Monday, December 6, 2010

My Two Cents on Income "Inequality"



The quality of the debate on income inequality in the US is scraping the bottom, so I might as well contribute to the decline. Quite often, some innumerate journalist would quote some scary statistic about the top X percent taking home Y percent of income, while the bottom Z percent take home substantially less. But there is something missing from the discussion: a serious look at the link between productivity, growth and inequality.

If you roll back time, you will find that one of the oldest forms of wealth was livestock. If you have a cow, how long would it take before you become twice as rich on a "per household member" basis? There are some limitations to the enrichment scheme, both in the numerator and the denominator. People back then had many children, hoping some would survive to help on the farm. So you have your own progeny's growth working against the "per capita" wealth. The limitations in the numerator are well-known: the cow can only have one calf per year, some might be male or stillborn, the cow itself may die, and, even if you grow your herd, there are external factors, such as feed availability or raids by the Visgoths, the Vikings or the Vandals. Clearly, accumulating livestock wealth on a per capita basis had been a long and arduous challenge.

Jump ahead a few centuries. Now imagine you're an intrepid merchant loading up sacks of spices on your caravel docked at what might still be considered an exotic location. You sail off for the homeland, hoping to sell the spices at a nice mark-up. The treacherous trip around Cape Good Hope might take a couple of years. You might also run into Berber pirates: again, accumulating wealth, even with good tail winds, took a lot of time.

If you fast forward again a few hundred years, you might see that a series of inventions (such as steel and the steam engine) had given birth to a new boom industry: rail roads. Laying track is substantially more capital- and labor intensive than breeding cows but, once completed, the lines started generating untold, for the day, riches for the tycoons of their time. So technology enabled faster accumulation.

And, if you fast forward to last week, the founder of a three-year old web site called Groupon walked on a $6 billion offer from Google. Just to put it in perspective with our livestock example, live steers/heifers trade at about $1 per pound, or about $1,250 per animal based on some USDA release I just read. The gentleman founder of Groupon could have had quite a herd. It is also important to recognize that the founder is literally standing on the shoulder of giants: countless manhours of thought and labor are making his success possible: electricity, power plants, metallurgy, conductors, semi-conductors, plastics, glass, paper, and, yes, even Albert Gore Jr., father of the internet.

So what is the progression in these examples? It's the ability of technology to accelerate value creation exponentially. This means that we might see bigger winners more often. Look at the social media space, something virtually unknown five years ago. Today, Facebook, Twitter and Zynga combined are worth in the tens of billions. Are the mythical Top X% more likely to benefit from this acceleration? You bet.

My view is this: I do not mind that people make a lot more than I do so long as it is done fairly. Someone's making more than you should be a source of motivation not envy. And we should be happy that we are in an environment where people can achieve so much, so quickly. Talk to your Eastern European friends about the gifts of institutionalized equality. More importantly, the income growth is NOT a zero-sum game: someone creating billions via twitter did not hurt the income of the greeters at Wal-mart (but making it sound so makes a better story to sell.)

Saturday, November 13, 2010

Time For A Taxi Cab Medallion ETF

. This article was featured at The Reformed Broker, a noted financial blog. The article was subsequently quoted and linked to by the Wall Street Journal.

Half-joking, of course. Let's talk about the ETFization of just about anything. But before we talk about ETFization, we should talk about securitization.

Most people by now have heard of securitization in the mortgage context. It has a bad rep but it does not have to have one, if it is done correctly. Mortgage securitization has been around for many years. But as any business gets standardized and more competitive, the profit margins in these deals decline for the people who put them together. At the same time, these people's steak dinners, condo dues and private school fees do not decline, quite the opposite. So the friendly folks start looking for other things to securitize, and get very creative with it. Toll road revenues. Parking fee revenues. Communication tower rents. Restaurant franchise fees. You might not know but the Dunkin Donuts buyout happened at an untold leverage number precisely due to the "award-winning" finance package put together by people who, in another day and age, would have been designing fuel pumps for diesel locomotives. The theory is simple enough: find predictable enough source of cash flows, tranche them, slap an insurance from the esteemed AAA-rated mortgage insurers, have them rated, and sell them to income-seeking investors. Voila! Oh, the things you can get away with when everyone is chasing yield...

But exotic securitization and mortgage insurers are so 2006. We have ETFization now. The scheme is even simpler. Find an asset class. ETF it. Collect 69-99 bps on AUM. Wash. Rinse. Repeat. Rare earth metals came in the spotlight after an unfortunate fishing trawler incident in Asia and the resultant spat between the Middle Kingdom and the Land of the Rising Sun, that led to claims that the former had stopped exports. The shares of the rare earth miners skyrocketed, and Joe Sixpack could get into the action very quickly with a convenient new ETF, REMX, that debuted just in time for the news that exports have resumed. Then last Wednesday, the CEO of Alcoa, the third largest aluminum producer, said that he'd be very supportive of a physical aluminum ETF and that they'd be more than happy to supply the product. I would like to warn you not to be too surprised when next Wednesday, the CEO of Kraft Foods comes out in full support of the new physical cheese ETF.

What is happening here? ETFs are great. They enable efficient sector exposure and are more liquid that mutual funds. Some invest in geographies or securities (esp. low-priced stocks) that an individual investor might not be able to acquire efficiently. BUT the creation of ETFs brings in new money into the pond without improving the cash flows of the underlying assets. Your risk increases simply because the asset prices are now higher. But the higher prices might result in more interest, new share issuance or whole new ETFs. This might be creating a positive feedback loop.

Let's look at an example of how things evolve. GLD, the major gold ETF, has been around for a few years. A year or two later, we got GDX, gold miners, and SLV, silver ETF. Well, that's not enough for a hot sector. We got palladium and platinum to play with via PALL and PPLT.

You'd think that this is enough for sector exposure? Think again. We got GDXJ, junior gold miners, for people who think that GDX is too staid. Why have five mines in Canada when you can have one in Burkina Faso?

By now we should be done, right? Wrong. There is a better mouse trap. GLD and SLV are favorites for PM market alarmists, so we later got the "physical" gold and silver, PHYS and PSLV. That should wrap it up, this looks like an ETF buffet table. Again, wrong. Why should you limit yourself to gold miners, when you should really be playing the silver miners, SIL. And if having operating mines just does not sound rewarding enough, you can always try to strike gold with GLDX, the "gold explorers" ETF released last week. And, where would we be without the levered gold and silver ETFs, UGL and AGQ.

I am no Soros/reflexivity expert but I can tell you that this looks like market participants really wanting to believe in their investments, and acting it out.

On to my proposal for a NYC cab medallion ETF. For the uninitiated, the cab medallion is the NYC license that allows the operation of the iconic yellow cab with all duties and privileges. The number of licenses has been roughly fixed since the 1930s (yes) which has meant that the price of having one has been increasing steadily as a testament to NYC's foresight, Byzantine politics and anti-entrepreneurial attitude. There are roughly two types of licenses, owner-operator and "corporate". The more expensive corporate (fleet) licenses are rented out. The current price of a corporate license is $825k. The price in October 2004 was $343k. So you have the asset price up 140% in 6 years. It is also cash flowing, and the cash flow is inflation-linked, as rates go up periodically. So, unlike gold, there is the combination of scarcity, desirability AND cash flow. Of course, if a buyer of size enters the market, you know what will happen to prices and yields: the cabs will not be producing more cash just because the medallion prices went up.

And don't get me started on my idea for a pre-paid college tuition ETF with redeemable shares...

Tuesday, November 9, 2010

ZIRP Thoughts: Labor vs. Capital


In many businesses, there is a trade-off between labor and capital. A very simple example is a ditch-digging business (look under “excavation” in the yellow pages). A ditch-digging entrepreneur can hire a few people, hand them out shovels and send them to the job. Alternatively, the same entrepreneur can purchase an excavator and hire an operator and send him to the job. The trade-off capital vs. labor is pretty clear. The racing track can hire people to check the redeemed tickets or it can have machine-readable tickets with the requisite system. The vending machines in the office can be monitored remotely or a guy can come through and check. The landscaper can push a mower or ride one. You get the idea. Now imagine our ditch-digging entrepreneur could have financed the excavator at 25% last year because the banks thought that ditch-digging is not coming back. This year, however, with the recovery and the bank’s own low-cost financing (0% on demand deposits, 1-2% on 3-year CDs for the typical corner bank), our entrepreneur can finance the said piece of equipment at 6%. Clearly, he’s not buying shovels and not hiring. Capital has won.

Looking at the labor part of the equation, is labor getting more competitive or less competitive vs. capital? My bigger picture view is no, even though high unemployment should be lowering labor cost. Why? The big factor is lack of predictability for labor costs: no one really knows what the effect of the healthcare “reform” will be. The other sad factor is that payroll taxes are the most easily collectible taxes for the Treasury. If there are tax increases, one can expect to see them (eventually) there. Then you have a heavily pro-union administration. The capital maintenance costs are generally predictable: depreciation, consumables, insurance, etc. Oh, and there have been accelerated depreciation tax hand-outs. No wonder capital is winning.

Who benefits from this? You see companies like Wal-Mart and McDonald’s issuing fixed-rate debt at record low yields and investing. It would be criminal for them not to. Where is the money going? Wal-Mart just announced a major acquisition in Africa. McDonald’s is continuing their expansion in emerging markets. These companies are building the future first world. Who’s paying for this? It might very well be you: zero-interest is the destruction of prudent behavior and a confiscation of wealth.

There are other beneficiaries that engage in little-to-no value added financial transactions: PE firms. Ridiculously low high yield rates are encouraging PE takeovers and aggressive dividend recaps. Buyouts also often involve “synergies” (read: labor redundancies) to make the projected IRRs, now advertised as “good” if they are in the teens. But the credit wave surfers will surely make it up on volume.

