Thursday, January 28, 2010

Thought of the Day

Sydney M. Williams

Thought of the Day
January 28, 2010

As I was out to dinner, I missed part of the President’s speech. While he seemed relaxed – there appeared to be more than the usual applause interruptions – I thought his forceful posture seemed somewhat contrived. Perhaps I am wrong. He is a masterful speaker and offered something for everybody, including, apparently from the camera shots, a sleeping pill for Senate Majority Leader, Harry Reid. I do wish that the cameras were able to show the President and not the puppet-like, nodding and smiling heads of the Vice President and Speaker of the House sitting behind him.

Though he called for fiscal responsibility, there is little question he continues to believe in a bigger role for government, which, definitionally, means more spending. He said, “Let’s leave behind the fear and division”, and then went on to bash his predecessor. It is little wonder that he has become the most polarizing President in recent years. With the Supreme Court justices sitting twenty feet in front of him, he dissed them for last week’s decision – an unusual rebuke during a State of the Union speech.

Jobs, as expected, were the core of the speech, but he continued to push for his trade-mark policies – cap-and-trade and healthcare. His poll numbers will likely rise, as is often the case in the immediate aftermath of such a speech. The important thing will be the follow-up, especially for positive proposals like building nuclear plants, eliminating capital gains taxes for small business and extending tax credits, based on mew hires, for small and mid-size businesses.

The President is a gifted orator and one can be seduced by his words, but in the end it is the actions that he and Congress take that become important. The contrast between Mr. Obama’s seventy minute speech and Governor Robert McConnell’s ten minute response was clear, not only in terms of style, but in content when Mr. McConnell said: “The circumstances of our time demand that we reconsider and restore the proper, limited role of government at every level.”

I am off again, for a few days in the sun, this time with my wife, returning on February 8. Now that I have a MacBook Air, I won’t be totally out of touch, perhaps to the regret of some, but, I hope, not most.

Wednesday, January 27, 2010

Thought of the Day

Sydney M. Williams

Thought of the Day
January 27, 2010

Partisanship, driven by allegations of torture and a demonized prison at Guantanamo, remembrances of Katrina and an economy collapsing due to a credit crisis, was very much on the minds of the electorate when Barack Obama was elected the 44th President of the United States. He spoke articulately and grandly of a post-partisanship Presidency, a promise incorporated in his eloquent Inaugural Speech.

However, in his words: “On this day we gather because we have chosen hope over fear, unity of purpose over conflict and discord”, he sowed the seeds of today’s continuing partisanship. Blaming the previous administration for our woes works for a while, but eventually it begins to sound like a whiner. Instead of being a unifier, he has polarized the Nation like no other recent President. According to a Gallup Poll, released two days ago, the gap in terms of approval, at 65 percentage-point gap is “easily the largest for any President in his first year of office.” (The Poll measures the difference between approval by Democrats [88%] and Republicans [23%].)

As has been widely noted by the Press, the reason lies in a too-aggressive agenda at a time when the most important thing on the minds of most Americans is jobs and when ballooning federal deficits are raising concerns of future inflation and/or debasement of the U.S. Dollar.

His first year has had to be a disappointment, with unemployment higher, not lower; Cap-and-Trade looking dead on arrival in the Senate; healthcare reform a shambles; reach-outs to Iran, North Korea and Muslims not returned; an embarrassment in China, and two failed trips to Copenhagen. On the other hand, the S&P 500 is up 30% and, with the credit crisis fading into the past and with GDP having turned positive, the mood of the country is decidedly more positive than a year ago. The greatest risks, in my opinion, lie in the size of the deficits being generated, primarily a function of an increase in transfer payments.

Tonight the President will deliver his first State of the Union speech. As always, it will be memorable and mesmerizing, for despite his dependency on Teleprompters, he is as good a speaker as I can recall. He will highlight his call for a reduction of $250 billion in spending, though the number represents less than one half of one percent of the budget. A call for fiscal responsibility will have to be followed by real action. His predecessor, George Bush, was certainly not known for his fiscal stewardship; so the electorate is “from Missouri” as regards promises in this realm. He will certainly focus on jobs and, it would be my guess, with his knowledge of a growing dissatisfaction with his policies, he will reach out to Republicans in an attempt to restore a sense of unity. He may do so by offering tax breaks to small and mid-size businesses. (I hope he does.) He is caught in a difficult position, trying to navigate between the far left – where I believe he truly lives – and the realization that pragmatism is necessary to move forward on his agenda.

One year does not make a Presidency, so Mr. Obama has time, but he will have to prove to be more empathetic toward the people, more conciliatory toward the opposition and he must recognize the enormous risk of excessive spending. Revenues are a function of taxes and growth in tax revenues are a function of growth in the private sector.

Tuesday, January 26, 2010

Thought of the Day

                                                                                                                                    Sydney M. Williams

                                                                                   Thought of the Day
                                                                                                                                    January 26, 2010

A five percent decline (in the S&P 500) in the last three days of last week spooked stock market participants. Ten years of negative returns have converted individual investors into speculators at best and stock-deniers at worse. Since the end of World War II, the S&P 500 has compounded at 6.6%. If one excludes the last two decades – the 1990s because they compounded at the extraordinary rate of 15% and the aughts because their negative 2.3% compounded return was equally extraordinary – the annualized returns were 6.9%, essentially the same.

Long term historical returns may provide little comfort to those who have seen their funds dwindle over the last few years, but I believe there is value in knowing where we lie along the grid. And those numbers suggest we are close to fair value – and that the next ten years are likely to provide better returns than the previous ten. But they also say nothing about rallies or relapses we are bound to experience in the months and years ahead.

There has been a significant change in the composition of the market, in the sense that forty years ago perhaps 10% of the population owned stock versus 50% today, but the individuals who were invested in stocks forty years ago did so with taxable money, while today they increasingly do so with tax exempt money. While I do not have the statistics, I would suspect that 90% of the money individuals invest in equities today is tax exempt money – pension, 401K and/or IRA accounts; that money is generally managed by professional investors, placing the investor at a distance from his money, a frustration as he has seen it evaporate.

