BKC Buyout by Private Equity

I will not repeat the new stories here about the offer from 3G to take BKC private. I blogged about BKC in April citing a $25 target. Today the tender offer was formally announced, the price is $24 cash per share.

In subsequent months after my earlier story, BKC shares slipped quite a bit, below $17 amid general market weakness. Still, BKC was weaker than peers, and Wall Street wisdom was that BKC had suffered from missteps like alienating franchisees, putting too many items on the $1 menu, having a message that was appealing to a demographic (young males) that is suffering more than other groups in this recession. Fortune ran an article the day of, or a day after, the 3G announcement outlining a "theory of the malaise" that provided a perfect explanation, in hindsight, of the weakness of BKC shares. Now we know?

In contrast, I would say that 3G has the same view that led to my earlier recommendation. BKC was undervalued, and when it got to an extreme, they called the market on its nearsightedness. The events mesh well with the original thesis.

Burger King may do well once it is private again, or maybe not. I figure that they will eventually recover business, perhaps 12 months to 24 months hence, and post some profits that are double the current level or more. It all depends on timing.

But that isn't what you need to know. Here: BKC shares are worth $24. At today's (9/16/10) price, there isn't much profit left. If you have nothing better to do with the capital, wait until your shares are called away. The annual ROR of holding is better than money market funds at the moment. If you do have a need to redeploy the capital, then certainly take the profit at your convenience, provided that is in the relatively near future. I don't see much chance of a counteroffer nor of any shareholder activism that would cause a price increase. The situation is too quiet. After all, that's how the shares got to $17, right?

Should you redeploy to YUM or MCD? I really don't like those odds at those companies' current valuations. There was clear value in BKC at $17 to $19, but YUM near $50 is a little rich. I saying this from partial ignorance, without a recent deep analysis of YUM to back it up. And YUM's future is very much driven by events in China and elsewhere, so your research will either be third-hand, remotely observed, guesswork, requiring extensive travel, or impossible. At current prices, this kind of play lacks certainty.

Current Equity Market Conditions: Frosty

Among the many stocks we watch perhaps 80% to 90% are deep in correction territory, price-wise. This contradicts fairly firmly our previous attempt at prognostication regarding general equity market movements. In case I have not it before, let me get this notice out and on the record: We do not believe that we can correctly call the direction of the stock market as a whole.

Where will the market be at the end of July 2010? We don't know.

What will happen to stocks for the rest of year? They will fluctuate.

What will happen to stocks next year? They will fluctuate.

Is this a good time to make an equity investment? Yes, if you are putting money into a venture you already control and other people are trying to make you sell them your stock. No, if you got a tip from someone in the last few days. Maybe, if you don't need the money back for the next 24 months.

Any more questions?

Are Healthcare and Capitalism Incompatible?

Results like this lend credence to the theory that the target price for any healthcare transaction in a market economy is "everything you have; hand it over!"

U.S. scores dead last again in healthcare study

Apple is as Big Brother Does

Reported today in Slashdot and elsewhere: Apple's iTunes, iPhone, iPad, iPod terms of service require that you grant your location data to Apple for unlimited sales to third parties thereafter.

Does this grant Apple the right to collect the location data of specific political candidates and their staff for use by the opposing side(s)?

Savers vs Alcoholics

Paul Krugman has been reported as being against austerity. The current economy is too fragile to avoid further stimulatory public spending, he says. The time to save money and trim spending is well into the future. That's his plan, to find the extra bucks to fill in debts when times are flush.

It won't work. The problem with stimulus spending is that it tends to be strongly captured or directed to those who can express, show, or prove the deepest human-felt need. Typically, the best "alcoholic," meaning the people with the most abject addiction, will make the best guilt-inducing case for the extra stimulus. The funds then are spent badly, without return on investment, and the government goes deeper in debt.

Really, the battle is titanic. It is the savers versus the alcoholics. Savers are responsible, putting money away against future adversity, denying themselves near-term pleasures, suffering, striving, working, doing the hard work of protecting their piece of humanity, whether themselves, their family, their team, their business, their company, their church, from the wild and wanton forces of nature. The alcoholics, typically addicting and loving their addiction, fill the need any way they can, indulging in short-term pleasures, spending, consuming, failing to plan, and carving bits of time, attention, money, and sanity from the people and institutions around them.

To the alcoholics, it is a game. "How much can I get away with?" is what they think. It is highly amusing to them to carve off a piece for themselves and have their community fail to notice, to excuse it, to let them get away with it. There is nothing more pleasurable to the alcoholic than getting away with stealing "juice," whether is genuine alcohol, cash, crime, overspending, or any other vice from which they derive pleasure at the expense of the future.

It takes a special person to be a "great" alcoholic. They strive to out-do themselves. They may feel guilty, but it is very brief, and then they have the pleasure of the successful crime, of getting away with it.

For the saver, encounters with alcoholics can be deadly. The ethic of self-denial, investment, careful stewardship doesn't have sharp and pointy weapons like the alcoholic's powers of indulgent destruction. There is no saver's "power move" comparable in strength to the alcoholic's running up of a credit card on worthless consumer goods. A saver is alone, an individual. The alcoholic might have entire government agencies under his command to flush millions of dollars to no good effect, with no one that can organize to stop him.

So, Paul Krugman, the excuses you supply to the spending alcoholics may have a dramatic short term effect on pure dollar flow, but each time you milk the savers to pay for these stimuli, you come closer to inducing an accidental societal fatal overdose. There is no evidence that you know how much more juice the body politic can take before it becomes toxic. After all, the actions and movements of the "liver" of the body politic, the savers, that remove poisons from the organization and purify it through the mending metabolics of investment and frugal habits, are nearly invisible to the alcoholics, who would have no idea how to replace the societal "liver" of savers if it were lost, or even what doses are toxic.

When you live in a fog of pleasured spending indulgence, it is extremely hard to gauge the meanings of those who do not indulge.

Consumer Spending Will Not Save You

Government stimulus programs depend on macroeconomic theory that was established many decades ago by folks like Keynes. When the government spends money, or gives it to needy individuals, the theory says that the economy as a whole will expand, creating economic growth.

At the microeconomic level, the theory doesn't hold. An individual's choice about where to put dollars they have been given has an enormous effect on the downstream growth prospects for the economy. As I've written here before, the individual could choose to spend the money on inefficiently-produced goods and services, in which case they have extended the misallocation of resources that will tend to extend the recession, and does not provide a foundation for future growth.

In addition, the character of the individual's acquisitions with the stimulus dollars can have an important effect on growth. Again, the choice can create growth or destroy it, depending on how it is spent.

Let us image Joe Smith, lucky recipient of $100 of stimulus spending. He doesn't have to pay it back, and he can spend it any way he wants. Some of his choices:

∙ 8 bottles of Jack Daniels whiskey
∙ 40 gallons of gasoline
∙ new air filter, oil filter, oil change, and other engine maintenance on his car
∙ repay loan to his brother, who is an accountant
∙ change or add working fluid in his home HVAC system

What is the rate of return on these options? There is a personal component, and a societal component. In some cases, Joe himself will make money, in others society makes money. What I would suggest to Joe is that, assuming that his HVAC system is a bit older or hasn't serviced in a while, is that an investment in bringing the HVAC system up to full working order could repay him as much as 20% per month on his $100 investment. The whiskey might have a negative return (showing up drunk to work would be bad...), repaying his brother might not earn anything but goodwill or it might restore a great relationship, and the gasoline is just another living expense.

