bizzXceleration: Performance, Value and Profit

We've spent a lot of time over the last couple of years looking at the credit markets, the economic impacts and the performance of the Finance Industry and their impact. Rather than review previous findings and/or charts and arguments we thought we'd try and focus on the Industry, it's strategic outlook and the regulatory and business climate by telling video clip stories. Which will highlight some of our key concerns. Starting with this recent clip from WealthTrack where an asset allocation guru (David Darst of Smith Barney) and a bond guru (Robert Kessler of Kessler Advisors) take a pass at bond strategies, the economic outlook - particularly the inflation outlook and what asset allocation strategies should be. They both raise some interesting points but, frankly, we've never heard a more politely but heated dispute on WT in any program. As they get in the argument and counter-arguments start flying fast and thick so it may well be worth your while to listen twice, take notes, take a break and then think really hard about what they're saying. Our take is that Darst is talking his book - though eloquently with a lot of "stuff" to back him - but his book is based on conventional wisdom. Kessler is talking his book a bit as well but his book is more in line with what we think is actually going on in the world. In fact as background to this discussion it'd pay you to go back and take a really good hard look at the post on money and inflation risks (It's All About the Money: Markets, Economy, Credit, Oh MY!) as well as our quarterly update (Skirting the Abyss: Economic Outlook, Financial Crisis & LT Consequences). The latter especially on the credit markets conditions and the economic implications.

Consumer Protection, Re-regulation and Trust

Most of us tend to view Big Business as if J.R. Ewing is the model and, sadly, there's some evidence of that. Particularly when you look at how customers are treated (need another tech support joke?). But, at the end of the day, for a company to stay in business there has to be a certain minimal level of trust that what they sell us will actually do something close to what we pay for. Nowhere is this more true than with regard to Banking and Finance. And nowhere has the level of trust been more badly damaged. Irreperably? Well time will tell. As we point out in the update and all the recent headlines are supporting banks are still facing asset writedowns, a weak economy and further loan problems plus a poor long-term outlook. And last year's trading based profits which should have been put to addressing those problems and were instead used to pay bonuses is about as "in-your-face" as it gets on respect for customers and value delivery. No where does this come thru louder and clearer than in this recent video clip where a bunch of SNL veterans reprise their Presidential imitations to pay a midnight visit to Pres. Obama to urge him to pass the Consumer Financial Protection Agency.

Interestingly enough they stretch it thru every President back to Chevy Chase as Ford and Jim Carrey as Reagan. In passing they actually make both an honest case and an honest admission of some of the root causes - which is and was the unbridled ideology of unregulated markets (a point that was no where better discussed than in the Atlantic's profile of Geithner and the various rescue packages, which we put up yesterday and again today and which you really need to read at some

point). Anyway passing CFPA is a very good idea because the Industry has proven terminally (implied puns intended) unwilling to put customer interests ahead of short-term profits but it shouldn't be. Trust is an asset that takes decades of careful investment, nurturing and protection to build. But it is not self-sustaining and you can badly damage it in an afternoon. Well we've had about three years of really bad afternoons - you have to wonder what's left? You also have to wonder how that's going to impact the long-term outlook for the Industry. We think it's going change people's willingness to deal with Banks in the most profound way though it will take time to work out because we've got so much digging to do.

If you'd like something a little more substantive then this Rose interview with Elizabeth Warren provides it, as well as a broader discussion of some of the financial, monetary and credit issues we've been discussing. Three things stand out to us: first, every lobbying group is adamently opposed, two she says the same things in essence that the SNL President's say (or that we've been saying for that matter) and this interview went relatively viral - considering the subject - very quickly. There are indeed a lot of angry folks out there. Oh yeah - one more thing. All the necessary legislative authorities already exist what's open is where they'll sit. The reason they weren't enforced was because of the mental mindsets of the regulators over the last two decades. Does anybody think that hasn't changed or that they won't and aren't already doing their best to enforce "never again"?

Industry Adjustments and Outlook

Another interesting Rose interview, this time much briefer, was this one on a recent biography of Jaime Dimon. The one bank CEO who's come thru all this with relatively flying colors. In the spirt of our emphasis on value, business performance and management systems we'll point out that seems to because he wholeheartedly endorses and enforces those principles as well as knowing what he's doing. He also, as he's said repeatedly, supportive of regulatory reform "almost" down the line with the current set of proposals. His one big objection is a TBTF or Volcker Rule breakup. Now how that'll play out isn't clear but the principles behind the Volcker Rule - public monies should NOT be used as private risk capital (as it was this last year) is pretty clear. The real problem is going to be the mechanisms. Dimon probably has a case for scope and scale - what we need are workable ways to wind down large institutions along with capital requirements matched to risk and limits on predatory proprietary trading. Like the NRA and gun control you'd think private and public interest are joined in finding good engineering to solve these problems but apparently not.

Fundamental Questions About the Future of the Industry

So we come back to our two fundamental questions - to what extent can we trust the Financial Industry to be careful of the public interest and, if we can't, what do we do? And, second, what is the strategic outlook for the Industry - how well do it's business models work. As it happens those are questions we've been digging into for close to two full years now and we collected all our prior work in a set of white papers that you can download (they're also addressed in summary in the recent update).

 UPDATES: Some Major News to Roll In

There was lots of breaking news and events so far this week that bear directly on the questions of reform, financial industry performance and the strategic outlook. Of that lots five are really major and four of them we've added to the top of the readings stack. Our previous listing of our analysis of reform and industry business performance has been moved to the bottom. An irony is that much of the news is in line with the major arguments of those papers.

The five major things are Sen. Dodd's decision to move his bill without joint sponsorship, the release of the latest Feds fund flow report, a major conference this week in NYC from the Roosevelt Institutute with some major names (Soros, Stiglitz, Warren,...), a major speech by Gary Gensler of the CFTC on re-regulating derivatives and the release of Booz & Co.'s annual industry outlooks. What do they all have in common - the firestorm of re-regulation is happening while at the same time the business environment is changing.

Specially the Flow of Funds report finds that de-leveraging is proceeding at the fastest pace in postwar history, some of it thru default of course, but representing a fundamental strategic change. But because the Industry has spent the last year stone-walling change you're getting a huge, and now organized backlash, where momentum is building. Dodd's announcement yesterday is well covered but the speeches by Gensler and the conference not so much, even though they may be critically important. The other thing everybody is missing that is critical is that a lot of more rigorous regulation can happen and is right now thru enforcement of current authorities.

Finally, and something we've been saying for a long time, the Finance Industry's businesses as businesses need to be fundamentally rethought, they need to focus on customer value, new products that actually deliver value and operational effectiveness. The two Booz reports (one on Retail Banking and the other on Capital Markets) are excerpted in the readings as well with a pointer to the full report. If you have any interest, i.e. you think the banks are in good shape going forward, think again. Speaking of which Britain's Financial Services Authority (FSA) has proposed a Round II Stress Test and our good buddy Calculated Risk has taken another look at that issue. In line with our prognostications about the continuing tsunami's of bad debt:The Next Stress Test Scenarios

Oh yeah, btw. The Examiner for Lehman found out they were screwing around with the books as well. But that you can read in the news, on the front page. This other stuff confirms the game is changing big time, and the industry is not adapting to it.

Continue reading "Just Say YES: the CFPA, Finance Misfeasance, Trust and Strategic Outlook (UPDATES)" »

Posted by dblwyo at 08:07 AM | Permalink | Comments (0)

At this point we're generally tired of talking about the general performance of the Finance Industry, Wall St. in particular and especially continue the apparently futile flaying/flailing at Goldman Sachs. Forgive the headline btw - we were savoring our own cleverness. Nonetheless let's take one more pass at least for several reasons. First, because as the recent Davos conference shows everybody else is tired too but the Industry still is pretty smug in its attitudes and fails to acknowledge fundamental breakdowns in its business models or lack of value creation. Second, though the pressures have picked up, the Industry is still fighting as hard as possible to avoid fixing the problems or adapting to re-regulation. And third, but most importantly, because PBS's Newshour just did two short segments on GS that take apart the sources of its profits and the sources of its liquidity and funding. Guess what - all the angry pitchfork bearing populists have it exactly right if you believe PBS. A position and attitude summarized, from the inside remember, in Hoofy and Boo's takedown of Goldfellas from Minyanaville (which is about inside as it gets).

Where the Vampire Squid Makes Its Money

The first segment is interesting and asks the fundamental question of where does GS makes its money. Ostensibly they are an Investment Bank who makes it advice, fees for M&A, Deals, capital raising, e.g. floating bonds or IPO's, etc. or all those other similar activities that go on in the mysterious bowls of the financial engineers. In actual fact now that GS is a bank holding company it's required to report its profits. It turns out that traditional IB activities - the things that arguably are their reason for being and what is supposed to be their value-add to society - are about 10% of revenues last year. The other 90% comes from vampire squid activities, speaking loosely. In fact 75% of their profits appear to come from proprietary trading! Which includes front-running their own clients. When the President proposed before Xmas that banks be forbidden from having prop trading, private equity or hedge funds in essence he was talking about GS.

As several people have put it, including a Republican investment banker who served in the previous administration, "Goldman is a hedge fund disguised as an Investment Bank".

Continue reading "Goldmine Sacking Vampire Squid: PBS Takes Down the Goldfellas" »

Posted by dblwyo at 04:51 PM | Permalink | Comments (0)

The next cluster of stories will be drawn from the Finance Industry. It's a story that touches a lot of bases including general economic conditions, business performance, corporate governance, politics and policy and, after re-reviewing the Davos video clips, some really fundamental issues about the nature of capitalism. The point we made earlier about enterprise management having to be increasingly alert, proactively and constructively, in monitoring geo-political trends couldn't be made more strongly by these clips. Beyond our earlier collection we added a couple specifically focused on these issues, cherry-picked the ones that bear directly and created a governance and regulation for Finance subset (in the readings). Since such large questions are being asked and are so fundamental we also embedded the last two years of work on analyzing the performance of the Industry (in online accessible whitepapers) and also included more recent blog posts. Whether you can to the opening Davos session to the last there is a constant refrain - the need for deep re-thinking of the Industry, new worldwide regulatory regimes, changes in governance and compensation, more value-creating business models or deep uncertainty about the "First Principles" of Capitalism. Two in particular stand out:Rethinking Market Capitalism led and moderated by Bil George (of Harvard and Medtronics) and After the Financial Crisis: Consequences and Lessons Learned.

Separately the WEF has been working for a couple of years with the Oliver Wyman consulting firm to re-examine the Industry and the 2009/2010 position papers are linked and excerpted in the readings, along with our readings. What we found fascinating (especially given the disparity in resources) is that we came to nearly identical conclusions, central to which are: 1) a need to re-examine the regulatory regime, 2) the sustained poor performance of the Industry (though our timeframe is longer), 3) the need to act proactively in a socially responsible way (though again in channeling Drucker we were able to get more constructive and prescriptive) and 4) the need to re-think, re-design and re-build business models and management systems. Here we think our specific suggestions go several levels deeper than the folks in Switzerland were able to go, though admittedly we don't have to serve all their constituencies or deal with their constraints. But just to set the table you might start by listening to this recent interview of David Stockman, Reagan's Budget Director. Frankly, we think you'll be shocked by many things he has to say. The really interesting thing is that Mr. Stockman, the Davos participants and the popular judgments in the cartoons have pretty commone sentiments!

Continue reading "Finance Industry Futures: Performance, Governance, Reform & Politics (Updates)" »

Posted by dblwyo at 05:19 PM | Permalink | Comments (0)

We're going to tunnel down on the Private Equity business, its past performance, reactions to the crisis and its strategic outlook. This is important for its own sake because the PE Industry heavily influence prices, values and capital allocations - furthermore, it will remain a major force into the future. But not as it was - the Industry needs to go thru a major re-think and shift from a financial engineering driven approach to an integration of financial plus operational engineering. Widespread studies indicate that something like 20-40% of the Industry might be shaken out in the aftermath of the crisis, let alone adapting to the turubulences of the "New Normal". Who survives and prospers will be those firms which make this transition.

But the Industry is important not just for its own sake (it is), its role and influence on Finance as a whole (that too) but also for what it tells us as investors about the likely evolution of alternative investments. Even without direct access to PE investing everybody has been influenced by the big deals, the leverage used and the prices paid. That world is gone and isn't coming back in anything like its old form. A good way to put this in context is this recent debate at the Economist's Buttonwood forum on Financial Innovation where the Cons were Jeremy Grantham and Richard Bookstaber. There's a very extensive readings section after the break that reviews how deals have (not) performed, how the firms and the investors are reacting, what the trends are for the future and changes in the external environment. Perhaps one of the most telling readings is the Business Week lead story on how KKR, one of the founders, is completely re-doing its business model - and the other firm they want to emulate is Buffett and Berkshire! Now there's a fundamental SEE change for you.

Continue reading "Alternative Investments, Strategic Futures of PE and Lessons?" »

Posted by dblwyo at 09:09 AM | Permalink | Comments (0)

The Markets have been tanking most of this week and have given up most of mini-bubble beyond 1100, which if you recall was our upper resistance limit in previous posts. It's doing so because a bunch of things have come together, though semi-predictably there's a chorus of voices blaming the President's announcements of a major reform to restructure the Finance Industry and change what it's allowed to do and how it functions. Given the poor quality of earnings since last March, recent reports showing how weak the core businesses are and Industry behavior over the year with regard to reform that announcement was, at best, a trigger that crystallized an already saturated solution. What really saturated things and put them on the cusp point of teetering over an edge was a slew of disappointing earnings, an improved grasp on the real economic outlook and China's major changes in policy. ALL of which we've been discussing for months.

Rather than reviewing all that it's collected in the readings but we're going to use it as our fulcrum to focus on the salvo across the bow fired on reform, and ask you to start with investing eight minutes in listening the President's announcement. This is not just political theater, though there's some of that, it's to the point, substantive, grounded and a sensible reaction to being stone-walled by the industry for one year (bear in mind the Administration reached out to the Industry within days of taking office and has been trying to reach out for months).

Continue reading "Comes 'round, Goes 'round: Hastening Forward Slowly to Finance Reform" »

Posted by dblwyo at 10:15 AM | Permalink | Comments (0)

Not to rush you along but we're going to swing back and pick up some more Finance Industry news - not least because so much happened this last week on the regulatory front. We mentioned the House moving out a giant reform bill last Friday but on Mon. the President met with the executives (some of who were conferenced in because of D.C. fog!), the same day Mcain and McCaskell announced support for a new Glass-Steagall, (this is REALLY critical) the SEC issued new regulations on compensation, the WSJ had a conference on the "future of finance" which didn't produce much in the way of reality-facing recommendations and Paul Volcker came out swinging all over the place (at the conference, one in London and elsewhere...whee!). It looks like that tsunami of backlash against business-as-usual might be starting to really rear up, doesn't it?

The cartoon, as have similar composites, captures the general reaction but the really interesting thing is that some very heavyweight players are now pushing along the same lines. They are fundamentally questioning the value of the Industry as it currently operates and the value it creates for society. And that is new.

Banks As Businesses: Whalen's Bloodbath

We've been raising similar questions for a while now and also pointing out that the Industry will continue to face some fundamental challenges for a long time to come. It's not just refreshing to hear folks with more clout beginning to chime in but, if we were involved in the Industry, we'd start thinking about things like jobs, stock performance, and minor little details like that. Not to mention what we'd think if we were investors. Fortunately Chris Whalen of Institutional Risk Analytics chimes in for us. And people listen to him and his firm for sure.

Continue reading "The Business of Banking: Challenges, Issues & Outlook" »

Posted by dblwyo at 05:29 PM | Permalink | Comments (0)

With the blockbuster financial reform bill moving toward the floor, a Presidential 60 Minutes interview and major discussion with the bankers its time to re-visit the Industry, its status, performance and management. Not least of the triggers is JPM's presentation at last week's GS Financial Services Conference but let's set the stage with Hoofy and Boo giving us their take on the public spiritedness of the Industry, as exemplified by the GS "Goldfellas". It shouldn't take long for you to figure out the movie they're riffing off of, not least because Blankfein does look a bit like Joe Pesci. But the real thing to keep in mind why is a Finance site/service like Minyanville taking this shot at GS and the Industry in general?

While you ponder that question allow us to observe that this post is not just its own thing, i.e. a FinInd update but also ties to the last several on the state of the Markets/Economy and Business Performance. On the former, in case we weren't clear, we'd summarize as: 1) there was a small run toward the dollar as the sovereign debt thing scared folks which drove up the markets confirming everything we've said, 2) some dozen different commentators from Paul Krugman to Rubini to John Mauldin to Mark Thoma have ALL come out to talk, in one form or another, about the "Mother of All Jobless Recoveries". If you'll recall our estimate is that we need 46 million jobs to recover a state of prosperity but are going to be lucky to get 20 million. In other words we're looking at doldrums decade of poor job growth, slow economic growth and constrained profits and earnings. Which then leads to the critical question of what companies are prepared or preparing for a very tough environment thru efficiency improvements, strategic changes in operational effectiveness and creating new value thru real Innovation? Our answer was that most of them are heads-down and hoping just to get by while everything returns to normal. That the banks are still not lending, still have toxic balance sheets and aren't talking about new products and services is critically important.

Continue reading "Paying the Piper: Finance Industry, Performance, Value & Regulation" »

Posted by dblwyo at 05:36 PM | Permalink | Comments (0)

Not to rush you along too fast but we thought we'd re-visit our previous posts on regulatory reform of the Finance Industry. Understanding the state of play AND the business performance of the Industry per se are important for their own sake. In fact this post should be considered as another deep dive into the state of the industry and as a case study. It's also important for several other reasons. One of course is the question of how viable investing in the Financials is. But because the industry is the ecology of the Markets it is systemtically important and influences how the entire economy does. It also controls how well you own investment does. This is particularly important, as we've been covering in multiple posts, because the old ideologies of Efficient Markets and Asset Allocation are being fundamentally re-visited. The long and short of it is that discussing reform touches Business Performance, Markets and Investments and the Economy! We will observe however that this famous painting, "The Scream", originally done to express the anxieties of the early 20thC, pretty well captures most folks feelings about the Industry. Which means, of course, that the pressures for reform are mounting. Which we'll discuss but pay attention!

Market Performance as Indicator

Let's start with a benchmark by looking at the stock performance of the Industry and its sectors YTD. We use the XLF ETF as a proxy for the industry as a whole while SPDR ETF's for various sectors including Banks, Regional Banks, Capital Markets, Insurance and Mortgage Finance are also shown.

As you can they all moved pretty much together into, through and after the March Madness when everybody thought the world was collapsing and the Financial Sector was going to end. Thank goodness for the Stress Test - it's called Animal Spirits, as in the world's not ending. The recovery continued for everybody thru mid-May on the back of earnings surprises (told you we'd close the loops) that turned out on examination to be a lot poorer quality than you'd hope.

Then things changed. The Regionals and Mortgage guys took some big hits as the size and scope of the CRE problems became more apparant. And as the up and downs of Housing optimism waxed and waned as well, though they both climbed back in the ballpark to keep playing with tre other teams. Since then the Regionals have re-deteriorated a bit as reality starts to set in.

The other important differentials ae with the Big Banks, the Investment Houses and Insurors. Strangely enough the Banks did relatively well but the real differential performer has been the Insurance Sector. Oddly enough the Investment folks haves slightly under-performed - it looks like performance actually matters a bit and some horses run faster than others. Of course which ones are important questions.

Continued ....

Continue reading "Firestorm Flaring up: Finance Reform, Compensation Wars & Sausages (Update)" »

Posted by dblwyo at 01:45 PM | Permalink | Comments (0)

If you're a fan of political theatre this is the season for you. After the stimulus and budget battles we've had a long-running, multi-scene Healthcare Reform debate that's almost Shakespearean! But the other one heating up in the wings is Financial Reform, which is going to be as much a sturm und drang drama as any other, and is moving rapidly from the cloakrooms on Capitol Hill to the front pages of the MSM and the talk shows.

This post should really be an addendum to the immediately prior post (Pictures for a Prosecution: Wall St. Bonuses vs the Public Good (Add)) but there was so much that bubbled up that came to our attention today that we decided to make it a seperate post. In particular we lost weigh too much time watching Dylan Rattigan's show this morning and then collecting various URL addresses so you could to. Now Dylan's always been a little loud and he's gotten more so with his new show. So one could take these various clips with a grain of salt or more. If we were the Finance Industry we wouldn't however. For technical reasons we aren't able to create a placeholder of a recent Bloomberg interview with Niall Ferguson on the state of the Industry but will try and create a little attention space. It doesn't take too long so we recommend you watch it for the level set...on the whole he gets it mostly right (our basic prejudice for selecting recommendations though Niall has a track record of not having as deep a knowledge of finance and economics as one would hope).

Ferguson Says Bank of America Shows Crisis Not Over 

 Industry Pushback and Administration Counter-attack

We've been on this topic for some time (years in fact) but particularly emphasizing it for the last several months and our take is that the Industry by pursuing business as usual and self-interested, narrow and short-sighted lobbying as traditional is building up a backlash that could swamp them. And under-estimating the commitment of the Administration, the magnitude of committed opponents on the Hill and the deep-anger of the American people. Now the Administration held out a hand to the interest groups in Healthcare literally days after taking office, and has slowly been pursuing its goals while continuing to offer them the opportunity to be constructive in helping shape the new legislation. Most of them were smart enough to take it and the Administration is in the process of winning this fight and getting a pretty good bill to boot (A Taught/Taut/Taunt Moment: Healthcare Speech, Policy, Politics & Realities, aths Toward Healthcare: Compromise, Consensus or Conflicts?).