Where are the landmines in the process I describe above? One is that the commodity inflation is getting out of control. I won’t recite the YTD figures here but when there are such one-directional imbalances (everything is up by a lot), there will be winners and there will be losers. There will be margin compression if you’re short cotton (and not charging 10,000% mark-up for your logo). There will be margin compression if you’re short coffee (and not selling the 20 cent cup for $3.49).

Then there are the legacy pension liabilities for a number of companies (not discussing state/local but they should matter to you if you hold munis). Low bond rates make it very hard for pension plans to meet their projected obligations: this means that companies will eventually have to make large contributions to the plans, essentially transferring money from shareholders/bondholders to former employees.

Two For One Book Reviews: “The Greatest Trade Ever” and “The Big Short”



In short, I recommend reading both books to people interested in finding out more about the few investors who were able to make money during the housing meltdown in 2006-2008. The two books track several people, the bets they made, the challenges they faced from their investors, competitors, ill-wishers, families, partners and brokers. There is a certain overlap in two of the characters covered between the books (Michael Burry, Greg Lippmann) but otherwise “the tracks” are separate and yet complementary. Both books are generally “mass market,” that is, neither requires heavy finance background to comprehend and appreciate.

“If you’re not inside, you’re outside”- Gordon Gekko

The overriding (and highly inspiring) theme of both books is that several relative outsiders in the world of high finance (neither character had had a high profile bank/sell-side or fund/buy-side career) were able to see the magnitude of the bubble, and, with the substantial help of the “housing” CDS apostle, Greg Lippmann of Deutsche, were able to short it. Here is a run-down of the characters. If you like stories like Susan Boyle or Paul Potts, these books will inspire you. If you have ever been annoyed by the non-stop optimism types, these books are for you: most main characters are painted as rather somber, dark types.

Lippmann: the odd man out of the group as the only member of the “establishment.” A fixed income trader at Deutsche, Lippmann is instrumental to the creation and proliferation of the CDS contracts linked to the performance of mortgage bonds. He ends up accumulating a large position, making his superiors uncomfortable. Lippmann’s endless proselytizing raises the profile of the new instrument. His is the insight that housing prices just need to level off to see the defaults spike. He’s described as a brash, arrogant, flippant character: how much of that is stereotyping of bond traders, how much of that is a literary embellishment, and how much is the truth, we will never know.

Favorite quote: Deutsche is trying to collect $1.2 bn from Morgan Stanley. MS argues that it should be putting up less because the models indicate that the value of the bonds in question is higher. Lippmann: “Dude, f*ck your model. I’ll make you a market. They are seventy-seventy seven. You have three choices. You can sell them back to me at seventy. You can buy some more at seventy-seven. Or you can give me my f*cking one point two billion dollars.”

Paulson: Paulson is probably the most connected, plugged and conventionally successful fund manager in the group. After enjoying a bon-vivant lifestyle for years, Paulson had moved up to become an M&A MD at Bear Stearns, eventually opening up a merger arb fund. The fund had been “another ham and cheese shop” until the big hit. There is quite a bit of interesting personal details on him in The Greatest Trade, especially his younger years. Otherwise, there is no deviation from the many media stories that have followed his hit.

Pellegrini: Pellegrini had known Paulson since business school and ended up working as a junior analyst at the fund basically as a last chance job substantially below his age. He had suffered setbacks both in his family life (twice divorced) and career (spent seven years as a VP at Lazard). Pellegrini had been the guy behind the housing analysis and the trades that netted Paulson the record wins. The relationship between the two is described as strenuous, mistrusting, and, ultimately, failing. It does not sound like Paulson ever fully trusted Pellegrini with decision-making. Ultimately, Pellegrini leaves the fund.

Burry: a bit of a fairy-tale story. Burry, as a medical resident, starts writing online about value investing at the height of the internet bubble. He ends up being seeded by Joel Greenblatt who had read his writings. Burry, an anti-social guy with one glass eye, ends up figuring out both the bubble and how to short it all by himself. However, he ends up having really hard time keeping his investors on board once they feel that he had shifted from value stock picking to macro. The stress and indignations he goes through are vividly described. Ultimately, he shuts down the fund. Burry’s problems with the banks are also detailed: from “massaging” the marks to outright lies about the contract values once the ball starts rolling to salespeople not even answering their phones, later blaming system problems at their respective banks on the same day.

Eisman: one of the “original” subprime specialists. Eisman had covered many now-bankrupt aggressive consumer finance companies since the early nineties as an analyst at Oppenheimer. He had been known for his too-honest analysis. Eisman had known the sleaze from before so he had been able to recognize it early on in the government-sanctioned expansion of subprime. Post Oppenheimer, he ends up trying to open his own fund only to find that the doors are all closed. Finally, he assembles a good crew of pessimists and some funding from a couple of places. Eisman was recently in the news with his aggressive questioning of Genworth’s management at the last conference call. It really sounds like the character from the book.

Favorite quotes: from his days as an analyst, “The Lomas Financial Corporation is a perfectly hedged financial institution: it loses money in every conceivable interest rate environment.”

Greene: a rich playboy real estate magnate and an acquaintance of Paulson’s ends up stealing the trade idea, and is the only individual able to pull off the CDS trade in size.

Lahde: Andrew Lahde made a splash with his long “good bye” letter. Younger than most, he had started out as a broker, getting his MBA at UCLA after a year of rejections, then working at a third-tier bank and a fund. He starts running his fund out of his apartment, almost runs out of savings before he gets a lucky break with funding. Lahde’s letter is reproduced in full in the book, as he touches on a wide variety of social problems, such as blind credentialism (a class struggle of a different sort) and inane government actions as well as his future plans.

Ledley, Hockett and Mai/Cornwall Capital. Three laid back guys that stumble into the trade somehow after having made outsized wins on a few options trades. Their story is probably the most underreported in the media pieces covering the housing debacle.

There are several other characters in the books that really help flesh out important pieces of the stories. Joe Cassano of AIG is there. CDO managers are there. Subprime industry leaders are there. Family members with various degrees of supportiveness for the main characters are there.

Full disclosure: no connection of any sort to the publishers or the authors of the books. Not that any of them clamor for my views.

Saturday, October 23, 2010

Forensic "Accounting": Is This High-profile Betting Exchange Minding the Store?



Betfair Group PLC had a high profile IPO on Friday (yesterday, October 22nd 2010) in London with shares doing well in aftermarket trading. Betfair (and its closest competitor, Betdaq) are a different breed of online bookmakers: they are the so-called "betting exchanges" where anyone can be the bettor or the bookie, and the odds are determined by supply and demand. Further, one can place a bet at the prevailing market, or can place a limit order of sorts at higher (or lower) odds in the hope of getting it filled if the market moves. One can trade in and out of positions as many times as he wants to, and can act as a market-maker, quoting bid/ask at any time. Unfortunately, Betfair does not accept US participants for regulatory reasons, but one can still poke around the site.


For any game, Betfair gives not only the odds but also the liquidity offered at each level, as well as the total matched (traded) and unmatched (bid/offer) volume so one can find the more liquid games where the spreads between the back and lay are tight. To back is to bet on a certain outcome; to lay is to bet against that outcome=what the bookie does. Betfair collects a % from the winnings for the service of matching counterparties, and, unlike a traditional bookmaker, does not act as a counterparty in any transactions.
It should be noted that most of the volume is in Western Europe soccer, and since soccer is a low scoring game, the typical bet is a straight-outcome bet (moneyline) and not a spread bet. There are three outcomes, home win, draw or visitor win (denoted as 1x2; and the home team is listed first, unlike the US standard). The odds are quotes as coefficients, that is the multiple of your bet you can expect to have back. For example, a 1.25 means you get $1.25 total back for a $1 bet (25% ROI). This is the equivalent of a -400 moneyline (you get 500 total back for your 400, 25% ROI).


I decided to check where the liquidity is on Friday night. One can search either by unmatched bets (bid/offer volume) or matched bets (traded volume). A decent % of the bets listed are longer-term bets (i.e. England Premiership winner this season), with some of the upcoming games mixed in (i.e. England Premiership weekend games). So imagine my surprise when I looked at the following ranking for matched bets liquidity:


Most liquid games as of Fri 11 pm EST:
Chelsea v Wolves $1,032k matched /$4,053k unmatched
Spartak Niltchak-Tom $527k matched/$101k unmatched

Tottenham-Everton $501k matched/$1,360k unmatched
Real Madrid- Santander $428k matched/$3,430k unmatched
Stoke- Manchester United $286 matched/514k unmatched
Birmingham-Blackpool $265k matched/$190k unmatched


There are a few REALLY odd things about #2. It is from the Russian Championship. Neither team is one of the premier teams in the league by far. There is a 5-to-1 ratio of matched-to-unmatched volume, versus 1-to-8 for the Real M game or 1-to-4 for the Chelsea game. A bit odd, right? Even the Birmingham game ratio is 1.4-to-1. So the data is showing lots of volume traded, but shallow depth, unlike most other games that show depth much greater than traded volume.


So this peaked my curiosity: since when has the Russian championship become so popular? I went to see the volumes traded in all the other games and I was in for a surprise. There was one game (Spartak Moscow, a high profile team) with $217k matched, but the other were $1.6k, $1.1k, $0.85k, $11k, $12k, $2.2k for the Alania, Saturn, Amkar, CSKA, Anzhi and Rostov home games respectively. The odd game has 50 times the average volume traded for all other games but one! Now this is getting really interesting.


Betfair also shows how the coefficients (the odds, basically) have changed over time. Based on my observations, the odds are fairly stable over the few days leading to the game, barring any major unexpected changes with one of the teams. So imagine my surprise when I saw that the coefficient for the home win (where most of the volume is traded, 521k of 526k total) has been DROPPING like a rock, from 1.60 to 1.25! So, in other words, you're seeing the strange "price" dropping on unusual volume over a few days, while bids/offers are uncharacteristically sparse at any level.