From the Keynesian perspective, the $100 has the same effect on the national economy regardless what Joe does with it. Obviously, this shorthand theory is incorrect. It matters a great deal where stimulus money is spent, and individual choices count heavily in the return on spending.

Hence the title of this article: Consumer spending from stimulus money, alone, is unlikely to generate economic growth, because decisions will be made to put some of the money in places that don't generate a return. Stimulus money carefully applied to areas where investments are made with high rates of return will generate economic growth.

From the investor's perspective, what should influence your perception of the future GDP growth rate is whether stimulus money is aligned with sharper investment sense. Money given freely to unemployed will be spent in ways that provide no return on capital. Money given to decrease energy spending will provide a return on capital. Money given in ways that boost the interest that individuals have in making good investments will also provide a return on capital.

American Leadership to BP: Now Look at What You Made Me Do

The Obama administration suggested that BP should be financially responsible for paying the lost wages of oil industry worked idled by the administration's moratorium on off-shore drilling, the Wall Street Journal reported yesterday.

As a legal principle, it is very unlikely that this has any precedent in common law. Assigning liability to a defendant for the plaintiff's self-chosen actions is rarely credible, and is against common sense.

If the effort succeeds, expect an avalanche of similar "they made me decide this way, I couldn't help it" legal actions, including an expanded tort system. The judicial system will need to expand significantly to handle the increased case load.

Example: A teenager hangs herself because of a bully at school. The parents of the teenager could be tried for murder because they failed to raise the bully properly to be respectful of others.

For more, see the outstanding article at the Daily Mail:
Cameron at odds with Tories as he refuses to publicly back BP after Tebbit and Boris attack Obama's 'anti-British' rhetoric

You could also see the U.S. reaction partly in Tech Ticker's comment on the Daily Mail article:
England Is Now Freaking Out About The U.S. Reaction To BP


Although the British reaction is overdone (there is nothing anti-British about U.S. anger over the oil spill, especially among those in displaced industries), the administration's redneck mentality about seizure of corporate assets is guaranteed to be perceived as threatening to the British. Deliberately destroying goodwill with alliance partners is against American interests.

Everything is an investment

The principal cause of recessions and depressions is lack of capital. Reduced capital stocks induce businesses and consumers to curtail their expenditures, in order to conserve their scarce stock of money.

What causes lack of capital? Poor return on investment is the primary culprit. During the preceding boom, consumers and business, and probably government as well, make what turn out to be poor investments. When capital and revenues are plentiful, people are less concerned with making the highest quality choices.

When I use the word "investment" here, I mean the allocation of any resource to any activity. We all think of stocks, bonds, money market funds, and real estate as investments, but what about time, purchases of durable goods, selections of educational topics, development of new skills? Home budgeting wisdom separates expenses from savings, but both come from the same income pool, and both have the capacity to return future gains.

Most expenses don't return cash, but they may return convenience, time, life satisfaction, and help you avoid costs. If you buy a reliable car instead of a flashy car, you may save thousands of dollars in maintenance over the life of the vehicle and spend dozens to hundreds of hours less time. Then again, if flashiness is supremely important, then buying a flashy car may return life satisfaction well in excess of any additional maintenance expense, or could induce you to extend your car maintenance skills, resulting in personal satisfaction and lower car repair bills.

If you don't think about which corn flakes to buy, you might buy the more expensive box, or the one with less quality per dollar. By not thinking, you lose money. When you don't pay attention, your resources go to the wrong place, and reinforce the wrong behavior in others.

These decisions get less consideration in boom times. If real estate is booming, people may worry less about what would happen if future prices fall than they otherwise would. The idea is that during bubbles the quality of many decisions about where to put capital may be reduced in quality. The result is a mis-allocation of resources, followed by substandard returns on those investments, further resulting in a reduced capital stock.

Hence, it isn't the lack of "animal spirits" that causes recessions, it the presence of "animal thinking" during the booms that causes capital to be allocated badly.

With this insight, the way out of a recession is clearer. Any policy or inducement for people to shortcut their thinking will make the capital deficit worse. Allowing people to sharpen the quality of their investments, to be frugal, insist on quality, and so on, directly adds to capital and immediately rewards those who are making the best efforts to allocate their capital.

Suppose burger chain A and burger chain B sell roughly equivalent value meals. Chain A sells theirs for $5.50. Chain B sells theirs for $4.00. If we assume that the psychological satisfaction of the two meals is roughly the same, the food has the same number of calories, the same quality, and same taste, then which chain is the better investment vehicle? Shareholders of Chain A might be better rewarded in the short term, but let's analyze what happens to society as a whole.

Say that Chain A "gets away with" selling its meals for $5.50. Over time, its employees might come to feel entitled to that $5.50. Or the price may reflect their higher costs, they may let costs rise because the price gives the company less impetus to cut their costs. In the long term, society gets fewer meals from Chain A for the same number of dollars.

Chain B, on the other hand, is generating more meals per dollar. Its customers have money left over, and their employees have succeeded at running the business on a leaner and meaner basis, which makes it more robust to economic shocks. In the long term, society gets more meals from Chain B for the same number of dollars.

In an economic boom, customers flush with extra cash may feel that they are able to show off their wealth by deliberating indulging in a meal from Chain A. Members of the opposite sex will be impressed: "Oh, he can afford the expensive burger! I want him to ask me out! Not that cheap Chain B guy!" Customers are then rewarding the less-efficient business, and making poor investment decisions because they get less for their dollars.

Society benefits from nurturing organizations that can produce and achieve more with fewer resources. Boom thinking, with conspicuous consumption, anti-frugality tendencies, and the success of even inefficient companies, is bad for the long term economy.

I hope that the point of the title of this posting is now clear. Even though a hamburger purchase may not feel like an investment, thousands of decisions to buy off the dollar menu are nevertheless the kind of capital allocation that sets the stage for long-term national economic growth.

All Your Informations Are Belong to Me

A storm is brewing around Facebook and its cavalier treatment of users' privacy. Over the weekend the Washington Post published an op-ed piece by Facebook's CEO designed to defuse some of the criticism. Commenting on that piece was a Monday Wall Street Journal article by Jessica Vascellaro that re-lit the subject, making it look like the Facebook pledge was fairly weak. But WSJ wasn't alone, the criticisms have become a flood:

Facebook CEO pledges another privacy rework (CBC)
Tension Building At Facebook As Staffers Challenge Zuckerberg's Approach To Privacy (BusinessInsider)*
Facebook Grapples With Privacy Issues (Wall Street Journal) (Jessica Vascellaro)
Dumb f***s (Forbes) (Meghan Casserly)
Facebook CEO Accused of Securities Fraud (slashdot)
Facebook CEO’s latest woe: accusations of securities fraud (VentureBeat)
Facebook Issues Statement On Latest Zuckerberg IM And Company Attitude Toward Privacy (BusinessInsider)

The shape of Facebook's grand strategy seems to be to take advantage of naivete wherever possible, then expose user data and expect that users will then forgive this slight by agreeing that it was all for their benefit anyway, as though Facebook knows better what is good for users than the users themselves do. From the WSJ article: "he [Facebook's CEO] has made no secret that he believes users should and will want to make more information about themselves public over time. "

Developers Can Exploit Facebook User Data
Facebook earlier deployed a series of programming tools that developers can use to add content to their websites. A lot of that content comes from the private data of individual users. One such site is YourOpenBook.org.

