Sunday, August 30, 2009

Where Are We Now?

I've just finished "A Colossal Failure of Common Sense: The Inside Story of the Collapse of Lehman Brothers," and I want to take some time to digest it and put it into context. I find that we're in a curious position right now, where there are still forthcoming books "explaining" the roots of the financial crisis. So, we're still looking back. Reading McDonald's book, along with many other presentations, it seems to me that the causality and chain of events is quite clear, as we've written about many times. McDonald tells the story from the trader's viewpoint, which is at the center of the storm, and it's quite a tale.

Meanwhile, while we are still looking back, it seems as if notions of regulatory reform, elimination of moral hazard, shrinking the size of the financial sector, and the need to regulate the creation and trading of lethal financial instruments in a casino environment have conveniently been forgotten. Remember "TBF" (too big to fail)? Psychologically, it's not hard to figure out why. I think it's "crisis fatigue." 24x7 coverage of the issues by talking heads and blathering Congress persons has numbed interest and critical thinking. Realistically, most of us are worried about employment and personal finance issues.

Taking advantage of this, the Federal Reserve has now shifted its own commentary from financial market and central banking issues to the shape of a recovery. Now, we're arguing about "V" versus "W" shaped recoveries. This is easy and fun, because everyone can have an opinion and nobody is responsible for where the Dow goes. "How 'bout those Yankees?"

In McDonald's book, it's ironic to hear a hugely successful trader of distressed debt talking about the lunacy of unwinding Glass-Steagall, even though it has allowed his desk and Lehman Brothers to makes tens of millions of dollars in profit in a day. Yet, this foundational issue is now lost in the reading of stock market tea leaves. Barney Frank, who fiddled in his role as head of Congressional oversight, has now quietly also slipped out of the spotlight.

Finally, we read that the new head of AIG is seeking wise counsel from the former CEO, who constructed the house of cards that threatened to incinerate the world financial system. It's too much irony for me.

Friday, August 7, 2009

That Was The Week That Was

Americans have no equivalent to the wacky, satirical, and cerebral BBC show written by Cleese, Chapman, Peter Cook, and Kenneth Tynan. I think we need something like this is the current manic depressive environment of Wall Street News. Equity markets are running the bulls in Pamplona because of the coming Q3 and Q4 inventory rebuilding, softening energy prices, and a positive unemployment report. Goldman Sachs now forecasts 3% or better GDP growth in the second half of 2009.

Fundamentally, it doesn't seem as if the snapback has legs to sustain it in 2010. Failure to act early and aggressively to head off foreclosures is now yielding its bitter fruit, as one-third of home sales are coming from foreclosures. Just as the Columbia Business School researchers stated last year, the servicers are now standing in the way of meaningful loan restructuring, claiming that they don't have the power to carry these out; the truth is that they are sitting back enjoying billing and collecting a plethora of new fees. Let's sweep this under the rug. Cars, appliances and other consumer durables are continuing to languish, with the exception of expensive and inefficient programs like Cars for Clunkers. Nothing meaningful has been accomplished in the financial re-regulation arena. Investment grade corporate spreads have narrowed significantly and that's appropriate normalization. It's also the past. What about the future?

Dr. Fathi Birol of the International Energy Agency published its study of more than 800 major petroleum fields around the world and found that production declines have been faster than previously thought. He notes that the world must discover the equivalent of "four Saudi Arabias" by 2030 if current levels of daily oil production are to be sustained. This seems like a remote possibility. Our July post reporting the comments by the CEO of Hess Oil captured all these issues. They have not gone away. Dr. Birol laments the "chronic underinvestment by oil producing countries" in exploration and development to maintain or grow production. The international majors, kept out by resource nationalism, have found it easier to buy back their shares than to take risks of investing in projects for which the terms may be abrogated in the future. Demand is down now, but if the economy recovers, demand comes back and supply won't keep pace.

