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September 02, 2005

New Company

Athena Investment Services is a new company that I've been doing some research and web development for over the last couple of months. They're trying to reshape the way mutual funds are categorized and evaluated, and we're starting off by challenging the traditional Morningstar Style Boxes.

Go take a look, download the Style Grid paper, and then go back as the thing develops.

Posted by joshuasharf at 03:28 PM | TrackBack

August 23, 2005

Light Blogging Today

Lots of work and catching up to do. I have reports from Friday and Grover Norquist's fundraising visit last night.

Satiate your blog-reading Jones with this week's Carnival of the Capitalists, for the moment.

Posted by joshuasharf at 11:23 AM | TrackBack

August 21, 2005

Morningstar's Style Boxes- II

One of the claims that Morningstar makes is that its style boxes have a lower correlation that their competitors'. That's true, but it depends strongly on what time period you use.

Using Morningstar's own numbers for annual returns, years 2000-2004, the average correlation among the style boxes is 0.927. However, if you include the years 1997-1999 in the calculation, the correlation drops to 0.606. Holding Size constant, the average correlation drops from 0.927 to 0.677. Holding VG constant, it drops from 0.955 to 0.756..


Well, for one reason, the years 1998 and 1999 provided a huge differentiation between value and growth (mostly Internet) stocks, and between small (mostly Internet) and large stocks.

But I think the more important reason is that Morningstar introduced their new style boxes in 2002. That meant that they were researching the algorithm as far back as 2000, and all they had to use was restrospective data. So it's no surprise that any formula would, like an Italian tank, work better in reverse.

I don't believe Morningstar is guilty of anything here other than marketing. But the fact is, the correlations among their style boxes are probably a lot higher than they would lead you to believe.

Here's the data, for those who want to check.

Posted by joshuasharf at 04:45 PM | TrackBack

August 19, 2005

Plug-In Car Runs for Minutes

So you've been waiting for your electric car? The car that's better than a Prius? The car you can just plug in at night and drive all day? The car that doesn't even use oil or even any fossil fuels?

Wait on.

AP and Denver Post salivating aside, energy independence at a reasonable price is not just around the corner.

Politicians and automakers say a car that can reduce greenhouse gases and free America from its reliance on foreign oil is years or even decades away.

Ron Gremban says such a car is parked in his garage.

It looks like a typical Toyota Prius hybrid, but in the trunk sits an 80- miles-per-gallon secret: a stack of 18 brick-sized batteries that boosts the car's high mileage with an extra electrical charge so it can burn even less fuel.

Gremban, an electrical engineer and committed environmentalist, spent several months and $3,000 tinkering with his car.

Like all hybrids, his Prius increases fuel efficiency by harnessing small amounts of electricity generated during braking and coasting. The extra batteries let him store extra power by plugging the car into a wall outlet at his home in this San Francisco suburb, all for about a quarter.

Ah, the greedy automakers and the lazy politicians in their hip pockets. Or maybe it's the other way around.

They have support not only from environmentalists but also from conservative foreign-policy hawks who insist that Americans fuel terrorism through their gas-guzzling.

See? If even conservative foreign-policy hawks are in favor of it, there can't be any arguments against it, can there? Never mind that "energy independence" is a bipartisan chimera that politicians have been chasing for decades. Never mind that we never pay the Saudis directly for oil, anyway. Never mind that lowering demand lowers the price, and since Saudi Arabia can produce oil by looking at the sand, the first oil wells to go out of business will be domestic ones. Or that oil gets used for a million things other than driving your Prius around town. Like diesel for hauling the Prius to the dealership. Doesn't matter.

But the problems with this report are even more fundamental.

The extra batteries let Gremban drive for 20 miles with a 50- 50 mix of gas and electricity. Even after the car runs out of power from the batteries and switches to the standard hybrid mode, it gets the typical Prius fuel efficiency of around 60 mpg. As long as Gremban doesn't drive too far in a day, he says, he gets 80 mpg.

So, how much does Gremban save every day? Let's do the numbers (cue "Stormy Weather.")

Since a Prius running on 100% gas gets 60 mpg, that means that first 20 miles normally costs about a third of a gallon. Since he's only using half the gas, he saves about 1/6 of a gallon of gas. Being generous, at $3.00 a gallon, that's about 50 cents a day. Minus the 25 cents he spends charging up. So for his work, Gremban is saving about 25 cents a day. But that's all. He doesn't save more by driving farther, because the extra batteries are run down. He extends his car's range by about 10 miles above a manufacturer's spec of about 650 miles.

At that rate, given that he's already put $3000 into the car, he'd better plan on its being his last if he wants to earn back his investment. And that's without using present value on the savings.

There are other people at work on this, though. People who want to turn this into a business:

Southern California-based Energy CS has converted two Priuses to get up to 230 mpg by using powerful lithium ion batteries. It is forming a new company, EDrive Systems, that will convert hybrids to plug-ins for about $12,000 starting next year.

The AP is making claims for EDrive that even EDrive doesn't make. Look at their FAQ:

Q3: ...The result is EV driving and electrically boosted gasoline driving for the first 50 to 60 miles with a gasoline efficiency of 100 to 150mpg. After the 50-60 mile 'boosted' range, the vehicle performs just like a standard Prius until it is plugged in again.

Q7: Can I really get over 200mpg with EDrive on my Prius?
A: Yes, but it requires low speeds (55mph freeway) and mild acceleration in city driving. Most Prius EDrive users will likely get closer to 100mpg.

So EDrive is being more honest that the AP or the Post that ran this turkey. For 60 miles, barely enough to get you from your home in Warrenton to your desk job for the EPA in Washington, DC, you can get about 120 mpg. That saves you about half a gallon a day, or about $1.25. Minus the $.25 for charging. At a $12K conversion cost, you, too had better be hoping for a VRE extension.

It's no good saying you can also charge the car at work or at the mall, and save going home, too. EDrive admits that the appeal is that electricity is cheaper at night. There's a reason for that, too. The last thing the electric companies want is more stress on the grid during peak hours. And like most arbitrage opportunities, this one will close at least a little if half the country has its cars plugged in at night.

The article closes with a dig at actual creative thinking:

University of California-Davis engineering professor Andy Frank, who has built a plug-in hybrid that gets 250 mpg, said that although automakers' promise of hydrogen-powered vehicles has been hailed by President Bush, hydrogen's backers admit the cars won't be widely available for years and would require new fueling stations.

Right now, batteries don't provide enough range to actually buy you anything. When and it the billions of dollars we've poured into battery technology over the last couple of decades pays off, you'll still need new stations, either to charge up or to exchange batteries.

Defenders will point to these two paragraphs in the middle of the article:

But Toyota officials who initially frowned on people altering their cars now say they may be able to learn from them.

"They're like the hot-rodders of yesterday who did everything to soup up their cars," said Cindy Knight, a Toyota spokeswoman. "Maybe the hot-rodders of tomorrow are the people who want to get in there and see what they can do about increasing fuel economy."

Personally, I think Toyota is being polite. It's not like anyone's actually throwing real money at this problem. But right now, there's a limit as to how much electricity you can pack into a given volume. And throwing extra car batteries into the trunk next to the spare tire isn't going to solve it.

The AP and the Post are guilty of raising unrealistic expectations, creating false bogeymen, at the price of ignoring honest efforts by people who have the most to gain by finding an answer.

Posted by joshuasharf at 09:33 AM | TrackBack

August 15, 2005

Markets That Aren't Always so Wise

People who've read my review know I'm a big fan of James Surowiecki's The Wisdom of Crowds. That said, I think his faith in the market's pricing mechanism may be a little overstated. And not just because it seems prone to frequent, er, corrections. Surowiekci himself notes the difficulty of pricing in long-term company performance. What he doesn't note is the way that analysts get around that problem, and how it violates of one his conditions for collective wisdom - independence.

If you're like most people, you probably think that analysts - even Janus-type "smartest-guy-in-the-world" analysts who dive into tunnels and count heads at restaurants come up with their estimates in sort of an isolated, cloistered, ivory-tower-with-oak-paneled-walls sort of way.


Most fundamdental analysts (and most analysts are fundamentalists) use one of two methods to value a stock: ratios or discounted cash flows. I won't get into a long discussion here, but basically discounted cash flows estimate the expected free cash flow - how much money the firm actually makes - and tells you what that's worth to you now.

So far, so good. Except that nobody acutally relies solely on those numbers. Ratios are things like Price-to-Earnings, Price-to-Sales, Price-to-Free Cash Flow; that sort of thing. Many people who use a discounted cash flow analysis also use a ratio analysis to estimate the value of the "out" years, the years past their 5-year model. And even those who don't, usually use some sort of comparison to industry ratios to make sure they're still in the same ball park, even if it is a little hard to see home plate from here.

Do you see the problem? Ratio analysis already includes the price of the stock. There's no independence here. Analysts - fundamental analysts, anyway - are alway all looking around at each other to make sure they're going in the same direction, which may still be right over a cliff. The technical term for this is "herding," an analysts do it all the time.

Now, you may say that analysts don't set the market price, the market does. And you'd be right. To a point. But analysts are extremely influential in making markets, especially when they act in groups. Why else do Schwab and other public sources of research report analysts estimates? And remember, this sort of modeling is exactly what M&A and investment bankers do to set purchase prices and IPO levels.

There's really no way out of it. Trying to forecast earnings past five years in advance is truly folly, and most analysts, given enough sodium pentathol, with readily admit to that. Still, the company does have expected earnings, and thus value, past that point, and they must be taken into account. The only way to do this is to assume that the market is basically right, and tweak the numbers until they look realistic.

But this may also help account for sudden changes in individual stocks on seemingly minor news, missing earnings by a penny out of 60 cents, or what-not. Not only is everyone re-evaluating their estimates on their own terms, they're also re-evaluating them on everyone else's terms, too.

Which means that a market's wisdom may not be so collective, after all.

Posted by joshuasharf at 04:40 PM | TrackBack

August 10, 2005

The AP (and the Denver Post) Do Layoffs

Well, those of who work at Janus (although not for Janus) knew it was coming. In the wake of disappointing quarterlies, the company cut 40 jobs yesterday, mostly in administration and operations. While the Rocky found plenty of space to describe what happened at one of Denver's major employers, the Post could only manage a couple of hundred words from the AP.

Tucked into the report was this somewhat snarky paragraph:

[COO] Miller is the only executive among those whose jobs are being cut, according to Peterson. The others are being drawn mostly from the ranks of the company's back office in Denver and include employees in administrative and operations roles.

Ah, the bigwigs protecting their own while the little guy gets the shaft.

Except that the Rocky reports that:

In another change, Janus said that Beery had volunteered to waive the renewal of her employment contract, which would have given her a payment of three times her base salary and bonus, plus accelerated vesting of restricted stock and options, if she lost her job or had her duties changed.

I also happen to know from personal discussions that at least two directors lost their jobs, as well.

It's miserable to get fired, especially when you've just been doing your job. But the Rocky found the space to give a full picture, while the Post left the impression that the 7th floor was taking it all out on the little guy.

Posted by joshuasharf at 02:07 PM | TrackBack

The Compleat Electronic Subversive

As any Neal Stephenson fan knows, it's an arms race between the encryptors and the decryptors. Still, this looks like the kind of thing that any aspiring terrorist operative - or Chinese protest organizer - would want to have.

Stealthsurfer II is a little USB device that looks like one of those Jumpdrives, but acts as a shunt for all your Internet traffic. Even browsers with very small caches still write to disk, and those files are more or less permanent. Arthur Anderson should also have taken hammer to all of their Enron hard drives. The Stealthsurfer intercepts email, web browsing, and FTP traffic, and encrypts it using ES3. It's apparently versatile and easy to use.

Why would this be useful? Well, think of the number of intelligence coups we've had when we caught al-Qaeda guys parading around with their laptops. Using the Stealthsurfer, much of this content would never have hit the hard drive. Captured, they could either impersonate drug mule or just toss the little capsule away. Someone could use the Net for operational traffic, and if they weren't under surveillance, searching their laptop wouldn't do intelligence agents or federal prosecutors any good.

Another feature lets you spoof your IP address, making it seem as though your traffic is originating from a computer thousands of miles away. Handy little tool for the terrorist on the go.

It appears that the service reroutes your traffic through their servers, 128-bit encrypted, so the host website your accessing thinks that Anonymizer is the client. Anonymizer claims to cooperate with law enforcement, but if the transmitted information is already encrypted or hidden, they might never know their service was being used this way. And since they also claim they don't keep any of the traffic, the trail might well stop at their servers.

Now the tool does have limitations. Chinese dissidents or protest organizers wouldn't exactly be able to parade into an Internet cafe and cover their tracks. There's a login screen, a popup window, and some other give-aways. Also, the ChiComs are in the nasty little habit of blocking internet sites and monitoring traffic, so this kind of thing is likely to attract the attention of that little white van parked across the street.

So, take an electronic one-time pad that tell me where to look for my next instructions, a host site that has nothing but an innocuous-looking JPEG with the instructions embedded in it, a hand-held GPS for setting up remote drops and meetings. Add plausible deniability to my laptop and even my physical location, and I'd say we've got a little problem here, 99.

Posted by joshuasharf at 08:01 AM | TrackBack

August 07, 2005

Carnival of the Capitalists

Welcome to this week's Carnival, sponsored by MarketingLinx, the best marketing site on the web, as determined by you. Contribute a link today to get your reward!

This week's contributions were fantastic. Hosting really is a different experience from reading, and I'd highly recommend it to regular readers. I haven't included any of my own postings this week, but feel free to look around.

Some of you may have received multiple pings while I was building the posting, and I apologize for any inconvenience. And so, without further ado, on to the Fair:
Editor's Choice
  • Sportsbiz thinks that Nike may be hearing footsteps, as Adidas buys Reebok.
  • Kathy Hutchins at the Reform Club comments on the economics of Pfizer, er, Willy Wonka and his Chocolate Factory.
  • Soccer Dad notes another failed attempt to repeal the laws of supply and demand.
  • Political Calculations has some eye-popping historical charts for the S&P 500, and links to more like it.
  • Photon Courier has a great customer service story, and some ideas on how more companies can encourage this sort of thing.
  • Will Pate offers a reminder to keep an open mind about new experiences,
  • while Big Picture, Small Office warns against creeping, or in this case, stampeding complacency.
  • The Big Picture looks back on last year's holiday tech purchases, and draws some conclusions.
  • Crossroad Dispatches doesn't read blogs for news, but for ideas. That right there is a pretty good idea.
  • Roth & Company has some very useful news about some SEC rules changes regarding insider options.
Corporate Strategy
  • Techtrader doesn't like the way Macrovision's going, and thinks maybe it's time for two divisions to go their separate ways.
  • BusinessWorks has some critical questions for would-be entrepreneurs. We've all forgotten about them at some point.
Personal Finance
  • Monty Loree wants people to make up their minds about how rich they really want to be.
  • Free Money Finance suggests that maybe having the latest designer pet won't help you get rich.
  • Multiple Mentality considers spending - even inconspicuous consumption - as the SOMA of our age.
  • In Cash Flow We Trust explains that frugal doesn't mean cheap, and it may keep you out of purgatory.
  • Sound Money Tips shows that money management isn't just for adults.
  • All Things Financial shows you how much you'll need for college - assuming that Soccer Dad is right.
  • Smart Money Daily examines the application of retail markets to help solve environmental problems,
  • and Half Sigma has related thoughts on conservation and recycling.
  • Interim Thoughts welcomes medical tourists to India. You don't see so much of that in China, yet...
  • Econbrowser has some critical words for the way the Conference Board is handling the yield curve.
  • Speaking of economies, WILLisms has a bar graph that should send Euro-boosters scurrying for the bar.
Finance & Investing
  • Consumerism Commentary thinks that the Golden Ratio may be a useful technical analysis tool.
  • Real Returns claims that large companies are sufficiently diversified so that top-heavy large-cap indices don't bother him.
  • This could also go under economics, but the Scrivener thinks that now may be the time to bet against oil.
  • Steve Pavlina finds that motivational tapes really do help manage your own emotional state, and make you more productive, too.
  • Gautam Ghosh offers some pointers on how to make training last beyond the post-classroom drinks.
  • Ales Rarus finds himself reluctantly defending WalMart from unfair accusations.
  • Chief Skipper lets leaders know that it's ok to be a little lonely, but they have to know how to handle it.
  • Talking Story has some very sound advice for leaders on how to grow more leaders. Maybe you'll be less lonely that way.
  • Interested-Participant is unconvinced by a Tulane study showing that women who flirt at work are only hurting themselves.
  • Wordlab tells you what Maybach is and why they named their new product the Fulda Maybach Exelero.
  • Strategic Marketing Montreal tells a story of harnessing the Internet to help debug his blog.
  • Drakeview tells marketers and retailers to brace for the Gen-Y onslaught.
  • The Egoist notes that video games are starting to branch out from Grand Theft Auto. I personally thought the
  • ad for that game in the Chassidic section of Brooklyn wasn't the best-targeted placement.
  • The Skwib lampoons some ads that were more than just poorly-placed.
  • Marketing eYe, whose blog includes a fine subscription form, instructs on how best to market through newsletters.
  • Worker Bees Blog has some post-Blogher ideas, and warns that networking and connections build traffic as much as good writing does. (Hey, why do you think I'm hosting this thing?)
  • Lip-Sticking offers some post-Blogher inspiration as well, valuable for all bloggers.
  • Blog Business World has a terrific FAQ about business blogging for non-bloggers, and those who want to get started.
  • Ripples... discusses how his traffic has benefitted from placing Blogads.
  • Gongol looks at Federal Government ROI, and thinks maybe we could be putting our money someplace better.
  • Warren Meyer of Coyote Blog wants to know why privacy rights seem contained to abortion, and wants them expanded.
  • Elie Rosenfeld would like a little more honesty from PBS (and who among us wouldn't?), this time concerning their fundraising.
  • Chocolate and Gold Coins wants to cut to the chase and allow local phone competition, already.
  • The Enterprise System Speculator follows more cases of SOX compliance run completely amok, and makes a plea for common sense.
  • Mover Mike names a few companies that could be hurt if the mainline churches continue to divest from Israel.
  • Health Business Blog's blood pressure is up over conflicts of interest in both the Journal and Sociey of Hypertension.
  • Catallarchy explores polygamy. Not personally, mind you, just theoretically.
Thanks to everyone who participated, and tune in next week at Weekend Pundit. (Elitch Gardens pictures courtesy of Elitch Gardens History.)
Posted by joshuasharf at 11:59 PM | TrackBack

August 05, 2005

Oil: Canary in a Coal Mine?

I'm now trying to get out of the web development biz, and into equity analysis, and interviewers are going to want to see work product. I don't actually have much work product, but one of the analyst positions I've applied for is an oil equity analyst. I'm sure once I'm finished writing them up, I'll post them over here, but for the moments, I'm following the industry news pretty closely.

Then, I noticed the Washington Post had an article about the creeping takeover of oil reserves by governments:

Peter J. Robertson, vice chairman of Chevron, worries about the increasing dominance of national oil firms. Given that they already control more than three-quarters of the world's oil reserves, "if governments can come along and gobble up the rest of it at a percent or 2 percent at a time, pretty soon the commercial business looks pretty thin," Robertson said.

You'll notice, by the way, that every country with nationalized oil companies and oil reserves is a prosperous, peaceful example of the democratic rule of law.

I can't see any way this is good - for the countries, where it will just perpetuate corruption; for the independent companies, who will have to pay higher prices and will likely face a future of endless technology transfer; for the world economy, which will pay to subsidize Hugo Chavez's not-so-excellent adventures.

International oil companies and national companies, while sometimes rivals, often work together. In many cases, national oil companies lack the money, technology or managerial skill needed to develop big projects and seek to work with the bigger firms.

But some national oil companies have gained enough know-how to begin closing that gap. According to PFC data, more deals are being made between national oil companies, allowing one to operate in another's home country -- leaving the international firms out altogether.

Time to go back and re-check those growth estimates...

Posted by joshuasharf at 12:55 PM | TrackBack

China Subsidizing Its Enemies

Larry Kudlow details the budding Pacific Anglospheric Alliance (PacAngloPac?) between the US and India, especially the business aspects. I think he's ignoring a possible stock market bubble there, but leave that aside.

He points out that India may be on the verge of relaxing foreign direct investment restrictions, and that the US would probably be the main beneficiary of that.

Now, for all of you who don't like economic globalization so much, consider this. US corporations, flush with cash, need places to invest. Much of their cash is coming from low interest rates, subsidized by Chinese investors. Or by Chinese FDI.

If we turn around and invest heavily in India, that means that, essentially, Chinese money is going into India.

How long will it be before we start seeing articles asking why, oh why, the Chinese are subsidizing the development of their enemies?


