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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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27
Dec 10

Life Lessons From It’s a Wonderful Life

One of the pleasures of the season is the classic film “It’s a Wonderful Life.”  The story is a virtual cinematic Rorschach test.  Each viewer can find a personally resonant message: the love of a good woman, the evil of greed, the importance of community, faith or thrift.  Angel Clarence helps our hero George Bailey realize that every life is precious, we are all connected to each other and each of us makes a difference.  These are certainly valuable lessons.  However, some of the film’s equally important lessons in George’s story are sometimes overlooked.

Should We Ever Question Authority? Young George Bailey’s boss, the pharmacist Mr. Gower, learns of his son’s death and accidentally puts poison in a prescription.  Realizing this dangerous mistake, George disobeys Mr. Gower and does not deliver the prescription.   He returns to the pharmacy and receives physical abuse from the distraught and distracted Mr. Gower.  Ultimately George convinces his boss that the prescription is lethal, and Mr. Gower is forever in George’s debt.

Should We Work in a Family Business and Delay College? After high school, George must work in the family building and loan and save money before going to college.  George has the opportunity to learn the savings and loan (S & L) business directly from this father. The experience is probably an education and valuable apprenticeship that George could not replicate in college or an MBA program.

How do We Lead in a Crisis? Just as George is preparing to leave for college, his father dies unexpectedly.  The evil and greedy Mr. Potter convinces the S & L board to close the business.  The directors rebuff Potter, but inform George that the business will stay open only if he agrees to succeed his father.  George must weigh his college career and dreams of adventure against his father’s dream of providing decent housing for his community.  Further, George knows that leaving for college now would mean loss of employment for his uncle and others.  Displaying leadership and courage, George gives up college and assumes the leadership of the savings and loan.

What Skills Get Us Through a Business Crisis? On his wedding day and in the taxi to leave on his honeymoon, George witnesses a run on his S & L bank.    Potter calls in the bank’s loan, imperils the business and threatens to close it permanently if it cannot remain open until the close of that very day.

At the gated door of the savings and loan, George calmly speaks to his angry depositors.  George opens the doors and invites everyone inside.  First, he reasons with the crowd, explaining that each depositor is invested in the other’s home, and there is little actual cash on hand.  Second, he points out their depositor agreements require sixty days notice before a withdrawal.  Third, when the depositors still demand their money he does not panic.  Rather, with his new bride Mary by his side, he begins to negotiate with his depositors.   Fourth, the new Mrs. Bailey devises a creative solution.  To allay the concerns of the depositors she waves $2000 of wedding gift money.  Fifth, while George agrees to give the first depositor all his money, he does not permit the man to close his account:  “Your account’s still here. That’s a loan.”   Sixth, he finally turns the tide, and convinces the next few depositors to withdraw only a small fraction of their accounts,  that is, only what they need immediately.  Everyone makes it through the business day, even though the bank has but $2 left in the safe.  This one scene is a veritable training film of management ethics, courage, improvisation, knowledge of customer base, negotiating skill and emotional intelligence.

Should One Change Jobs for More Money? Recognizing that George represents a long-term threat, Potter makes him a spectacular job offer.  Potter offers George almost tenfold per year with the promise of travel to New York and Europe.  Overwhelmed by the offer, George is on the verge of accepting.  But he realizes that this is another of Potter’s evil plans to destroy the savings and loan and keep more community neighbors in substandard rental housing.   Ever his father’s son, the principled George turns down the offer and speaks truth to power, berating Potter for unethical business practices.

Clearly, George has compared his current and prospective work environments and considered intangibles such as respect, responsibility, ethics and the reputation of the employer.  For George, success and job satisfaction is not defined by money alone.

How Do Managers Make Difficult Personnel Decisions? Uncle Billy loses $8,000 on his way from the S & L to deposit the funds at Potter’s bank.  George has witnessed Uncle Billy’s drinking and forgetfulness.  Banking requires sobriety and attention to detail.  Should George have terminated Uncle Billy years before?  George suffers the consequences of this personnel decision, and sets up the arrival of Clarence the Angel in the climactic scenes of the movie.

Do Big Bad Banks Get Away with Bad Behavior? Potter winds up in possession of the lost $8000 and he never returns it to Uncle Billy, George or the savings and loan. In fact, he swears out an embezzlement complaint against George.  Potter is never punished for his misdeeds.

How Important Is Family and Community? Faced with ruin George panics and flees. But Mary recognizes the enormous social capital that she and George have built up in their small town.  She gets on the phone and gets help.   Her former boyfriend authorizes up to $25,000 to help George.  Both rich and poor citizens and even the bank examiner contribute to save George, Mary and the savings and loan.

The overarching quote and lesson in this film, in business and in life, explicitly and elegantly stated, is “Remember George: no man is a failure who has friends.”  The unrecognized good that we do during our lifetime returns to us in ways that we may never expect.

Happy Holidays to All!

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13
Dec 10

Exploding Myths, Eroding Confidence

In this country, the American dream is with us from birth.  What is that dream?  Get a good education, work hard, be honest, and one will succeed.  What is success? A good income, one’s own home, a college education for the children, and a comfortable retirement.