Continue reading "Bonus Fantasies vs Political Realities: the Reform Firestorm This Time (Update2)" »

Posted by dblwyo at 05:15 PM | Permalink | Comments (0)

If you've been here before you may have noticed we like to tell our story with pictures and so shall it be this time as well, with the slight difference that they'll be more stories and less the complex graphics we're prone to. By this time you've no doubt heard that Wall St. is fixing to pay another set of stunning multi-$B bonuses while the rest of us are still crawling across the floor of the chasm, broken and bleeding on the rocks. How does that make you feel?

It's likely our point of view is implicitly clear and if it's not then several of the last posts will make it clearer. One of the bloggers we both admire and have learned a lot from, Barry Ritholz of BigPicture, has defended the bonuses as the way the Street works and if we want it to recover and do its job that's the price. Aside from the moral reactions or the questions of good public relations we thought we'd speak directly to the implied assessment of the contributions of the Street and whether or not they are justified and earned. We have three major problems leading to a major challenge.

And We Paid Bonuses Because???

1) Currently the Street's profits are entirely dependent on public policy ranging from reduction in competition to implicit guarantees of the TBTF banks to low interest rates to various quantitative easing programs, e.g. the Fed's purchase of mortgage-backed securities and the FHA's being the source of 80% of the mortgage market flow. The point being their profits are being made off our capital, not their own.

2) There is no evidence that the perverse incentives where all the gains went to the high-earners thru trading gains (read speculation) while all the losses went to us are being corrected. Add to which the perverse structure led to the failure or near-failure (including GS which had a near-death experience and was only saved by government action) of the firms themselves as well as almost collapsing Western Civilization.

3) The really deep argument is that banks and financial institutions are the intermediaries that efficiently and effectively allocate capital to their highest and best use. Well the prior two points tend all on their own to destroy that argument entirely but, since we've been reviewing the record, let's review it. We won't repeat ourselves but will simply cite several graphics we've previously put up and let you pop them yourselves because, taken all together they reach a clear conclusion.

• Wall Street profits and compensation
• Historical Growth of Debt
• WSJ Debt Growth
• Savings, Investment and Growth
• Finance Industry Case Theory
• Finance Industry Drucker Criteria Performance

What those charts tell you is a sequential story - a logical syllogism if you will - that makes perfect sense to us and, IOHO, completely destroys the argument that paying bonuses is innate in the industry, necessary for performance, part of the culture and ensures that the Industry contributes to the greater good. What they tell us is that, beginning with de-regulation in the mid-80s, that Wall St. compensation completely pulled away from the rest of the economy because the industry made exorbitant profits, that we "indulged" in astounding growth in indebtedness beginning then, which created the profits that paid the bonuses while destroying savings and investment, that the periods of highest savings were also the periods of highest economic growth (this one is particularly important), and that the Industry has failed in its duties to itself to perform as businesses and failed to deliver value to society. We really do urge you to review the charts and see if you agree with the syllogism. And if not then why not and what alternative data do you have to propose?

Continue reading "Pictures for a Prosecution: Wall St. Bonuses vs the Public Good (Add)" »

Posted by dblwyo at 07:07 PM | Permalink | Comments (0)

It's time to re-visit, update and wrap-up our discussion of the Finance Industry and the chances for regulatory and legislative reform. On the one hand this is an important part of the domestic policy agenda, and in some senses, arguably the most important. On the other it's been back burnered ostensibly by the press of events which has resulted in all the last few weeks punditry commentary getting it wrong, at least in our 'humble opinion. Analogously to Healthcare Reform the administration first focused on the necessary emergency measures while trying to build a sense of cooperative self-interest in the finance community. An attempt that, unlike the HC communities (believe it or not), has foundered on the rocks of short-term and narrow self-interest. A point we've been arguing for a very long time and used as our central point in the last post which reviewed the state of play. Here we want to concentrate just a bit more on the stakes, the liklihoods and outcomes and the potential impacts.

In Fed We Trust: Our Near-Death Experience

David Wessel of the WSJ has written an excellent book on the crisis, which he started before Bear-Stearns went under and which he tracked thru the entire crisis. While he's appeared on several talk shows, of various sorts, the talk he gave in a Washington D.C. bookstore was the best because he had time to cover his findings in some detail and because of the audience's pointed and intelligent questions. Before leaving this topic we highly recommend your watching the CSpan video clip. He concludes by making three points: 1) we had a near-death experience and were saved by emergency heroics,perhaps largely those of Ben Benanke and the Fed, 2) we've survived the worst of it barely but have a long way to go before we're restored to health and 3) there's been little or no change in the regulatory and legislative framework.

We'll come back to that last point at the end, and it's vitally important, but our critical observation is that the commentariat mis-understands the process the Administration is following. First, put out the fire and start the repair work while second, attempt to inclusively line up support. Now they are shifting to a full-bore press and we would suggest that the Industry NOT under-estimate their chances. It wouldn't take much to fan the smoldering torches into a conflagration.

Continued ....

Continue reading "Debt, Wealth, Finance & Outlook: Sixty Years of Bubbliciousness" »

Posted by dblwyo at 08:47 PM | Permalink | Comments (0)

The title is a play on words of course, taken from John Donne's Meditation VII, which starts, "No man is an island entire of itself; every man is a piece of the continent, a part of the main" and end with "And therefore never send to know for whom the bell tolls; it tolls for thee.". The message being in a society we are all mutually interdependent. Sadly, this is a message which not only seems to have been lost on the Finance Industry but they would appear, judging from last quarter's earnings and their source in proprietary trading profits, to turned on its head. Ask not for whom the bell rings for it rings for me, but never thee. Having been monitoring and analyzing the business performance of the Industry for two years now we were, and are, nonetheless very surprised. Because the other side of that coin is that society requires that it's major organizations and institutions provide a service that creates value. And, especially, does no harm to society. When the opposite is true, and when it looks likely that the behaviors will continue, society has no choice but to act. Well this week is the anniversary of Lehman's fall and it behooves us to ask what lessons have we learned, what have we done to fix the systemic and systematic problems and what will we do. Washington has been focused on saving us from our own and the industry's follies but the President marked the occasion with a speech to Wall St. putting them on notice that the reckless behaviors of the past will no longer be tolerated; and inviting them to constructively contribute to creating new regulatory regimes. An invitation they've had for months and been fighting in every possible way. The week ended with the Fed's announcement that they will start setting compensation policy. Meanwhile Barney Frank on MSNBC provided pretty clear indications of where he sees things going and Pecora II is about to kick off. Now it's a siren rushing to the crime scene and the results could be very ugly.

Perverse Incentives, Bad Consequences

Let's review some stuff we've gone over before separately and put a new picture together, plus add in some stuff, from this week. Here we look at the overall performance of the Economy vs sector Profits, the Economy vs Markets and Wall St. vs Society. The UL chart we've talked about a lot so moving on the UR chart is updated and shows real SP500 vs real GDP cumulative growth from 1950 to now. The bottom triptych puts charts showing the growth of Debt with Wall St. relative compensation and Bonuses. Taken all together it almost seems to us that a complete story is being told, eh what? But what we have is de-regulation that led to a wave of financial engineering innovation that started by creating value but soon focused almost entirely on internal products, e.g. proprietary trading, that created a tsuanmi of debt leading to completely out-of-balance compensation for the Industry. Not least amusing is that this didn't metastasize until this decade. In other words despite all the tooth-gnashing about systemic problems and accumulated history it wasn't really until the last five years that we all got ebolasized! Anyway that's how we read.

Continued....

Continue reading "Ask Not For Whom the Siren Shrieks: Let the Finance Wars Begin" »

Posted by dblwyo at 04:47 PM | Permalink | Comments (0)

Well we've refreshed ourselves on the economic (here) and market situations (here) with the primary conclusions being we've stopped the cliff-diving but are bumping along at the bottom of the cliff in a very rocky landscape. One that feels better only because it's not so much worse. As for the Markets we referred to them as "euphorilusion" since they ran up with a V-shaped recovery, earnings expectations beats that were really cost cutting with meat-axes and valuations run wild. No matter what happened this last week with the daily runups we still think that's true and without going into a repeat discussion if you want to check out the updated multi-period SP500 chart here it is.

That naturally leads us to the next stage in reality checking - what's the real reality behind earnings. Or, put another way, how are businesses performing and how are they likely to be performing in the future ? Which reminds us to explain that BaU is "Business as Usual" and NN is "New Normal". In other words, on the whole, we find way too many executives just waiting to be saved by the magical miracle recovery so they can revert to BaU (is there a sad parody of Value at Risk here ?) instead of making the reset adjustments required to cope with a NN. Nowhere is this problem more acute than in the Finance Industry, whose surprise earnings drove the market rally but are actually more vaporware and fumes than anything else. Based on various combinations of government money, guarantees, proprietary trading, reduced competition and so on and so forth. And which do not address the continuing threats of over-valued assets, rising bad loans, and long-term shifts in the industry.

More to Come: Bad Loans, Bad Earnings ?

We've organized the readings around several key themes and article collections, starting with the fact that banks are still sick and facing more problems. To quote the first excerpt, "...numerous large banks around the country are still struggling with deteriorating finances. Two dozen banks with at least $5 billion in assets get the lowest one-star rating on Bankrate.com's safety and soundness test...".

On top of which you should recall that all the bad securities are still on the books with grossly unrealistic market values, the CRE market looks to be starting the next wave of boulders rolling into the pond, foreclosures are continuing to grow, including in the prime mortgages and their traditional lines of business aren't doing very well at all. Even if nothing else changes, that is if the sand they're standing on doesn't turn out to be quicksand, they're still very weak and facing years of on-going operating and profit problems. Which explains why the drumbeat of bank failures continues and will keep growing, and the banks biting the dust are big ones. Which is changing the structure of the industry. To quote from another excerpt, "Scores of additional failures are expected in coming years, as the industry works through trillions of dollars worth of residential and commercial real estate problems.". BtW - we traced thru all these cyclical and structural problems in a prior post you might want to look at: Beyond the CRE "Bombshell": Real Stress Testing for Finance. In other words there are no major surprises here other than everybody seems to be surprised at problems that have been visible for a long...long time. That probably illustrates another major problem - one of the biggest - the tendency to subsitute ideology, delusions and wilfull ignorance for analysis and real data. Need to understand how the buzz saw works if you're going to be in a sawmill.

Goldman, Front-running and Bank Performance

In our last post on the Finance Industry (More Darkside Earnings Tales: Banks,Goldman und Unsinn) we covered some of the longer-term ground and asked where all these earnings were coming from so we won't repeat it. If you'll recall we use a "model" of the industry that looks at several key lines of business. In fact that model has three views we re-use: LOB vs Function, LOB vs Drucker Principles, and LOB vs Timeframe. Those Lines of Business are Wealth Management, Consumer Banking, Credit Cards, Business Banking and Securities Management. We include Transaction Services, M&A, Investment Banking, Proprietary Trading and Alternative Investments as sub-sets of the latter, where Alternative Investments include Venture Capital, Hedge Funds and Private Equity. Each and every one of those LOBs is facing major challenges currently, cyclically and structurally. And the Industry is failing, as best we can judge, to do anything about any of them. In an earlier post we even offered up a set of suggestions for strategic initiatives and innovations that would lead to some improvements in industry potential performance. (Firestorms, Finance, Futures: From Sociopathic Dysfunction to Value Creation). The result - da nada !

In the Darkside post what we found was that the only source of profits was proprietary trading, where GS was the exemplar. Or should we say bete noir ? Their, to say the least, highly unusual and unexpected profits all came from proprietary trading and, after the surprise, shock and outrage, a lot more people did a lot more investigating. The bottom line here is that their performance is so aberrational as to be completely incredible - hence the conclusion that seems defensible based on many folks work: GS is a hedge fund in disguise which makes it's money by making markets for clients and front-running them. In other circles that's called a violation of fiduciary trust.

We think the accompanying composite chart tells a terrible and scary story: re-regulation created aberrational finance industry profits which led to two stock bubbles that are still uncorrected and were built on the backs of loading up the rest of the economy with debt. And the primary beneficiaries, speaking of fiduciary problems, were the key players in the industry. How long is that going to continue ?

Alternative Investments: Venture Capital, Hedge Funds, Private Equity

David Swensen of Yale changed the world of institutional and endowment fund management by putting an emphasis on alternative investments. He shifted the portfolios from the traditional and conservation Stocks, Bonds and Funds to a much heavier emphasis on alternative strategies and was very successful for a long time. But the thing to bear in mind is that when he started in the early 1980s those alternatives were under-utilized and under-valued. Investment managers talk about the alpha and beta of investment returns. Beta is the amount of return that's based on market correlations. In other words the proportion of return being driven by the normal up and downs of the market and the economy. Alpha is the return resulting from finding hidden value. Put another way Swensen went after alternative investments when they had a high Alpha, a low Beta and one that was uncorrelated with the rest of the market.

Now as money from institutions, wealthy investors and asset managers flooded into the market you get what you always get - a huge surge in suppliers to meet that demand. In other words thousands more Hedge Funds, PE firms, etc. etc. The last time we saw a flood of hot money was the late '90s boom in Venture Capital chasing dreams of Tech Bubble pots of gold. In the last ten years the VC industry has barely performed as well as the Rusell2000, if that. 

Many firms have gone out of business but what we're looking at now is a huge shakeout, the return of funds and major industry consolidation. We suspect that the same thing for all the other alternative investments. You see Alpha = Anomaly. That is exceptional returns result from finding pockets of value that are under-appreciated and under-priced. Now all the alternatives are just so much BaU, or Beta. Worse yet, implicit in the prior chart, they are just leveraged Beta and the piper wants to be paid for his music.

Dick Bove, Fume Trading and the Last Word

We'll give Dick Bove, the well-known bank industry analysts the last work here because he brings it all home. This is a fairly recent interview on Canada's BNN where he discusses bank earnings, valuations and outlooks. When someone as respected as Bove speaks it'd pay you to listen. When someone that respected has been so right for so long and so contrarian you should really think about it. And when you put what Dick has to say together with our survey on the big picture and structural outlook you should start changing you atttitudes, actions and activities. The Finance Industry of the future will not look anything like the Industry that's evolved in the last thirty years.

But there are three other conclusions that are even more important:

1. On the whole nobody is paying any attention.

2. As a result nobody is doing anything.

3. Society cannnot afford to let the industry keep running around without adult supervision.

Updates, Adds, Refreshes

This morning's headlines are about the re-appointment of Bernanke, a great thing IOHO, and banks starting to raise more capital (Deutsche Bank plans Tier 1 issue, reopens market), on which topic you'll see more as the tide rolls on we suspect. But if our whole theme now is BAU and Denial our theme last year was broken business models, bad practices and malfeasant management. We collected all of last year's major posts on that topic and posted an "essay" on Scribd. Having just read-read it we strongly urge you to download it and at least review. With the caveat that no on is paying attention to:Credit, Leverage, Malfeasance and Broken Business Models.

Finally Simon Johnson and Michael Perino had this interview on Bill Moyer's Journal discussing the Pecoro Hearings in the 1930s which uncovered all the shennanigans that brought about the crash and led to the regulatory infrastructure created under the New Deal. At the time they didn't anticipate new Pecoro II but Congress has since chartered a blue-ribbon panel and, trust us, you need to hear the people singing. As Drucker said, "change the people or change the people". Well, the Industry is refusing to change...what do you think is going to happen ?

Continue reading "BaU vs. NN I: Finance Fumes, Realities and Pecora II (Refresh)" »

Posted by dblwyo at 02:38 AM | Permalink | Comments (0)

The last two posts tried to keep hammering what are the underlying realities behind the headlines - first on the economy and then on corporate earnings. Now it's time to go the dark side and talk about bank earnings, particularly Goldman-Sachs. The central message is that you have to look beneath the surface and make a real effort to understand what's going on - in a phrase, 'where's the beef?' !!! On the economic front, despite all the hoopla and hype, all we've done is stop cliff-diving not begin a recovery. Yesterday's Durable Goods Orders and the reporting are perfect illustrations but we aren't going to reproduce a chart that looks like everything else we've already talked about. (Realities vs Rhetorics: Economy, Policy, Real Data) For the record the latest YoY changes in DG and x-Aircraft, as well as Industrial Production, are here (click to view). Similarly the better than expected earnings were not the result of better performance but continued cost cutting and beating significantly "managed down" expectations. Earnings are terrible and revenue charts look like the economic data. (Earnings vs Growth: Cutting for Growth? Real Business Performance) Now it's time to talk about banks and their even more badly distorted earnings, particularly GS's. The bottomline is that everything we talked about in our previous assessment of the Industry was born out and the banks made money only on trading. The banks, i.e. GS, that traded more made more. The question is how did they make it besides that ? Other than the obvious strategic implications this matters because a market that was headed down all of sudden boomed on the back of those "amazing" bank earnings. You can see how the markets ran up over the last two weeks in this chart of the SPX.

Bank Earnings and Outlook

Another fairly recent post (Beyond the CRE "Bombshell": Real Stress Testing for Finance) tried to anticipate, partly and partially successfully, the reports by looking at the realities of the challenges that still face the Industry. When you look at either the Industry as a whole or any particular company you have to ask how they did in any line of business. We've applied our business performance framework to the functions that each bank needs to perform (click to view chart) and also to evaluating the strategic context, shown in this graphic.

With the economy still in terrible shape, with defaults, foreclosures and bad debt likely to continue to rise the traditional, "normal" lines of business will continue to be seriously challenged. That is consumer lending, business finance and credit cards will continue to see escalating pressures for the next several years. Wealth management will only hold its own as the markets perform and the industry re-thinks its products, services and customer relationship management. What brought down the house in the last 18 months and, literally, almost collapsed Western Civilization, was trading - either for own account or clients. One could argue that in a brilliant recovery banks turned the performance indicator green this time around. And as a result those that, like GS, were all about trading did well while those like C or BAC that are more about tradition did relatively poorly and face increased challenges. Just as a "minor" sidebar one contributing factor to alleged profits was reducing provisions for losses; if we're right that's going to come back to haunt them. So what did work and why ?

GS, the Gov't Put and Dancing with the Music

As you can see in this chart it was trading profits that drove GS's "exemplary" performance. One of the maneuvers that GS performed last fall as it was on the verge of implosion (bet you didn't know that, did you ? See the readings for proof.) was converting itself to a bank-holding company. That meant it had to start reporting and the UL corner tells us that they put more Value at Risk (VAR) than anybody else and even increased their own position. Furthermore GS is far and away the biggest player in derivatives.

Becoming a bank holding company was more than a maneuver - it meant GS had and has access to gov't subsidized low-interest funds. Now the purpose of all the bailouts and Fed special instruments is to get credit flowing again. If you check this chart you'll find out that the credit markets are self-repairing in the sense that interest rates are re-stabilizing and normalizing, which great news. But credit markets are still tight, i.e. that money is NOT flowing into the economy. What did happen is that the "Too Big to Fail" syndrome created the same kind of gov't put (an implicit guarantee) that FNM/FRE used to have, that failures reduced competition, that low interest money created subsidized funding and so on and so forth. All that means that essentially the nimble-feet made some brilliant tactical ploys to take advantage of unique circumstances on the taxpayers nickles without doing anything much to help out the rest of us. Those GS bonuses are being funded by you !

More than any other "bank" GS engages in proprietary trading - they are in effect, front-running their customers. By making markets and trading for so many clients they have more information than anybody on market trends and conditions and have actually been known to trade against the interests of their clients for their own advantage. So not only did GS make all its money on trading, not only did they double down or better using public resources but the can be said, arguably, to be acting against the fiduciary interests of their clients, the public and society. Tactical brilliance ? Surely. Strategic good sense - we don't think so. Just the opposite. Sustainable long-term ? Not in and off itself and l.t. profitability requires the assumption that as things continue to be in turmoil that GS will keep dancing with the new music, successfully every time. Given their track records it's possible but given they almost failed last Fall from getting off beat and missing some steps the question is, is it likely ?

What this pair of charts show us is that Mr. Market is not stupid in the long-run. He has figured out that GS is neither an investment bank or other standard financial firm. It is a giant risk-trading machine, otherwise known as a hedge fund.

Here the People Sing: the Simmering Backlash

The financial crisis made almost everybody from me to you to Bernanke tremendously angry. It was almost pitchforks and torches time; in fact we're sympathetic to the argument that it should have been. Now the firestorm that was is not going away. A few weeks ago we were at a conference for directors and consultants for medium sized business to talk about risk management, corporate governance and managing for performance. This was, in other words, a bunch of seasoned, experienced and mature adults. Nonetheless the second session got sidetracked and almost completely hi-jacked by a question on violations of the public trust which led to the whole audience jumping on the band wagon. Put another way a bunch of mature and responsible adults who are very informed about business and finance was and is so angry they're still stock-piling flammables. That potential firestorm hasn't gone away - it's just been temporarily banked.