Posted by joshuasharf at 11:00 AM | TrackBack

August 04, 2005

New CFA Blog Posting

The CFA blog's actually getting a few hits, so it deserves a new posting. Or two.

Posted by joshuasharf at 11:07 PM | TrackBack

The (Mis)behavior of Markets

According to Modern Portfolio Theory, the basis for most of modern stock market analysis, the crash of October 1987 shouldn't have happened in our lifetimes. In fact, it shouldn't have happened in the lifetime of the country. It should have happened, perhaps, once in the lifetime of the universe. It was just our good fortune to have lived through it. Now we can relax.

In fact, even as Robert Merton and Myron Scholes were accepting the Nobel Prize for their contributions, the markets were preparing to given the Royal Swedish Academy second thoughts.

So what went wrong? Why did MPT fail so catastrophically? What assumptions failed? Why do academics and researchers continue to base their research on those assumptions? And is there anything out there that might be better?

Benoit Mandelbrot, Father of Fractals, Creator of Chaos Theory, Maker of the Mandelbrot Set, has some ideas, and The (Mis)Behavior of Markets tries to bring them to the public.

I fell in love with fractals and chaos theory in college, when both it and I were young. I didn't pursue a career in physics, and left them behind, I thought for good. Ah, but life is strange, and just a couple of years before I decided to turn towards finance, so did Mandelbrot and fractals, and there there are, my old friends, waving me over to the table for drinks.

Actually Mandelbrot started out as a market analyst, but got sidetracked for a couple of decades, and is now turning his attention back to the problem that got him started: why historical cotton prices don't look anything like a normal distribution.

Mandelbrot spends the first half of the book explaining the roots of Modern Portfolio Theory, and why the simplifying assumptions simplify it out of relevance to the real world. He doesn't suffer fools gladly, and while he doesn't actually come out and call anyone a fool, he does let the read draw his own conclusions.

I've covered the problems with MPT is previous reviews and comments, so I'll just touch on them here. MPT is based on the early 20th Century work by M. Bachelier, who took his cue from Brownian motion, the random motion of particles suspended in water. That motion is normally distributed. Well, if dust motes, why not stock prices? Bachelier posited that stock prices moved some small amount each day, that the movement was normally distributed, and that there was no memory from one day to the next.

Why normally distributed? Well, like the guy who loses his keys over there in the dark, but looks for them over here under the streetlamp because the light's better, it's the only distribution that we can really find closed-form solutions for.

Modern Portfolio Theorists follow Merton in assuming that time is continuous. On the way down, or on the way up, the stock price hits every tick, (this used to be 1/8 of a dollar, now it's a penny), so you can always get the share price when you put in your order,

These assumptions don't hold. They're made largely because they're the only way to get to a closed-form solution to the math. What's more, anyone with eyes in his head ought to be able to see that they're not even usually true.

Mandelbrot starts from his distribution of cotton prices, and works from there. First, prices are more likely to follow what's called a Cauchy distribution. More peaked in the middle, and with much, much fatter tails, the Cauchy distribution is very ill-behaved.

From there, readers familiar with fractals will find themselves skipping large sections. Mandelbrot reintroduces self-similarity, scaling, fractal dimension, and so on. But he also introduces the idea of time-warping, warping along the x-axis as well as the y-axis. Do this, the produces some very realistic-looking charts.

And that's pretty much where the argument ends. Mandelbrot has produced charts that look right, and returns distributions that mimic reality, but he admits that it's purely descriptive. There's no mechanism, only behavioral speculation, and there's no real way, yet, to make money other than by selling books about it.

What are the implications for finance? Well first, with those fat tails, the Cauchy distribution is much, much riskier than the normal distribution, with the likelihood of ruin much higher. Second, the thing about the realistic-looking charts, that are indistinguishable from real charts, is that they really are random. Technical analysts, beware! Mandelbrot has some sympathy for the illusory patterns you see in the charts, but illusory they are. If I can produce something randomly that looks like the real thing, and you think you see predictive patterns in it that aren't there, what does that say about the predictive power of the patterns you see in real charts?

Mandelbrot also reminds us that he started to come up with this stuff just before the advent of MPT, but that in the trendy world of finance, his uncertainly was overshadowed by MPT's promise of managing risk. He reminds us more than several times, and it does get a bit tiresome. There's nothing the matter with enjoying being right, but even the disinterested observer, who's only looking for something better, get weary of hearing "I told them so."

He make up for it, though, but devoting the last chapter of his book to an uncritical discussion of current research based on his work. He's boosting these guys, with no expectation of recompense, in the best academic tradition, and he deserves credit for that. If he can use his name and popularity to create a community pursuing these ideas, more power to him.

We are reminded that this is a field still in its infancy, not really allowed to grow by an industry that thought it had the magic key. Retrenching and pursuing this line of thought, which currently offers little if any profit path, is hard. But it's better than building on sand, on a coastline whose length you can't even measure.

Posted by joshuasharf at 10:27 PM | TrackBack

August 01, 2005

LTCM Book Reviews

Finally! A two-fer on the book-review site.

Posted by joshuasharf at 10:34 PM | TrackBack

It's Carnival Time!

This week's Carnival of the Capitalists is up, over at Small Business Marketing Systems.

After seeing the number of entries grow over the last few months, I've got that "you mean want me to land the plane?" feeling right now...

Posted by joshuasharf at 06:29 AM | TrackBack

July 27, 2005

CFA Blog Rises From the Dead

Finally, I've started reading, so I've started writing.

Posted by joshuasharf at 10:28 PM | TrackBack

July 26, 2005

Big Labor Disintegrates

So another dinosaur bites the dust. Pretty soon, students of American business will look at the 20th Century the way we look at the Jurassic era. "What was the AFL-CIO, and who was this AT&T they had a problem with?"

Big Bill Heyward would know what to do. Before two major unions walked out on their brothers, there'd be finger-snapping and Leonard Bernstein music playing over the loudspeakers.

According to accounts, two, five, or seven major unions, fed up with a leadership that promised enrollment and elections and has managed to squander both, have and will soon pull out of the AFL-CIO and start their own umbrella organization.

Now, this isn't exactly going to force John Sweeney to seek refuge in Avignon, mostly because union membership down to about 1/8 of the workforce, and half of that is public employees. (No, the other half is not newspaper writers.)

Another one of the issues was competition. The dissident unions wanted the AFL-CIO to basically go all the way to godfather, sorting out inter-union disputes, marking out territories, forcing mergers, and preventing competition. That's actually pretty rich coming from the SEIU, which even now is scoping out the juiciest AFSCME territory for raids.

The Ted Kennedys (what union did he belong to? Riverboat pilots?) and Dick Durbins of the world can rail all they want about how Management, sitting pig-like in their boardrooms, smoking cigars in their tophats, are chortling over the self-destruction of their greatest foe, but the fact is, management had long ceased seeing unions that way.

Wal-Mart fights them, of course, but it was the unions that pillaged United and, even now, keep the company alive only to feed on its carcass. I remember talking to the head of one local company whose plant had recently unionized. You could tell, behind all the talk about how a single standard made things easier, that it really hadn't. But it was just a fact of life, not a hazard to navigation.

The new umbrella organization apparently believes that if you're losing elections anyway, your problem may be that you can't mobilize enough voters. So their main focus will be on recruitment. Fine. It also is probably at least a little in response to a membership that was voting 35% of the time Republican, while watching 99% of their political contributions go to Democrats. The UAW was only able to get away with this because of a combination of neglect and cowardice in the face of a very clear Supreme Court ruling.

Still, when most people still associate "union" with "hollow downtown Detroit," it's hard to see where all those new members are going to come from.

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July 25, 2005

Carnival of the Capitalists

This week's Carnival is up, over at Political Calculations. Lots of stuff there worth reading this week.

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July 11, 2005

Carnival of the Capitalists

The Carnival is up!

I'm seriously looking forward to hosting this thing in a few weeks.

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July 06, 2005

Adm. Stockdale, RIP

Admiral James Stockdale has died. For those looking for heroes, Stockdale was the genuine article. Kept in the Hanoi Hilton for 8 years, Stockdale became the leader of the POWs there, helping them survive an actual torture camp.

Jim Collins recounts interviewing Stockdale for his book, Good to Great:

"I never lost faith in the end of the story," he said, when I asked him. "I never doubted not only that I would get out, but also that I would prevail in the end, and that I would turn the experience into the defining moment of my life, which, in retrospect, I would not trade."

I didn't say anything for many minutes, and we continued the slow walk toward the faculty club, Stockdale limping and arc-swinging his stiff leg that had never fully recovered from repeated torture. Finally, after about 100 meters of silence, I asked, "Who didn't make it out?"

"Oh, that's easy," he said, "the optimists."

"The optimists? I don't understand," I said, now completely confused, given what he'd said a hundred meters earlier.

"The optimists. Oh, they were the ones who said, 'We're going to be out by Christmas.' And Christmas would come, and Christmas would go. Then they'd say, 'We're going to be out by Easter.' And Easter would come, and Easter would go. And then Thanksgiving, and then it would be Christmas again. And they died of a broken heart."

Another long paus, and more walking. Then he turned to me and said, "This is a very important lesson. You must never confuse faith that you will prevail in the end - which you can never afford to lose - with the discipline to confront the most brutal facts of your current reality, whatever they might be."

To this day, I carry a mental image of Stockdale admonishing the optimists: "We're not getting out by Christmas; deal with it!"

Those who like to prate on about the evils of Gitmo would do well to read his memoirs of those years. But then, that would take the guts to confront the most brutal facts of their reality.

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June 20, 2005

Carnival of the Capitalists...

...is up, over at Blog Business World.

So, which ride do you think best represents the market?

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June 14, 2005

McMad Update

Longtime readers will remember a discussion of a new McDonald's being planned for an old neighborhood.

Lynn Pressnall, and aide to City Councilman Marcia Johnson sent the following comment concerning plans for the intersection:

The Colfax/Krameria intersection has been scheduled for improvements including a left-turn light but has not happened previously due to problems with gaining enough land to add lanes and smooth out the off-set intersection. The developer, Drake Development, gave the land to the City in May of 2004. Since Colfax is a state highway, funds were then applied for by Denver to complete the improvements. The intersection will be redesigned.

To be fully informed about the background of this development, and to have a full description of "use by right", please go to our website at www.denvergov.org/councildistrict5. On our site you will have access to statements regarding this development by Councilwoman Johnson, the City Attorney, the Manager of Public Works as well as access to site plans for the development.

This certainly sounds like good news. The amount of land involved appears to be small, and wouldn't have affected the buildings in the strip mall, only perhaps a couple of parking places. I'm not certain how much goodwill this is going to buy the developer, given the level to which relations had deteriorated. But it can't hurt, and it also avoids having businesses at an intersection with a reputation for creating accidents.

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June 12, 2005

Carnival of the Capitalists

Byrne Hobart has this week's up a little early. Go there, follow the links, and print out some posts to read during the slow parts of tonight's NBA Finals game. Like, everything before 4:00 to go in the game...

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June 05, 2005

Carnival of the Capitalists

Over at Gala Time this week. It's better than the opening of Elitch's!

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June 03, 2005

Graduation Day

This is probably more appropriate for a 20-year-old getting a bachelor's than a 38-year-old (gulp) receiving a masters. But there weren't any blogs then.

You go to post with the songs you have, not to songs you'd like to have, I suppose.

Bright college days, oh, carefree days that fly,
To thee we sing with our glasses raised on high. [holds up eyeglasses]
Let's drink a toast as each of us recalls
Ivy-covered professors in ivy-covered halls.

Turn on the spigot,
Pour the beer and swig it,
And gaudeamus igit-itur.**

Here's to parties we tossed,
To the games that we lost
(We shall claim that we won them someday).
To the girls, young and sweet,
To the spacious back seat
Of our roommate's beat up Chevrolet.
To the beer and benzedrine,
To the way that the dean
Tried so hard to be pals with us all.
To excuses we fibbed,
To the papers we cribbed
From the genius who lived down the hall.

To the tables down at Mory's***
(Wherever that may be),
Let us drink a toast to all we love the best.
We will sleep through all the lectures,
And cheat on the exams,
And we'll pass, and be forgotten with the rest.

Oh, soon we'll be out amid the cold world's strife.
Soon we'll be sliding down the razor blade of life. (Oooh!)
(laughter) ... Ready? ...
But as we go our sordid separate ways,
We shall ne'er forget thee, thou golden college days.

Hearts full of youth,
Hearts full of truth,
Six parts gin to one part vermouth.

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May 25, 2005

MBA Almost-Mortem

With one more class to go, and an independent study to finish polishing, it's time to start looking forward to graduation and the post-MBA/MSF career around the corner. But it's also a good moment to pause briefly, turn around, take a deep breath, and consider what I'm on the cusp of finishing.

Let's do the numbers (Light, frothy piano version of, "We're In the Money", please):

  • Years: 3
  • Degrees: 2
  • Courses: 25
  • Credit Hours: 100
  • GPA: 3.72
  • Hours at Assistantship: 600
  • Courses Paid For by Assistantship: 6
  • Courses Paid For by Daniels Scholarship: ~4
  • Student Loans: ~$54,000

Now, Peter Robinson wrote an entire book about this, so I don't expect to be able to cover the whole thing in one blog posting. I'll do what I can.

First, this was a hell of a lot of work. I took courses over the summer, and DU runs on an archaic quarter system, designed to kill off the weaker students at the end of each August. There's a 5-week break that covers Thanksgiving to New Year's. After which, a 20-week marathon, 28 weeks if you're taking summer classes. Total time off between New Year's and Labor Day: 4 weeks.

Most of the courses actually required a fair amount of writing. These could be group projects, case studies, exercises, case studies, problem sets, group projects, mid-terms, group projects, finals, or case studies. Take away Friday night & Saturday, and that meant three years of endentured Sundays, be they to homework or housework. I will say that I cannot recall a single student who complained about our having to hold group meetings on Sundays or weeknights.

Most of this time I was working, too. Ah, yes, working. I remember one quarter when an exceptionally understanding contract allowed me to take 16 credit hours while putting in about 30 a week, and taking 10 during the evenings to babysit printers for the assistantship. Yum. Sleep? I'm sorry, I don't know that word....zzzzzzzz. (There was actually a reason for that. DU used to have a billing system where you didn't pay for any hours above 12 in a given quarter. That extra 4 hours was free.)

While there was never a time when I thought of quitting, there were certainly times when I questioned the value of the project; was I really learning all that much, or was it just ticket-punching? Seeing DU get top-5 honors in finance and top-50 honors overall, two years running, in the WSJ recruiter rankings certainly made me feel better about the whole enterprise.

Part of the reason I never thought of quitting was that first quarter. I had probably the best accounting professor on the face of the planet. I mean good. Buff Honodel is former USAF, runs his class like a drill sergeant, and keeps things lively. I was actually excited to walk out realizing that the numbers embodied actual concepts. And while the less said about the finance professor the better, the class itself made it clear that you could interpret these numbers in a meaningful way.

It won't surprise readers of this blog to find out that I also found plenty of room for participation in the ethics & law class first quarter. I am told - by a reliable source - that when I missed one evening session, the professor looked over and wondered out loud if it was worthwhile even having the class.

I blogged only sparingly about the classes while they were going on. Part of this was just because I wanted to give the thing a chance to play out. Part of it was fatigue: I was writing up case studies for the class as it was. It's also hard to blog as a spectator when you're a participant. I'll spare you a class-by-class rehash of the program, but I assure you I can remember something from every single class.

If DU were to ask me what I'd do to the program, I'd have three suggestions. First, re-introduce economics. Incredible as it may seem, DU's graduate business program doesn't teach econ. That's like being a pilot and not learning about the weather. One course. One lousy course: 5 weeks macro, 5 weeks micro. No excuse, really, especially with Thomas Sowell's masterpieces out there.

Second, make sure that every course referred back to the Foundations courses, the basic accounting and finance. Even the management courses. How can you even think about negotiating a labor deal when you don't know your costs? By the time I took the advanced accounting course, I was using concepts I hadn't even seen in 2 years. Every course.

Finally, include 2 or 3 top-flight Bill James articles in the finance courses. Silly? Oh, no, my friends. You may or may not like baseball, just as you may think of finance as a roadblock between you and those juicy organizational behavior texts. But you can't dispute James's writing, his love of subject, clarity of thought, and above all, his ability to tease meaning from numbers like nobody before or since.

OK. As Crash Davis said to Nuke, "moment's over."

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May 09, 2005

Business Blogging

This week's Carnival of the Capitalists is up!

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May 05, 2005

Hedge Fund Hijinks

I had written before that hedge funds and other major MCI shareholders might have been manipulating the Verizon-Qwest auction process to accept a Qwest bid loaded with equity, that they would then have to race to dump. Now, it looks as though some of them were also manipulating Qwest's share price to help keep that bid credible when it was financially unsound.

The Denver Post first reported last week that Qwest's stock spiked during the last 15 minutes of trading on the New York Stock Exchange from March 28 to March 30 to close above a critical price threshold known as a "collar."

Had Qwest's stock closed below the collar, investor confidence in Qwest's bid for MCI could have been shaken. Qwest was dueling against Verizon, which this week locked in a merger agreement with MCI.


Maintaining a certain stock price was key to Qwest's offer for MCI, which in late March was $26 a share in cash and stock. Qwest guaranteed the value of its stock within a 10 percent collar above and below $4.15 per share. Below the collar, MCI shareholders would receive less value for their Qwest stock.

Actually, since the number of shares, rather than the dollar value, was specified in the deal, any drop in share price would have cost MCI shareholders money. The collar was there to limit, not eliminate, such risk. Had Qwest decided to try to make up the difference with even more shares, they could have crossed the 50% threshold beyond which MCI would, in effect, have been buying a controlling interest in Qwest.

Since MCI shareholders clearly wanted cash more than they wanted to run a telecom, this wasn't quite the deal they were seeking. Moreoever, under federal M&A laws, it would have changed the entire structure of the deal, affecting valuation, taxation, and the ability of shareholders to resell their newly-acquired Qwest stock.

In fact, this kind of manipulation, if it in fact happened, is grossly illegal, and harkens back to the Wild West on Wall Street, detailed firsthand by Bernard Baruch and secondhand by Charles Geisst.

Whether or not it happened, the fact that it could have will likely be enough to stir up more calls for further regulation of hedge funds. That's too bad, because there's no inherent reason why funds, any more than individuals, should be restricted in the kinds of investments they can make.

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April 18, 2005

Carnivore of the Capitalists

Red meat for business and economics.

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April 12, 2005

Risk Management

On top of everything else, only JetBlue and Southwest will be profitable this quarter, because they're the only two airlines that managed to hedge a substantial part of their fuel costs.

The Denver Post covers this from the local - i.e., Frontier - angle, and includes this whopper: "Hedges come with risk, and good hedges require a solid balance sheet..."

True as far as it goes, which is basically far enough to back away from the gate, and not much further. Two hundred words isn't enough time to explain why an unhedged position isn't a risk-free position. But shouldn't the fact that the airlines who didn't hedge are getting killed on fuel costs kind of hint in that direction?

Look, you're running an operation that's wildly cyclical, in an industry that may not have shown a profit over its lifetime. Your major cost is the single most volatile commodity known to man, and it's completely beyond your control. Wouldn't you want to do something to protect yourself against that?

Hedging usually does require some up-front costs, but unless you're going to Vegas, selling uncovered calls or buying puts with borrowed money, proper hedging reduces risk.

Once again, it's the smaller, more imaginative airlines that were on top of this, hedging their risks, while the bigger boys apparently couldn't be bothered. Maybe there's a reason they're all in bankruptcy.

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April 11, 2005

Carnival of the Capitalists

Blog home of the Wordly Philosophy.

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Live-Blog: The Problematic Style Grid

The talk will be based on a paper by Callahan and our professor, Tom Howard, about the dictatorship of the Morningstar "style" grid. You know: large-cap growth, small-cap value, etc. These began as descriptive, but have now become normative, and their claim is that it hurts returns.

Specifically, their claim is that these boxes don't really represent style or asset classes, but characteristics of the portfolio. What had been intended as guides to the investor have now become strait-jackets to the manager.

5:36 - The boxes in the value-size grid are highly-correlated. Why, then, are they considered asset classes?

5:38 - It also means that an all-stock portfolio becomes a hard-sell, since it doesn't fit into these boxes.

5:39 - "Style" really should mean the method of investing; what do you look for in a company?

5:41 - Stocks that meet a manager's style may not fit neatly into a box. It only makes sense to keep managers in a characteristics box if the following 3 conditions obtain: 1) a manager's screened stocks need to fit into a single box; 2) the screened stocks themselves cannot drift to other boxes; 3) Multi-specialists outperform those who let their portfolio characteristics drift.

5:42 - This system, according to a literature search, did not evolve from empirical data, but from convenience and the above 3 assumptions.

