I’m not sure I buy Mr. Krugman’s argument. If money and the people who earn it were mere inputs in some kind of grand video game, then maybe I could go along with his reasoning, but the money is real, and the people who earn it are real pissed, sensing that the vast redistribution at the heart of Krugmanian economics is a short-term fix at best. More importantly, we should pause now and ask whether we are getting into a position where near-zero rates and stimulus are becoming structurally necessary to economic growth, a kind of longer-term deferral of economic pain that we’re passing on to later generations. At the end of the day, if we are living beyond our means, throwing more money at the problem is not the answer. And that doesn’t even begin to touch upon the nasty boom-bust cycles inherent in the Fed’s policies thus far during the new century.

The fiber of booms and busts is woven into the very fabric of market capitalism, but I think we can all agree that the speculative manias of the Noughties were as much a product of post-9/11 Federal Reserve policy as anything else.

2010 Trends: Exchange-rate instability

2009-12-29T14:48:00.008-05:00

I mentioned last week the group of essays at McKinsey’s What Matters website dealing with current topics in global currency, particularly the U.S. dollar. In one essay, Rakesh Mohan writes:

“The world is stuck with the United States and the United States is stuck with the use of its currency as the premier reserve currency for the present. But both are threatened. For the dollar to continue in this role, its value has to exhibit greater stability than it has in the past. Thus the fiscal and monetary policies of the United States also need to inspire greater confidence than at present. US monetary policy has been far less consistent than in other advanced countries in the years since Volcker presided over the Fed, resulting in greater swings in US interest rates and exchange rates than may be optimal for the rest of the world. The high volatility in commodity prices, particularly that of oil, is also related to these swings, which then feed back into the system, increasing the demand for foreign exchange reserves.”

Yesterday, The Financial Times reported on the steep rise of late in soft commodities. The chart from the article is below.

It is tough to disentangle the causes of this rise in commodity prices. As the FT explains, there are market-based reasons for some of the increases, such as bad weather, poor harvests, or a lack of investment, but the fact that so many commodities are rising in sympathy with one another also suggests that Mr. Mohan’s point above deserves attention. Dollar rallies and swoons of an historical nature are likely creating havoc for executives, making it difficult to manage manufacturing chains and inventories. These pressures should lead us to be extremely cautious when evaluating the projected earnings of large, complex, global businesses. With so much uncertainty in the commodities markets – much of it directly associated with fluctuations in the dollar – we will likely see in 2010 many companies wildly miss their earnings targets, both for good and ill.

Year in review: 2009 stock picks

2009-12-26T14:17:00.002-05:00

At the beginning of the year, I selected five stocks as safe bets for 2009, places to park your money with a reasonable expectation of capital preservation and, hopefully, a little growth to boot. At that time, the stock market still had not bottomed out – that was to come in March – and there was great uncertainty about the market in general. Admittedly, I did not foresee such a huge rebound in stocks in 2009, and my primary concern in January was merely maintaining the value of my investments. So, as one might expect with such a conservative investment philosophy, my basket of five stocks underperformed the S&P in 2009, which is up nearly 25% YTD. But by and large, the stocks in my basket met or exceeded my targets, with the exception of Procter & Gamble. Here’s the final tally, exclusive of dividend income:

1. Johnson & Johnson (NYSE:JNJ)
2008 Close: $59.83 Target Range: $65-$70
12/26/09 Close: $64.70 (+8.14%)

2. Procter & Gamble (NYSE:PG)
2008 Close: $61.82 Target Range: $65-$70
12/26/09 Close: $61.28 (-0.87%)

3. Philip Morris International (NYSE:PM)
2008 Close: $43.51 Target: $45-50
12/26/09 Close: $48.90 (+12.39%)

4. Laboratory Corporation of America (NYSE:LH)
2008 Close: $64.41 Target: $67-$75
12/26/09 Close: $76.09 (+18.13%)

5. Teva Pharmaceutical Industries Ltd (NASDAQ:TEVA)
2008 Close: $42.57 Target: $46-$52
12/26/09 Close: $55.94 (+31.41%)

It came upon the midnight clear

2009-12-25T14:48:00.004-05:00

Warning: If you’d rather not get pissed off on Christmas Day, then skip this post.

On Christmas Eve, while visions of sugarplums danced in our heads, the U.S. Treasury was busy completing a back-door bailout of the government-sponsored entities Federal National Mortgage Association and Federal Home Loan Mortgage Corporation, better known as Fannie Mae and Freddie Mac. According to the Wall Street Journal, the new policy is as follows:

“The new terms announced Thursday would allow the cap on Treasury’s support to increase by the amount of the total net loss the firms experience over the next three years, beginning on Jan. 1. The cap in place at the end of 2012 would apply thereafter.”

What that means, basically, is that Fannie and Freddie are being given blank checks, the ability to realize a theoretically infinite value of losses over the next three years.

The original government-sponsored enterprise (GSE) bailout was one of the first government interventions of the financial crisis, occurring even before Lehman Brothers blew up in September 2008, and was executed according to legislation signed into law by George Bush in July of that year, legislation that granted sweeping new powers to the U.S. Treasury to insure GSE debt and to shore up their finances. The New York Times characterized the law thusly:

“The law authorizes the Federal Housing Administration to insure up to the $300 billion in such loans but the Congressional Budget Office has estimated that only $68 billion of that authority is likely to be used. The original lenders will have to pay upfront fees into an insurance fund, and borrowers will pay continuing insurance premiums of 1.5 percent a year to insulate taxpayers against losses from defaults.”

In calculating the effect of the legislation on the public purse, the Congressional Budget Office’s director posted in July 2008 on his blog the following:

“Using historical and industry estimates of the expected losses on the different types of credit risk that the GSEs face in their current portfolios, CBO estimated the firms’ possible credit losses under thousands of possible future market conditions for housing prices. That analysis suggested that there was more than a 50 percent chance that the GSEs’ future losses would not exceed those already recognized, but there was almost a 5 percent chance that the added losses will total more than $100 billion. Given that distribution of possible future losses, CBO then evaluated how much assistance might need to be provided to the GSEs to allow them to continue operating in the capital markets.”

These CBO calculations look positively quaint today (bear in mind, these are the same folks who did the math on our recent health care insurance reform legislation). Bloomberg reported yesterday that, in the last nine quarters, combined losses at the GSEs total nearly $190 billion. I cannot say how much of these losses occurred before the above CBO estimates were drafted, but clearly, we’ve seen significant losses since then, an amount that figures to grow substantially in the next two quarters amid continuing economic woes in the U.S.

It is interesting to pick at the CBO director’s use of language, quoted above, as an exercise to show how bureaucrats use statistics to mask reality. To demonstrate the spread of risk, the CBO director bounded his presentation with two probabilities. First, there was a 50/50 chance that “future losses would not exceed those already recognized.” Second, on the opposite end of the pole, he gave us a trifling 5% risk of “added losses [totaling] more than $100 billion.” Presenting the data this way would lead a reasonable person to assume that the risks are manageable, assuming that the probabilities are right (and they likely won’t be). But why 5% and $100 billion? Plug in $75 billion losses, and I bet that risk percentage spikes a great deal. If he had said we have a 33% chance of realizing $75 billion in losses, I wonder if that would have changed the conversation? Probably not, because the policy-makers had already decided what they were going to do, numbers be damned, and President Bush was too clueless to know the difference, but the point is worth making because bureaucrats and journalists tend to treat these CBO estimates as pieces of Gospel. They get recycled and regurgitated to the point that they take on an element of immutable fact. To remind people in public discourse that these estimates are just estimates is to court the fieriest sort of reprimand and all manner of ad hominem attacks.

In a final irony, the New York Times reported in July 2008 that the original GSE bailout contained a plan to help as many as 400,000 homeowners pay off their troubled mortgages and replace them with affordable government loans. If you assume that those loans averaged around $200,000 each, that represents a total of $80 billion. Hell, we could have just eaten those loans with public money, made the lenders whole, and would still be $30 billion ahead of where we are now!

Instead, the money pit is getting deeper, and we are paying the GSE executives millions of dollars in compensation for helping us dig. Oy.

Lumps of coal for the U.S. Senate

2009-12-24T10:54:00.004-05:00

In this morning’s Wall Street Journal, the Obama administration’s communications director, Dan Pfeiffer, was quoted as saying “It’s not always pretty, but Washington still has the capacity to deal with big problems,” presumably evidenced by the Senate’s passage of health care legislation this week. Not to rain on Mr. Pfeiffer’s parade, but the ‘big problem’ is precisely what the legislation potentially has wrought, not today, but 10 or 15 years down the road.

The latest approach to health care insurance reform presented a false choice – a legislative either/or – ginned up to conjure support among wavering moderates. The bills’ supporters reasoned that, since health care costs are the primary driver of federal budget deficits, let’s position the legislation as the sine qua non of fiscal responsibility; therefore, a vote for health care insurance reform is a vote for budget discipline. Such logic gave moderates enough political cover in order to cast their fateful votes, but there is a hole in this approach.

In essence, progressives are telling the rest of us that in order to save money over the long term, we have to spend money today. If only it were so easy. The cost savings associated with today’s legislation are years from being realized, and given the way legislation works in Washington, it is entirely possible that key components of the legislation will change between now and then, regardless of which party is in power. In fact, given lawmakers’ recent bent toward kleptocracy, this is practically a given. Over 2,000 pages of draft legislation and a decade’s worth of time give enterprising lobbyists plenty of opportunity to ruin a delicately balanced piece of legislation. It should go without saying that, if progressives were truly interested in cutting the costs associated with health care, they could have instituted changes years ago without adding 30 million people to the dole. One doesn’t require the other.

I have always been told that federal legislation is a knife, not a scalpel, and yet we have just passed a piece of legislation that requires precision and discipline over many years if it is not to become a bottomless money pit, and as we just witnessed during the Bush years, it doesn’t take an inept administration much time at all to well and truly screw the pooch. I hope I’m wrong, but I feel this legislation was and is a very, very bad idea, something that our children will curse and lament.

Exchange-rate volatility and big business

2009-12-23T12:15:00.006-05:00

Earlier this month, The Economist published an interesting profile of Toyota Motor Corporation. The magazine notes that, in the fiscal year that ended March 2009, Toyota recorded its first net loss since 1950, even as it assumed the position of the world’s biggest automobile manufacturer. The Economist claims that the company has lost “its seemingly unstoppable market-share momentum” and chalks up the malaise to its slowness to market cars in emerging markets, failure to manage the geographical nuances of its business, and a lack of focus on its traditional strengths of quality and reliability.

These criticisms seem to be more or less on target, but there was an interesting nugget of information near the front of the article that was not dwelled upon at length, but probably deserved to be – the effect of foreign-exchange rates on company profitability. The magazine reports:

“In the most recent quarter Toyota made a surprise net profit of ¥58 billion. It also raised its sales forecast for the year from 6.6m units to 7m. Much, however, depends on the yen-dollar exchange rate. The yen has been climbing, and a rise of ¥1 can subtract ¥30 billion from Toyota’s bottom line.”

While the article makes a good case for the longer-term causes of Toyota’s recent slide, the quarter-to-quarter volatility of exchange rates can do a lot to mask – for good or ill – the underlying trends of a global business. According to McKinsey’s What Matters website, we should expect this volatility to increase in the near to intermediate term. Authors Richard Dobbs and David Skilling cite a recent McKinsey Quarterly survey as evidence “that both the level of exchange rates and exchange rate volatility have a large, and growing, negative effect on company profits and investment decision making.”

Another interesting point in the McKinsey piece is how the “yen-dollar exchange” talked about in The Economist is only part of the puzzle in figuring out corporate profitability, particularly for companies based in Asia. Take, for example, this interesting comparison between Japanese and Korean manufacturers vis-à-vis the yen-won exchange:

“And the competitive position of Japanese companies such as Toyota Motor and Sony, relative to South Korean rivals such as Hyundai and Samsung Electronics, has deteriorated as the Korean won has depreciated (as a result of capital outflows) and the Japanese yen has strengthened (because of its safe haven status). The yen is now 60 percent stronger in won terms than its pre-crisis level, currently trading at around 13 won, compared to below 8 in 2007. Observers attribute to this shift, the fact that Samsung Electronics’ third quarter 2009 operating profits were more than twice the combined operating profits of nine of Japan’s largest consumer electronic companies.”

For the investor, the impact of currency exchange puts an added layer of complexity on top of what is already a complex task. I have long treated currency exchange as mere white noise; it has never figured substantially into my investment decisions (not least of all because I scarcely understand it), but if we are entering a period of heightened volatility, it might benefit all investors to think about how to profit from it.

To this end, check out McKinsey’s What Matters website. They published earlier this month some interesting articles on currency, particularly the role of the U.S. dollar in the global economy.

Hail to the “champions”

2009-12-22T20:22:00.003-05:00

I used to hate the Bowl Championship Series (BCS), the admittedly lame method major college football uses to crown something that approximates a champion, but I have found something worse – casual fans of college football prescribing cures to what ails the sport.

They usually involve some vague, ill-defined scheme for a playoff “because every other sport has one.” They will invoke, as does Ashby Jones writing for the WSJ Law Blog, the inherent unfairness of the current system, which, in effect, prevents smaller, less well-known teams from winning the championship, or as Mr. Jones has it:

“People who follow sports for a living can make all the arguments in their sleep, but for me, it boils down to this: If you’re going to crown a national champion, isn’t it unfair, un-American, un-everything, to not give every team that wins every game a shot at the crown?!”

Well, no, actually, because the meritocracy that folks like Mr. Jones want to erect would be inherently unfair in its own way. A quick glance at the schedule of unbeaten Boise State University, Mr. Jones’ poster child for BCS inequality, reveals the sorry truth – the Broncos defeated one ranked team all year long (Pac 10 champion Oregon, 19-8, in Week 1). Thereafter, BSU feasted on a bevy of lightweights; beyond Oregon, not one team on BSU’s schedule had an RPI ranking above 40! By contrast, the Southeastern Conference (SEC) has only three teams (out of 12) outside the top 50. This is illustrative of how champions of major conferences must run a regular-season gauntlet of relatively strong opponents in order to secure a crown; Boise State beats one ranked team and then enjoys a buffet of cream-cakes on its way to a Top 5 ranking.

I don’t grudge the Broncos their high ranking, and I certainly believe that they would have a decent shot at defeating any team in the country, but I also think any middling major-conference team, say the SEC’s Georgia (7-5) or Pac 10’s Arizona (8-4), would have just as even a shot at defeating Boise State.

Enter Congress

The WSJ Law Blog seems an odd place for a BCS plaint, but the real topic for Mr. Jones is H.R. 390, a bill currently kicking around Capitol Hill that would, according to Mr. Jones, “prohibit the ‘promot[ion], market[ing], or advertis[ing]’ of a post-season Division I college football game as a national championship game unless it is the final game of a single-elimination post-season playoff tournament rather than the current BCS system.” Mr. Jones refers to the bill approvingly; I would beg to differ. Indeed, the degree of wackiness in H.R. 390 seems to be completely lost on its proponents.

At its heart, the bill attempts to prevent the BCS from marketing its #1 versus #2 season finale as the championship game. This is something I am amenable to, because I think the BCS “championship game” is really no such thing; however, it is clear that the proponents of H.R. 390 make this argument not so much to puncture the BCS’s pretensions, but to supplant it with a multi-team playoff system, a tournament. Implicitly, the bill’s logic is that only a tournament winner can properly be called a “champion,” but anyone with a little grasp of a history can easily see how slippery the label champion can be, even for tournament winners.

For instance, take college basketball. Once upon a time, during the infancy of the NCAA Men’s Basketball Tournament, the winner of the tournament was not so unambiguously considered the champion of all college basketball. For one, the NCAA Tournament competed with another post-season tournament, the National Invitation Tournament (NIT). For numerous reasons, the NIT champion was as highly regarded – and sometimes more so – as the NCAA Tournament champion. Over time, the NCAAs acquired cachet and became the dominant field, but this history lesson should demonstrate for us that the meaning attached to one tournament or another is assigned to it – it does not have any inherent meaning ipso facto. Tournament winners are national champions because that is what we have elected to call them in major college basketball, but it needn’t be that way and wasn’t always so. Tournament winners are merely the winners of tournaments, nothing more.