As of the time of this blog post, these were recent Searches:
my vulva
"I'm over it"
"jose gomez"
nigger
gay
win borden
interracial
acne
shaved my head
my new pictures
skinny dipping
lost virginity
my new number
"lost my virginity"
getting a divorce
naughty pics
had a threesome
slutty pictures
im a lesbian
radical muslim

Pick anything, and you get real pictures of real people, complete strangers, telling you exactly about their vulva or divorce or how they had a threesome or are radical muslim.

Go ahead, try it.

Coming Next
There is so much more to write on this topic, and how it intersects with economics and politics and the future of commerce. Future posts will explore each of these in turn.


* I first encountered a Forbes story, but that story is little more than a wrap of a BusinessInsider story which is in turn a wrap of a Wall Street Journal story. So for this news story, in effect, Forbes is suckling from the WSJ information stream. We chose the BusinessInsider headline because it was more colorful.

Bank Lending: Policy Makers Squeezed Tight?

The prescription to cure an economy that choked on too much credit is simple: Less credit. Unfortunately for officials, this is a very unpopular medicine, since it reduces economic activity by reducing leverage among lenders, reducing lending, and propping up medium-term interest rates that affect purchases of durable goods. If you want a bank to increase its capital relative to assets, then assets must shrink, since capital will only be generated over time through earnings. Fewer assets, less lending, fewer lenders who are open to lending.

If you are a public official, the last thing you want to be associated with is reduced lending. Hence our current official set of matched lies: "It is the banks who are refusing to lend" versus "You'd better increase your capital ratio." Calling it hypocrisy would be exact, but then some readers find that to be a loaded term, implying more criticism than is intended.

The key point is understanding how all of the players are influenced. While the economy is in bad shape, banks will be hit with blame from officials for not lending while being given incentives to do exactly the opposite. There is a gap between the genuine true and the printed and perceived words in the press. Bank lending will not increase until the real conditions, not words, are there to support it.

~ ~ ~

On the other side of the coin are consumers. If they don't want to borrow, they won't. Right now the prudent action for consumers is to pay down debt and build up savings. Eventually, government encouragement to spend and fail to save will arrive, but don't expect an increase in consumer lending until the mood of frugality has passed.

U.S. Should Require Minimum Investable Content in All Imported Goods

This post's headline is not going to attract many readers. Tough. Let it exclude candy-addicts.

I will try to warn you most times when I make a post that is normative. That is, if the post is pushing a policy, rather than an observation or opinion about what we think might be true, regardless whether anyone wants it to be true or not, then I'll tell you. So here's the warning: This post is pushing a policy.

The U.S. and China have a trade imbalance. China sets exchange rate policies in its self-interest that keep their export prices low, which generate surpluses and tend to have the effect of undermining industries in the trading partner's economy. The U.S. has free-trade principles that tend to reduce our retaliatory actions against nations that set exchange rates in order to capture market share.

For the moment, let's set political and labor considerations aside. Arguing about whether protecting domestic industries is good or bad is a separate debate. There is an alternative.

Presumably, in any trading relationship, both partners benefit when the lower cost producer of goods is permitted to export its goods. If both partners have specialties, then all benefit from the diminished input costs to the two societies taken as a whole.

The problem occurs if one of the countries wants to be the specialist in all goods. From a practical perspective, the only way to pull this off is for one country to set a society-wide policy that allows it charge less for all of its goods. At the national level, the most accessible lever is setting exchange rates, as China does. By holding the exchange rate so your currency is cheap, your trading partner's goods are expensive while your own are cheap, as measured in each others' currency. The disadvantage of this policy is that your profits are lower. If the goods you export have sustainable value, then on an absolute basis you tend to wind with less of the pie. If the goods you export have a rapidly declining value, then in the short term you lose but in the long term you can win.

So here comes the normative (and invented) part: U.S. policy for trade should require a minimum investable content for all imported goods. Investable content is defined as a residual value the product has at the end of its depreciated life. Every good has some nominal value that tends to evaporate as the product is used. Cheap goods that break easily have no investable value, because they tend to be discarded quickly. High quality durable goods that prove to be defendable have high investable content, because they return substantial value even after their nominal life has been served. Anyone who has ever bought a refrigerator, car, television, expensive electronics, or computer knows the difference between getting more than your money's worth from the best, and getting junk that has to be removed and discarded after a short life.

Some simple examples:

Back when it was produced, most Chevrolet Chevettes had negative investable content, because during their short troubled lives they broke down, had high repair and inconvenience costs, and after five years were close to worthless. In contrast, Honda Civics had high positive investable content, because they gave well above-average gas mileage, were reliable, had low maintenance costs, and after five years had high resale value because they had many, many more years of life in them.

Buying foreign goods cheaply is a net positive for the U.S. if the goods retain value. A trading partner that holds exchange rates fixed and which are advantageous to itself should be required to send only the best goods with substantial residual value, not junk. Then, in the future should exchange rates change and the foreign country try to complete its conquest of all goods markets, then the U.S. can simply wait out the attempt, by relying on its existing stock of durable high quality acquired goods, while rebuilding its domestic industries that produce those goods for both domestic consumption and export to the trading partner.

There is nothing unfair or retaliatory about requiring quality. I do not believe that requiring quality would violate any WTO rules. I don't believe that our trading partners would wish to be perceived as defending their right to send shoddy merchandise. Most importantly, requiring quality from imported goods raises the standards for all, sets good examples, and prevents trading partners from cheating on free-trade agreements in the long term.

Since this is a normative post, I'll add that most Americans probably already have too many things, so buying fewer things of higher quality and price is often superior to having more things of lower quality and price. The cheaper stuff requires more diagnosis work when it breaks, results in spending more time buying replacements, takes up more landfill space when it is discarded, and takes up more room in your house. Wouldn't you rather pay for less real estate to store fewer objects? Having fewer things will pay dividends every single day.

~ ~ ~

In the absence of official action, it is simple to make a difference and enforce the policy described above. You could, for example, send a short message to some of your favorite stores or vendors:

"Dear [retailer or vendor],

I understand that in the current global economy that opportunities for sourcing your products from countries like China gives you the option of maintaining good margins and passing on low prices to your customers. I want you to know, however, that in our [company, family, group] we feel that it is time China met all of its obligations, not just those based on price. In the future, we will be looking to make sure that products we buy from you have outstanding quality, regardless of price or China content. There will no longer be an implied lower quality standard for cheaper merchandise. We expect you to import only top quality China merchandise that has a very long-term sustainable value, even if it is inexpensive. We don't need things that t go straight to the landfill. Do the right thing. Insist on the best, and reject crappy cheap junk. Send that message, and we will support you.

Sincerely,
A continuing customer."

Jabber, part 3

He took his vorpal sword in hand:
Long time the manxome foe he sought--
So rested he by the Tumtum tree,
And stood awhile in thought.

The investor compiled his facts and figures
He'd long sought to destroy evil's smooth lies
He pause to observe the true actions around him
uncovering deceptions with trained and open eyes

Bank Bailout Cost Decreases Again

I reported on the rapidly diminishing estimates of TARP costs last month. Today, AP reported ("Lower bailout estimate assumes higher stock prices") that the total cost to taxpayers has decreased again, to $105.4 billion, according to the The Treasury Department. The White House and Treasury maintain different estimates.

Other estimates:
Congressional Budget Office, March 2010, $109 billion

Evidence of Soros' Reflexivity Theory

Germany has banned naked short-selling of securities in a move that was swiftly declared, catching other Euro partners off guard. The words Merkel used to defend this action are evidence for George Soros' reflexivity principle, in which markets feed on themselves to go too far. You can see this in the Reuters story "Germany declares solo war on speculators".