By now I was suspicious. I decided to check on WSN to see what is going on with the regular bookmakers and the Betdaq. Here are the odds quoted for a home town win: 1.57, 1.50, 1.53, 1.55, 1.57, 1.50, 1.53, 1.30, 1.23, 1.22, 1.53, 1.55, 1.53, 1.55, 1.53, 1.24, 1.24 from bet365, Wm Hill, bodog, unibet, expekt, sportingbet, Ladbrokes, PaddyPower, 188Bet, VCBet, BlueSquare, interwetten, totesport, bet-at-home, betsson, betfair, betdaq respectively. This is a HIGHLY unusual dispersion in quoted coefficients. It looks like some of the bookies had caught on the falling price, while other had not. The coefficient falls if there is large volume coming for the particular outcome (the equivalent of moving the line on a football game).


So what is happening here? To me it looks like there may have been some trading back and forth to move up the liquidity rankings, and once "dumb" money started coming in, there was heavy buying of "home win", moving the coefficient down. Again, usually the coefficient does not move much while here it looks like there was a big disbalance: someone was hogging all "home win" bids. The small number of unmatched bids is showing that there wasn't really a functioning market but rather an absorption of whatever "dumb" money came in to take the other side of the "home win" bet.


Was there an informed insider making the bets? Quite possibly, E European championships are (allegedly) rife with rigged games, reflecting the high levels of corruption in general. Traditional bookmakers will not take high volume bets on odd games, BUT the exchange gets paid on volume. So things like these can happen much to the detriment of the small bettor. If you think HFT and stock exchanges, you are not far off. You are not far off either if you think manipulation, "tape painting", etc.


Oh, yeah, and the final result: 2-1 for the home team. Color me surprised. Be careful because you don't know what the other side knows about the trade, and the deal facilitators will not look out for you.

Wednesday, October 6, 2010

Heretical Thoughts on Gold Miners

This story was linked to by WSJ columnist and investment book writer James Altucher.

Over the last few days, I went through over 90 precious metal miner presentations from a recent forum. The companies presenting ranged from the major majors to minor juniors (pre-production, spending your cash on drilling holes across the globe).
Here is what I found out:
-Every miner is undervalued compared to its peers
-Every miner is a steal at its 2012-2015 projected production level
-Every miner has multiple high-potential opportunities in the world's most prolific mining region
-Every miner has an experienced management team that has a history of delivering results
-Every miner operates in politically stable, mining-friendly jurisdictions
-Every miner has wonderful community relations
-Every miner is a low-cost operator and is also sure that their costs will continue to go down
-Every miner is drastically increasing both reserves and production, but overall reserves and production are expected to decline
-Every miner expects gold and silver prices to go up due to multiple, undeniable fundamental factors
-Every miner is unhedged (well, almost, there were 2-3 that were removing hedges)
-Many miners have brand-name investors that they are proud of

So, satire aside, can all be right? The answer is an obvious 'no' for some of the points, and a subtler 'no' for some of the others. Here is what I was able to surmise about the industry and its underlying dynamics.
-Demand for both gold and silver comes from two general sources: actual use (industrial apps, jewelry) or "investment." As investment demand has increased, so has the commodity price. It appears to me that investment demand for gold is about 3x the level it was at in 2006-2007. You don't have to be a market maven to know what happens to price when supply is relatively inelastic.
-Miners are generally levered to the underlying commodity price level, so the miners' shares have been going up as well. This also attracts attention, and additional investment demand for the sector. Again, you do not have to be a market maven to figure out the price dynamic in a relatively fixed supply environment.
-There has been phenomenal growth in the AUMs of ETFs such as GLD, SLV, IAU, PHYS, CEF as well as miner ETFs like GDX, GDXJ, SIL, and broader "material" ETFs
-ETFs are just like many other asset management businesses, they do very well for their sponsors if AUMs grow; AUMs grow very well if the sector is doing well, so sponsors issue more shares and buy more of the underlying assets
-This is a positive feedback loop, and I am not sure that I like this dynamic longer-term, particularly for non-productive assets
-Imagine having a fund that accumulates residential lots in California, starting in 2002. The fund issues shares, and starts buying lots, moving the price up. Other market participants see that and start buying lots, too. The fund is doing very well because the underlying assets are appreciating. So they issue more shares and go back to the market for lots. The fund also thinks that every investor should have residential lots in their portfolios because they don't make land any more, while demand for housing is projected to increase for the next 50 years, real estate is a privileged asset class, expanding home ownership is a national priority, most millionaires come from real estate, etc.etc.etc. You get the picture and you know how the story ends. It is not a perfect parallel but there are some striking similarities.
-So increased investment demand moves up the underlying PM prices, charging the miners higher. With miners being higher, now there is a 2nd level of investment demand, that of the miners' ETFs + everyone else who wants in. Does it mean that the feedback loop is accelerating? Possibly.

More importantly, does it mean "sell now"? Absolutely not. I do not have a price target for gold (and, hence, miners) because I cannot estimate for how long central banks and governments around the world will continue with their inflationary policies. I would think that most of the appreciation in PMs/PMMs between now and "the peak" will be due to psychological factors, and, by this stage, there are no milestones for them.

Full disclosure: both BCIF and I personally are long miners of various sizes and precious metals, and short the Bernanke- Greenspan- Obama- Pelosi- Geithner- G.W.- Rumsfeld complex and everything it stands for.

Monday, October 4, 2010

How Not to Woo Customers: Craig-Hallum Edition

So, imagine this: several of your micro-cap holdings and research targets are presenting together in a conference in your city. You register for said micro-cap stock conference put together by a small bank called Craig-Hallum. There are no restrictions of any kind on the registration process: a straight-forward registration form with standard questions. 

The day before the conference you get a call, asking you who you are. You explain your story, your plans, and specifically why you registered to attend. Then you get the question "so how can we benefit from your presence there?" You are a straight-forward guy and you explain that at this stage, there is no benefit to the organizer. Of course, there is a direct benefit to the corporate (so-called) clients as they get to present to a wider audience, and there might be benefits down the road to said bank. 

But, as is the case with non-apex creatures, such foresight is deficient. The caller just tells you point-blank that you're not welcome. 


So, dear Craig-Hallum, thank you for allowing me to register just to call me the day before your event to tell me that I am not welcome: you win my eternal adoration (and some fame on the internet).

Saturday, September 4, 2010

Labor Day Thoughts



Former Labor Secretary Robert Reich has an interesting piece out today on his blog regarding the state of the labor force and the overall economy ahead of Labor Day. While I disagree with a number of his interpretations and prescriptions, he does share a few thought-provoking things. Many have been repeated over and over, while some are under-discussed:

-Laments both poor private job creation and low % of union representation in the private sector
-The "standard" prescription has not worked: stimulus, ZIRP, tax credits to small businesses, low yileds
-So the problem must be structural, and we have to boost demand (by this paragraph, I was laughing)
-The current crisis has its origin in the growth of technology that increased productivity and enabled outsourcing
-This has kept a lid on real earnings for men for 30 years, while women entering the workforce enabled household consumption to grow
-The average workweek also went up, and, finally, debt/home equity extraction came into play
-This all came to an end, and now we have overcapacity
-The gains have been concentrated at the top, with the top 1% taking in 9% of the total income in the late 1970's, up to 23.5% in 2007; very similar to what had happened between 1913 and 1928 (as a reminder, income was not considered a bad thing and, hence, it was not taxed prior to 1913)
-This is bad because the "rich" spend less than the rest of us and this is not helping the economy (no comment)
-On top, the "rich" do not invest in America only but wherever the returns are the highest (capital mobility is a good thing, Mr. Reich)
-The Great Depression leveled the playing field with social security, union bargaining, minimum wage (laughable views, but more on that later)
-The GI bill along with a vast expansion of public education reduced economic inequality and was funded by 70-90% marginal income tax rates on top
-The result was rapid growth and more jobs (a very myopic view of the post-war economy, as Mr. Reich ignores demographics, relative peace, technology advancements, low-cost energy, no international competition, etc.)
-The only reform to "widen the circle of prosperity" since 2008 was the healthcare "reform" (another laughable statement)
What should be done per Mr. Reich?
-Extend the EITC to the middle class and pay for it with a carbon tax
-No income tax on the first $20k paid for with additional payroll taxes on $250k and over
-"0.5% transaction tax on all financial transactions" for early childhood education
-Free public universities with graduates paying back 10% of income for 10 years after graduation
-"Earnings insurance program" vs. unemployment benefits to pay 50% of the earnings difference to workers who take lower-paid jobs Here is my take.
That the problems are structural is one thing that I agree on with Mr. Reich. There have been many years of government-guided malinvestment in housing and education. Both have really distorted market dynamics and we are paying the price: too many houses, but also too many lawyers, art historians, gender study-ists, and so on. While I am all about the importance of education, the system proposed by Mr. Reich would create incentives for lower-productivity performance past graduation as it would effectively make "easy" majors free, and would not discourage loafing post graduation.

We are also facing the bill for the lack of actuarial foresight in all these great "equalizing" programs that Mr. Reich praises. At this stage, the message coming from all forms of government should be that your old age will not be what your grandparents' old age is now, and, chances are, your old age will be worse off both in terms of income from SS and healthcare price and availability.

Work (productivity), income, saving and investing are good things, not bad things, and this point is strangely missing the Labor Day piece by the former Labor Secretary. Taxation of work, savings and investment is very easy to do, but is but is simply wrong: tax the things you want to discourage: smoking, drinking, obesity, energy inefficiency, bad haircuts, etc.

