Posts Tagged business

Cars and Trucks

Sophistication has its limits even in the US of A.  Apparently so does Hudibras.  So the news last week from GM was as much surprising as it was long over do:
GM announced plans at its annual stockholders meeting today for new company strategies designed to “aggressively respond” to this increasing demand for fuel-efficient cars that the North American consumer can afford. The company will be focusing on a series of efforts aimed at cutting costs, eliminating jobs, and limiting its dependency on truck and SUV sales.

Unfortunately, the good comes with some bad. Since it is always about profit, and not very often the workers, nothing in the announcement mentions plans for reeducation, or transitional support for the unemployed thousands as four plants will close by 2010.

Investors cheered the decision, sending the company’s stock up about 2 percent in early trading.

What makes this news a Loser is that this decision smacks of not being about what is right and sustainable for the economy but what self-serves the interests of Wall Street and by extention we the stock holders.  Because no matter how you cut it, we are caught up in a web of our own making.  We have to consume, we need to make money, we are invested in the very corporations that we know have only self interest at heart.

Contrast that to this kind of story of a Winner from Alex at YBwhoUR?  It’s about an inventor named Matt Shumaker and his motor bike.  It’s an example of what each and every company should be using as a reason for being.  What do people need not what can we sell them. 

I think that a long time ago that was the way it must have been.  Then came the Mad Men, and the idea that the business of business was making money first and useful products second or even third.  Excessiveness meant success.  The more you made the more you could sell became the business model.  And it worked in two ways.  One, to show that we are a successful and abundant country where everyone has a chance to have more and more stuff.  Two, to set up a way of producing things that explained why we needed to be powerful enough militarily to enforce ourselves upon the rest of the world when the need arose. 

So now, even as we look at the younger generation as the ones who will have to solve this problem, we may be facing, are facing the possibility, that all the excess is about to come back and overwhelm us.  Unless, of course, GM is not too late and then, well, . . . ?

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What goes around, comes around, pt. 1

I’ve written before about the credit crunch, most recently in a six part review of Charles R. Morris’, The Trillion Dollar Meltdown. I’ve also mentioned my love of irony a time or two.  So this article in the LA Times just seemed too funny to be true.  The LBO industry is in deep trouble.  Of course, so are we because of it but that is the other story.

. . . some experts predict that buyout funds launched in the last two years will generate poor returns because they overpaid for the companies they bought and some of those companies will run into deep problems if the economy keeps weakening.

This seems to me more proof that the wizards who run these top funds are no smarter than the ordinary home buyers who somehow convinced themselves that the hype they were creating by buying and trading up was true and the ride up the roller coaster slope would never head down.  Oops!  Overpriced and now the search is on to find a buyer before they lose anymore equity.

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Popcorn, $6.50 for a small

She had a smile in her voice as she told me, “Boy, I just saved $6.50.”

“What?” I asked.

“I told you I wanted popcorn when I went out to the lobby but when the guy told me, $6.50 for a small, I just laughed in his face.”

I can imagine this little scenario being reenacted all across America especially when someone asks for a family-sized tub at just $20.  Bio-fuel is messing with our movies.  But here’s the thing.  I don’t know much about genetics but it seems to me that if we can clone sheep and design our future children we should be able to come up with a super-sized corn that is designed specifically for fuel so that the regular white and yellow stuff could stay just for human, and sometimes cattle, consumption.  Maybe fix it so it could be grown in super fields that double or triple the yield per acre and will even grow in soil not suitable for anything else.  Heck, with just a little research I found this.  And this.

I had to laugh at the cartoon strip I saw yesterday, Lalo Alcaraz’s La Cucaracha.  A street vendor says,”My prices now reflect the fuel companies demand for Ethanol.”  The customer then points out, “This is just meat.”  To which the vendor replies, “Tortillas are ten bucks.” 

Si si.  It’s a case of follow the money.  Why are the prices going up on biofuel-possible products?  Because there is money to be made.  Look at the futures market and the commodity exchange reports.  But when you look at commodity futures keep in mind who and what controls those markets.  If the hedge fund investors leverage futures options what happens to the prices, they go up.  If the prices go up on futures, then the actual trade prices go up too because the futures prices are used as an index to reference what the producer should be selling the product for.  The deal is sweetened by the fact that a hedge fund by its nature always covers it own ass.  It buys short and long and collects the difference.  When we are talking world wide markets and billions of dollars, then it is not so hard to see why the cost of popcorn at the movies is moving up.

 

See it yes.  Pay it, well as T so aptly put it, “I just laughed in his face.”