In the fourth paragraph:

"Merkel told Germany's parliament EU leaders had to ensure markets could not "extort" the state any more and the bloc would introduce its own financial transaction tax or levy if the Group of 20 nations failed to reach a deal in June."

While the description of the markets could be wrong, and explained as a leader's perspective on the markets, the underlying concept is a strong statement of the belief by German officials, from direct observation of the markets, that the marketplace will go too far on its own, with real and malevolent effects on the economy at large.

Although the tendency at the political level is to blame "someone else out there," as though speculators always seek to tear down countries for profit in preference to any other vice, it is clear that the danger perceived is real. That the danger is caused by collective economic behavior is a fine point. If legal action can defuse the potential for economic damage, then the state is correct to act by inserting obstacles in the path of the meltdown dynamics.

It remains to be seen whether the selected mechanisms will create the desired effect. The immediate reaction in Europe was to increase selling to reduce risk exposure, just in case the German government had inside information that the market participants weren't privy to. Still, the point remains: The short-selling ban is motivated by a desire to cut reflexivity short.

Goldman Sachs as Bucket Shop

I wrote last year about brokers and bucket shops. In that article, the subject was detecting brokers that operated Ponzi schemes. But there is another way that your broker can act just like a bucket shop.

A bucket shop of the old days just sold you a piece of paper that gave you a short term profit or loss on stock price changes. Since there was no one on the other side of the trade, in effect the bucket shop always traded against the customer. For each customer long position on a stock the bucket shop effectively took a short position exactly opposed to the customer's position. Hence, bucket shops are customer adversaries, a phenomenon that should always make customers queasy about doing business with them. And, in fact, bucketing trades, in which the customer's order is not cleared on a general exchange with a counter-party that is not the broker, is presently illegal in most states.

Even in 1905, bucket shops were not reputable. A pleasingly quaint account of the business as it was conducted in then is described in an old New York Times article (PDF).

Any time a broker is acting more or less like it is taking positions opposite its customers, then, it is acting in effect as a bucket shop. A key part of Goldman Sach's offense, at least in the figurative sense, is that it shorted any market in which it also underwrote securities. Customers expect brokers to act in the customer's interest. That is why they are trusted. If the broker uses any element of the customer's business or information generated by that business to trade against the customer then it is in violation of that trust.

This is the gray area between bucket shop and concerned customer agent. I suspect that most Wall Street brokers have been operating in the gray area for so long that they have forgotten where customers draw that line. I know a number of individual traders who never take it for granted that their brokers, whether full service or discount, Merrill Lynch, Raymond James, TD Ameritrade, Charles Schwab, or even E*Trade, are honestly processing their orders without somehow making illicit use of the information represented by the customer's current account holdings or orders. They take it for granted that brokers are shaving something off of every trade, whether information, front-running, or collecting "contrary indicator" data in which customer trades are data-mined for correlations to future price movements.

But expecting a certain level of despicable broker behavior is not the same as condoning it, or even thinking that it should be legal. Customers only tolerate this "at the edge" behavior because they know of no way to prevent their brokers from engaging in it. That Goldman Sachs has purportedly been caught at engaging in it will not save them from a significant and public punishment. After all, Goldman has long touted its superior moral values. That makes Goldman's behavior both marginal and at odds with how it represents itself.

Actually, not all customers tolerate bucketeering or, to coin a phrase, "data trimming" by the broker from their accounts and orders. There are techniques for double-crossing a broker that is front-running your trades. I will describe some of more than 20 ways to trip them up in future posts.

References:
Goldman CEO, under siege, concedes changes coming (Reuters)
Aussie fund director's Goldman claim gets traction (Reuters)

Jabber, part 2

"Beware the Jabberwock, my son!
The jaws that bite, the claws that catch!
Beware the Jubjub bird, and shun
The frumious Bandersnatch!"

Beware of Ponzi schemes my fellows!
the fantastic returns, too good tres fats!
Beware of cold-calling microstock brokers, shun
the Wall Street/Washington mutual backpats!

Jabber Translation, part 1, non-rhyming

`Twas brillig, and the slithy toves
Did gyre and gimble in the wabe:
All mimsy were the borogoves,
And the mome raths outgrabe.


The market was fluctuating, and all the participants, especially slimy sellers-of-ideas
were twisting and talking and attempting to out-do, out-talk, outwit their competitors and customers
And greedy but prudent were the mutual funds and asset managers and hedge funds
seeking outperformance, at least in their office and/or fees that were charged.

Public's Appetite for New Subprime Credit Grows

In addition to official Government interest in seeing increased lending, some companies too want to increase the number of new sub-prime loans.

GM wants more subprime buyers; will lender agree? (AP)

Wait a second! Didn't we just finish a major part of a severe economic downdraft inspired by subprime credit? Aren't we still burdened with trillions of dollars of public debt directly related to the excesses of asset-based lenders who overextended themselves in taking on too much leverage in order to serve all debt markets, especially and including subprime? Isn't one of the lessons that should have been learned is that taking on too much debt, whether individual, corporation, or nation, a bad idea? Aren't people at this moment basking in their new-found frugalness, thanking God for the lessons they have learned, and feeling the benefits of increased rationality in their financial lives?

Aside from the normative statements we could make here, there are telltales to note. GM appears to have benefited as much as it can from the past year's recovery in the economy. Strumpf writes: ""There's a real sense of urgency on GM's part to maximize its sales" as it gets closer to the stock offering, said Kirk Ludtke, senior vice president of CRT Capital Group in Stamford, Conn."

Some possible conclusions to draw:

• negotiate hard on price if buying a GM vehicle; they really need the sale
  
• avoid buying shares of the IPO, if it occurs
  
• look for bank earnings to level off, as competition increases among lenders to make subprime loans
• in your macroeconomic models (you have one, right?), increase the probability of a new credit crisis occurring in 2010, 2011, or 2012
  

Commentators Exceed LATimes Columnist

Put this in the "measurements of quality" category. David Lazarus is a syndicated LA Times financial columnist. A recent 4/25/10 column on bank reform legislation made reference to "puppies and kittens." I went looking for other telltales, and found Bank of America yanks Countrywide Financial customers' credit lines.

What's interesting is that reader comments show more sobriety than the columnist's original prose. For example, KathyA says:

"Mr. Lazarus, you seem to want it both ways. In the past, you have (rightly) raked banks over the coals, especially Countrywide (now Bank of America), for risky financial decisions in mortgage lending. You can't expect to be taken seriously when you now criticize these same institutions for making fiscally conservative financial decisions."

Lazarus' complaint is that Bank of America has declined to renew home equity lines at the five-year mark, as the contracts issued by Countrywide permitted. His reaction, over the bank's failure to provide an explanation, seems puzzling. At least, until you draw an analogy of the bank as bartender and home owner as alcoholic. The alcoholic doesn't like being cut off, even if, or perhaps especially if, the reason for severing the drug supply is rational.

In summary, the problem, the way Lazarus has described it, is that Countrywide was a good co-dependent, and Bank of America is not behaving right as a co-dependent properly should.

Snicker snack!

Risk

Punishing Scientific Liars

The problem with publishing articles about the outrages perpetrated by evildoers is that you wind up promoting the evildoers. In the process of promoting justice, you might accidentally promote evil instead. After all, as the expression goes in the entertainment business: "Print whatever you want. Just spell my name right!"

