Monday, January 31, 2011

"On Turning Seventy"

Sydney M. Williams
January 31, 2011

Note from Old Lyme
"On Turning Seventy"

“I don’t feel old. I don’t feel anything until noon. Then it’s time for my nap.”
                                                                                                                      Bob Hope (1903-2003)

The most remarkable thing about turning seventy, other than the veneration one expects but rarely gets, is how unremarkable it all seems. Of course, there is significance to seventy – one is supposed to be revered for one's sagacity and respected for one's endurance. Old age is associated with patinas, such as one might find on a dusty volume, an antique chair or, better yet, in a fine Bordeaux. But I don't feel any more revered or respected (other than by my grandchildren whose powers of discernment are not yet fully developed) than I did a week ago.

Gertrude Stein once said, “We are always the same age inside.” That is true. I look at my wife, or my brothers and sisters, and I see the person I knew fifty or more years ago. Returning to my high school's fiftieth reunion a few years ago, it was not the wrinkled, stooped, balding, elderly gentlemen that confronted me that I noticed; it was the young men they had been. Looking at myself in the mirror every day for the roughly 10,000 times I have shaved, I never notice the gradual change in my features. I feel a little like Dorian Grey, unaware there is a portrait in the attic that is aging.

As much as anything, it is the rapidity with which time seems to sail by, that is most notable. Thoughts of mortality rise to the surface more frequently than they did twenty or thirty years ago. In my teens I thought I was immortal, but no longer. Thornton Wilder captured the fleetness of time in his play, Our Town, written in the town in New Hampshire where I grew up, Peterborough, when he was a resident of the MacDowell Colony. The play is an allegory; it traces the residents of a small New England village through several generations. The stage manager delicately and sensitively assists the viewer, or reader, through several scenes portraying critical moments in the lives of some of the residents, from birth to marriage to death. In the middle of the second act – on Emily Webb's and George Gibb's wedding day – the stage manager ruminates on Mr. and Mrs. Webb's life together: “You know how it is: you're twenty-one or twenty-two and you make some decisions; then whissh! You're seventy.” That is the way I feel, especially about the passing of the forty-eight years since I met my wife, Caroline.

Life is filled with decisions. We pick a college. We find a place to live. We get married and have children. We pick up and move. We change careers. Each decision carries consequences, most of which cannot be foreseen. Decisions, subsequent to mine, have resulted in ten grandchildren, a source of immense pleasure and enormous pride. Knowing that they will follow fills me with hope for a future that too often appears uncertain. The message is: life is filled with wonder and surprises; it cannot be foreseen; it is to be savored. The greatest regret we have as we get older is rarely what we did, but things we might have done, but did not.

In a speech in 1905, on the occasion of his seventieth birthday, Mark Twain said, “Three score and ten! It is the Scriptural statute of limitations.” I don't think so. Seventy today is not the same as my grandfathers. I cannot picture my grandparents schussing Vail’s Riva Ridge, as I recently did. When I go out on the tennis courts at the Hillsboro Club in Florida, I look and feel like a newborn gazelle. There are people in their nineties batting the ball back and forth with surprising vigor. The concept of retiring is unappealing and, in fact, frightening, marking, as it does, the end of a person’s active life. It would bring to an end a career I still enjoy. The business has brought great friends, for which I am thankful; to be surrounded with youth helps keep me young.

Henry Wadsworth Longfellow wrote: “To be seventy-years old is like climbing the Alps. You reach a snow-crowned summit, and see behind you the deep valley stretching miles and miles away, and before you other summits higher and whiter, which you may have the strength to climb or not. Then you sit down and meditate and wonder which it will be.”

While I enjoy the memories, I don't have to sit down and meditate about the future. I know that I will aim for the “higher and whiter” summits, and will continue to live this life and hike these hills as long as I am able.

"The Angelides Commission's Conclusions - Analytical or Poliitical?"

Sydney M. Williams

Thought of the Day
“The Angelides Commission’s Conclusions – Analytical or Political?”
January 31, 2011

It began as a subtle shift in cultural attitudes, which became amplified over many years – in fact decades – that permeated the American psyche. The changes were abetted by a government more focused on equality of outcomes rather than opportunities. Layered on were myriad, innovative financial products, a consequence of new technologies. Combined, they led to the near collapse of the financial system in the fall of 2008. That was not the conclusion reached by the Financial Crisis Inquiry Commission; it is, though, my opinion.

The Commission found no absence of institutions to blame – Wall Street, regulators, banks, and real estate and mortgage brokers. It also cites a number of individuals, including Angelo Mozilo, Alan Greenspan and Robert Rubin. It essentially provides a pass to Congress and even implies that Fannie Mae and Freddie Mac followed the banks over the cliff.

The roots of the problem, in my opinion, go back a generation. The early 1980s saw a sea change in America – financial markets, after a decade and a half of slumber, roared back to life; confidence in the “shining city on the hill” was restored after fifteen years, which was characterized by a divisive war in Vietnam and a recession marked by high inflation and higher interest rates. Advances in technology permitted the development of derivatives, thereby allowing financial institutions to operate with increased leverage. However, change was underway. By the end of the 1970s, even Jerry Rubin, a one time anti-war activist, founder of the “Yippie” movement (Youth International Party) and one of the Chicago Eight became a businessman and early investor in Apple.

“Yippies” were replaced by “Yuppies” (young urban professionals) – a derogatory term, first used by Gary Hart in 1984, for young professionals working (mostly) in the financial sector and for whom conspicuous consumption became a way of life. Barton Biggs referred to their large new homes in suburbs such as Greenwich as “starter castles.” Their lifestyles became celebrated in books like Tom Wolfe’s Bonfire of the Vanities and Marissa Piesman and Manlee Hartley’s The Yuppie Handbook. Also, movies like “The Big Chill” and “When Harry Met Sally” publicized this new culture, which was noted for its emphasis on “me”. Television and the Internet only hastened the spread of this changing lifestyle.

It is unsurprising, then, that millions of others, who were not beneficiaries of inflated incomes, aspired to the same toys, including houses. Low interest rates, improving stock and bond markets, newly fashioned financial instruments (such as adjustable rate and interest-only mortgages) and favorable government legislation, such as the Community Reinvestment Act conspired to help millions achieve their dreams fertilized by this cultural change that swept across our country…and the world.

A Congress whose re-election campaigns had become increasingly dependent on funds from financial institutions, including Fannie Mae and Freddie Mac, looked the other way when it came time to scrutinize those regulatory bodies responsible for enforcement of commonsensical rules. Despite the bursting of the tech-internet bubble in 2000, an absence of bankruptcies had made most investors, bankers, homebuilders, consumers and politicians unusually complacent by late 2006 and early 2007. Derivatives, which had been used for years and without which modern day finance could not function, allowed financial firms to expand leverage to unrealistic levels. (In the case of the GSEs it approached 75 times, according to The Financial Crisis Inquiry Report.) Hubris replaced prudency. And, of course, greedy and nefarious bankers and brokers got caught up in the race for riches.

The Commission’s report is no doubt political. Excluding the introduction and conclusion, it runs to 450 pages, of which 40 are devoted to dissenting opinions from the four Republicans. (Peter Wallinson’s – an American Enterprise Institute Scholar and member of the Commission – 100 page dissent was not included in the publication made available.) The main body of the report concludes that the crisis was avoidable. Perhaps, but I suspect that the causes were sowed so deep and were embedded so fixedly in the American psyche that what happened may have been inevitable. (In my opinion, the fact that the financial system held is the real story.) I find it incredible, after glancing through the report, that banks “too big to fail” have not only survived, but have thrived. I further sense that Representative Phil Angelides and his team confuse cause with effect. Actions have consequences and so do new products.

Joe Nocera, writing in Saturday’s New York Times, came closest, in my opinion, to describing the real cause. He used as an example the tulip mania of early 17th Century Holland, suggesting that “the roots of ‘tulipmania’ were less the actions of particular Dutchmen than the fact the entire society was suffering under the delusion that tulip prices could only go up.” The same perspective infected homeowners around the developed world. However, despite all the criticism, including mine, the Report includes a wealth of information, which will be mined I am sure by an enterprising and insightful novelist whose fictional account of this period will come closest to revealing the incredible culture that caused this near disaster.

The effects of those halcyon days linger on in the expected (versus actual) returns of many defined benefit pension funds, especially those run for state and local unions. Those expectations, which bear no resemblance to reality, risk bankrupting governments, as they did the auto companies and other businesses that relied on defined benefit plans to attract and keep workers. Parties always come to an end. The stock bubble burst eleven years ago; the housing bubble five years ago, and now we face the effects of government promising more than can be reasonably delivered. These bubbles are a function of a culture nurtured in a belief in fantasies. Greed and criminal activity certainly played a role, and the culprits should be punished. But the real blame is far more complicated and is all-encompassing; it is the result of a culture cultivated and sustained by a society, including Washington and the media. This, too, though, will change.

