Thursday, March 27, 2014

The Fed's Stress Test Gives Citi Heartburn

We were in the minority when Citicorp removed Vikram Pandit from the CEO position and replaced him with Michael Corbat.  There were loud huzzahs from many quarters, from Sheila Bair to the financial press. Things were going to move much faster now, the chorus said, and shareholders would be rewarded handsomely; the stock did extremely well, but today the Fed took the wind out of Citi's sails by both announcing that it had failed its 2014 Comprehensive Capital Analysis.

Analysts' euphoria has reached such ridiculous heights that the WSJ reports analysts expected Citi to raise its dividend from $0.04 per share to $0.53 a share.  Analysts have been known to access controlled substances from time to time, but it would also seem that they were probably pointed to this kind of increase by  naive management guidance.

The bizarre thing about the CCA, is that Citi passed the quantitative portions of the test.  Consider this,
"Therefore, even if the supervisory test for a given BHC results in a post-stress Tier I common ratio exceeding 5 percent and post-stress regulatory capital ratios above the minimum requirements, the Federal Reserve could object to that BHC's capital plan based on qualitative assessment of the practices supporting its capital planning."
Now the problem is that the Federal Reserve has become another reviewer of Sarbanes-Oxley.  Consider this quote from the 2013 auditor opinion letter on Citi's financial statements on Form 10-K.
"We (KPMG) also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), Citigroup’s internal control over financial reporting as of December 31, 2013, based on criteria established in Internal Control-Integrated Framework (1992) issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO), and our report dated March 3, 2014 expressed an unqualified opinion on the effectiveness of the Company’s internal control over
financial reporting.
But if the Fed, using another set of arbitrary standards, opines that the capital planning process is inadequately supported by reliable practices, then this inadequacy must be reflected in the financial statements.  But, surely the auditors must have gone into more detail than the Federal Reserve?  Something has gone seriously wrong with the CCA process.

Let's be clear that nobody is a hero in this episode.  CEO Corbat deserves a reprimand from the board for allowing his company to be blindsided by its principal regulator. His job was to be far out ahead of this process and to make any changes necessary to achieve the corporate goal of passing both the quantitative and qualitative tests. Former CEO Pandit was said to be "prickly," but CEO Corbat seems inept in dealing with the arbitrary Fed framework. Also, his aggressive plans for capital return to shareholders were premature and unwarranted.

Mr. Corbat, in turn, should probably quite a few changes to his financial organization's senior ranks, and for that matter, to his board.  Why? There is no excuse for not being able to run a stress test, which is not new, to the Fed's specifications.

KPMG should also take some accountability, or they should explain to regulators that they stand behind their assessment of the banks's internal controls, on which they rendered an unqualified opinion.

Remember, finally, in the Fed's recently released FOMC minutes archive the discussion revealing that the Federal Reserve couldn't even figure out that IndyMac was failing even when mortgage brokers and most of the industry knew it months before.

The Federal Reserve didn't adequately audit its member banks in the past, and that is plain even for its staunchest apologists. However, now it seems to have gone too far in setting standards and seemingly not applying them consistently, while also treading upon regulatory oversight of other organizations, like the SEC.

Tuesday, March 25, 2014

Exxon's Solid 2013 Positions It Well for The Near-Term Future

Mutual fund investors who managed to avoid the global, integrated oil companies in the fourth quarter did well, and those who bought oil field services companies improved their performance relative to benchmarks. But, as prosaic and unloved as these companies (Exxon Mobil, Chevron, Shell, Total, and BP) are, they will be important to global development and to portfolios in the future.

Value oriented investors tended to take positions in Chevron, which has awakened to the importance of returns on capital for growth and portfolio management in the future.  If their returns improve, their stock should do well, since it is relatively cheaper than Exxon.

Exxon's 2013 after-tax earnings from Upstream activities were $26,841 million, down about $3 billion from 2012.  This decline was driven by foreign operations with after-tax earnings of $22,650 million, down $3 billion from 2012.  U.S. operations had a good year. Higher gas realizations ($4.60/kcf vs.$3.90/kcf worldwide) were offset by lower realizations on petroleum liquids; the net increment to earnings was $390 million. Adjusted production was flat.