So in the spirit of correcting injustice, I will instead present ten awesome people who deserve your attention and praise:

Warren Buffett - Great financial, investment, business advice, attitude, and outlook

Thomas Sowell - First class thinker, a man who plows through controversial topics as though he were wielding a vorpal blade [hey, it's been way too long since I worked in a Carroll reference to this blog's title...]

Meryl Streep - A master at her craft. Much better and longer-lasting than your average popular face in Hollywood.

Matt Groenig - Author of the "Life in Hell" strip and then The Simpsons, a classic television show that has withstood now for decades.

Tori Amos - She makes music that doesn't wear out, and she's prolific, different, and--dare I say it this way?--spicy.

Frank Tipler - Physicist who dares to blur the line separating God and Science through the use of cutting edge physics. This isn't pop physics or pop religiosity. Prepare to resume your graduate level math to follow his papers and read the appendices of his books.

Richard Dawkins - Author of perhaps the best scientific book of the last 30 years, The Selfish Gene.

Bruce Schneier - Security expert. In the digital era, knowing about computer security is not just a good idea, it is a survival skill, and Bruce has a great blog that maps out most of the pertinent topics.

Dan Seligman - Former Fortune columnist, and then a Forbes columnist, who was always pointing surprising statistical facts in his articles. Over and over he showed that conventional wisdom is sometimes pathetically stupid.

Kurt Godel - Famous for his incompleteness theorems, which he proved in 1931.

So who is the evildoer who originally sponsored this column? Oh well, I forgot who they were. And forgotten they shall stay...

Government Bailout Funds: 'Cause That's Where the Money Is!

I have to wonder, do people really think through their ideas, or are they just in love with the desired outcome? The most dangerous proposals are those where the real outcome is indeterminate but both sides imagine they will get what they want.

The thought that banks should be paying extra fees into a bailout fund so that Government can rescue them in the future is either wishful thinking or an extremely pernicious stab. Current legislation envisions a $50 billion fund created with taxes on financial institutions.

Where is the wishful thinking? The first wish is that $50 billion will be enough to ward off a future credit meltdown. The second, sneakier, wish is that the Government will have $50 billion it didn't have before.

Here is what will really happen: Willie Horton.

What? It is easy: A $50 billion pot of money will soon attract honey-seekers. The money will be there, tantalizing various special interests, seemingly doing nothing. Hence, it will not be in reserve for long. It will be transferred, borrowed, or stolen, for or by special interests via legislation, and will never be available for a bailout. Congressional action will loan it for other purposes. When a bailout really is required, the Government would then have to scrape up $50 billion from other accounts in order to effect the bailout, which will be that much harder to do.

Even worse, banks and financial institutions and their customers will believe that their actions are backed by a $50 billion bailout fund. Moral hazard will be increased, and many will act as though their actions are insured. Because, by gosh, they are insured. No illusions there, seriously! If that's what they've been told, in full faith, why shouldn't they believe it? You certainly can't blame them if they've paid insurance premiums under the impression that they are buying insurance.

The best argument for creating any sort of $50 billion is that it is a "rainy day fund." You save the money, just like an insurance company, against future hardship. The problem is that public finance has proven, over and over, that it an extremely poor steward of capital, and tends to overspend its budget, significantly and repeatedly.

Hence, the correct action to take is passing legislation that encourages the formation of private pools of capital that could intervene in the case of crisis. By encouraging private capital formation, the U.S. gets the benefit of rational self-interest, rewards the best stewards of capital in proportion to their skill, avoids the problems of attempting to retain and maintain public capital, obtains broad and powerful diversification across hundreds of thousands of small pools of capital, and generates a more powerful capital base from which to fund future technological investment.

What shape would such incentives have? The Government could buy special insurance, that would operate in two parts. First, it would pay a direct annual premium against failure of major financial institutions. Each capital pool owner would collect this premium from the Government in proportion to the amount of capital that they would guarantee as being available during a crisis. In the event of crisis, the claim is not for cash, it is for credit. That is, the insurance provider guarantees that they will make a loan available at a particular, contractually agree interest rate. For this loan, the Government also pays the interest. If the insurer is unable to make the loan, they would pay a penalty of multiples of the prior collected premium.

Direct cost to taxpayers of this system would be much lower. Annual premiums would be set by the market, of course, but since the insurer is only guaranteeing liquidity, they can invest their pool of capital elsewhere and still earn a return. The premium would be only a bonus. You can imagine that some of this capital would be in cash, money market funds, in deposits, and in stocks and bonds.

Obviously, the Government is not generating new capital when it makes a claim. Money moves as the insurers may be forced to liquidate stocks and bonds to post some of the claim. More importantly, though, a Government claim more likely forces highly liquid cash investments out of the hands of the insurer to the Government at exactly the time that a TARP-like rescue is required. It is during such crises that many private participants sit on cash hoards as a protection against uncertainty, so although the insurer may have less of a cushion than before, it is unlikely that such a capital claim will force down asset values. This system acts as a circuit breaker, forcing money back into circulation during a crisis when it is needed most.

The premiums paid by the Government could still come from premiums in turn paid by banks and major lending institutions. But such premiums would likely be much less, and the overall flow of funds would be less traumatic for all involved. Even better, the Government could still retain a fund of excess premiums it had collected, which presumably would vary but likely be much less than $50 billion. And there would be no public moral hazard to tap this Government slush fund.

[This post started May 12 and completed May 16.]

Cause of Meltdown: Massive Leverage

It is fairly clear that massive leverage was the primary cause of the financial collapse of July 2007 to January 2009. Companies like Merrill Lynch, Lehman Brothers, Bear Stearns, and various home mortgage lenders levered up their balance sheets in order to take advantage of historically low volatility in interest rates. By gearing their operations at 25 to 40 to 1, and adding other mechanisms on top of that leverage, they were able to make grand bets using the classic late night TV show trick called OPM, "other people's money."

It really shouldn't be a mystery to anyone, especially federal regulators and legislators, that this is what caused the crisis. Nearly all financial crises have too much debt and borrowing as the causative factors. All of the stomping around and looking for scapegoats just serves to deflect the public's attention away from the fact that regulators failed to apply sound financial management in their regulatory roles.

Which brings us to an especially important subject: Bailouts and moral hazard.

Bank insurance, government backstops, and similar special funds may actually make the next financial crisis worse, not better. The problem is that if the market perceives that Government has a special way to remove risk from a segment of the financial market, then participants will fail to exercise diligence in examining their counterparties and checking on their risk exposure. A consumer who believes that their money is insured by FDIC will not check on management's probity. A bond buyer lending money to Freddie Mac will accept a smaller coupon on the expectation that the Federal Government is backing the loan. If you encourage, or force, lenders and financial consumers to consider soundness of their counterparty, then everyone is going to be a lot more careful.

It reminds me of a saying that I believe is attributed to Robert Heinlein: "An ARMED society is a POLITE society."

The more consumers are discouraged from exercising their judgment about selecting sound institutions, the more the marginal institutions will use the cover of government bailout agencies like the FDIC to skate close to the edge. Blowups like Washington Mutual, Wachovia, Freddie Mac, and Fannie Mae wouldn't have been nearly as bad had they been required to trade on their full market risk.

In short, Government backstops that are funded with cash are a bad idea. Government financial regulation needs to focus more on information flow, especially sniffing out easily understood financial soundness measures of the lending and deposit-taking institutions. Shoveling financial data and telltales to the market will correct future problems before they happen, and with much more soundness than any cash-based bailout fund.