Thursday, January 27, 2011

"The Speech"

Sydney M. Williams

Thought of the Day
"The Speech"

January 27, 2010

In order to fix the major, long term financial risk facing the United States – the threat of insolvency – one must first confront two root causes that have led to this predicament: impediments to faster economic growth, such as over-reaching regulations that stifle innovation, and a tax code that discourages investment and encourages consumption; and secondly, an entitlement system that promises more than it can deliver and diverts funds from badly needed investments. Unfortunately, neither the President's State of the Union speech, nor Representative Paul Ryan's response squarely addressed these issues.

The first should be easily addressed – providing regulation, that besides being fair and enforceable, but recognizes the changed nature of our economy and the global competition we face.  The tax code can be simplified and redesigned to encourage investment and discourage consumption. The second cause – known understandably as the “third rail” of politics – is far more difficult.  It is far easier for politicians to offer their constituencies goodies than it is to ask them to sacrifice, to wean them from entitlements they have come to expect as their right, to ask them to become more self-reliant and personally responsible.  Yet it is what must be done. For example, raising the age of retirement – not by one year over  the next sixty-five – but by, say, five years in the next twenty is a concept people could comprehend. People implicitly understand that the current system does not work.  A means test for Social Security could be employed. Again, there may be some backlash, but people again understand that the current system, left alone, will implode. More generous IRA and 401K plans could be offered, providing the incentive to save, rather than spend.

Medicare and Medicaid are two important entitlements, but the consumer needs to be more involved in the decision making, in terms of what moneys are paid against what care is received. Generally, it is catastrophic, rather than comprehensive, insurance that most people require.  Yet simple solutions, like permitting insurance companies to compete across state borders, were left unmentioned. Again, means tests, and health savings accounts, could apply.  The new healthcare plan will no doubt morph into another entitlement, which is why its implementation is being challenged by so many.

It was encouraging that the President did suggest simplifying and lowering the corporate tax rate, but he said nothing about individual rates, other than defiantly promising to raise them for “millionaires.”  He also added, belatedly, that he will work with Republicans in dealing with obscenely costly medical malpractice law suits.

The President spoke eloquently of the need to invest in education, high-speed rail, renewable energy programs, infrastructure and high-speed wireless Internet connectivity – all laudable goals.  He compared today's challenges to two generations earlier when the 1957 advent of the Soviet manned spacecraft, Sputnik, launched the race to space.  He did not add, however, that today's entitlement spending has restricted the ability of the government to respond in the manner it did in the late 1950s and early 1960s. We simply don't have the options today that we did then.

I was pleased to see the President emphasize the need for change in schools – allowing principals and superintendents to fire teachers based on competency, not on longevity.  But I heard nothing of the ruinous role played by unions in fighting this change. I was pleased to hear his emphasis on offering citizenship to college and university graduates, instead of sending these talented young people back to the countries from which they came.  But the goal of having the highest proportion of college graduates in the world is not as important as having the world's best universities and attracting the best students from all over the world...and then keeping them.  While we need more scientists and engineers, not everyone will become one. Like all societies, we need workers at every level.  But most of all we must offer opportunity for those who aspire to success. A five year freeze on “some domestic programs” is better than nothing, but the $400 billion savings over ten years represents, annualized, one percent of last year's budget – not nearly enough. I was pleased to hear Mr. Obama acknowledge the Tunisian citizens who are fighting for their freedom, but I heard nothing about similar situations and missed opportunities in places like Iran. 

While the biggest applause came when he appropriately recognized our men and women in uniform and when he urged the return of ROTC to all campuses,  it was accompanied by him applauding his  “politically correct” initiative of allowing gays to serve openly in the military.  He avoided the term of “exceptionalism,” as it applies to America, but he received a big round of applause when he declared that “nobody here would trade places with any other place on earth.”

Mr. Obama is an eloquent speaker and, as he speaks most every day, he gets plenty of practice.  But it is action, not words, that people want. Unfortunately the speech avoided any serious discussion as to how we extricate ourselves from the financial plight we face, how best do we grow the economy and a recognition that the “third rail” of politics cannot be ignored.  “We do big things,” he said.  The President should take his own advice. Like after any big rally, we feel better at the time, but when we awake in the morning the problem is still with us.

Tuesday, January 25, 2011

"The Investor Class - Unsung Victims of Washington"

Sydney M. Williams

Thought of the Day
"The Investor Class - Unsung Victims of Washington"
January 25, 2010

Gretchen Morgenson’s front-page report, in yesterday’s New York Times, was a timely reminder of the fraud perpetuated on shareholders and citizens by the collusion between Fannie Mae and Freddie Mac management and their abettors in Congress. Ms. Morgenson writes that American taxpayers have anted up $160 million to pay for lawyers defending former executives of the two GSEs (Government Sponsored Enterprises) - $29.8 million just for former CEO, Franklin Raines.

During the six years Mr. Raines served as CEO of FNM, he reportedly made $90 million, $52 million of which was due to overstating revenues by $10.6 billion and the resulting fraudulent earnings on which his bonuses were based. In 2006, the Office of Federal Housing Oversight published an in-depth report accusing Fannie’s top management of manipulating profits and generating $115 million in improper bonuses. Those executives were sued for restitution plus $100 million in fines. The three top executives settled, paying out $31.4 million. Fannie Mae (read public shareholders and American taxpayers) ultimately paid out $400 million to settle the charges, according to Ms. Morgenson's report.

What sort of a message does this send? Committing fraud allowed Mr. Raines to pocket an extra $52 million of which he pays back $24.7 million. In the meantime, Mr. Raines incurs about $38 million in legal expenses, all of which is paid for by others, initially by shareholders, and later by taxpayers. Importantly, these two GSEs were among the largest contributors to political campaigns, thereby receiving protection and cover for their nefarious ways. The five largest beneficiaries of their largesse between 1989-2008, in order, were Senator Chris Dodd of Connecticut, Senator John Kerry of Massachusetts, Senator Barack Obama of Illinois, Senator Hillary Clinton of New York and Representative Paul Jankorski of Pennsylvania.

These agencies, whose purpose is supposedly to provide low cost mortgages to lower income people, became a source of significant contributions to favored politicians. As quasi government enterprises, they were able to borrow at favorable rates - borrowings implicitly guaranteed by the federal government. This allowed them to invest in mortgages and earn a reasonable spread. However, the temptation of low borrowing costs, increased allowable leverage and the advent of new derivative products proved irresistible. Congress did nothing to rein in their ambitions. By the end of 2007 the two GSEs had roughly $1.7 trillion in mortgages and other securities (including derivatives) on their balance sheets, supported by about $71 billion in equity - a leverage ratio of 25 times. Of the $1.7 trillion in assets, only about $484 billion in mortgages, the balance being invested in "securities and other assets," a portion of which obviously included mortgage backed securities.

Attempts to reform Fannie and Freddie by the Bush administration in 2003 and later in 2005 met with strong resistance from Congress. As early as 2003, Representative Barney Frank concluded: "these two entities - Fannie Mae and Freddie Mac - are not facing any kind of financial crisis." John McCain sponsored legislation in 2005 to protect what he termed "the enormous risk that Fannie Mae and Freddie Mac pose to the housing industry, the overall financial system and the economy as a whole." This proposed legislation was, in part, a reaction to the accounting scandal unearthed in 2005, which caused the ouster of Franklin Raines as CEO. (It would be difficult to impugn that Mr. Raines, a Harvard college and law school graduate and Rhodes scholar, was an innocent bystander of the scandal that enveloped him.)

Ironically, but not mystifyingly, the Dodd-Frank Bill, in all of its 2300 pages, never found space to include reform of Fannie and Freddie. As late as July 2008, two months before their collapse, Representative Frank declared that the two were "fundamentally sound and not in danger of going under."

While much of the focus of the Press has been on Wall Street's implication in the economic collapse and the loss of approximately 8 million jobs, very little has been written about the impact on the investor class - a group that represents more than half of all Americans. The collapse of Fannie Mae, Freddie Mac, AIG, GM, Citibank and other banks have cost investors at least half a trillion dollars - a significant portion of which was in retirement savings accounts. Additionally, the interests of bondholders, despite laws theoretically protecting them, were subsumed in favor of union employees - the most outrageous example being the GM restructuring.

This is all happening at a time when the country faces an impending crisis of too little capital to support an onslaught of retirees. This habit of ignoring impending doom reminds one of Nero fiddling while Rome burned. We are a consuming nation that badly needs to focus on investment, yet Washington still doesn't get it. Attempts to permit states to file for voluntary bankruptcy being another example. Investors once again risk being sacrificed, so that union leaders and politicians can honor the unrealistic commitments they have made to union and state workers.

Investors knowingly, for the most part, assume risk any time they reach for yield in excess of Treasuries (and they do take risks in buying Treasuries because of the potential ravages of inflation, made more likely should the Federal Reserve assume responsibility for some of the debt obligations of a few states.) No one is asking to bail out risk-takers, but with baby boomers turning 65 at the rate of 10,000 a day for the next eighteen years it is imperative that the government use the tax code to encourage investment and discourage consumption - otherwise default will become common, and the Fed will be further incentivized to print its way out of this mess.