A while back we started a whole series on performance, governance and social responsiblity and have since collected the entire set of postings in a single PDF files which we urge you to read (it's downloadable btw). Profit, Performance and Social Responsibility. Meanwhile Barney Frank made a recent major speech announcing that a) he anticipates completing a complete overhaul of the regulatory framework this Fall. At the same time Congress has charted a new "Pecora" commission. The original was the one charted to investigate the causes of the Great Depression and the shennanigans it documented led to the regulatory regimes we have now. We can anticipate something of equal or greater magnitude as the result of the new commission...and GS's malfeasant exploitation of public support for its own advantage just added fuel to the fire. Now be nimble in that guys because they're going to take away the punch bowl AND the party !

Continue reading "More Darkside Earnings Tales: Banks,Goldman und Unsinn" »

Posted by dblwyo at 06:13 AM | Permalink | Comments (0)

One of the things we've all learned, very painfully, over the last couple of years is that the performance of our investments and the activities of the Finance Industry cannot be taken for granted. Instead we must pay careful attention to both for obvious reasons (or so we hope). Like learning to play poker the tuition has been steep. As part of our own learning experiences, insurance program and to help out we've ended up writing so much about the Industry, Credit Markets, valuations, etc. that they've grown to have their own archives.

Our interest reflects a broader concern of course and one of the things that is going on is that the old, tried, tired and busted shibboleths that people went along with for the last ~30 years are being re-tested. Buy-n-hold for example or asset allocation; both of which have gotten increasing coverage in, for example, the WSJ and other publications. A major meta-class that grew enormously these last two decades are the alternative asset classes: Venture Capital, Hedge Funds and Private Equity. Now we've been regularly dissecting the status, outlook and performance characteristics of the Industry with forays into specific sectors (Hedge Funds) or firms (Citi). In this post we're going to focus on Private Equity, though we've pinged it before. Last week's Economist captured the situation nicely by showing wilted flowers dying in a devasted economic landscape. In this post we'll dig a little deeper into what that means.

A Little Background: Market Anomalies

David Swensen of Yale is probably the best-known and well-reputed endowment manager in the country and deservedly so as his re-thinking of portfolio and investing strategies led to fabulous returns for Yale and fundamental changes in the way endowment investments are managed. As well as what the world's asset managers do to manage their clients money as well. With all that he got badly hurt this last year because of the way the markets behaved but has since argued that once the storms are over and recovery begins he'll be able to return to business as was. To some extent we agree with several critical and important caveats that bear on this discussion. We borrow this chart from today's Bloomberg to make the point. When Steinhardt, Soros, et.al. got the Hedge Fund business going there were few in existence and they had their pick of talent. Recently the Hedge sub-sector was flooded with money, people and investors and the result was poor performance, a massive shakeout and poor prospects. In this last decade there were other major anomalous situations: Real Estate, Energy and Commodities and Emerging Markets. EM offered unusual returns because for years they had been heavily discounted but with globalization, widespread global growth AND the establishment of safer, more secure and more predictable environments they became better investments that were mispriced. In other words, in true Graham-Dodd fashion, there was a market anomaly where assets with real values were priced under what they would be worth as the result of these structural changes. Something similar happened with the alternative asset class. Yet consider what's happened to the VC Industry after the Tech Bubble burst, following it's own decade of bubbliciousness and bad business practice. In the last few months (18 ?) Hedge Funds have been taking a big hit. The question then becomes what's going to happen to the PE Industry ?

PE Industry: the Perfect Storm and the Coming Shakeout

Having beat our heads against the wall trying to explain business and economic realities to the Industry for several years and making little headway in the face of vast liquidity, leverage, out-of-control multiples and covenant-lite debt financing what we see, and hear from many sources, is that the Industry is just beginning its own major shakeout. At the end of '07 we were chatting with a delightful young lady who was an associate with one of the local firms who told us she'd never had a better year. A couple of months later we had the same conversation and found her looking and acting like the shell-shocked survivor of a bombing attack or a major natural disaster. The bubble this decade in PE investing was built on easy debt, massive leverage, outsize multiples and, dare we say, a "buff it, fluff it and flip" it mentality. The chart shows the massive collapse in the debt markets. It also shows the massive bubble over historical norms and trends that preceded the startling bubble. It wasn't just Housing that ran away with itself !

Excess debt, out-of-control leverage and inattention to business fundamentals are just beginning to reverberate thru the PE investment portfolios. Any time debt instruments trade at or over a 1,000 basis points above safe instruments that debt is badly distressed. That 10% difference (or more as you can see) holds for 60% of the LBO portfolio companies. Which means defaults, bankruptcies, major valuation write-downs and outright losses for the lending banks, the PE firms and their investors.

In other words the PE Industry is well into, but a long from the end or even the beginning of the end, of a perfect storm where all the excesses of this decade are coming home to roost. The bottomline impact is projected to be that somewhere between 20-40% of the firms in the industry will go out of business. On the other hand it's estimated that the firms that were both prudent and followed the traditional emphasis on good operating practices will survive and be well-positioned for the future; about 30% of them. The remaining 30-50% of the firms will be on the bubble and their survival will depend on re-thinking and re-structuring the way they do business.

PE Industry Challenges and Outlook

Now the industry, like hedge funds and VCs, is NOT going away. But it will move from having a free ride to having less access to debt financing, paying lower multiples, probably lower returns (certainly on recent vintages of investments) and having to make operational engineering, as opposed to financial engineering, a major component in their strategies and toolkits. It's going to be a brave new world, sort of a "back to the future" one if you would, as a result of all this. Now the Industry has in fact been able to continue to raise major funds but, as the result of huge writedowns, assets under management has shrunk significantly.

In the readings we start with some excerpts and URL pointers to the Economist article as well as some recent BCG studies (which we can't excerpt but are available in downloadable PDF format online at thos addresses and everyone interested should consult !). That's followed by a sampling of stories and cases collected over the last several months reinforcing and illustrating our themes and an even bigger collection talking about institutional investor reactions, firms outlooks and attitudes, fund-raising, debt and portfolio company impacts, deal flow, M&A trends, layoffs, investors pullback from the industry as they re-balance their portfolios and fundamentally re-think their allocation strategies and attitudinal changes.

Tough times all around - it's going to be more than interesting to see who survives and who doesn't. Our bet is on the firms that have traditionally been the top performers who stuck to sound financial practices, focused on operational improvements and passed the debt-driven quick flips. We suspect we're not alone and the turmoil will be massive and continue for a long while.

Continue reading "Wilting Flower, Perfect Storms: PE Outlook and the Return of Reality" »

Posted by dblwyo at 10:46 AM | Permalink | Comments (0)

One of the big announcements today was a member of Congress telling us that Commercial Real Estate was a major bombshell about to burst. This was actually kind of funny since CalculatedRisk has been laying down the law, graphically, on the CRE bust for almost two years now and calling it exactly. And he's done it by simple informed and competent analysis. Of course he also prognosticated the real estate bust early (very) in 2005 (which was just about the time that Merrill, et.al were piling on, taking more risk and creating special business units to get into the business !). There are NO surprises here - the good news is that this will be bad but not as bad as residential real estate and there's not as much leverage involved. We ourselves introduced this simple conceptual graphic well over a year ago to try and illustrate the various feedback loops that were at play (the immediately preceeding version is here - click on thru to note the changes). Credit markets are repairing but not in great shape and credit is still restricted. In the meantime the economy turned bright red but has since stabilized, as we've been saying, at a terrible level. Ditto on the stock market. Despite the headlines and talking heads the International Economy is worse - you think it's an accident that Iran and China have been beset by riots ? Despite China's headline growth they need 8% to stay ahead of the alligator of population and at 6% are in deep, deep trouble. Unfortuantely they're really storing up worse problems in the future when they have to deal with this credit bubble they are creating.

Credit Contagions

Even earlier in the game when we were all trying to decode the alphabet soup of CDS, CDOs, MBS, etc. etc. we came up with this little gem to illustrate the basic problem on of leverage, balance sheet blowups and cross-linked markets. This chart is close to two years old now (to the best of our recollection, anyway). We think it's fair to assert that, conceptual as it is and naive to boot, that it's held up pretty well. Even very well. The contagion that started in sub-prime saw boulder after boulder crash into the various debt and credit markets and sequentially take them all down. If you think it's an accident that nobody can get a mortgage or that the PE guys can't get financing or that the credit card companies are screwing us all...well look at this chart. Thougth admittedly we didn't spell out all the ramifications at the time since we didn't see them.

The Next Set of Credit Tsunami's

What we did suggest however is that Housing and the related financial markets were just the beginning. As credit problems metastasized into the real economy a vicious feedback loop was set up between a weakening economy, growing joblessness and increasing bad debt across the reach and range of debt. Including consumer, business and financial. Which led to this much more analytical chart. This one in particular we really meant, and mean, for you to trace the paths and think about them. The ONLY linkage path that's pretty well worked its way thru its doomsday scenario is Housing. Yet banks still haven't cleaned up their balance sheets and are both figting the government repair programs and refusing to come clean. Now as we continue in weak economic circumstances leveraged debt, for example for buyouts (CLOs) are headed say with rising corporate bankruptcies while credit card and consumer bad debt is growing exponentially. Similarly business defaults are growing rapidly. The level of balance sheet exposure and synthetic, leveraged debt instruments is somewhat less in these markets but they've got a long way to.

Repair My Sainted Aunt's Left Butt...

You figure out the rest. We've been harping in every market and financial post that the market was being driven by a surge in expectations built on the shaky finance repair and recovery. Courtesey of BigPicture we get this top chart which shows how the various sectors did from the Mar trough to the Jun peak and since then. Guess what - the unrealist of the unreal did the best far and away. Starting with the Pandit put and the "managed" earnings reports for Q1 we got this surge. yet all the bad news is hardly factored in. (NB: stay away from finance stocks unless you're a trader !)

 So what did that mean for the market as a whole ? Well the bottom sub-chart compares the SP500 to the Finance Sector ETF along with the the one for Industrials (XLI) and Consumer Discretionary (XLP). Take a careful look and the best performer by far was XLF closely followed by SPX; in other words Finance drove the market as we've been saying. Meanwhile Industrials didn't do anywhere near as well and Consumer stocks ran up with the trend but are since deteriorating badly. If this was a real recovery in sight just the opposite would be try, to some extent anyway.

Pound Away At Finance

Off and on we've been devoting major posts to the status of the Finance industry or key players within it. So much so that we found ourselves having to create a whole separte Finance Archive to collect the various posts where you could see them. Skimming back over the last two years it makes for interesting reading. The bottomline here is that we couldn't find any line of business in the Industry that was even in fair to so-so shape. Most are bad or worse. Now we're facing a world where: 1) things are going to keep getting worse for the banks but 2) they need to start do some fundamental re-thinking.

The result ? They're still in denial. In fact the whole thesis of the Industry being capable of self-supervision has proven false to fact; nobody else has come so close to bringing down Western Civilization all by themselves. Yet not only are they in denail but they are fighting reform of the regulatory regime tooth and toe nail while also insisting that just as soon as things "get a little better" it'll be back to busines as it was.

If you'll recall our discussions of the aberrational profit pictures that metastasized in the '80s, '90s and oughts for Finance that these is dead as a doornail. The real bottomline is that the Industry is facing a major structural shift that will be as momentus as the impact of de-regulation initially was. And that's going to eventually provoke a backlash of monumental proportions.

In the readings section you'll find a sampling of stories from the last couple of months or more that illustrate, as a whole and sector by sector, how the industry is fairing. We suggest you skim them for their own sake but keep all these points in mind ! And then think about the sector both as an investor, as a customer and as a participant in the larger economic picture.

UPDATES: the Latest Takes

Reviewing some recent WSJ coverage and other news we'd have to say that our take on storms yet to come along with the need for fundamental res-structurings and re-thinkings is beginning to be more widely reflected. Which is both good news and bad news. As evidence, which we think you really need to consider, we offer up some recent "Heard on the Street" comment along with some other stories.

Heard on the Street: Payback Time for Banks  After giving banks everything they could want in a financial storm, the U.S. is now demanding something in return. Assessing what the regulators, Congress and the Treasury actually want is a high priority for bank investors.Citigroup's management changes, announced Thursday, are likely the latest example of government intervention. The Federal Deposit Insurance Corp., one of Citi's regulators, has been keen on an executive shake-up.However, changing executives won't quickly fix Citi. The bank could face further pressure from the government, soon to be its largest shareholder. And Citi may find it harder than peers to generate sympathy in Washington by claiming it is a critical cog within the U.S. economy. Its domestic banking operations aren't huge and 60% of its deposits are foreign.Not just the weaker banks face change. Elements of the Treasury's financial-sector reform proposals could end up being quite stringent. The banks are pushing back against the government on many fronts, with a few willing this week to battle over the cost of buying back Troubled Asset Relief Program warrants.But bank executives need to realize that Washington might not be as receptive as in the past. Congress's desire for reform has remained strong -- witness the support for a recent credit-card bill -- and could even strengthen if some bank profits and bonuses balloon at a time when voters face hardships. It is consumer banking that politicians seem to care most about. A lender like Bank of America, with its large home-loan and credit-card portfolios, looks particularly exposed. Government support helped propel financial stocks higher in the spring. The summer political heat may cause them to wilt.

• Citigroup Shakes Up Leaders to Pacify U.S.
• Citi Gives a Glimpse of the Good and the Bad
  

Continue reading "Beyond the CRE "Bombshell": Real Stress Testing for Finance (Updates)" »

Posted by dblwyo at 09:19 PM | Permalink | Comments (0)

We've been plowing thru various aspects of the Finance Industry and it's outlook as well as the broader socio-political context since the end of January. Starting with a broad overview and then tunneling down into specific sectors outlook. The AIG firestorm led to or was associated with a look at the broader context. No business or other institution can exist other than on the sufferance of society, and if it does not contribute value to that society it will be changed - one way or another. That makes it a fundamental management responsibility of any business to be aware of broader socio-political trends and problems and to act proactively to intercept or correct them. If nothing else by anticipating problems and acting to support broader policy responses to problems beyond the industry's immediate ability to cope with. Judging from the remarks of the new Citi CEO the Finance Industry gives new meaning to phrase tone-deaf. Now that some of the details are leaking out we've found out that in the President's recent meeting with key CEOs he basically said, "we're the last thing between you and the pitchforks". We're tempted to put up the "Can You Hear the People Sing" graphic and URL again but hopefully the point is still relatively fresh in your minds, as it appears not to be in the minds of the industry.

The real question is now what ? Mike Mayo (cf. the readings) as well as Meredith Whitney came out yesterday and said in effect to short the Financials. Advice we heartily agree with because there is no function or aspect of the industry that doesn't appear to be broken. From internal execution capabilities to strategy to broader socionomic positionings. The really sad thing is that it doesn't have to be this way. During the 1980s we were all the beneficiaries of major value-creating innovations from money market funds to reasonable de-regulation to discount brokers to mutual funds. In the '90s that innovation evolved into internal financial engineering rather than value-creation and in this decade it clearly metastasized into value-destroying, on both the business, industry and social levels, "innovation". To survive, recover, return to profitability and restore it's place as a valued part of the system the Industry needs to realize these firestorms will rage and change everything.

Drucker Principles and Finance Futures

As we've worked our way thru an analysis and assessment of the broader impacts and consequences of the finance industry we've ended up depending quite a bit on Peter Drucker's insights on the major performance criteria for business value creation. The graphic at right is a summary of one interpretation combined with our earlier framework of the major sectors of the industry. But let's start by quoting Drucker (p. 369, "Management: Tasks, Responsibilities, Practices"):

"Essentially being a member of a leadership group is what traditionally has been meant by the term "professional". ...as a member of leadership group a manager stands under the demands of professional ethics - the demands of an ethic of responsibility. [A professional] is public in the sense that the welfare of his client sets limits to his deeds and words. And Primum no nocere, "not knowingly to do harm," is the the basic rule of professional ethics. There are important areas where managers still do not realize they have to impose on themselves the responsibilities of the professional ethic. The manager ho fails to think through the and work for the appropriate solution to an impact of his business because it makes him "unpopular in the club" knowingly does harm. That this is stupid has been said. That this always in the end hurts the business or industry more than a little temporary "unpleasantness" would have hurt has been said too. But it is also gross violation of professional ethics".

We trust Prof. Drucker's points are crystalline ? Just to compress and paraphrase them the actions of the industry are harmful, counter-productive and are going to lead to a massive social backlash that's entirely justified by the facts of the situation and the necessities of society. Remember if you do not create value society has NO reason to tolerate you. If in fact you destroy value and massively harm society it cannot even afford to tolerate you. In the graphic we've tried to depict the relative performance on the Drucker Principles of each of the major lines of business with the caveat that there is no multiple-red color to properly represent the behavior of the securities related business and the damage caused.

The Theory of the Case

When a logician or lawyer is looking for the core, fundamental argument that drives the entire rest of a complex chain of argument they talk about the "Theory of the Case". We've come to think that's a nice, powerful, description of how to think about a business. That is to ask "what is the theory of the case ?". In other words what's really going on here, what are you going to do about it and why are you convinced and convincing that value-creating performance will result. So far all we've heard from the Industry has been denial, rear-guard defensive actions and what can only be described as "forlorn hope" attacks. Nowhere have we seen anybody stepping up to present the theory of the case for the immediate crisis let alone for the necessary future timeframes. Instead they're leaving leadership to Washington, speaking for society. And Washington is indeed stepping in to fill the vacuum. But the policy-makers and politicians know they aren't experts and would more than likely welcome constructive engagement that looked to the greater good of society as well as the industry. Not just continuing defenses of egregarious compensation packages.

Observations, Suggestions and Opportunities

We aren't so bold ourselves as to make detailed suggestions just yet but we would like to make some observations and suggest some trial balloons. Across the entire spectrum of banking and financial services, including banking per se, consumer finance, SMB finance, financial companies, investment services and advisory services we think the basic business model and strategies of the future will have to deal with several key factors:

1. The industry will be significantly de-leveraged.

2. A focus on customer service, putting the customer's interests ahead of the firm's, will create value and ultimately a differentiating competitive advantage.

3. Fariness and value for compensation need to be fundamental principles of operation.

4. Innovation in new value-creating services and capabilities needs to be the driving strategic manatra of the new industry.

5. Survival, recovery and effective innovation need to be based on effective and principled management systems.

Which leads to some strawmen suggestions for financial innovations just to get the ball rolling:

1. Hedge-like funds for small investors to be able to cope with a low-return, topsy-turvey world.

2. Non-opportunistic (i.e. non-exploitative and with non-exorbitant interest rate) consumer finance and credit cards.

3. Securitized business finance based on deep understandings of fundamentals AND loanee re-payment capabilities. For example trade finance could be greatly expanded and help out the growth of the global economy.

4. Micro-finance in the inner city.

5. Ratings mechanism reforms coupled with performance insurance and/or bonding.

6. Localization of financial services where branch offices and staff truly return to being local in their knowledge and connections. This could be coupled with a "franchising" approach to combine the economies of scale of large institutions along with superb local knowledge.

7. Merchant banking for small companies in the best, "ye olde English" sense of informed investment in serious business opportunities. For example in green energy, bio-tech, etc.

8. Operations-based investing based on business fundamentals for the Private Equity sector.

9. Macro-monitoring and advisory services to help with budgeting, capital planning, expense control and general business planning.

SEE CHANGES: Glimmers of Hope, Honesty and Re-Thinking

The industry is faced with some very stark choices: Cooperate (go along with unavoidable policy changes just to survive), Collaborate (become pro-actively involved in shaping that policy) or Cave (be plowed under and constrained for decades by the popular anger at the violations of the public trust). The financial firms you want to be investigating and investing in are the ones that satisfy the Drucker principles AND have clear responses on the "Theory of the Case" on all timeframes for all lines of business.

So far we haven't seen any. Let's hope that that's just our lack of information access and not the reality. Otherwise a vital and important industry will do itself and us irreperable harm !

UPDATES: Nothing like good timing. As we were putting up this post it turns out Lloyd Blankfein was giving a truly stunning speech in Washington that finally acknowledges the public responsiblities of the Finance Industry, in detail. In particular he supports almost point by point the major elements of the Geithner Plan as well as the call for greated worldwide regulatory over-sight coming from the G-20 meeting. His speech got widespread, rapid and, dare on say, shocked coverage from a wide range of the commentariats. You can find some of this in the readings as well as a a valuable assessment from Steve Perlstein of the WaPo highlighting the need for fundamental cultural change. Our collective bottomline is that we consider all the points we've been making in this post and it's predescessors to have been supported by perhaps the leading executive in the Industry !

There is, btw, an enormous collection of readings after the break that we highly recommend you at least skim. Judging from the readership stats that hasn't been the case but there's quite a collection surveying the evidence behind the points we're making !

UPDATE2: Just ran across a fabulous oped from the WSJ on Wall St. cultural breakdowns that both fits nicely with our overall theme and serves as the perfect counter-point to Blankfein's Mea Culpa. The point being this - external and internal structural changes are vital but UNLESS THE STREET CHANGES IT'S CULTURE....IT'S CULTURE WILL BE CHANGED.