Consumer spending still has to be impacted with the massive loss in wealth and the continuing uncertainty about employment stability and growth. Early into the conversations about a New Deal type of recovery plan, there was talk about a nationwide infrastructure rebuilding program. Now that seems like something that is necessary, and it could be far-reaching and create employment in lots of trades and professions. Our grid is outmoded, our water supply systems are antiquated and at risk, and a combination of technology improvements and good, old fashioned reconstruction could yield real benefits. It beats Cars for Clunkers!

Dieter (Mike Meyers), the host of "Sprockets" on SNL said it best, "Zis conversaton has become tiresome!"

Wednesday, August 5, 2009

The Management Myth

Today's Wall Street Journal carries an interesting article by Philip Broughton, who writes about Matthew Stewart's book "The Management Myth." It discusses some first principles in thinking about corporations and the values that sustain the American model. We've written about these issues before, using the work of Professor Rakesh Khurana of the Harvard Business School.

Stewart approaches the issue by looking at the consulting business and how it operates within the largest American corporations. He notes that work of these consultants--you know the names-- are "built on a science of management that is both narrow minded and intellectually bogus." The skeleton of modern consulting practice evolved from the early work of "efficiency experts," and like a comet's tail, picked up material as it moved through time from economics, organizational theory, computer systems, pop psychology, and marketing. We've even picked up an odd label or two from genetics, when we speak about "growth being built into the corporate DNA." Now, that is real blather, but you hear it on almost every other corporate earnings call.

Stewart also talks about the corporation as being "obsessed with its own perverse value system and view of human nature.." Corporations are torn between presenting themselves as "environments" where people can realize their aspirations and contribute to some high-faluting corporate goal, or as "black boxes" devoted to growing earnings at 15% a year come hell or high water. Both kinds of entities wind up having cultures or value systems, but in the case of public companies rarely does anyone know where these came from. Apple for example started in a garage with the legend of Wozniak and Jobs, and somehow whatever drove that original culture is supposed to be continued into the papacy of Jobs. It really makes no sense. The American corporate view of human nature is still overwhelmingly Theory X, which everyone publicly repudiates but lives with every day.

Larger private corporations, where representatives of the founders are still active, seem to do a better job of articulating a value system with continuity that evolves into a culture that mirrors the value system. The changeover of corporate management in public companies makes it hard to accomplish the same continuity.

I've counseled some of my very talented financial staff not to shortchange themselves by going into MBA programs in finance. They were more than capable of absorbing all the rote technical material on their own. They owed it to themselves to learn much more about foreign languages, culture, philosophy, anthropology and economics. One of them solved the dilemma by going to business school in India from Minnesota! I'm anxious to see how it turns out. We should be educating our future business leaders much more through what's called the Core Curriculum at Columbia, or the classics at Chicago. More Plato, Seneca, and Montaigne and less Porter, Black-Scholes, and Merton.

Tuesday, August 4, 2009

Make That a Pepsi Without the Fizz

The Pepsi bottlers being acquired today might be more likely to say, "Make that a Dom Perignon, please!" Back in April, we should assume that Pepsi's $6 billion bid for the companies represented the best estimates of fundamental asset values, cost savings, volume growth, and some padding to make the deal palatable. Today, that number becomes $7.8 billion.

The fundamental problem for both Coke and Pepsi is the secular low case volume growth for carbonated colas, and for carbonated beverages in general. Looking out into the future, there are clouds on the horizon when pundits like Dr. David Kessler talk about making sugar the "new tobacco." That can't be good for for Coke or Pepsi, even if it might be good for American waistlines.

The distributors clearly have a better view of the endgame, and they enjoy a grand payday. Interestingly, the cost savings from the acquisition were stated as $200 million in April, whereas today they are $300 million by 2012. Perhaps the April numbers were disinformation. Either we found $100 million by definition, or it was conjured out of the air. The latter is more likely.