Forty-odd years ago, when I started in this business, public companies were largely owned by individual investors. Beginning in the late 1960s, institutional investors began to dominate shareholder rolls; so by the 1980s the individual had become noticeably less important to corporate managers. A third major shift I have observed is the increase (and now dominance, at least in mutual funds) of tax exempt funds.

As tax consequences have receded in importance, it has been accompanied by a concomitant increase in turnover. Mutual funds, which once had 20%-30% annual turnover (suggesting three to five year holding periods), now turn over their holdings more than 100%. In many cases, hedge funds, the scourge of politicians and corporate managers, tend to be longer term investors than their mutual fund cousins. Corporate managements now, rightly in many cases, view shareholders as renters of stock, not as partners in an enterprise. And, while it should not, short term investing influences corporate decisions. Managing “Street” expectations has become an important function for CEOs and CFOs and deflects them from focusing on longer term projects. As options became more important to overall compensation, the timing of those grants has become more critical, often pitting management against shareholders.

It would be good to see Congress and corporations focus on this subject. With markets down over the past ten years, with baby boomers reaching retirement age and with Social Security close to bankruptcy, Congress should do what they could to encourage savings (and discourage consumption) by reducing taxes even further on long term capital gains and dividend and interest income. Such tax cuts would not only be gifts to the rich (the very rich already know how to handle their tax liabilities); they are imperative to the future of millions of middle class citizens. Despite the performance of the last decade (or perhaps because of it), individuals should be encouraged to own stock or funds, not discouraged. Fund managers should encourage and welcome taxable investors and should manage their funds accordingly. Corporate management should recognize that the assets they use and the cash they consume belong to shareholders, and are not for the purpose of pocket-lining regardless of performance.

The future is unknowable. The halcyon days that marked the 1990s crashed into a wall of carefree (and careless) investing. Very few people saw the end coming. (One who did was George Soros who in April 2000 was quoted as saying: “The music has stopped, but people are still dancing.”) Today, deleveraging by the consumer, worries about enormous federal deficits and concerns about the potential inflationary actions of the Federal Reserve (on this subject one should read Richard Fisher’s – President of the Federal Reserve Bank of Dallas – op-ed piece in today’s Wall Street Journal) present risk to the investor.

But, I have found that the market is frequently ahead of us – a lot of today’s concerns are baked into prices; so that the goal of investors should be to take a longer view and try to get a sense of change yet to come. With the market looking neither cheap nor dear, one should be able to concentrate on stocks and fundamentals and worry less about short term gyrations.

Monday, January 25, 2010

Thought of the Day

                                                                                                                                                                            Sydney M. Williams

                                                                                          Thought of the Day
                                                                                                                                                                             January 25, 2010

On January 21 the Supreme Court, in 5-4 decision, decided that no restrictions could be imposed on corporate contributions to political campaigns. It is mystifying to me that the decision could have been decided in any other way. In our society, freedom of speech, protected by the First Amendment of the Bill of Rights, is fundamental to our rights.

The amount of money spent on political campaigns, to my mind, is repugnant, but people in a free society should always have the right to express their opinions and so should the corporations for which they work. To put artificial limits on the amounts spent, or have all campaigns financed with tax dollars, as some suggest, is to betray the rights of citizens. As a taxpayer, I do not want my tax dollars to be spent on candidates with whom I fundamentally disagree.

The answer has to lie in full disclosure of who has paid what to whom. Every gift, no matter how small, to a political campaign should be indicated on the candidate’s web site for all to view. Corporate gifts should of course be disclosed. Conflicts of interest, pay-offs, all would be known and publicized.

Every time artificial restraints are imposed by the government on the people (and corporations are composed of people) the consequences are far different than originally intended. A good example was the decision by the Clinton Administration, in 1993, to limit the cash component of CEO compensation, which corporations could deduct, to a million dollars. The result was a deluge of options, pitting the executive against long-term holders of the stock and a further widening of the gap between CEOs and the average worker. According to a 2005 Harvard Law School study CEO compensation rose from $3.7 million to $9.1 million in the dozen years following imposition of the law.

However, letting the sun shine into the dark recesses of campaign coffers could well serve to limit contributions, as much of the money prefers darkness and secrecy to openness and disclosure.

Skiing the Bolshoi Ballroom

                                                                            Skiing the Bolshoi Ballroom


About six inches of new snow fell Friday night; we awoke expecting Blue Ox to have been groomed, as that is the usual pattern in Vail. As a double black diamond, a groomed Blue Ox, covered in fresh powder, presents one of the most thrilling venues for those of us who love to ski, but in whom age has reduced flexibility and the stamina we once had.

However, on closer examination of the grooming report, we realized that Bolshoi Ballroom in Siberia Bowl had been groomed. It takes time to get there. One has to ride the chair out of China Bowl, glide along a cat-walk about half a mile to what is known as Siberia and then straddle a poma lift to the top of ledges that form the bowl’s northern perimeter.

Once on top, at 11,455 feet, with snow flurries competing with the sun, the .view is breath taking. Unmarked powder leading down through clumps of evergreens, which cling to the slope, give promise of the ride to come.

Skiing with three good friends, Helen and Bill Gilbert of St. Louis and Walter Harrison of New York, we jumped on to the slope, the lightness of the fresh snow providing little resilience against our turns while its softness made silence an eerie, but delightful companion – a silence only interrupted by sudden whoops of joy as we danced down the appropriately named slope.

It is difficult to explain to one not initiated in bowl skiing the thrill one gets as the skis pick up speed and the ease and the grace of the turns as one descends through fresh powder covering a groomed base, and doing this on a slope where we are, for all we can see, alone. We slip between trees and bounce down the undulating slope, each turn providing a sense of freedom and elation. Drugs or alcohol could never provide the high one experiences in those moments of wild abandon when the only care is the anticipation of the next turn.

In a matter of moments we reach the bottom, the thrill gone as quickly as it arrived; we catch our breath and follow Silk Road back to the Orient Express; as the chair ascends, we look at one another. We do it again.

