Friday, February 26, 2010

"Greece - It's Like Deja Vu All Over Again"

Sydney M. Williams

Thought of the Day
“Greece – It’s Like Déjà Vu all Over Again”
February 26, 2010

Reading the lead article in yesterday’s New York Times on how the situation in Greece was aggravated by the same notorious misuse of credit-default swaps as helped bring down AIG eighteen months ago, one was reminded of the famous Yogi Berra quip: “It’s like déjà vu all over again!” And like magic, amidst the dust of financial chaos appears the ubiquitous Goldman Sachs – first as creator of the mess and then, mop in hand, as saviour.

As I and others have written in the past, the CDS market is an example of financial innovation, not only out of control, but deliberately misused for the benefit of broker and speculator alike. The concept behind credit defaults, as a form of insurance, is perfectly legitimate. They operate on the same principal as house or auto insurance, but with some distinct differences: they are tradable; their value can greatly exceed the nominal value of the asset being insured; they are not subject to insurance regulation. In the New York Times’ article, Nelson Schwartz and Eric Dash quote the head of credit strategy at UniCredit in Munich: “It’s like buying fire insurance on your neighbor’s house – you create an incentive to burn down the house.” In their present form, CDS’s should be ruled illegal.

A buyer or owner of Greek bonds may well decide to purchase insurance (using the credit-default swap market), as long as the coupon minus the cost of the insurance provides a return commensurate with the perception of risk. A glaring problem is that, in this unregulated market, the total amount of insurance written often exceeds the nominal value of the security (securities) insured, thereby allowing speculators to bet aggressively in favor of default. A major difference, however, between Greece and AIG is that, astonishingly, AIG was a writer of the insurance against its own default. Greece does not bear that risk. (Though the EU or the IMF, inadvertently, may.)

In yesterday’s Financial Times, Gary Gensler, Chairman of the Commodity Futures Trading Commission, had a (somewhat self-serving) op-ed piece in which he called for three essential components for reform of the over-the-counter derivative market, rules that already exist in the regulated securities and futures market. But he doesn’t go far enough, as it applies to CDS’s or to non standard derivatives.

Mr. Gensler writes, first, that all financial groups that deal in OTC derivatives should have sufficient capital, post collateral and be subject to regulation. Second, standard OTC derivatives should be required to be traded on an exchange in a transparent manner and, third, the trading of standard OTC derivatives should be required to be brought to a clearing house. But, even tougher standards are needed. Non standard derivatives should be required to be fully disclosed in filings with the SEC, in a transparent manner and not be carried off balance sheet.

Credit-default swaps are insurance. As such, presuming they are permitted to continue, CDS’s should be required to be registered with state or federal insurance regulators; the dollar amount insured should never exceed the value of the underlying asset and pricing should be subject to actuarial rules and subject to review by the appropriate regulator.

If we fail to learn from earlier mistakes, if we continue to permit darkness to shroud derivative transactions, if we permit products that generate enormous profits, but add very little economic value, to risk our financial system, if we allow speculators to drive companies (and perhaps countries) into bankruptcy then we deserve our fate. I hope we have learned, but eighteen months have gone by since those frightening days of September-October 2008, and the White House, focused on cap-and-trade, health care and climate change, has been generally silent on this far more relevant and important issue.

Thursday, February 25, 2010

"The Kindness of Strangers"

Sydney M. Williams
Thought of the Day
“The Kindness of Strangers”
February 25, 2010

As Blanche DuBois says, as the doctor leads her away in the final Act of A Streetcar Named Desire, “Whoever you are, I have always depended upon the kindness of strangers.” Similarly, the United States, if the recovery is truly to take hold, must depend upon growth in Asia.

With consumers in deleveraging mode and business subject to an Administration intent on transforming the U.S. economy with its preference for government intrusion into energy (carbon taxes) and health care; its emphasis on the environment, regardless of costs, and its already announced $122 billion tax on business foreign profits and a redistributive tax policy, it is not surprising that confidence has once again ebbed. Daniel Henninger writes in today’s Wall Street Journal: “…while the tax and economic policies of the past four presidents worked for the economy – birthing whole industries – it was bad for society”, which, in part, explains President Obama’s socialist tendencies. His political philosophy carries risk. It is worth recalling the admonition from Charles Munger and his parable of Basicland, which I mentioned yesterday.

While most indications continue to suggest continued economic recovery, there are some worrying signs. The ECRI (Economic Cycle Research Institute) Lead Index, which foretold the recovery we saw in last year’s second half, has decreased recently. For the week ending February 12 the Index declined from 130.0 to 128.4. As the authors state, the Index “is still consistent with continued recovery, but a turning toward more significant declines would be a warning sign of a stalling recover.” The reading for the week ending February 19 should be out tomorrow. It is published in Investor’s Business Daily.

The lead article in yesterday’s Wall Street Journal dealt with bank lending. According to the article, the decline in bank lending was the lowest since 1942. With commercial loan problems looming, banks have been strengthening their balance sheets, making them reluctant to lend. Additionally, but unstated, is that securitization (the shadow banking system) has dried up.

The current reading of the Baltic Dry Index, an imperfect, and arguably volatile, measure of world trade has declined 41% over the past three months, from 4661 to 2724.

In testimony yesterday, Fed Chairman Ben Bernanke emphasized that last week’s cut in the Discount Rate was not a precursor of rate declines – that he expected rates to remain low for the foreseeable future. This less than robust view of the economy encouraged investors who, perversely, lifted the Dow Jones 92 points yesterday. (I guess persistent low rates, a factor leading to the credit crisis of 2007-2008, are viewed more positively than economic growth?)

I continue to expect economic recovery will gradually continue, but domestic headwinds exist and we are going to have to rely on strangers in Asia to help in the extrication process.

Wednesday, February 24, 2010

"Algorithmic Trading - Economic Value?"

Sydney M. Williams
Thought of the Day
“Algorithmic Trading – Economic Value?”
February 24, 2010

Over the weekend, in Slate, Charles Munger, Vice Chairman of Berkshire Hathaway, published a parable about how one nation came to financial ruin. He writes that the large Pacific island was discovered in 1790 by Europeans and named “Basicland”. The country bears close resemblance to the United States.

He tells the story of a country that gradually descends into fiscal irresponsibility. Citizens worked hard, relied on government only for essential services and came to lead the world in terms of GDP. However, with economic success, government spending, as a percent of GDP, quadrupled over a few decades. An increasing number of people came to rely solely on the beneficence of government, while their affluent neighbors, with more and more leisure time, took to gambling, betting on security prices. In time, 25% of GDP and 22% of all earnings were derived from such activity. Highly talented mathematicians and engineers were lured to work in these casinos, making bets on what were “now called ‘financial derivatives’”.

Over time, increased competition from developing nations and rising energy prices disrupted the calm. Recommendations to discourage speculation, and the concomitant encouragement for the production of items that could be sold to foreigners, were ignored. A belief that one should not interfere with free markets, no matter how destructive they were becoming due to the rising importance of gambling, led traders to double down on their bets. Keynes admonition was ignored: “When the capital development of a country is the byproduct of the operations of a casino, the job is likely to be ill done.”

The end was a tale foretold. Basicland, Mr. Munger concludes his parable, is now under new management and has changed its name to Sorrowland.

The parable of Basicland strikes a chord with those of us who have watched the New York Stock Exchange grow from trading less than ten million shares a day to a billion and a half today. No one – certainly not I – want to return to those earlier days. Trading has benefitted as technology has grown concurrent with finance, especially in the last couple of decades. According to Carol Clark, writing in the most recent Chicago Fed Letter and citing the TABB Group, algorithmic high-frequency trading accounted for 70% of U.S. equity trading in 2009.

Supporters of high-frequency trading, which include an estimated 2% of 20,000 trading firms in the U.S. and who made an estimated $21 billion in 2008 using such techniques, cite benefits to investors – narrowing spreads and increased liquidity. Both benefits may be true, but are difficult to quantify. On the other hand, that the principals of those trading firms benefitted royally there is no question.