The Oppressive Onslaught of Mediocrity

This degree of contingency is not lost on the Associated Press (AP), which has issued final rankings of college football teams since 1934. Despite BCS arm-twisting, the AP has resisted automatically crowning the BCS champion as its #1 team. This led to a split championship in 2003, when AP voters rebelled against the BCS and voted Southern California as the top team, despite Louisiana State’s victory over Oklahoma in the BCS “championship game.”

While some congressmen apparently desire to field a college football tournament, we should be skeptical of the idea. For starters, football is a very different sport than basketball. Adding a few games to the end of a 30-game basketball season hardly makes a difference; adding four games to a 12-game football season is by contrast a significant change. An already grueling season becomes nothing but a war of attrition, and such wars are almost always often won by depth alone. This fact embodies what would be the unintended consequence of a football playoff; far from offering smaller programs an equal chance at glory, it would tilt the competitive balance toward the major-conference teams because those teams are the only ones that possess the roster depth to compete in a four-game playoff at the end of the season.

But there is another reason why a playoff would be pernicious to college football, damaging the very thing that makes the game unique in the sports marketplace – a meaningful regular season slate of games that generates enormous interest each and every week. This is so abundantly self-evident to the fan of college football, I hardly feel it necessary to articulate why, but there are those in the press who persist in arguing otherwise. I can only imagine that there is something about being a sports journalist that warps one’s sense of drama and competition. What is so hard to understand about the “survive and advance” aspect of the college football regular season? Naysayers will claim that it is not an immutable fact that losing a game during the season eliminates a team from championship contention (witness two-loss LSU’s 2007 championship); likewise, it is not a given that going undefeated earns for a team a place in the championship game (witness Cincinnati, TCU, and Boise State this year). The playoff proponents will say, because of these imperfections, college football should trade in its current model for a playoff structure.

But let’s think about this. We are being asked to trade in the week-to-week drama of the current set-up for something more akin to professional football. I’ve tried to watch professional football’s regular season; I find it difficult to sustain any interest in it. Take, for example, the “classic” Week 10 contest between Indianapolis (8-0) and New England (6-2), a game the Colts won 35-34 on the now-infamous 4th down call by Patriots’ coach Bill Belichick. It would have been a great moment, had not the entire world known that the outcome was pretty meaningless. Despite losing the game, the Patriots – now 9-5 on the season – are well on their way back to the playoffs. Exactly how does that game in Week 10 matter? But that’s the story every week in the NFL, NBA, NHL, and, to an extent, Major League Baseball. The hype outweighs the reality, which is a group of players going through the motions, where any sense of drama and competition is leeched out of the game and replaced with mere entertainment. That’s how you end up with a 9-7 team in the Super Bowl, like the 2008 Arizona Cardinals, or a 83-78 team in the World Series, like the 2006 St. Louis Cardinals. It’s a wonderful formula for rewarding mediocrity, one that I hope college football avoids.

Rich bank, poor bank

2009-12-21T15:52:00.002-05:00

Writing in the weekend Wall Street Journal, Michael Rapoport had some interesting things to say concerning the Troubled Asset Relief Program, or TARP, that have kept many banks large and small from collapsing over the past year. Most of the media attention has been focused on the largest banks – most recently, Citigroup and Wells Fargo – and their frantic efforts to repay the TARP funds borrowed from the government. While it’s nice to think that these efforts reflect better banking industry health and a deeply felt concern with paying taxpayers back, they really are more indicative of how the banks want to return to the outlandish, pre-crisis bonus culture, something that was a no-go as long as they had TARP funds on their books.

In his column this weekend, Mr. Rapoport chooses to explore an area that has gotten less attention: the effect of TARP on smaller banks. He writes:

“Many banks below the top-tier national and superregional banks look unlikely to repay TARP soon. Beyond the eight original TARP recipients, only 17 of the other 69 banks who got at least $100 million from TARP have repaid the funds. The top eight’s combined assets of $9.4 trillion outweigh the larger group’s still sizable $2.5 trillion.

“Some banks would hurt themselves or their shareholders if they repaid now. They are posting losses, have high levels of bad or overvalued loans for which they aren’t adequately prepared, or have major exposure to the commercial real-estate crunch.”

In a recent speech to representatives of the big banks, Barack Obama was reported to have said, “Go forth and lend.” And lend they must if the economy is to prosper. But as Mr. Rapoport’s article shows, the banks most paralyzed by the crisis are the smaller banks. Likewise, the enterprises most endangered by the crisis are those banks’ customers, small and medium businesses. Conversely, big banks and big business are doing fine, better than fine, actually. Even if profits are depressed, they are slowly winning market share, consolidating in the face of so many smaller concerns collapsing. If a big business needs capital, there are myriad approaches it can take, from issuing shares to high-yield bonds.

President Obama seems to understand this and has even suggested to the big banks that they “increase…lending to small businesses – even if they don’t need the money or the numbers don’t stack up.” The recognition that small-business credit is an ongoing problem is a positive thing, but this seems a strange thing for a president to say, to encourage banks to pursue non-profit-making activities, but such is the state of American business. Besides, even before the crisis, big banks had relatively little to do with small business; they have little expertise in lending to small businesses, and the margins associated with such lending are too small for the big boys to worry about. But, with small and regional banks sidelined due to persistent woes, options are pretty limited at this point to jumpstart lending to small business.

Tiger’s fall and race

2009-12-20T23:20:00.002-05:00

I cannot pretend to understand the fascination folks have with celebrity, but it doesn’t take much special knowledge of mass psychology to understand the schadenfreude at the heart of celebrity culture. We build up our celebrities so that we can tear them down, and we seem to take special delight in the latter part of that proposition. Whether it’s a tabloid blasting furtive pictures of a slightly overweight starlet on a tropical beach or a politician caught on a security camera with his pants around his ankles, we can’t help ourselves in watching the mighty fall – and cheering on their descent.

That’s how I viewed the Tiger Woods affair, just another sorry example of the publicity machine rolling over a “star.”

But, then, yesterday while viewing the new Robert DeNiro movie in the East Village, a whole new component of the Woods embarrassment presented itself to me. The DeNiro movie, Everybody’s Fine, is a pretty standard sentimental holiday movie, a veritable movie version of Harry Chapin’s “Cat’s in the Cradle.” DeNiro’s character, Frank Goode, is a retiree and recent widower who attempts to visit his four children after each of them dropped out of a family reunion. Upon visiting one daughter, DeNiro is shown playing with his grandson on a miniature backyard golf course. After the kid chips one onto the green, DeNiro says something like “You’re a regular Tiger Woods.”

At that moment, you could hear a chorus of derisive snickers erupt from the sparsely peopled theater. A laugh at the expense of the mighty golfer? Certainly. But it was also a spontaneous moment, a kind of collective surprise at how deeply Woods’s indiscretions could be felt in the culture at large. After all, the movie was released on December 4. Woods’s fateful traffic accident occurred less than a week before. What a difference a week can make!

It wasn’t too long after this that I began to hear the tell-tale sounds of an argument behind me. I turned in the shadowed interior of the theater to see a black man standing provocatively close to a seated white man; he was yelling at him, apparently taking exception at the man’s audible pleasure with the Woods reference. After some heated words and some crazy, threatening gestures, the black man shuffled out of the theater, mumbling his disgust with the theatergoers in a display of anger and hurt more characteristic of a James Baldwin story than an East Village theater in 2009. It was then that I first came to realize that the Tiger Woods affair has some pretty heavy racial angles to it.

It’s been 15 years since the O.J. Simpson trial uncovered nasty residual race-based attitudes from both blacks and whites. Tiger Woods is no O.J. Simpson, but I can imagine that won’t stop folks from picking at scabs. All of this is to say that, Barack Obama notwithstanding, race relations is still an issue that inflames. ‘Post-racial,’ while a nice concept, is more aspirational than real. The 2008 presidential election was not unimportant, but it will take lifetimes of patience and kindness to create the society that some think came into being on November 4, 2008.

TARP repayment about banker compensation, not financial health

2009-12-14T11:17:00.002-05:00

Last week, the New York Times’ Andrew Ross Sorkin posted an article on the real reason behind Bank of America’s expedited repayment of bailout funds to the U.S. Government – the desire to escape onerous government restrictions on executive pay. Too often, repayment of funds lent to the banks under the government’s Troubled Asset Relief Program (TARP) has been characterized by banking industry spokesmen as a return to financial health. It is no such thing.

This issue has been thrust back into the public eye this morning with news that Citigroup, the sickliest of America’s big banks, has won government support for a similar repayment of TARP money.

The problem with the repayments is that the underlying conditions within the banking industry are essentially unchanged since last year. One indicator of how overleveraged and ill the banks are is what was done with the TARP money once it was secured. Rather than spurring an increase in the availability of credit, the money went straight into the vaults in order to shore up the banks’ capital reserves. Today, credit is still tight.

Granted, since last year, the banks have sucked in outsized profits associated with the Treasury Department’s policy of quantitative easing (QE), but that policy is likely to shift in the next few months, and the banks will then have to tackle the rotten assets on their balance sheets. The QE-associated profits and TARP money have, in effect, allowed the banks to place their toxic assets in a coma. But comas cannot last forever.

I suspect that some of the same banks repaying TARP money today will be back tomorrow with their hands out, except next time, they’ll want your money with fewer strings attached.

A different kind of market polarization

2009-12-11T16:14:00.006-05:00

A few weeks ago, The Economist published an excellent essay exploring the evolution of the so-called “blockbuster,” the hit songs, CDs, TV shows, and movies on which content developers of all kind rely to drive profits. Since the dawn of the digital age, alternative channels for distribution, chiefly the internet, have played havoc with the traditional model for content development and distribution, upsetting the means whereby media companies commercialize their wares. Over the past decade, it even became fashionable for talking heads to predict the end of the blockbuster. Thanks to instant, on-demand access and a multiplicity of distribution channels, there would be no more blockbusters of the kind seen in the past, such as ET, Elvis Presley, or Seinfeld. The thinking was that, given greater options and flexibility, people will tend toward smaller market niches, abandoning mass-media culture.

This explanation has been trotted out to explain many of the significant events (or non-events) of the past decade affecting the media industry. Everything from declining network news viewership to the large-scale abandonment of the compact disc has been shoehorned into this niche-driven view of the future.

As The Economist explains, it’s not as easy as all that.

According to the magazine, blockbusters are still thriving, perhaps more than ever, yet the niche properties are doing pretty well, too. It’s the middle of the market – the middling properties aimed at a mass audience – that is getting clobbered. The Economist cites the recently released movie The Twilight Saga: New Moon as an example of the enduring appeal of the mass-market blockbuster. In its first weekend, it raked in $140.7 million in its first three days and set an all-time high for its opening day sales with $72.7 million.

Much as the pundits have predicted, niche properties are thriving as well. While small, their audiences are fervent and are often willing to pay more for esoteric stuff. Meanwhile, the “depressed middle,” as The Economist puts it, is absolutely toxic – too bland to occupy a niche or to attract a large mass-market audience. The magazine reports:

“What is a media company to do? As sales become ever more concentrated, it is becoming both more urgent and harder to establish a foothold near the top of the market. A book or film that fails to attract a mass audience tumbles quickly into the depressed middle. To avoid this fate, should a company spread its development and marketing budget over lots of products, hoping that one or two catch on, or should it bet on just a few? The problem is especially acute in businesses like music, where money is tighter than ever and even the hits are not quite as solid as they used to be.”

The fate of large media companies over the next decade is likely to turn on these questions. To make matters worse, it’s not just a matter of identifying “niche” or “middling” properties, because these labels are very fluid and depend greatly upon the channels available to any one company. For example, consider the fate of Monday Night Football (MNF). Well into the 1980s, ABC could count on MNF to occupy Monday evenings with a Top 10 viewing audience, but beginning in the 1990s, that audience began to dwindle, and the program fell into the teens and twenties in the Nielsen rankings. Years ago, a #17- or #22-ranked show could survive while largely paying for itself, but due to the factors identified above, the middle of the rankings had become a commercial no-man’s land. MNF was no longer viable as a network primetime program; it was expensive to produce, and its advertising haul was less and less each year. Rather than kill the franchise, the program was transferred to ABC’s sister network ESPN, the cable sports juggernaut, where the economics of airing the program are different. What was a “depressed-middle” program to one network was a solid primetime niche program to another. Clearly, as the example above indicates, media companies that have multiple distribution channels have an advantage in that they can sometimes rescue the sunken development costs associated with certain properties by finding more appropriate channels for broadcasting, thereby salvaging some of the investment and brand awareness.

In this respect, CBS stands alone. Unlike other major U.S. television networks, CBS has no large cable business and is largely dependent upon the television network itself. This has led to some interesting choices and strategies. For example, among network programmers, it is an article of faith that the younger demographic is the only one that matters. Hit shows that thrive due to a younger viewing audience command higher ad rates than shows aimed at an older demographic. That explains why so much network TV programming is aimed at youth culture.

But CBS has consistently bucked that trend. As an article from today’s Wall Street Journal aptly describes, CBS has long been associated with programs aimed at an older, so-called “heartland” audience. TV’s current #1 drama, NCIS, is a perfect example. While NCIS can’t command the ad-rate premiums of other shows, CBS is perfectly pleased with its huge weekly audience – 22 million each week. CBS has decided that it can live without the rate premium, not to mention the fickleness of the youth audience. That might explain why the only dramas ranked in Nielsen’s 2009 Top 10 are all CBS properties, and yet the network has none of the reality/event TV Top 10 hits of the other networks.

Given the thesis propounded in The Economist, it will be interesting to see how CBS tackles the evolution underway in the media industry. The network is clearly the dominant broadcaster of what I would call traditional network programming, and with its SEC football and NCAA men’s basketball tournament packages, it has a decent portfolio of sports properties, but if the media industry is experiencing a kind of market polarization, CBS is under a lot of pressure to hit the sweet spot each time it debuts a new drama or comedy. Who knew that creating middle-brow TV for Middle America could be so risky? But, as The Economist concluded:

“But nobody knows quite what to do. The old-media world of limited choice, in which any product that was not too objectionable was guaranteed a decent audience, was a comfortable place. Pleasing a customer who can choose from several hundred films and television programmes even without getting up from the sofa, by contrast, is an unnerving prospect.”

Schizoid retailers

2009-12-11T11:55:00.003-05:00

The Wall Street Journal is reporting that November retail sales have nearly doubled the Department of Commerce’s expectations, clocking in at 1.3 percent growth. As we have been told since Thanksgiving, retail sales have been a mixed bag, with discounters and online retailers doing pretty well and mainline stores doing less well.

The Commerce Department’s qualified good news was released this morning, after the WSJ’s press time. An article from Section B (“Stores’ Dilemma: Set Discounts or Hold the Line”) of today’s paper has a slightly less favorable impression of consumer spending, relying upon data that show many consumers are delaying or deferring purchasing in hopes of getting steeper discounts. One industry observer was quoted as saying that “it looks like the middle of August out there.”

Black Friday may have featured a decent showing by retailers – and the November data tend to back that up – but I wouldn’t guess that December is going too well. We’ll see an increase year-on-year because December 2008 was terrible, but I’m expecting holiday-season retail data to confirm one of my main points regarding the New Normal – structurally lower consumer demand.

‘No’ to the BCS, ‘no’ to playoffs

2009-12-07T22:15:00.004-05:00

About this time every year, I publish a post expressing my deep dislike for the Bowl Championship Series (BCS), major college football’s method of selecting something approaching a champion, so this year, I’m going to do something a little different: I’m going to cheer the BCS.

That’s right…three cheers for the BCS.

“Why the change of heart?” you might ask.

Because I read Dan Wetzel’s column over at Yahoo Sports and discovered that you can hate the BCS for two entirely different reasons.

My gripe with the BCS has always been motivated by its attempt to introduce certainty into a system that thrives on uncertainty. The champion of the BCS is no less “mythical” than all of the champions that have come before, and I hate that the BCS attempts to thwart discussion by arbitrarily choosing the “top” two teams for a “championship” game. As I said last year,

“Why is it so important to figure out the mess before the bowls rather than after them? What we have today is no less arbitrary than the old system, what I would call the AP/UPI system, when pollsters with each news service would vote at the end of the season. When two clear teams emerge as #1 and #2, then they should be obliged to play one another, but when we don’t have that scenario, we should be able to pull the plug on the BCS and revert back to the way it was.”

