Tuesday, February 28, 2012

Miserable Wants Company

Frederick J. 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) and "The Coming Collapse of the Municipal Bond Market" (Aucontrarian.com, 2009)

Stockton, California (population: 292,000) an 83-mile drive northeast of San Francisco, and, more poignantly, 69 miles east of Vallejo, California (See: "The Coming Collapse of the Municipal Bond Market"), cannot pay its bills. Nor, is much else getting done. On-the-scene reporter Alison Vekshin (Bloomberg) filed a front-line view on February 23, 2012: "After a man with a laptop walked into Best PC Value computer repair in Stockton, California, owner Richard La Frentz telephoned the police. Hours before, the same man had been recorded by a security camera hopping a locked gate behind the store and stealing the computer. 'The police didn't come.' They told La Frentz to call his insurance company, he said. 'It is the Wild West out here,' said La Frentz, 47 [but feeling considerably older - FJS], who keeps two handguns at his store in Stockton's Miracle Mile shopping district. 'When I call the police department, I don't get help. The city can't help me because of the condition it's in.'"

The title of Vekshin's story was "California's Stockton Seeks to Avoid Vallejo Path to Court." For entities not awarded illusory funding by the ECB, U.S. Treasury Department, or the State of California, reality pounces like a thief in the night, sometimes literally. The very next day, Bloomberg's ace Stockton bureau chief (our very own Alison Vekshin) furnished the latest. Under the headline: "Stockton, California, May Ask Bondholders to 'Suffer,' City Officials Say," we learned the Stockton City Council "will meet February 28 to consider a type of mediation that allows creditors to participate, the first move toward a Chapter 9 bankruptcy filing under a new state law."

The privilege bestowed on bondholders, allowing them, perhaps, to prevent further assaults on Richard La Frentz, will not be shared by all. Like the "voluntary" participation of Greek bondholders in that country's default, investors will be shedding exposure to other municipalities in similar straits.

Forbes magazine chose Stockton, California as "America's Most Miserable City" in 2011. The selection committee explained: "Median home prices in the city tripled between 1998 and 2005, when they peaked at $431,000. Now we are back to where they started, as the median price is forecast to be $142,000" in 2011. A graph on Forecastchart.com shows prices had been rising at a decent clip since 1995.

In May 1995, Federal Reserve Governor Larry Lindsey warned the FOMC: "There has been a lot of easing of credit terms. At some point this is going to stop." Lindsey told the FOMC cadavers that bankers stopping by his office were lending on exceptionally easy terms. He went on to say that when bank "balance sheet go into reverse.... [i]t is going to exacerbate the downturn." It did not turn out well for municipal balance sheets, either.

Fed Chairman Alan Greenspan thought the debt issue mentioned by Larry Lindsey was an "interesting one."
He was more interested though, in gunning the housing market. At the next FOMC meeting (July 1995) Greenspan grew excited about the home builders' data, which was revving up. The future recipient of the Enron Prize for Distinguished Service noted, "if history is any guide...firmness in the home building area [would] exert...some upward movement in the motor vehicle area, which would be very useful." Useful to the most melodramatic civil servant since Rudolph Hess.

City manager Bob Deis took exception to Stockton's worst-in-show: "Stockton has issues it needs to address, but an article like this is equivalent to bayoneting the wounded. I find it unfair..." Employees at Best PC Value would tell Deis that no police protection from violent crime is unfair.

Where we find 67% house-price deflation, misery follows. Sixteen of Forbes' Most Miserable Cities are in California or Florida. Before the deflation, the same cities enjoyed - Oh, how they enjoyed! - house-price inflation. City revenues would rise as far as the eye could see, which was not too far. Vekshin reported: "Stockton is already worse off than Vallejo. It had the eighth-highest violent crime rate in the country in 2010; the second-highest foreclosure rate in the U.S., behind Las Vegas; and the eighth-highest unemployment, at 15.9 percent in December, almost double the national average.