There are obvious quantifiable effects from the financial crisis, such as reduced retirement savings, reduced income or job loss.  What about the qualitative effect: loss of confidence?   Every society has its dreams and mythology.  The financial crisis has exploded many of our collective myths and turned the dream into a nightmare.

Exploding Myths

Let’s touch on a few of the exploding myths:

1.      Myth: House prices only go up. Reality: Nationwide, from a peak in July 2006, house prices have declined 28.6 percent (Case-Shiller Index).  Many experts say that house prices will suffer a further decline. See Home Prices Falling at Faster Rate, New Report Shows.

2.      Myth: America is a capitalist society, supporting competition and free enterprise. Reality: We have a form of state capitalism bordering on fascism.  The government now bails out large, private corporations which get into financial trouble: Citibank, GE, GM, Chrysler, AIG and others.

3.      Myth: The Federal Reserve can fine tune the economy to avoid recessions.  Reality: Neither Alan Greenspan nor Ben Bernanke foresaw the internet stock bubble, the subprime crisis or the 2008 stock market crash.  We have suffered two 50% stock market declines in the last decade, and for the last two years we are living in a perpetual recession.

4.      Myth: Keynesian and monetarist economic remedies can pull us out of a recession.  Reality: The Federal Reserve and the Administration have tried every Keynesian and monetarist nostrum from economic stimulus programs, cash for clunker tax credits, home buyer tax credits and the outright printing of money (QE1 and QE2).  None of these programs has reduced unemployment or restored economic growth.

5.      Myth: Buying and holding stocks for the long-term is the road to true wealth.  Reality: In the last ten years the stock market has not appreciated.

6.      Myth: The US financial markets are the most open and transparent in the world.   Reality:  Insider trading scandals (Galleon Group), false accounting (Enron, WorldCom), financial firms secretly trading against their client (Goldman), perfect trading records for quarters at a time (Goldman, Bank of America, Morgan Stanley), high frequency trading and flash crashes all confirm for us the murky and duplicitous nature of our markets.   Our sole clarity is that they are run for the benefit of professionals and insiders to the detriment of the retail investor.

7.      Myth: Congress represents the American people.  Reality: Congress represents major corporations and unions who in turn contribute to selective political campaigns.   Winners in healthcare and financial reform were the major banks, investments firms, health care insurers and pharmaceutical companies, not the American public.

8.      Myth: A good education is the key to getting ahead. Reality: Eighty percent of  last year’s college graduates did not have a job upon graduation.  See A Dismal Outlook: Recent College Graduates and the Job Market.  Unemployment is close to ten percent and underemployment close to 17%.  If you listen to Dr. Bernanke’s advice to get a good education, you have a better chance utilizing that education in Mumbai or Shanghai, not in the United States.

9.      Myth: A combination of savings, home price equity appreciation and social security will support a comfortable retirement.  Reality: The financial crisis has decimated retirement savings and eliminated or diminished any gains from home equity.  Given the massive social security unfunded liabilities and the unwillingness of Congress to consider tax increases, even social security is in no way a sure thing upon one’s retirement.  Many individuals may never retire.

10.   Myth:   Everyone will have affordable health care.  Reality: Health insurance premiums have soared since the passage of Obamacare.  See ObamaCare Raising Health Insurance Premiums.  Moreover, with the cut in Medicare reimbursements and increased paperwork, many doctors refuse to accept Medicare reimbursements.

Myths are for Children

A “harmless” myth told to a child may have little consequence.  But the above myths are not being told to children, they are being foisted on an American population with lives and fortunes at stake.  And these false myths are at the core of our society.

One of the most dangerous myths is that debt does not matter.  Myth perpetuation can exist for a while,  but there are always consequences.

“Highly indebted governments, banks, or corporations can seem to be merrily rolling along for an extended period, when bang! – confidence collapses, lenders disappear, and a crisis hits.” [Quote from "This Time is Different: Eight Centuries of Financial Folly"]

Bang is the right word. It is the nature of human beings to assume that the current trend will work out, that things can’t really be that bad. The trend is your friend … until it ends.  See Unintended Consequences

Myths are exploding and confidence is eroding.  Things need to change, before “bang!”

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17
Nov 10

Unintended Consequences of QE2

In several previous posts we have discussed why QE2 is wrong-headed and potentially disastrous.  Let’s look at some of the unintended consequences since its announcement on November 3.