Upstream activities generated a return on average capital employed of 17.5%, with average capital employed at $152,969 million and capital expenditures of $38,321 million.  The portfolio mix of projects coming on stream around the world (six major projects including the Kearl Athabasca tar sands project in Canada) is well balanced from fuels, geography, and technology viewpoints.

Chemicals had 2013 after-tax earnings of $3,828 million, and a ROACE of 18.5%; the capital base was $20,665 million and capital expenditures were $1,832 million.  The bulk of chemical earnings, $2,755 million, came from U.S. operations, and this is where continuing opportunities for volume growth and profit improvements exist out to 2018 in the current plans.

Exxon is the largest chemical and natural gas producer in the United States.

Downstream operations, including retail gasoline operations, generated after-tax earnings of $3,449 million, with an ROACE of 14.1%.  U.S. operations generated earnings of $2,199 million in 2013. Overall, Exxon's returns on capital continue to be superior to its four peers listed above, no matter what the macroeconomic environment.

Over the next five years, the company expects oil-equivalent production from North America to grow from 32% of production currently to 35%.  Over the same period, LNG production is expected to increase to 55% of production on an oil-equivalent basis from 45% today.  Both of these mix shifts should be positive.

Exxon's $19 billion LNG project in Papua New Guinea is slated to load its first cargo in 2014.  This 6.9 million metric ton per annum project is extremely complex from the engineering, logistical and environmental management standpoints.  PNG is a difficult environment in which to get projects done, as they dithered for years on a seabed mining project, putting it though endless hoops that, along with a global recession, eventually put the project in a deep freeze.

This project's output will be primarily for export,and so it should be a great laboratory for our domestic cries to export LNG from the U.S. Exxon's project, in which it has a 33% operating stake, includes 253 miles of subsea pipelines connecting eight gas fields, with a gas conditioning plant and the liquefaction plant.  One of the real moats that Exxon has around its business is the depth and scale of engineering, procurement and project management expertise that permits it to work in all kinds of challenging physical environments.

Regulatory and compliance expense for all the global majors has been increasing much faster than revenue or profit volumes.  It is good to see the company organizing itself into nine or more cross-organizational teams to deal with global issues like Risk Assessment and Management and Incident Investigation and Analysis. This seems like a way of organizing that makes sense for the business, as opposed to checking a box required by incoherent legislation.

Despite having a robust capital spending plan and returning $25.9 billion to shareholders (the stock has a 2.6% dividend yield even after the run-up), Exxon filed a $5.5 billion shelf for a multi-part debt offering, with a AAA rating from both Moody's and from Standard and Poor's.  Proceeds will be for capital spending, acquisitions, and for refinancing of commercial paper.

A strong balance sheet along with disciplined capital utilization is a good tonic for shareholders.

Monday, March 24, 2014

Justice Department Holds Up Toyota Shareholders for $2 Billion

In 2012, we wrote an entry "Class Action Lawyers Stick Up Toyota for $1.1 Billion."  With the announcement that another billion dollar settlement with the Federal government was in the offing about alleged problems with disclosures to government inquiries, the episode has cost the company well over $2 billion.

The problem is the same as it was in 2012.  The NTSA and NASA studies into the sudden acceleration problem, beyond the acknowledged intermittent issues of pedal entrapment or the pedal sticking, could not be duplicated by the best technical investigative agencies we have.

Most of the first billion dollars went to attorney fees and to research on automobile safety.  It would be nice to know what politically favored organizations are doing that research and what they're coming up with.

The 2011 reports are still available on the NTSA website.

Toyota has paid out billions, suffered economic damage to its reputation, and lost sales for not being forthcoming, or as the WSJ writes about today for bad paperwork.

Toyota, like big banks and other big corporations, knew that it was better to transfer wealth from Toyota shareholders to the supreme beings at the Justice Department than to soldier on about facts, which are irrelevant when corporations are involved.

Saturday, March 15, 2014

Insurance Risks and Capital Markets

It's almost impossible to make a persuasive case that insurance industry companies were responsible for systemic risk in the last financial crisis.  Organizations like the OECD took that position way back in 2009.