 

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Financial Advice, pt. 8

It is a hard choice to trust our government these days.  Immense budgets, inefficient actions, regulatory nightmares, lowered taxes, deficit spending, incomprehensible debt loads and that’s just at the local level.  One of the main reasons for the swell of support for Obama is the hope that his election might change some of that.  So the final chapter of Charles R. Morris’ The Trillion Dollar Meltdown may prove to be just what the doctor ordered.

Chapter Eight:  Recovering Balance

Less is more.  In a free market environment that dictom can and, according to Morris, has been taken too far.  For by trusting to the market place to be self governing, we have come to the possible unwinding of not only the US financial markets but the world’s as well.  The term writedown (the act of reducing the accounted value of an asset) has become commonplace to the current financial news.  To Morris the real disaster, the elephant in the room, is the danger that the rest of the world’s confidence in American financial markets may be lost.  To deal directly with this problem means,

Any program to restore confidence in American markets must start with the banks.  Loans to very highly leveraged parties should carry penalty capital charges.  Absurdities like prime broker loans to hedge funds that do not disclose ballance sheets should simply stop.  Banklike capital requirements should apply to all lending entities, including intermediaries like mortgage bankers who plan to warehouse deals for securitization.  Loan originators should always retain first losses, and put-back agreements should get much stiffer capital hits than they do now.  Accountants shouldn’t recognize credit insurance purchase from thinly capitalized entities, which would put leveraged credit hedge funds and the insurance monoliners out of the riskier portions of the credit insurance business.

Reading the list above reminds me of my own feelings about banks.  They always seem to be ready to help when you don’t need it.  See the barrage of credit offers when your FICO is good.  But don’t seem to know your name when the mortgage resets and a refi would really save the day.  In other words, banks give the impression of not taking risks but as the list above and the first seven chapters of this book point out, that really isn’t the case.   Morris cites, and he is not alone in this, the removal of Glass-Steagal Act controls in 1999 which then allowed the commercial and investment banks to comingle as one culprit that could be corrected.

As an example of another reason why re-regulation of the marketplace is a good idea, Morris takes a long look at the health care industry.  Just like with the financial market you might have to stretch your mind a little bit to deal with that idea.  See it isn’t about you and your doctor.  It isn’t about the best treatment for your family.  It is about how

America’s high-speed technology adoption cycles produce higher financial returns for drug companies, device makers, and aggressive medical practitioners, but often it is not good medicine and is very expensive.

Health care is a business, son.  What a business is about is ROI.  Patient care doesn’t rank very high in the listing of incomes next to manufacturing and producing cardiac stents or over-priced drugs.  Says Morris, “Much of the problem stems from the insistence that health care is just like any other consumer market.  It’s not.”

 I wont pretend to know exactly how the Pareto principle is supposed to work but I can see clearly how it can be used by the free marketeers to justify their financial outlook.  The claim however to this idea as being some sort of natural law of economics however begs the question.  If all the wealth is concentrated in one sector while all the debt is in another, that only makes the world work for the 20 percent.  The 15,000 who pull in 284 billion a year while the rest of us struggle to make do on an hourly wage.   We need a market place reset.  We need to stop worshiping at the alter of retirement luxury, of being rich, of having it all, and recognize the rule that says enough is enough.

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Financial Advice, pt. 3

In re-reading Charles R. Morris’s, The Trillion Dollar Meltdown, I am reminded of one thing about the market place that we all know and still . . . forget.  Let the buyer beware.  In other words, no matter what the deal, you are on your own when it comes time to add things up.  With that said, lets continue with

Chapter Three:Bubble Land:Practice Runs

I think it is fair to say at the start, we never seem to learn that the money changers are playing a shell game and we are the pigeons.  This chapter cites three examples – The residential mortgage crash of 1994, the 1987 Stock Market meltdown of 1987, and the 1998 Long-Term Capitol Management crisis.  With hindsight firmly fixed, these three can be seen as the early models for our current sub-prime mortgage and credit bubble dilemma.  The advent of desk-top computing power, the use of mathematical modeling strategies, and the afore-mentioned leveraging quality of the pension funds, foundations, endowments, and hedge funds; all played their part.

Mortgage-Backed securities

The overview of the real estate lending business reads like this.  In the New Deal era, S&Ls were the base from which home loans grew through quasi-federal agencies called Fannie Mae, Ginnie Mae, and Freddie Mac.  These agencies bought up mortgages and then sold mortgage-backed securities or mortgage pass-throughs to maintain their own liquidity.