Regulators Feverishly Looking for Causes of Market Volatility

Mystified by recent market ups and downs, including the "flash crash" as rhyme-loving media organizations have dubbed it, regulators are pawing desperately through trade data, hoping to find a culprit to pin blame on. See: Regulators Dissect Trades, Searching for Cause of Plunge

The continuing bull market in blame-finding, fingerpointing, and scapegoating may surge in the near future with charges against Morgan Stanley, say AP and WSJ stories (and a Reuters report on the WSJ story) on the matter published today.

So far, repeal of the Glass-Steagall Act, the Community Reinvestment Act (CRA), low Federal Reserve interest rates, greed on the part of subprime homebuyers, Congressmen who trade on inside information, NY Fed directors who bought Goldman Sachs stock while still acting in their official capacity, and other angels and angelic acts have been omitted from the search for culprits.

Prospects for Real Estate Recovery in Los Angeles

Perhaps there was a good reason for the housing boom, says the New York Times.

[whoops, this link is now dead:
http://finance.yahoo.com/news/Was-There-Good-Reason-for-a-nytimes-3118998957.html?x=0
new link, fixed 12 Oct 2011:]

Was There Good Reason for a Housing Boom?

Homeowners and speculators in Los Angeles are hoping for a recovery. What are the prospects?

In my estimation, not very good for the near term. The last time Los Angeles real estate peaked in 1988 it took over 8 years to get back to even. The peak this time was much more pronounced, which will make the recovery that much longer and more painful. Look for a return to "normalcy" in Los Angeles real estate sometime in 2014 or 2015.

The Most Dangerous Time of a Bull Market

Is when it is not clearly a bull market anymore. Just two weeks ago the Wall Street Journal published an article touting the news that technical analysts thought the market had room to run. Instead, it has faltered fairly firmly. Stock action was a little too happy through March and April. Clearly, the market was near a temporary top, which has now occurred.

Where to go from here? Normally, reputation being dear, I would refrain officially and formally from making any sort of pronouncements about where the market will head next. And if I knew now, then I'd be wrong. Unfortunately, the certainty that existed just a few short weeks ago is no longer. The prospects for up, down, or sideways movements are all equally likely, at least to the non-measuring, qualitative human mind that is usually applied to such predictions.

All that said, I would conclude that the market is about to be completely random.

Which means, in translation, that we're likely due for a rise, but not for very long.

Economic Cycles as a Form of Spiritual "Payback"

Governments strive to keep their economies as healthy as possible, usually paying special attention to maintaining the fullest level of employment possible. But full employment has its own costs:

- Government stimulus programs result in higher taxes, putting a drag on economic activity
- lack of austerity reduces the incentive to maintain high standards for return on invested capital
- decreased appetite risk necessary for new ventures, since maintaining the status quo is adequate; result is that fewer new ventures are created

Deep recessions can creates a groundswell of sharp, tough decision-making among consumers that raises the bar for marketplace products, which has the effect of requiring lower prices and higher quality among businesses competing for a share of scarcer dollars. On the consumption side, having fewer dollars to spend tends to automatically enforce a higher consumption productivity, in which the same utility is generated from fewer expended dollars.

The hazard is pernicious: If the recovery from recession is too easy, consumers forget their tough, high return-on-investment habits and begin to make sloppier decisions. The right way to recover from recession is to have the recovery driven by the higher productivity of consumption and investment decisions among consumers and businesses, respectively. That is, as frugality is practiced more and more it becomes a habit and more ingrained. This frugality causes a national natural productivity boost, which then shows up in an expanding marketplace as consumers then find new surpluses at their disposal.

The converse also occurs: In boom times consumers feel that money flows to them easily. They get careless, and don't police their expenditures as much, or fail to shun higher-priced, less efficient services and products. Marginally inefficient activity fails to be curtailed during the boom, but then this leads to small decreases in the capital stock as resources are squandered and wasted and consumers fail to reward the good businesses and punish the bad businesses.

In the global scheme of things, a recession is a school lesson. It occurs because the nation forgot that it was supposed to be on good behavior. Once in the recession, the nation learns the good way, the right way, and these practices then lead to the recovery.

So the business cycle is payback: It is carrot and stick, rewarding you (economic expansion) for good habits (frugality) and punishing you (economic contraction) for bad habits (overspending or buying badly). It is a natural cycle, supplying invaluable feedback.

Stimulus interferes with this learning process. Supply enough stimulus, and the nation will forget how to invest in itself appropriately, and the lessons of frugality will be lost.

Congress Permitted to Trade on Inside Information

Based on what Tech Ticker and the Wall Street Journal report, members of Congress are permitted to trade on material, non-public information pertaining to publicly traded companies:

http://finance.yahoo.com/tech-ticker/congress-refuses-to-outlaw-insider-trading-for-lawmakers-478701.html?tickers=^dji,^gspc,^ixic,brk-a,brk-b,gs,xlf

We could make an argument that current SEC regulations don't distinguish between legislators and non-legislators, so theoretically the insider trading that has occurred is technically already a violation of U.S. securities laws.

Fed's "Fat Finger" Fantasy Fallacious

The cause of the last week's sudden plunge in stock markets remains an obsession of the Administration and securities regulators. The rush to blame something, or someone, has led to theories of manipulation, terrorist action, and a "fat finger" error in which a trader coded in an error to sell "billions" of shares instead of "millions." So far, the frenzied searches have turned up nothing.

In my estimation, they will not find a cause, because the cause is far too simple for them to believe. If you look at a chart of market action from last week, there was a clear rapid decrease in prices for several hours prior to the "sharp plunge" that caught everyone by surprise. Could it simply be that market action, exacerbated by programmed trading, simply resulted in the vast majority of participants deciding all at one time that stocks should be sold before they almost certainly would be cheaper in the near future? If all traders suddenly agree, you would see exactly such dramatic price moves. There is no inconsistency.

It seems very foolish that the SEC and Administration would find it "unacceptable" that the stock markets behave in such a fashion. One gets the feeling that they are highly offended that the market would show such volatility, as though a "normal" market should always be kind and smooth. I have a bulletin for you: Efficient market theory says that markets behave randomly. And random behavior includes sudden drops, and rises. Even if you don't believe in the efficient market theory, it seems clear that when everyone suddenly agrees that a good is too cheap or too expensive that the price of that good is going to suddenly show a very discontinuous pricing.

Probabilities:
90% chance that nothing "unusual" caused the sudden drop.
35% chance that this conclusion is buried by the investigators for several weeks.
85% chance that the sudden drop was caused by market participants deciding that political events in Europe, Greece, and Washington D.C. would cause a future decrease in U.S. GDP growth.

TARP Will Cost How Much?

In the beginning, TARP was announced and it would cost $700 billion.

Then banks began repaying, and the cost was lowered to $341 billion in August 2009.

Then some warrants and preferred stock, and the cost was reannounced at $117 billion.

April 23rd, TARP losses were re-estimated to be as low as $85 billion.

At this pace, the U.S. Government will soon be announcing profits from TARP.

How to Recognize Biased Blogs

This post started with the idea that I would track down documentation on the cause of ING Groep's severe losses in 2008 and 2009. I thought I had seen somewhere that most of the Mortgage-Backed Securities (MBS) ING had bought in the U.S. were required by U.S. law because of ING's deposit base. Well, aside from the important idea that a bank should make money on money that it borrows, the Community Reinvestment Act (CRA) was established to encourage banks and thrifts to make loans in disadvantaged areas. I'm still researching that, but I discovered an interesting blog along the way.