During the boom, tax receipts took off like a rocket, as did spending and promises. Vekshin found: "A drop in property-tax and program-fee collections shrank the city's revenue 20% to a projected $161.8 million in fiscal 2012 from $203.1 million in 2009. At the same time, union contracts drove employee pay and benefits higher." The Titanic had a better chance of remaining afloat.

Stockton City Manager Deis fills in the blanks: "Next year, we expect to pay more for retiree health insurance than [salaries and benefits] for our current employees." Deis called the promises "a Ponzi scheme." That's just what municipal bondholders across America should be investigating.

Tuesday, February 21, 2012

Leveraged Populists

Frederick J. 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) and "The Coming Collapse of the Municipal Bond Market" (Aucontrarian.com, 2009)

The recent offering of Facebook stock was the biggest news since a man landed on the Moon. The story was everywhere. Someone said the company is worth $100 billion and that was repeated one-hundred billion times. It is the saturation of noise, more than the supposed price, that should warn investors. This too, shall pass.

Technology stocks such as Facebook are a means for investors to put their money where their hearts lie. At the turn of the millennium the world lost its mind over technology stocks. This eerie atmosphere is too well known to require description. A merger of the time will substitute.

The America Online-Time Warner combination proved the thesis of "convergence." Stock phrases and Star Wars' linguistics had inflated AOL stock. ("To you, peering through your spectroscope, mapping the mazes of electromagnetism in its path, the web appears as a global efflorescence....the physical phase of the telescom, the radiant chrysalis from which will spring a new global economy." - George Gilder, widely hailed technology expert)

Page one of the
New York Times Convergence Edition in January 2000 frames the all-telling photograph, captioned: "Steven M. Case, chief executive of America Online, with tie, and Gerald M. Levin, chief executive of Time Warner, without tie, announcing the merger."

What beckons of course, is the haberdashery insight. "Left" and "right" would have fully explained who dressed down. So why the phrase? (To youngsters: Dressing down was still relatively new on January 5, 2000, so notable.)

It was an underscore. Here we had the Old Economy, and older man, agreeing to be bought out by the New Economy. Gerald M. Levin surrendered to the young man's conquest of the Old Media. Levin had embraced the New Era, albeit, disrobed, demoted and humiliated before the public like Chuck Connors in
Branded. Steven M. Case, an internet idol, wore his tie, a sign of respect for the old, shrunken media mogul who had seen the future in the nick of time. An industry analogy might be a silent movie studio that refused to make talkies in 1930.

In 1927, a third-rate movie studio, Warner Brothers, released the first talking picture:
The Jazz Singer. Practically breaking the bank with a $3 million publicity campaign, the studio's technological escapade swept the nation. We might compare the mass hysteria to the Facebook or AOL-Time Warner silliness. Every studio was soon borrowing and then borrowing some more to catch up with the People's latest need. That was a period, like our own, when cravings equaled needs. A substantial proportion of the lower classes in Muncie, Indiana (Middletown) mortgaged their houses that they had owned to buy a car. Twenty one of twenty-six families that bought cars (in the lower strata) did not own a bathtub.

hat was also a time when borrowing was easy. Lending to a booming, fashionable, and technologically cutting-edge business was fashionable in itself. By that time, movies were the fifth largest industry in the United States, where 90% of the world's films were made - indicating the tendency of American minds to admire visual (rather than verbal) expression and drift towards fantasy.

After 1929, financing was hard to come by and the highly leveraged studios needed constant infusions of cash. Most went broke. Those who bought and held Warner Brothers Pictures at its $67 peak could sell it for $1 in 1933. Unambiguous
needs during the 1920s turned to superfluous cravings a few years later. In The Crash and Its Aftermath, Barrie Wigmore wrote that movie sales dropped [in 1933] "to $546 million from $831 million in 1931....Somehow a myth has developed that Depression crowds anxious for escape sustained the movie business. This is not even remotely true."