Along the same lines, that mythic, evil "top 1%" is a very fluid group: many are people who have worked hard for years, built up their businesses, and are selling them before retirement. Do they deserve this spit in the face? No. The 1% subset that do deserve a kick are the likes of that tip-scrounge jumping entertainer that went to Miami, or that philandering endorser that hits plastic balls with a club, or that mummified former nude model that adopts African children as if they are some novel fashion accessories. Related, we really shouldn't be justifying policies by saying that they affect only X% and 20xX%: should we ban group Z from enrolling in college because there's only 3% of them but their disproportionate enrollment will open up space for all the rest of the population?

Former Secretary Reich also rails against the fact that the "rich" don't spend as much, and seek good returns for their savings. Capital formation, Sec. Reich, is a good thing, and capital floating to the best ideas is also a good thing. Your comrades' "usual" prescription of ZIRP discourages capital formation, and it really misprices capital, leading to a host of undesirable consequences.

Further, Mr. Reich is not considering the scalability of the rewards in the digital sector of the economy: the accumulation of wealth is now possible on a much faster and much grander scale than before because of the very high scalability of technology: that extra 1 million downloads does not require nearly the same capital as an extra 1,000 restaurant locations, thus, skewing the natural 80-20 distribution even further to the top.

If jobs are the primary concern at this stage, and I think they are for most policy makers, the discussion should center around job genesis. Is there a reason why an existing business should hire an employee today? Frankly, there isn't. From the macro-themes, like "regime uncertainty", twin deficits and kleptocracy, to day-to-day unknowns, like healthcare costs, the new burdensome IRS filing requirements, the increasing cost of simple banking, increased unionization threats, etc. there is simply no reasons for businesses to expand. Without business expansion, there won't be "good" new jobs, frustrating a full generation of people. Unfortunately, Mr. Reich (and the former media star currently occupying 1600 Penn Ave) are people who have spent their entire lives signing checks on the back, never on the front, so they can't really relate to the job-creators and are boxed in by their superficial, academe understanding of the process.

Friday, August 20, 2010

2015: Where Are They Now?

Some summer Friday humor, guaranteed to offend everyone.
2015: Where are they now?
Business:
Carly Fiorina: Runs a high-tech recycling company called Compaqtor after her political career ended due to an unsuccessful merger attempt between the US and New Zealand
Warren Buffett: Fixes soft-serve machines at local DQ Grill and Chill's, mumbles something about a missing part called "collateral"
Jimmy Cayne: Early investor in the California legalization business; has own brand of tie-dye t-shirts, lava lamps and glass pipes
Mark Hurd: QVC spokesman for scissors, shears, mowers, whackers, chainsaws, razors and other cutting tools
Steve Jobs: Unveiled the iAircraftCarrier, a cooperative effort with the Department of Defense; built by FoxConn in China (but designed in the US)
Donald Trump: Licensed a new line of fine aged beef, called Donald Rump
Bill Gates: Finally lets himself go, buys a pound of organic Granny Smiths at Whole Foods
Steve Ballmer: Wears only sleeveless shirts and runs an electronics store by Times Square; he carries Zune, Kin, hotmail mousepads and other hard-to-find items
Richard S. Fuld Jr.: Trying to collect on an insurance payment for his Sun Valley mansion that he burned down while trying to find the hidden Krugerrands
Stan O'Neal: Opened 3 mini-golf courses in Fairfield County, CT, branded as The Hundering Turd
Steven Rattner: Appointed as Sr. Brand Manager for Matchbox cars after his stint with Obama's auto taskforce
Politics:
Timothy Geithner: Runs an amusement park called "The Recovery" in NJ; plays target in Shoot The Elf, the park's answer to Coney Island's Shoot the Freak.
Mike Huckabee: As Education Secretary, cuts federal funding for schools and universities teaching sciences of any kind
Rahm Emmanuel: Joined his Hollywood agent brother; specializes in vampire and ghost movies
George W. Bush: Still working on cattle-generated methane capture system at his ranch it Texas
Barack Obama: Dissolved by oil dispersants while demonstrating that Gulf waters are "absolutely safe for the summer of 2014"
Elena Kagan: Argued in a minority opinion to have the Constitution discussed and voted on annually by Congress
Sarah Palin: Insists that her brown-shirt brigade is not what you think it is, and that she's not a modern "Jenny Dark" as she's not French-Quebecadian
Rod Blagojevic: Last seen trying to exchange a seat on the bus for a 6-pc Chicken Nugget value meal
Mitt Romney: Regretting his big screen debut as James Bond because Americans cannot yet accept a Mormon as 007
Barney Frank: Busy personally approving every mortgage in the US between poker games "to make sure we don't get in trouble again"
Last but not least:
Ben Bernanke: Retired, leads the influential group "Pensioners for Higher Interest Rates"

Tuesday, July 20, 2010

Thoughts on Historical Multiples and Value Investing



These two are somewhat connected, and let me explain how. Every once in a while, especially around sharper market moves up or down, the TV channels would parade numerous experts who argue if the stock market is overvalued or undervalued. One of the experts' favorite tools is looking at the 30-40-50-60-70 year average/median P/E ratios. Then the expert would inevitably make a pronouncement about the current state.

Here's something that goes a bit underappreciated in my view. Before the computers and the internet, collecting corporate data was a really labor-intensive exercise: I doubt many people active in the market now have gone "down to the library" of their institution to get the filings of Company X, and then proceeded to manually fill ledgers with numbers. I doubt anyone thought it would be possible to get all of this data (some vendors even adjust for non-recurring items), plug away a few numbers, press F9, and, voila, we "know" to the cent how much Company X is worth because "this is what the model says." The end result is that in the computer/internet era, financial information is much more democratic. So is corporate transparency: one can check if company X has that many stores, even ogle the storefronts with Streetview, or snoop on company Y's Peruvian open pit mine in 3D. If the management team seems fishy, one can check them out on LinkedIn or the federal prison bureau, lexis/nexis, facebook, basic searches, real estate records and so on. If you don't know much about the product, check the pricepoints online, see the vendors, read the reviews, order it for yourself to test. The drastically increased transparency reduces risks. Reduced risks increase multiples, and I think we have seen some of that: so that a 1920's P/E incorporates a lot more unknowns than does a 2010 P/E.

So, how is this linked to value investing? In its classic sense, value investing is about buying $1 for 50 cents. One of the most popular approaches is Ben Graham's "net-net". But here is the problem: back when Graham came up with the formula (or when Buffett did his famous cocoa liquidation trade), just trying to do a net-net calculation had been very laborious, as I describe above. And the people who did the work got rewarded. What is the situation now? One can screen thousands of companies just with the click of a button. What is the end result? Much, much fewer bargains (in my view, I have not validated at it statistically). Most of Graham's net-nets are usually small cap, illiquid stocks of companies in the middle of some reorganization: these might be fine for a smart individual investor, but difficult for anyone running more serious money. The greater transparency has resulted in making the screaming bargains nearly extinct. Even Buffett himself rarely makes substantial open market purchases any more (substantial vs. the size of BRK). Outside of the railroad acquisition, his other recent investments (GS, GE, etc.) were effectively private transactions.

"This time, it's different" is a dangerous statement, but maybe, this time it really is different: higher transparency and easy information flows might be warranting higher average multiples.

Sunday, July 4, 2010

Unstructured Thoughts on Structural Problems



Here are some unstructured thoughts on structural problems and malinvestments that I see. As long-time reader know, I belong to the Garage Logic University school of economics.


The whole housing "boom" was a malinvestment. Detached single-family homes are a malinvestment (vs. denser solutions) and lead to built-in dependency on oil, malinvested commuting times, too many furnaces, ACs, washers, dryers, roofs, siding, lawns, garage doors, automobiles, etc. Pushing homeownership is another malinvestment (even without the credit risks) as it reduces labor mobility, a US characteristic that has served us well. A big part of the euro-zone problems is the lack of intercountry mobility, while here people move for jobs from state to state quite often.

There is a structural problem (connected to the real estate industry kidnapping the American Dream and making it a single-family house). We are structurally short oil. This has translated to (1) permanent trade deficits with a number of hostile countries and (2) enormous military expenses to secure the flow of oil (please have no illusions about Iraq and the ~stan countries). I do not know what the solution would be here: Manhattan project, market forces, managed market approach (ie communicating that the excise taxes on gasoline will go up by 20% every year for the next X years).

College education is a malinvestment for many of the students (and the taxpayers who subsidize them). The generous (6-year) graduation rate is 56% as of 2008. This means that 44% of the enrollees possibly waste years and thousands of dollars (I say possibly to account for people who enrolled just for a class or non-traditionals). Of the 56% that graduate, there are plenty that majored in practically useless subjects, from Art History to Medieval Lit to Photography to "Interdisciplinary Studies", whatever that is. Sadly, the government policies will only increase malinvestment there: subsidies for college education are only going up and the government policies are based on the assumption that more people need to "go to college". This is pure malinvestment, as the likelihood of actual benefits accruing to the new marginal student is very low. The system is failing both the students and society as a whole. We really should face up to the fact that a "degree" does not ensure real world success, and, in some case, might actually impede it. Success in highly structured predictable environments, such as colleges or doctoral programs, can lead to both false confidence and inability to think independently.

We have other massive malinvestments, too: large federal bureaucracies that run large federal programs (for example, why do we have HUD or Dept of Education? Solve any issues in these areas at the local level.) There are too many others to list. On the other hand, we have the SEC and the DOJ completely asleep at the wheel with the frauds, including C-level, that became apparent with the crisis.

