The Stalwart

How Many Dr. Doom's Are There?

Heny Kaufman, AKA Dr. Doom, lost substantial money based on the Madoff fiasco. The Madoff losses are a tragedy for those involves, but what struck me in this article was that I was unaware of Mr. Kaufman until now, and his Dr. Doom status. This now brings the total number of Dr. Doom's to four in my book, which has me wondering... how many Dr. Doom's are there?

Henry Kaufman, the former Salomon Brothers chief economist whose bearish views decades ago earned him the nickname "Dr. Doom," lost several million dollars with Bernard Madoff, making him one of the most prominent Wall Street figures to emerge as a victim of the alleged Ponzi scheme.

This is because, to my knowledge, in addition to Mr. Kaufamn, there is of course Dr. Doom Marc Faber, the Swiss Contrarian in Asia before it was popular, and Nouriel Roubini, who I would say plays the part of Dr. Doom best if you've ever seen a video of him speaking. He probably is the most recent person to earn the monicker when his years-old predictions seemed to finally come through in 2007, though perhaps not for the exact reasons he initially described. 

And finally, there is Stephen Roach, who is has long branded himself as one of the key bears on Wall Street, and who despite a recent embarassing about-face right before things collapsed, can still hold claim to being Dr. Doom due to sheer inertia.

The funny thing is that all of these very intelligent individuals nevertheless likely had very different explanations of the problems which the global economy faced and how things would unravel, yet all can now capture a share of the Dr. Doom glory. They do this by just being long known as a bear, by relating todays problems somehow back to their own original premises, or even just ignoring their original premises, not looking back, and describing and disparaging the financial problems which we now know.

Interesting lessons to be learned for aspiring pundits, though the Dr. Doom space now seems rather crowded. Probably best to now swing for the other extreme and build yourself as a well known optimist, though perhaps despite a tough market there is still an oversupply of such outlooks. Well, at the very least I'm pretty optimistic long term for the US economy at least, so perhaps its time to start claiming the space.

Organic Vegetable Monopolies & Snack Food Vitamins

In regards to the Whole Foods/ Wild Oats merger. Won't burden you with a tirade here. But this is hilarious:

FTC lawyer Matthew Reilly told Friedman he could impose a range of remedies, and that because a lack of competition in the premium natural and organic groceries is harming consumers, the agency wants to stop further integration and impose a hold separate for the Wild Oats assets that its new owner hasn't absorbed.

Hard to see how premium natural and organic groceries are some sort of opportunity for an invincible monopoly. I got another good one, two in the same day. In regards to Diet Coke Plus:

The FDA said the soft drink, Diet Coke Plus, doesn't contain enough nutrients to qualify for use of the word "plus." Foods may use that name only if they contain at least 10% more of the reference daily intake or daily reference value of a nutrient than a similar product. The FDA also invoked a longstanding rule under which it "does not consider it appropriate" to fortify snack foods such as carbonated beverages.

I'm actually a bit moderate and not too perturbed by the requirement for 10% additional vitamins in order to qualify for "Plus". But nevertheless, I had a good laugh whereby a company is told not to add vitamins and minerals to a product. I think diet coke with vitamins sounds like a pretty good drink. What's another good idea, but one I haven't seen yet? Coffee with vitamins and minerals. Hopefully that is allowed. Would make for a pretty good start to the day. Anyhow.

(Vincent)

Live! From Austin

I'd been meaning to mention this sooner here, but I'm currently on my annual 2-week sojourn to Austin, TX. I have my fair slew of friends here from college days, but I always like meeting new people especially if you read this blog, etc.

Ping me jnathan@gmail.com if you want to meet up.

GM Could Go to Zero, Chrysler Even More Likely. Ahh... So We Do Have a Non-Govt Mechanism for Restructuring Companies

Yes we know. We could have been more succinct with our title. Nevertheless, one of the top US business stories yesterday involved a Credit Suisse analyst predicting that GM could go to zero in its restructuring process. Which would mean that over $2bn of equity value could be wiped out as debt restructuring could lead to current equity holders being diluted to oblivion. Of course in return for equity stakes, creditors would agree to haircuts on their principal. 

Which would reduce the debt burden and help restructure GM's business for survival... at the expense of current shareholders and creditors. Wait a second. So there is a non-government method to save the automakers. And taxpayers don't need to foot the bill? Creditors and Shareholders foot the bill and provide the concessions in order to salvage the remaining value of the company? Amazing this system we have.

Wonder why our system's basic functioning eludes most who argue for a government auto bailout as if its the only choice.

Shareholders get wiped out, as they deserve to be if indeed GM is worth less than its debt, creditors convert their debt to new equity, and there you have it GM can reduce its onerous debt burden. So where's the problem?