Having taxpayers financially support Mr. Raines, who played a key role in bringing the financial system to its knees and who destroyed over $40 billion in equity value, does not seem to me to be the mark of a government that understands the consequences of their actions. Ms. Morgenson did the country a service in publicizing this scandal.

Friday, January 21, 2011

"Political Correctness, Run Amok - Now It's Fireplaces"

Sydney M. Williams

Thought of the Day
“Political Correctness, Run Amok – Now It’s Fireplaces”
January 21, 2011

While I expect a firestorm of abuse from many of my liberal friends, there just are too many intelligent, cultured, wealthy Americans with too much time on their hands. These people tend to reside on the two coasts and they are characterized, outside of having ample idle time, as patronizing and disdainful of the masses who disagree with them – expressing their opinions in a manner I find especially offensive.

What causes this outburst was an article in – you guessed it – yesterday’s New York Times. The piece, “A Love Affair Cools”, graced the front page of the “Home” section and dealt with the idea that wood burning fireplaces have become hazardous to our health. Forget smoking or second hand smoke. Forget the poor guy in New York being sued for smoking cigars in his own apartment, arguing that a man’s home is no longer his castle – that the moat has been breached by the long reach of the government, ably assisted by supercilious citizens who know better than we what is good for us. Nirvana, for these people, will be reached when the individual is subsumed into a politically correct puppet.

The article suggests that wood burning fireplaces are “a direct pollutant to you and your family,” a “use of a natural resource that otherwise could have been spared.” Wood smoke contains carcinogens and is “very irritating.” One woman, a Karen Soucy, who I wish were my neighbor, refuses to enter a home “when wood has been burned, even infrequently.” Robert Frost wrote that fences make good neighbors. He likely never envisioned that fireplaces could prove equally effective in keeping annoying neighbors away from one’s hearth.

Another idiotic online magazine, The, has concluded that all wood burning fireplaces be replaced with electric ones – an idea, should it come to pass, that would warm the hearts (and fatten the pocketbooks) of the coal companies, as they produce about 50% of all electricity generated in the United States.

Perhaps I get carried away, but I grew up in New Hampshire in a house without central heat. Wood heated the downstairs – wood stoves in the kitchen and dining room, with a fireplace in the living room. I have three wood burning fireplaces in my home in Connecticut and one in my apartment in New York. It is one of man’s great luxuries to sit before a blazing fire, drink in hand, contemplating what irritant the wunderkinds of political correctness will dream up next.

However, snow willing, I am off to Florida for a few days; so it will be a week or so before I invite Ms. Soucy over for toasted marshmallows.

Thursday, January 20, 2011

"The Market? Worry About Individual Stocks."

Sydney M. Williams

Thought of the Day
“The Market? Worry About Individual Stocks.”
January 20, 2011

At dinner recently a friend lamented that there seemed to be little fear in the marketplace. Being a value investor, fear portrays comfort, the absence of which makes him nervous. Perhaps his sense of complacency is real? I am uncertain but, I feel more agnostic. Certainly the anxiety that enmeshed investors in the fall of 2008, when the possibility of a total meltdown in financial markets was a real possibility, has naturally dissipated. But neither are we experiencing the jubilation that marked the waning months of the twentieth century, or even those halcyon weeks of late 2006 and early 2007 when complacency blanketed investors on the eve of the collapse in credit and housing.

Even longer dated Treasuries fail to evoke, in my mind, a sense of fear or fearlessness. The yield on the Thirty-year is 4.53%, up 100 basis points from last August when fear of stocks was higher (and up 200 basis points from December of 2008 when fear was rampant,) but 30 basis points lower than it was last April and more than 100 basis points lower than June 2007, just before credit problems first manifested themselves. However, a slow but improving economy, a declining dollar and rising food and energy prices suggest to me that 4.5% is not enough of a return for the risks I envision, but I profess no expertise in the Treasury market.

There does seem to be some fear – justly, in my opinion – as to the financial condition of some of our coastal states; though, again, as Laszlo Birinyi would say, when the problem has been as well publicized as this one, they are likely reflected in the prices of municipal bonds.

Commodity prices have generally done well – a function of a weak dollar, improving world economies, and generally low interest rates. Reversals of two of those three trends will likely impact prices. Gold and silver have recently modestly traded lower, though grains and energy trade near peaks. Also, as usual, it is difficult to assess how much of the price reflects real demand and how much represents speculation.

China is another case. They grew their economy 9.8% in the fourth quarter of 2010, better than expected. While China’s numbers suggest some inflation fears, its reported GDP never showed the effect of the worldwide slowdown the rest of us experienced. Nevertheless, the Shanghai Index is down 4.6% so far this year, after being down 14% last year and is 56% below its October 2007 peak. I am no China expert, but one cannot help wondering if their market is getting cheap, or is there legitimate concern that the consistency of their growth resembles too closely that of General Electric during the Jack Welch era?

Curiously, despite being social animals, it is agoraphobia that bothers many investors. We all yearn to be contrarians, afraid of the consequences of being drawn into the crowd. We live at a time when information flows quickly and broadly – with high speed trading platforms making even the most nimble of us looking like tortoises – it becomes difficult to gain an edge. Additionally, it becomes imperative to differentiate between what is relevant and what is not. Virtually instant changing psychologies make sentiment indicators seem like relics of the past. So flying alone seems increasingly difficult; the best way of doing so is simply to focus on individual securities.

Computers can graph charts, spew out prices, consider pre-programmed hedges and ensure that all investors receive the same information at the same moment. But it is difficult to program or quantify judgment, to consider the effect of markets on emotions, or to take the measure of the executive across the table. Stock investing is always about picking individuals names, not letting markets dictate opinions. Despite operating with myriad blinking machines providing instant information in terms of prices and news, investing for most of us is an old fashion business.

Regardless, the investment business should remain a growth industry. When one looks forward there is an enormous lack of liquid capital, capital that will be necessary to fund the retirements of millions of baby boomers. Hedgeye estimates that 102 million Americans have no money in retirement accounts. It has been estimated that 10,000 people will reach the age of 65 every day for the next eighteen years. If each individual required a million dollars in capital – a sum too small to support most in retirement – that suggests a need for $65 trillion, a number larger than the entire capital markets in the U.S. today. Defined contribution plans have effectively replaced defined benefit plans in corporate America. Can anyone doubt that similar pressure will not be felt by state and union workers? Should that come to pass, will not similar plans begin to gradually supplant Social Security? Retiring off the backs of current workers will increasingly be a function of the past. Such a need requires substantial changes in tax legislation. However, the added capital will prove beneficial in fueling entrepreneurs and businesses around the world

Markets never move in straight lines. There will be years of gains and years of losses. It has always been that way and always will. Leuthold Group, in their January 6, 2011 report, had an interesting chart. It indicates that when the Ten-year Treasury outperforms stocks over long periods of time, it is rare and has proven to be a good time to own stocks. The chart goes back to 1926 and, during the ensuing 84 years, there have been only three times when that has occurred – 1933, 1949 and 2009. However, one should never rely solely on charts. Their patterns, like rules, are often broken.

Nevertheless, it provides me some comfort that the environment, no matter how fearful or complacent, should remain conducive to stock picking.

Wednesday, January 19, 2011

"Do Leopards Change Their Spots?"

Sydney M. Williams

Thought of the Day
“Do Leopards Change Their Spots?”
January 19, 2011

Has President Obama experienced an epiphany? Reading his op-ed in yesterday’s Wall Street Journal it certainly seemed so. When he spoke of the free market being “the greatest force for prosperity the world has ever known,” he could have been speaking for the Heritage Foundation. When he added: “Small firms drive growth and create most new jobs in this country. We need to make sure nothing stands in their way,” he sounded like a disciple of the American Enterprise Institute.

These are the words of a President with less business experience in his cabinet than any previous incumbent and from a man who added more regulation to our nation than any President since Franklin Roosevelt – healthcare and financial reform among them. A failure to pass “Cap and Trade” legislation resulted in the administration strengthening regulation at the Environmental Protection Agency. Nevertheless, one cannot help but wonder: has the leopard actually exchanged his spots for stripes, or are these the words of a politician who is looking toward 2012, after a disastrous mid-term election?

Signing 4000 pages of legislation, encompassing but two bills (healthcare and financial reform) both of which risk stifling innovation and have had a chilling effect on growth and jobs, does not appear to be the actions of the man who wrote in his op-ed that he did not want regulation to place “unreasonable burdens on business.” The healthcare bill of 2010, according to the Center for Health Transformation, will create 159 new federal government programs, bureaucracies and offices. The Dodd-Frank bill created two new agencies, along with hundreds of new rules and regulations. It not only left banks-too-big-to-fail in place, it enhanced them, and it did nothing about the derivative problem, whose nominal value exceeds the world’s GDP by a factor of six to seven. Is it any wonder that a reader (and the people) might be confused?