There are other structural problems besides malinvestments. There is a demographic tidal wave that is starting to hit now. As noted management guru Peter Drucker had once said, demographics is the future that has already happened. Ours is not pretty. The current crisis has only sped up the day of reckoning for the endless promises made by our election-cycle driven politicians. Now is the time to make decisive, drastic steps (raising the retirement age to 75-80 and truly reforming healthcare, for example): of course, the failure of leadership is astounding, but not surprising.

The demographic tidal wave can be offset some by immigration. The structural problem with the current system is that it does NOT favor skilled immigration. Many other "first world" countries have independent professional immigration programs, while our system creates disincentives for educated, law-abiding people to stay around, while, through lack of enforcement and promises of amnesty, keeps the low skilled people here as they have nothing to lose (even Obama's aunt ignored deportation orders). Between the crisis and the work visa quotas and kinks, many highly educated friends that were employed in brand-name places had to move (for some, 10 years after coming to the US for undergrad): this is not the sort of out-migration we want.

We also have a structural problem with healthcare at all levels (privately purchased coverage, employer-provided, government-provided). The upcoming reform does nothing to lower the cost of care: it neither reduces demand, nor does it increase supply. Healthcare is the millstone around the neck of small businesses (both for starting one up, and for attracting talent), and instead of moving away from the employer-based system (that originated by "great" government policies in the 40s), the current disastrous bill is expanding it. Also, when looking at real incomes, one sees that the increases in productivity have not resulted in increases in incomes: but employers have been absorbing higher and higher HC costs. So one can infer, non-scientifically, that the increases in productivity over the last 20 years have been expropriated by the HC complex. Then there is the problem of % dollars spent on actual care vs. % dollars spent on paperwork, administrators, and trial lawyers. There is also the unresolved basic fairness problem of paying for the care of the irresponsible (including the "clusters" of acute and chronic diseases associated with smoking and obesity, both largely "lifestyle choices").

And, happy Fourth, it's a holiday after all.

Wednesday, June 30, 2010

Tesla Motors: The Risky Fendi Bag of the Highways

 The article was also linked to by WSJ and Daily Finance Columnist James Altucher. The Kirk Report members-only section linked to it, too.

Tesla Motors (TSLA) IPO'ed today and rose 40%, underscoring investor enthusiasm for popular perceived "green" investments, underwriting ineptitude, or both. Congratulations to the lottery winners here, and best of luck because you will need it. Here is why:

(1) Tesla's product/s are/will be status symbols because they are transportation solutions that are inferior to existing, low-risk, well-known solutions. Here's my back-of-the-envelope calculation over an expected 200k mi life (and, no, if it does not work on the envelope, it won't work in Excel either). Tesla hopes that its "mass market" (20k units/year; 250-300 mile range) will sell for $50k. However, according to public information, the current battery pack needs to be replaced at 100k miles at a cost of $36k as it loses 30% of the range at 50k (and, presumably, 51% at 100k). Tesla reports subsidized (PG&E night charge) electricity cost of $0.01 per mile (per wikipedia). A 200k mile life of a Tesla would then cost $50k car + $36k battery pack + $2k power = $88k. A new VW Jetta Diesel is $23k, and gets 40 mpg. Over a 200k mi lifetime, that would be 5,000 gallons, at $3/gal, is $15k. So the Jetta cost would be $38k. Diesel would have to be $13/gal for the Tesla to break even. (As a side note, diesel at $13/gal would mean that a bunker with food and a shotgun would be the best use of money). I am making a number of simplifying assumptions here, including similar maintenance and insurance costs, and residual values. If I had to guess, Congress will make regular car owners subsidize the insurance of electrical car owners.

So the conclusion here is that because of its costs and limited range, the "mass market" Tesla will likely be a 2nd or a 3rd vehicle in for a well-to-do suburban household.

(2) The ecological benefit of electric cars is substantially overstated. First, most of the US electricity comes from fossil fuels (coal and natural gas), and, second, battery metals present problems both at the sourcing and at the recycling ends. So just relocating the tailpipe from the car to the power plant and the cyanide leaching ponds of the mines does not make electrical cars zero-emissions, despite them being advertised as such.

(3) The company has manufactured a little over 1,000 cars thus far, and the bodies are actually made by Lotus. This means that the production know-how is very low. On top Tesla plans to make the cars in a high-cost location (the old NUMMI plant in Fremont, CA). The location was unionized prior to the shutdown by Toyota and MTLQQ (aka "Old GM"). It is also highly visible politically, with Nancy Pelosi and Barbara Boxer hovering over the area. So you can imagine the pressure to have "good paying, union, green jobs"= tax payer and shareholder money spent for political favors. Also, Tesla does not even have the production machinery yet.

(4) Tesla is heavily subsidized by the taxpayer. The expected effective price of their "mass market" model is $50k after a $7.5k tax credit. Tesla also has a loan facility from the taxpayer via the Department of Energy. Just remember: good business ideas do not need subsidies. Apple's app store does not need them to thrive, nor do Biore strips, nor do tube socks, nor does the halal skewer vendor down at the corner.

(5) Tesla's CEO's personal financial problems are well-known. But here is what worries me: "We are a Silicon Valley company. Closer to an Apple or Google than to a GM or Ford in the way we operate the company"-- Mr. Musk said in a very recent public statement. I have some news for you. You are in the car business. This is a cyclical business that depends heavily on financing availability (for mass-market products). The scalability of your business is much lower. The likelihood that you will have to deal with a unionized, politically powerful, inflexible expensive workforce is high. 2 of the 3 US car companies are bankrupt, and the 3rd barely made it.

(6) Tesla is losing money hand-over-fist, but you probably knew that already. It will also have a period of no production as it gets ready for the "mass market" car.

(7) Last, but not least, Tesla means "adze" (a woodworking tool) in Serbian, Nikola Tesla's native language. Nice attempt to honor one of the most important inventors in history but it is also bringing a decidedly low-tech connotation to this aspirational company.

Wednesday, June 23, 2010

A Quick Look at Booz Allen Hamilton's S-1 Filing

 It was also featured on The Reformed Broker's Hot Links.

The market's rebound over the last year+ has brought some "interesting" potential IPOs. Back in February, we had FriendFinder Networks, a company in default, trying to raise cash. These folks own a number of adult-themed social networking sites, including adultfriendfinder, which they claim was among the top traffic-ed sites worldwide. The market events in February shelved this masterpiece. Then in April, a small movie production company called The Film Department filed for an IPO. This company focuses on movie productions (as if the Hollywood Exchange was not enough to skim money off the naive), and outright warned that they face substantial liquidity constraints and that even with the IPO, they would still have to raise additional funds for each production. Also one of the underwriters was getting warrants for the deal: generally, not a good sign. So that IPO also got delayed as the market got rocky in May. One can even track how the offering price was dropped over the months through the S-1s.

On to a substantially better business that filed yesterday: Booz Allen Hamilton, a brand-name consulting company that derives 98% of its revenues from the taxpayers (the US government). The company is owned by Carlyle, a top PE shop, and has hired Credit Suisse (left underwriter) to do the deal. I browsed through their financials and I really do not see myself as an owner of this business. Here is why:

A feature of attractive businesses is earnings growth outpacing sales growth. This is called scale, and is an essential factor with any enterprise. Some kinds of growth are more capital-intensive (i.e. build more stores/get more inventory), some less so (app downloads). But the scale exists in both cases as the fixed costs are spread over more profit-generating units. Building additional stores does not mean hiring more accountants in corporate or upping the national advertising budget.

Since BAH was LBO'ed, I will look at EBIT margin instead of NI to eliminate the effect of the increased interest expense.
2007: Revs: $3,209,211 EBIT: $130,695 (Margin: 4.07%)
2008: Revs: $3,625,055 EBIT: $153,481 (Margin: 4.23%)
2009: Revs: $4,351,218 EBIT: $66,401 (skip, LBO year)
2010: Revs: $5,122,633 EBIT: $199,554 (Margin: 3.90%)

What is going on here? Revenues are up 60% and yet, the margins are going the other way. This is not desirable. Where is the money going? Here's a clue:
2007: Revs: $3,209,211 G&A: $421,921 (13.15% of revenues)
2008: Revs: $3,625,055 G&A: $474,188 (13.08% of revenues)
2009: Revs: $4,351,218 G&A: $723,827 (16.64% of revenues)
2010: Revs: $5,122,633 G&A: $811,944 (15.85% of revenues)

If the G&A in 2010 were at the 2007-2008 levels (13%), then EBIT would have been $146k higher, and the EBIT margin would have been 6.75%, or exactly in the way an owner would like to see it go.

On the positive side, comp expense seems to be coming down, with last year's being "only" 51% of revenues. This is not unusual for "professional" firms, such as investment banks (see JEF or GHL), but as the crisis showed, labor expenses tend to be fixed when things are going downhill and variable on the upside. There is no shareholder control over these which is something that even Buffett was unhappy about when he owned Salomon Brothers.

Then there is the whole "use of proceeds" aspect. A potential shareholder would like to see that he is funding future growth or paying down debt. At the other end of the spectrum would be a shareholder selling out directly. BAH is paying down debt, but how did this debt come about? There is the LBO debt, and then there is a subsequent recapitalization which resulted in the sponsor's receiving a special dividend last December (on top of receiving a special dividend last June). So, in effect, the IPO investors are funding the dividend that Carlyle pulled out. This clearly is not growth capital.

Finally, BAH's services are expensive. The company has 23,300 employees and generated over $5 bn in revenues from the US government. This means that the taxpayers are paying $220,000 per employee per year to Booz (all employees, not just front office). This is approaching investment bank levels but the money is coming from the pockets of the tax payers. With 98% of the revenues coming from the government, I would be worried that BAH's gold-plated services might be an easy target.

One has to keep in mind that there are two components to a purchase: price and value. If the price is low enough, then the purchase is de-risked and may present a good value. But somehow I doubt that the IPO will happen if the price is low enough for me to buy.

