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9
Dec 11

This Dimon Doesn’t Have it Rough Enough

Jamie Dimon, CEO of JP Morgan Chase, is back in the news railing against those who bash the rich:

Dimon was responding Wednesday to a question at an investor conference about the hostile political environment towards banks.

“Acting like everyone who’s been successful is bad and that everyone who is rich is bad — I just don’t get it,” said Dimon at the conference, which was organized by Goldman Sachs Group Inc.

Dimon said he’s worked on Wall Street for much of his life and contributed his fair share.

“Most of us wage earners are paying 39.6 percent in taxes and add in another 12 percent in New York state and city taxes and we’re paying 50 percent of our income in taxes,” Dimon said in defense of his fellow Wall Street bankers. See Jamie Dimon Rails Against “Rich is Bad” Talk

Are We Bashing the Rich or the Well Connected?

America is a land of opportunity.  Children of poor immigrants can grow up to be President, entrepreneurs, brilliant scientists or even CEOs of Fortune 500 companies.  Thus, Americans venerate a Steve Jobs or a Bill Gates.  Not that these individuals are without detractors, but they are admired for starting from scratch, innovating, and filling a market need.  Often these individuals single-handedly create the market for their products and services. See All Millionaires are not Created Equal

Let’s examine why Jamie Dimon and other bankers are less admired and often vilified.  Note the deft sleight of hand in Mr. Dimon’s answer to the question: the question posed concerned the hostile environment toward banks.  Mr. Dimon’s response is that he does not understand why the public thinks that everyone who is successful is bad.  He in fact never answered the question of why everyone hates banks.

At the core of the hatred of banks (and perhaps Mr. Dimon himself) is crony capitalism.  Mr. Dimon’s “success” is owed largely to the unholy alliance between the Bush and Obama Administrations and the Too Big to Fail Banks.  Let’s examine the blessings the government has bestowed on Mr. Dimon:

  • Bear Stearns – JP Morgan Chase and Mr. Dimon merged with the “failing” Bear Stearns, paying $10 per share for a company that had recently traded at $93 per share.  The Federal Reserve then made a $29b non-recourse loan to JP Morgan secured only by the mortgage backed securities of Bear Stearns.  Thus, the Federal Reserve could not seize JP Morgan Chase assets, if the Bear Stearns collateral proved insufficient to repay the loan.  See Seeking Fast Deal, JP Morgan Quintuples Bear Stearns Bid, Wikipedia
  • Secret Loans from the Federal Reserve – From 2007-2009, the Federal Reserve made $7.7 trillion of secret loans to 190 financial institutions, resulting in profits of $13b.  These loans were at below market rates, virtually free, ensuring profit for the banks. Bloomberg, which made the Freedom of Information Act request, estimated that JP Morgan profited in the amount of almost $458m.  Mr. Dimon did not disclose these loans or the banks’ need to his shareholders:

JPMorgan Chase & Co. CEO Jamie Dimon told shareholders in a March 26, 2010, letter that his bank used the Fed’s Term Auction Facility “at the request of the Federal Reserve to help motivate others to use the system.” He didn’t say that the New York-based bank’s total TAF borrowings were almost twice its cash holdings or that its peak borrowing of $48 billion on Feb. 26, 2009, came more than a year after the program’s creation. See Secret Fed Loans Gave Banks $13 Billion Undisclosed to Congress

  • Zero Interest Rates – The zero interest rate policy of the Federal Reserve continues to permit banks to borrow at below market rates, thus enhancing bank profits at the expense of savers.
  • Compensation – While being rescued by the Federal Reserve, JP Morgan Chase’s board awarded Mr. Dimon a $17m bonus for 2009. In 2010, Mr. Dimon made $20.8m.  JP Morgan partisans will argue that this was modest compared to industry peers.  Should US taxpayers, those of us who ultimately stand behind these loans, reward executives with large compensation packages?  Unlike the situations of most of the rest of us, JP Morgan Chase makes available to its top executives tax advantageous programs such as the permitting tax deferral of compensation, 401k plans, a defined benefit pension plan and use of the company plane.  If terminated without cause, Mr. Dimon would receive cash and stock awards valued at $16.7m. See Are CEOs Paid too Much: Not All of Them; JP Morgan Chase CEO Gets $17 Million N0-Cash Bonus; Elements of Executive Compensation (JPM); JP Morgan Chase 2010 proxy

Being Rich Isn’t the Problem

Yes, there is income inequality and we have heard endlessly about the elite 1% profiting at the expense of the 99% of ordinary Americans.  But the real hostility goes deeper than just these income disparities.   There is a good reason why Mr. Dimon chose not to discuss the hostile environment toward banks.  He is well aware of why it exists:  the American public has been treated to the spectacle of secret loans to banks; CEOs have been permitted to keep their jobs after nearly destroying their own banks and the US economy; too generous executive compensation practices and perquisites continue which ignore the fact that taxpayers needed to bail out these institutions (and will probably have to do so again);  banks still fail to undertake serious loan modification programs for underwater homeowners; they hoard excess reserves at the Federal Reserve rather than make loans to stimulate the real economy; they attempt to impose fees on cash withdrawals from ATMs;  and finally and disgracefully,  these banks have not been  prosecuted.

Mr. Dimon, the focus is on you and other bankers, not necessarily “the rich.”   Perhaps we need more hard hitting articles like the Bloomberg piece on secret loans to banks, to focus the attention on the true issues, not bogus articles of class warfare.   Unfortunately, neither the press nor the Administration has been rough enough on Mr. Dimon.