William Fox and Sam Warner retained control, but investors went broke. How they accomplished this feat might be studied by Facebook executives today presuming the Warners of 2012 can identify their revenues

AOL bought Time-Warner with 45% of its stock: no cash. This gave AOL 55% ownership - and control - of AOL-Time Warner. The stock offered was worth $165 billion. In return, AOL now owned a company that had produced $6 billion of cash the year before. AOL's cash flow was about one-quarter that amount. Time Warner stock was trading at about 20 times cash flow, fairly high by historical market measurements, but a pittance compared to AOL's price: cash flow ratio of 110:1.

Levin's dressed-down marriage with AOL was quite a miscalculation. Even so, it is worth remembering that the company he headed is an example of the past half-century's leveraged finance, an aggregation of overpriced miscalculations. For the most part, finance has profited: not the companies, not the shareholders, not the customers, nor the employees.

A source of the late 1960s "garbage market" was identified by John Brooks in the
Go-Go Years: "Accountants came to think legalistically rather then conscientiously." This prompted offerings that, today, could make for a raucous feast on the Daily Show. Brooks writes of stocks for every fad: For nursing home fans, there was United Convalescent Homes. The budding fanciers of a greener world could buy Responsive Environments. For those who predicted a boom in spare time, International Leisure filled the bill.

The headline merger of the millennium gained traction during this rumpus. A funeral-parlor chain bought D.C. Comics and Ashley Famous Talent Agency in 1967; the morticians then bought Warner-Seven Arts in 1969; it renamed itself Warner Communications in 1972; Warner Communications bought cable operator American Television & Communications in 1978; Warner Communications and Time Inc. merged in 1989 to form Time Warner; Time Warner acquired Houston Industries in 1995; Time Warner acquired Turner Broadcasting Systems in 1996, this included Ted Turner's acquisitions and product launches - the Atlanta Hawks (1977), CNN (1982), the MGM library of movies and television shows (1986), Cartoon Network (1992), Castle Rock and New Line Cinema (1993), Turner Classic Movies (1994); Time Warner acquired Times Mirror magazines in 2000; and America On-Line bought Time Warner for $165 billion in 2000 - without one penny changing hands. As noted, payment to Time Warner shareholders was in America On-Line stock.

The day after Facebook monopolized the news, a proposed merger went relatively ignored. Initially priced at $88 billion, Glencore and Xstrata continue to negotiate with each other. The combination would produce, refine, transport, and sell most of the world's commodities that are harvested in most of the world's countries and then sold in most of the world's markets.

As for AOL-Time Warner, it did not take long for Gerald Levin to be shown the door. Time Warner spun off what little was left of AOL in 2009. In January 2000, Steve Case had taken his winnings and bought pineapple plantations in Hawaii.

Wednesday, February 1, 2012

A Real Phony

Frederick J. 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) and "The Coming Collapse of the Municipal Bond Market" (Aucontrarian.com, 2009)

"You're wrong. She is a phony. But on the other hand you're right. She isn't a phony because she's a real phony. She really believes all this crap she believes. You can't talk her out of it.... She's nuts."

-Of Holly Golightly, from Truman Capote's Breakfast at Tiffany's (1958)

"While central planning may no longer be a credible form of economic organization, the intellectual battle for its rival - free-market capitalism - is far from won."

"Anti-capitalist virulence appears strongest from those who confuse "crony capitalism" with free markets. Crony capitalism abounds when government leaders, usually in exchange for political support, routinely bestow favours on private-sector individuals or businesses. That is not capitalism. It is called corruption."

-Former Federal Reserve Chairman Alan Greenspan, who centrally controlled and underpriced the most over-leveraged interest rate in the world for 18 years and is now cashing in like a reality TV celebrity. Financial Times, January 30, 2012, under the fanciful title: "Meddle with the Market at Your Peril"