The world has become a far more competitive place than a few years ago and perhaps that is what the President was addressing. The hegemony that America enjoyed in the decade and a half following the collapse of the Soviet Union will never return. We remain the largest economy, but Asian nations are gaining ground. In 2000, the U.S represented approximately 24% of the world’s GDP. Today, we are closer to 23%. Estimates suggest that we will be about 22% in 2015. China is moving in the opposite direction. Today their GDP represents about 9% of world GDP. In 2015, they should be closer to 12%. While the future is always opaque, this trend appears inexorable; it means we have to be in fighting shape to meet the competition. Words, while they are pleasant to read and exciting to hear, do not substitute for action.

Tony Blair is a politician who has recognized the need and the urgency to re-think the political debate between a Left and a Right that persists as though the world, economically, had stood still for the last two or three decades. He writes (and, of course, he is writing about England, but his words have pertinence to the U.S.) toward the end of his memoir, A Journey: My Political Life, “As the new economies emerge, we have to compete. How? By brains and skill, by moving up the value-added chain. By working harder (my emphasis.) By competing on merit, on ability.” He goes on to add that the education system and the welfare state will have to be reformed not more cautiously, but more boldly.

It isn’t just regulation that must be streamlined and made more efficient. Regulations must be enforced. One of the problems in 2007 and 2008 leading up to the collapse of Lehman and the Bernie Madoff scandal was a failure to enforce existing rules. In my opinion, we individually have a moral responsibility to one another; the state, in that regard, plays an integral, but subordinate, role. Permitting responsibility for each of us to become principally the purview of the state, not the individual, risks an overly dependent constituency, not the characteristics needed in an increasingly competitive world.

Besides encouraging self-reliance, other steps should be taken. The deficits need to be addressed and government and unions must stop promising what they cannot deliver. Taxes should be simplified and lowered – a proposal President Obama put forth on NPR in December. We must engage with the world and avoid turning inward. While Amy Chou does not represent most mothers, our educational system needs improvement.

The headline in today’s USA Today: “Who is Obama?” In the article, retiring senior White House advisor, David Axelrod, describes the President as “consistent,” the one adjective that, in my opinion, does not describe him. While I hope that the President means what he wrote in yesterday’s Wall Street Journal, count me as being from Missouri, at least until I see action that matches his words.

Tuesday, January 18, 2011

"Laughter, The Medicine That Works

“Laughter, The Medicine That Works”

January 18, 2011
“I was irrevocably betrothed to laughter, the sound of which
always seemed to me the most exciting civilized music in the world.”
                                                                                                        Peter Ustinov (1921-2004)

Apart from the sensuality of cruising Cappuccino at day’s start or flying down Born Free at day’s end, or the adrenalin rush one gets from attacking a groomed Blue Ox in between, what I always remember best of my too-few days in Vail is the laughing – on the slopes, at lunch and at dinner. Laughter serves as a release, after an exciting, nerve-tingling run down Riva Ridge; it allows us to become easily reacquainted after months of absence.

Who can read the lines from P.G. Wodehouse without at least cracking a smile? “I could see that, if not actually disgruntled, he was far from gruntled.” Or, “She looked as if she had been poured into her clothes and forgotten to say ‘when’”. I am a member of a small group in New York, all aficionados of Wodehouse, called the Drones. We meet irregularly for dinner. In our youth we would toss rolls around the table – beaning the bald guy across and two seats down the table with a crusted roll – when he looked away – was a measure of sophistication, which caused raucous laughter from the rest. Our hands and arms have become stilled (with age?); nevertheless, our almost constant laughter still causes more sober diners to regard our childish antics with dismay.

An old Yiddish proverb says, “What soap is to the body, laughter is to the soul.” But laughter may also have medicinal benefits. Medical experts claim it reduces muscle tension and distracts attention from pain – both emotional and physical. But not only does laughter act as a distraction, it actually stimulates the release of endorphins, the bodies natural pain killers. Doctors suggest the act of laughing is known to lower blood pressure, reduce stress hormones and increase muscle flexion.

For most of my forty-four years on Wall Street, trading desks were the creative hot spots for jokes, especially those dealing with tragic events. The jokes were never meant to be demeaning or disrespectful; they were simply an expression of relief during tense moments. Traders thrive on intensity. A poorly executed trade can mean the difference between a profit, or a loss involving hundreds of thousands or millions of dollars. Stress is often followed by laughter.

“Humor is one of the most serious tools we have for dealing with impossible situations;” so once wrote Erica Jong. In 1976, Norman Cousins published the first chapter of his book, Anatomy of an Illness, in the New England Journal of Medicine. He had been diagnosed a dozen years earlier with ankylosing spondylitis, an acute inflammation of the spine, and had been given only a few months to live. He left the hospital, checked into a hotel, took mega doses of vitamin C and turned the TV to whatever humorous programs he could find. He discovered that 10 minutes of boisterous laughter resulted in at least two hours of uninterrupted, pain-free sleep. He continued the routine until he recovered.

We live during a serious time. Radical Islamic terrorists attacked our country ten years ago. We are finally exiting the most severe economic collapse in eighty years. A gun-toting maniac just killed six people in Tucson and wounded a U.S. Representative. Every day in America, about eighty people are shot dead – about 29,000 every year. Does laughter seem too cavalier for dealing with today’s problems? Do expressions of humor just seem callous and unfeeling? Violent Islamic protests broke out after the Danish newspaper, “Jyllands-Posten,” published a dozen editorial cartoons depicting the Islamic prophet, Mohammad. The Prime Minister, Anders Fogh Rasmussen, called the subsequent response (in which 100 people were killed) as Denmark’s worst international crisis since World War II.

Yet, the ability to laugh at one’s self is critical in all situations. The Revolutionary War period in America was a trying time and we don’t often think of the Founding Fathers laughing their way through Philadelphia in 1776. The Founders had put both their fortunes and their lives on the line when they broke with the Crown. However, they were not without a sense of humor. Benjamin Franklin once suggested sending rattlesnakes to England in response to them sending convicted criminals to America. George Washington, who is generally portrayed as a stern icon, in 1755 wrote his brother John (in words that anticipated by 150 years similar remarks from one of the Nation’s greatest humorists, Mark Twain.) “As I have heard since my arrival at this place a circumstantial account of my death and dying speech, I take this opportunity of…contradicting the first, and assuring you I have yet to compose the latter.”

In our country, it has generally been those Presidents with a good sense of humor – Lincoln, Roosevelt and Reagan – with whom must of us feel the greatest identification. While those like Nixon and Carter, though perhaps possessing humor, never used it to their advantage and thus suffered. It is a lesson President’s should learn.

Laughter is spontaneous. Shortly after I met my wife, she and I, along with her roommate, Posy and boyfriend Ed, were having drinks at the Eliot Lounge on the corner of Massachusetts and Commonwealth Avenues in Boston. Something, which I can no longer recall, caused Caroline to break out in paroxysms of laughter. Her joyful and contagious laugh was echoed by another young woman, who remained hidden from us in that darkened room. When one paused for breath, the other leapt into the breach. The effect was not unlike the mournful tone of taps, the music of which reverberates off distant hills from a second, unseen bugler.

Laughter is not learned; it is instinctive. “Infants will laugh almost from birth,” says well known psychologist, Steve Wilson, who refers to himself as a “joyologist.” Jokes may help, but are not critical to laughter. Mr. Wilson points out that pre-schoolers laugh on average 400 times a day, while adults laugh less than 15 times. I have long felt that children are there to teach us; in this regard they can. Humor is equalizing; it admonishes the pretentious and lifts the depressed. “Laugh and the whole world laughs with you; weep and you weep alone!” is an old but true adage.

"The Jasmine Revolution - A Precursor?"

Sydney M. Williams

Thought of the Day
“The Jasmine Revolution – A Precursor?’
January 18, 2011

A small country can, at times, have an out-sized effect. Tunisia may be such an example. It is too early to know for certain. Despite winning re-election with 90% of the popular vote in 2009, despot Zine El Abidine Ben Ali proved not to be that popular. While Tunisia never had the sectarian violence that mars so much of the Middle East, nor was Mr. Ben Ali an Islamicized leader, he did run what amounted to a police state, was personally corrupt and his family allegedly worse. WikiLeaks, in a demonstration that hockey sticks-in-the-air is a universal sign of victory, took credit for the success of what is being called the Jasmine Revolution. President Obama welcomed Friday’s overthrow of Mr. Ben Ali as “this brave and determined struggle for universal rights.”

For decades after World War II the concept of Realpolitik – the basing of foreign policy on practical, rather than moral or ideological grounds – determined the way Western nations dealt with totalitarian regimes. Reason held sway over theory. In 1986, Perestroika provided a glimpse that Soviet citizens wanted freedom. A year later President Reagan went to Berlin and gave the speech in which he demanded, “Mr. Gorbachev, tear down this wall.” Nevertheless, most of the West felt that the world had to be dealt with as it is, not as some Western democrat preferred it to be. And Realpolitik continued to be the path of least resistance for most in the West when dealing with the Arab world and their autocratic rulers.

However, the advent of the internet changed things, as it has played a powerful role in the spread of freedom. There may be those who will choose mercantilism, swathed in a system that stifles freedom, like China, but e-mail, twitter and Facebook have revolutionized the spreading of ideas, including democracy. It is a genie that is anti-despotic and will prove very difficult to re-bottle. Nevertheless, President Obama, early in his administration and perhaps as a way of distancing himself from his predecessor, downplayed the concept of a “freedom agenda.” For example, Mr. Obama chose not to support the “Green” movement in Iran during their 2009 presidential election.