 

 

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13
Sep 11

Re-Arranging the Furniture

Rarely do I look at the myriad sale flyers that seem to be staples of our mail these days.  However, my wife called my attention to a going out of business sale.  Bograd’s Fine Furniture, a store with deep roots in Paterson, N.J., sent out an unusual closing announcement.  It was not the usual notice trumpeting the final days of the company (for the umpteenth time) and hawking goods at deep discounts for a final selling splash. Rather, the announcement seemed from the heart of the owner and his family.  Its message encapsulated what is wrong with our economy and the burdens government puts on small business.

History

On August 1, 1930, two immigrant brothers opened a furniture store in Paterson, NJ.  Five years later they built a bigger store on Main Street in that city. The store remained there for over sixty years.

In 1975, I began my clerkship for a Superior Court Judge sitting in Paterson.  I walked by Bograd’s every day on the way to the government parking lot.  At that point, my wife and I were married for three years, but we had always lived in student housing.  We had our first rental apartment, which needed furnishing, at that same time.  Bograd’s carried quality brands that we could only dream about but could not afford.   Even then, our belief was that we should save and buy quality goods rather than settle for inferior goods.  Bograd’s represented quality, albeit at higher than department store prices.  We window shopped a lot more often than we bought.

At about the same time, Paterson was becoming a dangerous city, where once had been a prosperous town.  The population declined nearly 5% in the 1970’s.  White residents fled to nearby suburbs and now make up only 13% of the population.  Poverty is rampant, with 29% of families below the poverty line.  As in many urban areas, quality stores abandoned Paterson for the suburbs of Bergen and Passaic counties.  Bograd’s, however, held out until 1996 when it moved to a warehouse showroom in a suburban area near major highways.

The End of an Era

Instead of the traditional “going out of business sale,” the Bograd family calls their closing event “Bograd’s Last and Best Sale.”   Even though the store will no longer be operating, Mr. Bograd and his company  will  “be around after the sale is over operating out of our warehouse until every order is delivered, every customer satisfied.”

Below is a summary of the company’s decision to close.   It is a microcosm of what ails small American businesses.  I will provide commentary on each item:

  • We cannot and will not compete with stores who have lowered their standards by selling low quality merchandise.  We have always sold high end American-made furniture, often pieces signed by the craftsman while our competitors are bringing in low quality pieces from Indonesia and China. Comment – US free trade policy has permitted the importation of low quality, often shoddy, low price furniture.  How can a high quality US manufacturer expect to compete with near slave labor, foreign work conditions?  One cannot compare beautifully finished high end domestically made furniture and imports from China.
  • We will not employ a low quality, low paid sales force that cannot provide outstanding customer service.  Comment – Customers view items like furniture as disposable, so quality service is no longer factored into the price.  Only low price matters.  The US educational system produces employees without the educational background or mindset to invest years in developing expertise in high-quality furniture manufacturing or sales.
  • Given the state of the mortgage market we cannot refinance our store which we own or obtain favorable financing terms from our supplier.  Mentioning that we are in the furniture industry ends discussions with lenders.  Comment – The failure to resolve our banking crisis and forcing the banks to write off bad loans has tightened credit markets.  Tight credit has had the most impact on small businesses.  Banks would rather hold excess reserves with the Federal Reserve than take on more risky lending.
  • As a small business we receive no support from any level of government.  Comment – Complex business regulations coupled with the uncertainty of Obamacare make it almost impossible for a small business to succeed.  Government policy openly favors large enterprises, who also happen to be major campaign contributors, at the expense of the small business person.
  • Decline in trust between and among retailers, banks, and suppliers. Comment – Government policies which created the housing bubble and other speculative bubbles inevitably lead to an economic bust.  Stop-and-start economic policies destroy trust between economic parties. See Bograd’s Fine Furniture Latest Victim of Tough Economy, Eight Decades of Selling Furniture Coming to a Close, Bograd’s Historic Closing Sale – The End of an Era

Left unsaid is a major change in our culture and values.   As young adults we understood that to buy quality furniture we would need to save and defer our major purchases. When we bought a house, rooms remained empty until we could afford quality furnishings.  In a culture of instant consumer credit and shoddy goods, that ethic of saving and deferring gratification has eroded, placing a firm like Bograd’s at a disadvantage.

American Jobs Act

The much awaited announcement of President Obama’s American Jobs Act does little for the small business person. Small business is the lynchpin for both creating new jobs and for economic recovery in general.  Like Bograd’s, there are thousands of small businesses hanging on by their economic finger tips.   A large labor union (teacher, police or fire) or a large financial business (banks, insurance companies) gets the government’s attention and fiscal favor, but  if one is a small business, I guess one might  just fade into economic history, like the 81-year old Bograd’s.

Gresham’s Law says that bad money drives out good money.  In the case of Bograd’s Fine Furniture, bad furniture drove out quality furniture.  We have flawed government policy to thank, and a consequent culture which would rather spend today than invest in the future.

 

 

 

 

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9
Aug 11

“My Word is My Bond”

A phrase I heard often from adults when I was growing up was: “my word is my bond.”   I return to it often now, as it indicates to me not just a promise in a particular circumstance or business transaction, but rather a belief system. If we heard someone utter that phrase today would we believe it?  Sadly these days, most likely we would believe that we were about to be defrauded or worse.

In my professional life, I have witnessed the steady decline in the bonds of interpersonal trust. The financial crisis of 2008, which has never really ended, demonstrated that trust between people has deeply eroded. It was not only the outright frauds of Madoff and other Ponzi schemers, but more mundane misbehavior as well: borrowers lying about their incomes and assets to obtain loans, and lenders deceiving borrowers, government regulators and their shareholders.

It is time to reflect on some biblical wisdom.

The Bible and Truth

Sir Jonathan Sacks, Chief Rabbi of the United Kingdom, in his weekly blog “Keeping Our Word,” examines the Bible’s attitude toward vows and oaths, and the interconnection of trust with freedom.  As background he first examines adherence to the law.  People obey laws for two reasons:  (1) because of they are fearful of power and punishment or (2) it is to their self-interested advantage to do so.   However, both power and self-interest frequently corrupt those who pursue them. And corrupt power will lead to loss of freedom.  And corrupt self interest will lead to loss of social cohesion.