Bond Market

The stated goal of QE2 was to lower interest rates to stimulate spending.  The methodology was the purchase of intermediate term (5-15 years) Treasury securities.  Looking at last month’s performance of the Treasury market we see the following: five-year (current yield – 1.46%; one month ago 1.13%); ten-year (current yield -2.83%; one month ago – 2.51%); 30-year (4.23%; one month ago – 3.95%).  Source – Yahoo Finance, November 17th. Similarly, QE2 has triggered a crash in the municipal bond market. Yields have risen one-half percent since November 5th.  See Tax- Exempt Muni Bonds Tumble; Munis Continue Collapsing.   Increases in interest rates only favor banks over the real economy.  See Bond Market to Bernanke: F@&k You

The G-20 Meeting

QE2 has set off a currency war.  Our trading partners recognize that the Federal Reserve is flooding the world with US dollars.  To avoid importing inflation, these countries are contemplating erecting protectionist measures such as controls on imported capital.  Writing for the Asia Times, David Goldman captures the international turmoil:

…Never before has the world displayed the sort of public contempt for American policy that Germany, China and others expressed last week. Wolfgang Schaueble’s Spiegel interview last week describing quantitative easing as “clueless,” followed by Federal Chancellor Angela Merkel’s open attack on it during the G20 meetings, is entirely new, as is the Chinese and other Asian threat to simply keep dollars out.

The rest of the world is right and the Fed is wrong. QE2 is turning into Titanic I. The Fed has been exporting inflation through excess money creation; holders of dollars buy foreign currency, which forces foreign central banks to intervene on foreign exchange markets by selling their own currency. The foreign central banks create new local currency in order to buy the unwanted dollars and stabilize their exchange rates, which adds to inflationary pressures in their countries. They use the dollars they have bought to buy Treasuries.  See Exchange Controls and Deflation

Since countries such as Japan and China are major purchasers of US Treasury securities, alienating these purchasers will have the unintended consequence of further driving up US interest rates.  Mr. Goldman advises investors to avoid financial markets and stick to cash during this turbulent period.  In a disingenuous defense of QE2 William Dudley, President of the New York Federal Reserve Bank, claimed that: “I don’t think we knew that the dollar would necessarily weaken.”  Before implementing a controversial policy as QE2, shouldn’t Professor Bernanke and his cohorts have considered a falling dollar and rising commodity prices?

Cost Push Inflation

Living through the 1970’s, cost push inflation, where input prices compressed profit margins, was a major cause of the steep bear market in stocks.  Carefully massaged  current government inflation statistics need to be taken with a grain of salt.   In the real world companies as diverse as Kraft, Dean Food, Kimberly Clark and Campbell Soup have cited cost pressures, and reported poor quarterly results.  Kimberly Clark’s announcement cited its “highest-ever cost inflation…” And So it Begins… (Cost-Push Margin Compression)

The already beleaguered consumer is experiencing real world inflation at the checkout counter:

There might not have been a second round of quantitative easing, if Federal Reserve Chairman Ben Bernanke shopped at Walmart.

A new pricing survey of products sold at the world’s largest retailer showed a 0.6 percent price increase in just the last two months, according to MKM Partners. At that rate, prices would be close to four percent higher a year from now, double the Fed’s mandate. See Walmart: Inflation is Up

Stocks are now priced for perfection, the market’s way of telling us that investors have not considered rising inflation.  Declining profit margins will result in price earnings multiple shrinkage and a falling stock market.  See The Cliff

Misallocation of Capital

Since the US does not have exchange controls, the Federal Reserve cannot control where its newly created dollars are invested.  We have identified commodity speculation as one area for these funds.  See 1984 in 2010.  Further, money is being invested in emerging markets instead of the US economy.

Despite the belief that the Federal Reserve can create unlimited amounts of dollars, any society has limited capital resources.  These can either be invested wisely in new productive enterprises or squandered through speculation.  QE2 encourages the latter.  By artificially attempting to suppress interest rates the following occurs:

You get asset and credit bubbles – every time. The reason is simple: You have paid someone to perform an uneconomic activity.  That is, an activity which would not be performed by free actors in a free market system because it would inevitably lead to loss becomes profitable due to intentional interference in the market.

Maintenance of such a thing over time requires that “someone” be given incentives to perform non-economic activities.  This in turn fuels asset bubbles and that, in turn, leads to cycles of booms and busts. See Dishonesty All Around – Monetary and Security

Constant intervention in the economy will only lead to an inevitable bust.

Real Solutions

We are headed down a dangerous path: not only dangerous to our financial portfolios, but dangerous to our security.  Currency wars and protectionism lead to real wars.  The history of the 1930s is a dramatic example.

The ways out of this quagmire are painful.  They involve writing down debt, losses to bondholders, a failure of several “too big to fail banks” and a shock to the equity markets.  The pain will be great, but swift.   Remaining on our current course will be worse.

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11
Nov 10

1984 in 2010

In George Orwell’s 1984, protagonist Winston Smith works in the Ministry of Truth.  In Airstrip One in the mythical Oceana, the Ministry serves as a perpetual propaganda machine exercising public mind control.  Winston eventually rebels against “Big Brother.”  Ultimately, he is captured, tortured and “re-educated.”

Today’s media subject us to a constant barrage of spin, messaging, falsehood and half-truth.  We have traveled from the “No Spin Zone” to the “24/7 Spin Zone.”   Dangerously, it is our own government controlling and propagating news and messages:

1.      Spin:  QE2 is designed to meet the two Federal Reserve goals of high employment and low inflation.   [Bernanke op-ed Washington Post]  Truth:  Revealed later in the op-ed piece is that QE2 supports stock prices.  Moreover, the real likely beneficiaries of QE2 are our failing large banks.