Today, perhaps on the argument that regulation is looking forward, certain insurers, like Met Life and Prudential, are being bandied about as "systemically important financial institutions." Size would be the obvious measure to bring these companies under the microscope. Met Life's assets in 2012 were $562 billion, number one in the industry.  Number two was Prudential at $491 billion, both from the ACLI.  But, the business model, management capability, board oversight, and corporate cultures are what drove the bad actors in the last crisis to put the financial system on the brink.  Size, for the insurance business, was neither germane nor predictive.

John Cochrane of Chicago Booth and other scholars have talked about the fundamental importance of "runs" in financial crisis.  We know how banks have runs on deposits.  We now know how runs can create panic selling in asset markets, as they did in the last crisis.  Life insurers, with very long term liabilities, are unlikely to be be affected by policy holder runs, by the insureds demanding payment of cash values all at once. Fees and surrender charges provide insulation and disincentive, respectively.  Life insurance industry policy reserves were $1.3 trillion in 2012, and their share of policy reserves in total has been declining over recent years.  These reserves are built for mortality and longevity issues, not for unlikely or immaterial runs on policies.

What about AIG, though?  It is number four in assets of the life insurers in 2012, with $247 billion.  But, as we know, but sometimes forget, AIG's losses were caused by one, nominally small, unregulated, misunderstood, unmonitored renegade business called AIG Financial Products Group, a capital markets business.

Indeed, going forward, it will once again be the capital markets where the risks will be uncovered, after the fact.  The incentives and pressures for systemic riskiness are created by the continuing, artificial low interest rate environment which now cannot be unwound as quickly as it was put into place.

The low interest rate environment has put pressure on life insurers who have written variable life products with higher guaranteed crediting rates than today's levels.  The risk can be inferred from the composition of industry policy reserves.  Policy reserves for annuity products were $2.9 trillion in 2012, more than double the level for life policies, and 65% of policy reserves.

For pension fund sponsors, particularly in the public sector, enormous pressures are building from mismanagement, poor investment decisions, and mortality and and longevity risks.

Signs of a locus for the next crisis may be seen in some recent capital market and reinsurance market deals.

  • In 2011, Rolls Royce transferred some $3 billion in pension fund liabilities to Deutsche Bank, which in turn transferred them to a group of insurers and reinsurers.  RR pays fixed premiums for coverage if an agreed upon longevity index exceeds a cap, in which case RR receives payment from its insurers.
  • Aegon hedged its annuity portfolio by transferring 12 billion euros of longevity risk to Deutsche Bank in a swap.  
  • Aegon completed a second deal in 2013 through a more complicated structure created by Societe Generale's CIB business
If one goes to the current financial disclosures of these companies, it is almost impossible to find much discussion of these new types of businesses and their risks.  While some observers have said that there are only $2-3 billion of U.S. deal volume in mortality and longevity transfers done annually, they also say that worldwide appetite for these structures could be as high as protection for $21 trillion in assets. This kind of deal market would strain the capacities of even the giants like Berkshire Hathaway.

Keep an eye on the capital markets players and these business structures, if you can find them, understand them, measure the risks and track them back to the counter parties.  

Thursday, March 13, 2014

Is Met Life a SIFI? Still Undecided.

Since the middle of 2013, a decision about Met Life being a "Systemically Important Financial Institution" was imminent.  Now with the publication of their 2013 10-K, the company is still waiting.

In all our of American regulatory fog about SIFIs, it is funny to note that most documents and studies acknowledge that key concepts like "systemically important" or "contingent capital" do not have widely accepted definitions.

Recent research from the New York Fed, found in its Liberty Street Blog, has assiduously tried to show that the effects of the current "unconventional" monetary policy has been equivalent to conventional policies relating to monetary aggregates and Fed funds.  Their conclusion, not surprisingly, is that rates are not in a very different position than they would have been under a conventional policy.  Forget about the conceptual difficulties of this exercise, but the critical effects of a persistent, artificial low rate environment are on the behavior of market participants, which fall outside of any of these studies.

Insurance companies fall under the SIFI umbrella because it has been suggested that the pressures put on their net interest margins would inevitably force them to take inordinate risks so as to maintain their earnings.
In the case of Met Life specifically, this seems to be incomprehensibly far off the mark.

