Tuesday, July 13, 2010

Corporate CEOs Won't Invest in America, Why Should You?

Frederick Sheehan is the author of Panderer to Power: The Untold Story of How Alan Greenspan Enriched Wall Street and Left a Legacy of Recession (McGraw-Hill, 2009).

There is no end of economists, analysts, and reporters filling the air with investment recommendations. Is the stock market oversold? Should we invest for inflation or deflation? And so on.

That is talk. American CEOs are voting with their feet. Since they aren't investing in the United States, does it make sense for the individual stockholder or bondholder to do so?

One armchair columnist told his readers to ignore corporate whiners. Those overpaid stuffed shirts will always gripe, goes his argument. The columnist may have a point, but also an inconsistency. The columnist, who is also an economist, has skewered CEOs in the past for cashing out their stock options as quickly as possible. There is much truth to that. But, it is not in a CEO's interest to publicly denounce the Obama administration, which still has over two years to hand out and withhold favors. It is the favoritism that the CEOs are denouncing, either directly or by implication.

Corporate managers lived through the last episode of blatant favoritism, during the final months of the Bush administration. In the fall of 2008, when credit was scarce, the Treasury Department and Federal Reserve decided which companies would receive loans and government guarantees. Those that fell under the umbrella paid around 5% interest on their debt. Those not so blessed paid 15%, or went broke.

From an option-grabbing, foot-out-the-door view, the outspoken CEOs are acting against their personal interests. That may be one reason so few CEOs have condemned current administration policy. The outspoken bosses manage companies with long histories. Most are at least a century old. They may have a better historical sense of their position: politicians and bureaucrats come today and are gone tomorrow. To survive for such a long period, these companies need to change and to change often.

From an investor's view, the United States as described by the CEOs, deserves a long-term "sell" recommendation. These companies are moving capital and jobs to Asia, which is a comparative "buy." For Americans frustrated by the hopeless domestic job market, Asia receives a "look."

Most forthright is David Farr, President, Chairman and CEO of Emerson Electric Corporation, a 120-year-old manufacturer with over $21 billion in annual sales. Emerson's headquarters is in Chicago, Illinois, but maybe not for long:

"Why would any CEO invest one penny in the US? There is not one reason based on the new rules of the game."

- David Farr, CEO, Emerson Electric, quarterly conference call, May 2009

Even the corporations that threw themselves into the government's arms are now having second thoughts. In 2008, government appendages extended lines of credit to General Electric, another 120-year-old company. (It employs 304,000 people, with over $150 billion in annual sales.) This was an unenviable position but one that General Electric's CEO Jeffrey Immelt adopted without hesitation.

David Farr would probably commit hari-kari before entering such an arrangement. Following is from a speech Farr delivered at the November 2009 Baird Industrial Conference held in Chicago (noted by Andrew Upward, the industrious author of the twice-daily Fidelity Capital Markets' letters): "My job is not to shrink and roll over for the U.S. government. That is not my job. That is not what I get paid to do....I don't want government handouts. I can do without them."

The federal government guaranteed General Electric bonds, a precaution that GE bondholders might have insisted upon in the best of times, since General Electric's solvency required it to consistently roll over $100 billion (billion with a 'b') in the commercial paper market. Beggars can't be choosers, as Jeffrey Immelt made clear in GE's 2008 annual report: "The interaction between government and business will change forever.... [T]he government will be... an industry policy champion; a financier; and a key partner."

As an aside, the chairman of General Electric could have made this statement anytime since World War II, perhaps even from World War I, when General Electric president Gerard Swope helped to organize American industry to send armaments Over There. For those interested, stop by a library and flip through Fortune magazines from the 1950s. Reading isn't necessary; look at the ads. The government and large businesses were Siamese twins. The armchair economist's contention that CEOs always gripe is the opposite of the truth. CEOS may play golf with the president but rarely censure their commander-in-chief.