Sydney M. Williams

Friday, January 22, 2010

Thought of the Day


                                                                                                                                                                                    Sydney M. Williams


Thought of the Day
January 22, 2010

The image of President Obama staring down Wall Street banks with Paul Volcker behind him, and with grinning Joe Biden standing slightly off center, may have provided some succor to those who see banks as solely responsible for the mess we found ourselves in two years ago, but his two proposals don’t appear to have much bite, and, in his interest in appearing populist, he does not put the problem within the perspective it deserves.

The President, yesterday, proposed two reforms.  The first, which he Christened the Volcker Rule, was that commercial banks (which, as of September 2008, include both Goldman Sachs and Morgan Stanley) could not operate hedge funds, private equity funds or proprietary trading accounts, if those operations are “unrelated to serving their customers.”  His second proposal was to prevent any further consolidation among the large banks.

John Carney, editor of ClusterStock, pointed out that the key words in the first proposal are the ones I put in quotations.  He argues, reasonably it seems to me, that the banks are likely to be able to demonstrate - fairly or not - that customers are served by those three products.  The President’s proposal, in my opinion, seemed an elevation of naivete over reality.  I agree with the President that depositors money (a key liability of most commercial banks) should not be invested in high-risk assets.  Why not simply revoke the “commercial bank”  status of Goldman and Morgan Stanley?  Or why not reinstate an updated version of Glass Steagall?  As to his second proposal, we will have to see.  I happen to be a believer in the notion that if a bank is too big to fail, it is too big.

Eighty years ago, the conflict of interest within banks, and what led to the Glass Steagall Act, was  that banks were underwriting securities and placing them in accounts over which they had investment authority - an obvious conflict of interest.  Today the problem is the leverage banks carry on and off their balance sheets and that the risk assets they carry often seem designed to  generate returns to the employees while providing little economic value.  The leverage they employ and the interlocking nature of those assets between banks brings risk to our system, as we found out so devestatingly in September-October 2008. 

The financial crisis that brought us to our knees has many fathers, not the least of which is government.  Banks basically accept deposits and make loans.  They have been doing this for hundreds of years.  From time to time, in the interest of generating bigger profits, they take foolish risk.  When that happens, they fail; others learn from their mistakes.  Failure is a good master.  However, during he Depression, amid hundreds of banks failing, to protect depositors the Federal Deposit Insurance Act was created (under the Glass Steagall Act), providing a government guarantee against failure.   A bank may fail, but the depositors would be protected. 

In 1977 Congress passed the Community Reinvestment Act of 1977 which was designed to “encourage commercial banks and savings associations to meet the needs of all borrowers in all segments of their communities, including low-income and moderate-income neighborhoods” to obviate a practice known as “red lining.”  To ensure banks were in compliance of this Act, federal regulators regularly examined their books.

Under Presidents Clinton and Bush two, the push for homeownership became part of policy.    A slew of creative mortgages were created that could satisfy any purchaser; they were sliced, diced and securitized and sold to investors around the world - often carrying triple A credit ratings, thanks to friendly rating agencies. Freddie Mac and Fannie Mae, the two large GSEs (Government Sponsored Entities), were implicit in what amounted to a scam - purchasing high risk mortgages from the initiating banks to provide the funds so that he game could continue.  Their sponsors in Congress aided and abetted them, by encouraging a greater use of leverage.  Efforts, during the early and mid 2000s, to rein them in by the Bush administration failed.    

There were many others responsible for the problems, from consumers who lost all sense of responsibility to crooked brokers and mortgage bankers.   Rating agencies neglected their responsibilities.  Regulators failed to understand the monster that derivatives and leverage had created.  Bankers put bonuses ahead fiduciary responsibility.  And members of Congress were bought off.

A failure on the part of President Obama to acknowledge the role played by Congress makes his recommendations appear insincere and partisan.




Wednesday, January 20, 2010

Thought of the Day


                                                                                               Sydney M. Williams

Thought of the Day

The victory of Scott Brown, in Tuesday’s Massachusetts Senatorial election, spells the defeat of the Democrat’s plan to overhaul healthcare in the United States, but it should not diminish the need to reform our healthcare system.

First,Tort reform is badly needed.  Excessive payments in malpractice suits have had the twin effects of increasing the practice of defensive medicine, while raising the cost medical malpractice insurance.  It is important that victims of medical malpractice practice be protected and that compensation be made when due.  But frivolous lawsuits have served to enrich a host of trial lawyers, while doing little to curb mistakes, and have made the practice of medicine, in certain states which encourage such suits, prohibitively expensive.  Patients, consequently, have suffered.  The result fewer doctors, unnecessary tests and beleaguered patients.

Second, insurance companies should be permitted to compete across state lines.  The easiest and most effective way to lower the cost of insurance is to increase the number of companies competing for the business.

Third, we need to find a way in which the consumer assumes more responsibility for the cost of services he requires.  Employer-based plans, which have been in effect since the waning days of World War II, are part of the problem.  They came into being during a time of wage controls and benefit plans were one way businesses could differentiate among themselves.  That is no longer the case.  As individuals, we purchase home and auto insurance.  Each policy is essentially tailor-made to fit our specific needs.  We decide the level of insurance we need and the degree of deductibility with which we are comfortable.  Not so in health insurance where, under employer-based plans, one size fits all.  One concept would be to allow each employee take the money currently spent on his plan and, with the same tax benefits the corporation enjoys, purchase his own plan.  Details as to exactly how that would be done would need to be worked out; for under current plans younger workers, effectively, subsidize older ones, as do healthy and fit workers subsidize the less healthy and fit.  However, broad-based plans with increased competition should allay any fears.  It is worth keeping in mind that it is for catastrophic  events that we really require insurance.  The personal paying of routine doctor visits and generic drugs would result in a smarter, more efficient consumer and a more customer-friendly provider.  We would be incentivized to shop for the best doctor (and medicine or service) at the best price.   Self interest, knowing that we bear the costs, would encourage people to live ,more active and healthier lives.

Fourth, consumers should be allowed to buy imported drugs.  If Canadian companies can sell the same drug for less than their American counterpart, why should American consumers be denied the savings?