Thursday, June 3, 2010

Long Book Review: Confidence Game (the "Ackman/MBIA book")

 Update (July 5th, 2010): I strongly recommend reading John Hempton/Bronte Capital's review of the bond insurers (it is not exactly a book review but Mr. Hempton provides an incredible personal perspective on several of the underlying themes in the book). 

In short, I recommend to anyone with an interest in finance to read Christine S. Richards’s Confidence Game, probably better known as “the Ackman/MBIA book.”

Since I enjoyed Mr. Einhorn’s book on his short position in Allied Capital (“Fooling Some of the People All of the Time”), I think that that drawing some comparisons is appropriate as it would help me flesh out the intrinsic worth of the new book. I have not read “The Big Short” and “The Greatest Trade” yet, so no parallels there. Also, the latter two are not about specific companies that turned on their critics, unlike MBIA and Allied. Please do read Dasan’s book review that was posted here a short while ago.

To better understand the significance of both Mr. Ackman’s and Mr. Einhorn’s roles in the crisis, one needs to understand the role that iconoclasts play in society. The term “iconoclast” derives from the old Greek/Byzantine movement against the use of icons in church services. They questioned the use of artificial, human-created objects of worship much like Moses many years earlier had objected to the Golden Calf as a man-made idol, an action that, at its time, was, well, iconoclastic. Later in history, other men would risk their lives to challenge the man-made status quo, men like Galileo and Copernicus. In other words, the iconoclasts, the people who challenged authority, with the appropriate intellectual backing, did more to advance the world than did millions of compliant, complacent men. Much along the same lines, this book is a story about having the intellectual wherewithal to question an edifice raised by man, the triple-A credit rating, AND to take the iconoclastic position financially AND to have the courage to see it through. Mr. Einhorn, for those who have not read his book, took on the privileged status of Allied Capital as a BDC, which, much like a top credit rating, enabled its holder to do things that would not be done if there were sufficient market discipline. Mr. Einhorn was also probably the loudest voice regarding Lehman Brothers’ troubles, and was viciously attacked by the Repo 105 crowd that in a normal country would be digging ditches in orange jumpsuits for life.

In addition to appreciating the important societal role of iconoclasts, I also had the benefit of having read Mr. Ackman’s original white paper on MBIA, along with having followed all of his public presentations on investment ideas, such as GGP, TGT, CXW, O, KFT, and FNM. These materials, along with a basic understanding of the principles of general finance, financial reporting, credit ratings, municipal bonds, structured finance and insurance operations, will make the book much more enjoyable.
On to the book itself. It starts out in 2002, when Mr. Ackman, then a manager at Gotham, established a very inexpensive position in MBIA CDS. MBIA had enjoyed a cozy position for many years, using its own triple-A rating to guarantee municipal obligations against default, for a certain fee. There were three problems with this. First and foremost was the dependence on MBIA’s own triple-A credit rating. Its single largest producing asset was not under its control. Second, the ratings agencies admittedly used a two-tiered bond rating system, which was much harsher on municipalities (from a default standpoint), meaning that the agencies were costing taxpayers billions of dollars in either extra interest because of the lower rating or in fees to MBIA/cronies. The third problem with MBIA was that it had practically no insurance reserves because it operated recklessly on the assumption that even if a municipal issuer were to get in trouble, they would get bailed out one way or another by the state as a “moral obligation.” When that was not likely, MBIA would muscle the states into shifting funds all over the place to cover the shortfalls so that MBIA would not have to incur losses. In other words, if the game were not rigged, there would be no underlying need for municipal bond insurance.

Since the muni business is so sweet (even Buffett got into it when the established players got in trouble), this attracts competition. Eventually, MBIA decided that they are smart enough to do insurance on other products, namely structured finance. This is where Mr. Ackman’s 2002 white paper comes in, well before subprime became word dujour. The white paper itself is not a Cassandra-style vision of the financial system or of the credit bubble, but rather a very interesting and thorough analysis specifically focusing on MBIA’s risk exposure, and its inconsistency with the company’s triple-A rating.

From that point, all the way until MBIA’s collapse in 2008, Mr. Ackman and his team would uncover more and more problems with the company, while Mr. Ackman takes on the role of being the lone voice warning about the danger to anyone and everyone that would listen. Quoting Natalie Merchant, “a wild-eyed misfit prophet,” Mr. Ackman’s unstoppable zeal is described in full detail, including calls, letters and meetings with then-NY AG Mr. Spitzer, insurance commissioner Mr. Dinallo, the SEC, a number of analysts following the stock, the CEOs and chief credit officers of the ratings agencies, the board of directors of Moody’s, later on, the Warburg Pincus and Citigroup “rescue” financing teams, the auditors, and so on. Clearly Mr. Ackman had no shortage of courage, persistence and resourcefulness to bring the world to his viewpoint.

What makes this persistence even more admirable is that Mr. Ackman defacto took on “The Establishment” even as his original fund, Gotham, was falling apart because of an unrelated court decision on portfolio entities’ merger. It must not have been easy, particularly in the somewhat small and insular world of Wall Street. The bond insurers have been great fee generators to Wall Street, both via their own financing needs as well as their role in making sure that the municipal and structured finance machines keep churning. Obviously, the banks’ self-interest was not aligned with Mr. Ackman’s regardless of who was “right.” Additionally, companies and their management teams do not like having their stock shorted: it seems that many managers take this as a personal affront, and are classless enough to show it like MBIA’s CEO who demonstratively refused to shake hands with Mr. Ackman after threatening his career. MBIA goes on the offensive in many ways, some are direct, some are alleged, like having NYAG Spitzer (at the peak of his power) and the SEC investigate Mr. Ackman, or having undue influence on the court case regarding an unrelated Gotham investment. While it does not seem like MBIA went to the lengths that Allied Capital admittedly did (phone record theft, having his wife fired), MBIA and its management did engage in a number of unsightly and completely inappropriate tactics in their attack on Mr. Ackman.

Again, remember that this is a book about iconoclasm. Being a dissident in the financial world is not easy, because it is costly, the timing is very difficult, and simply, it is much harder to win against a large, entrenched member of the system. But, just like Goliath was taken down through leverage, so was MBIA taken down through its inadequate capital reserving, aggressive underwriting and greedy, myopic management. More contemporaneously, be alert when someone from the “establishment” blames market participants or critics for unfavorable development in the market, be it MBIA, Lehman Brothers or Greece. Ask yourself, why aren’t these “evil speculators” or “wolf packs” or “sharks” attacking the creditworthiness of Norway, Nestle or Exxon?

Unlike Mr. Einhorn’s book, which is written (predominantly, I assume) by the fund manager himself, the Ackman book is written by a journalist. While obviously edited/redacted by Mr. Ackman, the book is sorely lacking the true insight of what went on in the manager’s mind as well as the intricacies of the actual security analysis that went on inside the fund. Mr. Einhorn’s provides much of that, including the careful research of specific (fraudulent) properties backing the BDC financing, such as shrimp boats in Louisiana or gas stations in Detroit (yes, Allied, with its privileged tax status and SBA relationships, did lend against such “gems.”) The author here does describe only one specific situation uncovered by the fund, a hospital bankruptcy, along with several cases of municipal finance or collateral abuse that were investigated by herself in her own role as an MBIA reporter. While the journalistic gumshoe work is interesting, I found the lack of insight in the workings of Mr. Ackman’s funds’ approach to analysis quite disappointing.

Additionally, while very-well footnoted, the book is written with the grandeur vision of a classic novel, and, as a result, it does not have a single graph of MBIA’s stock price or its CDS! Not even as an appendix. I can probably blame the number-phobic liberal arts establishment for that, but I do hope that the soft cover would include at least a two y-axis time graph that plots the stock price and the CDS over the six or so years, along with notations of the major events in the book. That should not be that hard to do.

Finally, one should also remember Howard Marks’s maxim that being early is often indistinguishable from being wrong. Mr. Ackman’s vision of reality did lose money for the original investors in Gotham Credit, as they had a negative carry position in the MBIA CDS. People who stood by did eventually make a lot. So, much like the Dutch buying Manhattan for $600, timing is (nearly) everything, and Mr. Ackman’s campaign was, in my opinion, his way to accelerate the perceptions of the market participants towards his view, which, with the benefit of 20/20 hindsight, was absolutely correct.

(No Amazon commissions here, I purchased my own full-priced copy, I earn no compensation for writing this and I am not affiliated with the author, publisher or any of the characters in the book, save for the first Pershing analyst on MBIA, Mr. J. Bernstein, whom I knew only socially from a b-school committee we sat on; I was left with highly positive impressions of him.)

Shorting Treasurys In Anticipation of Inflation: Harder Than It Seems



One of the “slam dunk” trades for the inflationist camp has been to short treasury bonds, especially the long ones. On the surface, it makes perfect sense: a fixed income instrument should decline in value when rates rise. Notwithstanding the recent gains in T-prices, along with the commensurate pain for the shorts, this trade is much less of a slam dunk than it appears. Here are my views on why it will be a while before the short LT treasurys trade works the way it is supposed to.

First, interest rates in general. A bond short can be based on two views. One is credit quality, the other one is a view on rates. Credit quality (i.e. getting paid back as contracted) would be a problem for the US if we were not borrowing in a currency we do not control. For now, we can get away with both taking the loans out and keeping the printing press, and this privilege has been recklessly abused. In other words, the US government will almost certainly take the easy road of printing rather than the harder road of actually paying down the debt. So if there are no nominal credit problems, this leaves rates. Normally, the central bank/s raise rates when inflation picks up in order to cool off demand/growth, generally believed to be the driving factors behind inflation (a misguided, incomplete view, but this is another topic). When rates rise, bond prices fall. Longer duration bonds drop more for the same increase in rates. But my problem with this is that the interest rates are one of the most managed (manipulated, if you prefer the conspiracy lingo) aspects of the economy. There are very strong incentives besides steroid-based economic growth for low rates, namely the cost of government borrowing and bank profitability. The Fed is not really independent, and Zimbabwe Ben has this moniker for a reason, so you can be almost sure that headline rates will be managed to stay low by all means necessary.