On July 1, 2010, the Financial Times reported a heartening display of retro-capitalism on Immelt's part. Quoting from the FT, Immelt "had harsh words for Barack Obama, US president, lamenting what he called a 'terrible' national mood and expressing concern that over-regulation in response to the global financial crisis would damp a 'tepid' US economic recovery. Business did not like the US president, and the president did not like business, he said."

There was no hesitancy on the part of Edward S. Lampert, CEO of Sears Holdings Corporation, a combination of the Sears, Roebuck Company (117 years old) and Kmart (born 113 years ago as the first S.S. Kresge five-and-ten-cent-store). Sears Holdings employs 322,000 people and produced $47 billion in 2009 sales. In Sears' latest annual report, Lampert lectured the parasites who are making out well from the financial crisis. Lampert is best known for running one of the largest hedge funds (ESL Investments, which houses Sears Holdings), so blasting regulators, government officials and investment firms was not in his personal interest. The armchair columnist is not a fan of billionaire hedge fund managers, but it is Lampert who stands up for the huddled masses while the government-Wall street-media echo chamber does its best to strip them clean.

A portion of Lampert's diatribe in Sears Holdings 2009 annual report:

"Business leaders, regulators, public officials, and journalists have become an echo chamber of self-support and self-congratulation, whether on TV, in print or at numerous conferences. Their words and their actions are often self-serving (whether right or wrong), and they are typically regarded and reported on as if they were obvious and selfless. They get repeated as if there were no alternative views or possibility of error in their thinking. Dominant narratives develop and get defended primarily by repetition and secondarily by attacks on those who disagree with those narratives. When these favored people and views become endorsed in laws and regulations, some may benefit, but many get harmed.

"There are several examples of issues that have been smothered by dominant narratives. Accepting these narratives without critical evaluation can be a contributing factor to some of the negative unexpected consequences they produce. Did the seizure of Fannie Mae and Freddie Mac (the largest nationalization in our country and likely in history) calm or ignite fear in the financial markets and did those urging or supporting the seizure profit from it? Has raising minimum wage rates helped or harmed the individuals that those advocating such policy intended to help? Is there any link between a higher minimum wage and high unemployment? Has the consolidation in financial services helped or hurt depositors and borrowers? Why were some institutions saved and others seized, merged or left to fail? How does regulatory and policy uncertainty impact investment and risk-taking in society?"

"I fear that Americans have been provided a false choice between a little more and a lot more regulation and taxes. We keep hearing more ideas to create jobs and generate growth that almost exclusively require more government spending. Jobs can come from government, but those jobs get paid for by taking money from the private sector, reducing the private sector's ability to provide jobs. On the other hand, there are many who believe that less regulation, less government interference, less arbitrary regulation when it does exist, and lower government spending will generate more growth and more jobs. I agree with those views."

Lampert, or at least Sears, is more-or-less stuck in the United States. That is not true of other companies. Andy Grove, co-founder and past chairman of Intel Corporation, was interviewed by Bloomberg news on July 1, 2010, an interview which is worth reading in full. ["How to Make an American Job Before it's Too Late"] Grove explains, using past examples from other manufacturing industries, that when production leaves, the engineers, researchers and capital investment follow. Grove also discussed the social consequence of abandoning manufacturing:

"Today, manufacturing employment in the U.S. computer industry is about 166,000 - lower than it was when the first personal computer... was assembled in 1975.... You could say, as many do, that shipping jobs overseas is no big deal because high-value work - and much of the profits - remain in the U.S. But what kind of society are we going to have if it consists of highly paid people doing high-value-added work, and masses of unemployed?"

Paul Otellino, the current CEO of Intel (with annual sales of $35 billion), warned of jobs going overseas in a recent speech: "A new [world scale] semiconductor factory built from scratch costs about $4.5 billion - in the United States. If I build that factory in almost any other country in the world, where they have significant incentive programs, I could save $1 billion [From tax breaks]."