The risks of such strategies include the potential for systemic risk. The Chicago Fed Letter cites an example of a trading firm in 2003: “The firm became insolvent in 16 seconds when an employee who had no involvement with algorithms switched one on. It took the company 47 minutes to realize it had gone bust and to call its clearing firm, which was unaware of the situation.” It is the speed and size (in aggregate) of orders which pose risks. Latency is the term used to measure delays and latency is measured in micro seconds (millionths of a second). Credit Suisse was fined by the NYSE in 2007 for an incident in which a programmer changed the parameters on an algorithm which resulted in a message loop that sent 600,000 messages to the matching machine in twenty minutes, at least two thirds of them in error.

At this point we have been fortunate. Errors have been caught and losses have been relatively small. We may not always be so lucky. The size of trading, and the speed which participants demand, risk a financial fire bomb.

There is also the question of economic value. Derivatives, properly regulated, do provide value. They reduce costs of borrowing and allow market players to hedge risk, while providing an outlet for speculators. It is far more difficult to determine ways in which the economy has benefitted through high-frequency algorithmic trading.

Professor Edward Thorp of M.I.T., the godfather of today’s quantitative trading practices tested and honed his skills in Las Vegas in the early 1960s. If less than thirty percent of today’s trading activity is based on fundamental investing, it appears that our markets increasingly take on the mantle of a casino. Without proper regulation, a good dose of common sense and the means of avoiding systemic risk, we risk living the final chapter of Charles Munger’s parable.

Tuesday, February 23, 2010

"Stubborn Does Not Win the Day"

Sydney M. Williams

Thought of the Day
“Stubborn does not Win the Day”
February 23, 2010

While Special Forces used horses in 2001 in Afghanistan in their quest for Osama bin Laden, the last time they were used in a Calvary charge was almost 100 years ago during World War I. Their fate was German machine guns. On the other hand, mules (a relative of the horse) were used during World War II. I remember my father telling me of the mules used by his unit, the 87th Regiment of the 10th Mountain Division. He told me that he would have liked to have been a “mule skinner” (one who takes care of mules), but, at five foot ten, he was two inches too short for these big animals. Once in combat in Italy, mules did not fare well.

Mules have a well deserved reputation for being stubborn, something in common with our President, as he resurrected health care reform prior to a scheduled Thursday photo-op (called a health care summit) with Senate and House leadership. Polls indicate very little public support for either the House bill or the Senate version. The President issued his own version, which closely resembles the Senate version, but makes no concession to any Republican proposals, with no mention of tort reform or interstate competition among insurance companies. The entire proposal, as have all Democratic proposals, rests upon a questionable Constitutional provision – mandating insurance for all people.

Universal coverage, a worthy goal, depends upon young, healthy people buying insurance and thereby broadening the base. While I personally believe it a mistake for anyone not to carry health insurance, the concept of requiring people to do so will certainly be challenged.

The President’s version calls for a new federal body to review all insurance company price increases – an added layer of bureaucracy of questionable import at a time of already large deficits. One cannot help but think that this move is nothing more than a shrewd attempt by the President to deflect negative attention from the Democrat’s plan toward the “big, bad” insurance companies. State regulators are charged with reviewing all rate requests (and WellPoint’s California Anthem unit had their infamous rate increases approved without comment last fall). State regulators must ensure that rate increases are actuarially correct and that the company has adequate capital to pay claims. The proposed federal commission could simply roll back prices deemed politically unpalatable.

The President’s proposal also recommends increasing taxes for “wealthy” investors on unearned income, a critical error at a time when the country should be encouraging investment. The expected cost of the plan, which one has to expect is underestimated, is just under a trillion dollars over the next decade – an added burden to an already record budget.

The President is young, bright, articulate and photogenic. There is little doubt in my mind that he will shine, especially in comparison to a number of the older, un-photogenic Republican leadership. But the people have shown an ability to look through style to the substance of the recommendation.

The economy may be in recovery, but it is fragile at best. Unemployment remains high and Congress needs to focus on reforming the financial system. Whatever goodwill the President has with the opposition will take a step back, as he attempts resuscitating healthcare in a public forum and with a plan that makes no concession to republican suggestions. Democrats hope to show Republicans as the party of “no”, intransigent in their refusal to negotiate, but refusal on the part of the President to incorporate any republican proposal demonstrates who is truly stubborn, and we know the fate of those mules in the Apennine hills sixty-five years ago.

Monday, February 22, 2010

Federal Debt - Built on Compassion, but Dangerous

Sydney M. Williams

Thought of the Day
“Federal Debt – Built on Compassion, but Dangerous”
February 22, 2010

In the introduction to his 1997 book, Hamilton’s Blessing, John Steele Gordon quotes an 18th century British journalist trying to explain the magnitude of Britain’s national debt of ₤272 million, as it was in 1790: the debt was “a sum which the human mind can hardly form an impression. Were it to be laid down in Guineas (a gold coin worth 21 Shillings), it would extend upward of four thousand three hundred miles in length.”

Our debt can be expressed in equally dramatic terms. Yesterday the Space Shuttle Endeavor returned from sixteen days in orbit with the International Space Station, a trip that covered 5.7 million miles. If the astronauts had tossed out the window $250,000 for every mile they traveled, the total dropped would approximate our $14 trillion debt.

As a percent of GDP, the Federal debt, the current budget and the deficit are at the highest levels since World War II.

For decades Cassandra’s have been preaching the miserable fate that will be ours if we do nothing to reverse this trend that has been in place for the last fifty years. The very fact that these doomsayers have been proven premature and wrong has caused complacency to seep into Washington’s psyche. It is reminiscent of the Aesop story of the boy who cried wolf; when the wolf finally appeared, the boy’s cries went unheeded.

Nobody knows how far this band of debt can be stretched, but we all know there is a point of no return. And, if nothing else, the debt we have accumulated over the past five decades, a time of relative peace and reasonable growth, limits our ability to respond robustly during times of crisis. The current crisis has doubled our deficit in a year. Could we afford to double it again?

More than anything else, our debt is a function of compassion, of a willingness to share the great riches of this Country with those less fortunate. At home, the United States has a welfare system (Social Security, Welfare, Medicare and Medicaid) that increasingly consumes larger and larger portions of our budget – transfer payments that are considered inviolate. Abroad the United States acted as defender of the West during the forty-five-year-long Cold War. We are the first to respond in times of natural disasters. We do more to fund organizations like the IMF and the World Bank than any other country. We are the force and the check book behind the current War on Terror – the beneficiaries of which are free peoples all over the world. The United States is blessed in its natural resources, its climate and its people, but it is also blessed with an unparalleled work ethic and an innovative spirit that has permitted those resources to be converted into wealth.

No caring person wants to end such aid. No politician wants the government he serves to be less benevolent. But compassion without means is simply a deferral of an ultimate due date and eventually only an empty promise.

It is possible the Country goes on, digging an increasingly deep and difficult hole. No one knows the tipping point, the moment the rubber band snaps, but it will. President Obama’s decision to ask Erskine Bowles and Alan Simpson to head a bipartisan commission focusing on the deficit is a good first step. Peggy Noonan wrote in this weekend’s Wall Street Journal, the decision is “…politically shrewd and, in terms of policy, potentially helpful.” The irony is that, as the President announced the bipartisan committee, he also announced plans to re-spend returned TARP funds, money that was supposed to be used to reduce the deficit. With politicians, one must watch what they do, not what they say.

Spending will have to be reined in, as painful as that will be. On the other side of the ledger, revenues must be increased. There are three choices. We can increase tax rates, we can concentrate on economic growth, or we can implement some combination of the two. The Federal tax code has become so complex that very few individuals understand it – a boon to tax lawyers and accountants, but a bane to the people. There are so many special provisions and allowances for hiding income, which permit the very wealthy to escape. At the other end of the spectrum, almost half the working people in this Country pay no taxes, other than payroll, essentially suggesting they – with no skin in the game – are motivated to keep things as they are. With little expectations, I hope the Commission contrives a greatly simplified plan that encourages investment and growth and discourages consumption, and a tax which becomes difficult to dodge either legally or illegally.

But it is worth repeating that our enormous budget and subsequent deficits are not the result of evil politicians deliberately doing bad things. They result from a sense of unwitting compassion that exceeds our means and will result, if nothing is done, in an unconscionable burden being placed on our children and grandchildren.