Fifth, the number of doctors, nurses and other medical workers should not be kept artificially low.  Medical schools should be encouraged to increases student bodies without sacrificing quality.  Students from foreign countries once properly vetted,. should be granted the right to become a citizen.

We know there are a number of uninsured.  Some of these are the young who see themselves as invincible and so feel no need for insurance.  There are illegal immigrants, a group, as we have no sure ways of knowing who they all are, who will likely remain uninsured.  There are others who have been laid off and no longer eligible for benefits, but are without means to purchase insurance.  And there are the destitute that for whatever reason do not qualify for medicaid.  There is not much that we can do for the first group, though their entry into the healthcare system would lower costs for the rest of us, but it does not seem to me that we can require someone to purchase something they do not want.  The second group is likely to remain below the radar, causing costs for us as their access to healthcare is often through emergency rooms; though the advent of “minute clinics” and the like is a positive step in lowering costs. For the rest, the government should consider an expansion of medicaid.

The United States has a medical industry known for its research and innovation.  People from around the world come to these shores to seek attention.  Nothing we do should damage the quality of care we provide, n or the doctors, nurses and staff that provides that care.  We have a foundation on which we can build, not a structure that should be torn down.

Tuesday, January 19, 2010

Thought of the Day

                                                                                                                                                                              Sydney M. Williams

Thought of the Day
January 19, 2010

Besides being somewhat disingenuous, the decision by the President to levy a $90 billion, ten year, “tax” on banks receiving bail-out funds (a 0.15% tax on liabilities), illustrates the problem of government distorting incentives. The original purpose of the TARP program was to prevent a collapse of the financial system – a real possibility that seemed imminent in September-October 2008. We were all at risk because of the excessive use of leverage by banks; lax regulation; rating agencies being paid by issuers, not investors; politicians in bed with GSEs and investment banks, and consumers who believed the good times would continue to roll. Encompassing us all was a fog of hubris.

The disingenuous part of the President’s remarks is that he failed to mention that, with a couple of notable exceptions, the biggest banks have repaid the lent TARP funds with interest. Larger banks which have not completely paid back TARP funds include Citigroup, PNC Financial Services Group and SunTrust Banks. Of the $247 billion in TARP funds received by banks, $162 billion has been re-paid, plus $11 billion in interest. AIG has received about $70 billion and has re-paid nothing. The two auto companies received $66 billion and have re-paid nothing. While AIG is subject to the tax, the auto companies are not. Why not?

In taxing liabilities, the government is simply looking to the size of organizations and their subsequent success, a system which would reward failure and penalize success. Is this the proper role of government in a globally competitive world? When the auto companies were saved, so were UAW workers. Having helped put the auto companies into bankruptcy, should union workers be exempted from this tax?

The consequences posed by this action are serious and run to the heart of our capitalist, democratic society. Is it the role of government to prop up unprofitable businesses, especially ones like the auto industry, which are no longer vital to our national interests? We know that cars can be produced in this Country profitably, as Toyota, Nissan, BMW and Mercedes can attest. If a domestic auto industry wants to compete in a global economy, it is going to have to bring down costs (including legacy costs of long ago, too-generous, labor contracts) and produce cars people want to buy, not necessarily environmentally friendly ones. Do people really think that some government bureaucrat can do what private enterprise could not?

Deficits, no matter how incurred, must be repaid. Growing our way out is the best way, but higher taxes are bound to be part of the answer. There is an irony in that Americans are the most generous people on earth. When tragedy strikes they are the first to respond, as we can see in the disaster that struck Haiti last week. So a natural question: when tragedy struck our economy, as it did during the credit crisis and the ensuing recession, why didn’t people increase, voluntarily, the amount they pay the IRS? Certainly, extra payments would be welcome, accepted and tax-deductible. Warren Buffett has commented that his tax rate is less than that of his secretary. He has the ability to personally address that inequity. Like most of these people, he generously contributes to various charities. Why doesn’t he make up the difference and then some? Many of these same people call for higher rates. They say it is only fair. Their money is welcome, if they will only voluntarily write a check. Can it be that these same people question the efficiency of dollars spent on taxes once it falls into the hands of the tax collector?

I don’t pretend to have an answer, but I feel strongly that what has always driven Americans toward success has been the freedom to try, to succeed or fail, to be creative, to innovate and to excel. We want a tax code that encourages investment and innovation, not one that discourages hard work and creativity. A fascinating statistic of 2008, a year that started ominously and got worse, is that U.S. exports of goods and services increased by 12% that year to $1.84 trillion, or 13.1% of GDP. In contrast, exports in 2003 represented 9.5% of GDP and only 5.3% in 1968. Who, four years ago, would have predicted such an event given the crisis we have lived through?

A government that rewards failure, stifles innovation and penalizes success, is not one that can lead us to new levels of prosperity. I have been critical of many of the large banks, particularly the outrageous bonus payments of public companies. I deplore the drift over the past few decades that has greatly widened the gap between CEOs and average workers. But the answer, in my opinion, is not more government; it is in an education system that is aimed at improving the lot of all students, not one that keeps ineffective teachers employed because of tenure and keeps poorer children in under-performing schools; it is in an immigration system aimed at keeping the best foreign students in our Country after graduation, not one that sends them home for lack of a green card; it is a system that recognizes that people want to succeed, not one that encourages dependency.

The $90 billion tax, over ten years, is not going to break any of the banks, certainly not the well run ones, but it is the concept of penalizing success and the rewarding of failure that I find alarming. Success should be applauded. Bad luck happens and deserves our attention and support. Failure should be shunned. It is unnecessary and uncivil to demonize organizations that have proved successful and which are vital to our lives.

I will be off skiing the next three days, returning on Monday, January 25.

Friday, January 15, 2010

Thought of the Day

                                                                                                                                                                                 Sydney M. Williams

Thought of the Day
January 15, 2010

Partisanship, a fact of life in today’s Washington, is present in the membership of the Financial Crisis Inquiry Commission, a supposedly bipartisan committee which includes six Democrats and four Republicans. It almost assuredly will search out every possible cause of the 2008 credit collapse, but will not delve into the role played by Congress. (In contrast, the 9/11 Commission consisted of five Democrats and five Republicans.)