The Bible offers a third, more positive, reason for obeying the law:

… people obey the law because they have voluntarily undertaken to do so. This is a society based not on power or the pursuit of self-interest but on freely embraced moral obligation. Keeping our Word

We use words, performative utterances, to bind our future behavior, thus creating “an orderly future out of the chaos of human instincts and desires.”  The Bible is telling us that words create:

…because words are holy: that is to say, they bind. When words bind, they generate trust. Trust is to society what predictability is to nature: the basis of order as opposed to chaos.

Social institutions in a free society depend on trust, and trust means that we keep our word. We do what we say we are going to do. If we make a vow, an oath, a promise, a verbal undertaking, then we hold ourselves bound by it. This means that we will actually fulfil our commitment unless we can establish that, due to circumstances unforeseeable at the time, we are simply unable to do so.

If trust breaks down, social relationships break down, and then society depends on law enforcement agencies or some other use of force. When force is widely used, society is no longer free.  Keeping our Word

Stated simply, words, vows, oaths, promises and freedom are all intertwined.  When trust breaks down, freedom is lost.

The Current Crisis in Trust

At the core of our current sad state of affairs is a lack of trust.  We cannot count on our leaders to keep their word.  Government statistics are constantly “massaged” and restated.  When can we remember a business leader or politician telling us the truth?   Truth rarely emerges until we reach the crisis stage.

A memory and observation from my working life:  when I first started practicing law more than 35 years ago, I was routinely involved in corporate acquisitions and divestitures.  A contract to sell a business with several hundred million in sales (a large transaction at the time) would run less than 100 hand-typed, double spaced pages.   By the time I retired, a similar transaction would require massive teams of specialized lawyers: corporate, tax, employment, environmental, and more.  The documents would run into the thousands of pages.  At the end of such a transaction, I might receive several embossed, hard bound books for my library shelf (the size of a small encyclopedia).   Why?  I do not think we became more sophisticated.  I believe we trust each other less.  The same phenomenon occurs in federal regulations, with the Code of Federal Regulations filling an entire library wall.  Do all these laws, regulations and words create more or less trust?

Perhaps if we had a little more trust, we would need fewer words.  And when we uttered or wrote those words we would really mean them.

 

 

 

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5
Aug 11

The Meal Was Great…Part II

Dinner with friends included lots of discussion points that resonated and reminded us of our corporate working lives.   While these points were clear to us as working persons, our perspectives from the outside render these points just as important.  The revealing fact that hits home so closely is:  Americans are being impacted by flawed policies and assumptions whether employed or not, or impoverished or not.

  • Financial Sector Dominance – Government policy encouraged the growth of the financial sector at the expense of the “real economy.”  Glass Stegall, which separated banking operations from trading operations, was repealed by Graham-Dodd.   Devilishly complex financial instruments became Wall Street fee generating devices at the expense of traditional lending.    These firms became employers of choice for talented university graduates.
  • The Short Cut Society – Instead of saving for a house, a vacation or a new appliance we were happy to use credit cards or second mortgage lines for instant gratification.   Instead of a boring career in manufacturing, better a Wall Street trader or hedge fund manager.  CEOs expected huge compensation packages regardless of performance quality.
  • Spin vs. Truth – Shading of the truth became a national obsession.  Instead of honest reporting of inflation statistics, hedonic adjustments lowered the consumer price index, depriving social security recipients and federal pensioners of earned cost of living adjustments.   CEOs spun disappointing earnings results taking write offs, obfuscating the accounting or lowering earnings guidance so that when earnings were finally announced “they beat expectations.”   Congress is no better, promising “smoke and mirrors” debt reduction plans with little, if any, real deficit reduction.
  • Lack of Political Leadership – The debt reduction exercise is one more example of the lack of leadership at the Chief Executive and Congressional levels.  Politicians are more concerned about preening before cameras than serious statesmanship. Bipartisanship seems like a quaint relic of a bygone era.
  • Congress for Sale – Given the enormous cost of congressional races, representatives are in a constant search for dollars from corporations and other large contributors.  Thus, we have Congress captured by special interests.  Congress has long forgotten the middle class voter.  The appearance is that Congress is totally beholden to the corporate sector and that corporations appear entitled to special relief any time they are in need.
  • Complexity – Complexity pervades every part of our political and economic system.  Complexity is used to muddy rather than clarify.  The tax code, Obamacare and financial reform are the latest examples of overly complex legislation and accompanying regulation.  Only an army of lawyers can navigate through these legal minefields.  Conveniently, citizens are kept in the dark and small businesses cannot afford to compete with larger enterprises.
  • Rise of the Nanny State – We recently had New York’s ridiculous attempt to regulate kickball, dodge ball, waffle ball and Red Rover as dangerous activities needing state oversight and a permit.   See Classic Kid Games Like Kickball Deemed Unsafe by State to Increase Summer Camp Regulation.  This is emblematic of a society which demands a legislative or regulatory solution to every problem.   Businesses must be protected against failing (GM, Chrysler, Citicorp, AIG),  employees must be permitted leaves for such mundane diseases as chronic sinus infections (Family and Medical Leave Act), and the public must be protected against carcinogens such as the sun and salt.    Every aggrieved person must have a day in court.  Spill hot coffee on oneself, bring a lawsuit against McDonalds.  Play football and suffer an injury, sue the helmet manufacturer.  Somebody is always to blame and our legislative bodies are all too willing to protect us against life’s vicissitudes.
  • Free Trade– Say it fast and free trade sounds like a great idea.   Cheap foreign goods enrich our lives.   Thus, Ross Perot was ridiculed for saying that NAFTA’s giant sucking sound was American jobs heading for Mexico.   Mr. Perot sold American ingenuity short: American jobs are heading for China, India, Vietnam and a host of other low wage countries. These countries have few, if any, labor, anti- discrimination, family and medical leave, unemployment, child labor, environmental or safety laws.  American workers are being asked to compete against workers who are paid subsistence wages and afforded no protections.   Our politicians are only too willing to serve corporate interests at the expense of the American worker.
  • Immigration – Immigration is probably the purest example of selective enforcement of our laws.  It is difficult for American workers to compete against Chinese or Indian workers.  The problem is even greater as regards undocumented residents in our country.  Further, the cost of medical, education and municipal services is underwritten by the American taxpayer.  In places like Texas, Arizona and California this puts enormous strains on state and local budgets when education and medical services must be extended to undocumented residents.
  • Structural Unemployment – Technology and job outsourcing has added to shockingly high unemployment rates.  It is not clear whether any of these jobs will ever return. As we pointed out, zero interest rates lead to use of more labor saving capital equipment at the expense of hiring workers.  See The New York Times Finally Discovers Structural Unemployment. Hence, our employment problems may not be temporary but a permanent feature of the economic landscape.