It is easier to spend than to save, but the current recession has forced most companies and households to change behavior; government should be no different. Aggravating the future, artificially low rates have hidden the real burden of deficits – not a condition one can expect to last forever.

The World War II period is instructional. Deficits, in today’s dollars, for the years 1942-1946 totaled $2 trillion. For the years 1947-1951, the Federal government recorded $185 billion in surpluses. Debt remained high and it took years to repay it. But progress was almost immediate. It takes tough and unpopular decisions to achieve such gains, but history suggests it is possible.

Friday, February 19, 2010

"Public Unions - a Force for Destruction"

Sydney M. Williams

Thought of the Day
“Public Unions – a Force for Destruction?”
February 19, 2010

About 80% of the $280 billion of stimulus money that has been spent thus far has gone to state and municipal governments largely to ensure continued employment for union workers. These jobs represent the bulk of the alleged 2,000,000 jobs saved in the past year. It is perhaps a worthy cause, but serves as a band-aid on a gaping wound.

Despite Federal help, the Center on Budget and Policy Priorities estimates that budget shortfalls for the fifty states will total $350 billion. Budget shortfalls vary enormously among states, but those with the biggest gaps have one thing in common – sizable public unions.

The history of unions in our Country began of necessity. Workers, especially in assembly-line factories, mines and railroads, were ill-treated and under paid. Initial organization attempts proved violent, resulting in bloody strikes, the best known being the 1886 Haymarket Riots in Chicago and the equally bloody nationwide Pullman Strike in 1894. With the passage of the National Labor Relations Act (the Wagner Act) in 1935, labor gained respectability along with the right to organize and to strike.

Unionization in private industry peaked, as a percent of non-farm workers, in the immediate post-war years at 33.9%. At the time, 9.8% of public employees (all state and local) were unionized. Today those numbers have reversed – 7% of private sector non-farm employees are unionized, while 37% of public employees are union members.

A major boost to public unions came in 1962 when President Kennedy signed executive order 10988 permitting the unionization of federal employees. That act, as Daniel Henninger wrote in the Wall Street Journal in January, “…swung open the door for the inexorable rise of a unionized public work force in many states and cities.”

As well, that act became one of the prime catalysts to today’s state and local budget woes. There is direct correlation between states with high unionization and large budget gaps. States, like California, Illinois, Nevada, New Jersey and New York, with big budget gaps have large public union representation. Those with small gaps, states like Nebraska, Texas, South Dakota, North Carolina and Wyoming, have relatively low exposure to unions. There is also equivalence between high unionization and municipal bond ratings, suggesting that states that can least afford it, like California and New York, have to pay the highest interest rates.

This rubber band can be stretched only so far. An increase in taxes, at a time of stress, will accentuate the down turn. Costs must be cut, which, unfortunately, means reducing employment. According to Dennis Kneale, a CNBC editor, newly elected Governor Chris Christie, on CNBC Thursday morning, cited a stunning statistic: “A 42-year-old state government worker in New Jersey who gets a 20-year pension has paid in $124,000 – and will take out $3.8 million in payments and health coverage for the rest of his life.” Try comparing that to Social Security or to your 401K plan! Mr. Christie stated a truism: “…we’ve spent too much and we’ve borrowed too much. The only way to fix that is to stop spending so much – it’s the only way to do it.”

Excluding higher education employees, 85% of California’s 235,000 employees are unionized. According to a piece in the January 22 Wall Street Journal by Steven Greenhut, over the past decade pension costs for public employees increased 2000%, while state revenues rose 24%. Unemployment in California exceeds 12% and there is little likelihood of a budget resolution which will not involve gimmicks and accounting tricks. Perhaps the State should hire the same magicians from Goldman Sachs who so brazenly abetted Greece?

Governments have a history of bowing to union demands. In part, that consent reflects respect for those serving in public office and, in part, because, ostensibly, public employees give up the right to strike. But increasingly it reflects the enormous political power of public unions and the millions of dollars they provide in campaign contributions. It becomes a self-serving and self-reinforcing cycle.

Of course, there have been times when public employees have struck. In 1919, then Governor Calvin Coolidge of Massachusetts halted the Boston police strike by saying famously: “There is no right to strike against the public safety by anybody, anywhere, any time.” Forty-two years later President Reagan fired striking air traffic controllers, and kept planes in the air by hiring replacements.

President Obama, in his support for charter schools and voucher programs (with the, ironically, infamous exception of schools in the Nation’s Capital) has begun to take on the very powerful teacher’s unions. Perhaps this is an early indication that even the Democratic Party (the prime beneficiary of public union campaign contributions) has finally realized the futility and damning direction of current trends. I certainly hope so.

Unions are important, but they must be responsive and responsible to the needs of those they serve, and they must be cognizant that stubborn adherence to the past may bankrupt their employer and themselves, serving no one. There is no better example than the American auto industry – an industry bankrupted by a combination of poor merchandise and over-reaching unions, an instance of which government has first hand knowledge.

It is a tourniquet that is needed at the government level, not a band aid, and the tourniquet, as painful as it will be, means tighter controls on unions and reduced spending.

"The move is Symbolic but the Real Target was Inflation

Sydney M. Williams

Thought of the Day
“The Move is Symbolic but the Real Target was Inflation”
February 19, 2010

In a not unexpected move the Federal Reserve yesterday afternoon raised the Discount Rate. (In fact, yesterday, in my Thought of the Day, I wrote, “…the Fed may choose to raise the Discount Rate (the rate the Federal Reserve charges depository institutions) sooner rather than later.”)

While the Fed statement said that the increase “does not signal any change in the outlook for the economy or for monetary policy” the increase, in my opinion, does reflect that one, the patient (the economy) is out of intensive care and second, and to my mind more important, it is a preemptive move against inflation. TIPS (Treasury Inflation Protected Securities) prices have been assuming better than three percent inflation and, as The Wall Street Journal writes this morning, in an editorial, wholesale prices, over the past six months, are running 9.6% ahead of a year earlier.

The move is symbolic, in that of an estimated $10 trillion in bank liabilities only $15 billion are owed to the Fed. While futures are pointing to a lower opening for the market, it is my view this a positive move. Whether the move signals that the Fed believes the worst of the recession is behind us, or that deflation is no longer a risk, that’s positive, not negative.

Thursday, February 18, 2010

"Treasuries - A Cautionary Tale?"

Sydney M. Williams
Thought of the Day
“Treasuries – a Cautionary Tale?”
February 18, 2010

Year to date, the S&P 500 is down 1.4% (and up 4.0% from its low ten days ago). Investor confidence, as measured by State Street, peaked during last summer 120.6, has since waned to 107.9 (January), essentially the same level it was at last May. The next release will be next Tuesday, February 23. One would expect the number to be lower.

Reflecting sentiment, Treasuries have rallied, with the spread between the Ten-year and the Two-year, according to Bloomberg, at a record level. – 290 basis points. The Treasury Curve has steepened along all maturities. After a year in which Treasuries were one of the poorer performing asset classes, they have begun 2010 strongly; risk has been relegated to the back seat.

However, MarketThoughts this morning writes, “…as measured by the ECRI Future Inflation Gauge and inflationary expectations stemming from TIP prices, expected CPI inflation over the next 12 to 18 months has now risen above 3%.”

If these numbers are accurate, in terms of inflationary expectations, it puts the Federal Reserve in a tough position, as those numbers and expected modest GDP growth portend the possibility of stagflation. Current strength in the Treasury market may encourage the Fed to begin shrinking its balance sheet by selling some of their Treasury holdings and mortgage backed securities. I also believe, as I wrote in December, that the Fed may choose to raise the Discount Rate (the rate the Federal Reserve charges depository institutions) sooner rather than later. The FOMC’s next scheduled meeting is March 16.

Of course, we may well be underestimating the strength and durability of the economy. Industrial Production, out yesterday, was up for the seventh month and leading indicators, out at 10:00AM today, are expected to show at 0.5% increase, which would be the tenth month in a row. It begs belief to expect the consumer to lead economic growth, though he will remain the largest component; so for growth to exceed expectation we must rely on government, the rebuilding and restocking of inventories, business investment and exports.