2.      Spin: QE2 will not result in the Federal Reserve monetizing our national debt.  [Bernanke June 3, 2009 testimony before Congress]:   Truth:  “For the next eight months, the nation’s central bank will be monetizing the federal debt.”  Richard Fisher, President of the Dallas Federal Reserve Bank   Speech November 8, 2010

3.       Spin:  “Structural unemployment is not increasing.”  Federal Reserve Bank of San Francisco Report Is Structural Employment on the Rise?    Truth:  In The New Reality: Permanent Job Loss , we explored the new labor force dynamics.  Noted economist David Rosenberg estimates that we have a permanent job loss of 6.2m workers.  With slow revenue growth, outsourcing, skills mismatches and tight credit conditions unemployment will remain high.

4.      Spin:  “Jobs Expand by 151,000.”   Bureau of Labor Statistics Report Truth:  This statistic is patently misleading. Labor force participation is dropping (58%): more workers are no longer participating in the labor force (36%) and therefore are not counted.  Moreover, the BLS uses the birth-death model which fictitiously creates jobs based on demographics.

5.      Spin:  Inflation is low (below 2%),  therefore Social Security cost of living adjustment does not apply.  Truth:  The Federal Reserve uses a 2.2% inflation deflator when calculating Gross Domestic Product.  Since the beginning of the summer the following commodities jumped in price: corn (71%); oil (24%); oats (106%); wheat (67%); soy (44%); copper (47%); gold (21%) and silver (48%).  Commodity price increases have passed through to higher retail prices in every sector. Source:  Karl Denninger

6.      Spin: After performing stress tests on 19 banks, secretary Geithner declared the banking system fundamentally sound.  Truth:  Even after TARP, TALF, government guarantees and other programs have exceeded last year’s number of bank failures.  And this with two months of the year to go.  See Tracking Bank Failures: 2010 Exceed 2009 Bank Failures. More takeunders like that of Wilmington Trust are certainly possible, and that bank discounted its stock by 40%.  See A Canary in the Mine

7.      Spin:  The Administration has assured us that the brewing mortgage foreclosure crisis is merely a paperwork problem.   Truth:  Foreclosuregate raises a number of significant problems related to mortgage securitization.  Problems range from poor underwriting standards to outright fraud in court filings.   See This Magic Moment, Postscript to Foreclosuregate

8.      Spin:  The Treasury Secretary assures our trading partners and us that the US wants a strong dollar.   Truth:  QE2 has weakened the dollar and enraged our trading partners.  Since summer 2010,  the dollar has declined 16%.

9.      Spin:  the economy is recovering.   Truth:  Interest rates been held at zero percent for an extended period of time.  If the economy is recovering, why do we even need QE2?

10.  Spin:  Initial unemployment claims for the week of November 6, 2010, dropped by 24k .  Truth:  Unfortunately, that series has been revised downward from the previous week 36 times out of 42 weeks in 2010.  Similarly, continuing claims for unemployment insurance have been revised downward 42 out of 44 weeks.  Finally, without BLS adjustments the initial claim report would have shown a loss of 38k jobs.  Jobless Claims at 435K on Expectation of 450k, To Be Revised Worse Next Week

Becoming Winston Smith

The US Ministry of Truth has been on a concerted campaign to ignore or distort economic statistics to convince the American public that the recession has ended and a recovery is well under way.

The newest object of government attention is the stock market, with the goal of boosting prices to induce a recovery.  Charles Hugh Smith estimates that the Fed’s QE2 efforts since June have resulted in a net loss to the US economy of $4.6T.  That loss includes the 19% gain in the stock market.  See Fed’s QE2 Misadventure Costs U.S. Households $4.6 Trillion

We have been so conditioned to hear lies and spin that we can no longer discern the truth.  We have all become like 1984’s Winston Smith, the wayward and tragic civil servant. So far, no politician has the guts to stand up and say we have real structural problems in the economy. It will take more than hope and spin to solve our problems.  There needs to be some period of economic contraction, debt write off, fiscal and monetary austerity and probably another stock market crash before a real recovery can happen.  Who will have the courage to tell us an unpopular, unspun truth?

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29
Oct 10

Is the US Economy an Impaired Asset? Part II

In Part I we defined impaired assets and posited that the United States could be compared to a corporation so burdened.   Has ill-advised investment in multiple critical areas led US INC to be over-indebted with too limited income to repay that debt?   If the answer is yes, it also leads to other impediments to a genuine economic recovery.

Impediments to Economic Recovery

-          Discouraging savings – Productive enterprise springs from investment. Investment is predicated on a pool of savings to tap.  Zero interest rates and high taxes impede savings and investment.

-          Workplace regulations – We have overregulated the workplace.  Worker protections have been taken to an extreme.  We protect workers against a myriad of discriminatory behaviors: race, age, sex, national origin, pregnancy, gender, disability, union membership, marital status, veteran’s status and others.  While all noble goals, fearing expensive litigation, companies build costly compliance complexes and hesitate to discipline or discharge a poorly performing employee because of their protected status.