In effect, I imagine the BCS – at best – as a means to preserve the traditional bowl structure, something I quite like (though it, too, could be tweaked a little). When we have a clear #1 and #2, they should play each other, bowls be damned. And the BCS does a good job of making that happen. The problem is that the BCS pits #1 and #2 against each other every year, even when it is not clear at all who those two teams should be – kind of like this year. I mean, we all agree that Alabama is #1, but why does Texas get the nod over Texas Christian? Because they beat a mediocre Nebraska team 13-12?

Yahoo’s Dan Wetzel hates this, too, but instead of seeking a return to bowl season, as we have always known it, he wants to tear down the entire edifice and erect a playoff system in its place. Along the way, Wetzel – never one to pass up an opportunity to shout when a whisper would do – commits many of the same sins of which he accuses his BCS-supporting opponents.

The most obvious flaw in Wetzel’s playoff plan – and, for that matter, almost any playoff plan – is that it merely rearranges the deck chairs. It moves the arbitrariness of the selection process from choosing two teams to sixteen teams. Instead of debating the merits of the #2 and #3 teams, we instead will be debating the merits of #14, 15, 16, 17, 18 and so on. Wetzel anticipates this objection, but not satisfactorily. He writes:

“While the selection process would still draw complaints from the teams left out, those schools often would have two or three losses or significant flaws. In this year’s case, 9-3 LSU would edge out 10-2 BYU in a debate between flawed teams.

“There’s no need to dignify the BCS ridiculous assertion that such an argument would be more heated than five unbeatens vying for two title game spots.”

Wetzel’s logic pretty much concedes that choosing LSU (the last at-large team chosen in his hypothetical playoff for this year) is more or less arbitrary, as the Tigers “edge out” BYU (or Pitt). Wetzel supplies no real criteria for at-large selections and treats it pretty much as an afterthought, a mere formality in filling out a sixteen-team bracket. But it shouldn’t be a formality. His cavalier attitude toward it diminishes the legitimacy of the whole enterprise, especially if you start seeding the bracket with the champions of weak leagues (Troy, Central Michigan, etc.). I don’t find his reasoning here very compelling.

He goes even farther afield of good sense when he begins comparing a potential football playoff to the highly successful NCAA basketball tournament. Again, he anticipates the objections, but doesn’t really address them in an insightful way. To my mind, the biggest problem is the way the large basketball tournament field ruins the regular season; with 65 teams in the field – and with an automatic bid awarded to conference tournament champions, not regular-season champs – the NCAA basketball regular season is absolutely meaningless, a mere jockeying for position in the large post-season tournament. There is no reason to tune in until March. If this were to occur in football, it would ruin the appeal of the sport, where every week poses potential “elimination” games.

He anticipates this, writing:

“While no one would argue that the Sun Belt champ is one of the top 16 teams in the country, its presence is paramount to maintaining the integrity and relevancy of the regular season. While the idea that the season is a four-month playoff is both inaccurate and absurd – best proven this year – college football’s roller-coaster regular season needs to be protected.”

This is not an argument – it’s a point of view. First, the idea that having the Sun Belt champ in the field somehow safeguards the “integrity and relevancy of the regular season” is bullshit. His proposed bracket featured three – three! – teams from both the SEC and Big Ten. How does the fate of the Sun Belt preserve anything if you’re going to take three teams for one power conference or another? Make no mistake, Wetzel’s plan will diminish the week-to-week drama of the regular season.

Take, for example, this year’s contest between Alabama and LSU, played on November 7 in Tuscaloosa. It was a gem of a game, a sort of mini-championship game embedded into the middle of the season. Unbeaten Alabama entered the 4th quarter trailing one-loss LSU 15-10. The winner would have a strong inside position to the SEC championship game, and that fact added immeasurably to the game’s tense, raucous atmosphere. Winner takes all. Or, rather, winner stays alive. But in Wetzel’s universe, the loser gets a mulligan, maybe even a possible rematch. Alabama came back to win that day, 24-15, thanks to a gutty, statement-making final quarter in which it dominated LSU. LSU was vanquished, except in Wetzel World, where it gets a chance to play for the national championship despite its inability to win even a share of the SEC West. This is how a playoff system erodes the meaningfulness of the regular season. Wetzel says that the “roller-coaster regular season needs to be protected,” but his plan is a recipe for doing the exact opposite. It is something to be avoided at all costs.

Wetzel claims that “the idea that the season is a four-month playoff is both inaccurate and absurd.” Again, this is a good piece of snark, but it’s not an argument. That LSU-Alabama game that I alluded to above is proof positive that the “four-month playoff” argument isn’t inaccurate or absurd. Playoffs are characterized by an elimination from consideration – that’s precisely the function the regular season currently plays in a satisfactory number of instances. The fact that we don’t have pretty little brackets that casual fans and office girls fill out beside the water cooler doesn’t much bother me.

A more persistent problem is the arbitrariness of the system at the very top, the so-called BCS title game. I’ve already written on this and won’t reprise the argument here. Suffice it to say that I think TCU is every bit as formidable as Texas, and it’s a shame that the Horned Frogs are locked out of the championship game. But here’s a suggestion for the aspiring teams from non-BCS leagues – don’t ever, ever schedule Division 1-AA teams. Your league schedules are already weak; playing Texas State is not going to help raise your street cred come December. I realize that the TCUs of the world have a devil of a time scheduling top-tier programs, but they don’t have the luxury of scheduling out-of-division opponents. This year, TCU defeated two ranked teams; that’s the same number of ranked foes defeated by South Carolina, a very middle-of-the-road SEC team. That circumstance makes it very difficult to mount too bold an objection to the Alabama-Texas match-up that we’re all stuck with.

Let them eat overdraft fees

2009-12-06T15:45:00.001-05:00

There’s an interesting report posted at the NPR website detailing the extent to which Americans, particularly those at the lower end of the economic spectrum, depend upon the alternative banking system of pawn shops and check-cashing centers. The NPR report does a nice job of tapping into the reasoning and resentments that guide these folks away from mainstream banking, including the array of “hidden charges” that people living a paycheck-to-paycheck existence often have to pay, like overdraft fees and fees in connection with minimum balances.

As we entered the recession, I looked very closely at companies in the alternative banking industry as investment possibilities, figuring that these companies’ businesses would be enhanced by a glut of refugees from the traditional banks. One company in particular, First Cash Financial Services (FCFS), made it into the group of companies that I follow closely. In fact, it almost made my Top 5 stocks for 2009. The only factor weighing against it was the arrival of the Obama administration and its stated intention to introduce new regulations upon the shadow banking industry in order to curb loan-sharking and predator lending.

These regulations never really came to pass as Team Obama quickly discovered it had bigger fish to fry. So maybe it’s time to take another look at FCFS. Year to date, it is up 11.44 percent, but has seen 47% growth from the March bottom, much of it coming in just the last few weeks; FCFS’s share price is up nearly 17% since early November.

The upper end of earnings projections for 2010-11 put the company’s growth at a little under 50% over the next 24 months. If the stock were to see a similar rise, you’d be looking at a target price of around $30 a share by the end of 2011. The company’s financial ratios are solid. I’m not wild about the fact that the stock trades at 16x earnings – it is not cheap – but the growth story deserves some attention, particularly given the marketplace as described by the NPR report.

Concerning the regulatory environment, is the alternative banking industry out the woods? Hard to say. While there are certainly bigger fish to fry for financial regulators, the industry fits the profile of the kind of industry that gets clobbered when Washington enters a period of do-gooderism. The industry can’t boast the lobbyists or influence of mainstream commercial banking, and there is the potential for legislators to scapegoat the industry in its endless search for villains after the financial crisis.

For example, despite admitting that the alternative banking industry’s success is a product of rational decision-making by its customers, FDIC Chairwoman Sheila Bair is pushing policy that would transition people into the mainstream banking system by forcing banks to “lower transaction and penalty fees for poorer bank customers, as well as [providing] easier access to credit,” according to NPR. Mainstream banks, of course, are loath to do so, because there is no profit in FDIC’s recommendations. For the banks, providing banking services to poorer folks is more trouble than it’s worth. That’s why the alternative banking industry thrives – it fills a niche that the traditional banks have no interest in filling. I can’t bring myself to pull the trigger on FCFS just yet, especially after the recent run-up in its stock price, but it’s worth watching closely in 2010.

Chinese consumer demand: what are reasonable expectations?

2009-12-05T11:23:00.002-05:00

As a sometime commentator on the Chinese economy, I have been perplexed by what I perceive as irrational exuberance toward China’s long-term economic health and vitality. Last month, I expressed skepticism toward the notion that Chinese consumer demand could compensate for the declining American consumer.

Michael Pettis, professor at Peking University’s Guanghua School of Management and keeper of the irregular but rewarding China Financial Markets blog, has posted an excellent and balanced essay exploring this topic.

Investing notebook: 2009 in review

2009-12-04T22:46:00.008-05:00

Yogi Bear liked to claim that he was smarter than the average bear. I wish I could say the same, but 2009 presented a confounding set of difficulties for the bearish investor, myself included.

When the year started, my portfolio was largely cash, as I at least had the good sense to cut and run from the market after the Lehman Brothers bankruptcy in September 2008. As the decline continued into the new year, I used the depressed values to accumulate larger positions in a couple of stocks I kept, chief among them Altria Group. I also took a few short positions in retailers, positions that didn’t amount to much at the end of the day. And, finally, I watched the corporate bond market closely as the yields soared, ultimately buying pieces of BBB debt at a steep discount. These bond purchases have contributed most of the growth in my portfolio this year.

That’s because I was almost completely wrong about the stock market.

In a year of home runs, I only hit a few of them, buying a few REITs and financial firms at the market’s nadir, but my stock-related gains hit the wall in June, so I got out, sucked up the short-term capital gains taxes, and once again, was more than 50% cash by the end of July.

I never had any faith that the stock-market rally was enduring or grounded in market fundamentals, and so I have missed out on healthy gains since midsummer. So it goes.

The market’s performance, now well into December, is still defying gravity, despite the occasional bombshells that get lobbed into space, such the Dubai debt debacle or the failure of sizeable businesses, such as CIT. Despite this performance – the S&P is up over 22% year to date and over 60% from the March bottom – I remain firmly in the bear camp. I only admit to being early, and that’s bad enough, because in investing, to be early is to be wrong.

Throughout the entire crisis and subsequent market rally, my major mistake was in underestimating the lengths to which the federal government would go to re-inflate asset bubbles. Given the Lehman experience and the contentiousness surrounding the initial stimulus package, my expectations in this regard seemed reasonable. But the events that conditioned that attitude melted in the face of subsequent bailouts, and by late winter it was obvious that the Treasury and Federal Reserve had no stomach for another Lehman. With so money sloshing around thanks to near-zero rate policies, the stock market was pushed higher and higher.

Still, all of the factors that led me to underestimate the market’s buoyancy remain in play and in some cases are more pronounced than back during the summer.

1. Zombie banks
The credit crisis is not over by a long shot, and the government-orchestrated bank bailouts have not had the intended effect of making money available for middle-market corporations, small businesses, and individuals. Our initial attempts to put a floor beneath the bank’s toxic assets failed miserably and became, in effect, a subsidy that went straight into bank vaults to improve bank capital positions. Meanwhile, bank assets – from loan portfolios to asset-backed securities – continue to rot away, slowly sucking the life out of the banks. This condition will only get worse as the easy profits associated with the government-bond racket evaporate.

2. Restrained economic growth
The inter-connectedness of today’s largest banks makes it difficult to simply kill off the sickly ones, and yet without striking upon a better solution than the one currently implemented, we are consigning ourselves to a decade of Japanese-style economic malaise. Unhealthy banks won’t lend, and without capital, businesses can’t grow.

Philip Coggan, The Economist’s capital markets editor, put it this way in the magazine’s The World in 2010:

“It may well be that medium-term economic growth will be slower as a result of the crisis. Some capacity has been destroyed and, in developed countries, the baby-boomers are now starting to retire, which will limit the potential size of the labour force. Japan has spent two uncomfortable decades adjusting to an era of slower growth and greying population.”

3. Uncertainty of demand
The other pillar of economic growth – demand – is similarly challenged. Nearly all of our models developed over the past few years projecting consumer demand in the U.S. are wrong. Since the end of the Cold War, the U.S. consumer – and the U.S.’s willingness to run large trade deficits – has been the main engine of the global economy. I’m not at all sure what the global economy looks like when one factors in lower levels of U.S. consumer demand.

4. Regulatory inaction
I’m hardly the first to notice that the stomach for reforming financial industry regulations is quickly diminishing. Just today, Felix Salmon noted much the same thing:

“Last night I moderated a panel on the future of Wall Street, and there was definitely a consensus that we’ve wasted our crisis and that both Wall Street and Washington have started drifting into complacency. I don’t believe that Barney Frank and Chris Dodd have given up on implementing regulatory reform, but I do believe that the longer it takes, the weaker it’ll be. And I also see almost nothing in the way of constructive help on such matters from the Republicans, when this is an issue which should really unite the parties, rather than divide them.”

Given these problems, the stock market already resembles Wile E. Coyote having run off the edge of a cliff, remaining suspended in mid-air only because he hasn’t yet realized his predicament.

Charting shifting U.S. consumer behavior

2009-12-04T12:14:00.001-05:00

To me, the lynchpin of the New Normal business environment – or whether one exists – is the behavior of the American consumer. It has been American consumers, flush with borrowed cash collateralized by their bloated assets, that have smoothed out the economic cycle for exporters around the world for almost two decades.

This dynamic is not dead, but it is undergoing significant changes, according to data from McKinsey. The prolonged recession and tepid recovery has shifted the balance of power in the marketplace toward the providers of extreme value, i.e., low-priced products, and away from the providers of extreme high-quality or luxury. This new trend won’t impact just the manufacturers of, say, yachts and fine crystal, but any product situated at the higher end of the price-quality spectrum. So that means packaged-food and household good manufacturers will potentially experience declines in premium brands like Tide laundry detergent.

The data is difficult to apply across industries and product classes, but the McKinsey researchers sense that the shift they are seeing is real and broadly applicable. They conclude, “There’s evidence that the shift of consumers away from more expensive products is a widespread trend.”

Finance, mercantilism, and the New Normal

2009-12-01T22:35:00.003-05:00

Appearing over at the City Journal website, Nicole Gelinas has published a nice article exploring why the likelihood of coordinated, multilateral financial regulation reform is scant. The upshot, according to Gelinas:

“So far, no nation has credibly disavowed the notion that its financial sector can continue to expect bailouts in future crises. A credible system to enforce market discipline on financial firms would require national regulations that make it easier for financial markets to withstand failure, including limits on borrowing and mandates for financial instruments—such as credit derivatives—to trade on central exchanges. Because lenders to financial institutions are confident that a national government will bail them out, they continue to lend at lower rates—thus providing the subsidy.”

This is indeed the reality.

We must be willing to sacrifice a little short-term economic performance to craft stronger regulations. The business that we lose in the world of high finance will eventually come back to Wall Street if our new regulatory regime is fair-minded, sober, responsible, and not merely a punitive attack on the bankers. Once banks sense that our regulations are not capricious, the new system will encourage participation worldwide. We needn’t fear regulation when it is deployed in the proper spirit and targets the right set of goals. The first goal is protecting the public purse, which seems impossible if we’re going to bail out every hard case on the Street.

Castles made of sand...

2009-11-26T14:24:00.003-05:00

...slip into the sea, eventually.

It's probably too late now, but you might take a peek at the international pocket of your portfolio after downing your Thanksgiving turkey and stuffing. As reported all over the news today, the government of Dubai is proposing to delay debt payments, which risks “triggering the biggest sovereign default since Argentina in 2001,” according to Bloomberg.

The news hit European markets hard, as exchanges there experienced their worst trading day since April.

Since U.S. Markets are closed for Thanksgiving, we can only guess what shape the markets will be in when they reopen.