While rules provide that no member of Congress or any federal, state or local employee may serve on the Commission, it should be noted that the head of the Commission, Phil Angelides, is the former head of the Democratic Party in California, California Treasurer and board member of Calpers, the giant pension fund for state employees.

It has been my contention that blame lies all around – from consumers who willingly took on more debt than they could handle in the belief that house prices would continue to rise; to mortgage bankers and sales people whose only concern was closing the transaction; to bankers who created and traded instruments they knew to be flawed; to investors who willingly and unquestioningly accepted higher than market returns; to rating agencies who, incredibly, two years ago had only twelve companies rated as AAA, but had slapped that label on 64,000 pieces of securitized paper; to a government which, with the Community Reinvestment Act of 1977 (which breathed life into ACORN) had forced banks to forgo lending standards by providing mortgages to those without means.

Since I know that the Commission will leave no stone unturned in terms of the role played by banks, rating agencies and mortgage brokers, questions I would like to see the Commission answer would include:

     *What role did the Community Reinvestment Act, a Bill signed into law by President Carter and supported by succeeding Presidents, but especially Bill Clinton and George W. Bush, play in encouraging low income people to take on debt they could not manage?

     *Beginning in 2001 President Bush attempted to reform Fannie Mae and Freddie Mac, initially because the “financial trouble of a large GSE could cause strong repercussions in financial markets.” He continued the attempt in each successive year, saying in August 2007, “Congress needs to get them reformed, get them streamlined, get them focused.” Why did Barney Frank persist in preventing reform and how much money did those two organizations pay into his campaign coffers?

     *Why was the CDS market allowed to grow to a level that it exceeded by a factor of ten the nominal value of the debt it was insuring? What agency and who in Congress were responsible?

     *What is the real relationship between Senator Chris Dodd and Angelo Mozilo and why has Dodd not provided details on the mortgages he received from Mr. Mozilo’s company, Countrywide Financial Corp?

      *Early in the financial meltdown, why did it take so long for regulators to suspend mark to market rules? And why did the SEC not enforce rules such as prohibiting naked short selling?

      *Why did bank regulators permit off-balance sheet items to balloon to such critical proportions, thereby increasing leverage ratios far beyond legal (and realistic) limits?

While I do not expect any of these questions to be asked and certainly not answered, a responsible Press should raise them. Seeking truth has taken a back seat behind assigning blame and protecting a political class that will, as the Wall Street Journal says this morning, “do almost anything to avoid testifying.” It stands out as another reason why term limits should be imposed on members of Congress, as they have been on our President and many state and local officials.

Thursday, January 14, 2010

Thought of the Day (2)

                                                                                                                                                                                      Sydney M. Williams


Thought of the Day (2)
January 14, 2010

Artificial penalties, such as fees or higher taxes, as a means of reining in banker bonuses will never work. The better course is to encourage a change in the environment within which bankers operate. Andrew Ross Sorkin, author of Too Big to Fail, in an article in yesterday’s New York Times, clearly delineated the nefarious trading practices of Goldman Sachs’ fundamental strategies Group (an attitude confirmed by Lloyd Blankfein’s testimony when he stressed the importance of his proprietary desk over customer business and fiduciary responsibility). It is clear that the desk is run for the employees of Goldman, at the expense of their customers and with the U.S. taxpayer as backstop.

The simplest, least costly and most effective way to change the culture is to remove the label “too big to fail.” If bankers realized that their leveraged bets risked the bankruptcy of themselves and their organizations, one can be assured dangerously risky bets would disappear – along with the potential for outrageous paychecks. Jonathon Macey, in yesterday’s Wall Street Journal, writes that President Obama’s policy (despite his rhetoric) confirms the importance of big banks to our national interest, thereby suggesting they are too big to fail. Such an assurance from the government only encourages them to making risky bets. Professor Macey also writes: “The public shareholders of these companies tend to be diversified against the risk of failure at any particular institution.” His argument is that most of the stock is held by large institutions, not individual investors. There is, therefore, no natural governor on reckless behavior.

Robert Reich, writing in yesterday’s Financial Times, points out that no one “is talking seriously about using antitrust laws to break up the biggest banks – the traditional tonic for any capitalist entity that is ‘too big to fail’.” In my opinion, if a bank is too big to fail, it is too big. As banks increase in size, regulators should increase capital ratios. In the fall of 2008, Morgan Stanley and Goldman Sachs became commercial banks, allowing them access to the Fed window. That status brings with it reductions in leverage. And the capital ratios should incorporate all off-balance sheet items.

At the end of day, there is nothing like the threat of bankruptcy to maintain prudent lending practices, which has the side benefit of keeping excessive compensation in check. The problem of “fat cat” bankers would simply disappear.

Free capitalism only works with a carrot and stick – the carrot of success and the stick of failure.

Thought of the Day

                                                                                                                                                                              Sydney M. Williams


Thought of the Day
January 14, 2010

Knowledge that Jim Chanos has chosen to short China has become ubiquitous. Mr. Chanos has been a highly successful short seller and his opinion is always worthy of consideration, though I marvel and wonder that he allows his investment ideas to be so publically disseminated.

Thomas Freidman, in a column in yesterday’s New York Times, entitled “Is China the next Enron?”, questions Mr. Chanos’ thesis. (I find it hard to believe that a man such as Mr. Chanos, known for his diligence, has not considered these observations.) Mr. Freidman’s essential point is that, while agreeing China has problems in “spades”, “It [China] also has a political class focused on its real problems, as well as a mountain of savings with which to do so (unlike us.)”

That sentence highlights China’s real problem – a political class focused on addressing its economy, the exact opposite of what has produced two hundred years of unparalleled economic growth in the Western world – the willingness of creative individuals, operating in a society that supports personal freedom, to take risk. It is the ability to function freely that solves problems – not government bureaucrats. The Soviet Union and Communist Eastern Europe were the most recent examples of failed States that tried to control industrial production and the flow of goods and services to consumers. Tom Freidman hints at the resolution to China’s problems, but fails to make the link. He points out that China has 400 million internet users, half of whom, he claims, use broadband. In spite of current censorship in China – enough to cause Google to consider giving up $600 million in revenues – the internet is a great force for democracy, and ultimately will bring down the totalitarian dictatorship which is Chinese Communism.