Ah yes, the UAW. They refused to have pay rates competitive with other US autoworkers in 2009. A bankruptcy and associated restructuring as described above would force them to negotiate contracts on similar terms to most workers in the USA. Thus their fear of bankruptcy and the widespread promotion of the nonsensical idea that "bankruptcy is not an option". Not an option for whom?

Bankruptcy doesn't usually mean the death of a company, nor the firing of all its workers. Somehow these basic points, plus the point that UAW members have benefits well above the average American, have been obscured in order to persuade Americans that a government bailout is needed. Hopefully understanding why GM shares could go to zero can help illuminate the fact that we already have a system for restructuring distressed companies and making them viable gain - bankruptcy.

(Vincent)

Coase On Beet Greens

 Hey y'all, it's Joe here... haven't posted in a while, but alas that's happened from time to time before.

Anyway, I wanted to throw out something I've been thinking of. I feel like there's a real breakdown of the Coase Theorem when it comes to the vegetable beets. See, most people like to eat beets and they throw away the greens. I on the other hand, don't like beets, but prefer the greens. In fact they may the most delicious of all greens -- and it faces some pretty stiff competition among kale and collards.

It's problematic from an economic standpoint that greens that most people just toss the greens. I'd LOVE those greens. There should be a business collecting discarded greens and then selling them to people, but it's not obvious to me what the model is.

But this is such a big, sad waste that there has to be one. Just can't figure it out.

CEG Bids a Hasty Au Revoir to Buffet, Without Shareholder Approval

In what has been an action-packed M&A arb drama, Constellation Energy (CEG) has entered a defininitive agreement with France's EDF group to sell a 50% stake in its nuclear generation and operation business, bidding a hasty au revoir to Buffet's MidAmerican Holdings. 

Constellation Energy Group said Wednesday that it will sell a 49.9% stake in its fleet of five nuclear reactors and other holdings to Electricité de France SA for $4.5 billion, derailing the pending $4.7 billion takeover by Warren Buffett's MidAmerican Energy Holdings.

Nevertheless, CEG and MidAmerican parted on good terms and Buffet still made a handsome return given termination fees, an appreciated stake in CEG and related other cash payment requirements. Not a bad way to lose:

For its part, MidAmerican will receive a hefty termination package. The deal calls for MidAmerican to get a $175 million termination fee. Additionally, preferred shares issued to its wholly owned MEHC Investment Inc. unit will convert, giving MEHC a $1 billion note at 14% interest and about 20 million shares of Constellation stock, representing about 10% of outstanding shares; and roughly $418 million in cash.

But the real interesting point I feel is that it seems CEG wasn't required to obtain shareholder approval for this deal. I am no expert on these kinds of details, but I would have assumed that a shareholder vote was required. It appears not to be the case as shown in this excerpt from the CEG press release below.

The companies expect to receive the necessary regulatory approvals for the acquisition of EDF Development Inc.'s interest in Constellation Energy's nuclear generation and operation business and close the transaction within six to nine months. The companies will work closely with Maryland regulators to make them fully informed of the transaction's details. Approval from Constellation Energy's shareholders is not required.

Ok well I guess that's life in the big city. Shareholders were nevertheless likely to be overall positive on the deal given previous opposition to the MidAmerican $26.5 bid as being too low. And not to imply any wrong-doing at all here, but it is still surprising, at least to this Stalwart, that such a massive change in course did not requite shareholder approval. If someone wishes to clarify the situation or explain their take, then please feel free to do so.

(Vincent)

Clear Sign of Panic Via US Short Term Bond Rates

US treasury rates are at all-time lows, and the shortest maturities straddling zero percent interest. First, let us highlight that zero, or worse negative interest rates make almost no sense and cannot be sustained. For this Stalwart, they are a sign of true panic without refrain to logic.  Basically risk-averse investors mind as well put their money under "the mattress". Which for financial institutions, by using the term "mattress", I mean other forms of government-insured financial accounts and earn more, or at least earn nothing. Heck buy some corporate bonds backed by a rock-solid corporate with little leverage. They are probably more solvent than the US government and will pay you substantially more. 

I suspect that what is happening is that a lot of institutions just want by-the-book safety and their mandates or systems make US government bonds the most practical way of doing this. Its a clear inefficiency which cannot last since companies can over time put their money under "the mattress", as described above, have the same risk-free investment profile (risk-free defined as assets backed by US government, the world's current "risk-free" standard) and probably do better than short term government bond rates. They can also assume a tiny bit of risk with a solid corporate bond and earn substantially more. But many institutions probably see less potential blame in investing in US bonds for safety with the rest of the herd. Still, current ST rates seem unlikely to last and point to substantial relative value in risk-taking assets.

One surely has to give US stocks a second look given their valuations vs. US bond yields. In MBA speak, risk premiums are extremely high due to low stock valuations vs. earnings power and contrasting tiny risk-free returns, thus risk-takers are likely to get paid historically high returns per unit of risk assumed in the current environment, ie. for the same amount of risk you might have taken a year or two ago, you are now likely to get paid a lot more to assume that same amount of risk.