 

All of the factors are intertwined.  In fact, they are negatively synergistic.   For example, a Congress that supports failed banks condemns savers and pensioners to miniscule return on savings, further compromising any incipient economic recovery.  A below trend economic recovery only encourages the exile of more jobs overseas so that corporations can retain profitability.

Believe it or not, dinner was pleasant and more.  But our conversational substance and concern for what is happening with our country and what is wrong with America indeed cast a cloud over all our thinking.  Along with other “ways that we were,” optimistic was also one of them, and that is much diminished.

After all this postulating about what is wrong, clearly what should come next are some hypotheses about solutions that can work.  A discussion for another blog.

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30
May 11

Wildfires and the Economy

Sometimes very wise things are also very simple: like a story for children.  I am a mentor volunteer for local disadvantaged fourth graders. This week’s reading assignment was to read and discuss Wildfires, a short children’s book written by Seymour Simon.

The author’s theme seemed contradictory:  wildfires are not always harmful.  Rather, they are part of the natural cycle of forest life.   They occurred well before man populated North America.  Extended droughts provided the necessary environment so that when lightning storms arose, wildfires ensued.   No firefighters or park rangers impeded the natural order of things.   Eventually, enough rain fell to extinguish a fire, or a fire would run out of fuel.

In elegant language understandable to fourth graders, Mr. Simon advocates a controversial and grown up point. The US Forest Service actually did a disservice to the long term health of our forests.   Our ecosystem needs fires to allow light to reach the forest floor, to remove kindling which could cause even larger conflagrations, to permit certain animal species to reproduce, and to allow tree seeds to travel and reproduce.  New and natural growth cannot occur without the cleansing effect of a wildfire.   We now understand that aggressive firefighting was poor governmental policy that actually damaged the environment.

An Economy Managed Like a Wildfire?

The economic analogy is obvious.  When the 2008 great financial crisis occurred the Treasury and the government overreacted.   Treasury pleaded with Congress to create bailouts: TARP, TALF and an alphabet soup of other programs.  The Federal Reserve aggressively lowered interest rates to zero and made bank purchases of distressed mortgage-backed securities and other poorly-rated assets.   Finally, the Administration went on a policy and public relations campaign to save GM, Chrysler, GE, AIG and other large private companies.   Government chose to aggressively fight the financial wildfire.

Policy makers forgot that, like a healthy forest, capitalism requires “creative destruction.”   Coined by Joseph Schumpeter in his work entitled “Capitalism, Socialism and Democracy” (1942), this term denotes a “process of industrial mutation that incessantly revolutionizes the economic structure from within, incessantly destroying the old one, incessantly creating a new one.”

In a properly functioning capitalist economy, old or dysfunctional businesses must be discarded and  replaced by more dynamic enterprises.    If not, we would still be powering computers with vacuum tubes instead of advanced generations of semiconductors.

Killing the Business Cycle

On Friday, David Goldman’s blog Inner Workings pointed out the fallacy of aggressive governmental steps to arrest the financial crisis.  His prediction:  we will be mired in a little or no growth mode for years.

I’ve been on Larry Kudlow’s CNBC show arguing that the US will have 2% growth indefinitely–no real recovery, no double dip, no banking crisis, but no bank stock rally. Today’s depressing numbers are in line with my depressing expectations. We’ve got a creative-destruction economy, without the creation: the startups, the venture capital, the entrepreneurship. MySpace and LinkedIn don’t count: they are a faddish extension of old technology, a means by which Americans who bowl alone can pretend to have lots of friends.  The People’s Republic of America Reports 1.8% GDP Growth (or: Why this is NOT a Business Cycle)

Lending to create new businesses has evaporated.  In fact, credit creation is moribund.  Banks are happy to borrow at low interest rates and reinvest at higher interest rate government securities without undertaking the riskier business of lending.  New business formation is harmed.  Multinational corporations are satisfied with earning profits outside the United States, which means we have anemic job growth.  We are mired in a non-recovery recovery.

Let the Light In

In our wildfire analogy, the largest trees are the ones that most need to be eliminated.  These are the ones that block growth on the forest floor.   Government may have temporarily arrested financial decline, but at what cost?   I grant you that it will be painful to permit the creative destruction of our “tallest trees”: poor performing banks and industrial companies.   The pain would be sharp but not prolonged.  Using another analogy, we needed to rip the economic band aid off quickly to minimize prolonged pain.http://www.prophetwithoutprofit.com/wp-admin/post-new.php

Mr. Simon in Wildfires pointed out another flaw in aggressive fire fighting:  putting out smaller fires too early.  Dangerous residual undergrowth became tinder for more destructive, larger, out of control wildfires.   Similarly, our government did not fix the financial problems of 2008; they only postponed our date with a larger financial conflagration.