A pass-through is created by transferring a slug of mortgages to a trust, which in turn issues certificates representing a pro rata slice of all the principal and interest it receives.  A trust comprising $100 million in mortgages paying an average interest rate of 6 percent would sell a certificate entitling the investor to, say, 1 percent of the trust proceeds.

Big investors, however, found this format to be slightly cumbersome and not always rewarding.  In 1983, Larry Fink at First Boston bank came up with a solution.  The CMO, a collateralized mortgage obligation, an investment model that allowed a bank to transfer mortgages to a trust just like a pass-through “but the mortgages were then sliced, or tranched, horizontally into three segments, with different bonds for each segment.”  The top tier got first claim on all cash flows and triple-A ratings, the middle tier was rated lower but sold at a higher yield, and the bottom tier, or toxic waste, sold as junk bonds with high risks but higher returns.

As with the previous chapter, Morris points out that at first the new model worked well.  “An academic study concluded that by the mid-1990s, CMOs saved homeowners $17 billion a year.  It is a classic illustration of the social contribution of financial innovation.”  What followed, of course, is a classic reminder of free market competitions amplified by the new technology of computer power.

But by the 1990s, when Sun workstations were standard furniture, CMO shops gleefully spewed out phantasmagorical 125 tranche instruments that no one could possibly understand.  No matter how clever the structuring, however, a CMO was still a closed system: All the tranches drew their payouts from the same pool of mortgages.

Disposing of the toxic waste soon became the primary limit on growth. 

A market shift, a change in the Fed rate, and it all came tumbling down.

Next up, the 1987 Stock Market Crash and another new quant product called portfolio insurance.  Get ready to test your trading knowledge.  Are you familiar with your trading options, puts and calls and the futures market?  Did you know you can bet on the up side, a call, or the downside, a put, or even better yet, on the financial future of being able to sell or buy through a fixed contract, a commodity at a fixed and firm rate?  Did you know,

Synthetic trading strategies executed with options and futures are often more efficient and less expensive than trading the underlying instruments, and often easier to mask from the competition, so they became an essential tool of megaportfolio asset management.

and that “The portfolio insurance that so enamored big investors was actually a futures-based hedging strategy.” based on using a Black-Scholes type formula.  Black-Scholesis arguably “the most famous equation in the history of finance.”  since it solves for the price of a futures option.  And “Since any financial transaction can be cast in the form of an option, Black-Scholes became the tool for pricing everything.” 

With such an efficient tool in their hands who would be willing to bet that only a few managers would use it.  According to Morris, “By the fall of 1987, some $100 billion of stock portfolios were insured.”

The resulting crash, aptly named Black Monday, resulted in the New York exchange instituting “circuit breaker” rules to shut off trading and the newly named Fed chair, Alan Greenspan, to release tons of new money to keep the brokerages from collapsing.  Sound familiar?

Meanwhile, Morris offers us one more road marker to take a look at, the LTCM ( Long-Term Capitol Management) hedge fund that was created in 1993 by John Meriwether and by 1998 had forced the Fed into another miracle money rescue.

When Meriwether opened his books to Fed staff in late September, they were shocked.  No one had imagined the LTCM had positions in excess of $100 billion on an equity base that had shrunk to only $1 billion.

Morris leaves this chapter with one direct question and an implied answer.  Why did the Fed force the banks to bailout LTCM and coverup the scandal of the fact that a small number of financiers had been able to borrow hundreds of billion of dollars without any oversight in sight?   Friends help friends.

Maybe we will find out for ourselves in Chapter Four: The Wall of Money

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Financial Advice, pt.2

Yesterday, I began my review of Morris’s The Trillion Dollar Meltdown.  Today we continue with

Chapter Two:  Wall Street Finds Religion

I don’t know if the author meant this to sound ironic but it’s clear he does mean to show us how people bought into “monetarism” whole heartedly.  “Chicago school economics has mutated from a style of analysis into a Theory of Everything.” is how he puts it.  The theory of finance that Milton Friedman proposed had been not so patiently waiting in the wings for quite a few years as Keynesian style liberalism held sway.  In 1979 things were ready to change.

Morris points us to two events that took place:  the 1978 cut in capitol gains taxes and the 1981decontrol of oil prices.  Both of these events took on what Morris calls “foundation myth” status but he quickly points out the flaw in this belief.  It wasn’t the corporations and individuals that used the benefits of the tax cuts to invest,

When the regulations were finally eased in 1979, it was pension funds, foundations, and endowments that were the source of most of the new venture money.  Those investors are tax-exempt, of course, and couldn’t have cared less about “Steiger.”  It’s not that tax rates don’t matter.  It’s just that if you try to trace exactly how much they matter, the usual answer is”not a lot.”