Continue reading "Firestorms, Finance, Futures: From Sociopathic Dysfunction to Value Creation (UPDATE2)" »

Posted by dblwyo at 02:38 PM | Permalink | Comments (0)

Well last week should have been another stunner, beginning as it did with the biggest extension of the biggest bailout since the GD and ending with the largest regulatory re-thinking since the cumulative total of GD and intervening decades legislation and regulation. REALLY stop and think about that for a moment - almost EIGHT DECADES of incremental change has been compressed into sixty days. Or being slightly more fair 120 going back to Sept and the TARP kickoff. Five weeks ago everybody wanted to hang Geithner for malfeasance and lack of detail, now he's a genius and a hero. Be careful what you ask for too ! Pundits and interests on the left, right, up and down are all choking, albeit more quietly, on these details. Yet nothing should be a surprise since there's a clear pathway from Bush Administration decisions and recommendations, including Paulson's tentative plan from last spring (btw on of the key readings is a FT oped by Henry supporting a regulatory overhaul that looks like this one on a worldwide basis). Of this set of initiative what's most important - the economics, the financial technicalities, the politics or the popular reaction ? Actually all of them !! What's still missing is a context to help organize, categorize and organize our thinking about these myriad complexities so we're going to take our best shot at explaining what's going on. And make no mistake - these are enormous changes, mostly for the better IOHO, long over-due and the Finance Industry and it's role will never be the same again. The last three decades of business models, strategies and profit/performance relationships are gone forever ! We ended the last post with the accompanying cartoon to capture the popular reactions to date and so we start there. Now lets dig into the strategic context.

Helmet Laws and the Public Good

My personal reaction to seatbelt laws was they were unnecessary interferences in private decisions; as we used to say in the rock climbing game when the tourists went round the back side of difficult climbs, started down ravines and went splat in the parking lot that's how you sort out the riffraff and wannabees from the folks who belonged there. Ditto for motorcycle helmet laws and cellphone laws. All of which have become widely adopted. Now for anyone who's almost been run over by some weekend shopper chattering away (in our case one nice lady looked us directly in the eye and then almost ran us over and didn't even notice !) these laws begin to make more sense. Take at look at this YouTube clip and ask yourself what level of responsibility was displayed by the rider. Then ask whether or not the law made sense. Without a helmet this guy would have been history. Here's the policy implication - if the only person to be hurt had been the rider then sobeit. And if irresponsible riders had to post insurance for the bucket and mop brigades required for cleanup as well the public costs would have been balanced out. The realities are lots of folks continued, continue and will continue to act irresponsibly and the costs are not restricted just to them but impact the general public. There's the general principle - when the costs to society greatly exceed the cost to private individuals regulation is our only recourse.

Keep On Breathing: the Financial Circulatory/Respiratory System

What does that say about the Financial System ? If you go back to the Congressional testimony in the summer of '07 on executive compensation one can only characterize the responses of the boards, chairmen and compensation committees as being beyond tone deaf. And as publicly irresponsible as a drunken motorcyclist driving thru streets full of school children. We have at least $180B invested in AIG to date trying not to save the company but save the world economy; literally. (If you check out several of the last posts that show the credit and equity markets and economic data that should now be beyond challenge we hope !!!). The credit breakdowns and crisis is often compare to a terrible plumbing problem with rusted and clogged pipes, frozen values, and bad water. A fair analogy if you consider that it's not just a house but the whole neighborhood and town. A better analogy we think, that represents the complexity and inter-connections is how your circulatory system takes oxygen and energy and gets it into your system until it reaches the cellular level where a complex and inter-connected set of metabolic and bio-checmical reactions keeps you going. Credit has been called the lifeblood of the economy and, in some senses, that's almost literally true. It's pervasive, systemic and systematic involving inter-actions at the most minute and granular levels on up to grand flows of macro-systems. To tell that story we've composited a graphic that traces thru the flows of the circulatory system as a model and metaphor.

Supreme Truth and Systemic Poisonings

Back in 1995 the Aum Shinrikyou cult put Sarin gas into the Tokyo subway systems to purify things and bring on the new world, since they were an elect and spiritual elite who had deeper insights into the mysteries of the Universe. Now there are many good people in the Finance Industry but the leadership, perverse incentives and lack of controls combined with the "deeper grasp of the mysteries" of financial engieering led the Finance Industry as a whole to effectively mimic the cult's actions. Only instead of 5,000 people who were affected locally we had six billion who are effected globally. For nearly three decades the Industry has argued that it was capable of self-responsible adult supervision, that is it wouldn't drive recklessly, didn't need to wear helmets and was performing both a privately profitable and public good service. That turns outs out to be entirely false to fact. And, judging by the shell-shocked lack of leadership in response to these disasters the industry isn't stepping up to the plate to help re-formulate the proper "helmet laws" so society is going to do it for them. Which is truly unfortunate on many levels and in several ways. First off we truly do need a finance industry to help mobilize and allocate capital; much of human progress is built on the gradual evolution of capital markets, at least indirectly. And there's still going to be huge profit potentials for well-constructed, designed and operated financial institutions as a result. The question really becomes which ones.

Can You Hear the People Singing ?

 As Peter Drucker pointed out almost forty years ago businesses are social institutions and cannot survive or prosper if the societies of which they are a part are not also healthy and prosperous. Enlightened self-interest would, for a responsible adult, motivate businesses to encourage the welfare of the broader society. Or at least not damage it. Drucker identifies three major goals or responsibilities of the effectively managed business: 1) deliver an effective service that creates value - in the case of businesses this means making a profit that is sustainable in the long-run, i.e. balances short- and long-run decisions. Then, 2) operates efficiently and effectively by making work productive and the worker achieving. In other words by making sure that work is logically designed but also recognizing that people are social animals and to be effective one has to account for the non-economic dimensions of the business as a social institution. Finally, 3) act in a socially responsible manner to ensure that society is doing well (or as we put in an earlier post make sure that the prey populations are sustainable and self-renewing). Social responsibility requires two things - first when the activities of your business impact the broader society move to reduce the harm. For example when you create a pollutant act to clean it up before society forces you to do it. Second, identify broader social problems that are connected to your business and act proactively to eliminate them before they become so bad that society has to. The classic example is the Auto companies and Healthcare, which they've known is a competitive problem for six decades yet failed to pursue the social remedies of regulatory and insurance overhauls required.

Farther and Farther Behind the Curve

In particular Drucker points out that denial and fighting rear-guard actions to prevent regulation when it's in the interests of society and your company is a management failure, grossly counter-productive and irrational in the long-run. Paraphrased, either change the regulations or change the regulations !

Let me translate that: if business operations create a problem that individual businesses cannot solve because of the profit impacts and therefore require general regulation it is the fundamental responsibility of management to proactively engage in working with other institutions to craft the legislation and regulation. To fail to do so is irresponsible, malfesant and a gross failure of managerial leadership.

The Finance Industry would never be the same again after testing their engineering skills to destruction. But after the social damage they've done society cannot allow them to self-supervise. Something they should have been addressing for the last thirty years; there have been plenty of warning signals. Instead they chose to pursue the path of lobbying for greater and greater freedom which led to greater and greater risk-taking. Pursuing the analogy it's as if the Aum cult kept making more sarin.

The question is what happens now ? We'll take that up in another post but here's a hint: get out in front and help shape things or get run over by the Juggernaut. Two more: you won't like the alternatives AND if it gets out of control nobody will win.

Continue reading "Helmet Laws vs Adult Supervision: Re-Regulation & Finance Industry Futures" »

Posted by dblwyo at 08:57 AM | Permalink | Comments (0)

It's time to dive back into Part III of our extended round of dissection of the Finance Industry, a dissection which, btw, we have taken several passes at. So much so that there's an extended archive of previous postings looking at the Industry as a whole and particular companies. And course there's the prior two posts in this current series (Rescue, Recover, Re-Design, Re-Build: Finance Industry Futures,Finance Industry Futures II: Sector Transformations (Hedgies, M&A)) which follow along our revised mantra of Policy-Economy - Industry-Company. In those archives you'll find us arguing rather early in '08 and extending back to mid-'07 that the Finance Industry had become a vastly disproportionate share of earnings, market indices and corporate profits. And also arguing that that displacement was a recent phenomenon, since '00, but having roots stretching back. Our argument was/is that the displacement was based on mis-priced risk, leverage and liquidity, not on innovation or value-creation. Yet at the same time we MUST recognize that the Finance Industry plays a vital role in a modern economy and is essential to prosperity. What that all boils down to is that a re-factored industry will, and should, be with us for a long time but that the necessary re-factoring will take many years. What we'd really like to see is new service and product innovation, on the same order as money market funds, discount brokers and all the other major breakthrus that made the industry of the '80s so contributory. The jury is way out on that but at the end of the day it all boils down to the invidual companies and their leadership. Hence this post.

Citi as Exemplar

In a set of prior company specific posts (Poster-child II: Citi's Potential Turn-around as Performance Exemplar) we dissected Citi and Pandit's reform and re-structuring efforts. Our bottomline conclusions were that he was trying to do the right things, that he was in danger of being swamped both by systemic problems AND the legacies of bad management systems. Our final argument was that, given a multi-step strategy of arrest, recovery, re-design and re-build and then re-energize that the critical key was, and is, the implementation of a mangement system that set clear, simple and reality-based objectives and then implemented them with the appropriate resource commitments and measured them with the right accountabilities and controls. The presence or absence of a Management System will make or break Pandit's efforts; it will also make or break the huge new financial conglomerates create by Lewis at BAC or Dimon at JPM.

Citi, Management System and the Finance Industry

What do we mean by that ? Well the accompanying graphic tries to sketch it out conceptually, based on our approach to assessing and re-building "total enterprise performance" using the Management System as the driving engine of controlled adaptation and resilience. First you have to have a blueprint that lays out the Vision and Strategy, which have to be based on current or reachable Operational capabilities in critical functions. Then you have to develop the right implementation, operating plans and controls for each of those functions, both as a stand-alone capability and as part of a whole who's performance is more than the accidental sum of the parts. A point central to our last several postings on business performance (Let the Triage Begin: Business Performance vs "Stupid Is",Survivor: Search for the Next "Blue Chips" (UPDATE),Time, and Past to Play Bizzball: Economy to Business Performance (UPDATEs)). Finally a proper management system sets objectives and goals, establishes resource commitments judging the tradeoffs and then puts measurements in place for which each manager is held accountability and reponsible for delivering against.

It Ain't Just About Citi

In the readings you'll find an extended set of excerpts that trace C's trials and tribulations from last Fall to now. One of the scariest thing is, despite our earlier applause, is how oblivious they were to all these macro and management issues. But it's not just about Citi. The rest of the readings point to other examples, good and bad, of financial firms either adapting to the moment or not; and in the latter case dying as a result (cf. "The Last Days of Lehman"). The readings also start off with two context defining excerpts. One that reiterates and reinforces our fundamental point by pointing to a recent Booz study about how flat-footed, shell-shocked and non-adaptive leadership is on a worldwide basis. The other, a very recent Jubak column, is the only balanced assessment of the Geithner plan that integrates the politics with the policies we're aware of. The recent spate of policy announcements are, IOHO, much better and much better crafted in light of circumstances, than anybody yet grasps. (Miracles on Pennsylvannia Ave: Make it So, No. 1 !) Nor are the talking heads and pundiocracies getting to the heart of the matter - something constructive is better than standing pat, there's no time for more screwing around and you do the best you can with what you can lay your hands on. What's required is a cool head and a steady hand on the tiller, plus some communication skills. On the whole our public policy makers are doing enormously better than our private decision makers. Let's hope that changes and rapidly !

But as we wend our ways thru these minefields understanding how adaptive and resilient leadership is will be a critical factor to evaluating the future.

Continue reading "Finance Industry Futures III: Cases in Point (C as Exemplar)" »

Posted by dblwyo at 10:12 AM | Permalink | Comments (0)

Currently the Davos World Economic Forum is underway, and having watched several of the online videos which are available to you (SB: a great resource which you should invest some time and thought in - for example Putin and Wen's critiques of the financial system breakdown were small parts of their speeches, despite headlines, far less harsh than the Westerners themselves and their call for a new integrated economic and financial framework commonly shared very widespread) online. Several recurring themes/memes were (1) find and hang the guilty, (2) re-engineer the system, (3) the downturn's going to be worse than we think so far and (4) the geo-political strains immense (all of which we've been trumpeting for some time) are running thruout the sessions. There's no better horse's mouth sources about on-coming events, trends and changes than this stuff and the reporting is just flat getting it wrong. The vidclip graphic takes you to a session that's among the many you should listen and it's on "What Went Wrong" (click to see if the graphic doesn't work) and is hosted by the Money Honey and includes folks like Stiglitz, Shiller and Blinder as well as many leading luminaries. Listening to ought to scare you because the folks who are at the forefront and were at ground zero basically confirm all our arguments from the previous post (Rescue, Recover, Re-Design, Re-Build: Finance Industry Futures). Sorry if the graphic doesn't look as appealing as it does running :) ! But listen to it anyway (after the start you need to scroll to about 40 min but especially listen to the end. The discussions are the real meat though).

Brave New World and Confidence

The relevence for us is that we will see new national and international regulatory frameworks and the best thinking is that the Finance Industry as we knew it and are still extrapolating forward from will undergo deep structural changes. This is NOT a cyclic downturn it is a structural one and what comes out will look nothing like what we've seen. The readings after the break start by speaking to some of these strategic contexts and trends and then focus on two sectors which will undergo some of the most radical change as de-leveraging proceeds and risk is re-priced and regulatory mechanisms tighten up in new forms. Those sectors are Hedge Funds and M&A. In the last post we talked about the big picture trends and put up a graphic illustrating which sectors were in what kinds of trouble. The key to remember is that the more they relied on over-leverage, under-priced risk and bad operational practices the more vulnerable they are, the harsher the changes will be and the less the new will resemble the old. From that same conference it turns out that our coterie of flat-footed business executives are loosing confidence rapidly and the rest of the world is loosing it even faster in them. How's that going to play in Peoria ? Or more importantly among the stakeholders who went chasing returns in the alternate investment "brave new world" that's dying ?

No More Quoth the Maven, No More

 Well one way to judge that is by looking at long-term finance industry stock prices, here proxied by the XLF industry ETF, as a proxy for what people think of the industry. Not surprisingly not much at all, as shown by the literally abysmal drop into the depths of loss. Go look up Laurentian Abysmal on Wikipedia sometime, or better/worse read about the Challenger Deep. Let's hope we stay Laurentian instead of further challenged (there's several puns there...look it up as they say :) ). Meanwhile look more carefully at the chart, the top of which shows the 10Yr weeklies for XLF along with the 20Wk MA and the bottom two sections show technical indicators (Volume and a MA difference which shows momentum). Now really look at it carefully. From 02 to early/mid 07 finance went up 100% - a pretty good exemplar of a fantasy bubble in a week economy IOHO. So what differential, unique and new huge value add was brought to the table to so far exceed historical performance norms ? Well judging by the 50% drop since then BELOW the 10Yr zero point NONE. And it turns out that the industry lied to us AND itself - these are after all "the smartest guys in the room". Turns out that subsituting financial engineering and loosing sight of fundamentls looks more like the early rockets than Saturn V.

The Devil's Details

Let's consider that down another level of granularity to bring it home. The accompanying graphic provides a list of key bellweather financial stocks showing their status as of mid-day yesterday, relative to their 50Day MAs and 52WK High/Lows. Take a careful look and tell us who you think has turned in an exemplary performance ? Even the best investor of our lifetimes is down almost 40%. Which is a tad better than Jaime Dimon at JPM and enormously better than Lewis at BAC, the architects of the two new megabanks. On the other hand People's Bank of CT is down 24% - a stunning out-performance in this environment. So what does that tell us ? Well PBCT has been conservative, run a good bank and picked it's opportunities. Things Dimon and Warren are known for as well.

We come full circle (Survivor: Search for the Next "Blue Chips" (UPDATE))back to our key themes - good Strategy, great Execution on operational fundamentals, sound Management Systems and Leadership.

And if you don't think it makes any differences then work out what yearly return you got by buying XLF at the end of '02 and buying the inverse in early '07. Hints: try a 2 handle for the first and a 4 handle for the second !

Continue reading "Finance Industry Futures II: Sector Transformations (Hedgies, M&A)" »

Posted by dblwyo at 12:38 PM | Permalink | Comments (0)

Well it's time to return to the fray since we've "allowed" a natural and necessary focus on the credit and markets crisis and the coupled economic and markets disruptions and downturns to focus our attention. That means it's time to re-focus on business, specifically in our three-part mantra of Economy-Industry-Company that means it's time to return to discussing Industries and Companies. But where to start ? Ai...there's the rub Horatio ! Make no mistake about it, we're facing radical changes in each and every industry, deep structural changes (where structural means very long-term changes in how an industry is put together as opposed to secular changes where an existing structure moves as it would without re-factoring, or cyclic change which represents normal and natural ups and downs). In shorthand STRUCTURAL = TECTONIC, in other words we're facing tectonic shifts in any industry you'd care to name for lots of reasons. The gimmes are Finance and Autos but include Retail, Technology, Pharma, Mediatainment or any other. For example the Retail is enormously over-built and between the downturn and consumers changes in structural behavior there's going to be a lot of downsizings and BKs ! So if we can start any where let's begin with Finance.

Four things MUST happen IOHO: 1) Finance will return to it's roots and no longer absorb the resources and profits it has, 2) the industry will de-leverage, 3) the shadow-banking system will come under the regulatory umbrellas since they can't be trusted without adult supervision and 4) there will be an increased emphasis on operational efficacy as opposed to financial engineering. But bear in mind two other key short- to intermediate-term major factors: 1) the credit crisis is not over and the industry is facing a lot more bad debt without the capital to meet the calls and 2) in particular housing is going to have to be written down to reasonable levels meaning more haircuts for banks/lenders and homeowners. OUCH !!!

Structural Change

The share of national account profits going to the Finance Industry has historically been significant but grew much larger in the '80s and '90s but it took a major jumpshift in this decade. That's over. Hopefully you can peek at this composite chart and readily come to a similar conclusion. Now the question is, to start, what magic new source of value did the Industry create to cause such a dramatic shift around 2000 ? Recent experience would suggest value-add was large and negative. yet finance is an integral and essential part of the modern economy allowing the mobilization of capital for sundry endeavors that would otherwise lack funding. So it'll stay but NOT at this level ! So what happens if it goes back under 20% ? Or, lord forbid, back to the historic norms that might be guestimated in the 15-20% range ? What does that say about the L.T. structural outlook, performance and value/service requirements ? It's a brave new world folks.

Leverage and Operational Effectiveness

If you look at that history what you're seeing is the macro-indicator of lax regulation combined with a worldwide slushing of funds but most importantly LEVERAGE run hog wild. That's going to stop - which means when you break down the Industry be major functional sector and compare each sector by functional component that instead of 30X leverage banks will a) have to make money at 10X, b) so will everybody else and c) they're going to have to enormously improve their operational execution from Marketing to the back office to Product Development to Service. Pray for the day. This chart actually gets to the heart of the matter and illustrates the huge cliff facing JPM, Citi and BA, for example. In fact it started as a diagnostic for Citi but turned out to sever well as a way of blueprinting the strategic requirements and current status of them all. The key enbler will be the management systems - setting objectives and making sure they come to pass. The cardinal failure of Weill and Prince at Citi. It's not necessarily that super-market banks are bad it's that so far bankers have been bad managers. Given JPM and BA's acquisitions we'd better hope they get it right this time !!

Storms, Tsunamis and Quakes

If the credit crisis is turning out to be a never-ending series of perfect storms with a Cat 5 hurricane thrown in the parallel economic downturn will keep rippling thru with increased pressures on consumers and businesses leading to accelerating defaults, BK's and other ugliness. Right now it's estimated (by Roubini among others) that most of the major banks are technically insolvent and have inadequate capital as it is. If unemployment gets to 10% the resulting tsunami of defaults will swamp them. And of course we've just finished talking about the tectonic quakes that will result in huge shifts in the structure of the Industry. We're likely to be facing tight credit for years or longer as a result. The vicious and viscous positive (meaning reinforcing) feedback loops we're about to see accelerate are illustrated in the accompany graphic.

That means that getting the bad assets off the books, re-capitalizing the banks, re-designing the regulatory frameworks and marking to reasonable values are national strategic imperatives.

The question then becomes how will the banks adapt ? AND who's prepared ? 

That's back to our fundamental point last post about looking for blue chips, translated as who's leadership is up to these challenges. So far there appears to be a real shortfall.

Continue reading "Rescue, Recover, Re-Design, Re-Build: Finance Industry Futures" »

Posted by dblwyo at 07:11 AM | Permalink | Comments (0)

The title is a play on Kipling's poem If which we've quote before. Isn't it amazing how truly wise Rudyard is beginning to appear now that the rest of us are beginning to live in a troubled world like he experienced. But rather than rolling to your gun and blowing out your brains before the Afghani women come out to cut you up we'd suggest there are still some alternatives. Which start with understanding what's going on on several fronts, then developing a plan for how to re-position yourself and then executing that plan and sticking to it thru the chaos until it's time to "keep you head", in the sense of both keeping it figuratively - perhaps literally for those with more at stake than they should have risked - and in the sense of keeping a clear head. We will continue to do our best best to help with the latter by providing our best tools, analysis and assessments in the search for "what's really going on here".

On that note a friend's reaction to yesterday's posting was that he understood my analysis earlier in the year but thought my take was greatly exaggerated. As of yesterday morning my credibility has apparently risen a smidgeon in his view. Despite the fact that just about everything that's going on was discussed months ago, if not last year, in some detail with charts and everything. Now let's be absolutely clear because there are 2-3 critical lessons here. First, that apparent prescience is not the result of any particular virtue of mine but of having the right toolkit to understand and interpret the trends swamping us. With the right "Dashboard" it is indeed possible to monitor things.(Data, Dilemmas, Dashboards and Decision,Dashboards for the Real World: Economy, Markets, Industry, Company). As long as we're on the topic of  training yourself to  keep a clear head Mr. Kipling has some simple but profound  wisdom to share  on that subject as well:"I Keep Six Honest..."