Exports have risen from 5.3% of GDP in 1968 to 13.1% in 2008, based upon strength in emerging economies. That growth occurred during periods of dollar strength and weakness; the key has been the dismantling of protectionist measures and the opening of free trade agreements. The President has promised to double exports over the next five years. That optimistic prediction is possible, but depends on continued strength in BRIC nations, reinforcement of NAFTA and CAFTA and Congressional approval of trade agreements with Colombia and South Korea.

Inflation expectations of 3% plus are not reflected in Treasuries with the yield of the Ten-year at 3.73%, so either rates will rise or the ECRI Future Inflation Gauge will prove a false signal. My personal opinion is that Treasuries look rich and stocks represent more attractive value.

Wednesday, February 17, 2010

The Volcker Rules

Sydney M. Williams

Thought of the Day
“The Volcker Rule”
February 17, 2010

Color me grey, or, more accurately, white. Either way, I find sympathy with those interviewed in this morning’s New York Times: “Elders on Wall Street Favor Tight Rein.”

Following a first year with a litany of failed legislation, including a questionable stimulus (questionable in the sense that despite the $787 billion available, only a fraction was spent), healthcare reform that appears DOA, Cap and Trade that fortunately went no where; climate change, now in disrepute, and card check that also, luckily, withered, Mr. Obama has an opportunity to redeem his Presidency. Outside of creating jobs, the most important legislation that can be passed is financial and tax reform.

On January 21, the President introduced the “Volcker Rule” when he proposed tightening regulation on banks, the key component of which would preclude deposit gathering institutions from engaging in proprietary trading and investing in hedge funds or private equity funds. The proposals would also limit consolidation within the industry.

As would be expected, the proposals were received with less than enthusiasm by most on the Street. Critics praised Mr. Volcker as they damned him; expressions of “having great respect for Mr. Volcker” were always accompanied with a “but”.

Complaints that it would be difficult to distinguish between trades done to accommodate a client or for legitimate hedging purposes, and those done solely for the benefit of the bank may be valid, but appear self-serving.

Financial reform should include reducing leverage; increased transparency, including full disclosure of off-balance sheet items; reforming credit agencies, so that they are hired by a third party, not the issuer. It should include, as former Treasury Secretary Henry Paulson wrote in an op-ed in yesterday’s New York Times, a systemic risk regulator to monitor the stability of markets and a resolution authority to impose an orderly liquidation of any failing institution. The owners of failing firms should not be bailed out with tax payer’s money. Given my belief that people should be responsible for their own actions, a consumer protection board seems, to me, redundant and unnecessary.

But the problems of the last few years reflect a broader cultural problem, the need for instant gratification. The sense of investing, of looking toward the longer term, needs to be restored. The tax code can be used to encourage such behavior. This need for instant rewards is broad spread. It drove people in the naughts to buy homes to flip. Today it funds state treasuries with millions from lotteries. It is seen in the increase in frivolous lawsuits. It is a problem embedded in our culture that will be difficult to eradicate, but sophisticated behavioral economics should be able to provide ways to encourage the concept of looking further ahead. There is an imperfect circularity to life. The concept of let’s eat and drink today for tomorrow we die was first expressed in Corinthians 2000 years ago. However, societies and cultures have changed and will change. A society that invests for the future is better prepared for that future.

Rules and regulations, clearly understood and properly enforced, have never impeded Wall Street. It is uncertainty that concerns the Street. I agree with those elderly sages and their concerns of cowboy capitalism, with its emphasis on immediate rewards, which imperiled both Wall Street and Main Street in the fall of 2008. Should Mr. Obama put aside misguided liberal policies, focus on Congress passing financial and tax reform that encourages long term investing, he will redeem his Presidency and the Country will be the beneficiary.

Tuesday, February 16, 2010

“Negative Sentiment Based on Political Discord Presents Opportunity”

Sydney M. Williams
Thought of the Day
“Negative Sentiment Based on Political Discord Presents Opportunity”
February 16, 2010

“To him politics was like the weather. You could make occasional forecasts but you could not control it.” So writes John Marquand about Tony Burton, President of Stuyvesant Bank in Point of no Return. Despite the fact that the market is anticipatory, while politics tend to be reactionary, the two are inextricably intertwined. It is always important, therefore, to stay attuned to what is happening in Washington and around the world.

Greece, having been given a month reprieve by fellow Euro-zone countries, remains on the verge of bankruptcy. Germany and France worry, understandably, of the moral hazard of bailing out their prodigal southern neighbor. When a sailor returns penniless to his ship from shore leave he doesn’t expect his companions to ante up; he waits for the next pay day. The conundrum focuses attention on the weakness of a single currency among countries with different budgets and views toward deficits. It may well be that the answer will not be left to the Europeans and that the IMF will have to intercede.

At home, Congress remains a mess. In announcing his decision to not seek a third term, Evan Bayh said, while he loves most aspects of public life, he “does not love Congress” – an understandable attitude given the intractable nature of the two parties and the lack of civility among their leaders. Despite massive stimulus spending, government ownership of banks and auto companies, and record government spending and deficits which will require higher taxes, President Obama has declared himself a “fierce advocate” for the free market. In this regard, it is better to watch what he does than only listen to what he says.

These issues can be discussed endlessly. We all have opinions as to how best grow the economy and whether the impetus should come from government or the private sector (or some combination of the two.) And, while it is fun to debate these points, the arguments do little to make money. Agree or disagree, we must deal with political issues and decisions as they exist.

Earlier, in the same book, Point of no Return, Marquand describes his hero, Charlie Gray’s job: ”…but his profession was investment which in the purest sense was only an endeavor to cut the cloth according to the situations which radicals and liberal created.” This we must do.

When the noise surrounding us becomes muffled and we are able to look at our situation with calm, we see an economy in recovery, a government in debt, a consumer focused on his balance sheet and businesses generating cash and enhancing productivity at the cost of not re-hiring.

We have a market which is 6.5% below its January high, up 60% from its March lows, at 18X reported earnings, but, according to James Paulson of Wells Capital, selling at 13.5X current year estimates – a reasonable valuation, in my opinion. Total Federal debt, at $12.3 trillion represents about 90% of GDP, a peace time record. On the other hand, liquid-asset holdings by households and businesses stand at $10 trillion, also a record relative to GDP.

The profligacy of the State has been somewhat offset by the parsimony of corporations.

There is no such thing as clear sailing in financial markets, but, in my opinion (and being ignorant of a technical view of the market), current negative investor psychology has provided opportunity for the careful, selective investor.

Friday, February 12, 2010

A Great Recession?

Sydney M. Williams

Thought of the Day
“A Great Recession?”
February 12, 2010

The current environment has become known as the “Great Recession”, with the pundits borrowing the words from FDR and the Depression that wracked our Country eighty years ago.

Wordsmiths are hired by administrations to provide names they hope become immortal to describe the great tribulations Presidents undergo, or the programs they father. The New Frontier described the youthful Kennedy and his administration, which after his death became known as Camelot; Johnson’s was the Great Society. Reaganomics has entered the lexicon as a word meaning reduced regulation and smaller government. Presiding over recovery from the “Great Recession” would add prestige to Mr. Obama’s presidency.

It could be that we will experience a double-dip recession; economists such as Nouriel Roubini of NYU expect such an occurrence. I don’t pretend to know, but at this stage the situation is not nearly as severe as the recession of the 1970s and early 1980s. The current period, though, had the prospects of being far worse. The credit crisis which erupted in August 2007 and reached its apogee in September-October 2008 threatened to undo capitalism as we know it. While Monday morning quarterbacks abound, along with their back-seat driving brethren, there is little question that the speedy response of Henry Paulson, Ben Bernanke and Tim Geithner saved our financial system from what could have been a catastrophe.

With the benefit of hindsight could events have unfolded more smoothly? Did Paulson and crew mislead or fast-talk Congress in their attempt to get $700 billion for TARP? Should Ken Lewis have been more forthcoming with shareholders regarding the Merrill acquisition? Did Goldman receive more for their credit default swaps from AIG than they should have? There are hundreds of questions like these and the answer to most of them is “perhaps”, but time was not on the side of those who fate had placed at the scene in the fall of 2008. The interlocking nature of finance means that banks are like a series of dominoes. You knock one down and the others collapse.