Second, in-built structural demand and potential new (!) demand. Do not forget that there is substantial built-in demand for treasurys from a number of market participants. Since bonds mature, there is a ready roll-over market. If bond fund flows increase (which could be just a function of increased retirement savings contributions in target-date plans), this creates additional demand. Pension plans, endowments and so on have pre-set government bond allocations, and the simple act of portfolio rebalancing can increase the demand for treasurys. Then you have insurance companies that are subject to rigid portfolio holding regulations, as well as to liability matching (which is done via longer-term treasurys). I am sure that there are more examples. Finally, you have “your” politicians “working” hard to “protect” your retirement savings from the evils of the stock market, so do not be surprised if there is an Argentinean-style theft of the 401k/IRA balances to be put in treasurys (or removal of their tax status, unless they invest in Ts). This can be in addition to new, mandatory employer retirement contributions to all employees (de facto, an employment tax) that automatically goes into Ts unless otherwise specified by the employee.

Third, a possible slow-down in new supply. Despite Washington’s best attempts to saddle the economy with a whole new round of structural problems (healthcare “reform”, “climate” bill, financial “reform”, idiotic stimuli programs, etc.), the economy and the tax base may begin creeping back up, surprising everyone. Some of it might be natural, some of it might be due to some productivity breakthroughs, some might be due to baby boomers working much longer than anticipated, or withdrawals from the cesspools that Bush got us in and so on. This will reduce the supply of new paper (the rollover requirements will stay, have no illusions, the national debt cannot be paid off, let alone the unfunded liabilities). But shorter term, lower funding requirements for admitted tax cheat Turbo Tim might end up putting a lid on the yields.

Finally, the coupon. Don’t forget that the bond is a contractually yielding instrument. So in effect, you are already swimming against the tide to begin with, hoping that the rates move down enough to beat the coupon pass-on, and then cover the opportunity cost of the position.

Frankly, I am as bearish as anyone, may be even more, regarding long-term government finances/demographics/entitlements/etc. I am just afraid that there are too many tricks in the bag left to keep the government borrowing costs low. A few weeks ago I closed out of TBT (2x inverse LT Ts) at a small profit, and I do not foresee re-entering the trade any time soon (and if I do, it would not be with TBT for sure)..

Monday, April 26, 2010

GMCR: Why I Worry Little About the Patent Expiration


Update 9/28/2010: I have been getting a lot of hits today from a number of prominent asset managers after the SEC announced inquiry into GMCR's dealings with a "fulfillment vendor", most likely M Block and Sons. There have been allegation about channel stuffing for a while, as I note in the last paragraph, because a number of the short theses that I had seen question the relationship. This article has very little to do with the allegations: I refer to them only in the last paragraph+comments.

Original article. 

There is a lot of noise about the expiration of the k-cup patent protection in 2012, and its impact on Green Mountain Coffee Roasters (GMCR). Of all the possible problems with GMCR, this one is not a priority, in my view. (I have no position in GMCR but this can change at any time.)


Let's talk about patents first. Patents provide protection for inventions and are good for a certain number of years. Patent protection is crucial to human progress as it provides incentives for people and companies to go out and develop new things, as the inventors can reap the benefits of their efforts. There are certain industries in which patent protection is of paramount importance: pharmaceuticals for example. A patent-protected drug is a gold mine, de facto a monopoly. This is why one of the crucial metrics in valuing the large pharma companies is how many drugs they have that are coming off protection in the next few years. Patents are also important with tech companies and some industrials for the same reasons.

Enter GMCR. GMCR's spectacular performance is due to the success of its Keurig brewer system. The company sells the machines at cost, and then sells really expensive "k-cups" (vacuum-packed roasted ground coffee) that work with the machines. The company describes the model as "razor-razor blade". I prefer calling it a Trojan horse (but this is good from a shareholder perspective). A bit of history, the company did not invent Keurig. They had a relationship with them that culminated in GMCR acquiring Keurig a few years ago. Keurig had licensed out the production of the k-cups to several roasters, including GMCR. GMCR has been working at bringing the k-cup production under its roof by acquiring the licensees, most notably the pending DDRX deal. It has been dragging but once done, GMCR will have only one licensee outstanding, a private company up in Montreal. 

So the fear is that once the k-cup production patent expires in 2012, everyone will start making k-cups, suppressing GMCR's margins. I think that the importance of this expiration is overstated, and drawing parallels between a patent expiration event in pharma to this is misplaced. Here's why.

Look at the consumable products that you use in your daily life (including coffee) and think whether patent protection plays a major role. Are there cheaper cognacs than Hennessey? Sure. Do you drink them? No. Are there cheaper cigarettes than Marlboros? Sure. Are there cheaper chocolates than Lindt? Are there cheaper sodas than Coke? You get the picture. Very simply, you do not make consumption choices guided by price alone. What is the common thread in these examples?

Bingo. It's brands. None of the brands mentioned above are patent-protected and, yet, somehow, they are doing more than OK. This- in my view- means that it will be difficult for a non-major coffee brand to compete with GMCR for shelf space in the stores and for mindshare with the consumers. People who would buy a Keurig machine are already (1) higher income (paid $100+ for a machine vs. $10 Mr Coffee drip brewer), and (2) bought the machine precisely because they like good coffee. So I think that this eliminates the non-brand competition.

Now let's look at the potential major brand competition. What are the major coffee brands? Store: Folgers (SJM), Maxwell House (KFT), Taster's Choice (Nestle); Retail: Dunkin, Starbucks, Seattle's Best (also SBUX), Caribou (CBOU); Office: Flavia (Mars). There are a lot more brands at the regional and local level, however, to be a threat by 2012, the brand should have national visibility and distribution at this stage.

You may not know it, but Kraft, Sara Lee, Mars and Nestle have their own machine systems in existence for years: Tassimo, Senseo, Flavia and Nespresso, respectively. So the competition has been around for a long time. Of the major brands that I list above, Folgers (and related, like Millstone) and Caribou are aligned with Keurig, Starbucks is aligned with Sara Lee, and, obviously, the Kraft (Maxwell, Gevalia) and Nestle brands are with their own. This leaves only Dunkin out to the best of my knowledge. So, even with an expired patent, I do not see a major threat to the k-cup system from the branded competition either. Sara Lee is trying to do something like that with the Nespresso capsules in France but there they have major brand presence compared to the US.

Finally, you have the game theory bit. Even if you have a well-capitalized, popular brand enter the space, this does not mean that they will compete on price. If you look at instant coffee, for example, the only major new entrant (SBUX) is more expensive than Nestle, even though the margins are good. Players understand that competing on price simply shrinks the profit pool for the manufacturers. Further, an entry into the space by a well-known brand might even be beneficial to the wider adoption of the machines, which does help GMCR (a network effect of sorts).

So the patent expiration is not high on my worry list. If I were a GMCR shareholder, I would be a lot more worried about (1) compression of the earnings multiple, (2) dilution, (3) input costs, (4) integration issues, (5) the DDRX tender offer, (6) alleged channel stuffing, (7) the ongoing drop in average kcup usage per machine, (8) office market penetration, (9) growth/maturity issues, and so on. ***PLUG: the author of Barbarian Capital blog is available for the right consumer- or inflation-focused analyst opportunity within the US

Saturday, April 17, 2010

Corporate Governance Malpractice Case Study: Kraft Foods



In the earlier article about Kraft, I discussed at length the potential benefits and dangers of the combination with Cadbury. To summarize, I was mildly positive on the transaction as it provides a diversification away from KFT's commodity business. Additionally, I provided some color on Kraft's subpar performance vs. its comps. Pershing Square/Ackman came out with a presentation saying a lot of the same things a few days later but with the view that one should be long KFT into the transaction. Today's missive is about Kraft's problematic corporate governance and its link to shareholder value destruction. I have no position in Kraft Foods but this can change at any time.

One of the "textbook" problems in governance is the so called "agency" problem. Many years ago, when most owners ran their businesses, they made sure that things were running for their benefit. As businesses got bigger and more complex, the owners saw fit to bring in professional managers to run things for them. This is today's equivalent of the shareholders and the managers. And the relationship gives a rise to the "agency" problem. The interests of the managers are not always aligned with the interests of the shareholders. If you are a manager, you want to do as little as possible for as much money as possible. The shareholder wants the exact opposite. Since it is impractical for the shareholders to supervise managers, shareholders elect a board to keep an eye on the managers, set goals, set comp, hire, fire, vote on major decisions and so on. The most powerful position on the board is the board chairman (but you already knew that). Obviously, a hallmark of good governance is the separation of the chairman and the CEO role. After all, the board is supposed the defend the shareholders' interests, and the chairman should be spearheading the effort.

Enter Kraft Foods. The company brought in Irene Rosenfeld, a professional manager, from Frito-Lay in June 2006. She also became chairman of the board in March of 2007, and if you do not think that the chairman role was a part of the initial deal, you should keep your money in an index fund. The chairman has strong influence in the selection process of other board members. Since Mrs. Rosenfeld's appointment as a CEO (remember the high likelihood of her chairmanship being a part of the deal), the following individuals have joined the board: Mr. Banga (1/07), Mrs. Hart (12/07), Mrs. Juliber (11/07), Mr. Ketchum (4/07), Mr. McDonald (1/10), Mr. Reynolds (12/07), Mr. von Boxmeer (1/10), Mr. Zarb (11/07).