5:45 - First, Russ Wermers (U.Md.) did demonstrate in a August 2000 Journal of Finance paper that stock-picking ability does exist.

5:46 - Wermers also found that small-cap, growth, and good stock-pickers drifted the most, and had a 2.9% excess alpha. (July 2002 working paper.)

5:51 - Asness in Financial Analysts Journal, M/A 1997. A value-momentum specialist actually would perform better.

5:53 - Back-test Graham, William O'Neil, T. Rowe Price, and Neff. Rigidly apply each of these methodologies regardless of the stock over the last 20 years, and see how well the best stocks fit into each characteristic box. In order to avoid hindsight, use only forward-looking earnings estimates.

5:57 - In Graham's case, 53% of the top stocks fell outside the small-cap value box, the best box for his style. The % in value move all over the place, from less than 60% to over 90%. The % is small-cap also drift from about 35% to 80%. Finally, Graham outperforms the Russell 3000 by 8% a year, 1995-2003.

6:02 - You need to have the top 20 Graham picks to get the full benefit of his style. This averages out to his 10th best pick. In any given characteristic box, the best box averages to the 35th best pick. Which throws away almost all the benefit of their styles.

6:05 - Overall portfolio tilt? By combining the 4 styles, you actually get a very balanced portfolio, slightly tilted towards growth, and slightly tilted towards small-cap.

6:11 - The peer groups are M(arket) - S(ize) - V(alue) - M(omentum), rather than Growth-Value/Size. Measuring against a characteristic peer group becomes more complicated, requiring weighting for the boxes, rather than a single box.

6:16 - The correlation coefficients among the "style" boxes are huge, averaging 0.86. The correlation coefficients among sectors average 0.55. If the job of the portfolio manager is to look for low correlations, calling the "style" boxes different asset classes makes no sense.

And for the core paper, that's it. I'm going to try to re-start comments and trackbacks, hoping I've shaken most of the spam.

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Portfolio Management Live-Blog

Craig Callahan, Founder and President of ICON Advisers, will be addressing our finance class this evening. We've been told that the press may be there, which, in bloggese, means, "you may preempt the press with a live-blog." (Be careful to distinguish this from Bloghese, a clothing line from central Italy.)

ICON is a value investing firm, basing its methodology on the Graham-Dodd model. For the uninitiated, this means looking for undervalued stocks, as opposed to growth investors, who look for stocks with growth potential.

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April 05, 2005

Carnival of the Capitalists

This week's econo-blogging roundup is here.

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March 29, 2005

Carnival of the Capitalists

Weekly home of the Worldly Philosophers.

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March 23, 2005

Crushing of Dissent

Protesters at the Social Security Preso. There have been complaints that a couple of people who wanted to make a disturbance were escorted out. Too bad. If their purpose was to protest, there was plenty of room outside where they would have been guaranteed an audience and cameras. If their purpose was simply to embarass the President and disrupt the event, they deserved to be shown the door.

In fact, there was a small smattering of protestors outside. All the Reactionaries were able to muster was about 10 people in a couple of small groups. One of them, called "Billionaires for Bush," sporting faux furs (they had better have been faux) and real tophats, carried signs saying "Privatize Everything." As they walked by, I called out cheerfully, "Now, that's a policy I could get behind." One of them, who was into the spirit of things, laughed. Five of them didn't.

The other myth is that the crowd uniformly supported the President's proposals. They didn't. They may have been friendly Republicans, willing to be convinced, but that doesn't mean they walked in or walked out spouting talking points. My b-school friend, Kevin, is still sitting on the fence. People around me in line were expecting a substantive proposal, although they did want it to be civilized. Most of them were probably sympathetic, but not necessarily sold.

Columnists who want to turn us into the PRC are just blowing smoke.

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Social Security Roadshow

As mentioned below, President Bush brought his Social Security Roadshow to town on Monday, and I got to see the event up-close and personal. All the pieces were there, but I came away thinking that the presentation could have been much more persuasive than it was.

The pieces were the President, Sen. McCain, and the panelists. The President was at ease, relaxed, a terrific presenter and moderator, and clearly in command of the facts. Sen. McCain added some centrist wattage, a challenge to the AARP in one of its home states, and another articulate voice. And the panelists really were just normal folks picked to represent different life stages and incomes.

One of the lighter moments came when the President introduced McCain, "He's up here to claim some of his water." This drew mostly good-natured boos; "Never mind. Just a little inside joke that didn't work." It turned into a running gag when McCain said he was here to visit some of his water, and cracked up even the President by asking us to remember that "Arizona is so dry the trees chase the dogs."

The President is trying to offer younger workers something - a tangible account of their own with higher returns - that also appeals to middle-aged workers - it's transferrable. At the same time, he needs to reassure retirees and soon-to-retirees that their stated benefits will be paid. He can make this case.

The problem is, the program couldn't decide if it wanted to be a political rally or a policy presentation, so it came off as an infomercial. When the President said he wanted to have a "discussion," it sounded like the discussion your dad had with you about that D in Algebra. I didn't do much talking during those discussions. The panelists were props. Willing props, to be sure, who wouldn't have been up there if they didn't support private accounts, but still props.

A number of people came away having learned something. A friend of mine from business school said that he hadn't realized that the government spent the excess payroll tax it collected. But people want details; they're parched for details; and our whole system is predicated on the notion that they can handle details. If avoiding the details makes a plan harder to attack, it also makes it harder to support.

If the President is still in the Convince People There's a Problem stage, this may have helped. Even there, the case could be stronger. Europe currently can neither grow economically nor defend itself because of its welfare state commitments. Social Security has the potential to do that to us a couple of decades from now. The President needs to point to Europe, and ask the American people if that's the path we want to take. He'll win that bet.

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March 22, 2005

Herding Cats

The Carnival of the Capitalists round-up is over at Beyond the Brand. This week, as Carson would have said, "Good Stuff."

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March 21, 2005

Social Security Photoblogging

I had the great good fortune to attend one of President Bush's Social Security Town Hall Meetings this afternoon, held at the Wings Over the Rockies Museum on the old Lowry Air Force Base a few minutes from my house. More on the style and substance of the event tomorrow, but I thought these pictures could serve as an appetizer.

The event was billed as being co-hosted with Congressman Bob Beauprez, who didn't speak, but was there with his wife.

Governor Bill Owens (whose Deputy Chief of Staff Sean Duffy furnished tickets to the bloggers) gave a brief introduction, holding at least some of the crowd in rapt attention, at least when they weren't shamelessly using their children to promote their blogs.

A surprise participant was Senator John McCain. When his name was announced, an audible "oohhh, wow" ran through the crowd. Together, the Senator and the President helped the panel through the discussion.

And after the presentation, the President repeated his campaign peformance of diving into the crowd, or at least reaching across the barrier, and signing autographs for everyone who could get close.

As I said, more later. Probably tomorrow after I can read the Post account and see whether staff writer Susan Greene and I were at the same event. Heh.

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March 03, 2005

Demographics are a Moving Target

One of the capstone courses at DU Business School is something called the Integrative Challenge. Teams of students do research projects for local businesses and governmentes, evaluating expansion plans, marketing schemes, student-researcher compensation, and so forth.

This year, one of the teams drew a local amusement park/water park equipment company, who wants to expand into Europe. Their presentation was a case study - in missing Hannibal's elephants in the living room.

While dutifully noticing that while each European country has children, they also pointed out that the populations were aging and eventually, declining. Of course, the inconsistency goes away once you realizing that it's North African immigrants who are having all the children.

It's one thing to suggest putting a water park in a country where the Great Winter Pastime is skating on the canals. It's quite another to entirely miss the fact that 50% of Dutch children born this year will be learning the Koran in a few years.

There are obvious business implications here. After all, this is a massive cultural shift, which suggests that Marseilles might not be the ideal place for a water park that it was when the last group of fascists moved in. You'd hate to put up a nice water slide, only to find the next morning that someone had been tossing grenades at the supports.

Certainly there's risk for the team that someone from the company's management is going to notice this. Those of us who read Mark Steyn on a regular basis already knew about it. But this team spent a lot of time on these countries. Could it be that there's greater risk to the company that they won't notice?

One of the benefits of the blogosphere's explosion is that information like this is available. It's evidence of its continuing limitations, as well as the MSM's ongoing failure, that it could be completely missed by a team researching those countries.

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February 28, 2005

Index Funds - An Ongoing Study

A few weeks ago, I posited that the popularity of Index Funds could be increasing the volatility of the markets.

This is a testable hypothesis to a point. We can at least see a correlation, and see if volatility has grown with Index Fund investment.

Since it looks like I'll have a little extra time on my hands for the next few weeks, I'm going to go ahead and use public information sources, pull down the prices for the Dow Jones Industrials since 1/1/1970, and see if any of this works.

Obviously, this is a multi-step process, so I invite the readers of this blog to check the math, check the methodology, and work on this along with me.

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Franchise Failure

Dane over at Business Opportunities Weblog quotes Steve Strauss on franchise survival rates:

The good news is that the likelihood of you failing as a franchisee is fairly remote According to the Small Business Administration (SBA), roughly 30% of all non-franchise businesses fail within the first year, but that number falls to 5% when discussing franchises.

Strauss then goes on to discuss reasons franchises fail.

It's a good piece, with two quibbles. According to a 1998 study for Sloan Management Review, about 15% of franchises fail in their first year, and by the third year, they match that 30% failure rate. It may be that franchises have refined their systems since then, but 95% sounds pretty good, 85% less so, and a longer-term view is much less rosy then either.

Secondly, Strauss fails to warn potential franchisees that franchisors will sometimes buy back successful operations an have the company run them directly. This not only breaks faith with the franchisee, who's buying a revenue stream as much as a process and name. It also suggests that the franchisor's attentions aren't where they need to be: in brand-building, marketing, and chain-growing.

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Carnival of the Capitalists

Congrats to the Coyote Blog, located just south and west of here, for all the hard work.

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February 25, 2005

We Put the "W" in Qwality

Well, you have to give them credit for trying, even if they can't get any other kind of credit.

Qwest has revised its offer, speeding the cash payout to MCI, and offering to make good any losses if Qwest stock drops before the deal is done. Moreover, consumer groups are claiming that the Verizon deal is anti-competitive.

Color me unimpressed.

The latest word is that MCI's board will stand by Verizon, even as it fulfills its fiduciary responsibility to play wastepaper basketball with each individual sheet of Qwest's new offer. Owning 5% of something is better than owning 40% of nothing The board has obviously made its decision, but the whole deal will still need to pass shareholder muster.

First, the consumer groups. Consumer groups take a notably static view of the world. Their cry of "anti-competitive" is only true if you assume that there are no other competing technologies. I can see why the Post would pick up the refrain to boost the hometown boys, especially given the jobs at stake, but with cable companies, satellite companies, VOIP, all out there, the idea that anyone's market position is unassailable or even particularly stable is short-sighted. The only thing they can do is to sow uncertainty in MCI shareholders that the Verizon deal would get regulatory approval.

As for the deal itself, it contains a "put," in effect, an offer to make good any losses if Qwest stock drops below $4.15 a share before the deal is sealed. Which is all well and good. Put options are frequently included in buyouts, to reassure the buyers that they're getting something worthwhile. (This reinforces my interpretation that Qwest is not so much acquiring MCI, as offering a minority stake of itself for sale.)

The problem is, all Qwest has to offer is more shares, i.e., a bigger piece of a smaller pie. It's a meaningless offer, and everyone knows it.

The wildcard remains the shareholders, who include a growing number of hedge funds moving in to make a quick profit on a hoped-for bidding war (paid subscription required). They're expecting Verizon to up its offer, and will be putting pressure on MCI's board to make them do so.

Two problems with this. First, the broader market isn't buying, with MCI stock down from its premium over Verizon's offer. It's still trading a little higher than Verizon would pay, but much lower than Qwest's offer. And they can't all get out at that price, either. Second, MCI released its quarterlies, showing yet another operating loss. This means that MCI lost money for both the 2nd and 4th quarters, and will be down for the year. The early efforts by interested investors to promote MCI as a cash cow rather than a cash hoard don't hold up to scrutiny.

If the shareholders, including the short-term hedge funds, were to stampede shareholders into rejecting Verizon's offer, they'll get what they deserve.

Posted by joshuasharf at 10:54 AM | Comments (0) | TrackBack

February 24, 2005

Sen. Roseanna-Roseanna Deanna Hanna

In a surprise slap to their usually reliable allies the Progressives, the Denver Post this morning editorializes against yesterday's state Senate Business, Labor, and Technology Committee vote to pass the Keep Jobs in America Act along to the full Senate. I don't think they're necessarily reading this blog, but it's encouraging that they do repeat a number of the arguments made and referred to here. Heh.

As noted before, the Act would have all sorts of consequences for the state's budget and ability to function, without materially affecting the US or world economies. I wonder if sponsor Sen. Hanna also thinks that declaring Boulder a nuclear-free zone would dissuade the incoming missiles...

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February 20, 2005

No, Real Prawns Aren't Kosher

But don't let that stop you from visiting the Carnival of the Capitalists.

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February 18, 2005

"...What is Your Qwest?"

"What is your name?"
"Richard Notebaert."
"What is your Qwest?"
"Um, a technically bankrupt phone company."
"What is your favorite telecom?"
"Local or long-distance?"

After listening to Qwest's conference call, let's just say that Notebaert didn't sound too happy. When a guy starts talking about "keeping options open," and "seeing how the deal plays out," it's pretty clear there's no Plan B. They're going straight to Plan 9.

I've written about this non-deal before, here, here and here, so there's little point in repeating the details. What's astonishing is that Qwest isn't giving up.

Qwest's letter to MCI is somewhere between the sad and pathetic (click below to Read the Whole Thing). It sounds as though Qwest is being manipulated by a couple of large MCI shareholders who want a higher premium from Verizon. Some of them were arguing that MCI had a fine cash stream, when in fact it does not, and Leon Cooperman has been out there pushing MCI hard.

In fact, Notebaert really has very little left to bid with. Any more cash is essentially coming from MCI's own account, and defeating the purpose of the merger - cash for Qwest. Any more stock, and it becomes unclear just who's buying whom. So what's he going to offer? Mountain view property in Elbert County?

The only card Notebaert has to play is the MCI board's fiduciary responsibility to the shareholders, so that's the case he's trying to build. If the shareholders see through it, there's always a slight chance that the SEC, FTC, or Czar Spitzer might think otherwise.

It remains to be seen how far Qwest is willing to push this, but if they want to spend time negotiating deals, they have some bondholders who are probably folding their arms and tapping their feet impatiently right about now.

On second thought, maybe it's more like the Black Knight.

February 17, 2005

The Board of Directors
MCI, Inc.
Attention: Chairman, Board of Directors
22001 Loudoun County Parkway
Ashburn, VA 20147

Dear Mr. Katzenbach:

I am writing this letter to request information from you regarding Qwest's proposal to acquire MCI.

On February 11, Qwest submitted a written proposal to acquire MCI. On February 13, Qwest reconfirmed the terms of our proposal in writing to MCI's Board.

We are aware that MCI has signed an agreement to be acquired by Verizon Communications Inc. As of the writing of this letter, we have just received a copy of this agreement and we are in the process of evaluating it. Published reports, including public disclosures by MCI's President and CEO, indicate that the consideration to MCI shareholders in the Verizon proposal is substantially less than the consideration Qwest offered to MCI shareholders. In addition to the superior merger consideration offered by Qwest to your shareholders compared to the Verizon offer, we would like to remind you that Qwest's proposal is superior to the Verizon proposal because our regulatory approval process is likely to be completed at least six months more quickly and the value to the MCI shareholders from participation in approximately 40% of the synergies in a Qwest transaction will substantially exceed the value of synergies that would be received by MCI Shareholders in a Verizon deal.

To date, we have not received any response from MCI or its advisors on the terms of our February 11 proposal, as reconfirmed on February 13. If we had received this response, we may have been already able to communicate to you a modified offer that would be beneficial to MCI shareholders. In addition, we were provided limited access to due diligence information regarding MCI, which we have been informed was substantially less than the access provided to other parties.

In addition, we would like to advise you that once we have completed our review of the Verizon merger agreement, we do intend to submit a modified offer to acquire MCI and we would expect MCI and its advisors to engage us in a meaningful dialog regarding the merits of our offer and we would further expect access to due diligence information consistent with that offered other parties.

Sincerely yours,

Richard C. Notebaert
Chairman and Chief Executive Officer

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February 17, 2005

McMad Revisited

A couple of weeks ago, I had a very nice, very long conversation with Ms. Adams, who appears in the prior posting about McMad and its fight against McDonald's. I came away with the impression that the Rocky had made a couple of mistakes in its reporting. I also see why the neighbors might be a little hacked off at the company. They do have some legitimate complaints. At the same time, they're burying those complaints under a mound of inflated rhetoric, which doesn't bear up under scrutiny.

First, what the Rocky missed. They claimed that the demos were going on outside the vacant buildings - they're not. The protesters demonstrate outside the existing Glencoe St. McD's. This makes much more sense.

Secondly, the claims that seem valid. I can believe that this may not be the best intersection for a drive-thru. Krameria doesn't have a left-turn signal, there's an offset when crossing Colfax, and the Neighbors claim to have a study showing that this intersection is the most dangerous between Monaco and Colorado. (This may well be true; an email request to the group for the numbers went unanswered.) There is a garbage problem from the Good Times across the street, and Ms. Adams front yard will, evidently, have a front-row seat for the traffic exiting onto Leyden.

All of these problems (except for the offset) could be easily fixed by the city. However, there are no plans to put in a left-hand turn signal, nor will the city allow them to put in a "porkchop " to turn the traffic away from the side-streets and back onto Colfax. Between a company they believe has been duplicitous and hostile, and a government that seems utterly unresponsive, I'd be frustrated, too.

(Aside: there are other, unverified claims that they make against McDonald's, the developer, and the franchisee. I haven't spoken to them yet, and I don't wish to repeat them until I do. I mention them here to explain the neighbors' sense of being locked in an iron box, but I don't wish to give them substance without at least giving the other guys a chance to talk. What can I say? I'm busy.)

That said, I think the neighbors' frustration has led them to make claims that are simply wild and unrealistic, in order to garner support from a broader community. For instance, the area that they wish to turn into a Town Center, on the Stapleton or Lowry model is roughly 9 square blocks. Putting a McDonald's on the fringe barely affects the rest of it. Small businesses could easily be lured in, just like the coexist with Panera and Starbucks in other developments. The only signal it sends is, "open for business."

Also, Ms. Adams believes that overlooking a drive-thru from the adjacent apartments is worse that overlooking a parking lot. Except that now, while the parking lot entrance is on the side-street, the actual drive-thru lane is away from the apartments, on the Colfax side of the restaurant.

Ms. Adams also said something about this being "the worst possible business" to put there. Well, I can think of two or three other businesses that Colfax has plenty of that would be worse. Just ask Denny Naegle. She's worried about her daughter playing in the front yard with all the traffic. Fair enough. I'd be more worried about some of the role models for young ladies inhabiting this street out in Aurora.

I also haven't been in touch with Ms. Johnson, but it seems passing strange that a City Councilman can't prevail on the traffic department to bend a few rules and upgrade the intersection. For instance The Grid is hardly sacred.

...where traffic patterns are painful to your gears.
The Lowery development leaves you close to tears!
There are even places where it completely disappears,
Why, in Congress Park they haven't used it for years.

And what's so hard about putting in a left-turn light? It's not as though the traffc engineers in this town know anything about synchronizing the lights, anyway. People would hardly notice.

It seems to me that the bad guy here - to the extent that there is one - isn't the landowner or the restauranteur, but a city government that could solve the problem in one afternoon but chooses not to.

Posted by joshuasharf at 07:27 PM | Comments (1) | TrackBack


Many thanks to local DreamMaker Bath & Kitchen franchisee Skip Carson for taking an hour out of a very busy day to talk to our DU group about the challenges of franchising. We're analyzing the problem for a local firm looking to expand, and Skip's business has enough similarities to make it a good model to look to. If you need a kitchen or bath remodeled, keep him in mind. (This ad is completely unsolicited and unpaid-for.)

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February 15, 2005

Hanna Barbarians

The self-proclaimed Progressives (I like Bainbridge's point that they're Leftists hijacking the word "progressive") are throwing their - weight - behind a bill to require all contractors to the state to perform their work in the US. SB-05-023 is sponsored in the Senate by Sen. Deanna Hanna (D-Westminster).

The bill provides for a pre-contract certification, penalties if any of the work is shifted overseas, the right for the state the sue, and a 3-year lockout from future contracts if any work is offshored.

There are plenty of good macroeconomic reasons for offshoring work:

In July, economist Martin N. Baily, chairman of the Council of Economic Advisers under President Clinton, looked at who benefits from outsourcing. He found that... on balance, the U.S. economy gains $1.12 to $1.14 for every $1 invested in outsourcing.