Second, as many of the readings below make clear almost everybody on the inside lurches from surprise to surprise. Sterling and stunning examples of the lack of a clear head IMHO - that is in believing what you want to believe and distorting the signals to fit pre-conceptions until they rise up to bite you. Third, as several examples show, it is more than possible to have anticipated this and/or to take advantage of it.(This One's for Jay: Investing Strategies for a Dicey Market). Which we hope some of the readings will highlight.

Speaking of which they're broken up into a current tracking the crisis cluster, the longer-term consequences for the fundamental re-shaping of the Finance Industry and the BofA/MER merger. Now in several of these the best take on the state of things is a video clip which we haven't collected entirely for fun. Where they're included they're there because we think you'll benefit from taking the time to watch and think about 'em. That said there are three that IOHO are must watches: Meredith Whitney on CNBC on the state of play who compresses so much into a few minutes that you'd better take note. Jim Jubak on why the AIG problems are the single most important determinant of the next few weeks and a straight-forward explanation. And the Lewis/Thain interview which if you want to understand what went on, why, the outlook and the re-engineering of the financial industry that's underway listen carefully to those.(Finance Ind II(Readings): Fundamental Breakage in the BM ,Markets and Financials:4 Year Crunch, Broken BizzMods). When we said broken business model, a phrase that we notice is now rather widespread though we don't recall hearing it prior to our first flights ;), that may be a little to dry and abstract. Listen to Thain and Lewis and understand what throwing out broken ones and replacing them means for firms, employees, business partners and industries.

Bon Appetit' 

Continue reading "Keeping Your Head: Understand the Crisis, Navigate the Crisis ?" »

Posted by dblwyo at 07:11 AM | Permalink | Comments (0)

What a week, actually what a two weeks. There's so much going on it's hard to pull it together and wrap some common threads and themes around it all. But the bottom line is that the Credit Contagion Metastasis (Cramer's Anniversary: Continuing Credit Metastasis and Economic Outlook) we've been talking about for months (and it seems months and months...usw.) is about to collect the scalps of some more victims. In actual point of fact the size and magnitude of what's going on now is tremendous and scary but this is NOT AS BAD as things were in Mar. when BSC imploded and it looked like markets were going to collapse until the Fed found the magic tools and the right way to use them. Which is not to say that these aren't dire situations and you could see some very unpleasant surprises come Monday morning that are about as serious as it gets.

UPDATE: here's how serious this is in case you didn't get it:

• Masters of the Univers Meeting to Save Us: Lehman Deal Could Come Tonight As High-Level Talks Continue
• $5T in Exposures:How big are Lehman, Merrill, and AIG?

Update 2:

No Deal Reached Yet for Lehman The outlines of plans to determine the fate of Lehman Brothers Holdings Inc. emerged today even as it became increasingly clear that a clean sale of the entire firm to a big bank would be too difficult to execute. A sense of optimism that a rescue could be arranged today dimmed as a growing sense of gloom descended on Wall Street.

BUT, and seriously here's the good news in bad situations, this is the working out of the confluence of all the breakages we've been talking about: risk re-pricing, de-leveraging and broken Finance Industry business models. And that's not a light at the end of the tunnel it's the headlamps of the next crisis and breakdown coming down the tunnel. With last weekend's take outs of the world's largest financial institutions on whom the health of US and world economies was utterly dependent one would hope we'd get some breathing room. But beyond Frannie, Lehman (LEH), Washington Mutual (WaMu or WM), Merrill (MER) and AIG appear to be lined up right behind. And then who knows - though we'll find out. There was a small irony in all this - in reviewing my AIG problems clipping files they start with the '05 criminal charges that were partly the aftermaths of the last bubble bursting and associated shady dealings and led on to two years of write-downs, management changes, etc. etc. Nobody can catch a break. If you stop to think about it these guys had barely sobered up and hadn't repaired the damages from the last party when they starting drinking the koolaid again. This time we seem to be more prepared to face realities. Take a look a the chart which shows the Finance ETF (XLF), LEH, WM, MER, and Citi (C). Notice how extraordinary it is. The XLF was down over the last three months but the walking dead men were down 30-40%, which is outrageous though accurate. JUST in the last week they've all essentially collapsed, much the way Frannie (FNM, FRE) did last week and BSC did in March. In other circles when your market value goes to zero they call
that bankruptcy ! :)

Markets Reactions: Jaded But Not Faded

Let's start by taking a look at this very simple but very meaningful 10-day chart of the SPX and see what it can tell us. In case you forgot week before last began with a holiday which for market and economy watchers faded into a horror show - except for those of us who've been anticipating the onset of realities for some time. Confirmed with last Fri's unemployment numbers but subject so far this year to Kubler-Ross stage 1 Denial. Now this week was about as wild and woolly as it gets for going nowhere. All the daytraders were looking for a bump up Mon post rescue and didn't get it, unlike all priors. Instead we got some very odd days with huge opening gaps down that recovered by the end of the week. Yet at the same time we didn't get the kind of rallies we got earlier in the year. Reality check ? WTF ? What's going on here ?

Reality Setting In ?

Consider that last point because it gets to the heart of things and will define how they evolve from here. When the first metastatic crisis set in around January and we were all about to be taken out by BSC's collapse the Fed a) stepped in for a rescue but b) created a whole raft of innovative new intervention instruments that got the completely frozen markets working again. Like we said at the time that cleared the pipes but didn't mean there wasn't a lot of sewage to keep draining. (Credit Meltdown, Economy and Consequences: Putting the Pieces Together) But if you look at the yellow circle the markets thought it did. And again in mid-July when Frannie was going under for the 2nd time, the Treasury stepped in, and don't forget MER said it was all.....l right now (thank you Dave Mason) and we were back to the races. Notice each time that the recovery before the next binge is shorter and shallower though. And then we reach this very week. And there's hardly any recovery at all. Though if reality were truly at K-R Stage 2, Acceptance, we'd be moving on to figure out how to cope. So don't be surprised if there are some more Koolaid consumption episodes. The stuff is really addictive. But we think we're seeing some serious attempts by Mr. Market to go cold turkey and detox. One step at a time.

Speaking of De-Tox

Let's take a slightly shorter timeframe and see whether or not that detoxification program is beginning to set in. Like we said the bear market rally was pretty short and shallow in comparison to March's. If you take a look at this chart you can see where the rally was decisively busted apart, initially on the economic news. Yet in the intervening two weeks we've had huge swings for what amounts to a sideways market. So don't be surprised at some bounces while the toxins are sweated out. But what we think we're seeing is a fundamental shift in mental outlook here. Dr. Pangloss is in the process of being booted out of the building...at long last and at least 18 months over-due.

Beyond the Veils of Delusion 

The Buddhists have it right though - the world is filled with pain and it is inescapable. Whether it turns into suffering depends on your head - if all you can do is see the pain then you'll be consumed by the suffering. If you accept the pain for what it really is, don't deny and don't get hooked by the perverse pleasures of the suffering or looking for the "drugs" to offset you can keep your balance and figure out a way to cope.

And to our great delight we think that process of seeing the world as it really is and what needs to be done to cope with it is getting wider recognition and acceptence. First of the 12 Steps, eh ? Our reference points are the several articels we've made a point of drawing your attnention to recently that, for the first time in months, perhaps years, see the world the way we're seeing it. And this evening's WSJ had another which is as good a summary of the various feedback cycles that are feeding on one another. Heavens - soon we'll all be systems analysts together. (News Alert: Vicious Credit, Economy, Market Cycle Spotted) This one was so important we excerpted big chunks but it's as good an encapsulation as anything we've read. Also in the readings you'll find running softclips on LEH, WM, and AIG. Who as we speak are in the process of following BSC, FRE and FNM off the cliffs. Sadly that's not the Acapulco waterline below but rocks. The tide's out. 

Continue reading "The End is Nigh ? (Update2): Frannie, Leh, WamU, AIG and Wild, Wild Markets" »

Posted by dblwyo at 07:44 PM | Permalink | Comments (0)

A little earlier this evening an interesting and very major story just came out on the WSJ online that Fannie and Freddie are about to have the Treasury impose a "rescue" plan of some sort or another. We'll see what happens over the weekend but it looks like the long-delayed other boot (Paul Bunyan's spare) is about to be dropped. This is good news and bad news. You might want to review a little history (Bad Times, Really Bad Behavior, Bad Trouble: Fannie/Freddie and Perdition Road). This is ironic since the markets, after reacting in what we consider a properly rational way to an abysmal employment report, rallied back today to close in positive territory for the non-tech businesses. Guess what - it was the Financials, the Homebuilders and Consumer Discretionary that were up. All the things that a metastasizing credit credit crisis and an accelerating slowdown are going to hurt the worst. The continued triumph of delusion over analysis IOHO. Ironically in the after-hours markets the Frannie Twins were down about -20%+ ! Though to be fair, if very confused, XLF was up almost 5% and XHB up almost 3%. Clearly the weekenders think Frannie is toast but it bodes well for the financials and the homebuilders. BtW Barry Ritholz has obviously been up and reading as his excellent summary of the news is here: Roundup: Fannie & Freddie Bailout. His opinions about socialist bailouts are another thing IOHO.

Weekend Updates and Summaries: BigPicture, CalculatedRisk and Matt Trivvsanno & crew have come thru with summaries analysis and consequences that you should have in you reading lists.

BigPicture: Fannie & Freddie Weekend Wrap Up/Linkfest,Treasury Takeover of GSEs: 10 Key Points

CalculatedRisk: Fannie & Freddie Thoughts

Matt  Trivisonno: The Fan-Fred Short-Squeeze Rally

Update2: More interesting news below in the readings section detailing the behind the scenes on the Frannie rescue AND the impact on the Housing markets. Plus an assessment of widespread the problems with banking capital shortfalls are. Confirm our themes and "worsen" them in essence.

Let us try and disabuse everyone of those notions  that  a) a Frannie bailout is pork-barrel politics, b) that the Financials are /will be in good shape and c) it's safe to get back in. And do so by complementing all the news roundups with our usual focus on the  structural context and consequences. In other words , what's the lay of the land and what's the weather therein.

State of the  Credit Markets

 Starting by looking at the state of the credit markets using some of our standard indicators. What you see here are three different credit/money market measures the can tell us quite a bit about what's going on. First up is the spread between FedFunds and 10Yr Treasuries - which mixes instruments a bit - but is still telling us that the Yield Curve is "market favorable". That is short-term money is cheap, which generally encourages investing because borrowing is inexpensive. And longer-term money ain't that expensive at around 4% and dropping. But the really interesting thing about that spread is the abrupt switch around Nov. from no spread, indicating a flat/inverted yield curve and tight short-term money, to now. In this puzzle-palace world the short-term drop was Fed policy at work but why the long-term rates are staying up is....dollar ?

More interesting though is the spread between 3Mo Treasures and corporate commercial paper, which is still very elevated over last year and appears to be rising. An indicator that there's still a lot of fear and uncertainty in the market. Finally is the inflation-adjusted monetary base which tells us the effective supply of money is growing or shrinking. Normally it shrinks during downturns and this time is no exception ...except it's been shrinking longer and farther than the economy's been downturning so far ! The reason - it's called credit tightening. In other words the credit markets are working but under enormous pressures. If you'd like to see a really cool and implicitly informative history of how the yield curve works and relates to the markets try this: Dynamic Yield Curve. And in case you're wondering why you care Wikipedia has a decent, thorough and balanced description.

Frannie's Failures and Consequences 

After the break you'll find a largish collection of readings that bear on all this from the news that the Chinese banks have backed away from Frannie, for what now seem like sound, rational reasons. Which makes the rates they have to pay to borrow higher, funding harder to get and so on. Which leads us to one of the gray-headed potential triggers - though it's been months/years in the making. Bill Gross's latest newsletter talked about a financial tsunami freezing up and then collapsing the markets and specifically the need to rescue Frannie on Thur. But he wasn't alone - Paul Volcker, perhaps the most respected central banker in seven decades, came out flatly the same day and said the system is broken, more write-offs are coming and we need to re-engineer it. He further added he's never seen a crisis this complex or painful.

Our fear is that once we move beyond the perennial Pollyannas and into more realistic territory there's still a limited grasp of what a breakdown in Frannie, let alone the whole system, would mean for the economy. Shucks...:) We're not even sure we get it and we've been flapping our gums for months. Certainly if the XLF keeps getting run up like this though our fears of a major breakdown are very far afield from the common understanding. In other words there's still a lot of piping to pay for and Bill and Paul are telling us the bill's coming due. 

There's a bunch of other readings we think are worth your time including some more on the lingering after-effects and some very good discussion, similar to questions we've raised but now done in a wider venue by somebody who's very knowledgeable, about the future down-sizing of the industry. Plus some interesting stories of folks who have been or are navigating these storms thru what we'd call business acumen, guts and discipline. 

The one story though we really urge you to click thru, read, download think about is Robert Solow's review of Kevin Phillips book on "Bad Money". His shrill polemic against the Finance Industry. While there's a lot wrong he apparently didn't bother to figure out what worked but dug up some 100 year old anti-capitalist conspiracy theory stuff from William Jennings Bryan and his "cross of gold" speeches and re-furbished them. Now we're not denying there's a lot broken and a lot of malfeasant behavior since we've been arguing that as well. What Solow - btw, one of the best 100 economists of the last sixty plus years and a Nobel winner - does is is take you on a detailed tour and analytical dissection of the industry and the roles it plays and why it's so necessary. While also discussing what's wrong and thoughts about fixing it. 

Final Words: Frannie, Systemic Risk and Malfeasance

There's a lot of words being bandied about that this is yet another example of socialist intervention in the markets. Instead they screwed up, let them fail. Well this is disingenous at best and also ignorant both of how one thing leads to another and what underpins markets. Here are some things to think about that'll help you correct that.

1. First put out the fire and save the women and the children, don't lock the door because they aren't correctly dressed to appear in public.

2. Use this crisis to make structural repairs that regulators, the Fed (Greenspan) and others have been trying to make for years, if not decades, as Frannie increasingly spiraled out of control thru lobbying and corruption of Congress to protect its' interests and in the name of greed.

3. We all benefited from that greed and wallowed in it. The only thing that held up the US economy after the '01 downturn was Housing and what drove housing was debt securitization. There is no single one of us who's investments, incomes, jobs and general well-being didn't benefit some way or another. Old sayings come to mind...either when you eat at the King's table be loyal to your salt...or bring your own taster. Or both.

4. As the chart makes clear a Frannie failure would turn a nightmare Housing market into a catastrophic collapse and be a systemic threat to the entire financial system. BSC was a Sunday park stroll as compared to the Mongols' visit to Baghdad in comparison. But that's not the worst of it - because the full faith and credit of the US government was involved and exploited the credit-worthiness of the US Treasury was and is at stake and the Chinese have fired more than one public warning shot. For a fuller discussion of the consequences Jim Jubak does a beautiful job: The huge threat to the US economy

5. Markets don't exist in a vacuum but rely on a whole host of hidden infrastructure from a legal system to enforce contracts to security forces to make sure that one is free to trade and exchange as well as to defend the property you're trading and filing law suites over. The financial markets wouldn't exist without the regulatory framework that's been evolved to ensure their smooth, orderly and honest functioning over the last eight decades. That machinery is creaky and aging and needs a major overhaul. But to pretend it doesn't exist nor that it isn't in the public interest is ill-informed, to say the last (again we refer you to Solow's review).

With all the ideological ranting and raving you'll make better decisions if you understand the organic dependency of markets on government instead of pretending it doesn't exist. With that in mind here's the readings to back up some or all of those assertions.

Continue reading "Frannie From Pan to Fire (Update2): Rescue Me...Us...the System ?" »

Posted by dblwyo at 09:12 AM | Permalink | Comments (0)

Well we'll savor just a small smidgeon of feeling prescient today. Not only are the markets being led down by the Finance sector but one of Bloomberg's lead-off articles (picked up and reinforced as a must-read by BigPicture) was on the re-emergence of the credit squeeze. This morning's other major economic news was Existing Home Sales, which when you take it apart was about as bad as it could be. The headline, as usual for the MSM when dealing with such profound subtleties as recurring seasonal patterns visible for decades, was far off base: Existing Home Sales Top Estimates But Prices Plunge.The real goto is of course CalculatedRisk July Existing Home Sales: Record Inventory . There'll you find that the news was about as bad as it could be with a significant rise in months of sales inventory, a severe price decline, a dominance of foreclosure and short sales and a severe YoY drop in sales. You may recall our post on the crisis coming to head with Fannie and Freddie, perhaps this week which concluded with a promise/threat to take a deep dive review of the structural problems facing the Credit Markets and the Finance Industry and the chart above. What that charts shows in looking at the inflation-adjusted monetary base is that as THE result of the credit crisis liquidity is fast disappearing. While conversely the spread between 10Yr Treasures and Fed Funds, which normally shrinks during a downturn along with a drop in the Monetary Base in a previously predictable pattern, has jumped significantly. A kind of reverse conundrum where instead of long-term rates staying low when they shouldn't as the result of worldwide liquidity excesses they're increasing as those excesses are being drained from the system.

After the break we pull together several prior analysis of the various structural aspects of the crisis so you can see them all in one place and get a better handle on how they all play out together. But we want to start you with a selection of the weekend's headlines, to which you need to pay some careful attention.

Libor Signals Credit Seizing Up as Banks Balk at Lending in Money Markets Most of the bond strategists and salesmen that Resolution Investment Management Ltd.'s Stuart Thomson talked to last August expected the credit crunch to be long over by now. Instead, money markets show there's no end in sight, and it may even worsen. ``It's like an ongoing nightmare and no one is sure when we're going to wake up,'' said Thomson, a money manager in Glasgow at Resolution, which oversees $46 billion in bonds. ``Things are going to get worse before they get better.'' In a replay of the last four months of 2007, interest-rate derivatives imply that banks are becoming more hesitant to lend on speculation credit losses will increase as the global economic slowdown deepens.

Freddie, Fannie Failure Could Be World `Catastrophe,' Yu Says A failure of U.S. mortgage finance companies Fannie Mae and Freddie Mac could be a catastrophe for the global financial system, said Yu Yongding, a former adviser to China's central bank. ``If the U.S. government allows Fannie and Freddie to fail and international investors are not compensated adequately, the consequences will be catastrophic,'' Yu said in e-mailed answers to questions yesterday. ``If it is not the end of the world, it is the end of the current international financial system.''

View of economy somber from Fed mountain retreat 

"This turmoil is not going to go away quickly and will require serious efforts to overcome it," John Lipsky IMF

"The financial storm that reached gale force some weeks before our last meeting here in Jackson Hole has not yet subsided, and its effects on the broader economy are becoming apparent," Bernanke

"That's where we are today, in the middle of a financial crisis, with the economy sliding into recession, with monetary policy at maximum easing, and fiscal transfers impotent," Martin Feldstein, Harvard, NBER"More than a year into the most challenging financial crisis of our times we now face a complex and interlocking combination of rising inflation, declining growth, tightening credit conditions, and widespread liquidity tensions," Mario Draghi , ECB, Bank of Italy

A Shallow Recession -- Then a Shallow Recovery Is there a sign of a bottom in financials?The leverage in the financial-service industry is going to be wound down a lot, and I don't think the return on equity for these companies is going to be as great as it has been in the past. So the earnings for these companies in the next up-cycle aren't going to be as good. Maybe the financials have gone down as far as they are going to go down, but I don't think they are going up with any verve. And it sounds as if you see the business model changing for these firms, and becoming less profitable in the post-credit-crunch world.When I came into this business in the mid-1960s, what a doctor made or what I made as a securities analyst or what a lawyer made working at a big firm was all the same. Five years out, our compensation had increased -- pretty much in parallel. But in the period from 1982 to 1999, the compensation in financial services expanded much more rapidly than it did in any other field. I don't know that a securities analyst is a whole lot smarter than a lawyer at a major law firm, and I don't see why securities analysts or investment bankers should be paid so much more. So I think there's going to be a convergence of compensation.

 They start with the aforementioned Bloomberg story about the resurgence of tough credit market conditions. Followed by what should be the scariest of them all - a quasi-official warning from a Chinese economist that the Chinese government is counting on being made whole in any FNM/FRE rescue. In other words the credit worthiness of the US government is on tender here - the alternative being a credit implosion that would make the BSC collapse a Su. walk in the park. Then of course the sages and gurus have issued their findings from the mountaintop and see nothing but continued trouble ahead. And finally an excerpt from a Barron's interview with Byron Wien in which he tells us the adjustment process of drying out the liquidity excesses will go on for years and that the Finance Industry as we knew it will disappear for ever.

After the break we walk thru the spreading credit contagion (the Rocks in the Pond or RiP Model), the linkages between credit and economic conditions, the bad feedback between the credit contagion and the economy and the implosion of Finance Industry business models. Needless to say we're making three key points.

1. This isn't over by a long shot.

2. There is a developing vicious feedback loop between credit problems and the economy which is likely to get worse before it gets better.

