More on Google's Rights to Your Privacy

Perhaps the best article I've seen pointing out the intellectual deficiencies of Eric Schmidt's views on private information is "Eric Schmidt's privacy policy is one scary philosophy -- Offhand comments by Schmidt about privacy hints that Google is spying, critics say" by Julie Bort and posted on networkworld.com. I'll quote just one of over a dozen of Julie's stinging points:

"...If you don't want to share with people what you've eaten for lunch, maybe you shouldn't eat it..."

One thing that is good about this tempest that started December 8th: The subject is hot, and the ferment will almost certainly result in multiple academic papers that prove beyond any doubt that Schmidt's position is false, destructive, misleading, self-serving, or all of the above. Just in researching this short article I encountered a multitude of well-stated, rational arguments that rapidly lay the foundation for such a paper.

Commentators on this posting should post their addresses, home phone numbers, and most recent sexual liason's name in their posting, please.

Eric Schmidt and George Orwell

This is worthy of a much longer article, which is in research. But in the meantime, please enjoy this concise synopsis of Google CEO Eric Schmidt's opinion on information and privacy:

War is Peace;
Freedom is Slavery;
Ignorance is Strength

Financial Crisis Inquiry Commission: Data Coming...?

Bloomberg says the FCIC is holding a hearing, but the web site is slow in arriving.

http://www.fcic.gov/

Likely, the pace of real work done is slow.

“We aren’t just bringing people in to give their story and leave,” said commission Vice President Bill Thomas, interviewed by phone.

Which is probably exactly what will happen, since the FCIC has an assignment, but no authority. It might provide some sound bites or fodder for snipe-blogging, but investors might be better served using it as a contrary indicator and looking at something else entirely. That is, as a story, the financial crisis is done.

Jabberwocky as Financial Advice

Today's post is a puzzle and a tradition all in one.
Read old words think new thoughts and then you are done.

http://www.jabberwocky.com/carroll/jabber/jabberwocky.html

Cadbury's Todd Stitzer is Asking for a Lower Price

Yesterday I wrote that Cadbury's (CBY-NYSE ADR) CEO seemed rather impassioned about his attacks on Kraft Food's (KFT-NYSE) merger offer. I pulled my punches, though. The background data on my thesis is better than I let on.

On December 15 WSJ.com published a comment ("Cadbury's CEO Is a Real Paine" by Dana Cimilluca) about Paine's statements on a conference call Cadbury held to describe its case against the Kraft offer. Stitzer quoted Thomas Paine: "What we obtain too cheap, we esteem too lightly; it is dearness only that gives everything its value." To my ears, this has much more the tone of a woman who has failed to obtain sufficient obsequiousness from a potential mate than of anything to do with Revolution.

It is clear that Cadbury esteems Kraft rather lightly, Cimilluca writes, reporting that Stitzer said "Kraft is trying to buy Cadbury on the cheap to provide much needed growth to their unattractive low-growth conglomerate business model" (emphasis added).

Stitzer, likely facing a dimished role or unemployment if Kraft succeeds at acquiring Cadbury, has upped his target for long-term annualized revenue growth by 1%, from 4-6% to 5-7%. Targets for operating margins and dividend growth were also increased to make Cadbury appear more attractive.

Kraft's shares are stuck in a multi-year slump, currently trading for more than 10% less than their average price in 2006. Earnings have recently improved, with S&P estimating EPS of $2.00 for 2009 (ending 12/31). That puts KFT shares at a PE of less than 14, below its peers and potential. Perhaps Kraft's recent gains have made it anxious to begin spending its money on acquisitions?

This acquisition is a litmus test for Kraft management. If they do pay up for Cadbury, it is a sign that the company is willing to discard shareholder equity in exchange for top-line growth. Holding the line on price sends a far better signal to shareholders. So far, the signals appear to have been that KFT has made its only offer for Cadbury. If this holds true, expect an increase in KFT to $29 or $30 in the next few months.