Researchers from the Society of Actuaries--not exactly cowboy risk takers--have long written about the risks of a low rate environment for insurers.  Their advice, beyond the creation of deeper risk management processes within companies, really talked about product redesign, changes to the nature of policy guarantees and crediting rates, and hedging or re-insuring older products. These are the kinds of things that are evident in Met Life's financial disclosures.

MET reported fourth quarter 2013 operating earnings of $1.6 billion, up 14% yr/yr, and full year operating earnings of $6.3 billion, up 12%.  Diluted EPS on an operating basis was $1.37 in the fourth quarter (+10%) and $5.63 for 2013.  All of these were better than expected by the Street.

Adjusted return on equity for the fourth quarter was 11.5%, and 12% for the full year 2013.  Equity market performance in the fourth quarter and the steepening of the yield curve at the front end helped the return on equity and variable investment income by 50 bp and by 40 bp respectively in the fourth quarter.

Equity/Assets ratio was 8.1% in 2010 and rose to 8.9% in 2012 and finished 2013 at 9.9%, so the company has deleveraged through the risky period of low rates.

Sales of variable annuity products, per management guidance, have been reduced to $10-$11 billion, with the kind of product changes suggested by the SoA implemented in new product sold.

Although the absolute size is still small, international revenue, which is more oriented towards protection products, has been a strong point in Europe, Japan, and in Latin America, where the company acquired a profitable Chilean operation.  A shift in mix towards international should, all things equal, be better for the corporate risk profile.

The argument made by Met Life management is that imposing a bank-centric set of capital rules on an insurance operation with a fundamentally different business model will generate unintended consequences like raising the cost of guarantees and policy pricing for health and life products.

Wednesday, March 12, 2014

Mamma Mia! UniCredit's Fourth Quarter Loss at €15 billion.

We started watching UniCredit in 2012 when its rights offering was greeted less than enthusiastically by equity investors.  Their slide presentation on Q4 FY13 is fairly confusing, as it tries to weave in extraordinarily bad news with the good news to come from the strategic plan out to 2018. A reeling shareholder probably needs to get his feet on the ground first as to where the bank is today, and that is not clear.

For Q4, UniCredit reported a net loss of €15 billion ($20.8 bn), and a full year FY13 loss of €14 billion, which is the fifth biggest loss reported by a European bank since 2005, according to the Wall Street Journal.

The fourth quarter LLP was €9,337 million compared to a provision of €4,516 million in Q4 FY12, an increase of 107%. For the full year, the LLP was €13,658 million, a 47% increase over the prior year.  €6.8 billion in the fourth quarter provision was attributable to Western Europe, of which €5.4 billion came from Commercial Bank of Italy and €1 billion  from Corporate assets.

The company also wrote off €9,368 million in goodwill, covering €8 billion from acquired assets and €1.3 billion from the impaired value of customer relationships.  Operations in Poland, Austria and Germany seem to be good businesses, and deposit gathering in Poland was strong in the quarter, but there is little goodwill left in these operations.

There was a €1.4 billion pre-tax gain from a revaluation of a 22% stake in the Bank of Italy, among the non-recurring items.

Non-performing loan coverage increased from 54.9% in the third quarter to 63.1% in the fourth quarter. Overall, the gross impaired loan portfolio stands at €2.1 billion, and the charge off rate was steady between the first and second halves of 2013.  It's not easy to glean confidence about the asset quality going forward or about the new management's ability to get out ahead of any problems.

On the cost reduction side, 8,455 full time equivalent employees will leave by 2018, with 5,700 of them in Italy and most of these losses coming from the Commercial Bank of Italy operation.

Group revenue increased 6%, as UniCredit's trading operations and presence in syndicated loan markets is still strong. Most of the one-time items were non-cash impacts, and the company's massive additions to provisions were neutral for Basel III capital tests.  The stock price went up after the announcement.

Some U.S. value fund managers who got into UniCredit early have been burned and left.  Some others, like Oakmark, have continued to hold positions in Intesa Sanpaolo, an Italian retail and commercial bank, which had strong fourth quarter 2013 share price performance.