3. The Finance Industry as we've known it for almost 25 years is about to go thru an enormous re-structuring. 

Continue reading "A Smidge of Prescience, a Tun of Hurt: Finance Industry Issues Review" »

Posted by dblwyo at 10:35 AM | Permalink | Comments (0)

Well diving back into the on-going trials and tribulations of the Finance Industry wasn't today's strategic objective but with the industry ETF (XLF) up 3.3% and LEH closing up 7.4%, after being up over 11% on rumors of some sort of buyout, injection, something it seemed necessary. In a perverse way it pairs perfectly with the prior discussion of the dismal and deteriorating Retail outlook. The Finance outlook is much worse and the causes are linked - there's still more write-offs, the economic downturn will worsen loan losses and credit continues to tighten. In fact the spreads on some corporate bonds, discussed in the readings, are getting so bad that the credit markets are clearly anticipating a wave of bankruptcies in both the Finance industry and the general economy as the result of all this.

After the break you'll find the usual collection of readings. We want to couple those readings with an analytic review of the economy, monetary situation, the credit markets and the industry outlook. Which is far too much for one post so we're putting up this part with the readings and a few kickstart graphics and will plan to follow-up with the analytical dissection later. The readings are broken up into three clusters: some general stuff and examples, including some excellent BNN interviews which we've annotated a tad, some specifics on the disaster children (LEH, FNM, FRE) and some other exemplars (MER, AIG). The excerpts for the later, especially AIG, illustrate the pit fall trying to apply traditional analysis to companies facing these perfect storms of problems AND broken business models. On the other hand Dennis Berman's dissection of MER's stock float and the implications for the future is an excellent example of the kind of thinking that should go on. As is the BNN interview with Dick Bove where, among other bon mot gems, he points out that Dick Fuld of LEH has three days to pull the trigger or get bought in a hostile takeover. If not in so many words. The other thing that folks are missing, for all practical purposes, is that the Fannie and Freddie are effectively bankrupt with stock prices as close to zero as makes no never mind. What's going to happen when they have to be salvaged we wonder ? Talk about the collapse of Western Civilization if BSC was a threat this is the 8,000lb pre-historic ape in the parlor. We'll pick up the graphic with the next post but it shows a shrinking money basis as credit tightens and a rising yield spread between Fed Funds and 10Yr Treasuries. Most likely due to worries over the dollar and interest rates as the result of all this mess. Think about it in this context.

The Lehman Disaster 

And then consider the accompanying LEH stock chart, which shows today's bump true enough. But also shows the implosion over the last year as all these problems eat away at it. Today's little bump up in this context doesn't mean so much does it ? Wonder how it managed to take the markets up with it ? The story is that all the folks approached by Fuld have been balking because he wants 20% over book value, i.e. a ~ $40 price. Instead he'll be lucky to get $15-20 and has destroyed his company by not dealing with these problems. As Bove points out.

The Fannie/Freddie Catastrophe

But whatever has been going on at LEH is nothing compared to FNM and FRE - which are central not just to the Housing market but to our economy. Talk about too big to fail ! The "funny" thing is that when you dig back thru it, like MER and Citi, most of the really bad crap they engineered for themselves was done in '06 and '07. In other words after the crisis in Housing was generally visible and should have been crystal clear to companies who's entire existence depended on understanding those markets and mechanics. Talk about your boiled frogs being flayed and displayed. 

We dissected all that at great length in a prior post which you may want to review:

Bad Times, Really Bad Behavior, Bad Trouble: Fannie/Freddie and Perdition Road

Continue reading "Pits, Pendulums and Perils: LEH, FNM, FRE and Other Walking Wounded" »

Posted by dblwyo at 02:58 PM | Permalink | Comments (0)

We interrupt our regularly scheduled posting to warn you that our early storm warning system has detected more early signs of bad credit weather. Over the weekend our alert news monitors found a new wave of back-on-balance sheet adjustments, Fannie Mae issued worse than expected news, both GSE's (FNM, FRE) announced that they would be restricting new mortgage loans and guarantees. And (H/T CalculatedRisk) Fannie's conference call tells us that the books closed in June but there were significant deteriorations in July MORE THAN THEY ANTICIPATED when putting together their books. As you can see from the early warning reserve dashboard Fannie has both upped its' reserves and doesn't begin to cover its' risks. Making a huge Treasury equity investment increasingly likely, indeed mandatory to keep them from sliding into major default (dare one say the BK-word ?) and at least threatening to follow Merrill in throwing existing stockholders to the wolves of insolvency.

What's It All Mean: the Vicious Circle Grinds On 

 

Continue reading "News Alert: Vicious Credit, Economy, Market Cycle Spotted" »

Posted by dblwyo at 11:28 AM | Permalink | Comments (0)

Having hopefully laid some groundwork with the prior post (Cramer's Anniversary: Continuing Credit Metastasis and Economic Outlook) on the continuing metastasis of the credit crunch and what it means for the Finance Industry, and its' links to and from the Economy, it's time to dive back into the muck. Sorta speaking of which we'll also point back to our posts (Tipping Points, Blindsides, Ouches: Tough Times Getting Tougher) on the tipping point being crossed into a much more rapidly weakening economy and ask you to keep that in mind as well - in spite of today's near-olympian euphoria in the markets. A small confession first though - we are SO.....O tired of talking about the Finance Industry. Why don't they just get this over ! Unfortuantely we may be 1/3-1/2 thru the Housing price declines but we're barely 1/4 thru the Housing downturn and it'll take much...much longer for the consequences to work thru the credit machinery. In other words be prepared to be swimming in this gunk for a long time to come. For proper perspective we give Mark Gilbert's pastische and parody of a famous Monty Ptyhon skit which is uproariously funny and painfully accurate:

CDO Market Is Dead, Not Just Pining for Fjords Hedge-Fund Guy enters an investment bank. ``I wish to complain about this derivative security what I purchased not two years ago from this very boutique,'' he says. ``Ah yes, the Collateralized-Debt Obligation,'' says the Wall Street Banker. ``What's wrong with him?'' ``I'll tell you what's wrong with him, my lad. He's dead, that's what's wrong with him!'' Wall Street Banker: ``No, no, he's ... restin'.'' Hedge-Fund Guy: ``Look, matey, I know a dead derivative when I see one, and I'm looking at one right now.'' ``No, no, he's not dead, he's restin'! Remarkable investment, the CDO, isn't it? Beautiful plumage!'' ``The plumage don't enter into it. He's stone dead.'' ``Nononono, no, no! He's restin'!'' 

GSE's as Exemplars: Fannie, Freddie and
the Disaster of Our Making

To understand what's going on with the breakdown of the markets we're going to use the GSE's Fannie and Freddie as our bad examples along with a large collection of other readings - all from the last few days (think of this as something like 20 normal blog posts rolled into one as usual). The Marketwatch vidclip (H/T BigPicture) of an interview with real estate economist Ken Rosen walks thru ALL the big problems facing the GSEs and the rest of the industry. Capital raising, more housing downturns (and other loans for others), more write-offs, more capital raising, shareholder dilution (destruction) and a long way to go in Housing alone. Listen to it for itself, to set the stage and on a third level think that this applies to every other financial firm in "same differences".

Risk Management vs Prudence

Not since this week it's become fashionable to get the crap out of Fannie and Freddie, as as the accompany chart shows you, there's some good reasons for that. (click to enlarge in a seperate window please). What's startling about that is that as several astute and prescient observers were already waving their arms and shouting fire the GSEs were lowering their loan standards and upping the Loan-to-Value limits beyond all reasons. All in the name of a) business competition and b) in adherence to their charter (see below for a couple of CNBC interviews with the current Fannie CEO on this). Lest we think too harshly of these guys however let's remember that not to long ago (three months ?!!) the entire country was banking on these guys to bail the entire country out of the housing disaster. After we all knew that they were in serious trouble.

We Were All in This Together

While we're all finger-pointing at Fannie, Freddie, the malfeasant Finance Industry and the evil real estate and mortgage broker types we ought to remember something. Directly or indirectly we all bellied up, or down as the case may be, to the trough to get our share of the slops. After the Tech Bust we were headed for a major downturn that was only averted by a historically surprising and entirely anomolous sustained level of consumer spending. Take a look at the associated composite chart, courtesy of CalculatedRisk. The top sub-chart shows GDP with and without Mortgage Equity Withdrawls. It doesn't take much decipherement to figure out that without MEW we'd have been in a really serious downturn - the D work might have been even appropriate. Or least the Japanese malaise. After the construction kept confusing people CR started just reporting MEW - absolutely and as a % of Disposable Income. From his work we can see that MEW ran between $100-$200B per quarter. And we're all excited about a single $150B stimulus ? Without Housing where would consumer spending have been ? And jobs ? And the markets ? The bottomlines here my friends are that without all those financial shenanigans we'd have been in the you-know-what.

Profits and Outlooks

After the break you'll find a large collection of readings that start with documenting the Dead Parrot bounce we're going thru and what some of the real data mean. For example a wonderfully eloquent rant by Barry Ritholz on really understanding Pending Home Sales - which almost everybody got as wrong as possible. We then dig into the cultural and institutional reasons for how and why we got into this mess - in particularly read "Confessions of a risk manager " for a realistic tale of the trenches. The last section talks about particularly players and uses three key ones to tell critical aspects of the story. From AIG we learn why being blind to the hand-writing on the wall is deadly dangerous. From FNM and FRE we learn that and how much farther there is to go for them and for the rest of the key players. We start that section with two old history softclips - sorry no URL's available - to remind us that once they were widow and orphan stocks then sequed into exemplars of bad practices and malfeasances from which they hadn't recovered when business urges and congressional and public pressure pushed them into bad decisions. With half the US mortgage market mind you - and the faith and credit of the entire US now at risk. Think about that for a minute. And finally we use Merrill to show what happens when the wolves catch the sleigh - somebody gets thrown overboard to buy some more time.

Continue reading "Riding the Storm - NOT: Breakdowns, Culture & Malfeasance in Finance" »

Posted by dblwyo at 10:16 AM | Permalink | Comments (1)

The Road to Perdition is paved often by good intentions and traveled by opportunists and in the near collapse of Fannie and Freddie we have both working over time over years, even decades. But in the last several days and weeks the shibbolethic ideologists have certainly been getting their licks in to. Not to long ago, despite the fundamental structural flaws being well-known, we were fantasizing about propping up the Housing freefall with GSE debt and loans. Unbelievable - das ist unsinn as my old German teacher used to say. And on the other side we have well-informed people ranting about rampant socialism and throwing their usual careful focus on the facts and the nature of things to the wind. We won't mention names but you know who y'all are. After the break there's a bunch of carefully selected readings which we hope you skim. If you haven't the time to go read them all then the last couple - the Economists dissection of the situation and the structural flaws and Larry Summer's short, pithy and brilliantly insightful summary are essential.

Essential, why ? Well first off let's put it in context. Combined they hold over $5 Trillion in mortgages and guarantees and are counter-parties to another $2.3T in credit swaps. We're talking here about numbers so unbelievably huge that the sovereign credit and wealth of major worldwide economies are the only basis of comparison. Right now we're in the worst financial structural breakdown we've seen since the Great Depression but it has barely scratched the performance of the economy unlike that earlier episode. Why ? Because policy-makers have a much deeper and more profound understanding of how to manage markets. It was policy error that turned the Great Crash into the Depression. And from Aug07 to Mar08 we were headed that way because non of the traditional instruments were working as they should in normal cyclic patterns. This was a structural problem. When BSC went down that, IOHO, seriously threatened the stability of the entire system. To understand the difference between what happens if/when BSC was allowed to go under in capitalist purity and what would happen if FNM/FRE went you need to wrap your head aroung the Richter Scale. A reading of 2.0 vs 4.0 is not twicet - each number up is 10X the prior number. But that's not the real rub - the energy release scales by a power law so that a difference in magnitude of 2 represents a 1000X more energy. BSC was a 3, maybe a 4.0. A collapse of the GSEs would be an 8.0, maybe a 9.0. The difference between a kiloton explosion and a gigaton in the financial system.

All of this ideological prattling about socialist intervention is utter nonsense, it's also extremely disingenuous as well. On at least two strategic fronts and sustained over years. The most recent one being that it was spending on Housing and the Housing ATM that allowed us to sail past the Tech Bust without a major downturn. Now if the GSEs were/are half, at least, of the mortgage markets, and as the giant players, define the cost structure where do you think we'd have been without their implicit subsidies of lower than market mortgage rates ? Where would the economy have been ? And where would the so-called rally from '02-'07 have been ? All of which the critics benefited from without objecting to how the sausage factory was working.

But our turning a blind eye to the sausage factory health standards has gone on for decades. The GSE's managed to run with minimal supervision, grow into a serious threat to the Western world (literally), maniuplate their books and bribe Congress widely and deeply for years with our implicit cooperation. Greenspan, and to his great credit Bush, started trying to tackle all this back in '04 when accounting shennigans finally caught up with the Pashas and Mandarins of the GSEs. But again we've benefited for years ourselves. As the Economist points out the GSE are/were leveraged  up about 65X - a level no private company would ever be allowed to run at and one possible only with wink-wink, nod-nod government backing.

Which gets to the second bottom line and then the third. Since everybody saw thru the veil of independence to the implicit guarantee what's really at stake here is the faith and credence of US government debt. If we let Fannie and Freddie go what won't we not stand behind next ? And how good is the dollar - who'd want to keep their reserves in the currency of the banana republics ? Those are literally and legitimately the kinds of questions lurking in the backs of the minds of Finance Ministries all over the world. If a direct collapse could have been an R-scale event of 8.0 then the impact on our ability to borrow, on interest rates and on the dollar would be a 10.0 !

Which is not to say this can be allowed to continue either - as Summers points out. The last time we backed ourselves into these corners where the government guaranteed the S&L mess without forcing changes in business models, operations, policies, risk management and controls was a disaster with a huge bill. We need to get thru this and then re-engineer the GSEs. Which is exactly what Paulsen and Bernanke are proposing. And have apparently been working on for months if not years.

So it's time to throw out the ideological, man the pumps, repair the ship and get her to port. And then re-build her from the ground up. Or else. Oh btw that R10.0, let me quote:

10.0+ Epic Never recorded; see below for equivalent seismic energy yield. Extremely rare (Unknown). 1 teraton equivalent. Estimate for a 2 km (~1.2 mi) rocky meteorite impacting at 25 km/s (~55,000 mph)

Continue reading "Bad Times, Really Bad Behavior, Bad Trouble: Fannie/Freddie and Perdition Road" »

Posted by dblwyo at 07:27 PM | Permalink | Comments (0)

Sometimes you work to a plan and sometimes you get interrupted by events. If you can put the events into the context of the plan we call that interrupt-driven event-managed, the sine qua non of aglity and resilience :). In this case the plan was to take forward the prior economic discussions and apply the implications to various business sectors. The last two days of market gyrations, Merrill's stunning announcements and some serendipitous inside scoop from Big Picture cause us to change course...a little. Consider the following excerpt from a recent post:

 Merrill's $5.7B Write-Down, $8.5B Share Issuance My (naive) question: "Wait a second -- didn't Merrill just report last week? How did they not disclose a $5.7 billion dollar whackage?"Merrill guy's by-the-book-answer: "Earnings were the 17th; The decision had not yet been made to sell the ABS CDOs, or take the writedown, or issue more stock. That was done this week." I think:  "yeah, sure it was."  Frickin weasels. 

Other Merrill guy says: "Geez, the stock is gonna get hit tomorrow" (ya think?) The stock closed Monday at $24.33, down 55% year-to-date. Merrill woman: "When do we buy this?" CDO guy: "When it hits $15" Me: Ouch!

Only that wasn't quite how it played out. The markets nose-dived yesterday and got another nosebleed today from re-climbing back to their previous altitudes. As Barry occasionally puts it ...WTF !!! Take a look at the accompany 10-Day composite chart of the SPX and NDX and tell me it all makes sense you. Particularly in light of the last two posts on the domestic and international economic situation (Note: trade talks have collapse - NOW that's really bad news as we discussed). No way that all makes sense. The commentary yesterday was that the IMF report on Housing troubles was the trigger and the running unsinn today that better confidence was the re-trigger. BS ! But let's put those arguments to bed.

WTF 1: Real Data on Confidence and Housing Prices 

The first composite chart shows U of Mich. consumer sentiment on a YoY% and absolute basis. Notice that YoY changes are as bad or worse as the Volcker-Reagan surprise short-stop of the economy that broke inflation. But on an absolute basis they're as bad as we've seen in nearly 30 years. Headlines may talk about MtM improvements but in actual fact these haven't been worse in a long...long time.

Now, courtesy of Calculated Risk consider the composite of Housing prices based on this morning's SP Case-Shiller reports. Ditto...they also are about as bad on both an absolute and YoY basis as we've seen in a very long time. Much worse if you think thru the absolute numbers we'd think that there's a long way to go before a semblance of normalcy returns to the housing markets....years of future pain. Now everybody may be getting jaded.

WTF 2: What Really Happened ?

On the basis of those charts plus Merrill's stunning anouncement, which follows right on the heels (that's deliberate - heels as in slimebxxx not heals as in fixes or even heels as in bringing up the rear) of MER's recent earnings announcements which said "we're under control, don't need more capital and no more write-offs. Sheesh.... Several reactions.

1. If they didn't know this was coming a few days ago their grasp of their own situation is sadly deficient and the company is completely out of control (which should also make you wonder about the rest of the industry).

2. If they did know it was coming and weren't ready or refused to couple the two together that's borderline malfeasance. If the deception was deliberate it's beyond borderline and on a murderous cattle raid that should start a war.

But wait, there's more.

3. Yesterday's news should have been insufficient to trigger the major drops we saw, especially since it was triggered and driven by financials. If it was/is true then today's more credible news on the economy PLUS MER's announcements should have seen an even bigger drop.

4. It looks like the details of the announcement got leaked out all over the place without being formally and publicly announced yesterday. That, I believe, satisfies the technical definition of criminal. Now we're beyond bad companies and into bad judgement and bad behavior - can you spell integrity.

5. Oh BtW, as long as we're having several WTF moments - the recent fantasy rally was based on the Financials having seen reality, admitted it and cleaned it up. So much for that notion.

Who do you think can trust to tell anything resembling the truth at this point ? Now there's a question you should never have to ask. It's one thing - not a good one IOHO - to spin-doctor to keep the patrons from stampeding in the fire. It's entirely another to tell them there was no fire, there is no fire and anyway it's out. And leave the building while leaving them there watching the movie.

After the break are some readings you might want to consider on this business picture designed to survey the depth and breadth of the breakage as well as provide some guidances for finding candidate truth-tellers. 

Update: BNN comes thru again with the best, substantive and human discussions that'll actually do you some good instead of being more tainment than info

 Scott Peterson reports on Merrill Lynch & Co.'s plans to raise $8.5B by selling stock.

 BNN speaks to Janet Tavakoli, president, Tavakoli Structured Finance Inc.

Continue reading "Bad Times, Bad Behavior: Merrill, Malfeasance, Markdowns, Markets" »

Posted by dblwyo at 11:21 AM | Permalink | Comments (0)

Time to re-visit some confessionals. In case you didn't notice the recent market rally was driven by the Financials ! Of all things. And they were driven by better than expected earnings, i.e. smaller than disastrous write-offs and terrible but not catastrophic impacts to their bottomlines. Unfortunately when you actually start parsing the news instead of reading the newswires PR announcements a slightly different set of pictures emerges. But let's start with this "simple", by our standards, little chart of the Finance ETF, XLF. On the "since Oct" chart the recent runup was huge IOHO - more even than the April surprise when it was all over. When you look at the 10-day chart you get the more granular anatomy and that it's starting to fade. Hopefully as some semblance of reality fades in. It hardly took a day, or less than, for the talking heads to get trotted out to talk about "worst is over" again and the time to be investigating putting money to work in the financials was now. One of the readings you'll see excerpted is about Bill Miller - the most exemplary fund manager of legend of the last two decades - who got completely trimmed up by large and bad bets on just that thesis. What happened ? Well for one thing let's remind ourselves of the arguments from the last post about what constitutes a good company (Bad Times, Good Companies: Who's Swimming Naked). And then suggest that we're looking at bad times for bad companies.

 Economic Consequences

 But, before pursuing that, you need to think about the consequences which are complex, convoluted but ultimately not surprising. When banks start writing off big numbers they take big hits on their capital and have less to loan. When they think the economic situation isn't good they tighten up lending standards. The end results is that credit gets scarcer and the economy experiences more down-pressure. Which gets reflected in interest rates and the money supply. Which is worsened in a credit crisis by elevated rates as risks are re-priced. All of which you see in this chart. On the top the 3Mo spread between Treasuries and Financial commercial paper remain at elevated levels while the spread between higher quality and more risky corporate bonds does as well. The really fascinating, puzzling and scary thing is that the spread between very short-term Fed Funds and 10Yr Treasuries has widened out enormously. That usually only happens when the economy is booming, there's a serious fear of inflation or rates are getting driven up by exchange rate pressures. Almost none of that seems to be the problem right now though. The middle chart shows the YoY% growth in the inflation-adjusted monetary base - and it's approx. 3.5% and returning to a downtrend. In other words despite a slowing economy, very low Fed rates and everything else that should be mitigating things credit is drying up at a serious rate. And it's NOT inflation as you can see on the bottom which compares core CPI to the spread between TIPs and 10YRs. The biggest, most astute and biggest bettors in the world don't see inflation as a problem. After parsing all the puts and takes we end up with a metastasizing credit crunch slowly oozing its' way/weight thru the economy. And you wondered why mortgage rates were jumping !

Business Implications & Inferences

Returning to contemplate the XLF jump leaves one more than a bit puzzled. Here's a set of hypothesis that you might want to kick around.