Congress, as responsible as any entity for the cause of the crisis, will, in its inimitable fashion, conduct full hearings and investigations aimed primarily for publicity and only incidentally at getting at the truth, as long as the answers is not self incriminating. I believe in taking responsibility for one’s actions, so seeking truth should be encouraged, but I fear the bloviating blowhards in Congress are more likely to provide entertainment than facts.

But what should be important to all of us is that what could have turned into a destructive depression did not and for that we owe thanks to both the Bush and Obama Administrations and to those who served them. It could be that Professor Roubini will be right and/or that the situation in Greece proves contagious and credit markets tighten again. Spreads between 10-Year Treasuries and Investment Grade Corporates have widened by about 24 basis points since year end, as has the TED spread, enough to warrant a cautious eye, but not so much as to cause concern. It seems to me more likely – and it is certainly my hope – that this will not prove to be the “Great Recession”; if that proves to be the case we should give thanks, and not look to assign blame.

Thursday, February 11, 2010

Partisan Politics

Sydney M. Williams
February 11, 2010

Partisan Politics

“Divisions that now characterize the Senate were epitomized by the empty tables in the
Senator’s private dining room, a place where members of both parties used to break bread.”
                                                                                                                                             Senator Max Baucus
                                                                                                                                             As quoted by David Herszenhorn
                                                                                                                                              New York Times, Dec 24, 2009

“There’s no beginning, never will be end.
It makes us nutty; hang the astral chimes.
The tables spread; come, let us dine, my friend.”
                                                                                                                                         Robert Service (1874-1958)
                                                                                                                                        The Spell of the Yukon, “Quatrains”, 1905

Thirty-eight years ago, during a period of great divisiveness, President Nixon gave a speech on the Vietnam War in which he said: “And so tonight – to you, the great silent majority of my American citizens – I ask for your support.” Ignoring the fact that Nixon proved to be a crook and as polarizing figure as ever occupied the White House, he was correct in his assessment that a lot of people at the time felt disenfranchised. Many feel the same way today. It, in part, explains the recent rise of the “Tea Party” movement.

On the right, the Republican Party has been hijacked by xenophobic, religious zealots who feel that God is their co-pilot. On the left, supercilious coastal elites, emitting a sense of entitlement and spouting feel-good policies such as climate change and cash-for-clunkers, have taken over the Democratic Party.

The results are loud and boisterous sidelines and an ever-enlarging, but mute, center, to which many of us belong; we also sense that there are few who represent us. Thomas Friedman recently compared the situation to a patient just out of intensive care, with all the doctors and nurses bickering: “Are you people crazy?...Aren’t there any adults here?”

Partisanship, alone, is neither disturbing nor unusual in the two hundred-year plus history of our Republic. What makes some of us uncomfortable is the apparent lack of civility. Peggy Noonan, in Patriotic Grace, has written on the subject. The refusal to eat together, as Senator Baucus suggests in the quote above, is a visible manifestation of this attitude. Of course, the line between adamancy and blindly ignoring opposing arguments is diaphanous at best and invisible at worst.

The questions are: Is partisanship as bad as it ever has been? What was the genesis of today’s partisanship? Is the lack of civility damaging to our Democracy?

Historical Review

Relationships between politics and the media are closely intertwined. Pamphleteers were the forefathers of today’s bloggers. George Orwell, in British Pamphleteers, described their role: “They had the complete freedom of expression to be scurrilous, abusive and seditious; or, on the other hand, to be more detailed, serious and ‘highbrow’ than is possible in a newspaper or in most kind of periodicals.” According to Bernard Bailyn, writing in The Ideological Origin of the American Revolution, the purpose of pamphleteers were “to free the individual from the oppressive misuse of power, from the tyranny of the state.” The comments are applicable to today’s bloggers who fear the seizure of power by Washington. Marcus Daniel, in his book, Scandal and Civility writes: “Far from being an age of classical virtue and republican self-restraint, political life in pre-revolutionary United States was tempestuous, fiercely partisan and highly personal.”

Thomas Paine, author of perhaps the most famous pamphlet of that time “Common Sense”, in a July 1796 letter to George Washington, called him a “cold Hermaphrodite” – a symbolic slap at a man who despite being the “father of his country” fathered no children; the insult was an example that not even the most revered man in the newly established United States was above being slandered.

Congress, in those early days witnessed brawls and fistfights. On the morning of February 15, 1798, Federalist representative, Roger Griswold of Connecticut, strode across the floor of the House and with his hickory walking stick struck Vermont Republican, Matthew Lyon. The attack was not a random act of violence. A couple weeks earlier, Lyon insulted Griswold and spat in his face.

Partisanship, no doubt, was at its most extreme at the time of the Civil War. In 1856, anticipating the North firing upon Fort Sumter, Representative Preston Brooks of South Carolina beat Senator Charles Sumner of Massachusetts unconscious with a gold-topped cane. The War itself saw a number of politicians enlist. Jefferson Davis, elected President of the Confederacy, had been a Mississippi Senator. Congressmen Benjamin Franklin Butler of New Hampshire, Francis Blair, Jr. of Missouri, John Logan of Illinois and Daniel Sickles of New York, among others, served as generals in the Union Army. Representatives William Barksdale of Mississippi and Milledge Bonham of South Carolina became generals in the Army of the Confederacy. Two brothers (both politicians) from Kentucky, Thomas Leonidas Crittenden and George Bibb Crittenden, served as generals in opposing armies. John C. Breckenridge of Kentucky had served as Vice President under President Buchanan and then joined the Confederacy as a general.

In the years following the Civil War, years that saw a great increase in immigration, Congressional partisanship was abetted by constituents growing in numbers, knowledge, demands and diversity. Newspapers proliferated during the first hundred and seventy-five years of our history, providing an outlook for partisan feelings. Noah Webster, better known for his dictionary, established America’s first daily newspaper in 1793 in New York, American Minerva (later, the Commercial Advertiser.) While seven newspapers dominated the City of New York in the late Nineteenth Century, every political view and every ethnic group had their own paper or sheet. Cities like New York had papers in every Borough, representing the hundred or more languages that were spoken throughout the city. What now constitutes New York City had a population of 80,000 in 1800. By 1900 that number mushroomed to 3,400,000, all speaking with individual voices and all demanding representation.

The New York Press coined the term “yellow journalism” in 1897, a phrase that described (so-called) down-market papers like Joseph Pulitzer’s New York World and William Randolph Hearst’s New York Journal. At the end of the Nineteenth Century, muckrakers like Ida Tarbell – subsequent to pamphleteers and antecedent to today’s bloggers – rallied populist ire against big business and the trusts that operated them. President Theodore Roosevelt adopted populism as his own, becoming infamous as the “Trust Breaker”.

Partisanship, encouraged by a spirited and opinionated press, was very much a part of the political landscape into the first half of the twentieth century.

Genesis of Today’s Partisanship

Following the end of the Depression and the Second World War, consolidation began to limit the number of newspapers – thereby limiting the expression of a multiplicity of opinions. At the same time, network television came to dominate the evening news and, while each broadcaster had his own style, opinions were muted and tended to be centrist. The result was a (false, in my opinion) sense of a nation in unison. There were obvious and notorious exceptions to this feeling of camaraderie, the McCarthy hearings in the early 1950s being, perhaps, the best example. Two decades after the end of the War, in the mid 1960s, divisiveness reappeared in the anti-war movement as Vietnam came to dominate the news. However, those twenty years – 1945-1965 – of relative calm were the decades I and my generation grew up, and they influenced the way we see things. Most of the Country had united behind the War to defeat Hitler and Hirohito in 1941. That sense of a united people was particularly strong during the Eisenhower years.

Eisenhower, a grandfatherly figure, known for his ability to work with and reconcile the egos of generals ranging from Patton to Montgomery, was the perfect person to bring calm to a nation that had undergone a decade and a half of depression and war. The 1950s were a time of renewed economic growth and the emergence of the United States as the leader of the free world.