So, in browsing your portfolio – and those of mutual funds you might hold – what companies are directly implicated by this? DP World, the shipping company, is certainly one. It is publicly traded, with only 77% owned by the government of Dubai. To my knowledge, most of the other Dubai holdings are wholly-owned and not publicly traded.

However, there will be a ton of creditors with exposure to the situation, and you will want to watch the situation carefully. Many of the banks so exposed are already struggling to maintain adequate levels of capital even as they write down or write off the value of their loan portfolios and other, more exotic securities on their balance sheets. Bloomberg reports:

“The biggest creditors are Abu Dhabi Commercial Bank and Emirate NBD PJSC. Other lenders include Credit Suisse Group AG, HSBC Holdings Plc, Barclays, Lloyds Banking Group Plc and Royal Bank of Scotland Group Plc, according to a person familiar with the situation.”

Of eggheads and good eggs

2009-11-24T19:15:00.003-05:00

I have not written much about prospective new federal health care insurance legislation in many months as my position on it has remained essentially unchanged since the summer (it’s a bad idea). Some might find this close-minded, as the legislation currently evolving in the halls of Congress is different in scope and substance than the discussions from this past summer, but I don’t see that my approach is close-minded at all.

Many smart folks, better informed than myself, have done the heavy lifting of reading through thousands of pages of draft legislation (now over 2,000 pages in Senator Reid’s bill alone). Principally, the Congressional Budget Office (CBO) has issued a report on how the various bills and provisions will affect the federal budget and has concluded that the 2,000 pages of legislation will be “budget positive,” that is, extending health care insurance to 30 million or so people under the Reid plan will actually save money.

But here’s the rub: in order for the bill to be budget positive, this 2,000-page monster will have to be followed, without subsequent revision, to the letter. Raise your hand if you see that happening. Achieving this over the CBO’s ten-year budget window would be difficult enough, and even the CBO acknowledges that to venture a guess beyond 2019 is pure insanity. The CBO director Douglas W. Elmendorf has written as much on his blog, saying, “These longer-term calculations assume that the provisions are enacted and remain unchanged throughout the next two decades, which is often not the case for major legislation.” The director even casts doubt on his agency’s work within the ten-year window, saying that its estimate “is subject to substantial uncertainty.”

This state of affairs is Reason #1 that I can’t support current health-care reform measures. There are some very good ideas inside the various plans, but taken whole, the Reid bill swings the door wide open to future financial oblivion by committing American taxpayers to large unfunded liabilities. As I asked back during the summer, “Why on earth would we put the most profligate branch of government in charge of the most expensive entitlement program in American history?” This is also why my position – and rather inflexibly so – is that Congress must establish a sound record of cost-cutting in the health care arena before I could ever dream of sanctioning greater government participation in health care insurance. And it’s not as if the fat isn’t there to be cut…Medicare by itself is probably the most wasteful government program on record. Reforming Medicare doesn’t require Senator Reid’s vastly re-imagined marketplace for health care, just a little political will and discipline.

The reason I have tuned out the health-care debate and might appear close-minded is because there is nothing that Congress can do in 2009 to satisfy this condition…except, that is, take out its scalpel and start cutting costs without adding further to the nation’s future unfunded liabilities.

Opponents will argue – and do – that that is precisely what the Reid bill attempts to achieve. Take the Washington Post’s Ezra Klein. He believes David Broder, his colleague at the Post, is being not just thick-headed but disingenuous in suggesting that Congress will never abide by the Reid bill’s constraints, that if you would just take the bill’s arithmetic at face value, we will save money in the long run following Harry’s plan, or as he puts it:

“In other words, the revenue and the savings grow more quickly than the costs. Extend that line out further and, yes, federal spending on health care falls as a result of this bill. In other words, the bill satisfies Broder's conditions. But he doesn't come out and say that.

“Instead, he pivots to the now-traditional argument that Congress won’t be able to stick to the savings and revenue measures in this bill.”

Mr. Broder’s argument – really less an argument and more the application of common sense – is “now-traditional” because it is so patently obvious. Klein slams Broder for not having much evidence for his perspective on the Reid bill, but it seems pretty clear that today’s runaway health care costs and the dire condition of the nation’s finances suffice as Exhibits A and B. Simply put, you don’t “reform” institutions into being more accountable and responsible by giving them ever-greater accountability and responsibility. Concerned taxpayers aren’t asking anything more of Congress than they might ask of their financial planners. After all, you typically require some proof of financial acumen before handing over large sums of money and responsibility to another person. Congress has offered no proof of its acumen at all, certainly not in my lifetime. Mr. Broder might be guilty of rattling on about policy details he has little personal knowledge of, but to label him a hack journalist for giving voice to the fears many Americans share is sickeningly elitist.

The real conflict that I perceive – at least, among the chattering classes – vis-à-vis the health care insurance debate is between what I would call the Good Eggs and the Eggheads. A commenter over at the Capital Gains and Games blog alluded to a split that I think is important here, writing that “Broder is representative of a lot of folks (pundits, pontificators and et.al.) who have a wide appreciation of the talk and a shallow grasp of the analysis,” that is, Broder knows what a lot people have said and are saying about health care, but doesn’t have the chops or inclination to submit the bills to rigorous analysis. There is a kernel of truth here. I myself would not have the skill or patience to wade through 2,000 pages of Mr. Reid’s plan. Few people do.

But our intrepid commenter, I think, underestimates “talk.” Talk is not merely conversation points loosely modeled on an underlying policy, but the very real machinations of people figuring out their own self-interests. It goes beyond what is proposed in a bill’s language (something highly conditional at best), taking account of the “soft” data that most people use to live their lives. This includes things like a government’s track record in delivering on promises, a politician’s integrity in calling things as they see them, and an individual’s perceived risk in changing from the status quo to something uncertain. These machinations are inexact and highly susceptible to being manipulated by clever people, but they are – like it or not – the bedrock foundation of democracy. Yes, having the Eggheads around to tell us what a bill might augur – under certain circumstances, given certain conditions – should be valuable inputs to decision-making, but hard data, particularly when Washington is involved, counts for a good deal less than the Eggheads would have it. The Eggheads see the abstractions sketched out on a sheet of paper and wonder why oh why the rest of us can’t appreciate them. The Good Eggs stare at the Eggheads, bemused at the credulity of such smart people.

[HT: Brad DeLong for pointing to some of the material alluded to above]

The risk of unintended consequences

2009-11-24T11:03:00.002-05:00

In today’s New York Times, reporter Andrew Ross Sorkin seems to be telling us “Don’t just do something, stand there!”

His article on the clutch of new financial regulations being put forward in Congress ends forebodingly:

“All these proposals are well intentioned, and with a bit of refining, they may ultimately be the right solutions. But as we learned with the bailouts, they may come with unintended consequences.”

What new law doesn’t have unintended consequences?

Greater transparency (via congressional audit) at the Fed could imperil its political independence? Well, yes, perhaps. Subjecting secured lenders to a haircut if a borrowing bank falls into administration could make secured lending more expensive and “flighty”? Yes, that’s certainly a possibility.

When a guy who heads up one of the last two large independent investment banks left on the Street basically says that bankers can’t control themselves, it would seem the cost of inaction is greater than any of Mr. Sorkin’s unintended consequences. Sorkin’s points are duly noted, but the regulatory train’s leaving the station anyway. All aboard.

Neither a borrower…

2009-11-22T17:59:00.002-05:00

Over at CalculatedRisk.com, there is an interesting post today pointing to a story in the LA Times about so-called “strategic defaults,” or defaults on mortgage loans when the borrower has the ability to make the mortgage payment. The implications of ethics as it relates to this issue are discussed in the related materials found at CalculatedRisk, not so much to determine the rightness or wrongness of a borrower’s decision, but to address how ethics might affect the decision to default and what public policy implications ethical attitudes might have in this regard.

Public policy aside, I must say that I am a bit surprised by the degree to which such decisions by homeowners are couched in the language of ethics and morality. I find this surprising because we rarely, if ever, ask such questions of corporations and their officers when they seek protection from creditors in bankruptcy court. Business loans are business contracts, and all lenders and borrowers are well aware (or should be) of the possibility of bankruptcy and what that means.

Mortgage loans are contracts, too. If someone chooses to walk away from a mortgage because his investment is underwater, how is that so different from a corporation that screws its unsecured creditors in bankruptcy court, especially when said mortgage loans are structured in such a way that makes it easy to walk away? Both decisions, while relieving the distressed parties of certain debts, do have consequences. It’s not like pushing re-start in a video game. For example, a mortgage borrower might see his credit score negatively impacted or he might be sued, in the same way that a corporation might find it hard to establish business relationships with necessary vendors post-bankruptcy.

In a related report released in June quoted by CalculatedRisk, three academics conclude:

The most important barriers to strategic default seem to be moral and social. Ceteris paribus, people who consider it immoral to default are 77% less likely to declare their intention to do so, while people who know someone who defaulted are 82% more likely to declare their intention to do so. While moral attitudes toward default do not seem to be affected by the surrounding environment nor by the anger people exhibit vis-à-vis the current environment, the social pressure not to default is weakened when homeowners live in areas with high frequency of foreclosures or know other people who defaulted strategically. Our results suggest that these contagion effects should be seriously considered in public policy regarding housing.

In an earlier post, CalculatedRisk said much the same thing, that, in essence, one of the biggest fears in the mortgage industry is that the social taboo of defaulting on mortgage debt will disappear, leading to many more defaults.

I would go a step further and suggest that there should be no social taboo to walking away. It is a business decision with business consequences, and this is precisely how people should look at it. To start injecting the mortgage problem with “ethics” at this point seems ludicrous. After all, there was little talk of ethics when all the suspect loans were being made or when the decisions were made to rescue the banks at the center of the storm.

But, as I said before, the ethical rightness or wrongness of the decision per se is not the focus of the materials I’ve alluded to – they merely explore the implications on public policy of a culture that abandons the taboo against strategic defaults.

It is instructive to explore how the language of “ethics” has insinuated itself into the mortgage conversation far beyond its relationship to strategic defaults. For example, how many times have we heard politicians berate the banks for their failure to modify loans to underwater borrowers, and how many times do those arguments rely on a sense of “ethics.” Politicians are quick to point out the “duty” that banks have to do the “socially responsible thing” in helping customers cope with loans they can’t repay. Of course, often, there is a very solid business case to be made in favor of loan modification, but the business case usually takes a back seat to “ethics” and “social responsibility” in public discourse.

It is easy to see, then, how quickly the slope gets slippery when invoking “ethics” in the mortgage quandary. If, according to the politicians, banks have a duty to bail out borrowers, what reciprocal duty do borrowers owe banks? If we take the position that borrowers needn’t worry about the “ethics” of walking away from a mortgage, does that mean mortgage lenders likewise have no ethical duty to modify loans or otherwise help borrowers in trouble?

Enough already about Notre Dame

2009-11-22T15:07:00.002-05:00

It’s mid-November, and the telltale signs of the impending holiday season are upon us: eggnog, holly, and college football pundits asking why Notre Dame sucks. As we hurtle towards another bowl season, there are dozens of great stories to tell about players and teams impacting the national championship picture, and yet, the national media seems fixated on the happenings in South Bend, Indiana. One can only imagine how much oxygen would be used up if Notre Dame actually had a team worth talking about.

Yesterday’s game between Connecticut and Notre Dame was hardly over before Rivals.com’s Tom Dienhart wrote, “Look at Notre Dame, huddled on the shadowy fringe of irrelevance.” Never has so much been written and said about a football program that deserves so little attention, and yet the Notre Dame mystique persists, if only in the minds of the college football cognoscenti. Dienhart captures this attitude perfectly when he writes, “There’s no way Notre Dame and its wealth of built-in advantages ever should lose at home to UConn.”

But what exactly are those “built-in advantages”?

In any sport, at any level, money is always a great salve, and to be sure, no program in the country can boast an exclusive contract with a national television network like Notre Dame’s setup with NBC, but unlike Major League Baseball, money only goes so far in college football. You can’t buy players and stockpile them the way the New York Yankees are able to do. Who really believes that Notre Dame’s financial position is a difference-maker vis-à-vis the Alabamas, Floridas, and Southern Cals of the world? There are a lot of teams with a lot of money – some of them are successful and some of them struggle.

If it’s not money, then, what are other possible “built-in advantages” Notre Dame might enjoy?

Ah, it must be that Notre Dame is the flagship college of American Catholics and has the ability to leverage that role into a national recruiting base. Well, that might have been true 50 years ago when Catholics – particularly ethnic Catholics like Poles, Italians, and Irish – were discriminated against, but today? Not really. The fertile recruiting grounds in the Northeast and Midwest that used to fill Notre Dame’s roster with All-American players are now the locus of intense competition. Simply put, Notre Dame can no longer breeze into places like Boston, Mass. and northern New Jersey and cherry pick the best players. Besides, the “best players” in these areas aren’t as good as they used to be. Affluence and cultural assimilation tend to dampen a young man’s spirit for football, which requires a high degree of rage and aggression. The “poor, huddled masses” that Notre Dame used to count on for football players aren’t as poor and huddled as they used to be. The most fertile football recruiting grounds have shifted to the American South, a region that is, at best, indifferent to Notre Dame and, at worst, downright hostile.

If it’s not talent and money, then maybe Dienhart’s “built-in advantage” is the oft-invoked “tradition.” After all, Notre Dame is one of the hallowed programs of college football, touting numerous national championships and award-winning players. But let’s think about this. When Notre Dame won its last national championship in 1988, most of today’s college football players were not even born yet. Just this weekend, Notre Dame lost to a program – the University of Connecticut – that didn’t even play major-college football in 1988. That year, the Huskies’ landmark victories were against such powerhouses as Delaware, Yale, and Southern Connecticut State.

There is abundant evidence that “tradition” counts for a lot less than many folks assume. A simple comparison between the University of Pittsburgh and the University of South Florida is illustrative of this. Both schools compete in the Big East conference. Pitt began play in 1890 and has enjoyed long periods of dominance throughout its football program’s existence. From 1915 to 1938, Pop Warner and Jock Sutherland won over 80% of their games as Pitt racked up four national championships. More recently, Jackie Sherrill went 50-9-1 from 1977 to 1981, including a national championship and a Heisman Trophy winner in Tony Dorsett. By contrast, South Florida began play only in 1997, and only moved to the major college ranks in 2001. So what was the series record between these schools entering 2009? Tied at three wins apiece.

So much for tradition. It counts for so little in the here and now. After all, the Chicago Cubs enjoy a great “tradition” as well, but they haven’t won a World Series since the Roosevelt administration (that’s Teddy, not Franklin).

There’s nothing so wrong at Notre Dame that can’t be fixed with an excellent head coach, but let’s not kid ourselves about the school’s “built-in advantages.” There are none in this day and age of college football for a relatively small Catholic school located in a dreary town in northern Indiana.

Why housing didn’t bottom out

2009-11-20T12:18:00.004-05:00

“Yesterday’s subprime is today’s FHA. It’s a definite train wreck and the flag will go up in the next couple of months: Bail us out. Give us more money.”
--Robert Toll, CEO, Toll Brothers Inc.

Back in March, I pointed to an article by Henry Blodget as a pretty good articulation of why housing prices probably had much farther to fall before stabilizing, yet as the year dragged on, housing prices did stabilize somewhat, much to my amazement.

An article on B1 of today’s New York Times (“With F.H.A. Help, Easy Loans in Expensive Areas”) is lighting up the blogosphere and goes a long way toward explaining why.

It seems much of the loan alchemy practiced by the Federal National Mortgage Association (Fannie Mae) and the Federal Home Loan Mortgage Corporation (Freddie Mac) in the late stages of the housing bubble has now been picked up by the Federal Housing Administration (FHA).

The Times story details how three down-and-out guys with paltry collective assets were able to finance the purchase of a million-dollar apartment building in Boston, putting down a total of 3.5 per cent and financing the rest through the FHA. The article details how, thanks to the Economic Stimulus Act of 2008, the FHA’s role in the mortgage industry has drastically increased, offsetting the bailed-out failures of Fannie and Freddie. The legislation doubled the loan limits of FHA, in effect, opening the agency up for doing business with middle- and upper-class folks, rather than the working-class poor for whom the agency was created. The article also demonstrates how our Boston trio is not an isolated case.