In August, economist Charles Schultze, chairman of the CEA under President Carter, looked at the number of jobs lost to outsourcing. He found that between the end of 2000 and the end of 2003, at most 215,000 jobs service sector jobs were lost.

... U.S. imports of computing services -- the most controversial area of outsourcing -- came to just 0.4 percent of the gross domestic product in 2003.

(Hat Tip: EconLog)

And plenty of reasons to think that the only "deflation" is of leftist economic trial balloons.

More importantly, it's terrible budget sense. It all seems so reasonable. But for a gang that got elected promising to be fiscal conservatives, this ain't cheap.

Every bill has to have a Fiscal Impact Summary, describing, well, fiscal impact. This one doesn't even bother to estimate the costs, because they can't:

This bill may increase expenditures for a number of state agencies that contract for services with companies that perform services from sites located outside the United States. In most cases, the increases are not quantifiable, but stem from either (1) the limitation of vendor competition, or (2)
the elimination of potential vendors altogether. The following are examples of projects when departments would have incurred higher costs because of this bill's vendor limitations. These examples are not intended to be comprehensive but rather to provide anecdotal evidence for the types of state expenditure increases that would be incurred.

Here's anecdotal evidence:

Department of Personnel and Administration. The bill would affect the Division of Information Technology. Currently, the state's main central processing unit is made by IBM, whose primary support service headquarters is located in Asia. This bill would prohibit the state from obtaining any technical support with regard to the CPU. The division also utilizes two important software packages that are produced in London and Israel, respectively. This bill would affect the division's ability to both utilize and receive technical service on these packages.

Look, it's not like this kind of this hasn't been tried before. It's been very costly. And just remember whose capital it is that's going to fund this.

I will give them points for proper use of the term "paleocon," something that frequently eludes the Left, which suggests that maybe these guys are coachable, even if they do choose to associate themselves with the conservative economic illiterates.

Say it with me: Progressively More Expensive. Progressively More Intrusive. Progressively More Restrictive.

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February 14, 2005

Double-Dipping II

I asked State Treasurer Mike Coffman why leaving early and collecting PERA benefits made a difference to the state. It seemed to me that if you weren't accumulating seniority, you might start getting benefits early, but they'd be lower than if you waited.

Turns out there are two cases where that's not true. A friend of mine pointed out that after 25 years, PERA benefits don't increase. Which means that someone double-dipping really is costing the system money.

In the case Coffman cited to me, under PERA, you can buy years of benefits ahead of time. The problem is that until recently, the discount rate used to estimate the pre-payment was so high that it didn't cover the costs. If I pre-pay assuming that the government will make 8%, but it can only return 5%, the pension plan will be on the hook for the extra 3% in a defined-benefit plan.

I should also point out that Coffman has bond immunized College Invest, a pre-paid college tuition plan that had fallen short of its projected needs. By buying bonds to match known outgoing cash flows, Coffman has made sure that the system can cover those flows. Presumably the fund managers will still have to work at rebalancing from time to time, but that's a much easier job that playing catch-up.

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GM Buckles

It looks as though GM has decided to go ahead and meet Fiat's demand for protection money to avoid a protracted legal battle. Analysts had estimated that Fiat would want about $2 Billion to make it to the next fill-up, and lo and behold! that's what they got.

GM can pay the cash, although unhappily, and the bond market analysts, those little engines of profit themselves, didn't seem to like the effect on the balance sheet. GM is hovering just above junk status, for the moment. Any new long-term debt is going to cost almost 2.5% more than comparable Treasuries. Ouch!

This whole thing was a disaster beginning to end, despite GM's attempts to put a happy face on it. The spent money to get in, lost money on they way, and got maneuvered into almost doubling their loss to get out.

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Wholesale Blogging

This week's Carnival of the Capitalists is up.

Stop reading about politics for a moment. Go there. Change your paradigm.

Posted by joshuasharf at 08:19 AM | Comments (0) | TrackBack

Verizon and MCI

First it was Charles and Camilla, now it's Verizon and MCI.

Look, nobody believes in "synergy" except the people trying to sell it. There are a million reasons why mergers fail, and only a few ways to make them succeed. Marrying a company with no cash flow to a company with no cash isn't a recipe for success.

MCI chose some cash, and shares in a large, successful company, to little cash and shares in a company it was supposed to save. What would you have done?

Posted by joshuasharf at 06:47 AM | Comments (2) | TrackBack

February 13, 2005


Unlike HTML, which is all about the display, XML is all about the data. The tags don't tell your browser anything, but they do describe the data they enclose.

Since the data for each industry is different, companies have been busy developing trade standards for data. I've spent time writing code to parse the data for natural gas transport, for instance.

Now, financial data is getting the same treatment, and the general consensus is that it's the software industry's response to Sarbox. The SEC has announced a program allowing companies to file their 10-Ks' financial data in XBRL. In a BusinessWeek issue about web services, XBRL got an article all its own.

A local company, Rivet Software (profiled here), is releasing their Microsoft Office plugin that lets you take financials in Word or Excel and transform them into XBRL. It works with balance sheets, income statements, cash flows, shareholders' equity, and footnotes.

In fact, even without Sarbox, XBRL (eXtensible Business Reporting Language) would probably have come of age. To give one example, financial analysts use anomalies in ratios and ratio trends to spot potential fraud. Being able to import data from many companies in the same industry at once from the SEC site will make spotting outliers a lot easier.

That said, it may be that the benefit of XBRL to internal processes is being oversold a little. Companies do their mangerial accounting very differently from their financial accounting, because the metrics they're using are different. Activity-based costing, for instance, it completely different from GAAP. Also, "internal processes" can mean just about anything that ends up hitting the financial statements. The processes vary wildly across indutries and even companies. XBRL just isn't built to handle individual receipts and inventory flows.

Posted by joshuasharf at 08:41 AM | Comments (0) | TrackBack

February 10, 2005

Qwest & MCI & Verizon & Bell South

"This is MCI. We're out in merger talks right now, but if you'd please leave your name and phone number, we'll get back to you. Or you can read about it in the paper. < BEEP >"

< teenaged pimple-faced boy voice >
"Uh, hi? MCI? This is Qwest. Are you there? If you're there, could you pick up? Please? It's really important... Uh, thanks."
< /teenaged pimple-faced boy voice >

And so it goes. Look, there's a reason Qwest finds itself listening to the 101 Strings Play the Beatles every time the call about the merger. MCI shareholders believe they're entitled to a premium, even a small one, for the company. After all, they've got this great network, don't they?

Here's the problem: Qwest isn't interested in the network, they want the cash. Qwest has its own state-of-the-art fiber optic network that's sitting there like a desert highway in a car commercial. But they don't have the money to operate it, or do much else. Remember, Qwest owes more than it's worth.

Qwest wants MCI's cash, and they figure that if they pay MCI $6.3 Billion in stock for $5.5 Billion in cash and a rolodex from heaven, that's more than fair. In effect, Qwest is trying to sell a minority share itself to MCI for financing. They'll move MCI's customers from MCI's Route 66 onto Qwest's I-40. After all, Qwest also bought out US West for a huge premium, and then they had to write down the value of that network, plus eliminate about $40 billion in goodwill. They're determined not to make that mistake again.

There are still lots of reasons why this might go through, and other reasons why it might not. Verizon might or might not get into the game, and MCI might be looking at the best offer it's going to get. And MCI also might decide that Verizon stock will be worth more (read: something) than Qwest stock a couple of years down the line. MCI might look at those pending Qwest shareholder lawsuits and get the willies. Also, it turns out that as part of a fraud settlement, MCI proimised the state of Oklahoma that it would put 1600 new jobs in the state over the next 10 years. Who knows what else MCI had to promise various state attorneys general?

What's interesting here in the consolidation is that it's virtually entirely a result of lousy regulation made worse by the FCC. (If Michael Powell is at fault, it's only because he lost the battle; I seem to recall he was on the right side.) The 1996 telecom law was supposed to give Baby Bells and long-distance carriers a chance to adjust, forcing them to sell their network bandwidth at a discount to each other for a while. Networks that each had paid to build. So the law privatized the costs and socialized the benefits. Nifty idea, huh?

Last year, the FCC reworked the regulations. At the time, it looked like they might get rid of all the restrictions, and just let the companies go at it. Instead, they lifted half the rules - they let the Baby Bells charge market rates, but made the long-distance guys keep selling their bandwidth at a discount.

The result, as we now see, is that the long-distance guys have no cash flow, and figure they'd better get out while they still have something worth selling. The bidders are all Baby Bells (SBC, Qwest, presumptively Verizon; Bell South is sitting this one out, but you'll notice they're the ones with the option here), and the sellers are all long-distance carriers (AT&T, MCI).

These last few years should make case studies in Harvard's business and government schools.

This isn't entirely bad - cable companies are getting into the business even as the old giants bow out, and with the exception of Qwest-MCI, the buyers seem to have a long-term strategy in mind. And nobody made Qwest hire a guy (Nacchio, not Notebaert) who didn't really care what business he was in. But people who are complaining about less competition and more consolidation need to think next time before arbitrarity deciding to transfer wealth from one company to another.

Posted by joshuasharf at 06:17 AM | Comments (0) | TrackBack

February 09, 2005

Statehouse Stasists

In a move all but guaranteed to get them into Virginia Postrel's next book, Democrats in the state Senate are pushing a bill to require businesses to give employees time off to attend their children's school events.

The law:

  • Requires up to 5 hours a month, 40 hours a year
  • Permits businesses to limit absences to 2 1/2 hour shifts
  • Exempts farm workers, private domestics, independent contractors
  • Exempts emergency and health care workers
  • Allows businesses to requires parents to get a note from their principal
  • Actually lists a variety of "school activities"
  • Exempts companies with fewer than 10 employees
  • Only applies to times when 10 people or more are actually working

Talk about micromanaging! When a law has this many exceptions, caveats, details, and exemptions, it's a pretty good sign that it's a pretty bad idea. It's a simple idea. So simple, in fact, that most adults can probably be relied on to figure out the details for themselves.

UPDATE: A couple of requests to explain myself. Here's the problem. Look at the number of caveats applied to this very simple notion. The legislature is clearly trying to capture all the contingencies that might affect the appropriateness of the law. But I can think of 5 or 10 more without breaking a sweat, and I'll bet you can, too. And I can think of social trends that could make the law either intrusive or unnecessary.

The problem with passing a law to deal with micro-issues like this is that it's entirely too easy to make a mistake, and the only way to undo it is to amend the law or repeal it. If you're looking for an imperfect solution, there are far more flexible and responsive ways to get there.

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February 08, 2005

The Startup State

American City Business Journals has issued their rankings of the best small-, medium-, and large-sized cities (Links to Excel Spreadsheets) for small business (fewer than 100 employees). Colorado placed one city in each city size, making it only one of three states to do so (Florida and California were the others). Denver (8), Ft. Collins (6), and Edwards (7) made the cut in their respective categories.

  • Colorado Springs came in at #23 in the large-city survey of 91 areas
  • Durango and Silverthorne also made the Top 25 small cities.
  • Blue, blue Boulder and Pueblo both failed to crack the Top 200 in the 284-city mid-size city survey

Denver did well in the number and density of small businesses, which offset a so-so showing in payroll growth. The data are from 2002.

From Jeff Cornwall via Business Opportunities.

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February 07, 2005


Rome has fallen, defeated by its offspring. It may be a few years before the symbols of Empire are sent east for good, but for now, the barbarians are inside the walls, doing their will.

I've always had a hard time romanticizing even the great corporations, but if ever there were a Rome, it was AT&T. It grew up like Rome, squashing competitors in their cradles. At one point, it was the biggest company in the world. And it owned virtually the entire phone system, from your mouthpiece to your friend's earpiece. You didn't own your phone, you leased it. But the system, rollerskates and all, worked.

Then, it kinda stopped working so well. AT&T got a little fat, and a little arrogant, and sometime in the 50s, people started referring to "the damn phone company," and it wasn't so much fun to walk over to your neighbors' to call when your service went out. Nichols & May did a side-splitting, roll-on-the-floor-laughing sketch about trying to get a number from Information, and losing your dime(!) in the process. (It occurs to me now that this comedy sketch is probably completely incomprehensible to anyone born after 1985.)

My mom starting running the scissors through the old computer punchcard bill you had to return with your check, just to make the people at the damn Phone Company enter the numbers by hand.

It didn't help. As AT&T entered the Late Imperial Phase, it started to get more rigid, more arrogant. It tried to protect what it couldn't, and then it actually felt a little relieved when the Baby Bells broke away (or were broken away, really). After all, hadn't long distance subsidized local service for years?

They never did find a model that worked, even as they entered new markets. They even went through a little Justinian revival, reconnecting with local phone service via cable until some judge put an end to that, too. But really, if AT&T wasn't AT&T any more, what was the point, anyway?

It's finally over. And yet, in another way, it's only starting.

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Motivational Tool

MarkWest stock apparently hit $50 a few days ago, and the President & CEO sent each employee a crisp brand-new $50 bill and a short note of appreciation to mark the occasion.

My first reaction: "Hey, that's pretty neat." Most employees probably didn't even notice the stock price that day, but it's nice that senior management did.

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Carnival of the Capitalists

Business! Finance! Marketing! Economics! Everything the slave of the Mighty Engine of Profit needs to know is right here! OK, maybe not everything, but it's a great place to start.

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February 06, 2005

Archimedean Finance

"Give me a lever and a place to stand, and I will move the world." -Archimedes

Well, right now Mr. Notebart is looking for a lever, and I'm not sure they have a place to stand. Qwest (Q) is in talks to buy MCI (MCIP), formerly WorldCom, formerly MCI. The problem is, they don't actually have anything to buy WorldCom with.

As of last week, MCI had a market cap of $6.7 billion. As of the end of the third quarter, their cash balance was $5.6 billion. After going through scandal-induced bankruptcy, the company is relatively lean on the debt side. MCI's problem is that they can't make any money. Even as the sector was booming these last couple of years, the company has hemmhoraged cash, even from its operations.

Qwest has the opposite problem. Qwest is like that Monopoly(tm) player who's mortgaged everything to keep the roofing in shape on the Park Place/Boardwark hotels, and then sees everyone draw "Move Directly to Go!" cards. They have a little cash, so they can stay in the game. But they overpaid massively for US West and had to write off $30 million of goodwill in 2002. Goodwill is an asset. Which means that simultaneously, $30 million of shareholder equity disappeared. Poof. Gone. Ex-equity. Equity-no-more.

Which is a problem if it isn't there. That's right. Right now, Qwest owes more than the company is worth - it has negative equity. It's got negative book value, and you can't calculate half the valuation ratios because they make the not-altogether-unreasonable assumption that the company is actually worth something, at least on paper.

Their operations are showing a slight inflow, and they're not bleeding cash like MCI, which is how they've managed to avoid the big Chapter 11 in the Sky so far. Certainly, nobody's going to be lending them any money on their own.

So MCI may want Qwest, because it can't make any money, and it needs someone who can. Qwest wants MCI because it has cash, only it doesn't have any way of paying for it.

Enter the LBO - Leveraged Buyout. These were wildly popular in the 80s, until people started going to jail for being a little too creative on the financing end, and just for being so successful which we had a recession. Basically, the company borrows against the acquisition they'll be making, and the benefits they'll get from it.

This never works. Well, hardly ever. The problem here is that Qwest is going to be taking on not only cash, but also money-losing operations. They might be able to structure a deal, but my guess is that these are a couple of fish waiting to be eaten.

The other speculation is that MCI is trying to play Qwest off against other companies. Again, the problem here is Qwest's state-of-the-art fiber optic network. Those other companies, Verizon has been most prominently mentioned, will only rush to bid if they think they won't have a shot at both of them later. Qwest's network means that if it does wait, Verizon can pick up both companies, and Qwest won't be just dead weight.

Posted by joshuasharf at 11:30 PM | Comments (0) | TrackBack

February 04, 2005

Economics of Higher Ed

Via EconLog, a great discussion of Brand State U:

At the turn of the 20th century, one percent of high school graduates attended college; that figure is now close to 70 percent. This is an industry that produces a yearly revenue flow more than six times the revenue generated by the steel industry. Woe to the state without a special funding program (with the word merit in it) that assures middle-class kids who graduate in the upper half of their high school class a pass to State U. College has become what high school used to be, and thanks to grade inflation, it’s almost impossible to flunk out.


The most far-reaching changes in postsecondary education are not seen on the playing fields or in the classroom or even in the admissions office. They’re inside the administration, in an area murkily called development....

Development is both PR and fundraising, the intersection of getting the brand out and the contributions in, and daily it becomes more crucial. That’s because schools like mine have four basic revenue streams: student tuition, research funding, public (state) support, and private giving. The least important is tuition; the most prestigious is external research dollars; the most fickle is state support; and the most remunerative is what passes through the development office.

Not only do schools have marketing departments, look at the product and the value they're marketing:

The elite schools have to produce an entering class that’s not just the best and brightest they can gather, but one that will dem­on­strate an unbridgeable quality gap between themselves and other schools. They need this entering class because it’s precisely what they will sell to the next crop of consumers. It’s the annuity that gives them financial security. In other words, what makes Higher Ed, Inc., unlike other American industries is that its consumer value is based almost entirely on who is consuming the product. At the point of admissions, the goal is not money. The goal is to publicize who’s getting in. That’s the product. Who sits next to you in class generates value.

There's also a hilarious talk about the numbing sameness of diversity, although it's not really the heart of the piece"

Here’s what Nicolaus Mills, an American studies professor at Sarah Lawrence College, found a decade ago, just as the viewbook was starting to become standardized. Every school had the same sort of glossy photographs proving the same claim of diversity:

“Diversity is the hallmark of the Harvard/Radcliffe experience,” the first sentence in the Harvard University register declares. “Diversity is the virtual core of University life,” the University of Michigan bulletin announces. “Diversity is rooted deeply in the liberal arts tradition and is key to our educational philosophy,” Connecticut College insists. “Duke’s 5,800 undergraduates come from regions which are truly diverse,” the Duke University bulletin declares. “Stanford values a class that is both ethnically and economically diverse,” the Stanford University bulletin notes. Brown University says, “When asked to describe the undergraduate life at The College—and particularly their first strongest impression of Brown as freshmen—students consistently bring up the same topic: the diversity of the student body.”

In this kind of marketing, Higher Ed, Inc., is like the crowd in Monty Python’s Life of Brian. Graham Chapman as Brian, the man mistaken for the Messiah, exhorts a crowd of devotees: “Don’t follow me! Don’t follow anyone! Think for yourselves! You are all individuals!” To which the crowd replies in perfect unison, “Yes, Master, we are all individuals. We are all individuals. We are all individuals.”

To borrow a phrase, Read the Whole Things.

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Ayn Rand the Writer

Bryan Caplan is defending Ayn Rand on literary grounds. It's a novel approach, so to speak. I've never been a big fan of the "I don't owe nuttin' to nobody" core of objectivism (sorry, Persephone), although she ably defended the individual ego at a time when the intelletual world seemed gripped by various collectivist or aggregationist ideas of one sort or another.

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February 01, 2005

Judging Financial Impact

By law, any piece of proposed legislation must be assessed for the future financial impact on the state, looking at project effects on both taxes and spending. Like this assessment of this seemingly innocuous bill, for instance.

Now, Representative McCluskey and Senator Lamborn are proposing that Colorado adopt Dynamic Modeling to assess these effects for tax policy changes at the request of the Assembly leadership. This made quit a stir when the national Republicans started using it for changes at the Federal level a few years ago.

It makes sense. While models are inexact, the fact is that by projecting out straight-line, you're already using a model, just a lousy one. People do adjust their behavior based on tax incentives; the entire tussle over securitizing the tobacco revenue stream is predicated on this fact.

Democrats tend to dislike this sort of analysis, because it inevitably shows that higher tax rates depress business activity, and therefore revenue, in the long run. Again, beyond a certain point, this is a fact. Even the Tsar is having to sell his plan by using language like, "lowering the income tax rate and keeping the extra money it generates" (emphasis added).

One peculiarity is the limitation to 10 bills a year. There's no specific mention as to whether or not the leadership will have to throw a red flag, or if they'll be assessed a timeout.

So far the bill is still in committee. I'll try to find out more about its status.

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January 31, 2005

Gillette, RIP

I don't have anything against P&G, but its acquisition of Gillette looks to me like a stunning betrayal of Gillette's history.

And this may seem frivolous in the face of such larger issues, but Gillette has a great history and a unique culture, and over time, it will get swept into the dustbin. King Gillette, an amazing larger than life character who more than 100 years ago invented the modern safety razor and what could arguably be considered the business model of the modern age (how many businesses operate on a "razor blade" replenishment model?), will fade even further into history.