Vietnam brought that period of serenity to an end. Woodstock and the Democratic Convention in Chicago in 1968, for example, were events we will always remember. Through it all – Vietnam, Kent State, Nixon’s resignation – Walter Cronkite and Eric Sevareid on CBS, and Chet Huntley and David Brinkley on NBC kept their cool and, staying centrist kept us informed. Personal opinion took a back seat to news and the Country survived what could have been a real challenge to its stability.

This period of reasonableness on the part of the Press and reflected in politicians who, despite differences, at least were civil to one another was an anomaly in American political history. Ethnic differences vanished into the melting pot that was America, so many local papers failed. Intense competition put others like the New York Herald Tribune out of business. What we got was news without the edge we get today from CNN or FOX.

That began to change about 1980. CNN, founded by Ted Turner, became one of the first cable news channels, with David Walker and Lois Hart (a husband-wife team) as anchors. As time went on, and perhaps in response to the Reagan years, their programming increasingly moved to the left. In 1996 Rupert Murdoch, with Roger Ailes as CEO and Brit Hume as anchor, launched FOX News with 17 million cable subscribers to counter the influence of CNN. Today FOX news serves over 100 million people and is the most watched news program in America. In recent years, the tone of both have become more strident with Bill O’Reilly and Glenn Beck at FOX being offset by Chris Matthews and Keith Oberman of MSNBC, and Jack Cafferty and Wolf Blitzer at CNN.

The recent intensification of partisanship, though, can be partially attributed to the plethora of blogs. The term weblog was coined in 1997 by Jorn Barger and the first blogs were up and running by 1999. Today it is estimated that world-wide there are 300 million blogs growing at the rate of 50 every half second, or about 60 million a year. One can see that, with seven billion people on the planet, in a few decades there could be one per person. In that they are simple and provide quick means for individuals to express their opinions, they resemble the pamphleteers of the Revolutionary War period, multiplied by millions. The Tea Parties of last summer were greatly aided by bloggers, and the ease and ubiquitous nature of the internet.

In many respects, the vitriol of bloggers, forerunners and fomenters of political partisanship, is a reaction to politicians who increasingly are divorced from the people they purportedly represent. Gerrymandering has created Congressional districts that are no longer competitive, so provide life-long sinecures for members of Congress, at least until he (or she) dies or goes to jail. It takes millions of dollars to finance a campaign today for a new candidate, money that too often comes from lobbyists and other special interest groups. However, the internet has provided the ability to raise millions of dollars for “grass roots” campaigns.
Are Partisanship and a Lack of Civility Damaging Over the longer Term?

Edmund S. Morgan, Professor Emeritus at Yale University, has described representational government as a fiction – a fiction because it is impossible to represent every citizen’s view. Those of us who grew up in small towns know and appreciate real representative government. Every citizen is invited and encouraged to attend Town Hall meetings. Each voter has his say. As our Country has grown, we have moved further from that ideal. With 435 House Members and a hundred Senators, our representatives must perform a balancing act between the needs of their constituents and those of the nation. It is a conflict that is as old as the nation and divided Federalists, like John Adams, and early republicans, like Thomas Jefferson. Our bicameral legislature came about, in part, as a compromise between the Federalists and the anti-Federalists. In contrast to 1789 when each Representative represented 60,000 citizens, today each of the 435 House members represent about 700,000 people – an obviously increased fictionalized version of a representative form of government, to borrow the words of Professor Morgan. While the system has served us well, there is a growing sense that people are feeling increasingly disenfranchised.

A possible future problem will be finding attractive candidates to run for public office. The ubiquity of YouTube, face book, chat rooms, IM, e-mail, etc. has made every person’s life an open book. The question will become: who will permit (not to mention, who can afford to have) their past so closely scrutinized? Will the media play the role of spoiler, or, worse, accomplice? As a people, do we run the risk of losing our Democracy, especially in a commercially, competitive world?

China, still a Communist dictatorship, but with an estimated 80,000 protests a year, has adopted censorship, through limiting internet access, to assert control. But history suggests, as the wealth and education of a people grows, so does the desire to think and act freely. Either the heavy foot of government will come down, or democracy, with all its inefficiencies, will assert itself.

Marshall McLuhan had it wrong. The medium is not the message; at least it isn’t any longer. The message is the message. Politicians would be wise to listen to the rumblings of Americans, speaking in millions of voices, who are upset with their leaders and the direction they fear the Parties are taking the Country. America, according to most polls, is a center-right country, much as it has been for decades. The problem is that vocal extremists have hi-jacked the two Parties. And neither one speaks to the desires, concerns and fears of those millions who have banded together to form “Tea Parties” – a movement David Brooks alleges is bigger than either of the two major Parties. On the left, the State has been elevated above the individual. The State, to millions of Americans, is not the end; it is a means to an end – the end being an individual free to make choices, to succeed or fail, to express his or her opinions. Both Parties seem focused on their own narrow agendas – Democrats view the electorate as children in need of care and direction; Republicans have a singular focus on faith-based programs, with little tolerance for those who disagree with them. Neither Party seems conscious that it is the distrust of Washington and the establishment and the endangerment of individual rights that worry people, and that listening to Nancy Pelosi do battle with John Boehner is wearing and boring. Lost, in the noise, is what is most important to our future – economics and a civil debate as to which path we should travel.

“Scandal and incivility,” writes Marcus Daniel in Scandal and Civility, “were closely linked to the creation of a more democratic and participating political culture.” So perhaps the discord we are now witnessing is not such a bad thing. What is important is how we and government adjust. Thomas Jefferson spoke of the desirability of a revolution every generation. While that seems extreme, the concept may not be. Our founders laid down specific broad principles, but they also allowed room for expansion.

One answer, it seems to me, is term limits. No matter what one may think of her politics, Sarah Palin made a wise statement during her campaign in 2008 when she said she did not see herself as part of a “permanent government.” Government does have permanent workers, hundreds of thousands of them, the staff that keeps the bearings of politics oiled, but elected officials were never supposed to be in that position. We are breeding a class of people whose children inherit their parent’s vocation. Early on the Adams family was prominent, but today politics is becoming more of a family business. Examples include the Bush, Kennedy and Gore families. In 2000, two sons of prominent politicians (Bush and Gore) ran for President. Chris Dodd of Connecticut followed his father to the Senate. Speaker of the House, Nancy Pelosi’s father, Thomas D’Alesandro was mayor of Baltimore and a House representative. Harry Reid’s son is running for governor of Nevada. When Vice President Biden gave up his Senate seat to become Vice President, the word was that it was being held for his son. Is that right? Ted Kennedy’s seat in the Senate has been referred to as Senator Kennedy’s seat. It is not. It is the people of Massachusetts’ seat, as newly elected Senator Scott Brown so eloquently put it. The cost to mount a campaign to unseat a House or Senate member in a “safe” district is becoming so high that only very rich people can run. Again, is that democracy? The potential of creating an aristocracy of political leaders worried the founding fathers – the possibility that our leaders would increasingly become divorced from working men and women. Shouldn’t this concern us?

A time of crisis, such as we experienced in the fall of 2008 when our financial system came perilously close to collapse, created an environment in which extremists proliferate. In saving the system, government saved the banks, a necessary, though now, with the benefit of time and hindsight, an increasingly unpopular decision. In response, populism has risen in both parties, a form of expression which makes its case by demonizing the opposition – Republicans, like Sarah Palin, have set “real” Americans – those in small-town Middle America – against cultural elites along the two coasts. Democrats, like the President in recent speeches, are doing the same thing, pitting Main Street against Wall Street.

One can argue that today’s partisanship reflects two very different views of the future: on the left, there is a strong sense that government is the answer; on the right, there is conviction that the answer lies with private enterprise. The stakes are high. In a sense it is Keynes versus Schumpeter - demand side economics versus supply side.

The credit crisis has been resolved and the economy is improving. But unemployment remains high and nobody expects this year’s growth to be particularly robust. The only sector of the economy experiencing employment growth is government. That is to be expected during recession, but the risk is that Congress does what it is good at – spending money, and that they have been, taking Federal debt to $12.3 trillion, just below the debt ceiling. (The debt ceiling was raised to $14.3 trillion on January 28th to accommodate the $3.8 trillion current year budget.) Federal debt, as a percent of GDP, is at the highest level since World War II. All of this provides fodder to bloggers and populists within our government, exacerbating partisanship in Washington.