The story with Reagan’s decontrol of oil is a little more complex.  According to Morris,

The ratio of national output to energy inputs, it turns out, started improving sharply in 1973, by about 2 percent a year, with no help from the Chicago school.

So why did the price break happen in 1981?  In all likelihood, seven years of global efficiency gains, coupled with the 1981 recession, which was substantially global in its effect unblalnced OPEC’s demand/supply assumptions.  That happened to coincide with the peak of the Iran-Iraq war, when Arabs were pouring money into Iraq to forestall an Iranian victory.

In other words, the market worked.  But it worked over the long haul, across multiple regimes, and policy dispensations, reflecting tidal currents, like the advanced-country shift toward services, that policy-makers were only dimly aware of.

“Killing Inflation.” 

Since in 1980, I was the recipient of the benefits of the incredibly high interest rate cycle, my CD’s earned 18% for about a year and at the same time I was living a frugal life style with no car, TV, or phone, I was severely depressed when Paul Volker’s controls began to take effect.  Well, not severely depressed actually, just puzzled by it all since I had no idea of what inflation or stagflation or recession really meant.  Apparently, the U.S. was trapped between the rock of recession and the hardplace of inflation.  It was Volker’s job as chairman of the Fed to bring this situation under control.  To do so he adopted the strategy suggested by Milton Friedman.

He taught that inflation could be controlled solely by controlling the stock of money – the quantity of M1, the sum of all check money and all circulating cash.  If the Fed merely insured that the stock of money grew at roughly the same pace as the economy, all prices would remain on an even keel.

What happened next is truly amusing to read because it both supports the free market philosophy of the Chicago school and points out its major weakness.  As Adam Smith had pointed out so long ago, there is public interest and there is self interest.  “The transcripts of the Federal Open Market Committee (FOMC) through most of 1980 betray an air of semicomic desperation as the members try to discern which numbers they should count as the money supply.”  Volker’s success hinged on three things, his conviction to stay with the policy, Reagan’s support, and the committment of the American people to endure and rideout the situation.  “From that point, America’s committment to Price statbility was assumed as a matter of course.”

Thus, with all hope in the goodness of mankind and the efficacy of the free market place, the Decade of Greed, the LBO (Leveraged Buy Out) boom began.  Efficiency became the watchword.  Businesses were pared down, restructured, and top heavy management was rolled up.  It started out friendly but in 1986 when the stock market reported the average P/E averages had tripled,

the markets went crazy.  Returns on the first wave of deals were so spectacular that big investors, like pension funds and endowments, were clamoring to get in, while the fund start-ups multiplied like roaches.

 At the same time that LBO’s were playing out to their eventual busts, the growth of the non-regulated Savings and Loans Industry was taking place.

But the second half of the LBO boom and the S&L debacle demonstrate the dangers of loose financial markets regulation.  In the raw markets, the scent of money deadens all other sensory and ethical organs.   In both cases the quick, the deadly, and the unprincipled made a lot of money fast, while the ordinary workers and the taxpayer took it in the ear.

This chapter concludes with an analysis of what happened during the “Interlude: The Goldilocks Economy of the 1990s”  wherein the budget deficits created during Reagan’s tax cutting years were directly addressed by Clinton’s ability to pass an almost pure tax increase and the incredible boom of the dot-com bubble.  As usual, economists claimed theoretical victory but as Morris again points out, the tax increases were overwhelmed by the upsurge in capitol gains taxes from the stock market boom.

Morris concludes this chapter with what I call an ominous warning.  Despite the presence of multiple market bubble bursts and failures through out the previous 20 years, there was an increased conservative conviction that free market deregulated were what really worked.  Hello President Bush.

Tomorrow, Chapter Three: Bubble Land:Practice Runs

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Financial Advice

In yesterday’s post I mentioned that I was about ready to review Charles R. Morris’s The Trillion Dollar Meltdown.  However, since the book is such a dense compendium of financial analysis and covers a period of over 100 years of financial doings, I have decided to spread this review of the book’s eight chapters over the whole week.  To be frank, most of the terminology and a lot of the accountant like thinking it takes to read this book are outside my ken.  But the style of writing and the to-the-point examples helped me to overcome this mild but distracting short-coming. 