 

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22
Mar 11

Exposing the CULT in ConsULTant

Yves Smith of Naked Capitalism uses the insider trading accusations against Rajat Gupta, former managing director of McKinsey and former Procter & Gamble and Goldman Sachs board member, as a springboard to analyze the role of business consulting.  See McKinsey, the Insider Trading Scandal, and the Problems with Consulting.  Ms. Smith, a McKinsey veteran, catalogs the rise of her former firm and its current state:

McKinsey at the Beginning

Originally a time and motion study firm, McKinsey evolved to a premiere business consulting firm, selling its high quality, professional studies to large business clients.  These studies purported to be fact based, objective analyses, “telling the clients the truth even if they might not like it.”  A partner’s goal was relationship building and repeat engagements.

The intellectual heavyweights of the firm were top of the class MBAs from leading business schools.

McKinsey Now

  • Partners now consult on a specific problem and maintain relationships with the senior hiring executive to earn repeat business.  Does the client now receive unvarnished truth or “leading edge conventional wisdom?”
  • Does the firm “add value” or ever change client behavior?  On the contrary, I suspect the firm is serving as a kind of corporate therapist, only the patient never gets any better.  Again, a great way to earn repeat business.
  • With a constant need to perform studies, keep young employees productive and cost effective, McKinsey gravitates to troubled client firms with weak management.
  • Despite efforts to maintain consistent professional standards and quality, the McKinsey product has varied widely by partner, with embarrassing episodes of falsified data and poor advice.  Ms. Smith points to the AOL-Time Warner merger, Swissair bankruptcy, Enron collapse and other bad business strategies and outcomes as examples of poor consulting work.
  • To meet Wall Street competition for MBA’s, McKinsey raised rates and became an aggressive marketer of its services.
  • The Rajat Gupta allegations of insider trading undermine the expected trusted relationship between consultant and client.

See McKinsey, the Insider Trading Scandal, and the Problems with Consulting.

The Cult of the Expert

Ms. Smith expertly analyzes McKinsey’s rise and current path. She and I agree McKinsey’s current problems are emblematic of management’s over reliance on outsiders for analysis and decisions appropriately made in-house. At one time or another, my former employers have retained a number of the name brand consulting firms.   A couple of first hand observations:

  • How naive to believe that freshly minted MBAs with little or no practical business experience can add real value. These neophytes write well, dazzle with mathematical formulas and research, but are short on wisdom, judgment and usable advice.
  • Most of consultants’ research studies can be replicated by sending one’s own very bright employees to a corporate or local university library.  In fact, I routinely turned down hiring a consultant and used my own staff to research business problems. The results were excellent and very practical.  [Note: my staff should produce quicker, better cost-effective results; they know the business and are not billing by the hour.]
  • Insecure or weak managements are the target client base for business consultants.  Insecure management lacks confidence in its own judgment, thus creating a need for consultant validation.
  • The corollary to “insecure management” is “cowardly management.”  Unfortunately, many times management demonstrates both traits which opens the door to long-term consulting engagements. Consultants provide “air cover” for this folly:  McKinsey is the business version of a “Good Housekeeping Seal of Approval.”  In response to internal or external criticism of a business decision, management can respond that “I was merely following McKinsey’s recommendation.”
  • McKinsey can also be the CEO crutch to convince a skeptical or spineless Board of Directors to approve an important corporate decision: spin off a division, merge with another company, discontinue a pension plan, increase debt to equity ratios, or other corporate level actions implicating the fiduciary duty of the director to the shareholders.  An Ivy League-trained senior consultant, speaking in well modulated tones with multi-industry experience, backed by a wealth of data and analysis, can serve as the “closer” to convince the Board to ratify management’s strategy.

Human Nature

In narrow specialized areas, the cult of the “expert” may be useful.  An expert can diagnose a cancer or heart disease and in many cases successfully treat it.  Alas, business is not like medicine.  Rather, it is a blend of art, science, psychology, economics, mathematics, marketing, law, accounting, finance, experience, and old fashioned common sense.  Rarely is there only one right answer. But we are all entitled to our own levels of insecurity. And yes, it is good to have facts and rigorous analysis.

I worked for organizations that over used consultants to the point of undermining and neutering their own senior management.  I also worked for an organization that used virtually no consultants; their reluctance reinforced the insularity in their own management group.    A well-defined and limited role for a consultant indeed exists.  A good consultant can help with areas of uncertainty or in house inexperience or lack of resources.  Importantly, a good consultant will even provide a new perspective and derail unproductive in house “group think.”

One of the eternal truths is that no one can guarantee the perfect answer to a business problem.  In the end it is a CEO or senior executive who must decide and be held accountable.  Jean Francois Revel wrote about the European cult-like infatuation with communism in “Without Marx and Jesus.“ Perhaps we need to debunk the cult of the all-knowing business consultant.  Maybe we could prepare a study entitled:  “Without McKinsey or the Boston Consulting Group.”

 

 

 

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10
Mar 11

Single Malt Scotch Index Redux

Occasionally I visit Warehouse Wines & Spirits in New York City.  No, I am not a paid booster for this store.  But clearly, it has become a must for aficionados searching for premium single malts at discount prices. (Note – there are other good single malt shops in the city such as Park Avenue Liquors and Skyview Wine and Spirits).  Besides indulging in the eternal quest for the perfect single malt, I view my pilgrimages as windows into what is happening in the economy.  Single malt is a pursuit of the upper middle class (or those aspiring to be) and a relatively small luxury item, compared to cars, furs, mansions and private jets.