The President has noted the unfortunate influence of money in our campaigns and in Washington, and I agree, there is too much money chasing political influence. But the answer lies not in imposing artificial limits, but in allowing full disclosure of all moneys paid to candidates and making that information readily available for all to see and read. And it lies in reducing the power and influence of Congressional members, an affect that can be best achieved through the imposition of term limits, permitting a citizen’s government and then allowing those who have served to return to their homes and to a real job with all the ups and downs experienced by their constituents.

Political partisanship is inextricably tied to the media (including bloggers and the internet), which fans the embers of extremism. While we cannot, democratically, stop the presses, we can certainly learn to be more civil.

Politicians can be partisan and civil. But today partisanship is omnipresent and civility is absent. Civility is a function of culture. The Country has been through far more difficult periods than the one we are now facing. There is no reason why civility cannot return (as Robert Service wrote in Quatrains quoted above: “Come let us dine, my friend.) But restoring civility will require changing attitudes among parents, teachers and political leaders. The examples they set provide the framework for change. Partisanship, in my opinion, is fine, as long as it is conducted within reasonable bounds; it has a long history in our country and it keeps everybody on edge. But keep it civil.

This is not the time to be too negative

Sydney M. Williams




Thought of the Day
“This is not the time to be too negative”
February 11, 2010

I am neither a trader nor a technician, but it strikes me that stocks are pretty reasonably priced. I have no idea as to whether we are at resistance or support, or somewhere in between, but I do know that the S&P 500 is 30% above where it was a year ago (before its dramatic plunge in early March) and, according to Bloomberg this morning, cash on the balance sheets of the S&P 500 stood at $1.2 trillion at year end, up $500 million from a year earlier (70% higher) – not bad performance during a pretty nasty recession. Imagine how much cash they might generate should GDP advance throughout this year! Of course, hiring and investment will consume cash as confidence grows, but theoretically those investments are made with returns in mind.

Perversely (and inexplicably) it brings to my mind our government. David Lipton, of our sales desk, mentioned this morning that he had heard that it costs the government $100 million a day when their offices are closed. What was not said was that when government is open for business it costs us taxpayers just over $10 billion a day. As Steve Kroll, also on our sales desk, remarked, just think, if government closed for two years we could wipe out the deficit!

We all realize that we need government, but unlike a business, when government is open they do not generate revenues – they incur costs. When a business gets shut down for a day or a week, for whatever reason, there is a real cost in lost revenues.

But, back to the market; yesterday Bill Miller wrote a piece on the market in which he compared favorably the outlook for equities versus bonds. Mr. Miller has received negative publicity for his failure ten years ago to foresee the past decade; of course, very few people did anticipate ten years of negative returns. In a sense we are at the opposite end of the spectrum from where we were ten years ago and all of us are victims of using extrapolation to determine forecasts. Twenty years ago the S&P 500 was selling at 333.62; ten years ago it closed at 1387.12; yesterday the close was 1068.13. A compounded return of 15.3% during the decade of the 90s created a herd of bulls; a compounded negative return of 2.6%, during the aughts, has created a sloth of bears.

None of us can know the future. Nevertheless, it seems to me that the pessimism of today is as misguided as the optimism of ten years ago.

Wednesday, February 10, 2010

A few quick thoughts

Sydney M. Williams




Thought of the Day
A few quick thoughts
February 10, 2010

Yesterday, the President once again appeared before the Press. It has become a daily routine. Whether his appearances are meant to encourage the people during this time of “Great Depression”, or whether they are designed to boost his own sense of self esteem, I will leave to others.

Healthcare reform was resurrected yesterday (or at least its prospect was), as the President invited Republicans to attend a bipartisan meeting to discuss ideas, but emphasized he would not return to the “starting line”. The cynic in me wonders that this may be more a political ploy, than a true attempt at bi-partisanship. His obstinacy reminds me of the words in the song by Keely Smith, “The music stopped, but we were still dancing.” Resurrections are generally associated with divine events, not a category in which I would put healthcare, despite the obvious necessity for doing something about rising costs. The problem is that Republican proposals (including eliminating frivolous lawsuits, permitting cross-state competition and increasing the role of the consumer in the process) are very different from those of Democrats, whose center piece is some sort of a public plan and includes adding new bureaucracies to oversee both choice and information – with the emphasis on the state rather than the individual.

……………………………………………………………………….

The President also spoke of his desire to double exports over the next five years, a commendable, and not unrealistic, goal. In 2003, U.S. exports approximated $1 trillion or 9.5% of GDP. By 2008, exports were $1.8 trillion. This happened during a time of a declining dollar. But, as I pointed out on January 19, exports as a percent of GDP have risen from 5.3% in 1968 to 13.1% in 2008. And exports rose during the 1990s from under $800 billion in 1995 to just under $1 trillion in 2000, while the U.S. Dollar Index rose from 82 to 115! Certainly, a lower dollar might jump start exports, but history would indicate that encouraging and maintaining free trade agreements are more important. Signing the trade agreements with Colombia and South Korea would be a sensible start on the part of the President.

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Mike Terranova on the sales desk pointed out a new commerce index – the Ceridian-UCLA Pulse of Commerce Index. The index is based on an analysis of real-time diesel from over the road trucking and mirrors the Federal Reserve’s Industrial Production Index, but issued days before that index. The numbers suggest that the economy fell in January after a large increase in December. The “more reliable” three-month moving average indicates a 3.3% gain following an exceptional 14.6% gain in December. It suggests to me that recovery, as is widely expected, will be modest, reflecting a consumer who sensibly seems focused on restoring his balance sheet.

Tuesday, February 9, 2010

A Couple of Lessons from Overseas

Sydney M. Williams
“A Couple of Lessons from Overseas”
February 9, 2010

The possible bankruptcy of Greece highlights the need, not only for fiscal discipline, but for regulation of the CDS market. Insurance provided by credit default swaps serves a useful purpose. It allows issuers, in some cases, to reduce their costs of borrowing. It brings, when properly regulated, a discipline to the market – a role played by short sellers in all markets. But an unregulated market, a market in which the value of the contracts may exceed the underlying securities they represent, offers the potential for financial mischief at best and disaster at worse. It is unconscionable that Congress, following the near collapse of AIG has allowed this market to continue unregulated.

While the European Union is a loose confederation of independent states, the problems of Greece have not gone unnoticed in the currency markets. Despite falling U.S. government yields, the Dollar Index is up 2.7% and the Dollar is up 3.5% versus the Euro so far this year. Nevertheless, at home, the problems in California, New York, New Jersey and other states – particularly those with powerful unions – highlight the risk of fiscal irresponsibility in our country. The problems of our states will get resolved because of the legal requirement that they balance their budgets, but that will not occur without pain, including the loss of services and jobs.

Last week, President Christina Kirchner of Argentina dumped the president of the central bank, naming Mercedes Marco del Pont to the job; she is a Yale trained economist who has expressed the view that the bank should be subservient to the executive branch – indicating her willingness to finance the President’s socialist agenda. Mrs. Kirchner has taken her play book from her neighbor to the north, Hugo Chavez. Her desire to have her and her husband stay in office has led her to favor government spending – at a rate far in excess of revenues, the mark of a good socialist. Last year, inflation was 17%. Prospects for this year look worse. Increased taxes have discouraged investment and export taxes are leading to protectionism. The future looks bleak.

The lessons from Argentina (and obviously Venezuela) are twofold. An independent Federal Reserve is critical to the well being of our financial system. While in our country the chairman is appointed by the President and confirmed by the Senate, he must, to do his job well, ignore changing political winds. Secondly, Argentina is a prime example of the risks of too much government intrusion into the economy. In times of distress, socialism looks like a comfortable remedy. History suggests it does not work.

Monday, February 8, 2010

The Urge to do Something

Sydney M. Williams
Thought of the Day
“The Urge to do Something”

February 8, 2010

There is an urge, natural to most of us, that doing something – anything, no matter how destructive – is better than doing nothing. It is an affliction, as common within the halls of Congress as it is among those who make their daily bread on Wall Street. The urge becomes more demanding during times of crisis, creating opportunity for quick-witted traders and invoking such irreverent platitudes, among politicians, that a crisis is a terrible thing to waste.