Ivan Seidenberg, CEO of Verizon (which can trace its origins to Alexander Graham Bell, employs 217,000 people, and posted $107 billion in sales during 2009), spoke before the Economic Club of Washington in his capacity as president of the Business Roundtable on June 22, 2010. Seidenberg listed the reasons investors should take a break from the U.S. stock market. From the Wall Street Journal's summary:

"The Obama administration has created 'an increasingly hostile environment for investment and job creation.' The U.S. corporate tax structure is a 'major impediment to international competitiveness.' The government should 'stop trying to micromanage industries.'"

Seidenberg was seconded by Dan DiMicro, CEO of Nucor Corporation (20,000 employees, with $11 billion in annual sales, and a history that stretches back to Ransom E. Olds' REO Motor Car Company, founded in 1905).

"I completely agree with what Ivan was saying about how the government needs to be removing itself from the private sector. For a long time they worked through diplomacy, negotiation, and compromise. But the crisis we're in today is of such magnitude that we have to have action in support of the private sector in a bold and out-front manner."

Armchair economists and opinion-makers toy with their self-serving theories, basking in the glow of tenure and popularity and reminding the public how brilliant they are. Most have never held a real job in their lives. They know next to nothing about how people think outside their atrophied circle, yet, set society's course from opinions bouncing through the echo chamber of self-support and self-congratulation.

David Farr has a business to run. He described the reason he is moving Emerson Electric to Asia at the Baird Industrial Conference last November:

"What do I think Washington is doing right now? Washington is doing everything in their manpower capability to destroy U.S. manufacturers. Cap and trade, medical reform, labor rules, whatever they want to do, raise taxes. They're just going to destroy jobs.... What do you think I'm going to do? I'm not going to hire anyone in the United States. I'm moving. So they're doing everything possible to destroy jobs....we employ 125,000 people worldwide. So I do know what the (expletive) I'm talking about."

Wednesday, July 7, 2010

Municipal Pathologies Come to a Head

Frederick Sheehan is the author of Panderer to Power: The Untold Story of How Alan Greenspan Enriched Wall Street and Left a Legacy of Recession (McGraw-Hill, 2009).

Discussions about municipal finance generally assume three absolute conditions. First, the principal and coupon of municipal bonds are guaranteed: "Municipal bonds don't default," according to trusted experts. Second, the guarantees are backed by the taxing authority of the state or municipality. Third, accrued pension benefits are guaranteed.

It is universally believed (and rightly so) that services provided to those who pay taxes are not guaranteed. In this formulation, the taxpayers are the true victims of injudicious and ignorant spending on the part of municipal governments. Federal government mandates, often injudicious and ignorant, are an additional burden.

The rigidity of these categorizations led to poor decisions. Believing in an absolute world, lazy and pusillanimous mayors, legislators, and public union negotiators bid up benefits that cannot be honored. These multi-decade illusions are coming to a head.

Recent government solvency problems in Dubai and Greece raised the American public's conscious of possible bond defaults. This is in the wake of domestic budget problems that have gained attention over the past year. (See AuContrarian.com "articles" section: "The Coming Collapse of the Municipal Bond Market.") The travails of governors and mayors in California, New York and almost every other state have swelled to the point that credit-default swap spreads are wider now for some states than for Greece and Spain.

These relative assessments (of greater default risk among the states than of Greece) are not necessarily correct. The degree to which the spendthrift European Union and the spendthrift Obama Administration shovel money, credit lines and guarantees to prop up the spendthrift municipalities is unknown. It is also unknown, at least to the public, which European banks are on the cusp of failure, at a time when bank customers are moving money to safe havens. Panic could move quickly across the Atlantic when it is recognized how many U.S. banks that Deserve to Fail (DTF) have large exposures to European banks that DTF.