Observations from the Warehouse Battlefield

First, gone is the variety of single malts available for sale.  For example, Warehouse used to carry four or more expressions of Laphroaig; now it carries two. The same reduction has occurred in its Talisker line.  Second, on the remaining lines, significant discounts have largely disappeared.  On some items prices have been increased from $5 to $10 per bottle.  Third, the most promoted single malt has been Lagavulin 16-year-old.  As I have mentioned in previous blogs, this particular bottling reached a low price of $47.99.  It has since experienced two price increases to the current $54.99.  This is still quite a bargain compared to prices across the river in New Jersey where it sells for as much as $95 per bottle.

Why Is This Important?

While it appears trite or silly to discuss single malt scotch, it is a good indicator of what is happening in the upscale import market.  Single malt is priced in Euros (I was surprised as I thought it would be in British pounds).  The price increases in this market reflect price increases in imports generally.  It also demonstrates that at least in the upscale New York City beverage market, demand has picked up somewhat and importers and retailers have some pricing power.    Even at this discounter, prices have increased 10-20%.  The era of single malt deflation is at an end, as my Single Malts I Like Ever (“SMILE”) has risen.  See Update on Deflation

One has to wonder how much prices have risen for more other necessary, important and basic commodities.  Further, it is interesting that our choices are beginning to contract.  My guess is that down the road Americans, who heavily rely on imports, will be “treated” to further diminishing choices, and higher prices on less desirable merchandise.

Thank you, Dr. Bernanke and Mr. Geithner, for trashing the dollar.  I will not be drinking to you.

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1
Feb 11

Many Answers, No Solutions

Why do we never get an answer, When we’re knocking at the door…With a thousand million questions, About hate and death and war…’Cause when we stop and look around us, There is nothing that we need…In a world of persecution, that is burning in its greed.

Question, Justin Hayward (The Moody Blues)

The Financial Crisis Inquiry Commission (FCIC) issued its 576 page report analyzing the 2008 financial crisis.   Some of the findings:

  • The crisis was both foreseeable and avoidable.
  • Widespread failures in financial regulation and supervision proved devastating to the stability of financial markets.
  • Dramatic failures in corporate governance and risk management practices in systemically important companies such as AIG, Citicorp, Merrill Lynch and Fannie Mae were a key cause of the crisis.
  • A combination of excessive borrowing, risky investment and lack of transparency put the financial system on a collision course with the crisis.  Both households and companies borrow too much and save too little.  Risks were hidden from the public.
  • Government regulators (Treasury, the Federal Reserve, etc.) were ill-prepared to deal with the crisis and their responses were late and inconsistent.
  • There was a systemic breakdown in ethics and accountability.  Households lied to get mortgages and financial institutions knowingly underwrote bad loans.
  • Collapsing mortgage lending standards and the mortgage securitization pipeline lit and spread the flame of contagion and crisis.
  • Unregulated derivatives were a major contributing force to system instability.
  • The credit rating agencies charged with properly evaluating securities were a major contributor to financial destruction.

Even the public and political leaders were to blame for not reigning in excesses.

Republican members dissented from the report, and instead focused on the government encouraging home ownership and the roles of Fannie Mae and Freddie Mac and the majority’s over-focusing on lax regulation and greed.  See Financial Crisis Inquiry Commission’s 10 Major Findings

Some Observations

-          When everyone is to blame, no one is to blame.   The FCIC report focuses on ten areas, including the roles of the public and our political leaders.  Blame is so diffuse there is essentially no blame.  The uninformed average citizen will simply breathe a sigh of relief and hope that this does not happen again.

-          The FCIC report states that there was mortgage fraud, SEC violations and ethical lapses.  Where are the prosecutions?

-          The FCIC report misses an obvious culprit.  Easy money in the form of excessively low interest rates was the Federal Reserve response to the bursting of the internet stock market bubble in 2000.  Interest rates were kept too low for too long and stoked the housing boom. Easy money is misdirected into speculation and economically dubious projects.

-          The FCIC report reacts in horror to the Lehman bankruptcy.  The report implies that bankruptcies of large financial institutions are not acceptable.  Preventative regulation is not enough.  Instead of more regulation, wouldn’t fear of bankruptcy encourage more financial prudence?

Where Are We Today?

The public and our leaders should be asking whether or not we are in a better position today to avoid a new financial crisis.  We have punished savers, pension funds, insurance companies and retirees with zero percent interest rates.  We have run over $4 trillion in deficits and supplied $23 trillion in financial guarantees. We have stubbornly high unemployment and meager economic growth. Through outright money printing (QE2), we have triggered new bubbles in commodity and equity markets.  Both markets appear overpriced.  To show their true financial picture, banks are cheering another delay of the Financial Accounting Standards Board attempt to reinstate mark to market accounting.  We operate in a perpetual state of economic emergency.

Interestingly, we rushed to pass the Dodd-Frank financial reform bill even before the completion of the FCIC report.  We prescribed medicine before a diagnosis.

We applaud ourselves for avoiding financial Armageddon, and we are making many of the same pre-2008 mistakes.

Some Modest Proposals

We could do better.  Some obvious and necessary changes we could implement immediately:

§  End zero interest rate policies and quantitative easing (money printing).  Saving and investment will return and business will expand again.

§  End guarantees to our “too big to fail” financial institutions (and others as well).  Financial prudence will return without excessive new regulation.

§  Permit the imprudent to go bankrupt.

§  For two reasons, aggressively prosecute the guilty: 1.) our democracy is based on the principle that no person or institution should be above the law, and 2.) prosecution will chasten and deter the reckless.

§  Remove Bernanke and Geithner.  The Federal Reserve under Bernanke could not foresee the crisis. It failed to regulate the mortgage lending practices of the banks.  As head of the Federal Reserve Bank of New York, Geithner failed to control the reckless practices of Citicorp and other banks under his jurisdiction.