It wasn’t so long ago that numbers like a million were the ones we used to think about the very rich.  But I can’t be the only one to notice that nowadays, being rich seems to start with a billion.  And when we are talking about the national budget the numbers are now in the trillions. Hence, the title of this book, The Trillion Dollar Meltdown not only makes sense but seems somehow inevitable.

The sad truth, however, is that subprime is just the first big boulder in an avalanche of asset writedowns that will rattle on through much of 2008.  An overhang of subprime-like assets at least as large , is sitting in corporate debt, commercial mortgages, credit cards, and other portfolios.  Even municipal bonds may be at risk.  Loss estimates of $400 billion to $500 billion barely get you halfway there.

With a preface like that, it isn’t very difficult to see that Morris is on the track of some very serious financial mis-doings.  So let us begin our journey.

Chapter One:  The Death of Liberalism

 In his preface, Morris states that “all successful financial innovations must experience a crash cycle to discover their limits and risks, tighten documentation, and identify the proper role of regulation.”  So it makes sense that he would pick a period in our history when such an event, “the ten years from 1973 through 1982” took place as the place to start.  Things were so bad that

Economists even came up with a measure of how awful it felt.  In 1980, the Misery Index, the sum of the inflation rate and the unemployment rate, was the highest ever.  An ugly new word, “stagflation,” entered the political vocabulary.

In Morris’s short history though this all began at the beginning of the 20th century with the President of U.S. Steel, Elbert Gary, who pioneered the corportate strategy of market sharing and price-management agreements with his competition.  As this stragegy took hold in American business, Morris points out that “The locus of innovation in steel-making shifted to Europe and Japan.”  A fact that later played a great part in the American automobile manufacturer’s failures of the 70’s.  Speaking of cars, General Motors comes into the story during this same early period as the leader in setting up relations with the unions as GM set the standard for tying wages to productivity and bonuses and raises to the rate of inflation.  Morris is here concerned with the configuration of the businesses not with the economic fallouts of the Depression nor the New Deal.  I think this is primarily because though these two events were major in their social and economic effects they did not change the way that companies did business or that economists thought about it.

So quickly, Morris brings us to the age of affluence of post WW11 America, when jobs were plentiful, everyone could afford a house, and the only war was a Cold One.  Again, he slides through these times without pause because his aim is to set the stage for his analysis of why it all wound down in the 70’s.  As a student of social history, I can appreciate how the golden age of the 50’s could lead to a baby boom and the student unrest of the 60’s.  And how that could in fact lead to the parents of those students becoming more conservative.  Thus Nixon, who according to Morris,

by contemporary definitions, … was among the most liberal of presidents.  As the war wound down, he cut military spending sharply, pushed through the greatest expansion in Social Security benefits since the program’s inception, and created the federal affirmative action programs that quickly spread throughmost major corporations and public institutions.

The dawn lights as I read this section.  In political terms, liberal means top-down directive control not freedom from control as my uneducated politcal mind has long thought.  It meant more government to make the decisions and control the outcome.  A Keynesian approach through and through.  So when Nixon called his economic summit in 1971, and then announced the dollar would no longer be redeemed by gold, and that he was instituting price and wage controls, a tax on imports, and a cut in taxes it appeared that the “stag” had been deflated.  Unfortunately, for Nixon, Ford, and Carter floating the dollar led directly to OPEC tripling the price of oil in 1973 and again in 1979 while the price controls which were only supposed to last 90 days weren’t removed until 1974.  The removed controls “triggered double-digit inflation and the nasty recessions of 1974 and 1975.” 

I know, as usual with things political what you see isn’t what you get.  Because when we think Nixon these days it’s usually through the lens of Watergate.  So instead me trying to lead you through to understanding what I am just now coming to see, I’ll let Morris do the talking:

In its modern sense, liberalism is a theory of government posing as a branch of economics.  Adam Smith and David Ricardo called their discipline political economy, a useful term.  The “political” was dropped when the twentieth-century marriage of economics and advanced mathematics fostered the illusion that economics is a science.

A science that became the field of study in most major universities and helped to foster our current connection of elitism with the liberal frame of mind.

It is hard to exaggerate the faith of 1970s- and 1980s- vintage liberals in the power of a puppet-master government, especially in academia.

Morris goes on to say “Intellectuals are reliable lagging indicators, near-infallible guides to what used to be.” and so as the economy continued to wither so did the reputation of those who had advised the present course.

With the eclipse of Keynesian liberalism, the day had finally dawned for an alternative paradigm that had been waiting patiently in the wings – Milton Friedman’s “monetarism.”

Tomorrow, Chapter Two: Wall Street Finds Religion

 

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