1. The Fed thru magic, innovation and cojones has created enough instruments to provide technical tools to address the credit crisis but we're still faced with the consequences of bad business decisions and a slowing economy. At least we're not facing collapse as we were in March.

2. The Financials have "merely" worked their way thru the immediate consequences of the crisis, not the crunch. As the economy slows the "credit death spiral" we've talked about before will start working it's way on their balance sheets, losses and loss provisions. With attendant impacts on profit and credit availability. IN other words this still has a long way to go. AmExp's results should be reviewed for the reality check.

3. None of this is/was being factored into the market's thinking on the financials....otherwise we shouldn't have seen a bounce.

4. Another thing we've talked about is broken business models, the strategic consequences of de-leveraging and the need to fundamental re-think all the major banking/finance segments for future prospects when leverage gets driven to a more rational 10X or less from the 20-30X that many were depending on for profits.

5. While several commentators have noted this from Charlie Gasparino to Bill Gross it would appear to not be being reflected in much of anyone's real thinking or investing. We refer you to Jim Jubak's recent column (today ?) on the terrible outlook for several major financials. In his and our estimation this is going to take years to re-engineer. And nobody is facing that music that we can tell. On any front.

We'll refer you back to a prior post (Red Sky Mornings, Investor Take Warning: More Finance Industry) for more graphics and discussion of leverage vs business models vs breakage. But if you don't look at much else please take a moment and consider these two CNBC vidclips:

• Getting Back to the Basics The future of Wall Street lies in its simpler sleeker past, says George Ball, Sanders Morris Harris Group.
• Merrill's Comeback Man CNBC's Charlie Gasparino takes a look at the executive who helped Merrill Lynch raise billions in new capital seven months ago.

UPDATE: One of the great recent discovers I"ve made is how truly balanced and sensible the Canadian Business News Network is. More on that later but for now here's a very recent clip outlining why a sensible sounding sr. investor thinks it's time to get back into Financials:

• BNN sets you up for your trading day with Clement Gignac, senior VP, chief economist and strategist, National Bank Financial.
  

As it happens I continue to disagree with him for all the reasons discussed but his reasoning would be reasonable if we were in normal times. Nonetheless he's clear, articulate and intelligent interviewed. A real pleasure to listen to !! 

Continue reading "Bad Times, Bad Companies: More Finance Industry" »

Posted by dblwyo at 01:50 PM | Permalink | Comments (0)

Recognize the old saying ? "Red sky at night, sailors delight. Red sky in the morning, sailor take warning" ? It's actually grounded in science....as well as centuries of experience. Where the winds tended to be Easterlies a red morning sky meant the sun was being reflected off heavy cloud cover, i.e. storms. We seem to be in the process of alternately re-discovering red skies in the Finance Industry and panicing and then thinking the storms have missed us.

The next step after the Economy post was going to be looking at the Int'l situation but we're coming back and jumping on the Finance Industry instead because of the weekend bailout of Fannie and Freddie and the FDIC taking control of a failed CA thrift, Indy-Mac. BtW - sorry for the brief hiatus. Another warning sign. Every time a window opened up in my schedule to post my ISP/Hosting provider was having problems. Guess who - Yahung, that's who. Another red sky we'll pick up later. The chart's a pretty good red sky warning - in fact we'd view it more as a collection of major storm clouds. The real thing to ponder here is not how bad the storms are, or are going to get, but why everyone was/is surprised. There are a couple of really key lessons to think about IOHO. Really...really think about. First off the sky's been read for a long-time. Jim Jubak had a major column on regional bank problems in Jan this year, CalculatedRisk has been warning about commercial real estate problems and regionals for a couple of years now. And of course we've been beating the drum for so long we ended up with a whole dedicated archive. Another thing at a deeper level in the surprise is the follow-on question - if everybody's this surprised what else aren't they thinking about it ? What's not priced into the sector and the markets ? Yet a third thing at yet a deeper level is the problem with business models - when we say we think the business models are broken that means many of the major financial institutions are going to go thru a lot of pain and will never come back as they were in terms of growth and profitability. Let's consider some graphics we've discussed before.

 Bad Loan Tsunamis

 We won't dig thru this in detail but do want to remind everybody of this on-going set of bad loan tsunamis that are still to come. First off we're a long way from done with the Housing downturn - that means more foreclosures, more losses and writeoffs and tighter credit. Even if the economy doesn't get any worse than it is - not likely btw - this anemic environment still means that a lot of auto, credit card and other consumer loans will deteriorate. And ditto on the business side. How this will work out with the screwy debt instruments, excess leverage, etc. we've gone over several places (Markets and Financials:4 Year Crunch, Broken BizzMods) but it ain't gonna be pretty by any means.

Business Model Breakage

Now let's stop and think about the basic banking business model a little. A bank accepts deposits so people won't have to carry around cash thereby lubricating the wheels of commerce and consumption. Further it then turns around and loans out those deposits to folks who plan on spending more then they've got handy - serving as the intermediary between folks with spare funds and those with shortages. The former get paid interest and the latter pay it and the bank's revenue stream comes from the difference. Now the real magic happens when leverage enters the picture because the banks assets (the loans) can be some larger multiple of its' liabilities (the deposits). All it needs to have on hand is enough ready liquidity to meet the normal demands for cash. Over literally centuries the rule-of-thumb has developed that a bank needs to have around 6-8% of it's "assets" on hand - this its' capital requirement. Unless there's a sudden surge in demand, like when there's a run. But now you can see where multiplying your assets by 10X or so generates a much larger revenue stream. The problems come when folks loose confidence in getting their money back and they're made worse when that leverage is 20X or 30X or 70X - enormously worse. And we're not making those numbers up the Investment Banks were running at 30X leverage and by the time all the shenanigans with off-balance sheeting financings, synthetic instruments, etc. were in place they represented big X's ! Unfortunately when the bigs drop in value by a few percentage points it chews up much bigger chunks of capital. And there you have the reverse of the virtuous leverage cycle used to generate profits. The vicious cycle of capital writedowns leading to insolvency and bankruptcy. Now here's the business model problem for the industry - the more profitable segments weren't based so much on innovations and value-add for customers. They were based on leverage. Which means all the previously high-profit and risky strategies are going to get squeezed bad. It put BSC and Indy-Mac out of business, threatens Lehman and has caused $Bs in writedowns worldwide. With more to come for the known and acknowledged problems.

What we're suggesting with our little graphic on future tsunamis that a whole slew of other problems is hiding in the wordwork and coming out like maggots in a carcass. Which sectors are carcasses, candidates or survivors is, IOHO and inexpert opinion, suggested by the color coding. After the break you'll find our most recent collection of readings backup up these arguments. Bon Appetit'.

Continue reading "Red Sky Mornings, Investor Take Warning: More Finance Industry" »

Posted by dblwyo at 02:59 PM | Permalink | Comments (0)

Well putting put up this rather large collection of Finance Industry readings wasn't the planned next step but it segues so naturally from the prior post on market outlooks. Not just because obviously, because the two are so tightly intertwined. But also because if our perspective an a major shift in sentiment is correct when you couple that with the emerging vicious feedback cycle between the economy, credit and losses the Finance Industry is about to get called out. Again..big time. Just in case you missed it a couple of prior posts set out the context and summarize the situation and might be worth re-visiting (Markets and Financials:4 Year Crunch, Broken BizzMods, Markets: Fear, Loathing, Schadenfreude and Cusps on Wall St.) though both are consistent with things we've been seeing and saying for months. So consider the table reset, as the case may be.

After the break you'll find some readings on four major aspects of the outlook for the street: Culture and Crime, Industry Outlook, Lehman and other Players. There was a whole slew of bad news for specific companies last week with large layoffs being announced, more write-downs, more capital raising and so on - and we haven't even see the downturn and those losses start yet ! Wow, deja vu' all over again. Two of the outlook articles are particularly amusing - particularly for afficinadoes of the Marquis, black humor or schadenfreude - the industry's write-offs SO FAR have wiped out profits since 2004. Except for the senior executive escapees. Wrap all that together and you also saw a bunch of bad news on the criminal side of things - not just the indictments against two senior BSC guys either but a big slew of FBI filings against mortgage fraud actions. If this all gets rolling it may make the aftermath of the Tech bust (remember Enron and the rest ?) look like patty-cake. A final piece of macro-new....the pressures for re-regulation are mounting rapidly and exponentially. After all when a Rep. Treasury Secretary who's an ex-CEO of Goldman starts pounding that drum...well we'd say that a broad consensus has been built up.

Other than that we'll just let you skim the readings - between their headlines and what we've already laid it all much pretty much screeches for itself. Going to be interesting though to see what happens, won't it ? One thing we're particularly fascinated by is this whole "business model" discussion - as in broken business model. We've heard and seen that meme really getting traction  just in the last few weeks. As you may know from reading along here we certainly believe it's true.

Bon Appetit' 

Continue reading "Crime, Punishment, (Profits) and Outlooks: High Noon at the Street ?" »

Posted by dblwyo at 06:50 PM | Permalink | Comments (2)

In this collection of readings excerpts we combine Markets and Financials because the underlying issues are so inter-twined. As usual the same talking head debate continues - is the worst over ? And what would trigger an uptick in the market ? But the game has changed on several fronts and two of the critical things we've talking about for months are now common currency memes and being reflected in almost every discussion we read or hear. The two ?

Credit  Crisis to Broken BizzMod

1) The Credit Crisis has morphed into an on-going credit crunch where key players are now talking about seeing things take the next 2-4 years to work out. We refer you to the accompanying graphic charting the propagation of the contagion that we've used before. (Finance Ind(Readings): Barbarians, Fixes and Outlooks) Interestingly one of the chief new naysayers is Bob Doll, CIO of Blackrock, who's earlier assessments that the worst was over has changed to the most pessimistic 2-4 estimate. It turns out that what he meant to say was that the breakdown was over and now we're into the longer-running de-leveraging and risk re-pricing. Oh...now you tell me. :)

2) Which leads to the new key issue/meme - the broken business model of the financial industry.(Finance Ind II(Readings): Fundamental Breakage in the BM) In the excerpts we've collected a bunch of key CNBC vidclips that talk about Investment Banks, Private Equity, the re-structuring of the LBO business, a bursting Hedge Fund bubble and some of the consequences.(Finance Ind III (Readings): Private Equity Futures - from Golden(Gilt) to Iron Age) The interview with James Stewart on long-term business model breakage is especially worth listening to IOHO. But the one you should/must listen to is Meredith Whitney's - who's assessment, based as it is on deep industry analysis, wide familiarities with the key companies and players and very deep analysis still, strangely enough, sounds a lot like ours.

Market Assessment 

How this is playing out in the markets is fascinating. The "will we go, will we stay, Jimmy Durante" theme remains with us...all based around an apparent lack of clarity with regard to the economic outlook. A surge in Unemployment took out the market week before last and good news on Retail Sales brought it back this last Fri. Good news which, when you parse it out, is anything but.(HF Indicators (Sales, Rates, Money, Inflation, Oil, Dollar): Unscheduled Interruption) We've highlighted four key technical indicators in the chart and you'll notice that despite Fri's surge that we didn't recover all that much ground.

Just for fun here's the 1-year weekly and 5-year monthly charts presented as simply as possible with a little trading trend stuff thrown in. Continuing our usual interpretation we don't see any signs in either of these that the markets are pricing in anything serious in our economic future. If you do please let us know. A point, btw, made in several of the excerpts. Notice on both that we got back essentially to the 200-day MA after correcting a mild 10% correction and that we're still barely busting the long-term lower bound on the trend.

Sector Comparisons

When you de-compose the overall market into sectors (having covered the int'l situation and emerging economies jointly in the prior post) an interesting picture emerges in the short/intermediate-terms and the longer-run. Here we've divided the SP sector ETFs into the worse and better performers. As you can see the only real pain is in Financials (XLF) - what a surprise - with Con. Discretionary (XLY) doing poorly and Healthcare (XLV) not feeling the love while Con. Staple (XLP) is holding up reasonably well considering what the economic numbers are telling us. On the other hand the vaunted strong performers aren't, over a year, doing that well either whether it's Technology (XLK), Industrials (XLI) or Materials (XLB). Only Energy (XLE) is still going gang-busters. If any theme emerges it's that Energy still has a good story and nobody else does but nobody's admitting it as yet.

Then when you shift your perspectives to the longer-term it gets even more interesting. Over the long-term the story's consistent but still not "pronounced" - that is we haven't seen the clear emergence of a strong direction, let alone one that matches up with our views on the economic outlook. Over five years Finance has essentially given up all it's gains - and if you belive the BM discussion (puns intended) there's a lot worse to come. Of the Weak group nobody's done particularly well. Of the Strong group only Energy has truly been an outstanding performer while the rest have done decently well. In the last five years we had, perhaps, three-five dominant investing themes. Real Estate that went bust but made money. Emerging Markets which are shifting rapidly. Energy and Commodities - still rolling along. The New World Economy - while true that would appear to be shifting somewhat as well. And then what ?

Continue reading "Markets and Financials:4 Year Crunch, Broken BizzMods" »

Posted by dblwyo at 08:38 AM | Permalink | Comments (1)

A major and critical part of the financial frenzies of the last several years have been the LBO buyout and somewhat related buyback booms. As most of us know by now there's been a relative freeze on LBO activity since last summer, at least among the very large/large PE funds. Talking to my friends in the mid-size business that began to show up abruptly around the holidays and, judging from various statistics on mid-size deals, has spread there as well, if not as seriously. Yet at the same time the various PE firms have continued, successfully, to raise enormous amounts of investment dollars. Despite the fact that, if anything, the freeze continues and, if you believe our analysis, is likely to face much worse.

Part of it of course is that buyout funds have, over the years provided unusually good returns and part of it is that there have been few alternatives in this era of low returns...so why not ? And another part, how much we don't know, is that LBO activity, or more correctly Private Equity investing is actually facing several interesting opportunities. Thought not as business as usual. But let's backtrack a bit and start with this chart, slightly dated, of the cycle in buyout fund investments.

You'll have to update it a bit in your minds eye with the '06 and '07 data which was even larger than the illustrated '05. The catch is that buyout investment kept on during YTD for this year as well. As you can see historically there were pronounced cycles in the business accompanied by a general upward trend in the amount of funds raised. A trend that was non-linear. It'll be interesting to see what updated versions of this chart look like when they become available because if the news headlines are right fund raising hasn't busted so far even if investing has.

There's another interesting aspect of this, which is what do you do with the money. With so much of it floating around there was not only an enormous increase in total funds but a lot of new firms and funds got started. Like the Hedge Fund industry though there are also enormous differences in performance. My suspicion is that these historical differences in fund performance and in performance over the years are about to get greatly exaggerated as we find out who's been swimming naked indeed. In the first sub-chart notice that the top firms enormously outperform the rest of the pack. And then bear in mind that all the newbies performance is not yet, and won't be for some time, reflected in those numbers. The second sub-chart suggests that there's also a big difference in performance over time that's worth looking at as well.

 Take a careful look at this chart and notice that the years of great performance are years of significant downturn - that is investments made during '91 and '01 did exceptionally well. Why ? Well largely because they weren't made at extraordinarily high multiples with unusual leverage built into them. All of which is not true this last few years. This time around there were three things that were generally true. 1) Prices (EBITDA multiples) were exceptionally high - most likely as a friend of mine has pointed out historically unique and never to be repeated. 2) Funding was easy and cheap so the levels of leverage in deals was also unusually large - which is about to come back and haunt folks a great deal. And 3) the terms of that borrowing were extraordinarily lenient - what're called "covenant lite" in terms of re-payment, default and other loan terms. Which means a lot of deals got done at too high a price, with too much leverage and assuming that prices would keep going up. Stop me when this all sounds familiar.

Yet in these potential disasters lurks at least a couple of key alternatives. Actually several. First off all that debt is going to generate a lot more distressed debt than in previous cycles and the PE firms are going to be able to pick it up for half price, or perhaps better. Though they'll then face some serious workout problems. Which leads to the second major opportunity for those who kept some dry powder and their heads - as Wilbur Ross has shown in his beginning to buy up mortgage servicing firms. There'll be a lot of companies across many industries who used capital to buyback their own stock, are now leveraged at the beginning of a major downturn AND didn't make the operational improvements they should have with those funds. Judging from the historical cycles illustrated above that suggests that as we move into and thru the downturn, whatever it's length and depth, PE companies who focus on returning to their roots and have the skills and acumen to do so will be doing well in the years ahead.

By return to their roots we mean moving away from financial engineering, though not ignoring or neglecting the benefits of capital re-structuring. And moving toward what's been claimed as the major benefit, capability and strategy of PE firms. Putting in money, re-vamping operations, instilling good management and management practices and in general returing enterprises to high performance status. The firms that can do that in the next few years stand to do very well indeed and ought to be entering a new era. Not a golden one that turned out to be gilt. Rather an "Age of Iron". Look back at the second chart and the huge jump in performance between the top and restof the pack, especially during tough times.

As you go over the readings below you'll find a lot of these various aspects reflected from the section on the Strategic Outlook to indicators of current deals slowing and/or going bad. To my favorite section on the Mid-Markets. Now there's not a lot ever covered in the MSM on the mid-markets. So what you'll read there are the excerpts from various newsletters and seminar announcements which have come to my attention. Which aside from their intrinsic merits also are great indicators of the outlook - and they all are focused, one way or another, on the situation as we've sketched it. Life is about to get interesting indeed for the Private Equity industry. 

Continue reading "Finance Ind III (Readings): Private Equity Futures - from Golden(Gilt) to Iron Age" »

Posted by dblwyo at 01:06 PM | Permalink | Comments (0)

Let's keep cranking on trying to take apart the current situation and strategic outlook for the Finance Industry. But first we should note that BM stands for "Business Model". Not what you thought it stood for but, nontheless, the pun was intended. And gets to the heart of our argument - which is that the business models of key sectors of the Finance Industry are flawed to badly broken, and we believe that many of the readings support that. The extent of the breakage depends on the sector but those which depended on leveraged trading and investment are most exposed for multiple reasons which are discussed below. Those closer to traditional banking and finance practices have lots of room to improve but equally a good dose of sound business practice, a little innovation and an increased focus on marketing and customer service would go a long way. If you are a stakeholder in any of these you need to walk thru the blueprint and use it as a checklist for assessing their statii and outlook.

The chart at right will be no surprise of course. It shows the Industry as a whole (XLF), the Broker-Dealers (IAI), the Insurance sub-industry (IAK) and Regional Banks (IAT). If you buy the arguments of the last three posts (Market, Economy, Finance I) we've had a bull rally with terrible misjudgments on valuations and earnings outlooks with a weakening economy which has yet to tip over into a real downturn. Consumer demand has been weakening in any case, and that was before factoring in the implicit tax of energy and food costs surges, which would feedback destructively to hiring and investment spending (per the normal causal linkages). And as a result we were about to see many more boulders topple into the credit pond with a series of feedback loops between deteriorating economics and worsening delinquencies. Net net the question would therefore be how much farther on that chart - over and above where we think the markets are going ?

Well we could let you just skim the readings excerpts and reach your own interpretations. Which we urge you to do. BUT...we'd also like to testfly the framework we deployed against our strategic evaluation of Citi as a way of thinking about the industry as a whole. Both because we think the general enterprise framework works and because the work that Pandit and his team have done strikes us as capturing 80-90% of the total industry situation (excluding the Insurance industry of course). (Poster-child II: Citi's Potential Turn-around as Performance Examplar) You'll find the readings below collected in various takes on the Strategic Outlook, specific companies (including one that shows AIG's writeoffs and capital raising changing radically in a week as well as UBS's huge discounted rights offering...shocking though nobody appeared shocked...numbness setting in all over ?). The final section gets to the heart of the matter by providing various readings on thinking about the futures of the industry...that is does their business model and strategies still work, if they ever did ? 

Based on those readings, all the prior posts which basically dealth with the same question and the strategic assessments in Citi's presentation we end up with the graphic at right. After two decades of innovation in the '70s and '80s which provided tremendous value-add and new services for consumers and business the industry shifted its' emphasis to leverage, complex products and trading on its' own account. That worked, apparently, since the mid-90s til last year. And then broke badly despite bringing us an unprecedented series of booms and busts for the same underlying structural reasons.

Now we're in a regime where de-leveraging will be the dominant macro-environmental theme and as a result capital requirements will be raised, explicitly by regulation or implicitly by investment returns. So instead of being able to reap the profits from being leveraged 30x, or 40x or 70x the banks, brokers/dealers are entering an era where they'll have to return to fundamentals. Hence our judgements in the various shade of warning indicators as to whether the business models of the last decade are sustainable going forward.

We could argue thru each sector individually and then discuss each of the major players but won't - though we do think this is the kind of evaluation any employee, investor or stakeholder needs to do for each and every one of them. What we will assert though is that these fundamental re-thinkings aren't widely recognized, acknowledged or accepted though several key commentators have made similar observations. And this kind of re-thinking is clearly implicit in Citi's new strategic framework. So apply the Buffett test - which of these are businesses you'd want to own a piece of as businessess ? Our answer - not many until these re-structurings are begun. On the other hand as Rubenstein, Buffett, Jubak, et.al. are pointing out there will be lots of gems to be sorted from the rubble. Once the rubble all falls down...which point we are IOHO a long way from. 