-          Environmental regulations – While initially a worthy goal, the overlapping state and federal (EPA) enforcement regimes and expensive compliance impose significant costs on American companies.   Foreign competitors face little pressure in this area and thus enjoy a competitive advantage.

-          Unionization – Through a myriad of seniority and work rules, breaks, and generous wage and benefit demands, unions impose a significant employer expense. These limit employer flexibility to respond to changed economic conditions.  The Administration has an avowed policy of trying to make unionization easier.

-          Litigation – Besides employment, environmental and labor litigation, employers face significant litigation risk in product liability and securities areas.  States with pro-plaintiff orientations have encouraged expensive and prolonged class action litigation.

-          Public Sector – Expanded public sector employment creates a dual problem.  First, the private sector is at a competitive disadvantage competing for talent against the higher paid, secure employment in the public sector.   Second, an expanded public sector imposes greater tax burdens across all levels of government, all of which costs are ultimately levied against private enterprise.

-          A Culture of Entitlements – Public policy over the past seventy years has built an expensive safety net of personal entitlements: social security, Medicare, Medicaid, unemployment, disability insurance, family leave, medical leave and others.  The Obama health care initiative only adds to these burdens.

The US is much like the mid-1990s telecom environment.   We are burdened by too many legacy costs.  We have too much debt, overvalued assets and insufficient income to pay back our debts or support our regime of entitlements and regulatory burdens.

Solutions

Technology and poor economic policy have earned US INC the dubious status of impaired asset.   One way the markets have been expressing this concern is through the decline of the dollar.  Moving up the economic chain, the next move would be for foreign governments to refuse to purchase US Treasury securities.

Looking at government attempts to export our way out of this problem through depreciating the dollar, Doug Noland of Prudent Bear comments:

Having de-industrialized and failed to invest sufficiently in productive capacity during our prolonged Credit Bubble, there will be no near-term exporting our way out of trade deficits.  And there is little evidence that help is on the way from the current elixir of massive non-productive government debt expansion and ultra-ultra-loose monetary policy.  While extreme government stimulus has stabilized incomes, consumption and imports, it has done little to promote the type of productive investment necessary to rebalance our maladjusted economy. See Rebalancing the World

It is time to end extend and pretend.  If US INC was subject to private business accounting rules, the banks would be forced to write down their “assets” (loans) to fair market value.  Yes, this would involve hardship upon the equity and bond holders of banks.  But failure to remedy this problem will only prolong the economic agony.

Further, any good business person would look at the cost side of the enterprise and try to reduce expenses.  We probably have gone as far as we can in cutting employment expense through layoffs.  We need to move up the chain to look at societal costs being imposed on business.  We are not about to throw out all environmental, workplace and other protections  However, we need to see how a more sensible regulatory scheme could reduce costs and minimize employer litigation costs.    Further, public policy needs to reduce public sector employment numbers and cut back entitlements.

We need to take these steps before our foreign investors and competitors impose them upon us.

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27
Oct 10

The US Economy: An Impaired Asset? Part I

Rather than a political entity, for a moment view the United States as a massive corporation with divisions.  Think of housing stock, commercial real estate, manufacturing capacity, technology, mass transportation, infrastructure, airports, power, pipelines, and telecommunication, and one can easily imagine the nation as a conglomerate of assets: US INC.

However, assets depreciate and not may be worth the value assigned by the owner.  Accounting principles recognize that assets must constantly be evaluated.  Enter the concept of the impaired asset:

…long-lived assets and certain identifiable intangibles to be held and used by an entity (must) be reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. In performing the review for recoverability, the entity should estimate the future cash flows expected to result from the use of the asset and its eventual disposition. If the sum of the expected future cash flows (undiscounted and without interest charges) is less than the carrying amount of the asset, an impairment loss is recognized. Otherwise, an impairment loss is not recognized. Measurement of an impairment loss for long-lived assets and identifiable intangibles that an entity expects to hold and use should be based on the fair value of the asset. Summary of Statement – FAS 121

The accounting profession recognizes that an asset becomes obsolete when its income can no longer support it. Thus it becomes an impaired asset and must be written down to fair market value.

Telephone Companies and Impaired Assets

An example from the mid-1990s is the technological and business transition that faced US local telephone companies. As the industry sought to meet the demand for high speed data services and internet transport, regional phone carriers (the predecessors of Verizon,  AT&T and others) needed to switch from the slower, reliable copper cable network to fiber optic technology.  Similarly, switching went from analog to digital to “soft switches” to handle higher volumes of traffic.  Recognizing that income from voice services could no longer support the sunken costs of the investment in copper cables and analog switches, the companies were required to recognize an impairment charge and write down the value of their assets. See The Future of the Regional Bells

Focusing on the Present State of the American Economy

The current state of the US economy bears a striking resemblance to the telecom industry scenario of that era.   We have a boatload of impaired, non productive assets call residential and commercial real estate.   Encouraged by the government’s desire to create an “ownership society” and artificially low interest rates, Americans overspent on housing.  Housing prices were driven artificially high to the point where incomes could no longer support buyers’ investments in their homes.  Collaterally, commercial real estate mirrored the housing boom with wildly expanding retail and office space.  Again, our national income could no longer support this expansion.