With UniCredit, the value of the equity is a bit opaque. In some ways, it is analagous to Bank of America's position a few years ago.  On the credit side, however, KKR has become engaged with the new management, and this may be the better play in the short-term.

Thursday, March 6, 2014

U.S. Gas Exports to Europe Won't Worry Putin

We wrote about this supposed panacea in 2012, and the logic still seems to hold sway. Garry Kasparov's piece in the NYT  echoes a theme in our recent post.

The oligarchs who run globally recognized sports franchises like Chelsea FC and the Brooklyn Nets down to traditional rackets in Little Odessa have historically been like poodles when summoned by President Putin to pay their baksheesh.  The West, and particularly the United States, have a banking and financial system that was big enough to almost bring down the world economy.

It can certainly be used to freeze the pipes of the multi billion empires of the oligarchs, and when they rationally consider their future with an increasingly isolated President Putin who is running out of cards to play, they could use the advantage of the Ukraine crisis to get out from under their peculiar form of bondage.
It's something worth considering, as all the other hackneyed ideas being pushed around are too little, too late.

Game, Set and Match for Ukraine?

While the U.S. threatens, studies and ponders, and Europe does its disappearing act, Russian President Putin seems to be marching towards "Game, Set and Match."  Consider this from the Wall Street Journal,
"The Moscow-backed government of Crimea said Thursday that it will hold a referendum on whether to formally secede from Ukraine and join the Russian Federation, dramatically escalating tension as the West tries to negotiate a withdrawal of Russian troops from the region." 
The Ukraine is a sovereign state that doesn't have a "government of Crimea."  The state governs Crimea through its legislative representatives, local government elected and appointed officials, and representatives of the national military who are responsible for its security.  This is the usual propaganda technique (check Saul Alinsky or any other handbook) of introducing a radical change in terms of reference and switching the debate to a question which has no validity in the first place.

There is no government of Crimea for Moscow to back or not to back.  Therefore, there is nobody with the brief from the government of Ukraine to hold a referendum on secession.  Negotiating from here means game over.  Who is in charge of the government of Ukraine?  Where did Klitschko disappear to?

Without a charismatic leader who can stand for Ukraine's sovereign integrity and independence, Mr. Putin is once again negotiating with himself. Should I withdraw or not?  What a sad state of affairs.

Tuesday, March 4, 2014

Warren Buffett's 2013 Shareholder Letter: Gems From The Chairman

We are usually on Berkshire Hathaway's Letter to Shareholders earlier than this, but it was buried under a huge pile of back reading.  The 2013 edition doesn't break any new ground, but it has a few gems for anybody interested in wisdom distilled into relatively few words.

Talking about the non-insurance businesses, the letter notes that the "Powerhouse Five" earned $10.8 billion in pre-tax earnings in 2013.  The five all-stars include MidAmerican Energy, BNSF, Iscar, Lubrizol and Marmon. In 2014, these five companies could increase their pre-tax earnings by $1 billion or more, assuming no economic downturn. The rest of the non-insurance portfolio produced $4.7 billion in pre-tax earnings, so the Powerhouse Five accounted for 70% of the income from this portfolio of  non-insurance businesses. Remarkable performance from easy to understand businesses like a railroad and a regulated utility, among others. BRK paid about $3.5 billion to acquire the rest of Marmon and Iscar formerly owned by the founding families.

The Heinz deal is something we considered remarkable from the announcement, both in the target and the private equity structure of the deal.  At some point, the letter makes it clear that BRK might bid for the rest of the equity (47.4%) which it does not own now.  The gem in all this discussion?  "...better to own a partial interest in the Hope diamond than to own all of a rhinestone."

Messrs. Buffett and Munger don't overpay for acquisitions with expensive stock either. Of the Powerhouse Five, BRK issued shares only for the acquisition of Burlington Northern Santa Fe; stock was used to pay for 30% of the deal, and dilution was 6% for the premier company in the industry, which itself is undergoing an economic renaissance of sorts.