Cadbury's Derisory Opinion of Kraft

Were you the Kraft CEO, would you stick with your offer for Cadbury? Cadbury's chief has made it quite clear through his repeated use of the word "derisory" that he doesn't think much of Kraft, its products, or its shareholders. Or its offer, which even Warren Buffett was quoted as saying was "quite full." Cadbury would like Kraft to overpay, and insists that unless Kraft does indeed overpay, that the offer is an insult.

Kraft shareholders have been insulted. Cadbury clearly thinks that they are stupid enough to overpay for the acquisition, and in fact that unless the Kraft side is stupid, that there should be no deal. There is even a moral overtone to the objections, as though Kraft had violated one of the ten commandments by making a bid for Cadbury that did not contain extra fluff.

Now that Hershey's trust has decided to discard its highly regarded conservative stance and possibly make an offer for Cadbury, it is said (by the New York Times today) that Cadbury would be leaning toward a Hershey offer. It all makes sense now: Cadbury is willing to fall in love and marry the first company that loses its rationality and becomes hyperemotional. Obviously, Kraft is not emotional, as it made a rational offer. No wonder Cadbury feels so betrayed, no, disparaged, jilted, so unappreciated and unloved! Cadbury doesn't want a merger or a partnership. It wants to be courted by a suitor that proves first that it can't think straight for all its lust to consummate a deal with Cadbury, and only Cadbury...

Kraft can do without a partner that wants the chocolate business to be just like a dirty romance novel. Walking away is the best option for KFT.

An Inflation Straitjacket

What would be the catalyst for a new round of inflation? I've seen opinions for inflation and opinion for deflation, but with unemployment at 10%, I've generally sided with the deflation commentators.

But there is a possibility of inflation in the mid- to long-term. It would happen like this: Higher state sales taxes or new a VAT would raise the transaction price of most goods. Consumers, sensing the impending rise in taxes, would rush to buy products beforehand. The increased demand for goods would cause increases in retail prices, because of shortages.

Shortages? I hear you ask. What from?

Two sources: First, U.S. producers would still be working with reduced workforces and capital, and face higher marginal costs all around from increased payroll and revenue taxes levied by state and federal governments. Non-U.S. producers, who by then would be receiving cheap U.S. dollars, would mark up the price of their goods when denominated in U.S. dollars in order to keep up their revenues as counted in their local currency. U.S. retailers, of course, would have no choice but to pass along high goods prices to consumers in the form of higher retail prices.

There is a third effect: As inflation kicks in, the increased uncertainty about interest and inflation rates would then tend to cause consumers to be more conservative. Although consumers would pay higher prices for those items they do buy, overall their consumption would continue to drop or remain stagnant.

There would be an extended "frozen disequilibrium" that could last several years. Despite high inflation, low levels of production would tend to force the Federal Reserve to keep rates low, which would keep the dollar down and exacerbate goods shortages. Low rates would then encourage over-investment in goods because credit is cheap while inflation is high. Low rates would also depress tax revenues from earned interest.

Higher inflation would also reduce the future buying power of the Federal Government's budget deficits. Even better, inflation would send house prices up, fixing the mortgage crisis we are still in now. Hence, Government has several incentives to cause inflation.

To summarize: The inflation straitjacket is comprised of excessive Government debt and foreign exchange rates. We are headed for a period of stagflation that could last several years. It might not start until 2011, but once it is started it would be hard to extinguish.

Investment advice: Once again it is a great time to buy real estate. It is also a good time to invest in hard goods or collectibles that don't eat or need paint. Stocks are likely to remain stagnant; bonds will do poorly.

Citi to Pays Back TARP to Avoid Being Written About

In a move that surely will reduce the number of cheeky articles that finance blogs get to write about big bad banks, Citi announced today that it is repaying $20 billion of TARP funds.

For more see Tech Ticker and the article Citigroup Out from Under TARP: Is This Really "Good" News?