Here is the blog:
http://www.bankinnovation.net/profiles/blogs/kill-ing-direct

The ambiguous title "Kill ING Direct?" is the first clue that the blog may have an opinion mixed in with its commentary. Is it seeking permission? A clarification of a command? A quick read through the article shows a bias. The magic phrase?

"That it deserves to exist is."

Right at the top of the article is the implied normative question: Whether or not the bank deserves to exist. In my usage of English, "deserve" implies something other than "earned." Certainly, if a bank fails to make earnings, it will soon be gone. But that isn't how Americans use the word. It implies a moral judgment, something more than a simple weighing the business value of the enterprise.

Hornblass, were you offended by ING Direct? What is the problem here, earnings aside? ING savings accounts suck money from low-service checking accounts at major banks, but what is wrong with that? Savers get more control, more interest, better visibility into their earnings, and the ING user interface is a leader the industry. Banks with slow Javascript, bad and ugly page layout, limited features, and limitations on the number of accounts deserve to lose the business.

It does make me wonder who will wind up with ING Direct after ING Groep sells it before the 2013 deadline. Also, since the Dutch government ordered that only ING Direct USA be sold, is that payback for the losses imposed by U.S. policy on ING Groep and its shareholders?

The High Shrill Voice of the SEC

As this past week wore on and comments and observations from attorneys and analysts were weighed, it became increasingly evident that the SEC's civil fraud case against Goldman Sachs, announced one short week ago on April 16, was founded on slim evidence and had little chance of succeeding in court, even though it had a high-pitched emotional resonance. Mario Bartiromo found it wanting. Republicans charged that the suit was politically motivated, timed to correspond to debate over financial reform. The SEC itself decided to investigate ("UPDATE 1-Watchdog to probe SEC's Goldman lawsuit" http://www.reuters.com/article/idUSN2323274820100423?type=marketsNews).

But most damning is that Warren Buffett expressed his confidence in Goldman.
"Warren Buffett Has 'Great Confidence' in Goldman Sachs Says Berkshire Director"
http://www.cnbc.com/id/36742080

Looking at the charges and the assumptions behind them, you could make a strong case that the only way for Goldman Sachs to avoid being charged was that Goldman would have had to prove to its client in advance that Goldman would lose money on the deal.

Although the ACA portion of the suit is in tatters after a week's worth of reports, the IKB side of the argument will survive, reports the Washington Post.
"SEC confident on IKB part of Goldman Sachs lawsuit" http://www.washingtonpost.com/wp-dyn/content/article/2010/04/23/AR2010042305223.html

7 Illinois Banks Shut

The Federal Deposit Insurance Corp. took over seven banks Friday April 23, all in Illiniois, with four in Chicago. That brings the total number of closures in Illinois to 32 since the start of 2007. Georgia still leads the death count, with 38 failed banks since 2007.

The closures on Friday, in Chicago, with assets shown in millions:

New Century Bank, $485.6M
Citizens Bank&Trust Company, $77.3M
Broadway Bank, $1,200.0
M Lincoln Park Savings Bank, $199.9M

Elsewhere in Illinois:

Amcore Bank of Rockford, $3,800.0M
Peotone Bank and Trust Company, $130.2M
Wheatland Bank of Naperville, $437.2M

Bank failures remain concentrated in four states: California, Florida, Georgia, and Illinois. Minnesota is a distant fifth. Total closures by state, for January 2007 to date:

State Total
AL 4
AR 1
AZ 6
CA 26
CO 3
FL 25
GA 38
IA 1
ID 1
IL 32
IN 1
KS 4
KY 1
LA 1
MA 1
MD 3
MI 6
MN 11
MO 6
NC 2
NE 1
NJ 2
NM 1
NV 7
NY 3
OH 4
OK 1
OR 4
PA 2
SC 1
SD 1
TX 8
UT 5
VA 1
WA 8
WI 1
WV 1
WY 1

Total for all states, January 1, 2007 through April 23, 2010: 225 banks failed.

To get your own copy of the list of failed banks, in a CSV file suitable for analysis in your favorite spreadsheet software application, go to http://www.fdic.gov/bank/individual/failed/banklist.html.

Optimal Fed path: sell MBS inventory gradually

The Fed is divided over whether to sell off its mortgage backed securities inventory. Selling it too soon, or not at all, would have an impact on liquidity and short-term interest rates. Narayana Kocherlakota, president of the Minneapolis Fed, has the best recommendation, and it should be followed: sell $15 billion-25 billion of MBS each month. If performed regularly, this rate of divestment would take the Fed’s inventory to zero in about five years, and reduce the Fed's leverage and balance sheet, putting back into a position to intervene again should it need to.

Burger King (BKC) Target is $25

After a recent breakout from a trading range of $17 to $19, BKC moved to $21, paused, then jumped to almost $22 today. The catalyst? Likely expectations of improving margins and earnings as consumers return after the harsh winter. There is chatter indicating that some items may move up from the $1 value menu.

Now, if they can just get rid of that freaky "King" character, maybe sales would improve even more.

High tech hiring runs afoul of RICO?

The Wall Street Journal has reported (4/10/10) that the Justice Department is investigating whether high tech companies collude to hold down the salaries of engineers. Since certain companies do share salary data by pooling their information, the net effect is to curtail competitive bidding for talent.

Commentary on the article was instructive. I think one point that was missed is that with tax increases coming, the U.S. needs to mint more high-income earners, and engineers are typically paid less than legal and financial professionals, so boosting engineering pay would raise new income tax revenues and result in more students choosing to enter engineering programs in college.

The Unintended Consequences of Unintended Consequences Articles

This is commentary on commentary. Actually, it should be "commentary on reporting," but the Forbes April 26 article "Careful What You Wish For" isn't really an article, it is opinion.

The idea behind the article is that current Congressional work on restricting banks' and financial companies' abilities to issue abusive debt to consumers will have unforeseen consequences that will impact the consumers in ways that the Government doesn't expect. This is a fine thesis, one that probably is even correct in the large, but the author fails to make his point in ways that really count.

The article has a whiny tone, the kind a liberal would expect a right-leaning article on consumer finance to have. Policy based on behavioral economics research is ridiculed as an "assumption." Phrases like "regulatory overreach," "furious new round of maneuvering," and "variety of dastardly practices" lay down a challenge to the reader, as though designed to stir a rebellion.

The article does admit that that "consumers do dumb things." But ultimately, this admission is drowned out by all the contention so that the article fails to score the direct hits that should have easy to come by. So since Forbes couldn't pull it off, here's my list:

- Some consumer financing products have drug-like qualities, with extremely high costs and the ability to addict some consumers to financing they don't understand.

- Some financial deals are made so complex that it is nearly impossible for even an educated consumer to find the implied interest rate. A perfect example are balance transfer offers at 5.99% with a 4% fee that have only a 6 month term. Most consumers don't realize that this "money saving offer" has an implied APR of 15.31%.

- When high-risk consumers are protected from high interest rates, banks will simply refuse to lend to them at all. Depending on your perspective, this could be exactly what should happen, or it could be a problem. After all, if a consumer always makes their borrowing decisions based on immediate gratification, then they are a terrible credit risk and perhaps they shouldn't be given credit at all. It isn't cruel; it's good parenting.