Not to say that one should throw caution to the wind, the hard part is gauging how much risk you might be assuming so that the potential payback makes sense. But if one currently has the ability to hold risk-taking assets, then now is actually a better time to go and do so, better than any time in the last few years, even though it may not feel that way. 

(Vincent)

Software Predators and Overfed Prey

Predator and prey once again. You've got to love how Microsoft (MSFT) tends to see a good business, which has already been established and proven successful by another company, and then just move in and attack it. Some animals spent inordinate amounts of time scavenging for leaves and berries, while others just wait til those herbivores are full then eat them. We're not against such a strategy, it is just another way of doing things and not practiced by MSFT alone either. Well the latest potential lamb for MSFT seems to be Adobe.

Adobe Systems Inc. is facing increasing pressure from Microsoft Corp., which is using its deep pockets to challenge Adobe's dominance of Web design software.

Adobe's Flash software, which adds video and animation to Web sites, is at the heart of many popular Internet destinations. Retailers, media outlets and entertainment sites rely on Flash to make their sites interactive and to serve up advertisements. ...

But Microsoft has recently launched a new version of its competing Silverlight technology and has been aggressively courting the operators of popular Web sites and advertising agencies that are Adobe's core customers...

Adobe's Flash player is installed on about 98% of Internet-connected PCs, and Silverlight is only installed on about 25%, according to Adobe and Microsoft. Adobe executives said this gives the smaller company about a two-year head start. But Microsoft is "willing to invest" in order to win certain "trophy sites," said Mr. Muglia.

Best defense strategy for Adobe? Make a better product? Maybe... but probably easier to just try and get the EU's Commissioner for Competition Neelie Kroes involved. WinZip, RealPlayer, Adobe PDF Reader benefitted from such a strategy, and they were far more basic programs where most might have seen their demise as inconsequential and perhaps even as part of the normal course of software development since activities such as "listening to music" can done by pretty basic software these days.

And from our perspective, WinZip compression format and PDF document reading format seemed to be near monopolies which Neelie Kroes actually helped protect. Thus the fact that Adobe Flash is installed on 98% of PC's probably wouldn't be a concern for someone like Mrs. Kroes. We hope to  keep that fact clearly in mind if and when we see attacks on MSFT's "anti-competitive" move into this space.

Madoff: An Argument For or Against Regulation?

Minyanville attacks deregulation vis-a-vis Bernie Madoff in the article "Deregulation to Blame for Madoff Fiasco". Now while chock full of rather illogical statements which might be better left ignored, a dissection of this article does highlight some misconceptions in regards to regulated vs. unregulated markets.

Madoff senior was charged with a single count of securities fraud. He was released from prison a few hours later after posting $10 million bail. If convicted, Madoff faces 20 years in prison and a fine of $5 million. His list of victims includes Steven Spielberg, New York Mets owner Fred Wilpon, and the European bank HSBC

The question arises: How did this happen?

The answer is quite simple: Madoff’s investment firm was allowed to operate for 2 years without regulation from the SEC.

Well here's at least a very basic error. Madoff's swindle spanned far more than two years. If this is a mis-type, and they meant to say 20 years, then the statement is false as there was SEC oversight, with an investigation in 1992 to prove it. Madoff was even advising the SEC...

Odd, isn’t it? Diamond miners in the Congo are subjected to body-cavity searches to prevent them from secreting tiny gems - but savvy, ambitious men like Madoff are allowed to wander around unsupervised, carrying diamonds the size of fists. And we pretend to be shocked when some of the loot goes missing.

Ok now the fun part. This makes no sense. Mining companies are not regulated to body-cavity search their "diamond miners". Any such agreement is rather the result of a contract or other form of agreement between employer and employee. All rules don't flow from regulation. And a lack of regulation doesn't mean a lack of rules. Rules can be privately negotiated between willing parties, and are every day. 

Here’s a thunderbolt: There’s no such thing as a “free-market economy.” What does the “free” part of it mean? I have found no convincing explanation.

Wasn't sure to even include this one, admittedly. While indeed there is currently no country which can provide an example of a 100% free-market economy, most economics books nevertheless can explain what a free market economy means, this should be obvious to most and for perhaps another post. Anyhow, some businesses operate in effectively free market environments. Moving on.

Every financial system requires rules and regulations to function. The PR coup of the “free-market economists” is that they managed to convince the American public that only little people need rules.

This quote further exposes the misunderstanding whereby deregulation means the absence of rules. 

It makes the common, false, assumption that little guys are helped in a highly regulated environment. In actuality, large companies can easily cover the costs of regulation while smaller ones face higher barriers to entry due to them. They also benefit when little innovation takes place, as their are little challenges to their business positions. 