This change in FHA policy was accompanied by an increase in loan activity, such that, today, the agency “has an abysmally low 0.53% insurance reserve ratio,” as Edward Harrison over at Naked Capitalism puts it. In other words, the agency has greatly ramped up its lending, even as its financial resources are put under greater strain. FHA activity has probably had an appreciable effect on stabilizing housing values. According to Bloomberg, Housing and Urban Development Secretary Shaun Donovan was quoted on November 12 as saying that FHA “guarantees one of every five single family loans.” Quantifying the cost of this activity is less clear, unfortunately, because of the slapdash, panicked atmosphere that prevailed at the time the Economic Stimulus Act of 2008 was passed. It is not entirely clear how FHA accesses taxpayer money: does it need Congressional approval, or might it simply make a request directly to the US Treasury? If the latter scenario is the case, it doesn’t bode well for transparency or accountability.

And yet even as the HUD secretary characterized FHA as being in “real risk” of further cash infusions to keep the agency going, Barney Frank (D-MA), chairman of the House Financial Services Committee is pressing to increase the agency’s loan cap still further by an additional $100,000.

The Frank approach is not evil, and it’s not stupid. I can see perfectly clearly why Congressman Frank and his colleagues are doing this. It’s basically an attempt to outrun the same monsters that were menacing us last year at this time. The logic goes something like this: to save ourselves, we have to save the banks; to save the banks, we have to preserve housing values, because bank exposure is astronomical and any significant decline from here in housing values would, in effect, destroy the entire U.S. banking system. Their thinking is that, if we can just put the mortgage industry into some kind of protective coma, it buys us time to fix the economy, put people back to work, and see some kind of broad economic growth, i.e., we’ll be in a stronger position then to help banks unwind their bad bets by slowly letting the air out of the housing market.

However, there are significant flaws with this approach. First, Frank and his minions discount the sheer amount of taxpayer money required (a) to prop up housing values and (b) to spur a requisite level of employment and growth. It simply is not going to be possible to achieve these goals through the public purse without doing permanent damage to the country’s long-term finances with attendant hyperinflation and dollar devaluation. Second, the “value” and “growth” achieved through direct federal intervention is and would be transitory and unsustainable. As soon as stimulus is removed from the housing market or the larger economy, levels of demand would plummet. Remember, folks, the government is basically aiming to sustain a level of demand (in housing and more generally) that is well beyond our economic means.

The Frank approach, therefore, is destined to fail. It is, at best, a short-term solution, a plan designed to kick the can further down the street with the assumption being that the street never ends.

Sarah Palin’s brilliant publicist

2009-11-17T11:26:00.003-05:00

The dominant theme to emerge from former Alaska governor Sarah Palin’s recent blitz of television coverage seems to be that she doesn’t like being “handled.” Thematically, this coheres with the Going Rogue title of her new biography. It also plays to the disaffection inside the Republican Party, where many longtime Republicans are “going rogue” and ousting folks deemed to be insufficiently conservative. If this were the extent of Palin’s mythmaking, it would warrant a passing grade in the annals of political spin. Very clever stuff, all packaged neatly for lazy journalists to purvey.

Then something else dawned on me. Over at the Economist.com, a reporter reminds us that, when Oprah Winfrey asked her of her 2012 aspirations, Palin replied, “It’s nice not to be handled…to go where I want to go.” I didn’t watch the interview, so forgive my lateness to the topic, but was this a brilliant – and brilliantly cynical – answer or what? I mean, here we have Sarah Palin being interviewed by Oprah Winfrey, the shepherdess of millions of you-go-girl feminists, basically reducing the 2008 election loss to “handlers” (implicitly men) taking away Palin’s prerogative to act and speak (as a woman). This one answer shows Palin – or perhaps her new handlers – to be a ninja master of political manipulation. Scary good.

But then I think about that dreadful early interview Sarah Palin had with Katie Couric, when she repeatedly swung and missed at softball questions from a softball journalist. She recovered somewhat in a later vice presidential debate with the feckless Joe Biden, but that’s mostly because today’s debate format – much negotiated over by the candidates – allow participants to evade questions with set-piece answers, and Palin has shown the ability to deliver a set piece; however, anything that demands extemporaneity and easy command of the issues, she’s as clueless as you-know-who.

I look at Sarah Palin, and I see a lot of George Bush…and that ain’t good. The last person the Republican Party needs right now in the White House is another evangelical lightweight who compensates for his lack of judgment and knowledge with an austere, misguided sense of providence and personal loyalty.

Trying terrorists and reciprocal liability

2009-11-16T20:20:00.002-05:00

More to my post of this weekend questioning the wisdom of trying the alleged mastermind of the 9/11 terrorist attacks in the U.S., George Friedman of Stratfor.com has posted an excellent essay exploring the topic. The crux of the problem, according to Friedman, of trying terrorists as criminals in U.S. courts:

Spies, saboteurs and terrorists fall outside the realm of international law. This class of actors falls under the category of national law, leaving open the question of their liability if they conduct acts inimical to a third country. Who has jurisdiction? The United States is claiming that Mohammed is to be tried under the criminal code of the United States for actions planned in Afghanistan but carried out by others in the United States. It is a defensible position, but where does this leave American intelligence planners working at CIA headquarters for actions carried out by others in a third country? Are they subject to prosecution in the third country? Those captured in the third country clearly are, but the claim here is that Mohammed is subject to prosecution under U.S. laws for actions carried out by others in the United States. And that creates an interesting reciprocal liability.

This essay is highly recommended. It might not cross its T's or dot its I's perfectly, but in terms of teeing up the larger issues, I think it's right on target.

Nothing to see here

2009-11-16T12:40:00.003-05:00

It’s larger than nine U.S. states, more economically depressed than Detroit, and more conservative than any area in its immediate vicinity. It’s the 23rd Congressional District of New York, a huge swathe of backcountry extending from the Canadian border down to just north of the I-90 corridor running from Rochester to Albany. Its major population centers are places like Oswego, Watertown, and Plattsburgh, places that have long hemorrhaged jobs, wealth, and population.

You might have heard about the 23rd District recently thanks to the off-year Congressional election this month where a Democrat won the district’s U.S. House seat for the first time since the 1800s. It was the only bright light for the Democrats in an otherwise dreary election season, but pundits of all political persuasions have sought to interpret the 23rd District’s tea leaves as validation for their perspectives (imagine that). Democrats claim that their victory in this long-time bastion of Republican politics is proof positive of their message and program. Conservatives claim the opposite and point to the incredible second-place showing by a third-party candidate as validation that, with better financing and organization, he could have won. Moderate Republicans and independents feel confirmed in their position as kingmaker, even as the Republican Party’s official candidate quit the race amid eroding support.

In truth, all three groups have something positive to talk about. Democrats should feel good about winning the election, as well as their recent gains in the district’s voting rolls at large, but let’s not go overboard in what this means about their “message and program,” either locally or nationally. They merely profited from the Republican Party’s bout of civil war, where moderate and conservative Republicans decided to fight each other rather than the standing candidate from the Democratic Party.

Conservatives, too, should feel emboldened by the election results in that they were able to lift a third-party candidate (Conservative Party candidate Doug Hoffman) to within three percentage points of victory. For perspective, there are only two third-party members of the U.S. Congress (Senators Sanders and Lieberman). So, yes, this was an accomplishment of sorts…but at what cost? By backing en masse a third-party candidate, conservatives took a district that had been represented by a Republican since the mid-19th century and turned it over to Democratic control.

Which leads us to the final group that has something positive to take away from the election: the moderates and independents. The recent election demonstrated that this group does indeed make or break candidates. But figuring out how to appeal to them is much more difficult than making overtures to either political pole. In this era of shifting allegiances and alignments, what is the right balance of statism versus populism, fiscal rectitude versus New Dealism, labor versus management, free market capitalism versus government regulation, religion versus secularism?

Part of what explains the flux and drift of the American voter is that neither party has figured out how to govern, how to bridge electoral gaps, or how to forge sturdy coalitions focused on a few key issues. In my view, as we enter full swing into the 2010 mid-term elections, both parties seem content with sticking to old verities. The Democratic policy-making apparatus is still controlled by labor unions and Keynesian economists; the Republicans are still controlled by windbag evangelicals and Ayn Rand devotees; and the independents are still fissiparous and uninterested. I can’t see how recycling the same old arguments of right and left are going to help us surmount the considerable troubles we face. Sadly, I fear that it will take more pain before Americans begin to coalesce around a set of ideas – and a proper ordering of priorities – that might see us to better days.

The die is cast, unwisely

2009-11-15T13:36:00.001-05:00

The U.S. government’s recent track record in prosecuting high-profile criminal cases in not very good. It seems the incompetence that was part and parcel of the Bush administration extends to the Obama administration’s Department of Justice as well. Just this year, we have seen notable failures. First, back in May, a district court in Montana delivered a stunning rebuke to the government in what the DOJ called the most significant environmental case taken up by the government. In this matter the government didn’t secure one – not one – notable verdict. Then, last week, two Bear Stearns hedge fund guys walked away free when a Brooklyn, NY jury found them not guilty of the government’s charges of lying to investors. In both cases, hubris, prosecutorial ineptitude, and downright bad faith led to the defeats.

So color me skeptical concerning the Obama administration’s decision to try the 9/11 suspects held at Guantanamo Bay here in New York.

The China mystery

2009-11-12T17:09:00.005-05:00

Economic miracle or basket-case?

Given the decade’s worth of positive financial press, it seems almost irrational to ask this question about China, but every day, there are startling reports of economic waste and inefficiency that dwarf our own “bridges to nowhere” or Cash for Clunkers. For example, John Carney at the Business Insider unearthed an Al-Jazeera report detailing the construction of an entire new town in Inner Mongolia…only problem is, it’s empty. Since the world’s central banks rallied to throw money at the financial crisis, I have seen several such stories about the Chinese “recovery,” but they are typically drowned out by what has become the standard narrative in the press: the Chinese recovery is earlier and stronger than its Western counterparts.

So embedded is this perspective into mainstream American business thinking, exporting to China is now considered a magical elixir in corporate circles. The latest number of McKinsey Quarterly tees up the viewpoint this way: “Asia’s emerging economies are leading the world out of recession, and the region’s consumers are taking the baton from their over-extended counterparts in developed countries.”

To say that China is important to the global economy is an understatement, but its relevance has never been predicated upon the Chinese consumer; rather, it is cheap labor and cheap manufacturing that has made modern China. The country has basically followed the Japanese playbook on economic growth, making cheap goods for the rest of the world – read here, the Americans – to buy. McKinsey cites that private consumption accounts for just about half of Asian GDP versus almost three-fourths of US GDP. Certainly, if the Chinese consumer ever does wake up, it would make China the largest consumer market in the world, but to date, the consumer market in China has only posted modest gains in relation to the country’s overall growth.

It was the 16th century Italian Jesuit Pietro Maffei who first uttered the immortal characterization of the Chinese: “they sell everything and buy nothing.” This is less true than it used to be, and the McKinsey article details how a handful of American companies has done really well selling in China, including Yum! Brands’ KFC unit and General Motors. The U.S.-China Business Council (USCBC) would claim that more than a handful of U.S. companies benefit greatly from the Chinese market. After all, according to USCBC, China (including Hong Kong) is America’s third-largest export market, trailing only Canada and Mexico; however, Maffei’s sentiment still gives voice to the fear of hitching one’s wagon too tightly to China’s consumers.

If past Chinese behavior isn’t convincing in this regard, then maybe future economic prospects might be more so. This is why the dominant media narrative regarding China’s economic performance and future prospects becomes very important – many companies are making existential corporate decisions based on the assumption that Chinese consumers are the wave of the future, and this, of course, depends on a continuing economic boom in China.

But this narrative isn’t as straightforward as all that, and the caveats are often lost in the fine print.

The first caveat is “nothing is what it seems.” Over at the Business Insider’s Clusterstock blog, today’s Chart of the Day humorously illustrates why U.S. exports to China might be more underwhelming than the cheerleaders let on. The second-largest class of goods exported to China from the U.S. is so-called “waste and scrap,” i.e., trash. In a bit of snark, one might respond that is precisely what we get in return, but all kidding aside, it can’t be a good thing that America’s second-largest export to China is this mountain of unfinished, unimproved goods (in fact, they're not even “goods”).

Caveat Number Two – and the much more serious one – is the structure and substance of China’s economy, and to dissect that properly, the story must begin with Chinese exports to the so-called rich world. China wouldn’t be the subject of national conversation if it weren’t for the huge trade imbalances between it and the U.S. As a practical matter, what those imbalances do is purchase time for the Chinese to “catch up” and modernize. Part of that catching up requires that wealth be distributed throughout the country by maintaining high levels of employment, even when domestic demand is slow to non-existent. That in turn requires huge sums of “stimulus,” something the Chinese government is quite capable of given its huge reserves of U.S. Treasuries. But there’s a catch, captured neatly by Douglas A. McIntyre writing on the 24/7 Wall St. blog yesterday:

“China is making a clever gamble and probably a smart one. It can pour money into its economy be creating increased liquidity to banks which quickly makes it way to consumers and industry. The world’s most populous nation makes it its business to improve its infrastructure rapidly which creates more jobs and revenue for the construction industry. The money that the stimulus passes to consumers is often used to buy goods made in China, keeping factory production at an acceptable level.

“But, the Chinese gamble is based on a recovery of the wealthy economies occurring before the Chinese stimulus package runs out. A renewal of high demand for exports will allow China to move back to a period of “natural” growth and the government withdraws its artificial support.”

What doesn’t get talked about often enough, neither in the media nor in the C-level suite, is what happens if all of this goes horribly wrong (after all, it’s not like the Chinese “gamble” started with the financial crisis; they have been doing more or less the same thing for years). What if, as Politico.com’s Eamon Javers posits in a recent article, the entire Chinese economic recovery is a charade of fraudulent government bookkeeping and ginned-up demand? Javers characterizes the “China bears” as those who believe that slowing international and domestic demand and massive industrial overcapacity will create a huge crash in China…eventually. But how soon? And how long can the Chinese government hide the damage?

In this space I have written much the same thing, but that was a few years back, and China’s continued prosperity has chastened my appetite for predicting Chinese doom and gloom. But keeping my mouth shut is not the same thing as joining the China bandwagon. I have serious reservations regarding China’s ability to pick up the slack in the global economy created by flagging American consumer demand. At least, not any time soon. And if the timing of China’s material transformation to the first world is off by a few years, a worst-case scenario of internal civil strife and economic decay could delay China’s ascendancy for quite some time.

A Veterans Day post

2009-11-11T12:03:00.003-05:00

Through its RSS feed, the Metropolitan Museum of Art selects daily an item to feature from its Collection Database. It’s a fun way to acquaint oneself with the bounty of the Museum’s collection and adds a little spice to the daily barrage of economic reports and business headlines that flood into my news reader.

I was particularly moved by today’s item, “Two Minute Silence, Armistice Day” (1918), a black-and-white photograph taken, one presumes, on the day the Armistice ending World War One was signed (rather than the official commemoration of the event a year later and then every year since). The photograph captures the “original” two-minute silence in London, which then became a staple of Armistice Day.

As we observe Veterans Day today in the U.S., I think it is especially moving to recall that four veterans of World War One died in 2009, the last three UK-resident veterans of that conflict, as well as the last Australian. According to Wikipedia, only three WWI veterans remain, one American, one Brit (currently living in Australia), and one Canadian.

The Divagator wishes to honor all Allied veterans of foreign wars. Many thanks for your service.

EU-US antitrust divergence?

2009-11-10T13:11:00.004-05:00

It seems my admonishing post of last week concerning pretzels, antitrust, and bureaucrats merely presaged a more substantive story this week: the European Commission’s objection to Oracle’s purchase of Sun Microsystems, claiming the deal would be anticompetitive. U.S. antitrust authorities have already blessed the acquisition.

Are we witnessing a divergence of antitrust policy across the Atlantic?

This isn’t the first time that the European Union’s take on antitrust and competition law has flown in the face of American authorities, particularly in the technology sector. But the example of Microsoft involved alleged anticompetitive behavior, such as the bundling of music players and browsers with its Windows operating system. What about merger policy?