As I work through Larry Haeg's book, "Harriman vs. Hill: Wall Street's Great Railroad War," I understand much better why Ben Graham and his student Warren Buffett had railroads on their minds. As the letter points out, in terms of freight efficiency over long hauls rail is hard to match: 550 ton-miles on a gallon of diesel fuel. (lots lower sulfur now),

The insurance underwriting business contributed $3 billion in profit in 2013.  The performance of these businesses, given what I have seen about Property and Casualty is breathtaking.  Whereas State Farm Group is the largest direct premium writer of insurance in P+C at $54 billion, and a well managed company according to the Oracle of Omaha, it has sustained underwriting losses in nine of the twelve years ending in 2012.

By contrast, Berkshire Hathaway's insurance businesses have had an underwriting profit for eleven consecutive years, with a cumulative total of $22 billion income earned. The Chairman regularly skewers his favorite GAAP accounting peeves---acquisition accounting and the treatment of insurance float.  The latter has been vital to the success of the holding company over the years.

Rather than being treated as a liability for the purposes of focusing on solvency by NAIC, it should be regarded as a revolving fund.  Berkshire paid $17 billion in 2013 to 5 million claimants for old claims, but with new business being written, the float continues to grow.  Even as the letter notes several old contracts are rolling off, the worst case scenario might have the float declining by something like 3% in a year.

The Berkshire Hathaway Reinsurance Group generated $37 billion in float in 2013.  CEO Ajit Jain also started a business called BH Specialty Insurance under a new senior executive, and it is being well received in an industry crying out for capacity and financial strength. General Re's float was $20 billion. GEICO, despite its irritatingly cutesy Gekko, weighs in with $13 billion of float through an efficient, low cost gathering system. All told, these insurance businesses supplied the holding company with $77 billion in float in 2013.

I hadn't realized the critical role that Berkshire Hathaway played in the reorganization of Lloyd's which was on the brink from catastrophic losses and a failure of some of their newer names.  The company took on Lloyd's pre-1993 claims book in exchange for a policy with a $15 billion limit. Clearly, in the property and casualty reinsurance business, BRK has the bluest of reputational blue blood.  Or, maybe the greenest.

One peculiar reference is to the importance of wind energy in the MidAmerican Energy portfolio.  I looked up the financials and the notes, and it's clear that without federal subsidies and some "wink, wink" reporting this industry wouldn't exist. Looking at the financials of MidAmerican, wind and hydro renewable sources of energy are not reported at their total facility accredited net generating capacities, but rather at a name plate capacity provided by the manufacturers under specific conditions,  The upshot of all this? The wind portfolio might have a name plate capacity of $2,369 MW, but the equivalent accredited net generating capacity might be nearer 286 MW.  All of this capacity, built and under construction cost about $5 billion.

The good news is that the utility is guaranteed an ROE of 12%, which is about the historical rate of growth of BRK's book value over time.  The notes to the financials state that wind depends on, among other subsidies, the federal production tax credits.  As the Chairman notes, "...we put a large amount of trust in future regulation." Or to put it another way, we put a large amount of trust in the largess of our friends in the federal government.

New investment managers Combs and Wechsler each manage about $7 billion in portfolios which have outperformed the holding company.  BRK increased its stakes in WFC (8.7% to 9.2%) and IBM (6% to 6.3%) through purchases of additional shares.  Stakes in AMEX and KO increased as a result of sustained corporate share repurchases. The company has options to purchase 700 million shares in Bank of America for $5 billion, and the Chairman says he anticipates exercising the option as he likes the company.  The tax basis for the equity investment portfolio is $56,581 million while the market value is $117,505 million.

The equity base is $225 billion. I am not going into the last few pages of the letter which have a nice primer on investment lessons learned and applied by the Master.  Take out a pencil and enjoy this perennial educational read.

Is Steve Ballmer Still Casting a Big Shadow at Microsoft?

As we slowly come nearer Spring in the frozen Midwest, I like to look for shoots of hope.  Satya Nadella's appointment as the new Microsoft CEO is one of those shoots in the corporate technology world.
However, today's announcement that a politician/lobbyist and former senior adviser to Steve Ballmer is in charge of Microsoft's strategy function seems very inconsistent with what's been said before about Microsoft's retaking its mantle as a technology leader. Maybe Steve Ballmer is still, like Sir Alex Ferguson at Manchester United, casting a big shadow. Can someone can explain the logic of this appointment to me?