For years, the U.S. (and Europe) supported Arab dictators based on the concept that they were the only alternative to radical Islam. That is until President Bush made “freedom agenda” a policy of his administration and England’s Prime Minister Tony Blair identified “aspiration” as a critical element in the minds of people who wanted freedom above protection. Both Mr. Blair and Mr. Bush have been vilified, in this regard, for their role as it applies to Iraq. Partisan condemnation of Bush for allegedly promoting freedom at the end of a gun gave (wrongly, in my opinion) America’s support for democracies a bad name. But events have caused policy wonks to reconsider. Argentina seems to be slipping back into totalitarianism. The successful financial rise of an autocratic China and the apparent decline of democracy in Russia further impacted enthusiasm by the West for democracy promotion. So, in recent months it appears that that policy will be reversed and that encouraging democracies will continue to be an integral component of the United States’ foreign policy. Mr. Obama’s words last Friday indicate a change.

According to an issue last March in the Weekly Standard, if democracy and human rights do become a priority for the Obama administration, it will be in no small part because of the influence in internal debates of Michael McFaul, a senior director for Russian and Eurasian affairs on the National Security Council and former faculty member at Stanford. Professor McFaul argues that those who constitute the “renaissance of realists” are simply wrong when they argue that democracy can only be achieved after a certain level of economic development, or that transitions cause instability, or that attempts at democracy open these countries to radical undemocratic forces. “Officials,” he says “must remember the moral, security and economic interest the United States has in promoting democracy.” He also believes that, if truly successful, ultimately the idea of promoting democracy will devolve from Washington to places like New Delhi and Santiago; but for the foreseeable future American leadership remains indispensable.

It is far too early to predict what will happen in Tunisia, but the overthrow of a despotic Arab leader by pro-democracy forces is not a common event. It is a big deal. Tunisia is a small nation – no larger than Wisconsin – with a population just over 10 million, 98% of whom are Arab. It is Africa’s northernmost country, sitting between Algeria to the west and Libya to the south and east. It is a member of both the Arab League and the African Union. However, in the 2010 Press Freedom Index it ranked 164 of 178 nations. Similarly, the Economist’s Democracy Index for 2010 ranked Tunisia 144 of 169. As Roula Khalaf wrote in the weekend edition of the Financial Times, “a regime that rules by fear loses its balance once that wall of fear is shattered.”

It is the association of western values with democracy that have made so many in other parts of the world skeptical of promoting democracy; yet the desire to live freely is universal. And that is what the people of Tunisia have chosen. This revolt against tyranny should remind the West of the moral force behind President Bush’s Freedom Agenda. Should they be successful, the ramifications will be felt in places like Cairo and Tehran and the world will be a better place. The people of Tunisia must have felt comforted with President Obama’s words, recognizing their plight and hailing their victory in ridding the world of one more dictator. And we should all hope that what happened in Tunisia does not stay in Tunisia.

Friday, January 14, 2011

"The U.S. - China Debate"

Sydney M. Williams

Thought of the Day
“The U.S. – China Debate”
January 14, 2011

The contrast between Gideon Rachman’s piece in the January/February issue of Foreign Policy and a recent book by Adam Segal, Advantage, could not be more different. Gideon Rachman is a highly respected columnist who writes regularly for the Financial Times. Mr. Segal is the author of High-Technology Enterprises in China and is the Ira A. Lipman senior fellow for counter terrorism and national security studies at the Council on Foreign Relations.

The opposing views by two intelligent and well-read observers lend credence to an observation by Nigel Lawson who recently wrote a piece entitled “Five Myths and a Menace.” In it Mr. Lawson writes of the myth that economics is a science: “…economic policy is more like foreign policy than it is like science, consisting as it does in seeking a rational course of action in a world of endemic uncertainty.” Forecasting the future is a bet on anticipating human behavior, thus scientific analysis, or assuming static accounting, is of little use. Things change.

Mr. Rachman presents the more pessimistic view. He points out that China’s population is roughly four times that of the United States with a GDP that is growing almost three times as fast. He bases his conclusions on three premises. While the U.S. military might is substantially greater than that of China, our deficits will mandate a slowing in defense spending. At the same time, China is increasing her defense spending, thanks to $2.5 trillion in foreign reserves. Second, Mr. Rachman questions the assumption that economic growth inevitably leads to democratization and that, even if it does, concludes that those democracies would not necessarily be friendly and helpful to the U.S. And, third, he worries that globalization may not be a zero-sum game – that a mercantilist China may encounter a protectionist America.

While China is much larger than the U.S. in terms of population (1.3 billion versus 300 million), their population is growing more slowly than the U.S. (a total fertility rate of 1.73 versus 2.05) and aging more rapidly. The median ages of the two countries are not that different; (China’s is 34.1 versus 35.3 in the U.S.). However, if current GDP trends persist, China could overtake the U.S. as the world’s largest economy in less than ten years. If, over the next ten years, China grows its GDP at 9% (less than the last ten years) and the U.S. grows its GDP at 3.5% (a little more than the ten year average), China’s GDP will exceed that of the U.S. by about ten percent in 2021.

In his book, Advantage, Adam Segal provides a primer as to what must be done to compete effectively with a rising, economically powerful Asia. He lays out an argument suggesting the future may not be so dire as many fear. He suggests that two characteristics uniquely reflect America – technological innovation and entrepreneurship. Half a million companies are founded each year in the U.S. and, while most fail, the number is indicative of America’s creative spirit. He acknowledges that technological capacity is shifting to China, but suggests the spread is “incremental.” In the meantime, the United States, despite a level of xenophobia emanating from Washington, remains more open to immigration than China. Mr. Segal points out that a Duke University study found that a quarter of tech companies started between 1995 and 2005 had at least one foreign born founder. He writes of the continuing need to address the attracting and keeping of immigrants. Mr. Segal points out that eighteen of the world’s fifty best universities are American.

Mr. Segal acknowledges that China copies technology and argues that the U.S. should make protection of intellectual property an element of competition. He cites the America Competes Act of 2007, signed by President Bush with bilateral support from Congress, a bill that doubled the budgets of the National Science Foundation, the Department of Energy, and the National Institute of Standards and Technological Laboratories. The bill also provided more scholarships in math and science. Certainly, more needs to be done, but it is not as though the competitive threat has gone unnoticed. Toward the end of the book, Mr. Segal writes: “Yet one of the great strengths of the U.S. has always been its ability to re-create and renew itself, especially when confronted with a crisis.”

In my opinion, I believe we have the ability to follow the roadmap laid out by Adam Segal. The question is: do we have the will? The very size of our deficits, a consequence of unaffordable entitlements, places us in a precarious financial position. This morning’s Wall Street Journal has an article (page C2 in my edition) headlined, “S&P, Moody’s Warn U.S.” They point out that markets may be focused on Europe, but debt problems in the U.S. continue to worsen. Admiral Mike Mullen, chairman of the Joint Chiefs of Staff, has said that the national debt is the single greatest threat to national security.

Mr. Rachman ends his article with what seems to me a truism: “But America will never again experience the global dominance it enjoyed in the 17 years between the Soviet Union’s collapse in 1991 and the financial crisis in 2008. Those days are over.” It is hard to disagree with that assessment, but that does not necessarily mean the U.S. is bound for second or third place. It does mean, though, that we have to become far more competitive, which will require rethinking our priorities as a nation, a subject I am sure that will be on the mind of President Obama when he sits down next week in Washington with President Hu Jintao of China.

Thursday, January 13, 2011

"A Climate of Hatred or a Climate of Frustration?"

Sydney M. Williams

Thought of the Day
“A Climate of Hatred or a Climate of Frustration?”
January 13, 2011

While civility in politics is a wish devoutly to be realized, it is unlikely ever to come to pass. Politics has long been both personal and vitriolic. Late 18th century political pamphleteers make many of today’s commentators seem mild in comparison. In 1856, Representative Preston Brooks of South Carolina beat Senator Charles Sumner into unconsciousness with a cane. President Truman famously said if you can’t stand the heat, stay out of the kitchen. Nevertheless, the idea of Congressmen carrying weapons as self-protection in the wake of last Saturday’s tragic shooting seems an irresponsible response.

Paul Krugman, while admitting that the Arizona killer who badly wounded Representative Gabrielle Giffords last Saturday was mentally deranged, nevertheless concludes that Jared Lee Loughner was motivated by the hatred spread by the right, notably his nemeses: Glen Beck, Sarah Palin, Fox News and the Tea Party. He is joined in his own inflammatory remarks by others on the radical left, notably and even the editors of the New York Times. Hypocrisy on the Left is rife. To suggest that hate emanates only from the Right is just wrong. President Bush was perhaps the most reviled president in recent history. Is it their conclusion that the term “Bush lied” was not inflammatory? Tony Blair, in his book A Journey, refers to President Bush: “Of anyone I ever met at a high level in politics, he was the person least likely to be rude or offensive.”