§ Impose claw back provisions on bank bonuses.  In exchange for providing deposit insurance, TARP, below market interest rates for bank, the public has a right to demand that bank bonuses be “at risk.” This means that in good years bankers get to keep their bonuses, but in bad or abusive years those bonuses can be reclaimed by shareholders, creditors or the government.

According to Einstein, insanity is “doing the same thing over and over again and expecting different results.”  We continue to repeat past behaviors.  With QE2 we introduced nuttier behavior to prop up our too big to fail banks. The FCIC report raised a million questions and too few solutions.  Thus, we are truly facing a world that is “burning in its greed.”

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24
Jan 11

Don’t Let Your Lawyers Grow Up to Be CEOs

“Mamas, Don’t Let Your Babies Grow Up to be Cowboys” – country music song – Ed and Patsy Bruce

As the open range diminished in the United States, the above lyric was excellent advice.  Today, songwriters could be penning a similar lyric: mamas, do not let your attorney sons and daughters grow up to be CEOs.  The recent resignation of Pfizer CEO Jeffrey Kindler is a cautionary tale about elevating lawyers to CEO status.

A Great Legal Career

Mr. Kindler has a stellar and storied legal career: magna cum laude Harvard Law graduate, clerk for Supreme Court Justice William J. Brennan, attorney for the Federal Communications Commission, partner in the Williams & Connolly law firm, Vice President of Litigation and Legal Policy for GE, Executive Vice President and General Counsel of McDonalds Corporation.  From 2000 to 2002 Mr. Kindler spent time in line management with McDonalds’ Partners Brand (Chipotle Grill, Boston Market and Pret a Manger).  In January 2002 he returned to his legal career as Senior Vice President and General Counsel of Pfizer.   Selected over two long term Pfizer employees, Mr. Kindler became Pfizer CEO in 2006.   Source Wikepedia, SEC Filing

The following comments partially describe and analyze Mr. Kindler’s troubled tenure as Pfizer CEO:

…His tenure, though, has been far from smooth. Within months, Kindler was forced to announce that torcetrapib, which was supposed to have been a blockbuster cholesterol drug, had to be scrapped. Then, two highly touted product launches proved to be disappointments – the Exubera inhaled insulin … and the Chantrix anti-smoking pill.

Kindler eventually followed the same game plan as his predecessor – to appease Wall Street, he pursued a huge acquisition, which was the $68 billion purchase of Wyeth last year. This followed and extended a series of huge cuts across the company, including eliminating 14,000 jobs, several facilities and various R&D efforts….. Investors, however, have remained lukewarm, especially since Pfizer has endured several recent setbacks in the lab and as the patent expires next year on the best-selling Lipitor cholesterol pill. Pfizer stock, meanwhile, continues to languish..  See Jeff Kindler Unexpectedly Resigns as Pfizer CEO

To replace Mr. Kindler, Pfizer selected Ian Read, a company employee since 1978.  Mr. Read had extensive domestic, international, and financial experience, all within Pfizer.

The Difficulty in Selecting a CEO

As a long term observer of CEO selection, the one clearest truism is the extreme difficulty in finding and selecting a good one.  Two things suggest that Mr. Kindler was not the right selection in 2006.  First, he had extremely limited knowledge of the pharmaceutical industry generally and Pfizer specifically.   No matter how much intellectual horsepower he could muster, it was no substitute for being steeped in the science and culture of the industry and knowledge of the day to day operations of the company.  Second, Mr. Kindler was an attorney by trade with only two years of line experience in his career.  Let’s look more closely at that second problem.

Attorneys vs. CEOs

We attorneys have some solid career traits.  We are educated to analyze a problem, dissect the issues, develop a legal strategy and then communicate that strategy clearly in both oral and written form to a client or ultimately a court.  Law is a conservative process; that is, attorneys are charged to look at risk and any financial or criminal downside of an issue.  Attorneys are called counselors for a reason.  They are not deciders.  They present options and courses of action to a client.  Ultimately, the client must decide how to proceed: negotiate, litigate, or settle.  Attorneys also are trained to be self sufficient.  Working in a law firm, an attorney is more a group leader and project manager than a corporate executive.   Trained litigators like Mr. Kindler assemble a team of junior attorneys, associates and paralegals for a case and when that case is resolved the team disbands.  It is a constant process of personnel and skill recombination on behalf of one’s client, rather than any long term team building process.

By contrast, the best CEOs are ultimately team builders and strategic decision makers.  They have both operational (line) and staff (finance, legal, human resources, etc.) responsibilities.   They prefer to make decisions rather than just analyze and counsel.  In a world requiring both thoughtful and rapid decision making as well as risk taking, an attorney/CEO is operating outside the usual legal comfort zone, experience and training.   Moreover, a fine CEO must get highly knowledgeable and strong willed senior management to work together, a far cry from commanding a team of compliant junior partners and associates with the knowledge that the process will be short term.

Boards of Directors

An old corporate saw describing bad corporate governance goes something like this:  if the company is having a financial problem, its Board will elevate the chief financial officer to be the CEO.  Similarly, if the company has a manufacturing problem, an outstanding operations executive may be tapped for the highest executive position.  In the case of Pfizer in particular, and the pharmaceutical industry in general, recent times have been beset with product liability law suits, patent infringement actions and threats of new legislation.   The easy choice for Pfizer’s Board in 2006 was to select its general counsel or an outside law firm partner as CEO.  That turned out to be a mistake.  Clearly, what Pfizer did not do was keep its fine general counsel, Mr. Kindler, who would have continued to assemble and direct a first rate products liability and patent law legal team to tackle the problems.    If Pfizer’s Board, at the same time, found a fine CEO to shepherd the company through its immediate problems and its long term issues, perhaps better company performance would have resulted.