Gillette had run into trouble before and managed its way out of it. Its heroic CEO Colman Mockler was profiled in Good to Great:

While it might be a stretch to compare the 11 Level 5 CEOs in our research to Lincoln, they did display the same kind of duality. Take Colman M. Mockler, CEO of Gillette from 1975 to 1991. Mockler, who faced down three takeover attempts, was a reserved and gracious man with a gentle, almost patrician manner. Despite epic battles with the raiders—he took on Ronald Perelman twice and the former Coniston Partners once—he never lost his shy, courteous style. At the height of the crisis, he maintained a calm business-as-usual demeanor, dispensing first with ongoing business before turning to the takeover.

And yet, those who mistook Mockler’s outward modesty as a sign of inner weakness found themselves beaten in the end. In one proxy battle, Mockler and other senior executives together called thousands of investors, one by one, to win their votes. Mockler simply would not give in. He chose to fight for the future greatness of Gillette even though he could have pocketed millions by flipping his stock.

Consider the consequences had Mockler capitulated. If a share-flipper had accepted the full 44% price premium offered by Perelman, and then invested those shares in the general market for ten years, he still would have come out 64% behind a shareholder who stayed with Mockler and Gillette. If Mockler had given in, none of us would likely be shaving with Sensor, Lady Sensor, or the Mach III—and hundreds of millions of people would have a more painful battle with daily stubble.

Certainly, the Wall Street Journal (subscription required) has speculated on the difficulty of aligning management and shareholder interests:

While some say Mr. Kilts, 56 years old, deserves every penny for turning Gillette around and adding billions in shareholder value, his big payday after just four years is spotlighting some longstanding issues about CEO pay in general: Are top executives sometimes motivated to do mergers, at least in part, by personal gain? And is it right for the top people to walk away with megamillions while thousands lose their jobs in post-merger downsizing? P&G and Gillette have said 6,000 jobs are likely to be cut in the combined company.

I'm not sure there's a right answer here. A substantial part of Larry Ellison's pitch to shareholders was that management was failing them by refusing to sell Peoplesoft to him. It doesn't have to be one or the other, but it does mean that there's no automatic right answer.

I think the problem was more lack of commitment than outright greed. Kilts had done this before at Nabisco, revitalizing the brand and then selling it to Phillip Morris. And he never moved his family to Gillette headquarters in Boston. Kilts had also brought a large group of managers from Nabisco over with him to Gillette. He may have known how to make Gillette's culture work, but I doubt he really saw anything special in the place.

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Carnival of the Capitalists

For the business blogger in you...

Someone you know may have made the cut, but please, go read someone else. There's a lot of really, really good stuff there this week.

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January 30, 2005


I had an long, interesting conversation with Sandra Adams of McMad Neighbors this afternoon. Ms. Adams and I ran through some of the issues, many, many of the complaints, and a fair number of the complexities of putting a McDonald's at Krameria and Colfax. I'll need a little time to digest the whole thing, but look for a post on the subject soon.

The impression I got is that there are some valid concerns, but that they are of an extremely local nature. This doesn't make them less valid, but it does make them of less interest. Therefore, in order to gain greater interest, the group has had to exaggerate other potential impacts. And at the same time, McDonald's and the developer aren't necessarily the bad guys here - the city government and CDOT could take some simple steps to alleviate the legitimate worries altogether.

As I said, McMore to come.

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With the mechanics' union rank-and-file voting down concessions, including some pretty severe ones like jobs cuts, United Airlines is once again facing bankruptcy.

Oh wait, we're well past that. They're looking at liquidation. The union is claiming that it can save the airline millions of dollars without further cuts, and let's hope they're right, because everyone agrees that a strike will kill the airline once and for all. The real question is, when the local spokesmen say that mechanics are ready for that, is it the real turtle soup, or only the mock? Because now it's for all time, and not merely a lark.

Pointing that the unions (not this particular union, though) sat on United's board for years, and helped to plunder the company just as surely as any Global Crossing executive doesn't help things now. But it does raise some interesting questions about this au currant idea known as "Stakeholder Theory."

Briefly put, Stakeholder theory claims that a business has responsibilities that go outside of satisfying shareholders. Milton Friedman has argued vociferously that if you don't like what a company's doing, pass a law, or maybe strike, but that to load all the responsibilities of the world onto corporate management is to create insolvable problems. It's bad enough they're expected to make a profit when the guy next door is trying to do the same thing; burderning them with other, fairly ill-defined obligations is just going to sink the company in the long run. The employees, neighbors, suppliers, customers, generations future and past, and presumptive visiting space aliens all have the means to defend their own interests if they exist.

Nevertheless, Stakeholder Theory is now standard fare in b-schools. Hundreds of books have been written, thousands of seminars taught, millions indoctrinated, so going back probably isn't an option. And to be fair, to cite a current topic of conversation, it might not, strictly speaking, be a food chain's fault that it smells like french fries and its customers forget how to use trash cans when they walk out the door. But the company might still be considered to have an ethical obligation to mitigate some of those effects.

Now these are usually presented as management obligations. In the first place, the people teaching ethics tend to lean a little to the liberal, though not usually Leftist, side. Still, the mechanics' case suggests that this water may flow in many directions.

For the sake of argument, let's suppose that the union proposal, due in court this morning, saves cash but prevents improving internal processes. The company won't emerge from bankruptcy, and it wouldn't be any better-able to compete in the long run. The company would liquidate.

Who would be hurt? All the other employees, who have accepted cuts, for one thing. United's debt-holders, who have gone along with this long-running last act for years, hoping to get paid back. Airport business employees and owners, who would find their concourse following the mining industry. Not to mention a judge who'd have to find another case to manage. All these people would be perfectly furious with the mechanics, and rightly so. If management has an ethical obligation to consider employees and customers, unions have no less an obligation to consider other employees and downstream businesses.

In a way, this argument should be resolved by now. Margaret Thatcher and, to a lesser extent, Ronald Reagan, were both elected as a result of union intransigence that was hurting non-members. Like the people freezing to death for the greater glory of Scargill.

At the same time, maybe the union is, in a perverse way, actually aiding stakeholders. United isn't coming out of receivership any time soon. It retains its death-grip on gates it can barely use, and can't possibly be the most efficient tenant for. It's already prevented Frontier from expanding service, and reconsidering its plan for a maintenance shop here. As sinking ships go, United is taking a lot of surrounding shipping with it.

There's no way to do this calculation, of course. Once you start expanding the universe of people with claims, there's practically no end. Not to mention the fact that if shareholders have to consider everyone else, who'll be left to consider the shareholders? Which is perhaps the best reason to leave Stakeholder Theory on the shelf, for now.

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Modern Management

Last week, the Bush Administration began implementing the new, non civil-service rules for the Department of Homeland Security.

The Bush administration unveiled a new personnel system for the Department of Homeland Security yesterday that will dramatically change the way workers are paid, promoted, deployed and disciplined -- and soon the White House will ask Congress to grant all federal agencies similar authority to rewrite civil service rules governing their employees.

The new system will replace the half-century-old General Schedule, with its familiar 15 pay grades and raises based on time in a job, and install a system that more directly bases pay on occupation and annual performance evaluations, officials said. The new system has taken two years to develop and will require at least four more to implement, they said....

A raise or promotion -- moving up in a pay range or rising to the next one -- will depend on receiving a satisfactory performance rating from a supervisor, said officials with homeland security and the Office of Personnel Management.

"We really have created a system that rewards performance, not longevity," OPM Director Kay Coles James said in a briefing for reporters. "It can truly serve as a model for the rest of the federal government."

And soon it might. The White House will propose legislation within a month to allow all agencies to restructure their personnel systems in a similar way, said Clay Johnson III, deputy director for management at the Office of Management and Budget.

Naturally, the government employees' unions aren't happy about this change, and its proposed extension. After all, using actual evaluations instead of a clock-punching, time-marking system for grade and pay-scale threatens the very core of the civil service.

"They are encouraging a management of coercion and intimidation," said John Gage, president of the American Federation of Government Employees. He added: "This is not a modern system. This is a step backward."

Actually, it's a quantum leap forward, the very definition of modern management, fraught with the perils and promising the rewards that business managers have been dealing with for generations:

Smaller-scale experiments with changing pay systems at the Internal Revenue Service and the Federal Aviation Administration have produced mixed results. Managers at both agencies have said that it is easier to recruit talented workers at higher salaries than before, but it has also been difficult to create new pay systems that rank-and-file employees view as fair.

The current civil service system dates to the Pendleton Act of 1883, which replaced the "spoils system" of distributing jobs through political patronage with a merit-based system.

The proposed system appears to be based on an evaluation practice called the Balanced Scorecard, a means of aligning and evaluating employee and unit performance and activities with the organization's broader mission. In this sense, there's no reason why public sector organizations, or non-profit and government agencies can't apply it just as effectively as businesses. And there's absolutely no reason why it should only apply to agencies with a national security interest. The Balanced Scorecard Institute has been helping the Feddle Gummint do just that for a while now.

Initially developed in a series of Harvard Business Review articles, the Balanced Scorecard develops four sets of metrics for any organization: 1) financial, 2) customer-based, 3) internal processes, and 4) learning and growth.

Developing a balanced scorecard for an organization can be a very strenuous and time-consuming approach. It requires clear definitions of missions at all levels of the organization, and for all units. It requires a clear vision of the strategy to accomplish those missions. Established companies that may have strayed can spend months or years figuring this stuff out, all the while still having to conduct business.

Defining the measurable results is probably the next-hardest goal, and it's one that many companies have punted on, using traditional metrics like profit margin and ROA. Those measurements are derivable from public sources, so they're ones favored by analysts. And if a company is interested in pleasing analysts, those are the metrics it may focus on in the short- to mid-term.

But public information is decidedly and intentionally limited. The Balanced Scorecard approach is intended to make more sophisticated use of managerial accounting which uses internal numbers. To take an example from Jim Collins, Walgreen's measures its store performance in profit-per-customer-visit, something an outside analyst could only guess at, and even then only at a company-wide level.

According to Gallup, 60% of Fortune 500 companies now used the Balanced Scorecard in whole or in part. That number will probably grow as companies adopt it earlier in their lives.

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January 26, 2005

Blogs in the Classroom

When will we see the first class taught using a blog as source material? I think I've found a candidate.

Michele Leder is a financial reporter who likes finding things in footnotes, where companies hide - or try to hide - the really scary stuff. She posts once a day to her blog, Footnoted, about some juicy tidbit she's found in some company's 10-K or 10-Q. Her book, Financial Fine Print: Uncovering a Company's True Value, looks like a very accessable discussion of what companies will do not to disappoint the analysts.

So instead of an accounting text that the professor ignores and that I may never open after I graduate, but that I still have to pay $40 for, how about making the book required reading, and using the blog-postings as the basis for in-class discussion.

Obviously, professors have a tremendous financial incentive to publish their own case-studies, and then to update them every year or so. But how much more fun it would be to look at live examples rather than ones already under glass.

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More Steel

Sometimes you win on long-term contracts, sometimes you lose. California's Grey Davis lost big time. US steel producers, who've been enjoying a very good year, may be insulated from suddenly rising iron ore and coking coal prices.

North American steelmakers have stronger relationships and longer-term contracts with their suppliers and are expected to be less affected. Still, the effect of higher raw materials could be felt by steel consumers world-wide. Steel prices were expected to remain near current high levels for the first half of the year, then taper off in the second.

"What this is going to do is push up selling prices [for steel]," says Chuck Bradford, a New York-based steel analyst with Bradford Research/Soleil Inc.

Well, maybe. But with profits strong, it may also be a chance to weed out some of the weaker producers, and a market-share opportunity for US steel producers. After all, "[i]n some ways, the price run-up is a delayed reaction to high steel prices."

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Checking in With the Mother Ship

Jonathan Sabin of Mangled Cat is in town this week, and we had a chance to get together at the company store last night, and chew over his new HP Tablet PC, business in general, and Howard Schultz's creation, in particular.

Jonathan has completely drunk the KoolAid Latte for the place, but it's hard to argue with him on objective grounds. As part of their training, Starbucks employees each get a copy of Pour Your Heart Into It, and Schultz makes a point of stopping by to autograph every copy. Starbucks really hit its stride when he took over, so there's a question as to whether or not it qualifies as Good to Great, or just great, but if you're looking for a case study to do on your own, there are worse places to start.

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January 25, 2005

American Banks Enter China

Merrill Lynch is going to enter the market for underwriting Chinese securities, it reported today.
Man, Walter Wriston dies and everyone forgets everything his Big Latin American Misadventure taught him. Let's just hope they're going in with their eyes open.

But many say there is no need to rush into the market, citing the difficulty in finding the right partner, regulations precluding majority control, and the pace of regulatory changes in China's fast-evolving securities markets.

Under existing regulations, foreign banks must work with a Chinese partner to do business in the country. Chinese rules allow foreign firms to own as much as 33% of securities joint ventures, and permit underwriting -- but not trading -- of domestic securities. In other parts of China's financial sector, such as the asset-management business, foreign firms can own up to 49% of a venture.

Add to that opaque financial and unreliable economic numbers, cozy loans from banks to state-owned businesses (a la South Korea), and an increasingly untenable currency situation. Sure, the Chinese boom is likely to go on for a while. A few serious financial reverses won't alter the long-term trend there, any more than they did here, 150 years ago. But that's no reason to set yourself up.

Still, if Merrill has learned something, and has the guts to stand up to its domestic partners (so to speak) and demand better reporting, it could help to encourage better standards on the part of Chinese businesses. Or, they could end up lending their good name and respectability to enterprises doomed to destroy market capital on an untold scale.

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Meaningless Numbers

When even the professor gets sucked into a meme, you know it's powerful. It's a shame it's also meaningless.

Consumer confidence rose again last month. Now, while I'd rather have people cheerful than depressed (financially or emotionally), this is one of the less useful numbers around.

As our securities analysis professor said, "never trust anything that anyone tells you." We ran a correlation between the consumer confidence numbers and economic performance, leading, trailing, and side-by-side, and we got "pretty close to irrelevant" as our answer.

While it makes intuitive sense that a confident consumer is our best customer, in fact, consumer confidence has a lot less to do with objective national or personal economics, and a lot more to do with the news you're getting. Freed from the frenzy of a national election, not only is MSM reporting probably less tilted, but people's perceptions of it are probably less biased, too.

This isn't bad news, but it isn't really good news, either. It's just no news.

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Nokia, the Official Cell Phone of Blue America

OK, that's a little harsh, but these comments from Nokia CEO Jorma Ollila show a couple of things.

Nokia's chief executive, Jorma Ollila, said in a rare television interview that the world is living in "an era of selfishness" very different from his childhood days in a small town in central Finland, when family values were of prime importance.

"Put in a nicer way, it is an era of individualism. This is a very self-centered period, which also has plenty of good features too because, when understood correctly, it can help you live independently and stand on one's own two feet," Ollila, 54, said in a candid interview broadcast on state-run YLE television.

Speaking with Finnish philosopher Esa Saarinen, a personal friend, Ollila said he thinks people are more concerned about individual rights than taking responsibility for their actions and trying to have a positive influence on society.

"What I'm worried about is that if this disintegration of values continues and develops further, we'll get a conservative counter-reaction precisely like what has actually happened in the USA," he said.

"This ultraconservatism, coupled with the elements of the church ... which, as we well know, has also supported the current (U.S.) administration, is a powerful counter-reaction to a longtime vacuum of values in society," Ollila said.

Later on in the interview, Ollila talks about the importance of his company being an "educartional establishment," which means that not only do the employees learn, but that the organization's implicit knowledge improves, too. It's a key insight, and part of what's made Ollila such a successful CEO.

No, what this interview shows is that any leader, even a CEO, especially a CEO, is only as good as the information he gets. Ollila gets gobs and gobs of market research data on the US, and yet clearly understands so little about our culture and how we see ourselves. He clearly gets his political news from the European MSM (or whatever the Finnish acronym is), who very quickly adopted the Americans-as-religion-obsessed-reactionaries meme.

"The church," as such doesn't exist in the United States. Perhaps Ollila is viewing religion through the European experience of established churches? In fact, religion in America has adapted quite well to individualism, paralleling business success.

The marketplace of religion in America never resembled AT&T as The Telephone Company. It may have, centuries ago, resembled post-breakup AT&T and the regional Baby Bells. Bur if Ollila wants a good analogy, it's the telecom market of today, with competing companies offering competing versions of competing technologies. Ironic, that.

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Steel Steal?

So, this catches my eye in the earnings reports (hey, you, wake up, this gets interesting).

U.S. Steel Corp., the first major domestic steelmaker to report earnings, swung to a fourth-quarter profit of $462 million from a year-earlier loss, helped by strong demand, particularly in its tubular business.

The company posted net income of $3.55 a share, its fourth straight quarterly profit after four quarters of losses in 2003, before a pricing boom lifted the steel industry's profits and share prices.

U.S. Steel, the country's largest steelmaker, had a loss of $22 million, or 26 cents a share, a year earlier. Fourth-quarter revenue surged 47% to $3.93 billion.

The company was able to make a $255 Million pension contribution, and will have about $1 Billion in the bank for foreign acquisitions. It's not just rising prices, either, as shipments were up 14% over last year. The company seems to be running as somewhat leaner operation, as SG&A and per-unit cost of production have fallen. US Steel has lagged behind Nucor for years, but may have actually caught it this quarter, and may pass it in cash on hand.

Imagine that. An industry that was being taken to a chop shop itself a few years ago is now ready to buy up foreign competitors. I'm sure this isn't news to industry followers, but for people like me, it's going to mean a whole new paradigm shift. While my parents had to shake their heads at a crumbling empire, I got used to seeing the dead mills in and around Johnstown, PA. (I had a weekly commute from DC to there for a brief time.)

Now, I'm going to have to get used to thinking of the US steel industry as profitable.

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January 24, 2005

More Trouble for GM

Won't American car companies ever learn? Heaven is a place where the English are the Police, the Italians are the cooks, and the Germans are the mechanics. Hell is a place where the Germans are the police, the English are the cooks, and the Italians are the mechanics.

There may have been some American-Italian car partnerships that succeded, but I can't remember them. Chrysler spent hundreds of millions of dollars to build a few hundred specialty cars with Maserati back in the 80s. Now, GM is trying desperately to find a way out of its money-hemorrhaging deal with Fiat (the WSJ has a superb article, but you need a subscription).

The problem is a $2 Billion put option that Fiat holds - over GM's head - as part of the price of the 20% acquisition. Both companies have gotten killed in Europe:

According to the Journal:

The negotiations are coming to a head as GM, which paid $2.4 billion for a since-diluted 20% stake in Fiat's car unit in 2000, faces a possible cut in its credit rating. In its core market of North America, GM has been losing market share and been forced to cut production amid increased competition from Asian rivals such as Toyota Motor Corp. and Nissan Motor Co. If GM is forced to pay a hefty settlement to wriggle out of the put option -- or worse, has to acquire the Italian auto maker and its $10 billion in debt -- it could weigh heavily on an already burdened balance sheet...

When Mr. Wagoner negotiated the Fiat tie-up he also agreed to another clause -- the put. The agreement, which is valid between 2005 and 2010, gives Fiat the right to force GM to buy out all of the Italian company's car unit at a price to be negotiated. Fiat had insisted on including the put option as an insurance policy should its alliance with GM go awry, something which neither company considered likely.

Now, puts between companies aren't normal, but they're not unusual, either. Sometimes they can be added when one company is selling a division to another. When one Canadian telecom sold a division to another, it included puts, to be followed by calls. At other times, they're included to limit risk.

But GM might have been expected to smell a rat here. If "neither company considered [failure] likely," then Fiat shouldn't have insisted on it. Instead, they cheerfully went along, and are now looking at the unappealing possibility of litigating in the famously arbitrary Italian courts, a home field advantage for Fiat if ever there was one. Now, Fiat is using the put to hold up GM for cash it needs, while GM is trying to avoid shredding its balance sheet beyond recognition.

Things may have improved since Luigi Barzini wrote The Italians, but if you were GM, how eager would you be to test that thesis? And don't you wish that GM's CFO had a blog?

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Carnival of the Capitalists

It's up, and...it's Good!

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United Out of Bankruptcy?

From flying to United. The Rocky is reporting typically optimistic comments from United CEO Glenn Tilton that the airline will be out of receivership by the fall. Where have we heard this before?

Nobody wants United to die - there are too many jobs at stake locally - but the airline's been operating in backruptcy for over 2 years. Labor and management reached sweet deals which drove up the industry standard and have helped contribute to the airlines' recent malaise. But merely undoing those contracts won't solve the problem.

United has both a customer service and a cultural problem. I have never encountered the kind of rudeness that I have at a United ticket counter. United doesn't seem to have a culture of improvement that the smaller airlines have. I don't think it'll be able to overhaul its outdated hub system, destined to become more outdated as the FAA permits point-to-point flying rather than forcing prescribed routes.