The willingness of the Chinese government to embrace capitalism suggests an understanding of the powerful, long-term, forces of freedom; reluctantly, they will be dragged toward democracy. It will be at that point that China will realize its full potential.

Unknowns breed risk, and in China there are a lot of unknowns. Has infrastructure run ahead of development? How controlling and/or corrupt is the government? Transparency is an issue (as it is in our derivatives markets.) How significant is the social unrest in last year’s 80,000 demonstrations?

It is far beyond my capabilities to weigh in on the merits of investing in China. My only experience was a, very brief, visit a year and a half ago, but I was struck by the youthful dynamism and confidence of the people in Shanghai and Beijing. There is a feeling that one is at the start of a long and important journey. It is an exciting place.

China has allowed capitalism to flourish. But capitalism constrained by Mr. Freidman’s bureaucrats over individual freedom will not unleash the “animal spirits” that allow creative responses to specific problems. A necessary component of capitalistic growth is, unfortunately, recession, the healthy part being that it eliminates excesses. There will be economic downturns, which not even China’s leaders will be able to prevent. One cannot rule out future Tiananmen Squares, but there is little doubt as to the long term trajectory.

Over the past ten years China’s economy has compounded at 10%. In contrast, the Shanghai Index has compounded at less than half that rate – 4.5%. Not knowing anything as to the valuations, those numbers suggest to me that there is at least some degree of skepticism built into the market.

Monday, January 11, 2010

Thought of the Day

Monness, Crespi, Hardt & Co., Inc.

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Sydney M. Williams
Thought of the Day
January 11, 2010

The yield on Treasuries rose in 2009 making U.S. Government Securities – the stand-out investment in 2008 – the goat last year. Money poured into corporate bond funds, to the tune of $239 billion, helping to bring down yields on Investment Grade Corporates by 128 basis points and on High Yield bonds by 786 basis points. Spreads between High Yield and Investment Grade and Investment Grade and Treasuries narrowed considerably, by 650 basis points and 298 basis points respectively. In other words, the further one went out on the risk curve in 2009, the better the performance.

Spreads are now below where they were at the end of 2007. It is hard to imagine that 2010 will be a repeat of 2009, at least as far as corporate bonds are concerned.

The growing federal deficit with the spending program in place, along with that proposed, will continue to put pressure on Treasuries. In fact, the Treasury just announced an increase in the TIPS (Treasury Inflation-Protected Securities) program, a recognition of the increasing creditor demand from China and Japan. The fiscal status of most States remains a mess. The incredible deal struck by Senator Ben Nelson of Nebraska and Harry Reid, in which the Federal government would pick up, in perpetuity, increased Medicaid costs associated with the ill-conceived health care Bill has raised the anger of governors in states such as California and New York with much larger Medicaid problems. (Senator Nelson now claims he never meant to have Nebraska receive special treatment. It is truly amazing how these guys can lie so brazenly! Term limits cannot arrive soon enough!) Given the sorry fiscal condition of State budgets, pressure will only intensify to add the estimated $25 to $30 billion Medicaid costs to the Federal deficit.

With mid-term elections around the corner and unemployment elevated, the Administration’s focus will finally move from health care, climate change and cap-and-trade to jobs. The economic recovery, even if slower than normal – restrained by a chastened consumer and rising taxes – will induce higher borrowing costs. Any whiff of inflation and bond funds will watch inflows morph into redemptions. In fixed income markets, ironically, municipals alone may have a good 2010. The problems within States have been widely publicized, so are well known and are likely discounted. Additionally, rising taxes increases the attractiveness of this tax-exempt sector.

It is widely anticipated that JP Morgan will be the first of the bailed-out banks to increase its dividend – a welcome relief to shareholders who were hit in the last two years, not only in their capital accounts, but, important to an aging population, in terms of income. Because of the greatly increased number of shares outstanding for many of these banks, it is unlikely that former dividend rates will be restored, but increases are better than decreases.

Friday, January 8, 2010

Thought of the Day

Sydney M. Williams

Thought of the Day

January 8, 2010

The Fed’s minutes for the December meeting were released on Wednesday. The interesting point from my perspective is that while the economic news continues to improve – real personal income continued at a “solid pace” in October, housing construction held “fairly steady” in recent months, real spending on equipment and software was estimated to have “risen slightly” and consumer spending appeared to be on a “moderately rising trend” – nevertheless the decision on rates was to keep the range at 0 to 0.25% for an “extended period.”

The Committee did indicate that “weakness in labor markets continues to be an important concern” and that they expected unemployment “to remain elevated for quite some time.” They also noted concerns “about the potential default by some sovereign borrowers.” But it has been positive news on economic growth that has been most surprising, to investors and probably to the Fed.

As a start to the unwinding of the stimulus, the Federal Reserve’s Open Market Committee indicated that they would gradually slow the pace of purchases of housing related agency debt and Mortgage Backed Securities. In the meantime, though, the Fed’s balance sheet will “expand significantly in the coming months.”

The size of the deficits is a concern to markets. The yield on Three-Month Treasuries has risen from five basis points in mid November to forty-five basis points today. In the same time the yield on the Five-Year has risen from 2.06% to 2.6% and the yield on the Ten-Year has gone from 3.2% to 3.8%. Government has four options for dealing with the deficit: they can raise taxes; they can allow the dollar to cheapen by inducing inflation; they can reduce spending, or they can encourage economic growth, thereby naturally increasing tax revenues.

Washington being Washington, reductions in spending will not happen. In fact, given current and expected legislation, spending will increase, perhaps at very high rates. The best way to encourage economic growth is through tax reductions, an unlikely event. That leaves, as the most likely path, the raising of taxes and/or inflating our way out of the problem. However, should growth in the economy persist, tax revenues will increase.