Merck Follows Pfizer

In November 2010, in almost the same time frame as Mr. Kindler’s departure, the Merck Board appointed Kenneth Frazier as its CEO.  Mr. Frazier is credited with devising the litigation strategy to deal with Merck’s Vioxx products liability suits.   Mr. Frazier appears to have followed a parallel career path to Mr. Kindler.  Working in various legal roles at Merck from 1992 to 2010, Mr. Frazier was not appointed to an operations role at the company until April 2010.  In other words, he had a mere seven months of operational experience.

Merck has had a long and distinguished history of CEOs with scientific backgrounds.  I would argue that the transition to CEOs with staff backgrounds, such as finance and law, has contributed to the company’s decline:

The key to understanding Merck’s slide is to compare its CEOs. During the glory days, it was led by scientist P. Roy Vagelos, who is almost universally described as brilliant, charismatic, arrogant, and hard-driving, both by industry experts and by people who worked with him….The son of Greek immigrants, Vagelos grew up cleaning tables in his family’s luncheonette, in the shadow of the Merck labs. As head of Merck’s R&D for nine years, he brought in hundreds of new scientists, modernized the labs, and increased the research budget an average of 17.2% annually. Because he understood the science, old-timers say, Vagelos was able to inspire …creativity and energy….Moreover, Vagelos got personally involved in the everyday workings of the company. He even ate lunch in the cafeteria.  See Merck’s Fall from Grace

Perhaps Mr. Frazier will break the pattern of failed attorney CEOs.   In hindsight, both Pfizer and Merck’s Boards would have been wiser to avoid selecting attorney CEOs and have their fine science companies led by a long-term company scientist with operations experience.  For now, if I were investing in these companies (and I am not, nor am I purporting to provide investment advice), I would place my bet on Pfizer’s Mr. Read:  a long term Pfizer employee with a scientific background and in-house financial and operations experience elevated to his company’s highest corporate position.  Let’s see how he does.

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30
Dec 10

Are We Getting the Government We Deserve?

There is an old labor relations saying: “companies get the unions that they deserve.”   In plainer words, poorly managed companies, constantly at war with their employees, tend to spawn highly aggressive, combative unions.   Put most succinctly, bad management yields bad labor relations.

In this context, let’s look at our series of rolling economic crises.  Our government’s response to each one has been to encourage or spawn “bubbles.”   (1.) Federal Reserve chairman Greenspan recognized the internet bubble.  Instead of squelching the identified “irrational exuberance,” he continued to encourage speculation.  (2.) Responding to the internet market crash, the Greenspan Fed spawned the housing bubble.  (3.) With housing now in shambles, the Bernanke Fed is openly trying to create a stock bubble. See Who Elected Ben Bernanke?

My hypothesis is that our political leaders do not have the courage to speak truth to the electorate.  Economies need recessions as a curative for financial and business excess. Without these necessary corrections, the seemingly easy way out of low interest rates, easy credit and promises of speculative riches becomes public policy.  If we are a populace seeking easy fixes to complex problems, we get a government that acts accordingly.

Spending is Easy, Savings is Hard

In Retirement Account Fantasy and Middle Class Erosion – 1 of 3 Americans Has Zero Dollars in a Retirement Account (“Retirement Account Fantasy”) the author exposes our dangerously low level of retirement savings.

1 out of 3 Americans has zero in any retirement account (not one slowly eroding dollar).  Half of Americans have $2,000 or less which puts them one month away from needing government assistance. See Retirement Account Fantasy

In a recent insurance company survey, 84% of young adults (18-29) and 60% of adults (30%) recognize that they need at least a million dollars to retire.   Actual retirement savings are nowhere near that:

The median retirement account for US households is $2,000.  This is why the vast majority of retirees depend on Social Security as their primary source of funds in old age even though Social Security was never designed to be a long term pension system.  The average retirement account is closer to $50,000 a year but this is heavily skewed by the top 1 percent that keep most of their funds in stock wealth.  See Retirement Account Fantasy

Thus, we have a failed retirement savings system which only exacerbates the shortfall in social security funding.  In turn, the government will be forced to borrow even more to fund future social security payments.

Ants and Grasshoppers

The author of Retirement Account Fantasy lays the blame for the retirement savings shortfall on our low income growth, income inequality and Wall Street pilfering.  While these observations are true they describe the patient’s symptoms, not causes.  The causes are a lack of savings and true investment rather than speculation.  Government has only worsened this problem through accommodative monetary and economic policies.  Zero interest rates are a disincentive to save and invest.

Prior to 2008, there was comparatively low unemployment and GDP growth.  Like the ant in the fable of the Ant and the Grasshopper, workers could have chosen to over save and under spend.  That would have required living in a home one could afford, and spending money that one actually had.  Instead, during this period we had our national savings rates turn negative.  Debt (especially housing debt) became a virtue and cash an anathema.

Instead of a policy of shared sacrifice and thrift, the government encouraged consumer spending, especially on expensive items such as McMansions and SUVs as a means to achieve economic salvation. See The Greediest Generation – Where has Shared Sacrifice Gone?

Reflecting more on the issue, I believe there is a deeper societal issue.  We live in an age of instant gratification.  If a web page loads too slowly, we need a better “app” or a better device.  If a marriage does not meet our expectations, we divorce our “life long” partner and look for a new one.  We suffer poorly even minor hardships.  Faced with a recession, we ask government to bail us out.

What happened to the ethic of earlier generations:  savings equals freedom: freedom to leave a job, start your own business, transfer to a new location, avoid government assistance, or simply to retire by choice while healthy and vigorous.

Right now government openly favors financial elites who are the merchants and promoters of debt.   But the way out of the financial crisis requires personal sacrifice and discipline.  Unfortunately, we seem to lack that will; thus, we get the government we deserve: easy fixes, easy money, short lived artificial booms and long-lived genuine crashes.

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