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January 21, 2005

Health Care, the New Pensions

Underfunded defined-benefit pensions are killing corporate giants. They've already taken out Bethlehem Steel and TWA, and now they're stalking airlines and car companies. The companies had to choose between huge cash flow diversions and remaining competitive. Sometimes, they didn't even get to choose.

Now, it's health care. From yesterday's Wall Street Journal:

A decision by the ratings company, while not imminent, would represent a significant symbolic blow to a 108-year-old company that has epitomized the strengths and weaknesses of the American manufacturing belt. It could also deal a financial hit to one that has recently relied on cheap borrowing to keep its costs low while it deals with foreign competition and rising health-care costs.

If this isn't a canary in the coal mine, I don't know what is. Smaller companies groan underneath the radar. But GM? (It's a shame their CFO doesn't have a blog.) GM may be decades away from failure, but western Pennsylvania had turned into a junkyard 20 years before Bethlehem finally went under. We don't have Europe's welfare state problems, but we do have the same laws of economics and mathemtics, and as interest rates rise, it's going to be harder for GM and others to play this shell game.

Defined contribution 401(k) have largely replaced defined benefit plans. Give us the money, we'll take care of ourselves. Health Care needs a comparable shift. Employers, as the deep pockets, have been subsidizing rising costs, and now even deeper pockets are being called in.

Health Savings Accounts (Ted Kennedy's shrieks of indignation notwithstanding) are a good start. Other ways to get decision-making back down to the consumer level need to be found.

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January 20, 2005

From the Nobody Ever Learns Anything Department

If JP Morgan thinks this is going to satisfy anyone, they need to do a little more historical research:

JPMorgan Chase & Co. is the first company to acknowledge that two of its predecessor banks had specific links to the slave trade. The filing was meant to comply with a Chicago ordinance requiring such disclosures.

The bank, the nation's second largest, said in a statement Thursday that the two Louisiana banks had received thousands of slaves as collateral before the Civil War.

The New York-based bank also apologized for contributing to "a brutal and unjust institution" and said it was setting up a scholarship fund in Louisiana as a way to make amends.


The bank said that historical researchers had found that two now-defunct predecessor banks - Citizens Bank and Canal Bank, both based in Louisiana - served as banks to plantations from the 1830s until the Civil War.

"Collateral" for mortgages and other loans "included land, equipment and/or enslaved individuals," the statement said.


The two Louisiana banks merged in 1924 but failed in March 1933 amid the Depression. A federally chartered bank in May 1933 assumed some of the failed banks assets, and that institution - the National Bank of Commerce in New Orleans - was a precursor of Bank One Corp. Bank One was purchased last year by JPMorgan.

So let's get this straight. JP Morgan is claiming implicit moral responsibility for two failed banks who (presumably) stopped trading in slaves 68 years before they failed, and we acquired by a bank that later was acquired by a bank that was later acquired by JP Morgan Chase. If I've got my genealogy right, that's a cousin subsidiary precusor three times removed through marriage. By this logic, it should be sometime this year that we get an official statement from the Palace that Queen Elizabeth II has taken personal responsibility for some massacre perpetrated by William of Orange.

The worst part is that Morgan has managed to make the worst of a silly situation. They've implicitly claimed moral responsibility for a problem, and then put down money that wouldn't pay the paralegal fees for any claimant's case against them. They've accepted the bogus social science that links slavery to today's poverty, and the agitators they're trying to appease won't care, they'll just use it to hijack the next company.

Posted by joshuasharf at 11:03 PM | Comments (0) | TrackBack

The Nanny State Continues

Since the theme of the day is Liberty, let's take a quick look at a rising-power-wannabe that could use a refresher course ("Brussels Warns on Junk Food"

The food industry has been given a year to stop advertising junk food to children and improve product labelling or face legislation in the European Union.

Markos Kyprianou, EU health and consumer affairs commissioner, warned in a Financial Times interview that urgent action was needed to tackle Europe's obesity problem, particularly among the young.

Mr Kyprianou believed self-regulation in the food industry was the quickest and most effective way to tackle the problem. But he warned the European Commission would resort to legislation if progress proved disappointing.

"Nice business ya got here. Wouldn't want anything to happen to it."

We won the Cold War for this?

Posted by joshuasharf at 08:41 PM | Comments (0) | TrackBack

Accounting Conservatism

In Financial Accounting and Reporting last night (also known as Fraud 101), we started in on Enron. With masks and gloves and scale at the ready, we pulled back the covers and began our own autopsy. Amid the talk of stock watering and push-me-pull-me companies, came the discussion of red flags, especially compared to other industry companies.

"But," the professor asked, "what is Enron's industry? They're trying to create a new industry all by themselves." It certainly does make it hard to find a standard for comparison. Enron's business, fraud aside, was to try to be the bookmaker for the world, to become a marketplace for just about any saleable commodity. "They even were talking about setting up a market in pollution tax credits!"

Wait a second.

Just as some cops come to believe that inside every citizen is a thug, do some accountants come to believe that inside every legitimate market is a fraud? What Enron did with its own stock was repulsive. But Global Crossing was just as crooked, and nobody would claim that long-distance or fiber optic capacity weren't legitimate assets. Pollution tax credit markets are a fine way to help reduce pollution, although they offend the regultory impulses of environmentalists. As long as the asset is real, there's no reason it can't serve as the basis for derivatives.

This professor's reaction helps confirm some of my worries about Sarbanes-Oxley. Accountants may well go from asking how we value an asset to assuming that we can't. Along the way, a large number of good ideas may get thrown out with the few truly fraud-inducing ones.

Business is too important to put in the hands of accountants.

Posted by joshuasharf at 11:24 AM | Comments (1) | TrackBack

January 16, 2005

Larry Ellison - Working Man's Hero


In my review of In Good Company, I complained that the companies that were most likely to treat their employees like checkers were the ones run by kids. Of course, as Ringling Brothers Barnum & Bailey always reminds us, children can be of any age.

From yesterday's Rocky:

Oracle Corp. Chief Executive Larry Ellison is firing about 5,000 employees after combining Oracle and PeopleSoft Inc., and as many as 600 of those job cuts could come in Denver.

PeopleSoft employees were told Friday they would find out their fate today in an express letter sent to their homes from Oracle.

Oh, that's classy. Complete a hostile takeover of a company, gloat about how the employees don't really have any other options, and then tell them to wait at home, enjoying a nice Friday night meal with their families waiting to find out if they'll have a paycheck in two weeks. Ellison is famous for winning sailing races and infamous for taunting people still out on the course by buzzing them with his plane. It's a shame he couldn't have put a couple of dozen people on that plane to go tell people face-to-face that he was letting them go, and what the company would do to help them.

Gloat? Consider this exchange from a December 13 interview with Neil Cavuto:

CAVUTO: Let me ask you, are you worried that in the months that this battle ensued that you had a bit of a brain drain to deal with, that some of the best and brightest at the company might have already left?

ELLISON: I don`t think so. Keep in mind that Silicon -- this is not the Silicon Valley of the dot-com era. It`s not like there are hundreds and thousands of really wonderful jobs available for engineers in Silicon Valley.

I'm sure that the 12,000 employees at Peoplesoft were looking forward to serving their new boss, Mr. Warmth, but I also seem to recall the Peoplesoft buyout of J.D. Edwards having a little different tone. Maybe those Peoplesoft executives who fought tooth-and-nail to save their company actually did have something more than their own jobs in mind.

In Good to Great, Jim Collins recounts how Colman Mockler fought to save Gillette from Ronald Perelman, The deal would have meant an immediate 44% profit for shareholders, and the company would have been carved up with its own razors and sold for scrap. Sometimes, it's not about today's cash.

Collins also talks about the need to be rigorous, cutting people who won't fit the corporate culture rather than keeping them on, damaging the company, and preventing them from finding a new niche. He uses the example of Wells Fargo's takeover of a more traditional bank whose managers enjoyed more traditional bankers' perks.

I did take a look at some of the relative overhead costs of the two companies, based on their most recent annual financial statements. (Oracle and Peoplesoft) It does turn out that Oracle is running a leaner operation than Peoplesoft. Oracle's SG&A is about 3/4 of Peoplesoft's as a percentage of revenue, not entirely surprising giving Oracle's revenues are about 4 1/2 times larger. So some cutting is probably justified.

I'm sure Ellison believes these cuts are necessary, and businesses have a right to run their operations as they see fit. But there's a reason more and more people are rooting against him.

Posted by joshuasharf at 10:14 PM | Comments (0) | TrackBack

January 13, 2005

More Social Security Public Accounts

Nathan Newman has responded. My ups.

What policies could the government impose on companies due to holding a board seat that they can't impose through legislation? State pension funds hold significant shares of a number of companies and, most of the time, the problem is that management ignores most of their good governance complaints. The only time their presence makes a difference is when a lot of other shareholders get concerned about the same issue. And if the social security fund is reflecting the views of other investors in the private equities marketplace, we are hardly talking about a galloping socialist impulse.

Whether or not that's the problem depends on whether or not you think their good governance complaints are valid. Certainly, if you're Eliot Spitzer, you can legislate through the courts. But in a well-regulated economy, there's a process both for passing laws and for adopting regulations. Calpers and others like it do indeed have an oversized voice in corporate governance already, and a bully pulpit to push it from. A Social Security Investment Corporation would have the threat of government action behind it, as well. not merely on one board, but on many, many boards.

I said,

investing in inefficient domestic companies virtually guarantees the investors - you - lower returns. In effect, you're subsidizing inefficiency, a national version of making everyone pay more for groceries because you don't like WalMart.

In a fair comparison, returns are returns, no matter who's doing the investing. And domestic economic growth only happens when there are returns to investors. Governments don't get any more out of that than anyone else.

And Newman replies,

This last point is the ideological argument that "what's good for General Motors is good for America," but it's also patently untrue in this situation.

If the social security trust fund loans money to build housing in the United States and gets an 8% return on investment, but also gets additional payroll tax payments from the labor involved, the additional payroll payments are hardly irrelevent to the gains to the trust fund over time. Money is money whether it comes through dividend statements or taxes. If that same investment by the social security fund goes to Enron investing in off-shore financial investments and there are no payroll taxes generated, the social security fund may do worse even if Enron pays slightly higher dividends than the housing investment paying the 8% return.

I'm actually not making the "good for General Motors" argument. I've always despised that argument. It refers to the chairman of that company arguing for preferential treatment on the grounds that he was better for the economy than the alternatives. I was obliquely referring to laws, such as Manhattan had for decades, that kept small groceries open at the expense of larger shops, by limiting the size of certian types of retail establishments. Everyone paid more for plums because of this policy. Which means they ate fewer plums, or less of something else.

The latter point stands. The government collects taxes whether those new jobs were created through private investment or public investment. And the businesses that created those new jobs did so by rewarding their investors. The comparison between dividends and taxes had occurred to me, too, but I rejected it because taxes aren't dividends. If the government holds shares of AT&T, it collects dividends, too. You can't count things in one column and not the other, and you can't count things twice.

Those taxes that get collected will be reinvested at a lower rate, as well. Newman claims they compound the return. I say they compound the shortfall in the returns.

Posted by joshuasharf at 07:05 PM | Comments (0) | TrackBack

January 12, 2005

Public Savings Accounts

Nathan Newman of New York University wants to know why his idea of having the government invest Social Security money in the stock market is such a bad idea. I don't think any of the arguments I present here will persuade him, but an honest effort demands a thoughtful response.

Efficiency...while current administrative costs for social security are just $15 per worker involved, private accounts could cost as much as $50 per year. Such a system would knock out up to thirty percent of the touted accumulated returns on investment.

Could knock out up to 30%, on average knocks out much, much less than that. In the first instance, I think he overstates the cost. Most of the reasons for increased costs that he cites are already either built in or would remain irrelevane. Even give an extra $35 a year, though, if an employee gets a 12% contribution on $30,000, that's $3600 per year. Thirty-five dollars is almost exactly one percentage point interest. If current after-inflation returns are close to zero, and they are, the extra costs come to 14 of the added return. Mutual fund companies with hundreds of thousands of customers routinely make do with much less than that. Even to give the government that much is to confirm conservative suspicions about giving them the cash in the first place.

Government investments could be directed to investments that strengthen wage growth: The idea that the government might actually use all this capital in the social security trust fund in a pro-active manner gives rightwing economists hives, but it makes a lot of sense. James Glassman from the American Enterprise Institute attacked Clinton's proposal to have the government invest in stocks with the S scare word:
I do not want to sound overly dramatic, but, by definition, the plan is a step toward the dictionary definition of socialism: government ownership of the means of production.

Yet even in Glassman's hyperbolic venting, he admits that the government would own only 3.7 percent of the total value of the shares on the stock market, hardly enough to implement five-year plans. The government's existing regulatory powers over business gives it far greater potential control of business operations than this tiny minority share of stock would. Even with this reality, many promoters of government investing in the stock market call for elaborate controls to require blind investments in stock indexes.

This is just nonsense. Anyone with experience in the financial markets knows that a 3.7% share in a company is gigantic. It guarantees broad say in policy decisions, great leverage in proxy fights, and frequently means a seat on the board. Outside of confiscatory taxation, I can't think of a better example of galloping socialism than to start giving the government board seats.

Add to that the fact that this money wouldn't be invested evenly across the entire universe of funds, and you realize that for many companies, government ownership would exceed 5%. At those levels, it becomes almost impossible to punish bad management by just dumping shares without crashing the stock. This has exactly been the justification that CalPers has used to start exercising extra-legal regulatory powers over a number of its biggest holdings.

To compound the problem, which Newman's suggested use of this power may or may not be benign, there's nothing inherent in the proposal that would insulate the government from making political decisions with the money. In the long run, I don't believe such safeguards are possible.

The only way to manage that problem is to, in effect, forbid the government from trading by forcing it to hold some large, fixed portfolio. This doesn't replace distributed decision-making with centralized decision-making, but with no decision-making. Those shares have to just sit there, free-riding on the market. You'll get a better return than T-bills, but I'm not sure you'll be contributing in any meaningful way to economic growth.

I don't want to get into the whole colossal off-shoring issue, which is where Newman takes this argument. However, it's worth noting that investing in inefficient domestic companies virtually guarantees the investors - you - lower returns. In effect, you're subsidizing inefficiency, a national version of making everyone pay more for groceries because you don't like WalMart.

Newman also argues that collective investment spreads the risk more. That's true. But it also highlights the difference in incentive that inevitably makes government returns less attractive. The government's job may be to spread risk, but an individual investor will tend to be motivated by a desire to maximize return.

Finally, there's this:

Privatizers want to talk about "returns on investment" from social security, while ignoring the fact that social insurance systems are not like regular investments. Individuals start out with a fixed amount of capital and the only returns that matter are from annual investment returns. But governments investing their capital have two sources of economic returns from those investments -- conventional returns from equity or bond markets PLUS the taxes derived from the domestic economic growth fueled by those government investments.

This is a bait-and-switch. In a fair comparison, returns are returns, no matter who's doing the investing. And domestic economic growth only happens when there are returns to investors. Governments don't get any more out of that than anyone else.

Posted by joshuasharf at 11:02 PM | Comments (1) | TrackBack

January 10, 2005

Business Blogs IV

Hard on the heels of that Fortune article and Hugh's book (what? Hugh has a book out? I hadn't heard), is a conference on businesses and blogging. Among those Who Should Attend: PR agency execs, employee communications managers, marketing managers, and crisis communications managers.

The sponsorship tells you a lot about where this is heading. Not only are blog-technologists like Six Apart (of Moveable Type fame) and PR firms like PR Newswire there, but also companies that are promising to put their ears out on the blogostreet and find out what people are saying about your company.

The topics of conversation are pretty much what any business cares about: image, product placement, and the techniques and mechanics of blogging. Honestly, this has the feel of a Web technology conference around 1996 or so. Mature enough to be interesting, new enough to be exciting.

A follow-on conference is planned for France later this year. Europe so far has been very far behind the blogocurve, but I wonder if business, being more tightly controlled, may also be seen as a safer topic of conversation than the Zionist Entity.

Posted by joshuasharf at 06:16 AM | Comments (0) | TrackBack

Carnival of the Capitalists

Blogging from around the world of business, investing, and economics.

Posted by joshuasharf at 05:14 AM | Comments (1) | TrackBack

January 08, 2005

Business Blogs III

Powerline mentioned this Fortune article, and now it's online.

Businesses are already catching on to this. As usual, the hardest part is resisting the impulse control. Which is why I think that in the end, the Blog will become an extension of the Street.

Posted by joshuasharf at 06:33 PM | Comments (1) | TrackBack

January 07, 2005

Pension Plans

Coyote Blog has some sound discussion on the transition between fixed benefit pension plans, and fixed contribution plans.

I think, however, that he's a little hard on the company in terms of their obligations to their workers. The unions, as he points out, were also perfectly aware of what the books were saying, and yet continued to insist on defined benefit plans. This sort of "generosity" is exactly the thing that helped sink Bethlehem Steel, giving them less and less room to maneuever even as their equipment aged and their market share shrank.

While he also overstates the risk from inflation in a properly managed plan, the cost of insuring against inflation would have been greater deductions from the cash flow. Using bond immunization, it's possible to manage a large plan in such a way that it's virtually free from risk due to interest rate changes. Barring the body-snatching of Alan Greenspan by Arthur Burns, inflation without higher interest rates is almost unthinkable. Such a mechanism would have required greater cash outlays, but it also would have sent out warning signals much earlier.

Posted by joshuasharf at 04:52 PM | Comments (0) | TrackBack

Business Blogging II

Hmm. Bob Lutz, who is GM's VP for product development, and Chairman for North America, has started a blog. As Rob May points out, posting can be a lot of work, but by begging for feedback at the beginning, Lutz is making it clear he hopes to read as much as he writes.

I follow cars as a consumer, and on the highway, not as a passion or as an analyst. But when Lutz says that Saturn's brand has been associated with quality rather than a look or design, that sounds about right to me.

Posted by joshuasharf at 07:46 AM | Comments (0) | TrackBack

January 06, 2005

Index Funds and Volatility

Is all this investing in index funds bad for the market? To restate it, at what point does all this investing in index funds become bad for the market?

Index fund investing is based on the idea that since it's incredibly hard to beat the market, it's a better use of your time not to try. Market returns average 8% a year after inflation, which is pretty good, and good enough for most people.

That it's incredibly hard to beat the market is based on two piece of theory. One is the Efficient Market Theory, that information is so quickly absorbed into a stock's price that you can't get ahead of it. The other is the Capital Asset Pricing Model, which argues that there's exactly one mix of assets that optimizes return for a given amount of risk. Put these two together, and you decide very quickly that you should just find that optimum portfolio and let your money sit there, rebalancing every once in a while to account for some companies doing better than others.

Of course, nobody really believes these things.

At least securities analysts and portfolio managers don't, which is why they do what they do for a living. But for most people, told that they can eliminate risk over the long term and make great returns, without having to wire money to Nigeria, will try to do just that.

Over history, most investing has been done on a security-by-security basis, building portfolios that satisfy certain criteria, but nonetheless are composed on individually-evaluated stocks. Index funds are just a way of capturing market efficiency without having to do all the work.

So here are the problems: First, excessive investing in index funds will increase market volatility. Therefore, second, it will decrease market efficiency in allocating capital. Third, it can become an excuse for analysts and investors to become lazy.

It will increase market volatility by reducing the ability of the market to act as a balanced portfolio. Instead of moving independently of each other (in terms of investing, not in terms of economic factors), index issues will be traded in tandem. Instead of balancing out each other's volatilities, index issues will instead tend to reinforce those movements.

To the second point, this means that good companies will be rewarded less than they would have been, and poorly-managed companies will be punished less. If you're trading AT&T and IBM together, simply because they're part of an index, you're not taking into account anything specific about AT&T's and IBM's management or prospects. Instead, you're treating them as a single security, even though they are completely difference entities.

The last point. In theory, the market is only efficient because people seek out information and try to apply it to stocks. That's the only way information makes it into the market. Index trading takes advantage of that efficiency without contributing to it.

This model certainly does have some assumptions built into it. For instance, we have no idea at all if or when these effects would start to make themselves felt. People are ingenious, and would find ways other ways to invest that took advantage of whatever inefficiencies were introduced. We don't even know if index trading even is introducing increased volatility. I hope to use my last term at DU for an independent study on the matter.

But the logic itself looks pretty good, and it does have one whopping implication for public policy. If and when we do allow private Social Security accounts, we should be very, very careful about what restrictions we place on peoples' investment choices. A massive infusion of cash, in a way that increases market volatility, would only make those who don't trust people not to lose their money into self-fulfilling prophets.