Continue reading "Finance Ind II(Readings): Fundamental Breakage in the BM" »

Posted by dblwyo at 10:04 AM | Permalink | Comments (0)

The prior two posts were our weekly surveys of Market and Economic information. We'll grant that typical blog practice is one/two clip(s) per post but we think something is served by collecting and categorizing them so that the patterns and implications are clearer. At least it works for us. We mention that by way of pro forma apologia for the infodensity, there and now. Because that econ/mkt information is only mildly interesting to us for its' own sake. What we think is even more important is the implications for business performance...industries...companies and you. Which is also by way of suggesting that with those two in mind it's really time to roll it forward and look at the consequences....which are, IOHO, pretty dire. Before rolling on we'd like to suggest a few minutes spent listening to Dave Wessel on CNBC will help set the table:Econ-Recon Mission  Perspectives on the economy, with David Wessel, The Wall Street Journal economics editor.

Here we'll focus on the implications for the Finance Industry...at least in part. Consider the graphic at right where we've down our best to capture what we think is going on. Though admittedly I'm not a finance industry expert we've all had to learn more about that arcane and mysterious industry in the last year than we ever wanted (btw do you realize we're over a year on the first small canary the Shanghai Surprise and the big one - the first BSC disasters ? Think about those as warning sigils in light of this arm-waving).

What we've tried to capture is the impact of the credit crisis so-called and how it's rippled thru the system and what's likely to still happen. So what we've seen so far is bad loans (1) moving up the chain of leveraged links to create ripples (2) and breakdowns across many different credit markets. That almost brought the whole house of cards down. Those losses led to massive writedowns and P&L losses (3) which severely damaged almost all the players in the Finance Industry. The catch on that set of loops is that sub-prime problems aren't thru and we have a whole host of other sources, e.g. ARM resets, HELOCs, etc. which are also turning bad; which'll keep that loop going. It's that metastasis of the credit contagion that folks like Whitney are warning about. Consider this the revenge of the "Rocks-in-the-Ponds" model.

The real on-going problem likes in the deteriorating general economic conditions which will lead to to additional credit tightening (4) and asset deteroriorations (5). In fact as we enter a "normal" cyclic downturn all the host of standard consumer and business loans (6) are now qued up to go thru a similar decline. And there impacts on things are not even factored in because everybody knows "the worst is over", right ? So as you skim the readings below please keep in mind that the real reason to make you wade thru the Market and Economy readings was to frame the context of what's going to happen to the Finance Industry as these cycles kick into high-gear. 

UPDATES (5/22): Two other major data points on rising delinquencies and on leveraged loans have been added to the readings. 

Continue reading "Finance Ind(Readings): Barbarians, Fixes and Outlooks" »

Posted by dblwyo at 02:59 PM | Permalink | Comments (0)

The meme running around the Street and the Treasury is, of course, that the worst is over. As we've noted previously that's a bit more than disingenuous (WRFest 4Apr08(Markets): Do We Stay, Do We Go..Jimmy,Readings (Finance): It's Over, It's Over...Yeah Right). The worst of the credit crisis in terms of a deep structural breakdown is over which just leaves us with a re-pricing of risk, de-leveraging and a burgeoning economic downturn that will lead to more writedowns, balance sheet pressures and losses from more bad loans and be based on feedback from the real economy. As opposed to internal dysfunctions in the broken credit markets. The real worst is yet to come and nobody's paying any attention. Us usual ?

Well not quite or entirely. Finally we're seeing some serious consideration of that feedback loop as well as a variety of articles finally addressing the real fundamentals of the Finance Industry. Are their business models broken ? We think so. And as a result there's going to have to be some very deep and fundamental re-thinking followed by some even deeper re-building, re-structuring and painful changes. Otherwise we'll just go thru this again...and again...and again.

All of which is reflected in the various company stories of continuing writedowns JUST dealing with the aftermath of all that bad paper. Some very serious players from JPM to Wolfensohn see more serious trouble ahead. Banks are going to be seeking and needing even more capital with all that implies about dilution, earnings pressures, tighter lending standards and so and so on. We've collected a bunch of stories that support that line of argument but conclude the excerpts with two poster children. On Fannie Mae who's recent announcements of surprisingly large losses, more trouble ahead and more capital raising were greeted by a stock price jump, of all things ! Which grossly misses the real, deep-seated damages done and the work to be faced. Our other poster child is Citigroup which, under Vikram Pandit, has made the right emergency moves but now everybody wants a clear, quick fix to make it all right. After four months in the job he's supposed to lay out the workable strategy for the next decade ?!

Give me a break. It's this kind of thinking that created all the problems in the first place. While the jury is out and will be for some time to come he seems to us to be taking some of the right, small steps. As he says you've got to get some of the immediate, small and operational improvements in place before you start re-engineering the super-structure. And Citi is a badly broken as they come, at least IOHO. For those of sufficiently long memories this reminds us of the early days of Gerstner's time at IBM when everybody wanted a vision and a strategy. As he said, "that's the last thing we need right now". Ditto for Citi. We'll see where Pandit goes but in our book he's started right. The question is...is anybody else getting it ? 

Continue reading "Business (Finance Industry): Boiled Frogs Getting Flayed" »

Posted by dblwyo at 02:10 PM | Permalink | Comments (0)

Here's our rather massive collection of readings excepts related to the Finance Industry. Judging from the fact that the ETF, XLF, is up almost 4% to day clearly the worst is over. Of course that not only is there no good news on the economic front but that this has been a month of writedowns and downsizings gone wild we'll admit to feeling a tad disconnected to the new realities. With this large a collection it'll be hard to summarize and just skimming the headlines, let alone the excerpts, will just about put you in the picture. But we'll take a pass.

1. The general theory, other than the talking heads talking themselves into thinking the "worst is over", seems to be that this was the kitchen-sink finale and from now on it'll be tough, very tough, but clear sailing. Until we see fundamental reform and re-structuring we're going to be locked into this boom-bust financial cycle with increasing frequency and severity of breakdowns.

2. The structural flaws of the industry's business models have yet to be addressed because it's the work of a decade or more - fair, considering it took nearly three to evolve this mess. Speaking of boiled frogs. UBS recently came out with the most candid internal appraisal which could be paraphrased as, "boy, did we ever screw the pooch on this" and "there was a total lack of either adult supervision or responsible business management". Seems fair to us.

3. The writeoffs aren't over and the various institutions are going to be exposed to more as Housing continues its' dive off the cliff, bad mortgages and securities reset and other asset classes, e.g. consumer debt, business loans, etc. come under increasing pressure. Future writeoffs will continue the debacle most likely. Which will in turn continue to put pressure on capital and will likely lead to a need for more infusions - the capital base of many of the banks is inadequate as it is without more writedowns.

3. In reaction to the destruction of capital the banks are tightening up on credit enormously. The business cycle was going to put serious pressure on loans anyway and lead to defaults, losses and bankruptcies. Combine the two and we have yet another Perfect Storm. And the writedowns, infusions, capital pressures, losses, etc. will feedback on one another. In other words in addition to the writedown problems we are just heading into a classical increase in loan losses.

4. These troubles in slightly different form are percolating to other sectors. While not exposed to the securitization debacle the Regional Banks are just beginning to feel the pain and are headed down their own slippery slop, I mean slope.

5. Accounting for this mess has been disingenous to deceptive with Level III "funny-money" assets protected and inappropriately valued and with various manuvers being used to keep other writeoffs and impairments away from the balance sheet and the bottomline. Even if nothing changes there'd therefore still be serious risks hiding in the wings. 

6. Each major sector is having problems from LBO loans to the PE firms. For example no LBO's no fees. And the LBO debt is getting written off at ginormous discounts. The PE guys are going to have to re-discover their roots of actually focusing on and improving the operations of their portfolio companies. Hedge funds are being called on the carpet as well.

7. And this all doesn't mention the burgeoning job losses that have actually been fairly low so far.

8. When you look at individual companies from UBS to Merrill to Wachovia to National City to Credit Suisse are facing major hurdles unique to them as well as the general breakdowns.

9. There are few, almost no, good stories on any front in this mess of messes. A possible exception is JP Morgan where Dimon has provided discipline and adult supervision. As a result JPM may be in a good position to do a little shopping. We're hard put to find anybody else. Nominations are open.

Before or after your excerpt skim the one single thing we think you ought to dive in on is George Soros' interview on Charlie Rose: A conversation with George Soros, Chairman, Soros Fund Management. And take a look at the chart at the right which shows corporate profits over the long term both in absolute terms and as shares of the total. There's a lot of information hiding there. For example why did corporate profits surge so hugely in this decade ? Well ask all the people who didn't get the jobs a real recovery would have generated. But for our purposes it's the shares that tell the story. Look at shares of the Financials.After growing gradually with the slow evolution of all this cleverness from 10% to 20% in the '80s it stayed in the 20% range thruout the '90s. And then suddenly boomed to 30% around 2000. Rapidly ! Now what sudden major structural innovation, say on the order of Pharmaceuticals, Electronics or the Internet lies behind that ? What new major source of value was created ? In case you're wondering that's both a rhetorical question and something for you to ponder. Because if there were no such innovation, i.e. if Financial firms were able to grab a dispproportionate share of  profits thru a combination of a weak economy and financial engineering, then it's not sustainable. And we're back to our first point.

Happy Skimming ! 

Continue reading "Readings (Finance): It's Over, It's Over...Yeah Right" »

Posted by dblwyo at 12:37 PM | Permalink | Comments (0)

Here's our collection of story excerpts for the Finance Industry. With all the near-death experiences we were going thru we didn't get the excerpts for the week of 23Mar up so they've been combined with last week's in one kind of massive posting. Nonetheless they make interesting reading taken all together, particularly in light of the market's huge rally with the SP500 up almost 4% and the Dow up just short of 400 points. Of course we've seen a lot more days like that in the last couple of months than not. And, for our money and for several of the commentators in our stories, the writedowns are far from over, the downsizings have just begun and we've got a long way to go. And we assure you that these weren't selected to excerpt just because they agree with our views. They capture some of the better thinking. We'll especially call you attention to the stories by Michael Lewis (Mr. Liar's Poker) and Merdith Whitney (who'll soon be known as Mrs. Dr. Doom for telling it like it is) who both point to troubles to come.

Our title comes from a Fortune article which got re-covered but came to a similar conclusion this week as well. And just happens to coincide with our assessments about the future of the Finance Industry which we've been harping away at in all the related posts. Another story worth paying attention to is the one reporting estimates of 200,000 job losses on Wall St., which is an unprecedented number.

Now tell me - is the worst over for the industry and financial stocks ? Or are we just at the gust front of the storm as the artificially inflated profits and earnings of the last decade are destroyed, the share of industry profits in national income begins to reverse, a new regulatory regime that'll change the rules systematically and systemically goes into effect ? And most especially (cf our earlier comments about good business practices) as the basic business models, management systems and leadership development of the industry are re-thought !

Interesting times indeed. 

Continue reading "WRFest 30Mar08(Finance Industry): End of Wall St. as We Know It ?" »

Posted by dblwyo at 09:40 PM | Permalink | Comments (0)

Well, well, well. This is startling news but the Bush Administration under Sec. Paulsen's leadership has proposed a broad overhaul of national financial regulation. Think about that for a minute - a strongly conservative President under the leadership of the ex-CEO of Goldman is not just beginning to re-think their regulatory approach but is putting a major proposal on the table that's the first major re-thinking since the Great Depression. And from what little I can see of the early sketches it's an extrordinarily profound, comprehensive and thoughtful proposal. More interestingly it's been worked on for over a year and largely in secret. The latter may be the most astounding part. But the case has certainly be made and the timing of the announcement couldn't be better.

You really need to pay attention to this one because, win, lose or draw, the Finance Industry, the Markets and the Economy will not be the same ever again.

Continue reading "Adult Supervision Re-emerges: Bush Proposal for Regulatory Overhaul" »

Posted by dblwyo at 05:12 AM | Permalink | Comments (0)

The prior post focused on putting the systemic risks in the Credit Markets as clearly and simply as we could manage and we'd like to continue that discourse by looking at what other folks had to say. The graphic at right take you to a recent apperance on Charlie Rose by Andrew Ross Sorkin discussing the BSC deal. Bear in mind that was the Mon. during the height of the crisis but it's not bad "Inside Baseball" despite the lack of detail. And despite the fact that the discussion and subsequent NYT stories still don't quite have it right. Before diving in however let's borrow a point from one of our favorite scifi characters Lazarus Long.

"What are the facts? Again and again and again-what are the facts? Shun wishful thinking, ignore divine revelation, forget what “the stars foretell,” avoid opinion, care not what the neighbors think, never mind the unguessable “verdict of history”--what are the facts, and to how many decimal places? You pilot always into an unknown future; facts are your single clue. Get the facts!"

The link to Galileo is that he's credited with being the Father of modern science by placing an emphasis on what the actual data is really telling us. When you listen to the Sorkin interview here are some points we'd like to add:

Continue reading "Continuing the Dialog: Facing Realities in the Credit Market" »

Posted by dblwyo at 02:34 PM | Permalink | Comments (0)

Let's pick up the thread of our weekly Readfest with last week's excerpts on the Finance Industry. Obviously THE major story was the sudden evaporation of Bear-Stearns as a going concern. There's a lot to say about that and the whole story is far...far from in. From various sources as late as Thur. executive mgt. hadn't a clue but, as in all sudden catasrophic events, there was a tipping point on Fri. Which led from a "we can make it thru" to "oh, my god we've got to bail". In some ways my hat's off to the BSC leadership team who had less than 24 hrs. to re-wrap their heads, to the Fed and to JPM and Jaime Dimon who responded with what, so far, appears to be style, grace, guts and knowledge. I'm sure as the story comes out they may have had a little more warning but it still isn't every day that an 88-year old legend that was worth $30-40B on Fri. afternoon gets sold for a paper price of $2/share or approx. $298M ! Astounding.

Continue reading "WRFest 16Mar08(Fin Ind):" »

Posted by dblwyo at 10:53 PM | Permalink | Comments (0)

The last post pretty well summarized the credit contagion crisis in it's title: WRFest 9Mar08(Economy): It's All About the Credit. And the results of being all about the credit is de-leveraging, magin calls and liquidation. The only real question left, aside from all thos messy...messy details, is how will this impact each of the players at the industry and company level. There's another one I guess - who'll be well-enough positioned to take advantage of this insanity by having the credit, cash and liquidiy to take advantage of what are really once-in-a-lifetime opportunities. Hopefully. After the break what we have are the week's business stories ranging from the beginning of hearings on finance industry CEO compensation (one of last week's potentially most interesting and important stories. Do the words de-regulation, Enron and SOX ring any bells. THINK about it). Almost all the rest of the stories can be summarized whether banks, LBO's, hedge funds, insurers, whatever is who survives and who doesn't. IF we're not being clear here this is going to be a real mess, take a lot to cleanup and is barely started. This is the Housing market ~ early '06 when everybody could see it coming who paid attention but the scope and breadth wasn't clear in the face of denials.

To put this in context this CNBC intereview with, among others, Wilbur Ross touches all these issues:  Equities Roundtable

Continue reading "WRFest 9Mar08(Finance Industry): De-leverage, Margin Call, KaBoom" »

Posted by dblwyo at 12:10 PM | Permalink | Comments (0)

We've had several recent posts detailing the expanding crisis in the credit markets and the spreading turmoil and havoc it's creating. Including the increasing liklihood of the failures of major financial institutions (point: Ben Bernanke). And yesterday we noted Warren Buffett's comment on CNBC that he was being presented the opportunity buy loan portfolios for < 70% of their value or better (he of course was non-specific). In fact last Fri's big drop in the markets was partly due to the liquidation of an English hedge fund's (Pelaton) portfolio, or at least part of it. This post collects up some very interesting story exceprts on the continuing impacts on the LBO business. Now this is important not only for its' own sake but because buyouts were a major prop for market prices over the last two years. And THE major prop for the buyout feeding frenzy was the availability of cheap and easy credit for leveraged loans. Well lo and behold what should appear in our mail this morning but one of John Mauldin's occassional "Outside the Box" newsletters where some of his correspondents share their work with him and his readers.

Continue reading "WRFest 1Mar08(LBO Markets): Leveraged Loans, Liquidations and the LBO Bizz" »

Posted by dblwyo at 04:28 PM | Permalink | Comments (0)

The ripples in question refer of course to the ripples in the credit market pond from the various boulders that are toppling in. Which started with housing problems, spread to the various artificial debt created on housing mortgages and generated several waves that impacted other markets. At the time we predicted that other rocks, then boulders, etc. would topple in and that seems to be the case. In fact one could envision a whole set of ponds layered on top of one another, each being defined by the chain of asset classes and instruments that toppled and were impacted and so and so. We mention all that because Warren Buffet was bold enough to get on CNBC yesterday and tells us that we've reached 3rd/4th stage Ebolatization where many of the financial institutions are starting to be forced to sell off, or even liquidate, portfolios of these assets to protect their solvency. NONE of which is being talked about as yet. The readings below the break are all stories from last week regarding various ripple impacts on players in the Finance industry who are beginning to rock on their foundations.

Continue reading "WRFest 1Mar08(Finance Industry):Results of the Ripples" »

Posted by dblwyo at 06:06 AM | Permalink | Comments (0)

We've ended up splitting our regular news summaries into multiple parts because of the number of valuable stories. Not just splitting Econom, Market and Business but in turn we'll end up splitting business itself into four parts, of which this is the the 2nd. The prior post looked at the strategic context and even provided a graphical chart to conceptualize all the multiple factors that any business must face, in general and specifically at these times.

These particular story excerpts focus on the Finance Industry and build on prior posts on the general conditions in the Economy, Market and, most...most especially, the Credit Markets. The bottom line is that a) the credit markets continue to experience a widening crisis whose end is not in sight. In fact whose details and working out are not at all clear. So, b) we think it's fair to consider that the Finance Industry as a whole is in as severe an emerging crisis as the Housing industry. Without the same level of broad understanding or consensus.

One that will, eventually, force serious re-thinking of the strategies, product offerrings, company structures and operating principles. Yet at the same time, given past history, who's corrective measures will be temporary pallative fixes because the Industry, despite it's vaunted "free-market" principles is in fact dominated by near-term and short-sighted thinking. Which tells us that, as investors, we can look forward to continued downtrends in these firms. And recurring cyclic opportunities to ride up and down with these cycles.

None of which is good long-term news. 

UPDATE: for anybody who thinks the bad news is over we suggest listening to this Bloomberg vidclip of Meredith Whitney's outlook for Cit and the Finance Industry. She expects that Citi will have to start selling it's highest quality assets, upto and including Smith-Barney, to raise capital to offset more writedowns. Her slashing of earnings estimates is startling:

Whitney of Oppenheimer Slashes 2008 Citigroup Forecast: Video

If you can't see the video trying searching the Bloomberg site. Meanwhile here is the associated story: Citigroup May Post First-Quarter Loss, Whitney Says

Continue reading "WRFest 24Feb08(Finance Industry): Troubles Continue to Accumulate" »

Posted by dblwyo at 08:23 AM | Permalink | Comments (0)

Being somewhat connected into the mid-market (that's smaller firms) M&A/Buyout market and community it's something I follow and every once in a while something really interesting comes across my desk. Now we've discussed before that the implosion in large deals might be spreading into the mid-market (circa Jan08) based on anecdotal evidence that the deal flow began drying up in late Dec07. Now some much harder data has crossed our desks from OEM Capital. OEM is a specialist in mid-market M&A for the technology space and has an enviable track record, and sterling reputation. They track activity in that space montly and from their data we can begin to see the downturn spreading. If you're interested check out their web site and see if you can subscribe to their monthly newsletter. An excellent if dry information source.

Continue reading "Mid-Market M&A Outlook: Spreading Downturn ?" »

Posted by dblwyo at 02:10 PM | Permalink | Comments (0)

Last week, actually the last several, were terrible for the markets. And judging by the carnage in Asia and Europe so far today we can anticipate more trouble as the markets re-open. While it's not clear how much farther we've got to go it looks like a major shift in outlook and sentiment is underway. One which, partly in a spirit of schadenfreude, we've been pointing to for quite a while now. There was so much last week in fact on the spreading credit contagion that we pulled those excerpts out into a seperate post (Ebolatization Contagion: Credit Mess II) to highlight them. A comment on that post asked an interesting and key question:

It's as if you are discriminating between financial sector growth, which I assume you measure in financial terms, and economic value, which I also assume you measure in in financial terms. That is, there is non-value adding financial growth. Am I close to correct here?If so, how do we distinguish between the value-adding financial growth and that which does not add value?

One could argue that any shift of resources into newer sectors helpe the overall economy become more efficient - in the case of the Finance Industry by helping to raise and create capital and more efficiently allocate it. The question we were asking that led to the comment was whether or not the shift of resources into the Finance Industry had gone too far and our implied answer was "hell yes". But it was an answer based on a fair amount of prior investigation on the rapidly rising share of the Financial sector in profits (The Heart of the Matter: Profits vs Earnings ?), on the buyback and buyout manias (Market Drivers 3 (Buybacks):Investment, Hiring, Nah...Bonus, Bonus, Bonus ! plus two prior posts) and on what's turning out to be alleged profits built on leverage and unaceptable risks (Rocks, Ponds, Perverse Incentives: More on Credit Contagion)

Continue reading "WRFest 20Jan08(FinInd): Re-thinking, Re-Thinking, Re-Thinking ?" »

Posted by dblwyo at 09:53 AM | Permalink | Comments (0)