In a speech given in Los Angeles five years ago, Mario Monti – the European Commissioner who started Microsoft’s competition trouble – was confident enough about cross-Atlantic policy harmonization to assert:

“Put simply, the EU and US agree on what competition policy should be all about. We share a common fundamental vision of the role and limitations of public intervention. We both agree that the ultimate purpose of our respective intervention in the market-place should be to ensure that consumer welfare is not harmed.”

One wonders if he feels the same way today.

To me, the crux of the matter isn’t so much the application of tested economic theories to mergers vis-à-vis market competition, but making sure we don’t stack the deck against small and mid-cap companies. If gaining merger clearance becomes an overly expensive process, only big companies – like Oracle Corporation – will have the wherewithal to pursue strategically important acquisitions. And at that point, the fine line that often separates a regulatory thumbs-up from a thumbs-down becomes less meaningful. As important as economic impact and economic theory are to merger policy, they cannot be the only considerations, and yet, when we compare the approval granted to Oracle with last week’s dropped pretzel deal, one begins to wonder if the costs associated with greater antitrust enforcement aren’t falling disproportionately upon smaller businesses.

Too small to succeed?

2009-11-05T17:02:00.003-05:00

These days, there’s a corollary to being “too big to fail” – being “too small to succeed.” Not to oversimplify a very complex set of circumstances, but it can’t be a healthy thing when two mid-sized businesses call off a merger because of antitrust concerns. And this against a backdrop where (a) dizzying amounts of taxpayer aid has flowed to the biggest banks in the country and (b) the U.S. government practically forced mergers upon a handful of other banks (think Wachovia, Washington Mutual, and Bear Stearns).

And yet I read today where two small pretzel (pretzels!) makers have decided to call off a prospective merger for fear of unending FTC inquiries. When the Obama administration took office, everyone knew that the bar was going to be raised on government scrutiny of mergers. It was clear that there was going to be a more active merger and monopoly enforcement presence at the FTC. And this by itself is not necessarily a bad thing. But this latest bit of news, less than one year into the new administration, is already a matter of beating a housefly to death with a hammer.

Given that companies are keeping record amounts of cash on their balance sheets of late, it is understandable that Synders of Hanover might scupper M&A plans in order to further their cash conservation, but whatever the strategic reasons for scrapping the deal, FTC clearance should be at the bottom of the list for a company of its size and industry.

It is illuminating to compare the dropped deal by Synders of Hanover with the European Union’s recent €1.1 billion fine slapped on semiconductor chip manufacturer Intel. It took a lot of bureaucratic sweat, courage, and skill to amass the case against Intel, and I realize comparing merger clearance with prosecuting anti-competitive behavior is an apples-to-oranges comparison; however, I do think the scale and target of the EU’s enforcement action illustrates the yawning gap between America and Europe when it comes to the proper focus of antitrust enforcement. Just as it takes a lot of time and resources to prepare information in response to an FTC inquiry, it takes just as much time and resources to review the material. Why on earth would we want to waste our precious bureaucratic bandwidth on pretzels?

(HT: Vince Veneziani at The Business Insider)

Signs of the “recovery”

2009-11-03T10:07:00.001-05:00

In my inbox this morning courtesy of the Wall Street Journal:

Johnson & Johnson announced plans to cut as much as 7% of its global work force of 120,000 in an effort to cut costs through 2011. The company will book a restructuring charge of up to $1.3 billion in the fourth quarter. Earlier this year, J&J cut about 900 jobs from its U.S. pharmaceutical unit, and in August it consolidated its management structure.

Conceptual art and branding

2009-10-16T11:30:00.003-05:00

It has long struck me that successful conceptual art relies more on branding than aesthetics. Perhaps all art. But it is in conceptual art that branding is more pronounced because so very often that is the only thing on display.

Writing in The New York Times, Dennis Dutton gets at some of these issues in an interesting op-ed piece. He also reminds us of the origins of conceptual art and why today’s practitioners lack a certain authenticity, or even relevance:

“Since the endearingly witty Marcel Duchamp invented conceptual art 90 years ago by offering his ‘ready-mades’ — a urinal or a snow shovel, for instance — for gallery shows, the genre has degenerated. Duchamp, an authentic artistic genius, was in 1917 making sport of the art establishment and its stuffy values. By the time we get to 2009, Mr. Hirst and Mr. Koons are the establishment.”

And what of the poor schmoes who pay eight-figure sums for today’s conceptual flavor of the day? Dutton remarks:

“Future generations, no longer engaged by our art ‘concepts’ and unable to divine any special skill or emotional expression in the work, may lose interest in it as a medium for financial speculation and relegate it to the realm of historical curiosity.

“In this respect, I can’t help regarding medicine cabinets, vacuum cleaners and dead sharks as reckless investments. Somewhere out there in collectorland is the unlucky guy who will be the last one holding the vacuum cleaner, and wondering why.”

And yet the bankers roll in dough

2009-10-14T13:18:00.002-05:00

Nice profile on The New York Times website about a commercial pilot whose salary was cut in half. A great illustration of my issue with Andrew Ross Sorkin’s piece from yesterday.

Wall at Main: the disconnect

2009-10-13T13:40:00.002-05:00

No one is ever going to accuse Andrew Ross Sorkin, the New York Times financial industry beat reporter and keeper of its Dealbook, of being a populist, but his article this morning concerning Goldman Sachs has to be one of his worst efforts on record, dangerously straddling the line between advocate and shill. In trying to capture the country’s ill-at-ease feeling regarding the bank bailouts, Mr. Sorkin somehow penned this paragraph:

“But we can’t have it both ways, either. At one moment, many in the nation crossed their fingers hoping Goldman and the rest of Wall Street would be saved to halt the country’s downward spiral. But when the banks finally get up on their feet, we want them to fall flat again. Mr. Blankfein can’t win.”

Really? “Many in the nation crossed their fingers”? This might be remotely true if the nation Mr. Sorkin had in mind ended at the Hudson River. Of course folks wanted “to halt the country’s downward spiral,” but almost as many would have rather done it without the malefactors who created the mess in the first place. The country was basically told by then Treasury Secretary Hank Paulson, “If you want to save yourselves, you have to save the banks.” Even today, after a month or so of triumphal speeches by central bankers telling us that “the worst is over,” I am not so convinced that the bailouts were a good idea, and almost certainly, the terms at which the money was given were a very bad deal for taxpayers.

And try telling the folks on Main Street that “the worst is over” – you’ll get laughed out of the room. Unemployment continues to spike, real wage earnings have been flat for a generation, health care costs continue to soar, public services are under strain from being underfinanced, tuition costs are ridiculous, and to top matters off – the bank bailouts that Mr. Sorkin chides us about wanting “both ways” threaten to undermine the long-term financial condition of the federal government. And for what? So Mr. Blankfein can create a $23 billion bonus pool for his bankers?

Mr. Sorkin reminds us that Goldman paid back the $10 billion in TARP money, that it didn’t need the money in any event. Maybe that’s true, but who knows in the middle of a bank run what will happen – I’m sure the Goldmanites were glad to have the extra capital. In any event, what Mr. Sorkin doesn’t mention is that Goldman is one of the principal beneficiaries of the massive AIG bailout. It’s all very well documented how Goldman was a counterparty in many of the derivatives transactions that sank AIG, so I won’t warm over what someone else has already prepared, but you’d think that intellectual honesty would have led Mr. Sorkin to at least mention how the AIG bailout saved Goldman Sachs billions of dollars, dollars that presumably will go toward the giant bonus pool that the bank is amassing.

There’s a second point in Sorkin’s quotation above that I find infuriating, that bit about “when the banks finally get up on their feet, we want them to fall flat again.” The banks may be back on their feet, but they are a group of staggering drunks. The government has liberally filled the punch bowl for the banks. With interest rates where they are and government printing presses working day and night, how could the big banks not make a ton of money over the past two quarters? In short, the banks haven’t earned the rebound they experienced, just as they hadn’t earned their profits during the bubble years. The rebound, too, I’m afraid, is nothing but funny money, again completely enabled by damaging long-term federal policy that stacks the deck in their favor. Alas, Mr. Sorkin chooses to leave this little bit of context out of what is chiefly a puff piece for Goldman Sachs. Instead of describing the justified anger of “most people,” he decides that they are just being wishy-washy and petulant whereas the banks are concerned. It is an unfortunate point of view for an otherwise smart and conscientious fellow.

Life’s little ironies

2009-10-11T16:01:00.003-05:00

Today, a friend of mine sent to me a link from The New York Times about news that had escaped my notice concerning a personal hero of mine. Jozef De Veuster, better known as Father Damien, will be canonized today as a saint by The Vatican. It has been well over a century since Father Damien ministered to and cared for the lepers of Hawaii’s Kalaupapa peninsula before succumbing to the disease himself. The recognition was a very long time coming.

After 9/11, in deep need of some healing of my own, or some confirmation of man’s essential goodness, I visited the leper colony that Damien had made famous, and while I can’t say the visit lit the candles of the world for me, I can say that I found it strangely ennobling and humbling to visit the vestiges of his life and work. I am pleased that, after such a long and tortuous struggle, Father Damien has finally received the status within the Church he so truly deserves.

It is more than a little ironic that Damien’s long path to sainthood concludes today on the weekend after the Nobel Prize committee announced Barack Obama as its winner of the 2009 Nobel Peace Prize. Damien’s canonization – and more so, the story of his life and work – puts into perspective for me just how divorced from reality the Nobel committee has become. My own opinion is that the Nobel Peace Prize has for many years been something of a laughingstock, a pathetic stab at relevance for a group of people otherwise highly irrelevant. The juxtaposition of Damien’s canonization with the committee’s decision for Obama is as much edifying as it is a sad comment on the emptiness, spiritual and otherwise, of the so-called elite opinion of Europe.

A man in search of a cartel

2009-10-09T11:08:00.002-05:00

Over at the Business Insider, Jay Yarow has posted an AP story detailing the grumbling noises emanating from Rupert Mudoch, head of News Corp., and Tom Curley, head of the Associated Press, about the “free” usage of their organizations’ content by search engines like Google News.

Yarow points out how exceedingly easy it is for the content generators to block Google by inserting a little bit of code on their pages; however, it seems they’d rather fulminate about freeloading “aggregators and plagiarists.”

Talk about wanting to have your cake and eat it, too!

In the AP article, Curley describes the issue at stake as “especially serious because search engines and bloggers were directing huge amounts of revenue away from content creators,” but is that claim true? The ultimate answer is probably very difficult to quantify, and if nothing else, the organizations’ refusal to take even baby-steps toward protecting their own content via coding is quite telling. News organizations want a large number of eyeballs, but they want them on their own terms and at a price they set. They want the magnifier effect of social networking, but they want it on the terms they used to set with the old distribution channels of yesterday. When viewed from this perspective, who is the freeloader?

When you hear the Rupert Murdochs of the world talk about “taking back control of our content,” it rings a little empty, for he and his organization have always had the ability to “control” their content. If you don't want to participate in the social aspect of new media, then don't, but for God's sake, stop complaining about having to share the ball with the other kids on the playground.

Pay walls grow taller

2009-10-06T11:46:00.003-05:00

As many online media outlets moved to the so-called “ad-based” model over the past few years, I have been trying to figure out how giving away content for free could possibly be profitable. We all know the argument by now – free content means more eyeballs, and more eyeballs mean more exposure for advertisers, thus higher rates for ad placement, thus more revenue. This seems logical enough, and even former pay-per-view stalwarts like The Wall Street Journal and The Financial Times seemed to cotton on to the free future by lowering or eliminating their pay walls.

But since the onset of the financial crisis it appears that sentiment is moving in the opposite direction, as more and more formerly free content is being placed behind a pay wall. For example, I received this morning an email from The Economist announcing a new policy concerning non-subscriber online access (see image). Clearly, the ad-based model has been tried and found wanting by media companies. So what is the problem with the logic spelled out above?

There are several possible answers to this question. First and foremost is the ability of online advertisers to measure the effectiveness of their online ads via click-through statistics. In the bad old days of print, radio, and television advertising, it was wickedly difficult to measure the effectiveness of ad placement. Data was often at best correlative. If sales revenue spiked after an ad campaign, marketers were quick to assert a causal relationship; however, the metrics offered via click-throughs and e-commerce have raised the bar, allowing companies to better track the actual effectiveness of online advertising. My thinking is that a lot of companies don’t like what they’re seeing from the click-through rates on ads placed on web pages with free media content and are pushing back against the media companies on price, arguing that they should pay less if people aren’t actually interacting with the ad placements.

If this is in fact the case, then the very thing that was supposed to lift advertising revenues – the ability to provide targeted and measurable ads – could be a problem for media companies. After all, ask yourself, when is the last time you have clicked on an ad whilst reading the newspaper online?

The quiet month

2009-09-30T10:32:00.000-05:00

Per the usual, my posting activity this September has been practically non-existent. This has been the case every September since I started keeping this online diary in 2006. Only in September 2007 have I posted more than two items (it was seven that year), and that was only because the third quarter of 2007 was when the proverbial shit started to hit the fan vis-à-vis the economy. In other words, there was plenty of important stuff to talk about. Even that year, however, conformed to the September pattern eventually, as my posting activity trailed off precipitously, thanks to the intrusions of college football.

So, having said that, I will resume a close-to-normal schedule in October, including some thoughts on personal finance and investment, financial regulation, foreign policy, and maybe a few posts on recent books I’ve read and trips I’ve taken.

BMD overhauled, not scrapped?

2009-09-18T09:57:00.003-05:00

According to this morning’s New York Times, President Obama’s decision to scupper the Bush administration’s ballistic missile defense (BMD) program in Central Europe does not mean that there will be no BMD capability there. Obama seeks to replace the Bush plan with his own that, according the White House, “provides for the defense of U.S. deployed forces, their families, and our Allies in Europe sooner and more comprehensively than the previous program, and involves more flexible and survivable systems.”

This is better than what we thought yesterday. The substance of the policy bothers me less today, but the styling of it is troublesome. We could have elected to make this switch in policy under the radar had we chosen to do so. After all, we are not abandoning missile defense, merely tweaking it. So why the big, splashy press effort over what amounts to a tweak?

I can’t imagine that such a loud announcement of this matter was politically beneficial to those American allies in the Czech Republic and Poland who have labored and risked much to sell this program to their constituents. Our allies in Central Europe are probably wondering what, precisely, to make of this shift in policy and the way it was announced. While we might find their worries in this regard to be neurotic, you would be worried, too, if Russia was in your neighborhood. This is a corner of the world that knows what it’s like to be abandoned to the wolves (the Sudeten crisis, the Molotov-Ribbentrop Pact, Yalta) – slights and broken promises are serious business. We’re probably going to need more than a press release and speech to reassure the Czechs and Poles that we’re not going anywhere.

BMD is scuttled

2009-09-17T16:55:00.001-05:00

After catching ton of grief over the past nine months for not moving far enough away from several of the former administration’s policies, President Barack Obama today announced a fairly large departure from the Bush years: the US is scuttling its effort to deploy ballistic missile defense (BMD) systems in Poland and the Czech Republic.

This is a pretty big deal, if only in terms of symbolism. The reason why is that the Russians loathed the idea of the US putting such high-level military assets inside of the former Warsaw Pact. Although Russia was not the ostensible target of the weapons system (that would be Iran), it mattered little to the Russians who the Pentagon’s stated adversary was. The decision to scuttle the BMD plans opens up the possibility of closer US-Russian cooperation elsewhere, namely against Iran.

But don’t hold your breath. There have been no reports of an agreement in principle, and the two countries many times have approached the dance floor only to move in opposite directions ultimately. Indeed, the justification given by the Obama administration for ending the BMD effort – that Iran was further away from deploying nuclear weapons than previously thought – argues against close US-Russian cooperation by trivializing the importance of Iran’s weapons program. Indeed, if Iran is behind schedule, so to speak, why pull the BMD card off the table – it’s one of the few points of leverage we have vis-à-vis the Russians. Why not let it remain a pending issue for a while longer?

The US president has taken body shots from every which direction over the past few months on an array of issues, some deserved, but more have been petty in nature. But this decision is unwise. Many observers of US foreign policy will want to see definitive progress in US-Russian relations in the aftermath of this decision. Lacking that, it’s hard to see why we would appease the Russians without gaining anything in return, especially when this decision will likely alienate the remaining US supporters in Poland and the Czech Republic. Ah, but what’s a little perfidy among allies?