Posted by joshuasharf at 07:22 PM | Comments (0) | TrackBack

January 03, 2005

Business Blogging

The last sections of Hugh's book talks about the benefits of blogging as opening up new two-way communication channels. There's a lot of truth to that, although the way blogs will be used will probably look a lot different from what Hugh suggests.

There are, I think, a couple of fundamental roadblocks to blogs being used the way he envisions, and they don't just come from the attorneys. (Although, I've no doubt that the reason lawsuits from blogs haven't happened is that most bloggers don't have deep pockets.) But that doesn't mean that good, creative businesses won't use them, just the same.

While narrowminded legal objections are one source of roadblocks, there's also a question of content. Good blogs can range over an entire range of issues and questions, economic, technical, ethical, public policy. Most CEOs spend some time dealing with these things, but usually in the context of corporate strategy that they may or may not want to advertise to their competition.

There also just usually isn't enough internal news to justify daily postings. Perhaps senior management as a whole could generate enough postings to be interesting. But then, there's the danger of wrongheaded tea-leaf reading, either by employees or by the market.

That said, many of the best CEOs like to write think-pieces for the Wall Street Journal or other business periodicals. A personal blog, intended not for internal company communication but as a sounding board to the world at large would probably attract a lot of interest and feedback.

This doesn't have to happen at the senior management level to be interesting. This Wired article suggests two uses. Steve Rubel is only a VP at CooperKatz, but runs MicroPersuason. It's a place to air out ideas without affecting the company so directly.

Secondly, company or product fan-clubs have been around for a long time. Hugh suggests hiring the best writers outright. I think that compromises their integrity and their "earned" eyeballs. A better idea would be to troll blogs for news and buzz about their company and its products. Companies are already reselling this service.

If any of the blogs feature good, insightful writing, the company could establish informal relationships with those writers, treating them as reporters, inviting them to company events and using them to float trial balloons. Obviously there's risk here, too. A blogger who becomes to closely identified with the company can lose his credibility, while a company who manipulates a blogger or uses him for disinformation runs the risk of losing its source. These, however, are problems attendant not to blogs, but to media as a whole. "There is nothing new under the sun."

Hugh quotes from Ecclesiastes (Kohelet, to those of us who know Hebrew): "Vanity, vanity, all is vanity," in order to break it to the bloggers that their dreams of longstanding influence are so much vapor. He might well have quoted another verse: "There is nothing new under the sun." Business is both more innovative and more conservative than we think. For a while, blogs will be an extension of current practice. Eventually, they'll be used in ways we can't imagine now, but it'll take a lot of trial and error to get there.

Posted by joshuasharf at 11:11 AM | Comments (0) | TrackBack

December 29, 2004

Back to Work - and Something to Chew On

It's back to work, so I'll have less time for blogging. This doesn't mean no time, just fewer days like yesterday.

In the meantime, here's some economic analysis to chew on from Robert Samuelson. (It seems that old orders are crumbling all over the place.)

Samuelson notes four major changes happening in the US and world economies:
• The economy is bound to lose the stimulus of rising consumer debt.
• The benefits from defeating double-digit inflation are fading.
• The welfare state is growing costlier.
• The global trading system has become less cohesive and more threatening.

All four of these are long-term trends, not short-term problems. The fix is going to come from internal restructuring (reducing the welfare state costs, for instance), and external sources (watching China and India mature from export machines into internal markets).

Probably the most important thing we can do is to restrain our mercantilist impulses.

Posted by joshuasharf at 06:55 AM | Comments (0) | TrackBack

December 28, 2004

Terrorism as Law Enforcement

Yesterday's Wall Street Journal carried another article about the growing internal Muslim threat to Europe, "New Terror Threat to EU: Extremists With Passports."

Interviews with dozens of investigators, terrorism experts and acquaintances of Mr. Azzouz, as well as access to previously sealed court documents, suggest he may be more than a lone, misguided youth. Prosecutors see him as the face of a new terrorist threat: a homegrown network of young European Islamists dedicated to waging jihad at home.

Until this year, the West's struggle with Islamic terrorism has largely been a battle to stop outsiders from entering and doing harm. But according to European officials, the Continent now finds itself fighting members of its own Muslim communities -- young men like Mr. Azzouz who were born in Europe or moved there at a young age.

The challenges for law enforcement are huge. These young men hold local passports, speak local languages and fit into local immigrant populations. And instead of using Europe as a safe house for plots against the U.S. as earlier groups like al Qaeda had done, they are taking aim at targets across the Continent.


Terrorism experts say Europe is also proving to be a good substitute for Afghanistan, where from 1996 to 2001, an earlier generation of Islamic terrorists trained and coalesced from disparate bands into a coherent organization. Although Europe doesn't have the sort of training camps used back then by groups like al Qaeda, it has its own advantages. Instead of pickup trucks, transportation is on high-speed trains across the borderless Continent. Money doesn't come from charities or rich donors, but from petty crime in urban areas packed with rich tourists. And recruits come not from Peshawar guesthouses, but from pools of common criminals or the disaffected youth of Europe's immigrant slums.


Mr. Issar, who is thought by police to be hiding in Italy, is believed to have introduced the group to the teachings of Takfir wal Hijra, an ultra-orthodox sect that arose in Egypt in the 1960s. Takfiris view violent jihad as an obligation for every Muslim, and they have expanded targets of jihad to include practically everyone outside of their sect, investigators say.

Bolstered by Takfiri thought, younger European Islamists have turned to petty crime against infidels to finance their actions. Radicals in Spain, for example, bought the 440 pounds of explosives used in the Madrid bombings with hashish smuggled from Morocco, investigators say. In France, a Brinks security guard in March allegedly helped steal more than $1 million from an armored truck by simulating a kidnapping. Some of the money was later traced to Algerian radicals, and officials believe the rest is likely being used by European cells.

We probably want to avoid making too much of the Takfiris themselves. If they're spending time targeting other Muslims, they may be lethal when encountered, but unlikely to be encountered much.

What really bothers me is that we see articles like this every couple of months, and Europe still doesn't seem to get it.

By now, the demographic problem that Europe faces is well-known to everyone but the Europeans. Apparently, so is the ideological problem. These people take Saudi-trained clerics, mix in a dash of Iranian mullah-worship, and claim to see theocracy as only a bomb's-throw away. But their governments are happily midwifing an Iranian bomb, so long as it's aimed at the real threat to peace and stability, the Jews - er - Israel.

All they're doing is playing defense, expanding their treatment of the Law-Enforcement-and-Intelligence Problem, without understanding that there's a war going on out there.

Posted by joshuasharf at 05:17 AM | Comments (0) | TrackBack

December 27, 2004

Bauxing Day

Yes, Boxing Day was yesterday, but the title was just too good to pass up.

If anyone wants to see what "industrial policy" can do, they should take a look at China's aluminum industry. Unlike the steel industry, which has been a problem since at least the Mother of All Industrial Policies, the Great Leap Forward, aluminum has been profitable for some time, but it's gotten out of whack with the country's needs Now the government is trying to crowbar the thing back into alignment.

The booming Chinese economy has kept aluminum prices high, even as the country is a net importer of both aluminum, and a key smelting ingredient, alumina. The Chinese have been trying to slow down their economy. Whether or not they're succeeding depends on what month you read the WSJ. (3/23 - maybe; 4/7 - No; 6/1 - Yes; 8/11 - No; 10/29 - Maybe; 12/21 - No.)

The difficulty is multiplied by the fact that China has only just signed a Memorandum of Understanding to join an international regime to help ensure more accurate statistical reporting of both consumption and production. (China's claims to have passed the US in both categories have to be read as all Chinese economic statistics - you're lucky if there correct to within an order of magnitude.)

Now, with world aluminum prices falling, China has imposed both an export tax on aluminum, and a ban on small smelting plants' importing alumina.

(Here's another problem: the Chinese business media doesn't seem to have discovered basic economics. A recent report attributed falling alumina prices to a major supplier, Jamacia, going offline. It also attributes plants' holding back on their purchases to these falling prices. This is quite obviously garbage of the highly recyclable kind.)

Now, the WSJ quotes analysts and believing that China has neither the capacity it needs, nor the energy is needs to supply that capacity. So even as it's shutting down smaller plants, forcing them to buy importing rights from the larger plants, it's building more large plants.

The simplest expanation is that the government wants to shut down these smaller plants, because they're eating up too much energy. The problem is obvious. If the economy is slowing down, the smaller, less-efficient plants will be the first ones to fold, anyway. If the economy heats up again, that capacity will be lost. And aluminum, unlike steel, goes mostly to private ventures rather than public ones.

Aha! Could that be it? Could it be that the government is shutting down less-efficient aluminum plants in order to conserve energy for the state-owned steel plants? Which provide mostly low-grade steel for government make-work projects? Or maybe it's to make the new plant venture more attractive to the Chinese banks backing it. In either case, this kind of interference suggests that the Chinese still have a lot to learn about basic economics.

Nobody knows, and nobody is going to know, because economic statistics are produced by local governments and parties who are tasked with meeting certain growth goals. Their incentive is still to cook to the books, rather than to provide transparent information for investing. The only real information we have is indirect, like world commodity prices. The Chinese can no more insulate themselves from these forces than anyone else.

Posted by joshuasharf at 02:30 PM | Comments (0) | TrackBack

December 15, 2004

Cutting the Wires

Good news: The FCC is getting ready to approve air-blogging. Bad news: it's going to take two years and be very expensive.

They may even approve cell-phone use, so someday, people will read this passage from On Paradise Drive...

...workaholic corporate types boarding airplanes while talking on their cell phones in a sort of panic because they know that when the door closes they have to turn their precious phone off and it will be like somebody stepped on their trachea.

... and ask, wistfully, "you mean there was a time when they couldn't use cell phones on a plane?" You mean there was a time when I didn't have to listen to the next Donald Trump yell over a jet engine into his phone and into my ear all the way from Washington to Los Angeles?

Hold the champagne for a little bit, though. It's more of the same: "why, what would they need us bureaucrats for if we let people make these decisions on their own?"

The FCC approved a measure to restructure how frequencies for such "air-to-ground" services are used and allow the airlines to offer wireless high-speed Internet connections.

Left undecided was the issue of how many companies the FCC would allow, through an auction, to offer such services. Verizon Airfone maintains that letting one company handle the service would ensure the best quality, and existing technology can't support two competitors.

Others, including Boeing Co. and AirCell, argue for two competitors to prevent one company from having a monopoly. FCC officials said the auction would take place within a year.

Once plans are completed and planes outfitted with the equipment, wireless high-speed Internet access might be found on commercial domestic flights by 2006, said Jack Blumenstein, chairman and CEO of Louisville, Colo.-based AirCell.

I know this is too much to expect, but, guys, what about allowing the airlines and the phone companies to figure this out? You'd have more plans, newer technology, maybe even ways of sharing frequencies. Personally, a duopoly has never impressed me as being much better than a monopoly: the weaker company knows you're only keeping it around because you have to.

There's no reason to believe that the FCC will be as good at setting technical or performance standards, price levels, or terms, as airlines who are grasping for any source of revenue they can think of. There's absolutely no reason to wait until 2006 to get this thing going.

Posted by joshuasharf at 12:44 PM | Comments (0) | TrackBack

Telecom Reregulation

The problem with reading a book like The Future and Its Enemies is that you see Stasists vs. Dynamists all over the place. Stephen Moore has a good example.

Specifically, the FCC is going to decide this week whether to promulgate new regulations that would allow the competitors of the incumbent telephone companies — the "Baby Bells" — to have access to the infrastructure that the phone companies built with billions of dollars of private investment capital. Yes, of course, competition is a desirable goal. But if the government mandates that the privately financed infrastructure must be shared by all competitors, who will make the initial investments in the first place?

Posted by joshuasharf at 07:51 AM | Comments (0) | TrackBack

December 13, 2004


Could this be the sort of thing that gives employers a bad name?

Swift & Co. is laying off 800 employees at its Greeley meat-packing plant, in anticipation of losing business from some major feedlots. Four days before Christmas.

There's never aa good way to announce layoffs, but there sure are some lousy ones. I once had a contract with Corporate Express, in Broomfield. The stock price had tanked back in September of that year, and the company was awash in rumors. (Management tip #1 - don't ever let that happen.)

Then, in December, two weeks before Christmas, management called a company-wide meeting. Contractors were told to go home. (Fine, that's the nature of contracting.) Employees were told to go back to their desks and wait for a call. Maybe that sort of treatment was why they had hired Bruno, the former interior lineman for the Broncos, to stand by the guard desk in the lobby as security.

Posted by joshuasharf at 10:33 AM | Comments (0) | TrackBack

December 01, 2004

Good Riddance

It looks as though Sean Harrigan, of Calpers, is going to get the boot. Both the Washington Post and the Wall Street Journal covered his impending demise. Can't come too soon, as far as I'm concerned.

For instance, Calpers seems to extend notions of conflict of interest to corporate boards that it's not willing to apply to itself.

At Safeway, Calpers charged head-on into the grocery chain's labor dispute. Acting at Mr. Harrigan's direction, Calpers's Mr. Feckner wrote Safeway Chairman and Chief Executive Steven Burd on Dec. 17, 2003, two months into the United Food and Commercial Workers union's strike against the chain's California stores over cuts in employees' health-care benefits. Noting that Calpers owned $77 million of Safeway stock, the letter urged Mr. Burd to wrap up union negotiations "fairly and expeditiously," adding that "fair treatment of employees is a critical element in creating long-term value for shareholders."


In the interview last month, Mr. Harrigan said he directed Mr. Feckner merely to look into the issue in response to comments at a November board meeting by members of the public and the board. Besides being Calpers's president, Mr. Harrigan is executive director of the UFCW's Southern California council. Big public-pension funds rarely take sides in a labor strike, corporate-governance experts say. (emphasis added -ed.)

This sort of meddling has already led to further politicization of Calpers:

Meanwhile, another controversy was on the horizon. On Oct. 18, Philip Angelides, a Calpers board member and the California state treasurer, issued a news release on the fund's behalf urging directors at CACI International Inc., where the Army is investigating three civilian interrogators who worked at Iraq's Abu Ghraib prison, to "get out of denial and hold company executives accountable for any misconduct that has hurt both shareholders and the country." Mr. Angelides cited Calpers's $12 million stake in CACI.

CACI responded on Oct. 19 with a statement that rejected Mr. Angelides's "crass, politically motivated antics" and said that if Calpers wanted to walk away from a stock that had risen more than 50% since August, "we fully support their decision."

Good for them.

Harrigan pioneered the use of Calpers as a tool of shareholder leverage, to affect corporate governance, rather than merely selling shares of companies it was worried about. As one of the few institutional investors large enough to throw its weight around, Calpers effectively began exercising regulatory control that it hadn't been given. Certainly everyone wants to be on guard against corporate executives plundering the company for their own benefit, a la Dennis Kozlowski and Ken Lay. It's far from clear that Calpers's judgment as to executive salaries is any better than that of the boards of the companies they invest in.

Calpers's job is to manage a pension fund, not enforce its own ideas of corporate good governance, ideas which may not have been vetted by the marketplace first.

The question of shareholder rights, and corporate governance is a tricky one. On the one hand, shareholders do own a piece of the company. On the other hand, the company has hired Boards of Directors and executive management teams whose job it is to run the company. Shareholder revolts tend to be a pretty blunt management tool.

Without a doubt, board members also tend to be large shareholders, and take very seriously share price drops. In other words, boards already tend to get upset when the market punishes bad management, even if there's no rule that says that they have to.

As stock ownership becomes more widespread, it's clear that a clubby sense of corporate governance won't cut it. But there are existing regulatory tools, like the SEC.

Posted by joshuasharf at 01:20 PM | Comments (0) | TrackBack

November 29, 2004

A New Commerce Secretary

The Wall Street Journal reports that President Bush has chosen Carlos Gutierrez, chairman and CEO of Kellogg, to be his new Commerce Secretary. Gutierrez's family managed to escape Cuba in 1960, before Castro started strafing people in rafts. Cuba also produced another great CEO, Robert Goizueta, of Coca-Cola. Those who consider Castro a hero to the Cuban people might consider the talent he drove away, and how much better-off that island would be under a different regime and ideology.

is known as a charismatic and approachable executive, widely admired in business circles for reviving a flagging company. Mr. Gutierrez joined Kellogg in 1975, beginning his career in Mexico City as a sales and marketing trainee for the Battle Creek, Mich., cereal giant. Mr. Gutierrez subsequently held a number of jobs at headquarters and ran Kellogg's Canadian and Asian Pacific operations before being named president and then chairman and CEO.

He took over four years ago when Kellogg's cereal sales were sagging and soon acquired Keebler Foods to diversify and boost profits. He also put together an international top management team, which includes an Indonesian, an Italian and two Australians, as well as Americans.

So for those who think that Bush is reaching out to an already-safe Hispanic constituency, Cubans, note that Gutierrez knows a little something about Mexico, too. Gutierrez's management team underscores the international nature of business today - it's not Americans giving orders to docile overseas subsidiaries. Smart corporations have been incorporating foreign operations into management for some time now. Operating on a global scale doesn't imply an imperialist attitude.

This is a terrific choice in another way. Kellogg has done extremely well at a time when the economy was recovering, but their industry sector was struggling, according to the Strib (9/27/04):

Analysts say Kellogg's chief executive, Carlos Gutierrez, has delivered through a strategy of making money with higher-priced products. At the same time, the Battle Creek, Mich., company is reinvesting those profits into brand marketing, innovation and increased productivity.

Sounds like a good plan, but most companies would claim to have those same strategies. The difference is old-fashioned execution, analysts say. Kellogg actually is doing what it says, and in a difficult competitive environment, said Eric Larson, an analyst with Piper Jaffray & Co. in Minneapolis.

"They have found a sweet spot," Larson said. "Having the right products and the right marketing programs can overcome low-carb diets and commodity costs. ... [Gutierrez] is the real deal. He is very methodical, and runs the business for the right reasons. You got to give him credit."

Gutierrez has strong ties to the Republican Party, having been one of the sponsors of the Gran Fiesta Hispana at the RNC in NYC this summer.

Posted by joshuasharf at 10:49 AM | Comments (0) | TrackBack

November 28, 2004

Rising Chinese Expectation

The Washington Post reports from the Chinese provinces that once-docile workers, merely happy for wages, are now unhappy. If this is representative of larger demonstrations, it could be the end of the beginning for China's rise to great power status.

This spring, a large number of factories faced informal but organized labor action, protesting wages that hadn't kept pace with inflation. That dissatisfaction, combined with the urgings of human rights groups, have encouraged these wildcat actions. (The Communist Party sponsors the only legal labor union, news that should come as a surprise only to those who went to sleep sometime in the 19th Century and are only now waking up.) What's given the workers the leverage to call these actions is the first appearance of labor shortages in these regions.

Looking at these things one at a time, we begin to see some of the choices and binds facing the Chinese government. In the first place, remember that the yuan has been pegged to the dollar, falling as the dollar falls. The Chinese manufacturing economy is probably more dependent on commodities than is ours, so is also being squeezed by the run-up in commodity prices.

Combine that with possible over-building in response to government pressure to grow at 8% a year, and you've got too many suppliers, most not making a profit, being squeezed by their purchasers in the US, and in turn squeezing their employees. The falling yuan may bother Europe because it makes the Chinese more competitive, but with so much domestic competition, there may not be room for them to raise prices.

Look for Wal-Mart to get blamed here. The company is the single biggest importer of Chinese goods to the US. It's got a reputation for leaning on its suppliers, since it competes almost exclusively on price. Wal-Mart has always allowed unions, if workers vote for them, but the Chinese government has trumpeted a public repetition of that policy as a major breakthrough. The goal, of course, is to introduce the official union into Wal Mart, giving the government, although not the workers, leverage with the company.

As for unions, it's a sign of the bankruptcy of the US labor movement that it's NGOs, not unions, that are stirring the kettle overseas. Time was, US labor unions strongly supported overseas organizing, even in the face of foreign government opposition. (Ronald Reagan was able to join with the AFL-CIO in supporting Solidarity, for instance.) Unions ought to see that worker leverage overseas helps their employees here at home.

Instead, they push for regulation by treaty, oppose liberalizing trade agreements, and support tariffs and quotas, thereby becoming one of the most reactionary voices around. Instead of supporting their natural allies in other countries, their policies would depress production, increase costs without increasing benefits, and keep those Third World economies from developing into places where workers can earn a decent living.

Finally, and perhaps most importantly, the Communist Party is starting to run up against the limits of trying to control everything. It is the only legal political party, so it runs the government as an arm. It runs the only legal labor union. The local governments have become investors in business operations, so the Party is both labor and management. With inherent conflicts of interest, the government can't play its Western role as honest broker between business and labor.

No matter what it does, the Party will get the blame. Workers already see a replay of the last chapters of Animal Farm. With the more alarmist views of China as a bottomless job sponge starting to hit up against reality, the Party will also be under pressure from domestic business. But with foreign consumers still driving the Chinese economy, and expansion being the Party's main goal, it's hard to see where they have much room for maneuver.