Obama Wants to Eat the Regulators' Cake

As I described last week, loan demand is down, which is good for the economy in the long run. The FDIC and Federal Reserve are encouraging banks to lend prudently and hold large capital reserves. Today's remarks show that the Executive Branch is not comfortable with that course of action, however, as the President called for banks to step up lending to small business. Is a titanic struggle in the offing?

Hardly. Bank of America and Wells Fargo pledged $5 billion and $4 billion respectively in increased lending to small business customers. These amounts, which will seem large to the public's ear when played as sound bites, are small relative to the discretion the banks have, as viewed by their regulators. In other words, it is all a show: The President gets to sound like he is beating up big banks again, and the banks get to show that they are complying with the President's request. Since the FDIC is happy, you should be happy too.

It is just another day in the scapegoating business for those holding blame bags chock-a-block with hot air and invective.

The second Glass-Steagull Act, passed in 1933, separated commercial banks from investment banks. This Act was reversed in November 1999 by the Gramm–Leach–Bliley Act.

The Glass-Steagull Act would have prevented the financial crisis of 2007-2009, but Congress removed the protection just eight years prior to the crisis. It is time that Congress admitted its mistake and re-establish the original second Glass-Steagull Act. The current financial legislation under consideration in Washington will not perform as well as the original Act passed in 1933.

Is Your Broker Running a Bucket Shop?

Perhaps the most engaging book on speculation I have read is Reminiscences of a Stock Operator. It is about a world that happened many decades ago, before television, before Stalin was dead, even before radio, and yet it speaks of the core experiences of equity and commodity trading that ring true even in this day.

Early in the book, the protagonist has his formative experiences in a retail venue that has no modern equivalent--a bucket shop. Back in the day, those without sufficient capital to buy genuine common shares of corporations could instead go to the local bucket shop and gamble on price fluctuations. It was gambling in part because no shares ever traded hands. The customer put down a deposit, essentially buying a $100 stock for a few dollars, and if the stock rose they could rapidly double their money, but if it fell even a few dollars, they were wiped out.

There is supposed to be a primary difference between bucket shops and brokers, in that while a bucket shop takes your money in exchange for a promise to pay if you win, a broker theoretically delivers shares, which are at least somewhat tangible, even if just paper. Bucket shops, being gambling establishments, certainly aren't or weren't as reputable as brokers, who theoretically had greater probity.

But look at modern brokers: You deposit your genuine capital or its electronic equivalent, and the broker in return issues a periodic statement. You buy shares, sell shares, collect dividends, and everything is regular and above board. Except for one fact: The vast majority of customers will go many years, or even decades, between putting their money in and taking it out. There is a huge time delay in the flow of the physical capital. And there is the problem.

An unscrupulous operator can take advantage of this time delay to operate a Ponzi scheme, as Bernie Madoff pleaded guilty to running, and several other investment promoters have been accused of. The uncovering of investment frauds and Ponzi schemes has been one of the defining characteristics of the recent financial distress.

Which is to be expected. As Warren Buffett said, "It's not until the tide goes out that you learn who has been swimming naked." A financial crisis tends to cause cash flow problems for operators of Ponzi schemes, who then get discovered and prosecuted, we hope.

The problem I put to you is this: Have we discovered all of the Ponzi schemes? Or have we just discovered the bad ones, those operating with a little too much deficit? Can you know for sure that all of the existing investment managers and brokers aren't, in reality, just bucket shops that don't actually have the shares in storage, but instead just say they do?

Genuine crises cause deflation of asset values and abnormal calls for capital that will put even the most conservative and honest financial institutions into some distress. I am not saying that the financial crisis was caused by major institutions because they were "Ponzi schemes." The purpose here is to point out that, statistically, there are likely to still be more problem organizations out there that haven't yet been exposed.