Nevertheless, the environment is not all bad for stocks. The market is a discounting mechanism. An article in Monday’s Wall Street Journal by Tom Lauricella pointed out that over the ten years ending December 31, 2009, stocks traded on the New York Stock Exchange lost an average of 0.32% a year – making it the worst calendar decade going back to the 1820s. Stock investors, despite last year’s rally, remain cautious. Between March and the end of December, Morningstar reported that investors pulled $20.7 billion from equity funds. During the same period they put $239 billion intro bond funds. Should rates rise and the economy continue to improve, we should see a reversal.

Thursday, January 7, 2010

Thought of the Day

Sydney M. Williams
Thought of the Day
January 7, 2010

I recall a quarter century ago when Henry Kaufman, Salomon’s chief economist and head of research, said that he wished he saw more analysts deep in thought rather than crunched over their terminals preparing spread sheets. One has the same wish today about that great deliberative body – the United States Congress.

In a recent article in National Affairs, Jim Manzi (former CEO of Lotus Development) discusses competing forces that are challenging America today: the need to compete in a globalized world and the importance of maintaining our historical position as a compassionate people. Up to now we have been successful, in a competitive stance, in that over the last thirty years our share of global output, despite the rise of China, has remained constant at 21%. Western Europe, in contrast, has seen its share collapse from 40% to 25%. To stay competitive requires an innovative spirit encouraged by limited regulation and few restrictions on behavior. The problem, though, is that that growth has come at the cost of a less cohesive society – a society marked by a growing disparity between rich and poor, educated and uneducated; a society in which it has become increasingly difficult to mount the ladder of success. History suggests that such disparities, if ignored, ultimately end in tyranny or revolution – not a course most of us would choose.

The great challenge for America, as Mr. Manzi writes, is to reconcile these competing forces and, I would add, in such a manner that raises the median, not the average. This is where Dr. Kaufman’s comment seems relevant. Jim Manzi suggests four steps that could be taken. Simplified, they are: one, unwind last year’s partnerships between Big Government and Big Business. Government is too inflexible to compete in our global environment; two, implement financial reform aimed at avoiding systemic risk without stymying innovation; three, deregulate public schools – let charter schools bloom and allow money to follow the students (rather than the other way around), and four, “re-conceptualize” immigration by recruiting talent wherever it may be, “from Mexico City to Beijing to Helsinki to Calcutta.” While I agree with all four proposals, the last two have particular appeal.

Proposals of this sort – out of the box thinking – deserve careful and thoughtful consideration and debate. Congressional members should set aside their fractious differences and in a harmonious spirit try to resolve this Sisyphean problem – let members come together, heeding Dr. Kaufman’s wish, and think seriously of these issues.

President Obama, addressing one side of the conflict, has seemingly set us on a course toward European socialism. Such a path will require higher taxes and will likely result in a depreciated currency. It will dull our native instinctual spirit of innovation and creativity. His policies may flatten the differences between rich and poor, but they will ultimately lower the standard of living for everyone.

Too many people, especially the unions, are mired in a past that will not return. No man is an island, wrote John Donne 400 years ago, and certainly no country can afford to be. We live in a world in which competition is intensifying – for customers, for goods, for immigrants and for services. To survive and flourish in the decades ahead, we must recognize and meet our competition.

Wednesday, January 6, 2010

Thought of the Day

January 6, 2009

An old English proverb states: “The devil finds mischief for idle hands.” Now I realize there are many, including members of that august body, who will claim that Congress has no idle time (and they will cite this year’s Christmas Eve vote), but there are few occupations in which employees’ crowd microphones like moths to a light and who jostle one another for multiple photo-ops like those on the Hill in Washington. Should those in the private sector spend as much time courting the press, as does this un-photogenic group, profits would sink and tax revenues – the life blood of government – would disappear.


Now that government has invested in banks, insurance companies, the auto industry, finance companies, attempted to control the energy industry with cap-and-trade and now that plans to reorganize healthcare under a federal umbrella seems all but done, they are planning to do their magic in repairing the financial regulatory system.

With Wall Street in the corner wearing a dunce cap, populist politics have become all the rage. Bankers have been vilified, consumers, with unemployment at thirty-year highs and personal bankruptcies at record levels, are chastened, but politicians remain unrepentant.

While there are many reasons as to why the financial system came close to collapse, the root of the problem was the government’s decision to increase home ownership to those who could ill-afford the obligation – so that more people could realize the “American dream”, a dream that became a nightmare. Fannie Mae and Freddie Mac, permitted by the Clinton administration to leverage 40:1, became the uncritical buyers and guarantors of high risk mortgages that government required banks to issue. George Melloan writes in The Great Money Binge: “In short, the Clinton administration drafted the mortgage finance industry into the service of social policy.”

Mortgage backed securities were developed so that mortgages could be bundled and sold to institutional investors. The system worked well as long as the quality of mortgages remained high. The effect was to widen ownership and provide issuers the capital to make more loans, thereby keeping rates lower than they would otherwise be. However, HUD, in the late 1990s, set explicit quotas for Fannie Mae and Freddie Mac – it required that no less than 50% of the mortgages they purchased be for low and moderate income families. That led to the creation of Alt-A loans, commonly known as “liar loans.” AIG, and others, insured the loans, so that rating agencies treated the bundled loans the same as before, despite the obvious deterioration in quality. Buyers, made comfortable by the insurance they had purchased, were guilty of not asking the questions they should have, as the government’s policy was well known.

When the Bush administration – also supporters of the concept of a home in every portfolio – attempted to reform the two GSEs, they were shot down by their two principal supporters (and financial beneficiaries) – Senator Chris Dodd and Representative Barney Frank.

Mr. Melloan quotes Representative Frank, regarding Freddie Mac and Fannie Mae, at the time of the 2007 hearings about President Bush’s reform proposal: “I think it serves us badly to raise safety and soundness as kind of a general shibboleth when it does not seem to be an issue.” A year and a half later, following the collapse of the two entities, George Melloan quotes Dodd: “Where was the administration over the last eight years?” and then answers, “It had been hammering on Chris Dodd to stop blocking Fannie and Freddie reform.” (Senator Dodd’s decision yesterday to not run for re-election, in my opinion, is a cause for celebration!)