Technology conspired to impair even more assets and reduce our national income.  Faster telecommunications, larger and faster ships, cheaper foreign labor, and transferability of skilled labor made it feasible for offshore production and services.  Again left behind were empty factories, shopping malls, office buildings and warehouses.   The Midwest was particularly hard hit with factory closings and high unemployment.  Returning to our corporate metaphor, US INC  purchased too many assets at historically high prices with insufficient corporate income and profits to support them.

Hiding the Problem

Since FASB has suspended mark to market accounting in 2009, the banks have been the main culprit and beneficiary in failing to mark down these impaired assets.  The Federal Reserve continued the deception when they purchased from the banks over $1.25 T of impaired mortgage backed securities.  So now the taxpayer is another potential holder of impaired assets.

The Federal Reserve is on a maniacal quest to start QE2 (quantitative easing) to purchase even more impaired mortgage backed securities.  If the mid-1990s telephone companies were the object of the Federal Reserve’s affection, perhaps they would have been buying the impaired copper telephone networks and paying top dollar.

Part II will discuss further impairments and solutions.

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11
Oct 10

You Say You Want a Revolution Part II

In my last blog we described the seeds of the next American revolution.  See You Say You Want a Revolution Part I. Paul Farrell outlined the incompetence of the Republican and Democratic parties and the greed of Wall Street.  One institution targeted for dissolution is the Federal Reserve:

…the Fed cannot survive. Why? Not because the Fed is at the center of America’s economic problems, beyond repair, a dying institution. But because the Fed is a pawn of Wall Street’s Happy Conspiracy, which is incapable of seeing the train wreck that it set up.

This out-of-control, conspiracy of greedy Wall Street bankers, corporate CEOs, corrupt politicians and Forbes 400 billionaires will, in the near future, trigger the third catastrophic meltdown of the 21st century, a collapse that paradoxically can transform America into a new, stronger post-capitalist economy … but only after a revolution and brutal class warfare. But few will talk about what’s coming.  The Fed is Dead, Maybe by 2012

You Should Always Tell the Truth

Nassim Taleb, author of The Black Swan, believes that the Federal Reserve will not exist in 25 years.   Mr. Farrell demurs, warning that it will happen much sooner as fallout from the second American Revolution.

It’s inevitable: Wall Street banks control the Federal Reserve System; it’s their personal piggy bank. They’ve already done so much damage, yet have more control than ever.

Warning: That’s a set-up. They will eventually destroy capitalism, democracy, and the dollar’s global reserve-currency status. They will self-destruct before 2035 … maybe as early as 2012 … most likely by 2020.  The Fed is Dead, Maybe by 2012

Taleb uses two simple formulas to determine the veracity and competence of our politicians, business leaders and academicians: do they tell the truth (not half truths or other deceptions) and prior to 2008 did they foresee the financial crisis?

Taleb’s view is that you cannot trust anyone in government. He cites two US Treasury Secretaries:  Timothy Geithner and Henry Paulson.  Geithner cherry picks dates and misleads about the economic recovery.  Paulson warned President Bush about the financial crisis in 2006, but failed to warn the public.  Worse, Paulson’s public declarations in 2007 and 2008 led the investing public to believe in the strength of the US economy and that the housing bubble was well contained.  The Fed Chairman, Ben Bernanke, made the same deceptive statements.

Turning to economists, Taleb focuses on Paul Krugman who never anticipated the financial crisis.  Moreover, his economic proscription of exchanging private debt for public debt only creates moral hazard. Our grandchildren will be burdened with our debt.

He heaps special scorn upon President Obama and the Senate for reappointing Bernanke after his miserable track record.  Bernanke remains in his position despite failing to revive the economy.  Taleb believes that Bernanke is a shaman, “whose methods make ‘homeopath and alternative healers look empirical and scientific.”  The Fed is Dead, Maybe by 2012

A Recipe for Collapse

Charles Hugh Smith in The Recipe for Collapse,  supports Mr. Farrell’s proposition that we are heading for another collapse.  The following mixture all but assures a coming collapse: central planning (the Federal Reserve); encouraging speculation through reducing the safe return on capital to below the inflation rate (zero interest rate policy); creating bubbles in real estates, stocks, bonds and commodities (e.g., nine million vacant homes); corrupting the power elites to continue financial skimming and speculation (watering down the financial reform bill); concentrating wealth and power in a small elite; promoting debt and leverage so that the economy will collapse with ever increasing amounts of debt; continuing to promote failed economic remedies (stimulus, zero interest rates); making corruption, cronyism, embezzlement, insider trading and fraud endemic; concentrating media in a few hands; devoting an increasing share to internal security or military adventures; making an ever greater number of laws hampering productive enterprise, and raising the hopes of the general population that they can get rich quickly (housing, stocks) only to have their dreams deflated or dashed.