How do you guard against fraud? Look out for excessive fees, extra or unneeded assurances that your money is safe, late delivery of withdrawals, and promises of high performance. Test the system by suddenly moving money out, and what the reaction of the organization. Most importantly, diversify your accounts to minimize the damage that a 100% loss in any one account would cause.

Hysteria a Sure Contrary Indicator

It is always useful to observe the other market participants. Not so much to see what they are doing so you can copy them, but to observe emotional overreactions that are telltales. Today Henry Blodget declared that Bank of America's (BAC) repayment of TARP funds was a bad thing.

If he weren't so hysterical about it, he might have been able to make a case. In this situation, however, the overreaction would seem to be good indicator that people are against the bank for reasons that are more emotional than logical, but that it is otherwise on the right track (65% chance). So paying back TARP is a good thing for BAC and its investors. The future course for the stock is up.

Let's suppose BAC were to obey Blodget and not repay TARP. Then it would be subject to further negative publicity, could possibly fail to find a CEO in a timely fashion (40% chance), and would likely be constrained in its business and employment practices that are either self-imposed out of fear (90%) or by the Government directly (30%), or both. It would also be the convenient scapegoat for bank-haters.

If BAC pays back TARP, it both violates the expectations of those who expect BAC to fail or to fail to pay back TARP and elevates the bank's status. If your conception of BAC is that it can't do those things, then suddenly you have cognitive dissonance. Hence the histrionics.

Now, whether it is a good and proper thing to hate banks is not the subject of this post. There may be societal value to having a goat to heap your scorn upon, or not. The point here is that the telltale says to buy BAC shares.

True Frugality/Prosperity Too Bitter for U.S. Leaders?

One of the essential elements of the business cycle is that it instructs market participants. When times are too good, immoderate behavior is rapidly rewarded, but soon after is then rapidly punished in the subsequent collapse. When times are bad, those who stored resources against bad times pick up bargains and benefit from their careful attention to economic reality.

The financial crisis of 2007 to 2009 is firmly rooted in overextension of credit to non-worthy borrowers. Clearly the lesson to be learned was "stop lending to poor credit risks; stop lending aggressively." As painful as a recession is, it really does reinforce the message that people must engage in economic behavior that is tied to reality. Unlike bubble behavior, in which people make investment decisions that are unsupported by economic fundamentals.

The collective decisions of consumers and businesses drive the economy. Each individual misallocation of resources hurts the long-term economy, even if in the short run it "feels good" or would seem to increase the velocity of money. When money is scarcer, the quality of these individual decisions rises. That is what generates recoveries.

If you have a recovery that is based on the millions of tiny gains that arise from good resource allocation decisions, then it is a sound one. If your recovery is based on a command-driven push to increase lending in order to restore some measurement of economic activity to a former level, then you are in danger of undermining your own long-term prosperity. Economic lessons in frugality are expensive; they hurt. We should not throw away the benefits of those hard-won lessons.

Are banks presently lending enough? It is a poor question. Better: Are banks meeting the existing demand for loans at prices that repay them for their risk? My sense is that commercial banks are lending appropriately, and if loans outstanding are dropping, it isn't their fault. Demand for loans is low and will stay low while consumers and businesses make prudent decisions based on the hard lessons they just learned.

This concept, that loan demand is dropping and is a good thing seems to be hard to grasp. Some people assume that loan levels are just set by the banks, and currently banks are being mean or trying to inhibit a recovery by failing to lend. This is echoed in the words selected by the interviewer in this video story at Tech Ticker. Mike Shedlock and Peter Atwater make the case that banks are reserving for current risks based on their customers' assessments of economic prospects, and that the building of non-loan assets is a reasonable use for their liquidity and has good historical precedent.

Conclusion: Profits are good now because of the steep yield curve, but consumers are laying a good foundation for a recovery through their credit decisions. There is a risk that this prudence could be short-circuited by governmental action, though my guess (95%) is that lobbying efforts for windfall taxes on banks, and other measures to force new risky lending, will not succeed.