President Obama yesterday in Arizona attempted to damp the vitriol and cooler heads now seem to prevail. However, in the immediate aftermath of the crime, in a statement that seemed incredible at the time, Sheriff Clarence Dupnik attributed the shooting to the “vitriolic rhetoric that we hear day in and day out from people in the radio business and some people in the TV business.” Other than to deflect attention from his own failure to apprehend Mr. Loughner prior to the incident (and, given Mr. Loughner’s drug use and abusive behavior in the class room at Pima Community College, Sheriff Dupnik had plenty of cause), one cannot imagine a law official making such a prejudicial statement before the facts were in. He should be removed from office.

No matter how crass it may seem politicians will, with soaring rhetoric, use this case to further their own advantage. It is the world we live in. Unfortunately the Tucson massacre serves to distract attention from the real cause of dissent that infects our politics and society today. It has nothing to do with a deranged schizophrenic on a murderous rampage, other than the fact our laws no longer permit the coercive institutionalization of patients with serious mental problems. Perpetrators are now provided more protection than victims. According to Dr. E. Fuller Torrey writing in yesterday’s Wall Street Journal, the National Institute of Mental Health estimates that there are over 21,000 individuals in Arizona with untreated schizophrenia - about 10% of whom are capable of violence.

However, to draw a link between the actions of Mr. Loughner and elements of the Republican Party does a disservice to the root cause of dissatisfaction that seems to permeate our society today. What people like Krugman fail to acknowledge, and yet what Tea Party members instinctively understand, is that the American people sense themselves to be the victims of a giant Ponzi scheme that is being foisted on them by politicians (and a few others) who put re-election ahead of seriously dealing with a problem that risks driving our nation over a cliff - the problem of promises, in the form of entitlements, that are proving impossible to keep – an example being the teacher’s unions of New York City which guaranteed pension returns of 8.25% (Madoff-like returns) regardless of what the investments really earned.

Whether at the household, business, or government level future obligations must be accounted for honestly. For too many years, the government’s promises for retirement (Social Security) and healthcare benefits (Medicare and now the new healthcare bill) have had the consequence of increasing the dependency of the American people on what they have been led to believe is a beneficent government. At the same time, it has made them less dependent on their own resources. Further, it has fostered a cavalier and dangerous attitude of living well today, letting the future bring what it will.

Deficits are simply the result of borrowing from the future, so that we can live better today. Most of us incur debt to buy homes, cars and education, and most individuals and businesses do so reasonably and responsibly, as they understand the consequences of a failure to repay. Not so government and not so unions who, in return for a vote, have sold a promise of future economic security in return for loyalty. Ironically and perversely, the standard set by government – of promising more than could be delivered – infected millions of people. The result was a principal cause of the housing bust in 2007-2008. (Wall Street, banks and mortgage brokers all played a part, but nothing would have happened without the willingness of people to participate.) Deficits, per se, are not the problem; it is when financial obligations become too large to be serviced by income that problems occur.

Millions of Americans have come to recognize that the path we are on is unsustainable. They have come to the conclusion that the king has no clothes. We saw it in the November elections. Their concern reflects a growing frustration with a government that everybody knows cannot meet the obligations they have promised. This, in my opinion, is what prompted the ground swell that became the Tea Party. It is not so much a “climate of hate,” as it is an acknowledgement that the current path leads nowhere, but to bankruptcy. It has created a climate of frustration. Government, thus far, has failed to acknowledge the seriousness of the issues. Short term solutions for long term problems, including kicking the bucket down the road, are no answers...and the people know it.

The partisan passage of the healthcare bill served as the match that lit the tinder. “You can fool all the people some of the time and some of the people all the time, but you cannot fool all the people all the time,” so famously spoke Abraham Lincoln. Liberal politicians and union leaders thought they could. No matter the rhetoric from the White House, Congress, the New York Times and Paul Krugman, the people instinctively understand that another entitlement is not a way to balance a budget.

Krugman and his political brethren are wrong. It is frustration, not hate that has driven millions toward the Tea Party. It is frustration with a political system that will not acknowledge it has made promises it cannot keep. The king is naked. Jared Lee Loughner is no doubt consumed with hate, but hate driven by internal demons, not a consequence of politics. To assume otherwise makes a serious misjudgment.

Monday, January 10, 2011

"CEO Salaries, Shareholder Returns and the Future of Our Nation"

Sydney M. Williams

Thought of the Day
“CEO Salaries, Shareholder Returns and the Future of Our Nation”
January 10, 2011

It is the focus on the short term, not the long term, that increasingly dominates how we think and what actions we take. It has created an hedonistic environment where the loci of our focus is, “what’s in it for me?”

This quality of self interest too often today manifests itself in the corporate boardroom. Most CEOs of large, publically traded firms - apart from those who are founders - take on the job for a number of reasons: many simply look forward to the challenge; others have little or no doubt that their personal qualifications have eminently prepared them; for several, the job satisfies an innate aspiration; a number may want to grow the business (or save a failing enterprise) and feel they are the right person for the job; for most, their ego has been assuaged by the search committee and the Board. Compensation, though, is seen by CEOs as a form of scorecard - the higher the pay, the better they must be.

However, if pay is an accurate measurement of the best, should not one expect that to be reflected in the prices of their stock? Sadly, that is not the case. In 2007, a year before he was forced to sell his company (Countrywide Credit), Angelo Mozilo was the third highest paid executive in the U.S., bringing home $124.7 million. A year before he lead his company (Lehman Brothers) into bankruptcy, Richard Fuld was number 13 on the list, earning $71.9 million. What were the directors who authorized the compensation and responsible to millions of small shareholders (most of whose investments were in pension and retirement plans,) thinking?

Increasingly over the past couple of decades the job of CEO has become a means to personal riches. There is nothing wrong with such desires, but in too many cases there is little recognition of the role played by (or on) shareholders. Should the CEO be successful, they are the obvious beneficiaries. But, if he or she fails, they are the victims. As owners of the enterprise, they are the ones paying. Directors’ responsibility is to shareholders, not management. When Hank McKinnell, former CEO of Pfizer was paid $213 million upon leaving the job as CEO, it was not some entity named Pfizer or the Board that paid; the money came from the shareholders - shareholders who had cumulatively lost $160 billion during Mr. McKinnell’s tenure as CEO.

Large public companies are increasingly run by professional managers, hired to boost earnings per share over the immediate future. In essence, they are encouraged to speculate and make short term bets with the company’s capital, money that belongs to shareholders. They are paid to manage expectations on a quarterly basis. Despite the great need of the country and millions of investors to focus on long term goals, these men and women are incented on achieving short term ends. R&D budgets are often slashed, along with departments such as customer support, so that the costs eliminated will flow immediately to earnings per share. Worse, their employment contracts are often written so that should they fail a healthy severance removes any blemishes of embarrassment.

According to research done by two professors from the Kellogg School of Business at Northwestern, there are three reasons why firms grant lucrative severance packages to CEOs with their initial employment contracts: to encourage risk taking, to provide insurance for an incoming executive, and to compensate CEOs for entering into confidentiality agreements. Ironically, the shareholder, who is anteing up the money for the contract is wholly at risk, while the CEO, who stands to benefit the most, takes on no, or very limited, risk. Again, most of us have no problem with CEOs assuming business risk; that is what they are paid to do. But shouldn’t they have real skin in the game?

Were shareholders served well by the directors of Home Depot when they offered Robert Nardelli $82 million ($20 million due in cash within the first 30 days) if he were dismissed? Did the shareholders of Hewlett-Packard get treated properly when the directors offered Carly Fiorina, in accordance with a pre-nuptial, a severance of $21.4 million? Stanley O’Neal steered Merrill Lynch into subprime mortgages in the mid 2000s. He was fired “for cause” in October 2007; nevertheless he pocketed $94 million in 2006-2007. Were shareholders appropriately compensated? Were directors held responsible in any of these cases? Of course they weren’t. The answer does not lie in government mandating executive compensation, ala Kenneth Feinberg; no, the answer lies in a cultural change that causes people to take responsibility for their actions - the good and the bad. And the answer lies in a shift in priorities that emphasize long term investments, not short term results. The problem exists in professionally managed public companies, not those run by founders. Entrepreneurship is to be encouraged.

When Goldman was a partnership, the partners were at individual and collective risk. Betting on any investment, be it subprime mortgages or an equity stake in Facebook, was a function of betting their own money. Bad investments penalized them and good ones rewarded them. Over the decades they made far more good decisions than bad ones and, thus, were well rewarded. As a public company, they now bet with shareholders capital - some of which is their own, but most of which is not. It creates a different ethic and a different culture.

In 1980, according to Business Week, the average CEO was paid 42 times the average hourly worker’s wage. By 1990, the number doubled to 85 times; by 2000 that number had risen to 531 times! Reasons abound: during those two decades the stock market recorded annual compounded returns approaching 18% and CEOs were surely beneficiaries, but to ascribe that advance solely to the competence of the CEO would be to misunderstand the nature of markets.