So You Want a Revolution

The Administration, the media and the financial elite are unwittingly marching down the path to revolution.  What I find most disturbing is that we re-cycle and give prominence to the same public figures that got us into this mess:  Ben Bernanke at the Federal Reserve, Timothy Geithner formerly of the Federal Reserve Bank of New York and now Treasury, Barney Frank in Congress, Paul Krugman at the New York Times and a host of others.   We need some new thinking and directions, not a repetition of the same tired nostrums which have not, and probably never, worked.

So we are at the crossroads of a revolution.  Revolutions do not have to be violent.  But it would take revolution to upset the smug, intellectually and morally bankrupt status quo.  We need some leaders who regularly speak truth.  Only when we make a complete break from the past, do we have the possibility of a brighter future.

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22
Sep 10

In Praise of a Liberal Arts Education

Years ago I sat at another boring business dinner.  One of my colleagues, a president of one of our larger subsidiaries, leaned over and asked me what her freshman son at the University of Texas-Austin should major in to get ahead in the business world.  I was surprised at the question and even more surprised at my response.  I replied that he should get a well rounded, liberal arts education and major in something he loved.

Higher Education at the Crossroads

While no one wishes for bad economic times, these events have a way of provoking thoughtfulness, values clarification, and ultimately a crossroads.  Many pundits now question the value of a college education.  With the cost for higher education rising dramatically, some professionals in the education and business communities now question its value.  Are students wasting their time taking art history or gender studies?   Should emphasis be on skill-specific, career-oriented majors that will result in good jobs and rapid loan payback?  Should we be guiding young people into applied scientific, computer and accounting majors rather than the traditional liberal arts?

The Meaning and Purpose of Education

Like many high school seniors, I had no real idea about what I wanted to do.  I did know that I wanted to go to a four-year college, and I attended and graduated from the large state university where I was resident.  Luckily, the school had distribution requirements (a few colleges refer to these as core courses) which required freshmen and sophomores to complete two full years of a foreign language, basic science and mathematics, humanities, English, the social sciences and the history of western civilization. I clearly remember not having elective courses until my junior year.

College is not a trade school.  A good college education exposes a student to a broad range of intellectual thought and dialectic.  Knowledge of art and its context, the rise and fall of governments and cultures, nuances and idioms of English and a foreign language, creative and expository writing, economics, mathematical history and theory and various theories of science all contribute to the thinking of an educated, well-rounded individual.

So why is this valuable?  Because all this teaches a student to think critically about issues.  It emphasizes written and oral communication skills, and the ability to express ideas in clear and concise language.  Context and nuance matter when discussing an idea, and  great ideas did not just spring forth in the last fifty years.  We are part of an inexorable march of history, culture and progress.  Translate all this to the adult working world, and we have critically thinking and appropriately expressive citizens, parents, executives, and employees.   In essence, this type of education should be the first act in the play of lifelong learning.

What Should I Major In?

The answer to “what should I major in” is “anything that is a pleasure to learn.”  My daughter recently graduated from a prestigious eastern college, magna cum laude.  She majored in history.   Her history department, one of the great history departments in the country over the past one hundred years, invited parents to a post graduation collation.   The head of the department earnestly thanked the parents for permitting their children to major in her department.  She clearly had had experience with parental resistance, mild disdain and at best rolled eyes when students declared a history major.  After the speech, I went up to this noted professor and thanked her for teaching my child.  To me it was a privilege to be a history major in this prestigious program.  Moreover, my daughter excelled and thrived;   she was mentored, she learned much about many things, and she learned to create, criticize and be criticized for her ideas and writing.  What more could a parent ask for?   What we saw for ourselves, and what her professors all said, was that she had grown into a thinker, a writer and a scholar.  As an aside, she has not had a problem obtaining several excellent job offers upon graduation.

Education for the Workplace and for the Self

The benefits of a liberal arts education became obvious only when I entered the workforce. When I went to school, with a major in economics and labor studies, computers were for a select group of scientists working in the computer science labs.  However, from my math and science background, I was able to teach myself computer skills, perform actuarial calculations although I was not an actuary, and master complex industrial processes.  I learned management, accounting and business processes although I never had a college business course.  In contrast, most of the practical subjects I learned in college and even in law school were outmoded within five years of working.   Without the ability to learn new ideas, the specific processes, equipment and modalities of the workplace would have been much more difficult to master.  Learning the new was all grounded in a solid liberal arts education.

In the midst of a recession, with college costs soaring to more than $200,000 for a four year private college, the temptation is to gravitate to a “practical major” such as applied engineering, accounting or computer science.  In a rapidly changing economy, I would suggest that even the most career oriented students would profit from the broader perspective obtained from knowledge of history, foreign language, mathematical concepts, English and humanities.   The essential paradox is that a narrow, technical, vocationally oriented education may provide the skills for today’s job, but not for tomorrow’s careers.

For those who are intellectually talented, a liberal arts education is a great boon to future business or government pursuits.   It can also provide the intellectual underpinnings of all kinds of professions:  medicine, nursing, law, architecture, engineering, education and others.   As we enter this challenging environment we need more leaders who can think critically and communicate clearly.  Perhaps we all need a more liberal definition of what constitutes a good education.