Many municipalities will find themselves in desperate straits if lenders, particularly bond buyers, step away from the market. The tendencies are apparent. (Bloomberg News, July 2, 2010 - "The Metropolitan Transit Authority, which runs New York City's subways, buses and commuter trains, shrank a $555 million taxable bond offering by 16% as it struggled with a deficit and as investors sought to avoid risk.") The National Association of Budget Managers estimates that fiscal year 2010 (which ended June 30, 2010) cash balances have shrunk to 2.2% of expenditures, excluding Alaska and Texas. If the bond market shuts down, city workers may be paid in scrip rather than money, as often happened during the Great Depression.

We should not expect emergency steps to make sense, whether or not the trigger is as described above. Just as at the federal level, the political and financial leadership is mostly the same that created this crisis. A problem that is not understood cannot be solved by those who do not understand it. A battle-scarred veteran of municipal finance boards wrote to me: "During my time on two pension boards, the boards did less as the problems got worse. Board members tend to be town employees caught in the headlights. They are not financially trained, and they tend to believe rather unsophisticated consultants who all say the same thing: 'You can earn your way out in 15 years.' This is not true. Not even compounding can save you when benefits are rising faster than the return on assets. We have yet to begin to seriously attack this problem. The most we have done is 'tried' to initiate cuts of annual percentage increases in benefits." [Lazy and pusillanimous pension consultants deserve notoriety on the list above.]

Having, myself, spent nearly two decades meeting with municipal pension committees, I saw that the incapacity to pay future pensions, already evident in 1988, grew to mathematically insolvable proportions. Most cities and states, as well as the media reports about those entities, are so far short of understanding the depth of this cavern that they are examples of Bernankeism. (Federal Reserve Chairman Ben Bernanke: "U.S. households have been managing their personal finances well." - June 13, 2006)

To remain solvent, bloated pension benefits need to be cut severely. This is not being considered. News stories of public sector pension cuts are mostly aimed at future employees or future service of current employees. There are stories of concessions being made by current retirees that will reduce current benefits, but this is not clear, short of reading the new contracts.

As we enter the sinking-lifeboat period, imagination is constricted. Consumers of municipal services are expected to bear the burden. This assumption will spark revolts. The reduction in public services is already an annoyance. Consistently decreasing non-government income is more than an annoyance. Private income in the U.S., which excludes federal, state and local pay, fell 5.4% from the third quarter of 2008 to April 2010.

There are municipalities where property tax rates have been doubled recently to absorb the deficit. It is at such moments when taxpayers remind municipal boards that all government revenue comes from the taxpayers. Tax strikes in the past, such as in Chicago from 1928 to 1931 and again in 1977, succeeded.

Whatever the future holds, there are two certainties. First, this is another leg in the deleveraging of American credit, which should not be ignored by economists trying to tease a recovery out of the already corrupted and overstated GDP. Second, only seasoned participants should still be holding municipal bonds.

Thursday, July 1, 2010

Kartik Athreya for Fed Chairman

Frederick Sheehan is the author of Panderer to Power: The Untold Story of How Alan Greenspan Enriched Wall Street and Left a Legacy of Recession (McGraw-Hill, 2009).

Federal Reserve economist Kartik Athreya has written what all Federal Reserve apologists believe: "Economics is Hard. Don't Let Bloggers Tell You Otherwise." This paper of June 17, 2010, penned from the Research Department of the Federal Reserve Bank of Richmond, was not so much a beef with economist-bloggers, just those who are not blindly devoted to the supernatural authority of the Federal Reserve.

Athreya observes: "[I]t is exceedingly unlikely that these authors have anything interesting to say about economic policy." However, "Greg Mankiw and Steve Williamson are two counterexamples."

And rightly so. Minkiw, Professor of Economics at Harvard University, past chairman of President George W. Bush's Counsel of Economic Advisers, the Uriah Heap among would-be Fed chairmen, wrote in the New York Times on December 23, 2007: "The truth is the current Fed governors, together with their crack staff of Ph.D. economists and market analysts, are as close to an economic dream team as we are ever likely to see. They will make their share of mistakes, but it is too easy to find flaws when judging with the benefit of hindsight. The best Congress can do now is to let the Bernanke bunch do its job."