Monday, March 3, 2014

Tragedy in Ukraine

We've gone from what we thought was a very promising entente between Ukrainian protesters and the government of President Yanukovych covering limitations on Presidential powers and a commitment to early elections, to a very unstable situation which threatens the existence of the nation.

Russian President Putin, the world knows, is a formidable player on the world stage, but his very strengths may be the undoing of his desires for Russia, e.g. recognition on the world stage as a power center equal to the United States, Europe and China.  Whatever goodwill might have been cobbled together by the Sochi Winter Olympics has now made them seem as meaningful as the long-forgotten Goodwill Games.

President Putin does not hide his contempt well.  Clearly, he has no regard for President Obama, who has been even more disconnected from foreign policy than usual, with his laser focus on mid-term elections and on the next Presidential campaign for the Democratic nominee.  Into this vacuum, President Putin pounced with his roughshod entry into Crimea.

The Ukrainian political system has itself to blame for allowing resolutions to be passed in defiance of the brokered agreement, and for leading President Yanukovych to seek safety with the national treasury. Now the release of self-styled opposition leader and former oligarch Yulia Tymoshenko has done nothing but muddy the waters as to who is in charge of Ukraine's central government.  All of this could have, and should have, never been allowed to happen.

As many observers have noted, the tactics of fomenting the problem through paid agents, and then answering the call to protect the human rights of Russians in Ukraine with masked gunmen, armed forces, and Russian nationalists in Ukraine, are straight out of the KGB playbook.  Of course, President Obama responds late with another "red line" variation.  The Europeans may be more politically sophisticated to realize there are few options, but they too are inept and navel-gazing to the threat right on their doorsteps.

So, President Putin has played the hand quickly, forcefully and with no compunction.  The problem is going to be: what's next?

If President Putin weren't so one dimensional and short-sighted in his thinking, he would realize that playing this old hand may relegate many of his dreams to the scrap pile of history.  The best thing for a real Russian economy (not the kleptocracy of an oligarch-run economy) would be a vibrant Ukraine producing grain and other products and services for export to Russia and to Europe.  Logistics and infrastructure projects, in which Russian companies could compete with European suppliers, have long been recognized as providing real economic returns to investors with longer time horizons, like sovereign wealth funds.

The Russian population in Ukraine, if they got the message from President Putin, to end their "sleeper cell" model and instead to become committed citizens of Ukraine, they too would prosper.

If the Crimea were permanently occupied, China and Japan would have to become concerned with Russian naval power now in total control of its base in Sevastopol, as opposed to operating under an agreement with Ukraine as owner of the territory.  Relationships with these two powers would not be warm and friendly.

With the U.S. and Europe, prospects for meaningful economic and political relationships would be damaged, perhaps irreparably.

With the Obama administration's foreign policy apparatus being led by nincompoops, and with a President preoccupied with domestic concerns, U.S. policy could go in the deep freeze until the new President is elected.  This too would be a very dangerous situation, especially if the American shift were to become more isolationist and confrontational.

What message can be read into President Putin's actions by his own restive citizens?  If Russian becomes preoccupied with instability and control over a divided Ukraine and, for example, if chaos were to spill towards Europe via Moldova, then it might be a good moment for separatists inside Russian republics to play stronger, more violent hands.

Even if President Putin once again played his energy hand with Europe, consolidated inside Crimea and Eastern Ukraine and ethnic and religious rebels inside Russia, what would have been won by all this? Russia surely aspires to be more than an OPEC.  The Russian economy would be devastated, more well trained Russians would leave and even the oligarchs might get restive with their leader, whose successor isn't apparent and who probably couldn't survive with the same playbook. Oligarchs are subservient now, but the chess player Putin recognizes that relationships change over time.

The interests of the international community are undoubtedly best served by a vibrant economy in Ukraine, which certainly has the human capital and desire to take its place a major agricultural producer. Whether Ukraine "tips" to Russia or Europe is irrelevant: that is playing a game that has left town for good. Let's hope that the situation can be brokered back to political solutions.