Green eye shades and long term investing, a staple for investors for decades, have given way to fast stock trading, dark and algorithmic trading. Exaggerating the concept, one can conclude that computers, a boon to those whose income depends upon turnover and quick trading profits, have become a bane to owners of capital – especially to those whose investment horizon is measured in years. This is not to disparage computers. Most of us could not do our job as effectively or as efficiently without them as with them. But the decline of contemplation and the rise of hyperactivity are symptoms of our time and show no signs of reversing.

Spending a week in Florida, during which the principal daily decisions are with whom to play tennis in the morning and where to take a postprandial nap in the afternoon, provided the perfect venue to think “big thoughts”. Future growth, the generator of tax revenues, is dependent upon investment – by individuals, institutions and corporations. The tax code can be (and is) used to influence behavior. One possibility would be to index capital gains. For example, day trades could be taxed at 90%, while investments held more than five years might incur no tax, with a sliding scale between the two extremes.

Politicians are equally guilty of attention deficit disorder and the mischief such conditions bring. Longer term problems, like growing deficits, Social Security, Medicare and Medicaid, are constantly pushed off to the next generation. Not unnaturally, Congress finds it easier to spend (doing something) than reducing deficits (doing nothing). Unspent funds are like spare change to a teenager. The returned TARP funds (re-paid with interest) by major banks, supposedly earmarked (to use a well-known Washington word) for debt reduction, are now to be used to fund other programs. On another matter, one cannot help but wonder, will the government’s 60% ownership of General Motors impact Congressional hearings into the Toyota recall?

But commonsense and solutions often appear at the most unexpected moments and in unanticipated ways. While Berkshire Hathaway has lagged the market since its rise from last March (50% versus 55%), Warren Buffett, with his steady focus on long term investments, has proved far superior over the past ten years than the market (plus 24%, versus a negative 22% for the S&P 500). The much maligned – by the mainstream press – Tea Party folks, with their emphasis on fiscal responsibility and small government seem a throwback to Newt Gingrich’s Contract with America in 1994, a movement which helped foster the surpluses of the 1990s.

While I would not expect every investor to begin emulating Mr. Buffett, or for Washington to immediately become fiscally responsible, the world is in constant flux. Perhaps it is my Panglossian naïveté, but the problems we face seem so obvious and are so widely discussed, the future may be not as bleak as rational analysis would have us conclude.

Wednesday, February 3, 2010

Thought of the Day

Sydney M. Williams

Thought of the Day
February 3, 2010

As the President presented his $3.8 trillion budget on Monday, the lesson of FDR, as taught by Amity Schlaes, should be the “canary in the coal mine” for Mr. Obama. Shakespeare has Juliet say, “A rose by any other name would smell as sweet”; the same could be said, with differing conclusions, for a pile of manure.

There were a number of factors that caused the stock market crash of 1929 to morph into a ten-year Great Depression, but among the most obvious were increased tariffs, tight money and higher taxes - based on the concept that retribution was necessary for recovery. (Amity Schlaes’ op-ed piece, on this subject, in Tuesday’s Wall Street Journal is worth reading at least twice.) It is important to understand that Roosevelt was hardly alone in misunderstanding the way out of the Depression; Hoover started the damage with his signing of the Smoot-Hawley Act and an unfortunate desire to balance the budget by raising taxes.

Extraordinary times demand extraordinary reactions. Most of us would agree that the events during the fall of 2008 were extraordinary and the responses taken were unique. As we climb toward recovery, it is critical to keep economic growth foremost in mind; anything that hinders that growth will be regretted. Increases in taxes on business, while popular in a populist sense, are almost always regressive, in that the affect of the taxes fall unduly on the neediest. A good example is the plan to increase taxes on oil and gas companies. Does anyone truly believe that any such tax increases will not be passed on to the consumer? A decision to increase corporate taxes on international earnings impedes, not encourages, exports. Permitting the Bush tax cuts to expire is a tax increase on all taxpayers and raising the tax on capital gains hinders investment at a time when investors are wanted. The President has claimed that he cut taxes for 95% of all working families, but since 40% of working families pay no taxes (other than payroll and state taxes) that really means an increase in transfer payments – not tax cuts.

There are tax increases, which the President has proposed, that seem fair, such as taxing carried interest for hedge fund managers as ordinary income, rather than treating it as a return on capital. As Warren Buffett once asked, “If it isn’t income, what is it.?” Proposing a tax on banks that provides a reserve against future bailouts seems important, certainly as long as banks are allowed to remain as large and untethered as they are today.

As the Wall Street Journal pointed out on Tuesday, there were bits of good news within the budget. The temporary fix to the AMT (Alternative Minimum Tax) would be made permanent and indexed for inflation. Taxes on estates would be re-imposed following the current year – a good year for the rich to die! – but at more realistic levels than in the past.

However, the quickest and least painful way out of the fix in which we find ourselves is to grow revenues, and the way to grow revenues is to encourage the private sector. Government can spend, but they cannot generate tax revenues; only the private sector can do that. Government can cut budgets, but we all know from experience that both parties are better at talking than acting when it comes to cutting favorite programs, and there is no such thing as an orphaned government program.

There are two recently written books that should be required reading for every member of Congress, especially at this time of enormous deficits: one is Amity Schlaes, The Forgotten Man , a new and fresh look at the Great Depression, and the second is George Melloan’s, The Great Money Binge, a clear-eyed look at why supply-side economics led us out of the 1970’s and into almost two decades of growth.

From my week-long perch in Florida, despite a rainy Monday and deficits that look to stretch to the far horizon, the world doesn’t look all that bad, and I was very much encouraged by reading David Brook’s in Tuesday’s New York Times, in which he concludes, “The elderly. They are our future.” It may not be true, but I like the sentiment.

Monday, February 1, 2010

Thought of the Day

Sydney M. Williams


                                                                                         Thought of the Day
February 1, 2010

Writing of the mood in the post-credit-collapse environment, Robert Shiller, in Sunday’s New York Times, states: “The fears themselves are an integral part of the problem. Economists have a tendency to assume that everyone’s behavior is rational. But post-boom pessimism is a factor driving the economy and it is likely to associate with attitudes that may be enduring.”

While I am not an economist, I find Professor Shiller’s comments a little too glib and seem designed to fit snugly within his role of a behavioral economist. Common sense and a reading of history suggest there are times when people act rationally and times when they do not.

In 1933, in his inaugural address, Franklin Roosevelt spoke his famous words about fear: “So, first let me assert my firm belief that the only thing we have to fear is fear itself – nameless, unreasoning, unjustified terror which paralyzes needed efforts to convert retreat into advance. While the statement provided the memorable phrase, what largely prolonged the Great Depression was not so much fear as it was the tight monetary policies, increased taxes and the passage of the Smoot-Hawley Tariff Act by the Hoover Administration and the continued tight money, trade restrictions and even higher taxes of the Roosevelt Administration. Those policies, along with the attempt by the government to insert itself into the economy, are what prolonged the Depression. A good example of government intrusion into the private sector was the passage of the National (Industrial) Recovery Act – one of sixteen pieces of legislation passed by Congress during Roosevelt’s first 99 days in office, a Bill which encouraged collective bargaining and which fixed work hours and implemented wages and price controls. Such acts did more to extend the Depression than end it. Essentially, it was the advent of World War II that ended the Depression. (The NRA was, fortuitously, overturned by the Supreme Court in 1935, in the case Schechter Poultry Corporation versus the United States.)

A significant reason for the growth our Nation experienced in the last decade or so can be directly attributed to the increase in leverage, particularly for assets and especially for homes. Alan Greenspan famously referred to the “irrational exuberance” as it pertained to stocks in late 1996. That same irrational exuberance caused consumers to bid up the prices for housing, in many cases to levels above their offering prices. That period was a manifestation of people acting irrationally.

De-leveraging during this post-boom period, definitionally, will slow economic growth, particularly at the consumer level. But de-leveraging is rational behavior, driven more by common sense than fear.