- Restrictions on pay day loans will cause an increase in illegal loan-sharking. If an instant-gratification-addicted consumer can't get a payday loan because they are illegal, they may turn to the black market for their financing. Prohibiting fringe behavior will drive it underground, where the dangers of non-payment are physical, not just fiscal.

- High interest rates are necessary where risk of default is very high. And some people are just really bad credit risks. They don't have the money, they don't intend to pay it back, or they just don't want to pay it. So credit grantors have lost more than $313 billion in the last decade, according to Forbes. Which means that the consumers "won" and the purportedly smarter banks got taken! So maybe financial regulation will protect the banks from themselves more than they protect consumers from themselves!

- The logical extension to protecting all of these bad banks and bad consumers from each other is that financial regulation will chill the credit market. I'm not sure that is a bad thing. It may be exactly what this country needs: A blast of ice water in the face that cools the prevalent idea that borrowing more than you make is a good idea. Perhaps forcing everyone to live a little closer to their actual production rate will pay huge dividends in moral values, savings rates, and set a better example for our children.

All in all, I think there were some valuable points to be made that were simply dropped on the floor. There is also a minor goof in the mortgage example in "Financial Foolishness" box.

Zuckerberg's Rights to the Privacy of Chinese Activists

Facebook's Zuckerberg Says The Age of Privacy is Over
http://www.readwriteweb.com/archives/facebooks_zuckerberg_says_the_age_of_privacy_is_ov.php

Is Privacy Already Dead?
http://www.mediapost.com/publications/?fa=Articles.showArticle&art_aid=120500

Facebook Does Not Understand the Meaning of Privacy
http://business.theatlantic.com/2010/01/facebook_does_not_understand_the_meaning_of_privacy.php

FaceBook’s Mark Zuckerberg: The Age Of Online Privacy Is Dead, And We Killed It
http://myhosting.com/blog/2010/01/facebooks-mark-zuckerberg-the-age-of-online-privacy-is-dead-and-we-killed-it/

Google threatens to leave China after attacks on activists' e-mail
The company said it has evidence to suggest that "a primary goal of the attackers was accessing the Gmail accounts of Chinese human rights activists..."
http://www.washingtonpost.com/wp-dyn/content/article/2010/01/13/AR2010011300359.html

Cadbury Shareholders Losing Potential Gains

In waiting for a higher bid, Cadbury shareholders have been injured twice recently by not accepting the Kraft offer. The first comes from the decline in market price. The second comes from the loss of potential future gains from holding KFT shares, which had been underpriced, and likely remain so. By changing the mix to include more cash and less stock, Kraft has reduced the future bonus that CBY shareholders might gain from selling to Kraft.

References:
Reuters story, from Yahoo Finance: Cadbury shares dip below Kraft bid for first time
BusinessWeek, citing Bloomberg story: Cadbury Price Falls to Near Kraft Offer

Some shareholders see any price under 800p as "horrible." If Kraft walks away, CBY will likely drift below 800p, since no other suitor will be seen as emerging. As I have written before, this is a dominant strategy for Kraft, with no options that Cadbury currently sees as workable available to it to counter a Kraft departure from its offer. Kraft can thrive in the absence of Cadbury.

Odds of Hershey bid: 10%
Odds of Ferrero bid:
Odds of Nestle bid: 5%
Odds that Kraft abandons offer: 35%
Odds of other offer (e.g. private equity): 5%
Odds of a reduction in the Kraft offer price: 15%

Cadbury Stamps its Feet at Buffett's Remarks

It bears repeating that Cadbury's response to Kraft's merger offers is like that of a woman who feels insufficiently worshipped. On Tuesday Warren Buffett publicly stated his opposition to Kraft issuing new shares to pay for a Cadbury bid, fearing that Kraft would overpay. In response, Cadbury Chairman Roger Carr said that Kraft's comments about fiscal discipline is really "about management weakness" and that the offer was limited by "powerful Kraft shareholders restricting the stock content."

Rarely before has a business manager so clearly stated his opposition to the careful stewardship of capital. Over and over again in many companies over the past hundreds of years, managers have believed that they should be paid proportionally to the number of people employed or by the top line, while shareholders are correctly and properly concerned about per-share performance. This conflict is always present, but generally management keeps their share-dilutive aspirations to a dull roar, hoping to make acquisitions that accomplish both goals or which sneak under the radar. Granted, Carr is in the to-be-acquired company, but by so deliberately insisting that Kraft overpay, he has shown a spotlight on the degree to which Kraft shareholders are being asked to hurt themselves in voting for the acquisition.

Indeed, Carr's position directly disparages Kraft shareholders, either in the way that he insists that they be forced to throw money away, or that they must be stupid enough to throw the money away of their own free will, all because of an infatuation with Cadbury.

Quite clearly, Cadbury is not worth the emotion that is being requested of American shareholders. The bid price is already rather full, as has been stated by a number of competent capital managers, and Cadbury's management behavior has been rather emotional, as was stated here earlier.

Kraft shares are undervalued at recent prices. KFT has already been moving up, as I predicted in previous postings. The profitable course of action for capital managers is to be long KFT and short CBY. If the Kraft bid fails, KFT shares will continue to move up and the company will have avoided a dilutive action. If the Kraft bid succeeds, KFT likely will not fall much, as management would need to contradict Warren Buffett in order to raise their bid further.

If Cadbury had wanted American shareholders and management to have fallen in love with it, maybe it should have made itself more accessible over the past 100 years. Figuratively, it has presented itself to American investors while wearing slouchy jeans, sneakers with holes, and a sweatshirt. If you go into any U.S. supermarket, convenience store, buying club, or gas station, do you see Cadbury products? No. Does Cadbury show up at Halloween, Thanksgiving, or Christmas? No. So there is no basis for any emotion, even IF you were to accept the questionable premise that an investment decision should be made on emotion.

There is more: Today Reuters and the The Financial Times ran articles with headlines of substantially opposite meaning, although the articles both made vague reports about Cadbury approaching Hershey, or vice versa, or indicating that a Hershey bid would be more welcome. The difficulty with the scenario is that Cadbury is twice Hershey's size, so Hershey is in no position to be a white knight. In fact, meeting the bid price for CBY would be even worse for HSY shareholders, who would likely even greater dilution than KFT shareholders would.

Then there is the emotional problem: Cadbury's management doesn't really want to consummate a merger. They would prefer that Hershey compete in the bidding process, but they wouldn't want Hershey to win the auction. Suppose that Hershey's managers aren't blinded by their love for Cadbury. In this case it is likely they can see the awkwardness of agreeing to a shotgun marriage where neither bride nor groom are in love, and no one is pregnant. It's likely that Hershey isn't emotionally committed, otherwise they would have made a bid earlier. Therefore, Hershey will probably stay out of the bidding. After all, their worst case would be accidentally winning the auction.

Ref:
FT, "Cadbury denies pursuing Hershey"
Reuters, "Cadbury talks to Hershey for rival bid - sources"

Nestle Share Repurchase; Cadbury Bid Prob Decreases

Bloomberg reports today that Nestle has set a $9.6B share repurchase. Although less than the $28.1B it will receive from selling its Alcon stake, this event diminishes the likelihood of a bid for Cadbury that competes with Kraft's. Indeed, KFT is up 1% today as I write this. CBY is also up 1%, but if KFT were to win the auction, then CBY's stock moves would be correlated to KFT. Hence, the market believes KFT will win CBY.

CBY market cap is $70B. The $18B remaining after the Alcon sale isn't sufficient to cover the price of a CBY bid higher than KFT's.