None of this is to forsee doom, of course. The Chinese have been able to trade off false promises for decades, and with the conventional wisdom being that the 21st Century will be Beijing's. foreign business may yet talk itself into paying higher prices now for tomorrow's illusory profits. Or, they may start to look at other countries with too much labor and not enough capital.

Posted by joshuasharf at 02:38 PM | Comments (0) | TrackBack

November 24, 2004

SusPension of Disbelief

The Wall Street Journal is reporting that, "the Pension Benefit Guaranty Corporation, the quasi-government agency that insures private pension plans, announced a record deficit of $23.3 billion." They compare it to another S&L crisis in the making, and they're probably right. The S&L crisis was born of government insurance of an industry prevented by regulation from competing effectively.

Not only does this have immediate implications for the taxpayers, it could also help derail Social Security reform past its window of opportunity.

The proposal's immediate boost came in allowing companies to continue using an index of corporate bonds, instead of 30-year Treasuries, to discount pension liabilities. Since rates on corporate bonds are higher than Treasuries, liabilities appear to be lower and funding appears plumper.

A word on how this works. Treasury securities are assumed to be risk-free. That is, there is no doubt that the government will be able to pay its debts. Despite what you may have heard about the Federal deficit, this continues to be an excellent bet. Corporations, however, regularly go bankrupt. Even ones with excellent credit ratings have to reschedule their debts from time to time. Because of the added risk, companies have to pay a higher interest rate to attract investors.

"Discounting" is a means of determining how much today's money will be tomorrow. If I can use a higher interest rate to discount, I am assuming that I will be able to get a better return. Since a pension fund knows what its obligations will be, say, 10 years from now, using a higher interest rate means that I can claim that I'll be able to cover that same obligation then, with less money now.

Basically, the short-term fix proposed here is bookkeeping, to keep companies from drawing on the PBGC's resources if they don't need to.

The long-term fix would have required companies to match discount rates to the terms of liabilities, introduce more transparency in funding and stop underfunded companies from improving pension benefits.

This builds on the above explanation. If I know I have an obligation 10 years from now, I should use the current 10-year interest rate in discounting this particular obligation. Since short-term interest rates are typically lower than long-term interest rates, short-term obligations will need more money to be fully funded. Greater transparency subjects the pension fund managers to greater scrutiny; sort of the equivalent of having bloggers looking over Dan Rather's shoulder.

And if you're already underfunded, if you already can't fulfill your promises, you shouldn't be allowed to promise even more, just to keep your union from walking out on you. Supposedly, we learned this lesson with steel.

Naturally, Congress tried to revoke the long-term fix proposed by the President, while sweetening the short-term fix even further.

The problem in a nutshell, is that there's no incentive for companies to fully fund their plans. They pay a premium for belonging to this insurance system, but the premiums don't cover the long-term costs. Since the government has contracted this obligation, the taxpayers will get stuck with the bill for all these bad debts.

One popular solution is to raise the premiums paid by companies -- which haven't been increased since 1994 -- along with adjusting those premiums for risk. But a premium increase would make it more likely that healthy companies will drop out of the system, and risk-adjusted premiums give those financially fragile companies a strong incentive to terminate their plans.

There's actually a fairly simple solution - relieve fund managers of the burden of trying to beat the market. (While government pensions funds aren't covered by the plan, they're directly using public money, and have a horrid record recently.) Fund managers can restrict themselves to investing in bonds, where they can match the incoming cash flows to their obligations.

They can even, with periodic rebalancing, inoculate themselves against interest rate changes. Generally bond prices fall when interest rates rise, since new issues will pay a higher interest rate and be more attractive. But remember, you get to reinvest your payouts at that higher interest rate. Some fairly simple calculations will allow fund managers to match those investments against what they know they'll have to pay out.

This will disappoint a lot of fund managers, who want to earn their stripes before moving on to the big-leagues. Too bad. The state and city pension funds are one public trust. Poorly run corporate funds abuse another, while lying to their employees.

The good news is that even if nothing changes, the system won't go belly-up for about 16 years. The bad news is that if it isn't fixed, the papers will discover the problem just in time to discredit Social Security reform.

Posted by joshuasharf at 06:23 PM | Comments (0) | TrackBack

Sarboxed In

Sarbanes-Oxley was passed in the wake of the corporate accounting scandals. Two of the bill's provisions have gained the most attention. One holds corporate officers personally responsible for the accuracy of the financial statements and annual report. The other requires that all of a company's internal processes be auditable.

Today, Holman Jenkins takes on the costs of these provisions, and their presumed benefits ("Thinking Outside the Sarbox", registration required):

Unprecedented and little appreciated is the extent to which the Big Four have been handed vast and sweeping new powers over companies and their managements.

Take the approaching deadline for many companies to implement the law's Section 404, whose 169 words require that an auditor attest to the adequacy of a company's internal controls over financial data. ... By and large, it's the accounting firms who decide, not only telling companies what they must do to meet the law's requirements, but frequently selling them the software and expertise to comply.

What's more, each of the Big Four is free pretty much to interpret Section 404 by its own whimsical lights, acting as judge and jury, with the accountants' dominant incentive being to protect their own posteriors with paperwork lest they be targeted in a shareholder lawsuit next time one of their clients goes bust.


Sarbox, rather, is the last gasp of a corporate governance kludge in which auditors became, in the public's eye, something they've never been in their own eyes: namely proof against fraud. In the audit industry's eyes (or at least in its behavior), the mandatory audit is a welcome gravy train that has gradually revealed an unwelcome Faustian caboose. Whenever a company blows itself up in an accounting scandal, the accountants pay for their gravy train by serving as an additional set of deep pockets for trial lawyers to sue.

Sarbox's "internal processes" bring to mind "insider trading." Oh, you think you know what insider trading is? Perhaps you'd like to send your suggestion to the SEC or to Eliot Spitzer, because in fact, there's no definition written into the law. George Mason's Henry Manne has made an academic career trying to show that there's no logical place to draw the line.

"Internal processes" suffer from more or less the same problem. For most companies, it means tracking not only dollars but product, all the way through the system. Good companies have always tracked this sort of thing. But what's different about Sarbox is the legal aspect.

Jenkins accurately notes the control that this give the Big Four accounting firms over internal accounting practices. But by implication, it gives them control over internal processes. There is no doubt that companies will begin, perhaps have already begun, to make business decisions based on the effects they'll have on their accounting. There's some evidence that this is already happening:

...The number of companies alerting the SEC that their latest financial reports will be late doubled last quarter, adding to a backlog of late filers that recently topped 600. One strategic-investor type who sits on the boards of a number of companies called a few weeks back to gripe in detail about what all this was costing the economy. Under the SOX regime, something as slight as an anonymous letter alleging accounting irregularities can effectively deliver a company entirely into the control of outside auditors. Directors, so fearful about their own liability that they stop thinking about what's good for the business and worry only about securing their own alibis, write a blank check with shareholders' money to do whatever the auditor dictates.

There's a secondary effect here, as well. The financial markets rely on timely information to make investment decisions. Sarbox, while doing little to improve that information, seems perfectly capable of delaying it. As the backlog increases, this will make it increasingly difficult for fundamental analysts to make informed judgments. It will place a higher premium on insider information, encourage rumor, increase market "surprises." Even technical analysts will have a harder time assuming that the market already has assimilated available information. In an era marked by stunning increases in market efficiency and responsiveness, Sarbox represents the first tangible step backwards in decades.

As much as this is costing big companies, consider the cost to small companies trying to gain access to the markets:

No wonder that the annual bill for Sarbox is going through the roof, with the latest estimates being about $6 billion for the Fortune 1000 alone. One investment banker estimates that a small company nowadays would have to generate $150,000 in free cash annually just to cover the additional paperwork before it can even consider going public. Then there's upwards of $100,000 each to insure all who sit on its board, if any can be found. Oh yes, and the fact that audit fees, for the average company, have risen about 50% in a single year.

Access to markets means access to capital. Access to capital is the means for competition, innovation, and for getting that innovation to the consumer. While large companies might be willing to pay for protection against new competition, it's hard to see why consumers, or even investors, would.

Sarbox is a bad law. It's vague, overly-intrusive, non-responsive, and will eventually subject even routine operational decisions to outside scrutiny of the most conservative and least dynamic kind. And it doesn't even fix the problems that inspired it.

Posted by joshuasharf at 12:23 PM | Comments (1) | TrackBack

November 22, 2004

Currency Markets and the Dollar

The latest Wall Street fixation is with the declining dollar. Make no mistake, the decline does carry some real risks, and not just that people won't be able to afford those trips to Paris they've stopped taking. The weaker dollar is partly and attempt to close the trade deficit, which clearly can't keep going at 5% of GDP forever. But both the trade deficit, by definition, and the budget deficit are being financed by foreign investors in the US economy, buying up government and corporate debt.

The potential problem is that a declining dollar makes those investments less attractive, since foreigners will be paid back in cheaper dollars, meaning they'll get less back of their own currency when they cash in. In order to continue to attract foreign investment at rates necessary to finance the deficits, the Fed may have to raise short-term interest rates, hurting the economic recovery and, incidentally, making investment in the US less attractive economically.

There's also a risk of inflation. Usually, this is cited as coming from more expensive imports, since it takes more dollars to buy those yen- and yuan-denominated goods. The other, possibly more important source of inflation would come from a loss of confidence in the dollar. If other countries see the dollar as weaker, they'll be less likely to use it as the international "reserve currency," or the currency that foreign treasuries hold in reserve in case theirs, or that of a major trading partner, hits a rough patch. If many foreign treasuries were to come to the conclusion that they needed to hedge their bets, they would sell dollars, increasing the number in circulation, raising the dollar money supply without increasing the amount of goods on the market. By definition, that would increase the number of dollars it took to buy something - inflation. For reasons discussed below, this is the more dangerous source of price increases.

The administration, despite its talk of a strong dollar policy, not only hasn't done much to stop its slide, there's probably not much that it can do aside from psychology. Trillions of dollars each day are traded on the world currency markets, and no country's treasury has enough money to keep buying high and selling low for very long. A currency panic, such as what happened to England when it was forced to abandon the European currency agreement, would be impossible to derail once it got going. (More troublingly, George Soros has demonstrated the market authority to help create, and the savvy to exploit such a crisis, which could certainly make life pretty miserable both for his adopted country and his nemesis, the President.)

On paragraph sticks out though:

Some European leaders sharply criticized the U.S. for failing to take action on the dollar - and cited that inaction as a reason why Europe wasn't moving as quickly at the U.S. would like to overhaul its labor and regulatory systems. "You can hardly demand from the Europeans to constantly carry out structural reforms - which we are doing - without addressing your own needs as quickly as, from our point of view, would be necessary," German Chancellor Gerhard Schroder said.

This is like the child who, having waited to get ready for the car trip until the last minute, suddenly says he needs to go to the bathroom. That the Europeans have dawdled on reform for decades, and are only now taking baby steps in that direction, takes some of the starch out of their complaints. There's no doubt that their exporters are being hurt by the same currency swings they once benefitted from. But European central bankers have a fixation of their own with budget deficits that has hampered their own reform, and their own economic growth. There's no doubt that one export they'd like to make to us is their own anemic GDP growth.

That said, the US economy has grown during strong and weak dollar periods, and can almost certainly handle and orderly decline. It's nowhere near all-time lows, and there's no sign of a panic that would send the currency into a tailspin. Markets almost always figure stuff out before governments do. So short-term interest rates have been rising in response to the Fed increases, long-term rates have barely budged. This suggests that investors haven't lost confidence in the dollar - they figure over the long term it's a strong currency, and will bubble back up just as it's drifting lower now.

Posted by joshuasharf at 06:31 PM | Comments (0) | TrackBack

Gas Pains

Among the corporate accounting scandals that has gotten less attention has been the overvaluing of gas and oil reserves. This is probably less understood than it should be. The Journal explains:

resisting a push by the Securities and Exchange Commission in the wake of the Royal Dutch/Shell Group scandal to change its methodology for booking oil and natural-gas reserves.

The dispute puts the oil giant at odds with U.S. securities regulators over a rule that oil companies broadly dislike but are increasingly complying with, even at the cost of reductions in reserve counts.

At issue is an SEC requirement that oil companies use year-end commodity prices to calculate their annual reserves, a number watched by investors as a sign of a company's prospects. The roughly 50% jump in oil prices this year has given the issue more urgency.

Rather than year-end prices, many of the largest oil companies have traditionally estimated reserves on the basis of long-term "planning prices," which reduced the impact of the sometimes-large year-to-year swings in the volatile energy markets.

Typically, high oil prices are seen as a boon to oil companies. But under a sort of contract that is becoming more common in the industry, high prices can force a company to report lower production levels and reserves, even as profits rise.


Under contracts in the U.S., the U.K. and other conventional energy basins, higher prices usually result in bigger reserves, as more projects become economic. But under so-called production-sharing agreements, a government owns the resource and guarantees the company enough oil to cover its costs plus a percentage of the oil left after those costs. As the price of oil goes up, the volume a company gets under such an agreement declines.

Reserves show up on the balance sheet as a long-term asset. By forcing down those numbers, the SEC will end up increasing the apparent leverage of these companies (ratio of debt-to-assets), possibly raising borrowing costs. It will also force up the apparent return on assets, as well, enticing invertors. I don't know if this actually is a better rule, in the sense of more accurately reflecting the companies' actual financial health. What's scary is that I don't know if the SEC does, either.

Posted by joshuasharf at 06:19 PM | Comments (1) | TrackBack

Regulation 'In Terrorem'

Eliot Spitzer, in his drive to become Governor of New York, has turned into a one-man regulatory dynamo. As Henry Manne puts it in a WSJ op-ed today (Regulation 'In Terrorem'),

In an era of general acceptance of deregulation and privatization, Mr. Spitzer has introduced the world to yet a new form of regulation, the use of the criminal law as an in terrorem weapon to force acceptance of industry-wide regulations. These rules are not vetted through normal authoritative channels, are not reviewable by any administrative process, and are not subject to even the minimal due-process requirements our courts require for normal administrative rule making. The whole process bears no resemblance to a rule of law; it is a reign of force. And to make matters worse, the regulatory remedies are usually vastly more costly to the public than the alleged evils.
Since Mr. Spitzer wins his cases in the media, where business is now all but defenseless, the best hope is for the American business community to develop its own public voice. The free-market scholarship needed for this purpose is available, though it is rarely availed of in these fights. Too often the corporate defenders conclude, out of ignorance to be sure, that the opposition really has the better case.

Spitzer's actions both mimic and take advantage of the kind of judicial legislation we've gotten used to over the last few decades. Its obvious personal political agenda makes it only slightly more odious. Spitzer may see himself as a latter-day Brandeis, but he's clearly capable of much more damage than Brandeis ever did.

Manne directly takes on Spitzer's takedown of Marsh & McLennan, which has not only cost thousands of people their jobs, but also probably helped make the insurance industry less efficient and competitive, raising your insurance rates, not lowering them:

But what if Mr. Spitzer is wrong, and what if none of the practices complained of was either unethical or anticompetitive? After all, Mr. Spitzer's case against certain practices in the mutual-fund industry relied heavily on one academic study claiming $5 billion a year losses to the investing public. The author of that study now admits that the figure -- in any event based on some very dubious suppositions -- should have been $2 billion rather than $5 billion. It is probably much less than that.
Let us suppose, for example, that Marsh & McLennan, in order to gain various efficiencies of integration, bought out numerous insurance companies and operated them as divisions of one company. We would call the resulting firm a multi-divisional, vertically integrated company, a perfectly legal way of doing business. There could then be no antitrust concerns about internal decisions to allocate business to one division or another or about allocating costs and revenues internally as they saw fit.

Now suppose that these same economies of integration could be obtained more cheaply by contract, or even by customary norms, rather than through expensive acquisitions and the administration of a larger organization. Certainly there could be no greater economic harm in the latter scenario than in the former. Yet the latter, which is the more likely explanation of what occurred in the insurance industry, is susceptible to easy misunderstanding. What in one case would be seen as internal cost and price management now looks like illegal bid rigging. Of course, it could be, but we cannot assume that from the facts we know. (emphasis added)

I would point out that Manne has, over the years, been a leading voice in opposition to insider trading laws on the basis that they decrease market efficiency while creating a set of vague and arbitrary trading rules. Whether or not this gives him Hillary Clinton's ear is another matter.

Still, Manne is right when he claims that the academic research is there to oppose Spitzer. But it's going to be a question of political will. The main opposition would have to come from someone like Governor Pataki, but he's shown no interest in spending his own political capital to preserve the country's economic capital. (Republicans should remember that in 2008.)

Since the major papers and networks are unlikely to take on their crusader-hero in a critical manner, this might be a place for blogs to try to influence the debate.

Posted by joshuasharf at 01:54 PM | Comments (0) | TrackBack

November 11, 2004

Red State Dependents

Lawrence O'Donnell, writer for The West Wing and newly-popular bomb-throwing talking head guest, has been pointing out that, as a whole, the Blue States pay more in federal taxes than they get back, while the Red States get more back. O'Donnell's point is that the Red States are somehow wards of the Blue States, not economically viable without the Blue State subsidies they receive.

The kind folks over at the Tax Foundation actually look at this sort of thing. Sometime when Mr. O'Donnell needs a break from writing about Congress ("Where the Wild Things Are"), he might take a look at their charts.

In the aggregate, he's right. No, he's not right that the Red States have "no wealth. None." He is right that most of the Blue States see money going out, while the Red ones see money coming in. But seven of the tax-loss states are Red, and six of the tax-gain states are Blue. Suddenly, things are starting to look a little purple.

If you look at the extremes, and include the 1996 results, things get more muddled. New Mexico is the champion tax-wangler, getting a whopping $1.99 for every tax dollar it sends to Washington. But it was blue in 96, and very nearly so this time. Likewise, New Hampshire, who really needs to find a good tax shelter ($0.64 back on the dollar), is only Blue this time because of the tax refugees from Massachusetts. This ignores the most Blue spot on the map - DC - which couldn't exist without federal taxes.

And things aren't so secure there at the top, either. Of the top 15 Blue sugar-daddy states, Wisconsin and Minnesota are in play, and Michigan would be, too, if it weren't for some hyperactive election clerks in Wayne County with access to blank absentee ballots.

So, what's O'Donnell getting at? If the Blue States decided to secede they'd take with them the country's economy? Or are the Red States supposed to be grateful to the Blue? Or maybe, the Blue States will really punish us and vote to lower taxes and take back their goodies. That'll show us.

Leave aside the fantastical notion that the Blue States really would secede and say, join Canada. Never mind that the western Canadian provinces would jump at the chance to apply for statehood, leaving the Northwest Territories as the only overland route from Minnesota to California.

Speaking as a resident of a Red State that's getting soaked like a Blue one, I'd personally like to see another tax revolt. But that's not going to happen, either. At least not at the instigation of Senators Clinton and Schumer.

Honestly, it sounds like more of the hysterical raving that started when he was on with John O'Neill. It's not enough that we're morons and Crusaders; we have to be welfare depdendents, too. When I hear conservatives talking about the "elites," it's clear that they mean a minority of even blue-state voters. Even a minority of liberals.

When I hear the Lawrence O'Donnells talk about Red State voters, I think that maybe we really do need to make Zoloft accessable at more affordable prices.

Posted by joshuasharf at 06:57 PM | Comments (0) | TrackBack

Economy Picks Up

A while back, someone commented that the chip manufacturers were a leading indicator of rough economic waters ahead.

Well, Dell just showed a 25% profit growth on increased business buying. This despite a weaker quarter for government orders. Since profits are accounted for in dollars, the weaker currency also improved foreign sales. But isn't that what it's supposed to do?

Since we were all waiting on improved business investment, and consumer retail buying is now showing respectable, although slightly softer, year-over-year growth, it's safe to say that the Kerry Recovery is underway.

Posted by joshuasharf at 03:23 PM | Comments (0) | TrackBack

A Civil War

Supreme Command

The (Mis)Behavior of Markets

The Wisdom of Crowds

Inventing Money

When Genius Failed

Blink: The Power of Thinking Without Thinking

Back in Action : An American Soldier's Story of Courage, Faith and Fortitude

How Would You Move Mt. Fuji?

Good to Great

Built to Last

Financial Fine Print

The Balanced Scorecard: Measures that Drive Performance

The Balanced Scorecard: Translating Strategy into Action

The Day the Universe Changed


The Multiple Identities of the Middle-East

The Case for Democracy

A Better War: The Unexamined Victories and Final Tragedy of America's Last Years in Vietnam

The Italians

Zakhor: Jewish History and Jewish Memory

Beyond the Verse: Talmudic Readings and Lectures

Reading Levinas/Reading Talmud