A site such as Minyanville should also consider how much harder it would be to get their online business running if they had to comply with, say, more onerous online financial commentary regulations. Anyone who has ever considered a small business in the finance space should realize that there are already massive regulatory barriers.

Further along in the piece, the author then goes on to say that while the SEC missed Madoff, it was due to too few officers. This kind of argument allows for any failure of regulation to then imply the need for more regulation rather than to see it as a sign that crooks exist in all environments.

I predict, as the case goes to trial, that coverage will focus on Madoff’s personality flaws, the warning signs, and his dramatic fall from grace. 

But that’s trivial. What’s important, and worth discussing, is that Americans are so deathly afraid of “regulation” that we meekly allow ourselves to be swindled. 

Now, the WSJ does a far better job at explaining this last post and at delivering an overall rebuttal to this Minyanville post, than I can do here. (Madoff and Markets)

Nevertheless, the main takeway hopefully from this post is that this Minyanville article exposed a common misconception among many who argue against free market principles- that rules don't exist in a free market. It also exposed a general misunderstanding of what a regulated vs. unregulated market are, which I have seen to be rampant when talking with people or reading online. 

Rules still exist in an unregulated market, its just that there is a difference is in who gets the opportunity to negotiate them (individuals on their own vs. bureaucrats forcing them on everyone). There is also thus a difference in the resulting opportunities for diversity and sophistication of economic activities. Hopefully doesn't have to be repeated here, but the ability to zig and zag with new ideas is a foundation of US success in many industries, including the financial industry. Its no surprise that financial innovations such as Venture Capital (as distinct from merely wealthy families funding companies) were invented in the US, and along with sophisticated capital markets, allowed global companies to leap to multinational status faster than anywhere else. Recent example- Google.

Finally, in regards to the Madoff case, nobody was forced to invest with him, just like how there are $10,000 pairs of Michael Jackson underwear on Ebay (I'm admittedly assuming) yet nobody is forced to buy them. He also was able to avoid a lot of currently standing regulation as it was. Smart crooks like him can likely jump around some a few more. There will always be clever crooks. And... some of the most clever crooks actually use regulations to their advantage. Take a peek at the wealthy monopolistic tycoons in heavily regulated, poor countries and you'll see that regulation by no means reduces economic crime (it even sanctions it in many cases). 

We should be willing to take the responsibility to do our own homework when presented with opportunities, in return for a country where we have the right (and of equal importance where other people have their own right) to choose the rules of our own economic engagement. 

(Vincent @ The Stalwart)

Let's Hope the Auto Bailout Has Failed for Good, We Might Even Get a New, Competitive US Auto Company

Let's hope that the auto bailout has failed for good. The fact that US auto companies (and more specificually employees) weren't willing to reach parity with the wages of their japanese competitors by 2009 was outrageous. For this stalwart it is a relief that this bailout did not pass, and I find the markets' negative reaction to the result very short sighted. This of course presupposes that the US and world markets' drop was indeed a reaction to the auto bailout news, as financial media ascribe. Nevertheless, assuming that markets did fall in reaction to the news, then their reaction is very misguided.

Rewarding and sustaining value-destroying companies is not good for markets, whatever the apparent near term jobs loss. Overpaid workers for companies which lose money are not value creating for an economy. Reallocating workers into positions which earn a profit for their companies is.

One crucial point widely ignored in all the talk of US auto industry collapse is that in the current situation we're actually just talking about the collapse of the current major US auto companies, in their current form, and not necessarily the industry.

Here's a shocker- Might the demise of the old actually leave room for the new? We might actually have new, leaner, efficient US auto companies emerge out of all of this, whether as a restructured companies based on the old or perhaps even (and this would be very exciting) a brand new companies. It was a pretty crowded space for a new US automaker to appear previously, especially with the fear of getting snagged by onerous employee contracts.

What if a new company could pick and choose the assets it wanted from the old dying companies, and employ the best US autoworkers avalaible with a salary system far less parasitic than the current UAW backed system?

There is definitely room for at least one major US home-branded automaker in the American popular psyche.  Just marry a truly American branding with efficient operations, good design, and strong marketing, and then perhaps you have a business. If the US can make iPods, semiconductors, and passenger jets, there's no reason why cars competitive vs. the Japanese are some sort of insurmountable task. Or maybe in the end, US companies have better businesses to pursue than auto manufacturing. This no one can predict for sure.

But I see no reason why the bankruptcy of the current US automakers' corporate entities spells the demise of the US auto industry. And in fact, it could actually spur a renaissance in US auto leadership once the field for US branded cars gets less crowded. Provided automaking is a profitable worthwhile business on par with other opportunities for US investment. From this perspective I feel then the failure of the auto bailout is actually positive, rather than negative, for the US economy, and in turn US and global markets.