Blame for the surge in executive compensation, especially that in the last two decades has been principally a consequence of the passage in 1993 by Congress of section 162 (m) of the tax code. That Bill limited the deductibility of annual executive compensation to $1,000,000, unless it was performance based. And options were performance based. The stock market was in the midst of an eighteen-year bull run and the use of options exploded. As a result, CEO compensation for the S&P 500 companies rose from $3.7 million in 1990 to $9.1 million in 2000. Options have long been mis-identified as aligning executive interests with that of shareholders. They do not. A stock option is exactly that, an option to buy stock at a specific price over a specific time. If the stock rises, the option is exercised; if the price falls, the option expires worthless, but no loss is incurred. Holders of options incur no risk, other than that of opportunity. However, should the stock rise during the designated period, they often stand to make millions. Worse, a number of companies re-priced options when stock prices declined, permitting the holders to benefit from the decline in price. Shareholders, on the other hand, own the stock outright, so enjoy gains when the price rises but suffer losses when they fall.

A fixation on short term results has hurt many of our largest companies, impaired our markets, damaged our country and caused losses for millions of workers and shareholders. Nevertheless, we need free and vibrant capital markets. Congress and the President should consider changes to the tax code that encourages savings and investments - lowering or eliminating taxes on long term capital gains and reducing taxes on dividends and interest. While I am not a fan of a VAT, perhaps some form of taxation should be considered on non-essential items. Congress and the President should encouraging people to think of the future – of education and training – and the need to compete in a global environment.

Thursday, January 6, 2011

"The New Normal? Some Consequences, Not All Intended or Expected"

Sydney M. Williams

Thought of the Day
“The New Normal? Some Consequences, Not All Intended or Expected”
January 6, 2011

I no longer fly as much as I once did. However in the past two months, five flights - two on American and three on United - have had five things in common: the number of flights has declined; fares have risen; the planes are full; service has declined; extras cost...extra. Departures are less frequent. No longer can one spread out with an empty middle seat; attendants no longer come by offering a pillow or blanket; anything more substantial than a bite size snack or a can of soda/juice costs extra, and the airlines no longer accept cash. (Charging $1.79 to your Amex card seems ridiculous.) And, for all this we have the opportunity to pay a little more.

Warren Buffett once remarked that the airline industry, in the years since Orville Wright first went airborne in Kitty Hawk, North Carolina in 1903, in the aggregate, never made money. But tough times make for tough decisions. Thus an unforeseen consequence of the credit collapse-induced recession (unforeseen by most investors and probably all policy makers, but likely not by business) has been that a number of industries have been placed on sounder financial footings.

The airline industry may well descend into its previous profligate ways, but perhaps not. Low cost carriers such as Southwest and Jet Blue had already made important inroads and the bigger airlines have responded by buying up competitors, thereby reducing competition. The retirement of planes and schedule reductions were obvious means of reducing costs and increasing load factors. As a customer, I miss the amenities of an earlier time, but also as a customer I feel more comfortable that they will have more money for maintenance where some of the savings hopefully will be spent. The truth is I always felt a little queasy about air carriers losing money when so much (and so many) depend on their adhering to strict maintenance and safety rules.

The auto industry is another that for years has made little or no money. Unions successfully negotiated egregious hourly raises, too-generous pension benefits, unaffordable healthcare plans that effectively denuded shareholders, but not management who managed to wring generous contracts from their compliant boards of directors. As the past recedes, it will become difficult to recall those hectic months two years ago when General Motors and Chrysler went bankrupt. In spite of the fact that bondholders got reamed during negotiations with the auto companies two years ago (contract lawyers must have spun in their graves!), it may finally be shareholders time; though investors should be cautious. Despite the obviousness of the link between Wall and Main (pension and retirement funds are the largest single holder of equities), there persists among liberals in Washington a feeling that all stock holders are cigar smoking, top hat-wearing insensitive capitalists. The enemy, as “Pogo” might have put it, is us.

Yesterday the auto industry reported industry sales in the U.S. of 11.6 million units versus a 27 year low for 2009 and, remarkably, the industry returned to profitability. Estimates for sales in 2011 are expected to expand to 12.2 million units. Assuming that target is reached, it would still be 23% below the average annual sales of 16.8 million units for the years prior to the recession, and would, in fact, be the third lowest in the past eighteen years! That American manufacturers have been able to return to profitability speaks volumes for industry changes. However, one should keep in mind that bankruptcy permitted extrication from billions of dollars in debt, and pension and healthcare obligations. Should the latter reemerge (the former will), losses will follow.

For decades following the end of World War II, the “big three” (GM, Ford and Chrysler) dominated the American automobile industry. Now, according to yesterday’s Wall Street Journal, the “gang of seven” (those three plus Toyota, Honda, Nissan and Hyundai) will split the spoils. Thirty years ago GM captured almost 50% of US auto sales and had trouble making money. By the end of 2008 GM’s stock was lower than it had been fifty years earlier. Labor had done well and so had management, but not so the owners of the enterprise - the shareholders. Last year GM captured 20% of a smaller market and was profitable. Necessity, as I wrote recently in a different context, becomes the mother of invention.

Commercial banks represent a third industry that has benefitted through difficult adjustments to tough times - again mainly self inflicted. (Investment banks, in contrast, have benefitted from the get-go of the credit crisis, as most were awarded commercial bank status, allowing them to borrow from the Fed’s Discount Window at 0.50% – so they can use the money – your money and mine! – to speculate, for example as Goldman did earlier this week in purchasing one percent of Facebook for $500 million – at twenty-five times revenues – providing little risk to Goldman, but almost no return to the lender – the taxpayer.) Reductions in mandated interest rate charges for poorer credits have caused banks to sever relationships with less credit worthy clients, improving the bank’s charge-offs, but forcing the borrowers into the arms of pawn shop owners and unregulated check cashers, both of whom often charge usurious rates. The amount needed to be held in checking accounts to qualify for free checking has risen five to ten fold. And, thanks to the Dodd-Frank Bill, an effective 84% reduction in debit-card merchant fees is causing banks to consider imposing annual fees on their use – an ironic response to a nation and a people trying to undo three decades of an unsustainable growth in credit card debt.

As a nation, we lived beyond our means for years, borrowing from the future to satisfy today’s hedonistic desires. This has been particularly true for politicians who ingratiated the electorate, especially state and local union members, by providing benefits in return for votes – knowing full well that the road had to come to an end. It now has. Businesses had done much the same in the post war years, but decades ago realized that pipers need to be paid, as most switched their pension plans from defined benefit to defined contribution plans. Reform, when it comes, is never easy. It takes time to adjust. Tony Blair, in his book, A Journey: My Political Life, speaks to the progress of reform (He is speaking of tuition reform in the U.K.): “The change is proposed; it is denounced as a disaster; it is unpopular; it comes about; within a short space of time, it is as if it had always been so.” In my opinion, we have not yet accepted the changes that will be forthcoming; nevertheless, necessity is dictating that eventuality. In the case of the U.S., investing for the future, whether it is in education or industry, must replace today’s culture of immediate gratification.

Whether this is part of the new normal envisioned by the bond gurus at PIMCO, I could not say. But businesses, like people, survive however they can. And it looks like these three are attempting to do so. If my being squeezed into a two foot square space for a four hour flight to Denver is the worst I will suffer, then I should consider myself lucky. But the consequences of rising airline fares, costlier cars with more onerous financing charges and tightening credit conditions for the neediest may not meet the expectations of millions who voted for Mr. Obama in 2008. They may have hoped to keep the good times rolling, digging the hole deeper and to hell with the consequences.

Tuesday, January 4, 2011

"Time to Think? - Not Likely"

Sydney M. Williams

Thought of the Day
“Time to Think? – Not Likely”
January 4, 2011

All of us, I am sure, are overwhelmed by a plethora of information – stock reports, market commentary from strategists and technicians, lengthy economic treatises, which not only deal with the U.S. but with the global environment and missives like this. IMs and e-mails have the annoying habit of notifying us every few seconds that a new message has arrived. Up-to-date information on every conceivable subject is a click away on the internet. And, of course, every day news papers arrive and stick around waiting to be read. The television is always on, tuned to all-business news-all-the-time channels.

According to most experts, the total wealth of written knowledge doubled between 1750 and 1900 and then doubled again between 1900 and 1950. Eric Johnston, president of the U.S. Chamber of Commerce in the mid part of the twentieth century, claimed at the time that knowledge was doubling every ten tears. A year ago Robert Brown, a Dean at the University of North Carolina, suggested that knowledge was doubling every 900 days and predicted that by the year 2020, global knowledge would be doubling every 72 days. Even more aggressively, IBM in a white paper written in 2206 and entitled “The Toxic Terabyte” predicted that by 2010 “the world’s information base would be doubling in size every 11 hours.”

Will man be able to cope with this flood of information? Ray Kurzweil, once described by Forbes as “the ultimate thinking machine” and the author of The Singularity is Near, believes that man will be billions of times more intelligent than he is in today. “Today’s human beings,” he claims, “will be as outmoded as Homo Erectus.”