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16
Sep 10

Chivas and Chivalry

Even before Mad Men became so popular, advertising was always fascinating.  Embedded in a glossy print ad or an imaginative television or radio ad is a commentary about us, our hidden aspirations and how we see ourselves.

One such ad has caught my attention.  Chivas Regal has a new worldwide campaign to promote its scotch whiskies.  The ad is aptly called “The Movement, Living with Chivalry.” It is beautifully filmed and supported by haunting, inspirational  music from The Cinematic Orchestra: “How to Build a Home.”

Ads cannot convey the aroma, taste or quality of an alcoholic beverage, so Chivas had to create an image.  The viewer must believe that the beverage is part of an exclusive lifestyle.  Chivas brands its new campaign a “movement,” a return to chivalry.  Part of the genius is the play on the words “Chivas” and “chivalry.”

Chivalry is defined as the medieval institution of knighthood which emphasizes individual training to hone skills and give service to others. Chivalrous virtues are honor, loyalty and courtly love.  Let’s look at Chivas’ idea of modern chivalry from its Live with Chivalry website:

Here’s to doing things the right way.
To giving a damn about others.
Here’s to giving your word… and keeping it.
Here’s to honour,
And it’s simple extension… the handshake.
Here’s to style, exuberance and charisma.
Here’s to gallantry… long may it live.
To the man rich… in experience.
Here’s to chasing wealth… in all its forms,
And here’s to sharing it.
Here’s to straight talking or, as it used to be known… honesty.
Here’s to having some front… and watching someone’s back.
Here’s to knowing that life’s real luxuries are time and friendships.
Here’s to optimism and leaps of faith.
And while we’re at it… here’s to freedom.
And having the audacity to go out and get it.
Here’s to knowing that you are not alone.
That together we’re better, stronger, smarter.
Here’s to the brave and the enlightened.
To a shared way of behaving that sets certain men apart from all others.
Here’s to those who Live with Chivalry… here’s to us!

“The Movement” video-mercial starts with a well dressed young man in a tailored conservative business suit walking in a financial district of a large un-named city amidst a crowd of faceless business people.  Passersby jostle the actor; he looks dejected.  Then a voiceover: “Millions of people…everyone out for themselves. Can this be the only way? No.”

The background music intensifies.  “Here’s to honor and gallantry, long may it live…” highlights scenes of men in formal wear with their hands together in the center of a circle and an attractive formally dressed young man carrying a pretty young woman (damsel in distress?) on his back across a rain soaked field.  “Here’s to doing the right thing and those who give a damn” shows us men in formal wear in unison pushing a friend’s stuck Mercedes (what? No Honda in this ad?) out of the mud.  “Here’s to the straight talkers who give their word and mean it” accompanies scenes of older, gray haired elders in suits looking like they just sealed a deal. “Here’s to freedom and the true meaning of wealth and men who keep their word” shows men about to sky dive and signaling each other, followed by other young men on horseback riding along the seashore.  “Here’s to the brave among us” accompanies sooty fire fighters near an extinguished blaze.   “Here’s to a code of behavior that sets certain men apart from others” (what else?) lauds a triumphant sports team clasping a trophy and celebrating by jumping into the water.   Finally, “here’s to us” shows us another formally attired young knight entering a ballroom with his similarly attired friends and handsome proud parents.  And Bingo!  They all raise a crystal tumbler and enjoy a Chivas.

What is the Ad Saying?

It is no accident that the commercial starts out in the financial district of London or New York.  The pushy, faceless automatons bumping into our hero are not random.  The scene symbolizes all that is wrong with our financial era, with faceless, greedy, well dressed, smooth talking bankers dehumanized by the mercantile process.  A sense of honor and acting for the common good are absent in the canyons of finance.

Chivas has imagined an alternative world: the medieval code of knighthood brought into the bright light of good looking youthful privilege and adventure.  Alexander Dumas in literature and Hollywood in movies gave us the chivalry of the Musketeers:  one for all and all for one; this ad simply updates the context.   Knights are gallant, rescuing damsels in distress.  Young men have a code of honor; their word can be trusted and they confront real danger, not the faux combat of an electronic trading floor.  Plus, these modern knights are not afraid to get their hands dirty while doing the right thing.  They clean up well, put their tuxedos back on, and get the girl.  Bottom line:  they earn their Chivas.

The Knights of Today and Tomorrow?

Thank goodness there are still people of honor who walk the earth.  Given the behavior of our politicians, business and financial leaders, we can only hope there is a cadre of good men and women somewhere who can lead us forward.

It is ironic and disturbing that a whisky company needs to clarify these values for us.  As in the ad, I wish we could rely on people’s personal honor and need only a handshake to seal a deal.   In addition, I wish that we could say not only “drink responsibly” but also “lend or govern responsibly.”

I would be the first to raise my crystal tumbler to these honorable lads and their exploits.  However, as I mentioned in previous blogs, I would be toasting with Lagavulin.

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