You might be asking yourself, was there a "friends and family" discount for Kraft board memberships? It sure seems this way: only 3 board members pre-date Mrs. Rosenfeld (vs. 8 post-2006). One also wonders about issues like continuity. More interestingly, management's compensation is set by the compensation committee of the board. Who are the members of the comp committee? Well, those are Mr. Banga (Chair), Mrs. Juliber, Mr. Ketchum and Mrs. Wright. Three out of four are "Rosenfeld appointees," so to speak. Last year, Mrs. Juliber's seat was held by Mrs. Hart, another "Rosenfeld appointee."

The only non-Rosenfeld member is Mrs. Wright, who, according to the proxy materials, is qualified to serve on KFT's board, in part, because she is the CEO of Carver Bancorp ("CEO of a federal bank"). You might be forgiven if you have never heard of Carver: their market cap is $21 mm. Yes, that is twenty-one million dollars, 2,000 times smaller than KFT's. They have 9 branches. She is also on a few non-profit boards, including The Sesame Workshop. Oreo cookies, Cookie Monster. You get the picture.

A cynic might call this board composition "stacking the deck." There is no way they would get tough on management. But cynicism alone is not a good investment approach, so let's look at some numbers from Kraft's latest proxy. I am looking just at actual comp, not at the golden parachutes and other uncertain/potential provisions, nor am I looking at the pay % based on "adjusted" measures.

How has the board done in the past with defending the shareholders' interests by rewarding performance and aligning incentives?

Rosenfeld total comp for 2007: $13.5 mm; 2008: $18.7 mm; 2009: $26.3 mm

So, Mrs. Rosenfeld doubled her income between 2007 and 2009. Not bad at all, I wish I could do the same thing. Surely the shares must have done very well if what should be largely a fixed cost is so variable on the upside.

How did Kraft shareholders do during the same period?

Kraft Foods share price: Jan 1, 2007: $31.45 Dec 31, 2009: $26.92 (both adjusted for dividends received, looks much worse without, $35.61 in '07 to $27.18 in '09).

You can judge for yourself. Like they say, where are the shareholders' yachts? And the shareholders pay the board members $250- $270k per year for this.

The increase in the 2009 compensation was justified with "Ms. Rosenfeld’s leadership in executing on the formal bid for Cadbury in November 2009 and closing this complex deal in early 2010 as exceptional" (this quote is the #1 reason given).

My guess is that the board did not bother with the question "what if the deal is ultimately value-destructive and how are we going to measure it, and how are we going to adjust comp if the deal turns out to hurt shareholder value?"


But wait, there is more, just like in a Billy Mays infomercial. Note that the board describes the leadership as "exceptional". Is it? Here are some recent developments to keep in mind. Also remember that the deal was uncontested: there were no other bidders.

During the due diligence process, Kraft had missed a substantial pension liability with some of Cadbury's UK workers and ended up forcing 3,600 workers to opt out of the plan or to have a 3-year pay freeze. During the bidding process, Kraft also lied about not planning to close the Somerdale factory: KFT changed its mind post-takeover, based on unknown new production capacity in Poland (if I remember correctly). While this has not been reported widely in the US, the scandalous takeover the iconic British candy marker led to Parliament hearings (!) during which Kraft promised NO more job losses in the UK for the next two years. Further, the EU mandated that Kraft divest some product lines in some geographies.

Poooof! This is the sound of your mythical "synergies" disappearing. You could add paying 100% more than the 52-week low for Cadbury's stock. "Exceptional leadership" in deed.

Here's something else, from My Investing Notebook, Jamie Dimon of JPMorgan possibly takes a stab at Kraft in his latest shareholder letter: "We do not pay bonuses for completing a merger, which we regard as part of the job. When the merger has proved to be successful, compensation might go up." Cold.

So, is it any wonder that Buffett, KFT's largest shareholder, is upset? There might be more to his displeasure than just the use of KFT stock in the acquisition.




Monday, April 12, 2010

The Value of Counter-intuitive Thinking

 This article was a featured link on The Reformed Broker's Hot Links.

There is this anecdote about the Battle of Britain (if you slept through history class, this was largely an air operation). After every mission, the planes that came back would be inspected for bullet holes and subsequently repaired and strengthened in the areas that were hit. Makes sense, right? It did, until someone pointed out that the ground crews should be more concerned with the areas of the planes that did NOT have holes in them: the planes that were hit there simply never made it back... This is a fine example of counter-intuitive thinking.

Here are my not-so-fine thoughts on a number of policy and other initiatives that might benefit from some counter-intuitive thinking (that is, counter to what seems to be the mainstream view). As long-time readers know, I belong to the Garage Logic University school of thought, so pardon any inconsistencies with what your advanced econometrics professor told you.

As a country "we need":

(1) A "jobs" bill: no, we do not. It is scary, arrogant and delusional to think that "jobs" can be created by decree. Central planning has failed over and over again but apparently this is beyond the comprehension of many of our elected representatives. The government should ensure that there is a fertile soil, and let the collective efforts of the market participants decide what the next growth industries would be. What would have happened if Congress, years ago, had decided to protect jobs in the horse and buggy, abacus, whale oil, vinyl record and candle industries?

(2) A healthcare reform bill that expands "access": no, we do not. There is no problem with access: there are no waiting lists, that I know of. The problem is cost. Cost=price. This means that there are issues with supply and demand. The thing that passed does nothing to increase supply, and does nothing to decrease demand (not even the simplest things, such as a minimum mandatory out-of-pocket copays for any office visit, a cap on malpractice liability and transparent pricing). Oh, and don't forget, it uses 10 years of taxation for 6 years of spending to be "neutral". It would be laughable if it these clowns (one thinks that Guam will capsize if there is more US troops there) were not in a position of real power.

(3) To encourage consumer spending to "help" the economy: no, we do not. Higher consumption (along with higher taxation) hinder capital accumulation. Having more capital is a good thing, not a bad thing. An added bonus, the joy coming from an acquired object drops very quickly post-acquisition, we just get used to having the object, and we lose the option of spending the money on something else.

(4) To keep zero interest rates to "help" the economy: no, we don't. Everyone loves free money, but this discourages savings. The rebound in banking profits is simply the expropriation of value by the banks from the savers. Greenspan waited for way too long to raise rates in the '00s, and it surely seems to me that Zimbabwe Ben is repeating the same mistake. ZIRP, the last time around, also had other undesirable effects, such as high housing inflation in select markets and the now-infamous "reach for yield."

(5) To increase government spending to "help" the economy: no, we don't. To begin with, the government must take the money from its rightful owner, the earner, via taxation. I am not sure that bureaucrats spending other people's money can make better spending decisions vs. people who spend their own hard-earned money. Second, since we have a huge budget deficit, the increase in spending has to be borrowed. When you add the shocking lack of political will to do a real entitlement reform, we are creating "path dependent outcomes". Simply put, the financial mismanagement of the last and the present administrations has cut the number of options that will be available in the future.

(6) To subsidize "green energy": no, we don't. If a certain technology is not ready for the market, then may be it should not be in the market. Last time I checked, there were no rebates for people buying iPhone apps because it is such a cool new efficient technology, and, yet, there were billions downloaded. Why? Because it makes sense to download apps that make you more productive (for example). The sad truth is that neither solar nor wind can have utility-level reliability. Further, with 50% of the current energy coming from coal, that electric plug-in is not the zero-emission vehicle it is sold as. Finally, with solar panel and car battery efficiency dropping with age, exactly what are the recycling implication? Or there will be a "hybrid car battery recycling tax" levied on all drivers that dare not to buy a Prius (on top of the tax subsidy for purchase)?

(7) To pass "cap and trade" legislation: no, we don't. The man-made global warming has been exposed as the single largest science fraud of our times. Further, carbon dioxide is an essential part of the carbon cycle, this is the cycle of life. The creation of a "carbon credit" to trade is simply a transfer of value from the productive segments of society to the financier class. Personally, I am all for fuel efficiency and mass transit: a driving commute is largely unproductive time from an economic perspective, but personal views are not necessarily a good starting point for a larger policy.

(8) To help stem the foreclosure tide: no, we don't. If anything, foreclosures should be accelerated. Instead of throwing good money after bad, the government should cut its support of the housing market. This way the speculators will get flushed out, and the prudent participants will be rewarded. Further, as the market finds its ground, this will, shockingly, spur more investment. Finally, more foreclosures will actually enable the home-borrowers (not "owners" btw) to move to where the jobs are: the mobility of the US labor force has been severely constrained over the last two years because of the real estate problems.

(9) To pass comprehensive financial reforms legislation: no, we don't. I can see something dealing with the Too Big to Fail problem, but outside of that, we need actual enforcement of existing regulations (instead we have SEC staffers surfing porn all day, and getting reassigned, not fired!). To wit, the costliest problems have come from institutions that were already heavily regulated and, on top, were dealing with heavily regulated products, such as mortgages. The biggest blow-ups (Lehman, Bear, Merrill, Fannie, Freddie, AIG, Ambac+friends, Countrywide+friends) have led to virtually no persecutions or convictions: normally "professionals" are held to certain standards, and doctors/lawyers/dentists/architects are sued if they fail to meet them. I do not see the equivalent level of responsibility with financial "professionals" at all levels, from Frauddy N. Komish, a mortgage broker, to Trancheè M. Bonusky, the guy who knowingly stuffed the MBS with garbage, to Mr. Bonusky's bosses, who were in on the 'bezzle and then some (i.e. the repo 105 crowd).

So, there it is, 9 areas that can benefit, in my humble view, from a counter-intuitive look that goes beyond the knee-jerk, soundbite non-logic that seems to dominate. Criticism and your own examples are always welcome.

(PLUG: the author of Barbarian Capital blog is available for the right consumer- or inflation-focused analyst opportunity within the US)