When Mankiw's article appeared, the dream team was comprised of Ben S. Bernanke, Donald L. Kohn, Kevin M. Warsh, Randall S. Kroszner, and Frederic S. Mishkin, all of whom had completely missed any sign of the mortgage meltdown during 2007.

This was of no importance to Mankiw, nor to Athreya. In his paper, the Richmond-branch staff economist tells the "open-minded lay public" just what an economist is good for. A professional research economist has "a very precisely articulated model that has been vetted repeatedly for internal coherence...whose constituent assumptions and parts are visible to all present... [including] explicit, careful reasoning, its ever-mindful approach to the accounting for feedback effects, and its transparent reproducibility."

This is nonsense, but is it the right kind of nonsense? According to Athreya, whether the model works or not does not matter. He is a macroeconomist. The government bureaucrat explains: "Macroeconomics is most narrowly concerned with the tracing of individual actions into aggregate outcomes. What makes macroeconomics very complicated is that economic actors...act."

We, the people, are what Athreya calls "economic actors." This silly jargon is necessary since macroeconomists cram people into mathematical equations, a preposterous way to make a living, which is completely lost on Athreya: "Of course, all parties may be terrible at forecasting, that's certainly a possibility, but that's not the issue."

Philosopher George Santayana wrote: "It is a marvel that mathematics should apply so well to the material world, [but] to apply it to history or ideas is pure madness."

Today, the Federal Reserve Board is monopolized by mad professors. This is simple to understand, and impossible to ignore, by any non-economist who reads their ravings. However, it seems that the hypnotic spell under which Americans revere academic credentials blinds the public to the utter incapacity of the Federal Reserve Board of Governors to accomplish any activity beyond finding the men's room.

Kartik Athreya's promotion to Federal Reserve chairman may be our last hope to destroy this malignant body of pillagers before it destroys us. Current Federal Reserve Chairman Ben Bernanke has not attracted the scorn he deserves. There is an allure to Athreya sitting in front of the Senate Banking Committee and stating, as he does in this paper: "Why should anyone accept uncritically that Economics, or any other field of human endeavor should be easy...? Would anyone tolerate the equivalent level of public discussion on cancer research?" The poor child seems not to recognize that even he is permitted to sound like an inebriate on the field of cancer, as he does here, in this analogy between his destructive field of study and cancer research, which, might or might not save a patient from the disease, but in the worst case, does not stomp on the patient's body and fling it into a car crusher.

Bernanke acquired his degree in post-graduate economic studies by spouting a single idea that mimicked his professors' obsession: the Great Depression would have evaporated by 1931 if the Fed had printed more money in 1930. Having put this half-baked theory into practice, both Bernanke and his comrades have received an "F." Despite his failure, Simple Ben has never deviated from the doctoral thesis, and, he never will. The senile professors who rule the academic community see no reason for him to do so. Athreya writes, on behalf of this petrified field of study: "[W]riters who have not taken a year of PhD coursework in a decent economics department (and passed their PhD qualifying exams), cannot meaningfully advance the discussion on economic policy."

Any meaningful advance would eliminate the Federal Reserve and employ Athreya in a government-sponsored soup kitchen. Economics, if it is nothing else, at least studies how to make the most from the least. A liquidation of all "decent economic departments" in the country would dismantle the architecture that has ravaged the country with the most ruin since Sherman's March to the Sea. If Athreya is in command, his scorn for the unwashed may spur the public to a popular uprising. If not, by the time Bernanke is through plundering the middle class of its savings and investments - a staple tactic of desiccated ruling classes since the beginning of time - Sherman will be a footnote in history of American destruction.

Frederick Sheehan writes a blog at www.aucontrarian.com