Two Americas

2009-08-29T14:36:00.003-05:00

The weekend Wall Street Journal’s page one contains an interesting article on the so-called recovery in which it paints a picture of two Americas, but the dichotomy it notes has less to do with erstwhile Democratic presidential candidate John Edwards’ poverty/wealth divide and more to do with Wall Street versus small businesses. This notion is populist in its own way, but more accurately identifies a real and emerging fault line in American politics, much more so than Mr. Edwards’ lame attempt to parrot William Jennings Bryan.

This fault line was first exposed anew last year during the congressional debates over the first bailout package, when the populist wings of both parties rebelled against their parties’ leadership to defeat the initial bill. I had noted at that time how strange it was to see those at the far left and far right of the political spectrum make common cause against the center, but for one moment last fall, this was the case. As it happens with most alliances of convenience, however, the cooperation almost immediately dissipated, and a second attempt to get a bailout bill succeeded.

Lefties and conservatives loathed the bailouts for essentially the same reason – each side felt that too many resources were being deployed to help the elite and too few to help others. Of course, they disagree on who the “others” are, with left-wingers wishing more could be done for the disenfranchised and poor and conservatives sticking up for small businesses, middle class entrepreneurs, and local chambers of commerce.

As the recovery takes shape, the political conflicts of last fall are likely to sharpen. First and foremost, as the Journal points out, the Two Americas perspective highlights how relatively easy it is for corporate America to get access to credit, while small businesses are struggling to do so. Even marginal large companies have ready partners in the banking industry who are willing to provide junk bonds (this Bloomberg article was well circulated last week). Small businesses don’t have this luxury and are increasingly imperiled by a vicious cycle, described in the Journal article by John Graham, a finance professor at Duke University’s Fuqua School of Business:

“If you’re not making money, you need to borrow money … you need to be creditworthy in order to borrow, and if you’re not making money, you’re creditworthiness isn’t very strong.”

To make matters worse, those institutions that cater to small businesses – small and mid-sized regional banks – are themselves in a ton of trouble. Experts estimate that anywhere from 300 to 500 such banks will fail in the next twelve months. Their ill health and dwindling numbers will further exacerbate the credit problems of small companies.

In any event, the plight of small companies promises to be a huge issue during the 2010 election cycle.

Coming to terms with the ‘new normal’

2009-08-27T12:13:00.002-05:00

Repeatedly over the course of the past month, I have read equity analysts who are puzzled by the prolonged summer rally in the stock market, especially when viewed alongside the likelihood of a halting corporate earnings environment. For instance, S&P’s chief investment strategist went on the record to claim,

“We don’t expect this recovery to be spelled with either an upper- or lower-case ‘V’ but rather a lazy ‘U’ … Today’s investor appears to be more willing to embrace the upward price trend than accept the weaker-than-normal economic growth story or the questionable confidence that the huge 2010 EPS estimate inspires. We think the risk/reward tradeoff doesn’t warrant increased exposure.”

This seems on overly tactful way of saying that the investors currently bidding up the market are doing so with very little regard for fundamentals. I largely agree. I have participated in the rally this summer along with everyone else, and while I didn’t beat the major indices during the June-July-August time period due to an excess of caution, I still outperformed my expectations for the summer months. Good enough for me. I went 50% cash this week, and if I leave money on the table, so be it. That caution served me well during 2008, and I see no reason to start overriding what my gut tells me today about the markets just because the markets are being pushed higher by weak companies.

In a service-heavy economy like ours, corporate earnings are driven by the consumption patterns of businesses and individuals. The problem for us is that – in my opinion – we are currently going through a generational shift in those consumption patterns. For too long, these patterns were artificially enhanced by housing values and easy credit. As households and businesses de-lever, consumption will necessarily decrease and will do so on a rather long trend line (over 3 to 5 years, perhaps longer). This is the new normal, but it is difficult to accept for some folks.

Certainly, the government doesn’t want to accept it. After all, what was the Cash for Clunkers program but an overt attempt to swim against the macro-economic current by inducing greater consumption artificially. The Fed’s policies are aimed at the same target: by pumping into the economy huge amounts of liquidity, the Fed basically seeks to re-inflate (or just stabilize) asset values, principally the stock market. This can work – and has worked – in the short term, but it also, potentially, touches off a cycle where similar government interventions will become structurally necessary to keep the economy aloft. Not a great idea for the long term sustainability of the economy at large.

The government’s refusal to accept the new normal is best seen in budget projections. Only within the past week have government economists come round to the notion that our deficits are going to be much, much higher toward the end of the current projected time period. Writing for Forbes.com, Joshua Zumbrun summarizes the situation:

The Congressional Budget Office and White House both released alarming projections for the long-term deficit on Tuesday. When it first unveiled its budget in February, the White House said the deficit over the next 10 years would be $7.1 trillion. On Tuesday, they revised that figure to $9 trillion.

The revision reflects a more pessimistic, or simply more realistic, analysis of the economy. What it does not reflect is any concession that it will not pass its budget initiatives.

Sad, but true. Even when staring at the new normal right between the eyes, we go about our business, as if nothing has changed. These new budget projections confirm what most sane folks could already sense – that this latest crisis has impaired our economic prospects for quite a long time, perhaps as long as a generation, perhaps permanently. Even before this latest crisis, our long-term public finances were in bad shape, especially when considering that Social Security will, one day, become an expense rather than a source of cheap extra revenue.

That we find it impossible to align projected government expenditures with the new normal is quite serious business.

Bernanke spins the crisis

2009-08-25T11:49:00.002-05:00

I learned this morning that President Obama has reappointed Ben Bernanke as the Chairman of the Federal Reserve. This is not surprising. Mr. Bernanke has battled the most destructive economic event in several generations, and while far from perfect, his strategy to remedy our condition has produced a leveling off of the worst of the crisis to date.

On Friday, speaking at Jackson Hole, Wyoming, to a global convocation of central bankers, Bernanke attempted to lay out the “lessons” of the past year, but my sense is that he left a good deal out of the speech. Indeed, some feel the speech was too triumphant, but I’m not especially put out by its tone, but rather what it leaves out of the discussion.

Most notably, the Fed Chairman’s summary of why the US government allowed Lehman Brothers to fail – calling its bankruptcy “unavoidable” – is simply false. Lehman’s case was difficult, but no more so than AIG, the large insurer that US financial authorities have bailed out to the tune of $180 billion. If anything, the gallery of failed enterprises bailed out by Washington – from GSEs Fannie Mae and Freddie Mac to General Motors – has demonstrated that there was absolutely nothing “unavoidable” about Lehman’s bankruptcy.

A more likely explanation for why Lehman was allowed to fail is timing and ideology. Lehman Brothers was the first enterprise of what I would call “global systemic relevance” to falter and to do so without a white knight acquirer to save it (remember, Bear Stearns was “saved” earlier via a government-arranged sweetheart deal with J.P. Morgan); therefore, it put the bureaucrats on the spot – they had to make a decision. Unswayed by protestations that Lehman’s collapse would be very bad, the authorities invoked moral hazard and made an example of Lehman. No one at the Fed has invoked moral hazard since.

Overall, I agree with Bernanke’s sense of where we are – things could definitely be worse; however, by papering over his early mistakes and misapplications of ideology, his speech lacks a certain veracity. Bernanke characterizes the “lessons” learned as nothing all that surprising to economic historians such as himself, but judging from his policy responses post-Lehman, I’d say the destruction unleashed by Lehman’s bankruptcy surprised him and most everybody else. If they had had a clue as to what was to follow, they would have never let Lehman die.

I suppose there is a need for central bankers to seem like they’re in control and that they fully understand the financial system, but for a few months last year, the global financial system became unhinged, and we’ll be counting the costs for years in the form of bloated deficits and economic inefficiency. Give Bernanke credit on one front, though – rather than continue to mouth platitudes, he took decisive action when few others were willing to do so. While Federal Reserve policies played a role in the creation of the financial mess, it was not Ben Bernanke’s fault that so many market actors made so many bad decisions over a such long period of time. It was just his bad luck to have the job of cleaning up the mess.

Would you like to play a game?

2009-08-19T14:36:00.003-05:00

Last month, I noted the growing awareness of the speed with which we have plunged headlong into the Age of Robotics. Via this strange research note, Standard & Poor’s has noticed, too:

Robotic warfare is not the Buck Rogers-version of science fiction anymore. Today, unmanned intelligence, surveillance, reconnaissance, and combat weapons are a necessity in the global war against terrorists and insurgents.

Although the United States and other countries are cutting back on big-ticket weapons, spending on high-tech military equipment such as unmanned aerial, ground, and sea vehicles is increasing rapidly. At least 40 countries have programs to develop military robots, according to a recent Times of London article.

While S&P did not link any equities to the surge in military robotics, the Robotics Trends portal site has a ton of suggestions for you. Happy investing.

Journalists of the world, untie!

2009-08-17T15:08:00.002-05:00

“But if we can’t have journalism, can’t we at least have stenography?”

I generally don’t post sound bites, quotations, etc. by themselves, but sometimes, you come across one too good to pass up. This one from Brad DeLong is brilliant, as tangy as sucking on a post-shot wedge of lemon.

Claws of the czar

2009-08-17T11:03:00.005-05:00

Reuters reported last night that the Obama administration’s “pay czar” Kenneth Feinberg commented this weekend, when asked about targeting bonus pay at current and erstwhile TARP firms, that “anything is possible under the law.” I hope this was merely a poor choice of words and not indicative of the administration’s view of contract law. That’s the point of the law: everything is not possible, but rather is circumscribed by letter and spirit. A world where “everything is possible” is not a lawful one, but anarchy.

I am not a fan of excessive bonus payments to executives failing or failed enterprises, but the pay czar’s remarks this weekend – indeed, the entire notion of having a “pay czar” – is misguided. The contracts that govern bonus pay and executive compensation don’t just fall out of the sky; they are agreed to by a board of directors that is supposed to have the company’s interests in mind, but this is rarely the case in this area of corporate decision-making.

If the Obama administration were truly concerned about excessive pay, it would focus on the boards of directors, it would consider how to curtail or end bonus pay contracts at institutions that lose money, and it would do so at the appropriate place and time. Attempting to claw back bonus pay after the fact makes a mockery of contract law, much as the Obama administration’s handling of General Motors’ bondholders trampled upon creditors’ rights.

For the past eight years, there was a swooning chorus of protesters that harangued the prior administration over its insensitivity to perceived constitutional rights, especially as it concerned the Patriot Act; however, these same voices have fallen silent when it comes to legal rights associated with business contracts and a company’s capital structure. That is a shame. The fact that we are more apt to know the names of bonus-pay recipients at Citigroup, rather than the names of the directors who agreed to the compensation, says volumes about how sadly out of focus our concerns are. Those directors should be hung in effigy; because of their manifest poor judgment, they should be forever barred from other directorships. Instead, they continue to live in the cloistered ease that anonymity and wealth affords.

Yes, we should be angry, but the anger needs to be directed at the right people, and it needs to take on a form that is respectful of the law.

Another jobless recovery?

2009-08-13T16:48:00.002-05:00

I think this is a very astute observation and might go a long way toward explaining why, while (maybe) reaching a cyclic bottom in terms of economic destruction, we will likely see unemployment continue to rise. The stabilization that we’re seeing across several sectors is a product of operational downsizing to meet the sudden drop in demand; that doesn’t exclusively mean job-slashing, but much of it has consisted of shedding jobs.

I can’t help thinking here of the ‘Bush Recovery,’ which puzzled a lot of folks in the early years of the decade. That recovery was characterized by rising corporate profits, but not a complementary rise in employment. The subsequent creation of the asset bubble in housing cloaked for a while our inability to see real, organic economic growth.

In any event, back-to-back ‘recoveries’ with little growth in employment can’t be a sign of long-term, sustainable economic health.

Competing stupidities

2009-08-11T10:46:00.000-05:00

A big hat-tip to Brad DeLong for pointing to a post written by James Fallows and published on The Atlantic’s website that reminds us that idiocy in the health insurance debate is not the exclusive preserve of wingnut Republicans. Mr. Fallows quotes approvingly from Steven Pearlstein’s Friday Washington Post op-ed piece, ominously titled “Republicans Propagating Falsehoods in Attacks on Health-Care Reform.” And it’s true, there are Republicans canvassing the country, making outrageous claims about the health insurance plans wafting around The Capitol. Rather than focus on the issues (namely cost, cost, and cost), some Republicans have chosen the kitchen-sink approach, whereby hyperventilating wingnuts carry on about how President Obama wants to euthanize grandparents and institute “Death Committees,” or panels of bureaucrats charged with the heavy responsibility of determining who gets health care and who doesn’t.

The perceived need to stoop to this level is telling – it says that large numbers of conservatives are unmoved by fiscal reality (I assume, as a matter of course, that is already the case with many Democrats). So it would seem that we have collectively abandoned any notion about whether these new entitlements are in any way affordable, not just now, but over the life of the program (which, in Washington, is always forever and a day). Instead, Republicans fulminate and miseducate.

Okay, fine and good.

But here’s the attitude that I find even more maddening than right-wing stupidity and bad faith: progressive officiousness and self-importance. It is on full display in Pearlstein’s op-ed when he chokes down all humility and declares, “Health reform is a test of whether this country can function once again as a civil society.” That “once again” is a nice touch, as if the sentiment wasn’t asinine enough. Why it is so difficult for the Pearlsteins of the world to understand the justifiable fear many have at the idea of creating a larger healthcare mandate for the US government is beyond me. You may disagree, but you don’t get to question the validity of my presentiment, nor do you get to claim how someone’s position on federal health insurance is a bold stroke for or against “civil society” – at least, you can’t do it and maintain any illusion that you’re a journalist (or even intellectually honest).

There are 1001 good reasons that the federal government’s role in health care should not be expansionary, and it is a pity that many Republicans can’t seem to make a case against it without resorting to hysteria. But the Pearlsteins of the world seem determined to make our politics into a battle of competing stupidities. If this is progressivism’s idea of fighting fire with fire, then Brad DeLong is absolutely correct when he says, “We need a much better press corps. We need a very different opposition party to oppose the Democrats. We need both of these things. We need them now.”

Technically speaking

2009-08-06T09:18:00.001-05:00

Even the technical analysts are growing cold on the stock-market rally. The text below is from Standard & Poor’s Morning Briefing:

The S&P 500 has run into the underside of a major area of resistance that runs from 1007 up to 1020. We think this zone will represent a ceiling for the index in the near-to intermediate term. Besides nearing key resistance, we think the S&P 500 is overbought from an intermediate-term standpoint from both a price and internal perspective. Also, many market sentiment indicators are showing fairly extreme levels of bullish sentiment toward the market. While we think the S&P 500 will take another stab to the upside, we think this will represent a topping phase that will eventually lead to a pullback toward the 950/960 zone.

I always have to suppress a chuckle when reading through technical analysis and its approximation of the English language, but at least the text above was clear where it matters – “we think the S&P is overbought.”

Welcome to the recovery

2009-08-05T10:07:00.002-05:00

In an earlier post I had mentioned that the majority of companies I follow – about 50 or so in sum – were having their earnings projections lowered by analysts. Yesterday was no exception; five of seven companies that experienced a revision were revised down. This movement was punctuated this morning with news that Procter & Gamble saw continued decline in its lines of business over the past quarter. The Wall Street Journal reported that “P&G projected further sales declines, saying sales excluding acquisitions and divestitures would be flat to down 3% in the first quarter.”

If a well-managed business like P&G is not able to equal pre-crisis highs, most other business can forget about it. In other words, the business environment over the past quarter was lousy and is projected to stay lousy for the next quarter, yet the stock market has taken off – the S&P index has risen nearly 15% over the trailing three months and over 35% since the beginning of March.

There are several theories that have tried to explain this phenomenon, ranging from wonky and esoteric to downright paranoid. There is the persistent buzz in the blogosphere about high-frequency trading and latency arbitrage, tools that trading houses can use to front-run client orders and perhaps move the market. This is an egregious practice if it’s true; however, I have a hard time believing that this practice can inspire a months’ long market rally that defies any and all common sense. There must be another explanation.