It could be that Mr. Kurzweil will ultimately be proved correct, but people adapt in evolutionary, not revolutionary, time frames. And we live in the present, not the future. Even today it is humanly impossible to know more than a small fraction of all there is too know. For most people, this has led to narrow areas of specialization and broad areas of ignorance. On Wall Street, it has meant an emphasis on marketing and trading, as opposed to in-depth research. It has promoted high frequency trading platforms and other algorithmic, computer-driven investment programs. Of course, most of us, whether on Wall Street or Main Street, cannot even conceive of the speed of China’s new supercomputer, the Tianhe 1A, which calculates at 2.5 petaflops (or 2,500 trillion operations) per second.

This emphasis on speed has been reflected in the shrinkage of sound bites, first in newsprint and now on TV. The average sound bite during a presidential election was 43 seconds in 1968. Today, it is about nine seconds – roughly the same amount of time it takes to read a 140 character Tweet, one of the newer forms of communication. In politics, have we become more or less knowledgeable about our candidates? Craig Fehrman, in a recent piece in the Boston Globe, quoted two University of Nevada professors who argue that the shrinking sound bite “stems less from a collapse in standards or seriousness than from the rise of a more sophisticated and independent style of journalism – which means the [shrunken] sound bite might not be such a bad thing.”

I remain unconvinced. The Press is invaluable to a free society. Allegedly, Edmund Burke once pointed to the Press gallery in the House of Commons and said that there sits the fourth estate and they are more powerful than any body of government. No one can deny their influence; however, their sense of responsibility is no longer individual but collective – collective in the sense that almost all opinions are represented somewhere, so there may be a “collective” balance. There is very little unadulterated pure news coverage today – everything, whether in print, over the airwaves, or on-line is slanted toward some particular agenda – and that in itself is not bad, if one reads or listens to opposing opinions. The problem is very few people do; so the net effect of shrunken sound bites and fast moving news items is one of further polarizing the populace – using the media to reinforce their preconceptions.

Perhaps it shows my age, but I am of the school that thinks reflection is worthwhile and improves rather than hinders decisions. Perhaps a Tianhe 1A computer could pitch stocks to warren Buffet at speeds approaching a trillion or more a second, but would a programmed algorithmic response provide better returns than those Mr. Buffett achieved over the last fifty years using paper and pencil? Algorithms must be programmed and somewhere during the process a potentially fallible human must be involved – perhaps in designing or writing the program, perhaps in deciding which characteristics to include and which to exclude. Thus, when a mistake is made, the consequences are far direr.

The fact that the level of information is growing faster than our ability to absorb adds to our attention-deficit-disordered condition. We are also living during a time of momentous changes – think of the rise of the East and of the draconian deficits of the West – that will force our people and our nation to adjust behavior, and require thinking through policies and their effects. The successful person, whether in business or politics, will need the ability to explain complex problems in simple, understandable terms – in parables, fables or stories, a practice, ironically, as old as history.

It is true that we live during a pivotal time. As a friend, who manages money in the hills of Montana, put it in an e-mail on Friday, “the coming years will see change beyond anything we can imagine.” The explosion of information will persist. Distinguishing between the wheat and the chaff will not become easier, but will be critical to our futures. Taking a few moments every day to quietly think through events and opportunities should allow one to come to more intelligent and proactive conclusions, and not be simply instinctively responsive.

Even when one is away from one’s desk, the surge of information continues. Newspapers, television and the internet are available. Cell phones are always on, as are IMs. Persistent, ubiquitous and demanding e-mails allow no let up. Tweets never cease twittering. Moments of relief are rare.

Tomorrow I leave for a week of skiing. The information flow will not stop and will follow wherever I go. But my mind, for a few days, will be focused on balancing the thrill of the slope with the need for getting safely down the hill. The growth in information may continue at ever increasing rates. But my principal concern will be that, while the trails may be no steeper than they were, my body begs to differ.

Monday, January 3, 2011

"The Coming Retirement Crisis - Mater Artium Necessitas"

Sydney M. Williams

Thought of the Day
“The Coming Retirement Crisis - Mater Artium Necessitas”
January 3, 2011

It was the Revenue Act of 1913 recognizing the tax exempt nature of pension trusts that first promoted the concept of defined retirement plans. The Act was a consequence of the February 3, 1913 ratification of the 16th Amendment, which gave Congress the right to levy an income tax, without apportioning the tax among the states or basing it on census results, as the Constitution stipulated.

The concept of pensions spread slowly. It was not until 1940 that General Motors’ chairman, Charles Wilson designed the first modern pension fund. Potential problems surfaced in 1963 when Studebaker terminated its underfunded pension plan, leaving employees with no legal recourse for their pension promises. Thus, the next piece of major pension legislation: The 1974 Employee Retirement Income Security Act (ERISA). That Act put in place reporting and disclosure obligations and minimum standards for participation, vesting, accruing and funding. It established fiduciary standards for administrators and asset managers and established the Pension Benefit Guaranty Corporation (PBGC) to protect participants of terminated plans. Additionally, the Act authorized qualified Employee Stock Ownership Plans (ESOPs) and IRA plans.

The growth in pension and retirement plans then exploded. According to Wikipedia, by 1980 there were “approximately 250,000 plans covered by PBGC. Peter Drucker, in the spring 1991 issue of the Harvard Business Review, wrote that pension and retirement funds had $2.5 trillion in assets and owned 40% of American common stock.

Before the advent of pension plans (and before the start of Social Security) people were left to cope on their own. The very small number of wealthy people were, of course, ok. The rest had to rely on whatever meager savings they had managed to accumulate, but more often on the generosity of family, friends and charitable organizations, such as churches. It made for an untenable and Dickensenian situation.

The risk of unfunded liabilities to companies (and to the PBGC) of defined benefit plans prompted the transformation of retirement plans toward defined contribution plans, including 401(k) plans – where the individual could put a percent of his income, up to a certain level, that may be matched by the employer, into that individuals account. The Revenue Act of 1978 included a provision that allowed employees not to be taxed on income they elect to receive as deferred compensation rather than direct cash payments. By 1982 many of America’s largest companies had adopted such plans. The Tax Reform Acts of 1984 and 1986 modified the plans tightening the nondiscrimination rules and reducing the before-tax salary deferrals. In terms of numbers, in 1984 7,540,000 participants had accumulated assets of $91.75 billion, or a little over $12,000 on average. Six years later, 19,548,000 held $384.85 billion, just under $20,000 on average.

The trend continues. In 1980 there were approximately 250,000 Defined Benefit Pension Plans in the U.S. By 2005, there were less than 80,000, as defined benefit plans gave way to defined contribution ones – but those remain seriously underfunded.

Today, millions of Americans facing retirement have insufficient funds. Starting this week, on average, 10,000 baby boomers will turn 65 every day for the next eighteen years. At the peak of the stock market in 2007, according to the Employee Benefit Research Institute (EBRI), the median balance for a Defined Contribution/401(k) Plan was $31,800 and the median plan balance for an IRA/Keogh Plan was $34,000. The combination of the two plans suggest how grossly ill prepared is the average person for a retirement that could continue for at least twenty plus years. With the S&P 500 trading 14.3% below where it was at the end of 2007 and with unemployment just under 10%, those numbers must be lower today. Inadequate savings, coupled with an increase in retirees, combined with anemic economic growth suggest troubled times ahead.

The last bastions of defined benefit plans lie principally today with unionized state workers. One has only to look at the severity of finances in places like California, Illinois, New York and New Jersey to recognize that that path is strewn with obstacles and will lead, without significant change, to bankruptcy. States will find themselves moving toward defined contribution plans.

There are about 55 million baby boomers. They all need liquid assets in order to retire. Given current trends, they will not be able to count on Social Security. Thus, at a minimum, a retiree will have to have at least $500,000 in liquid assets in order to retire, about eight times more than the average of today’s combined defined contribution/401(k) and IRA/Keogh Plans. An average of $500,000 suggests $27.5 trillion, or about one half of the total capital markets in the United States. And this only includes the 65 million baby boomers – not those younger, or older.

It is the critical nature of this problem that a resolution must be (and will be) found. In 1519, the then headmaster of Eton used the term mater artium necessitas in his Grammar, Vulgaria, to describe the concept of necessity being the mother of invention. There are only two possible answers to the conundrum of too many people retiring with insufficient means. One, the least desirable, is that millions of retirees will become wards of the state; a condition that will only increase dependency on the state. The second not only will require policy changes, but also depends on more educated, independent-thinking and self-sufficient individuals. It means that demonizing capital markets is unhealthy and counter productive – it will mean acknowledging that Wall Street and Main Street are linked in a symbiotic relationship. Policies will have to encourage investments and savings. The past fifty years have seen the country become increasingly consumption focused – concerned with the present, leaving the future to take care of itself. That will have to reverse.

Besides being necessary, the benefits of such change are obvious. More capital invested will encourage entrepreneurs; it will allow businesses to expand, thereby fostering stronger economic growth, which will add to employment. On the other hand, if the problem is allowed to fester the consequences will be severe. Thus, there is little question in my mind it is the enormity and severity of this looming problem that will sow the seeds of an answer – mater artium necessitas.