It is my sense that there is need for reform, but as important there should be enforcement of existing rules. Realistic leverage ratios should be imposed on banks and other financial corporations, and should be enforced. However, any reduction in leverage ratios should be imposed gradually, for reduced credit availability lowers economic growth. Derivatives, especially credit default swaps, should be exchange traded with improved transparencies.

But government needs to consider the financial impacts of imposing social changes they choose to implement. Consequences, intended or otherwise, will result. Requiring insurance companies, for example, to ignore prior health conditions require changes in actuarial tables – an increase in rates will follow. By permitting young, healthy people to opt out of insurance plans by paying a fine will also cause rates to go up. Allowing people without insurance to buy coverage only when they need it will cause rates to go up. If Congress forbids insurance companies from raising rates, then our taxes will rise; for no matter what they tell you in Washington, nothing in life is free.

“First do no harm” are words attributed to the Hippocratic Oath; it is an oath that should be sworn to by all by members of Congress.

Tuesday, January 5, 2010

Thought of the Day

Thought of the Day


January 5, 2010

A consideration, as we enter 2010, is that the Administration is likely to alter the way it views and comments on the economy.

While economies march to their own drummer, perception and the spin put on commentary play a role. Last year it was in the interest of the Administration, as the in-coming Party, to paint the economy in as dark tones as possible. The blame would be laid, as indeed it was (justifiably, if one also includes the Democrats who run Congress), on the former Bush administration. This year the Obama administration will have full authorship of the economy and one can bet that the rhetoric, in the months ahead, will assume a much more positive bias. The trillions of our dollars that have been spent or committed will be credited for the recovery, as it takes shape.

It is not that the “blame game” will end, but that the emphasis will be on the improving outlook – an outcome I expect. But an improving economy brings its own set of risks. In the early months, employment will lag; so that positive words may well fall on despondent, out-of-work ears. Secondly, and of longer lasting consequence, interest rates will rise, hampering housing as it struggles to improve. As we head toward the mid-term elections and the crowing, as an improving economy intensifies, it will be difficult for a theoretically independent Federal Reserve to remain mired in providing money at zero interest rates.

One can expect mainstream media to echo the raising of hockey sticks by the Obama White House.

While the tone of both the rhetoric and the real economy should improve as the year progresses, the real choice for voters as November approaches will be the in the expectations for government and the role that it plays. Is government the solution to our problems, as President Obama and the far left would have us believe, or is it the problem, as President Reagan so famously stated? Keep in mind that it was government which brought us “affordable housing” and which now wants to bring us “affordable healthcare.”

Monday, January 4, 2010

Thoughts of the Day - 2010

We begin a new decade. Purists will claim that the new decade begins in 2011, but this works for my purposes. It was ten years ago that we realized that the millennium change would not shut down computers around the world and that the Federal Reserve’s precautionary measures of pumping money into the system proved unnecessary, though that stance came to symbolize a decade of low interest rates and easy money that came to an horrific end in the summer of 2007.


Besides intelligence, characteristics of success in America have long been based on diversity, meritocracy, hard work, innovation, and the willingness to take risk with an overlay of optimism. While none of these qualities are uniquely American, we have historically blended them better than most, in large part because we are truly a nation of immigrants. At times such as these, with the economy in trouble and confidence low, there is a risk that we push aside those characteristics in favor of less attractive ones – cynicism, based upon the failure of people and institutions; dependency, based upon a government, which can convert compassion into subservience; a xenophobic fear causing people to turn inward toward nationalism and the substitution of meritocracy with seniority (a favorite of unions.)

A manifestation of the last ten years in equity markets was high volatility with a downward bias – an attractive combination for the proliferation of hedge funds that multiplied over the decade like rabbits in a vegetable patch. Hedge funds have been around since at least 1949 when Alfred Winslow Jones founded A. W. Jones & Co. Michael Steinhardt started Steinhardt, Fine & Berkowitz in 1967 and six years later George Soros began the Soros Fund. Others followed suit. While never equaling mutual funds in asset size, they dominated trading with a combination of leverage and trading skills.

The market, over the past decade, proved accommodating. The decade began with the market commencing a thirty-three month decline. The S&P 500 closed December 31, 1999 at 1469.25. By October 9, 2002 it had declined 692.49 points to 776.76. It then proceeded to rally 785.71 points, over five years, to an all-time high of 1562.47 on October 10, 2007. An eighteen month decline took the index to 672.88 on March 9, 2009. We closed on December 31, 2009 at 1115.10 – a price decline of 24.1% over the ten year period, but one that encompassed 1227.93 points on the upside and 1582.08 points on the down side – a level of volatility made to order for newly started hedge funds.

It is easy to peer out from our snow encrusted homes and offices and despair of the risks that abound – a time of unprecedented government intrusion; a Congress divided by partisanship; Local, State and Federal deficits that dwarf anything we have known in the recent past; a world in which terrorism persists and one in which a terrifying dictator is likely months away from nuclear capability, and an economy with fifteen million unemployed with asset prices – homes and equities – far below their highs of a few years ago.

But we are absent the one factor that always concerns me – complacency (except, perhaps, for certain commodities.) We watch, listen and read daily of these problems; so we know, one, they are, at least in part, being discounted and two, they are being addressed.

To the extent that history is a guide (and one should always be wary of history as a guide, for times are never the same), it seems that the decline in volatility, both in terms of the VIX and in terms of daily moves, is likely to persist. Expectations remain low. Investors continue cautious. The buy-and-hold, long term investor has been declared, if not dead, an endangered species. However, the essence of our character has not changed, and I, for one, would not rule out a ten year period during which confidence is gradually restored, with optimism ultimately tossing cynicism over board.

The rip tides that permitted hedge funds to prosper may well abate. Such an environment, should it occur, could well be more suitable to long-only investors. We shall see.

On a more personal level, the next decade will see enormous changes in my grandchildren. For all but the youngest, it will be their coming-of-age decade – a time when they exchange the innocence for the enticement of young adulthood. Heartbreak and tears are part of growing up, but so are joy and discovery. I only hope the transformation is achieved with as little pain as possible.

Happy New Year!