Some folks think they have one in the form of government intervention. The London Forex Broadsheet posits that intervention from the Federal Reserve – by becoming the lender of last resort – “instigated” the stock-market rally. Writing last month in the Wall Street Journal, former hedge fund manager Andy Kessler put it this way:

“At the end of the day, only one thing has worked – flooding the market with dollars. By buying U.S. Treasuries and mortgages to increase the monetary base by $1 trillion, Fed Chairman Ben Bernanke didn’t put money directly into the stock market but he didn’t have to. With nowhere else to go, except maybe commodities, inflows into the stock market have been on a tear.”

As a small retail investor, I try to maintain a more or less traditional view of the markets and ask myself the same question I always ask, “Do these prices represent value in the marketplace?”

The answer today, almost across the board when looking at the market as a whole, is No.

Henry Blodget seems to agree, at least, he did last month, writing that “the market didn’t get nearly as cheap as it usually does at the bottom of a major secular bear market (single-digit PEs). And another leg down would be in keeping with the way other massive crashes have behaved.”

As I asked back in the winter when debating the merits and demerits of Mr. Obama’s stimulus package, what happens when the stimulus runs out and the economy is still broken? Looks like we are going to find out sooner or later. In the mean time, this summer’s hot stock market has all the markings of a sucker’s rally.

The unicorn economy

2009-07-30T12:59:00.002-05:00

This time a year ago, I probably would have thought Tyler Durden was an internet crank par excellence, but with each passing day, his invective against Wall Street, the media, and the U.S. government becomes more and more believable. Even someone like myself with modest financial skills can easily see that corporate earnings – which should be the greatest measure of economic strength – are stuck in neutral. That should portend flat stock-market valuations, not the perky markets we have experienced of late. And it should serve as a muzzle for stock-pumping journos (but it hasn’t).

On a daily basis, I follow a basket of about 50 companies, and by a ratio of about 3:2, analysts have been revising 3Q earnings projections down, not up, with the oil and gas sector leading the way down. Some companies have beaten estimates of late, but those estimates were insanely low to begin with, and as more companies reported at the end of the month, it was clear that this was no earnings season to write home about. So, again, what gives with the stock market?

There is no way that current and projected earnings justify the valuations we are seeing, and yet here we are mid-day with another strong increase in the market, or as the Wall Street Journal’s MarketWatch site gushed:

“Investors were perhaps primed for some good news following a two-day decline in which the Dow shed 38 points. That soft patch was an exception to what has otherwise been a stellar month, with the blue-chip index up more than 7% amid investors’ rising appetite to take on risk.”

We’re truly a nation of idiots.

From We to Wii

2009-07-29T19:43:00.002-05:00

Every now and again, two electronic blips in the fiber-optic miasma of my RSS feed crash into one another, producing something that, in the old days, one used to call insight.

First, this story from David Axe, writing in Wired magazine’s Danger Zone blog, reports on the fast-growing use of drones in U.S. military planning and execution, such that the Air Force can now an envision, as Axe’s ominous headline captures it, an “all-drone future.” Drones, or unmanned aircraft, are already becoming a huge part of ongoing engagements, notably in Afghanistan and along the Pakistani border. Danger Zone reported earlier this year that drones in the U.S. Air Force logged over 400,000 flight hours during 2008, more than double 2006 levels.

Visit here to get a very nice archive of Danger Zone’s coverage of drones in the U.S. military.

That story caught my eye because of several reviews that I have read lately on P.W. Singer’s new book, Wired for War: The Robotics Revolution and Conflict in the 21st Century. I have not read Singer’s book yet, but if the reviews (mostly favorable) are to be believed, it is a magnum opus in the field where public policy and robotics meet. It’s definitely on my list of things to read before the year is out.

Then there is the provocative essay published by Paul Wilmott in yesterday’s Paper of Record. Mr. Wilmott is a so-called quant guy, or someone who makes money in the financial markets by designing fancy mathematical codes telling computers when to buy and when to sell. These algorithms are the drones of the financial world.

But Mr. Wilmott seems to voice some misgivings about the rise of high-frequency trading (HFT), which, at its broadest, is a trading technique that – arguably – allows certain market participants to move the markets all by themselves. The aforementioned algorithms play a central role in HFT. Mr. Wilmott, being a hedge-fund quant guy himself, should know about the effect these things have on the marketplace, even if it makes him a less than ideal messenger for the following kind of warning:

“Buying stocks used to be about long-term value, doing your research and finding the company that you thought had good prospects. Maybe it had a product that you liked the look of, or perhaps a solid management team. Increasingly such real value is becoming irrelevant. The contest is now between the machines — and they’re playing games with real businesses and real people.”

Warren Buffett called derivatives, like the credit-default swaps that made AIG a ward of the state, “financial weapons of mass destruction.” And over $1 trillion dollars later, it seems he was right. Perhaps we should pay a little more attention to the HFT and flash trading, as they may have the potential to wreak as much damage, if not more. Besides, the only people that benefit from this technique are financial-industry professionals, as Felix Salmon has pointed out in his characteristically even-handed way.

Trading algorithms sifting terabytes of data, flying robots that, like angels of death, can hits targets from worlds away…these are the icons of the new age. Like it or lump it.

The flying money pit

2009-07-24T09:01:00.001-05:00

Here in the leaner, meaner (read poorer) America, we have to learn to cut corners and do without (Perish the thought). That includes the US Air Force, which saw one of its weapons systems nixed this week.

A buddy of mine wrote in to The Divagator offering up a little analysis of the F-22’s demise. Since I’m one of those people who never met a weapons system he didn’t like, this was a very instructive short essay on the F-22, which, like national health insurance, is something we don’t need in this era of trillion-dollar annual deficits.

According to the FOTD (Friend of The Divagator):

“I have read a number of news and analysis pieces about the killing of the F-22, and they all tell the same story (expensive hardware, redundant, lobbyists, jobs in congressional districts, military industrial complex – all of which is true). But none of them dig down into the bureaucratic shifts and service rivalries that are clearly part of this issue.

“The F-22 is an Air Force jet, not capable of Close Air Support (CAS) of troops on the ground. For that, the military relies on the Army and Marines (A-10 Warthog "tank killers," AC-130 Specter Gunships, various attack helicopters). Beyond high altitude bombing runs by heavy bombers and drones, the Air Force is pretty much sidelined in Iraq and Afghanistan (and the CIA is operating a lot of the drones).

“Despite the little CAS the Air Force could provide, the Army and Marines would rather use their own assets since the command structures and protocols are more familiar. And when the Air Force does offer CAS, it arrives because an Air Force combat controller (a trained pilot) is embedded with ("fragged out" in the lingo) an Army or Marine infantry unit, and with lasers and communications equipment he directs the Air Force's mission.

“But in most cases, the air assets are part and parcel of the whatever Marine or Army unit is on the ground. The 10th Mountain Division has its own air wing; the 101 Airborne is a helicopter assault force with light infantry, mortars, and field artillery. Etc.

“So where is the Air Force?

“Preparing for war with China and to strike North Korea. Which is all well and good, but F-22s don't help with Afghanistan, and the Pentagon planners have been pretty courageous in preserving current priorities over high-tech wish-lists. Besides, the F-35 Joint Strike stealth fighter-bomber is already being developed to annihilate an enemy. Why is killing the F-22 (we do have 187 of them) even controversial?”

The soaking continues

2009-07-23T09:37:00.006-05:00

You keep thinking that, at some point along the way, people will say enough.

This morning, The New York Times reported that the $6.2 billion pension plan of Delphi Corporation, a bankrupt auto parts maker, would be taken over by the Pension Benefit Guaranty Corporation (PBGC), a government entity that is itself over $33 billion in the hole. The Delphi incident has become something of a hidden bailout to the auto industry as it becomes more and more likely that federal taxpayers will foot the bill on the long-term pension costs associated with Delphi.

According to the Times, PBGC had attempted over several years to compel Delphi’s healthy business units to pay for the pension benefits doled out to workers by placing liens on their assets, but this attempt has been more or less given up because of the adverse impact it would have on government-owned General Motors, Delphi’s main customer.

This is how the worm turns in this new era of government involvement in industry.

Worse still are the sordid little details pouring forth about the preferential treatment that Delphi’s union workers are getting in the deal. Here’s how the Times had it:

“The Delphi pension failure has another unusual twist. Normally, when a company pension fund is taken over by the government, workers may lose part of their benefits because pension insurance is limited. But it appears in Delphi’s case that one group of workers and retirees will be spared cuts — the ones represented by the U.A.W.”

And further:

“There is no precedent for a company making workers whole once their pension plan has failed and the government’s insurance limits apply, according to the federal insurer. Typically, the P.B.G.C. places a claim on any remaining assets in the affiliates of a bankrupt company to help cover its own costs.

“It was not clear whether G.M. would “top up” the retired U.A.W. members with corporate assets or money from its own pension fund. A spokesman declined to provide a cost estimate.

“But word that Delphi’s union retirees would get a special break provoked outrage from Delphi’s nonunion retirees.”

And these are the same folks begging to handle a $1 trillion health care insurance scheme. Politicians have chutzpah, I'll give them that.

Congress and health care costs

2009-07-21T19:28:00.002-05:00

In my prior post I cited Congress’ inability to stem health-care spending over the past two decades as the primary motivating factor in my rejection of President Obama’s effort to revamp the nation’s health insurance system. Essentially, my reasoning is “why on earth would we put the most prodigal branch of government in charge of the most expensive entitlement program in American history?” Sheer madness.

I didn’t expect to see confirmation of this so quickly – on my evening commute no less. From today’s Lex column of The Financial Times, there is an illuminating short piece on so-called biosimilars, which are the biotechnology equivalent of generic drugs. As you probably know, using generic drugs can save a lot of dough. When a health-care plan adds generics to the list of prescription medications that it will pay for, so-called formularies, it’s a win-win for everybody…except the drug companies, of course. That’s why they spend millions of dollars per year on lobbyists and patent lawyers to extend the patent life of their drugs. The biotech industry would love to extend patent life in much the same way, and it seems they have powerful friends in Congress that agree with them. As the FT has it,

“To patent large biological molecules is difficult; and because similar molecules can perform similar functions, makers of biologics tend to patent production processes instead of the drugs. The industry has called for special rules to limit generic competition for 14 years after launch of a new biotechnology drug – about the time traditional drugs enjoy before patents expire. The White House, eager to cut healthcare costs, favours seven years; industry-friendly senators last week proposed 12 years.”

It’s pretty simple, really. If you want to demonstrate your willingness to control costs – and thus put into play a health-care insurance system that is sustainable – cutting down the patent life of biologic therapies would be a great starting point. It is more than fair, particularly when you consider the legal shenanigans that drug companies engage in to extend patents long beyond their original expirations, costing the system billions of dollars in the process.

Be afraid. Be very afraid

2009-07-21T17:50:00.005-05:00

The Obama administration’s new strategy to sell its health-care plan to the masses is now to tell people how the opposition is fear-mongering. Sometimes that strategy works, usually when calling on people to do what they know is morally or ethically right.

But the health-care plans pushed by Democrats in Congress are no such thing. Greater government involvement in health care is not a moral or ethical issue in the way, say, civil rights was. Some of the heavier breathers on the Left might disagree, trotting out the 40-plus million “uninsured Americans” as Exhibit A.

“Isn’t it a shame that the greatest country in the world cannot insure all of its people?”

Or, at least, that’s the refrain that has come to characterize the pity party Democrats want us to have on the health-care issue.

The great irony is that we do have the resources and wherewithal to provide affordable health care to all Americans. Certainly, if we can register every automobile in the country, or inoculate all schoolchildren against rubella, a nationwide health-care service – run for the people, by the people – is not too far-fetched from a logistical point of view.

The problem is money, not so much today, but down the road.

You see, health-care expenditures have grown faster than nearly every other kind of expenditure in the United States over the past few decades, even faster than the cost of a college education. But contrary to the Democrats’ claims, health care today is hardly premised on the free market. It is a wickedly complex mixed market, filled with loopholes, treatment gaps, reimbursements, non-reimbursements, premiums, co-pays…well, you get the picture. Health care in the US is a Frankenstein monster of programs and markets, and at every turn, government is already deeply involved.

So when health-care reform advocates cite statistics about the inefficiency of the American system – such as how we spend almost twice as much as other advanced nations (as measured by percentage of gross national product) on health care – one could just as easily argue that less government, rather than more, is the solution. After all, without a track record of controlling costs – and at this point, the Democrats don’t even have a viable plan to control costs – why should anyone trust that the budgets allocated to health care in today’s plan will be observed tomorrow?

Indeed, Health Affairs, a public policy journal, published in 2002 its projections on health-care costs, saying that they were poised to rise quickly, from roughly 13% of GDP to over 17% in 2012. Well, we passed the 17% mark in 2007 with a bullet (just half the projected time period). The point is that very smart people have studied this area of spending for a very long time, and they, too, tend to undershoot in their projections, sometimes massively so. If the best and brightest can’t get the math and the projections right, why would we expect the federal government to do any better? And more to the point, when health insurance becomes part of the federal mandate, what happens to the budget when we experience cost overruns or undershoot our projections? You guessed it: (a) ever-greater taxes; (b) ever-poorer service; (c) and the shifting of resources to health care away from areas like roads, bridges, energy, and education.

Make no mistake, judging from Washington’s inability to curb spending to date – and this in an industry with heavy government involvement already – any government-led health insurance plan will devolve into an ever-dwindling set of services for an ever-increasing amount of taxes. It will be just as wasteful as the current system is, but at least the current system doesn’t “socialize” the waste by making all of us pay for it.

A far, far better way forward is achieving small goals in incremental steps. The federal government, despite President Obama’s personal popularity, is simply not trustworthy. If there is to be federal health insurance, Congress will ultimately set the rules for it; therefore, congressional leaders need to build trust with political moderates; they need to demonstrate that they can be fiscally responsible, that they understand the issue, and that they can develop solutions that are something more than throwing tax money at the problem. Before taking one extra dime in taxes, Congress needs to demonstrate that it can control health-care costs. It needs to show folks who provide the cash that it can say No to industry lobbyists, activists, and other special interests who ply the health-care route for government booty.

Earnings estimates not exactly moonshots

2009-07-21T16:02:00.001-05:00

From 24/7 Wall St., here is some sound advice in connection with the spate of “positive” earnings announcements over the past few sessions –

“From what we have seen in S&P 500 components so far this earnings season, we have roughly 70% of companies beating earnings estimates as the estimates were set at very conservative levels. We would argue that this was not conservative but artificially lower. In short, we would not expect positive reactions in the companies that miss or that might have been given a “good enough considering the economy” reception we saw in last quarter’s earnings season.”

Earnings in with a bang

2009-07-21T09:55:00.001-05:00

I met last week’s positive earnings announcements from Goldman Sachs and JPMorgan with more than my fair share of skepticism. After all, what is so outstanding about an investment bank posting big profits during a quarter that saw the stock market indexes rise appreciably (the S&P 500 was up nearly 20% in the second quarter), not to mention the favorable interest-rate environment? I wanted to see more earnings surprises in general industry categories, not just banks, before I declared the big, bad recession over.

Yesterday and this morning has brought some more evidence of improving health in various industries. Caterpillar, the heavy machinery maker, posted a better-than-expected quarterly profit and upped its full-year outlook; chemical company DuPont posted a 61% decline with its second-quarter profit on lower sales volume and charges, although it beat estimates on an adjusted basis. Merck and Coca-Cola also topped profit estimates.

The situation with DuPont is one that I’ve seen a few times recently. The estimated EPS was too low, gift-wrapping a PR opportunity for the company. It’s not often that earnings can plummet 61% and you still beat the Street.

The safest assumption at this time is that, yes, the recession is not getting worse and probably won’t get worse from here. But that, in and of itself, is not a recovery. What does that mean for the stock markets? The answer depends upon whether or not you feel the market was oversold in 4Q 2008 and 1Q 2009. For my part, I don’t think it was. Certainly, there were individual companies that were beaten up without good cause; however, the markets overall, as judged by cumulative P/E values, are not as ‘cheap’ as one might think. Factor in the aforementioned 20% surge since March, and stocks are already getting pricy relative to their earnings, about which the best we can say is “it could be worse.”