Time Inc.'s Maghound: Potential for Thoroughbred And Not Dog

According to Advertising Age, Time Inc. is introducing a pay-as-you-go, mix-and-match magazine subscription program.

The main problem I see with this is that, in the name of serving readers, you can actually undermine them in the long run. To not just barely succeed, but thrive, you have to give customers not only what they want, but what they didn’t know they wanted. In the middle of letting them choose this and that, why not the occasional short blurb saying, “Given what we’ve seen of what interests you, we think this is an article you’d find interesting. We know it’s not what you might normally pick, but here are the reasons we think you might find it really interesting. Because we value you as a customer, we’re making this particular piece freely available to you. Hope you like it, and let us know with the check-off buttons at the end whether we were right or wrong.” This would be like high end restaurants offering free tastes or little treats available to regular customers. The technology exists to do this, the content exists to do this, so why not just do it? Build a relation and show how you can help direct people to what they’ll find important. It would get around the potential Balkanization of news and eventually strengthen the relationship between publisher and reader.

Finance and the Roll of the Dice

From the what-were-they-thinking, department, we have the latest insanity at Merrill Lynch. A big producer of the securitized mortgage deals, the company has already written down $8.4 billion in two clumps. The powers that be there talked about some number of billions, and then almost doubled it two week later. CEO Stanley O'Neal has made a public mea culpa, but as one analyst on NPR said Friday night, they should have warned everyone the minute they knew, and not delayed.

Now, according to the New York Times, O'Neal floated the ide aof a merger with Wachovia without talking to Merrill's board - which would mean a sale at a low point of the stock, forcing the shareholders to bail out management - and the board is ready to fire him. It's certainly drama, but how about the culpability of the board? Was there no oversight? Did they ever ask about the degree of risk the institution was taking on a regular basis? I realize that such things can be difficult for a board to uncover. AFter all, it's getting the numbers from management, and given how difficult it apparently was for many to understand just how shaky some of the assets were, they probably would have essentially said, "All is well."

But at this point, it's obvious the even the largest and most respected corporations are capable of screwing up on a level that is almost inconceivable. Everyone in the business community should remember that capitalism is essentially the combination of two activities: gambling and mitigation. You take risks to make more money, and then you try to minimize the downside and the possibility of an explosion. But as I quoted from a commentary, many people in these institutions never face the essential instability of statistically unlikely activities that happen on a regular basis.

Or, as someone in risk management recently told me, there was the head mathematician in a financial business he once worked for. There was some big loss, and the CEO said, "What can we do to keep this from ever happening again?" The mathematician said, "Sell refrigerators." When you can calculate demand, pretty well know your costs and what you can get, you can make safer decisions. But you won't make as much money. The CEO of that company had forgot that they are gamblers, and, apparently, people at Merrill, and virtually all other financial institutions and investors, have been forgetting that as well.

Mortgage Superfund Worrying Financial Experts

Although the Treasury may be involved with the concept of bringing together Citigroup, Bank of America, and JPMorgan to create a $75 billion fund to help prop up a sagging mortgage market, not all experts think it's a good idea. Alan Greenspan questioned whether it was wise to intervene in the market, as reported by CNNMoney.com and others. Today, the Financial Times reports that during a trip to South Korea, Warren Buffett has added his own voice of wariness:

“One of the lessons that investors seem to have to learn over and over again, and will again in the future, is that not only can you not turn a toad into a prince by kissing it, but you can not turn a toad into a prince by repackaging it,” Mr Buffett said during a one-day visit to South Korea.

“But very imaginative people in the securities market try to do that. If you have bad mortgages they do not come better by repackaging them. To some extent the chickens are coming home to roost for the mortgage originators and securitisers,” he said.

Both of them have expressed concern that the market should be the force stabilizing the situation, and not governments and banks. I'm not the most laissez faire guy in the world, but in this case I'd tend to agree. The people who set up these investments and who then promoted the hell out of them tried to build with sub-standard materials. You don't fix a wall by painting it. You fix it by finding the weak spots, reinforcing the structure where necessary and replacing the fallen plaster. (I use this analogy because it literally hits close to home, as I'm in the process of fixing a wall.)

To use the money to boost prices unrealistically might make some well-off people happy that they don't take a bath, but to be fair, many of the people who bought into these loans are bearing a heavy burden at the moment. Why should they be the only ones paying the price?

I can hear some people thinking it now: They should have known what they were getting into and seen that they shouldn't have taken more loan than they could afford. But we could say the same about the investment crowd. If anyone should have known what they were getting into, it should have been these people. That's what they do for a living. Artificially reduce the pain, and not only do you run the risk of only temporarily propping up this financial Rube Goldberg machine with a more painful crash to come, but no one learns anything from the experience. They become the Peter Pan crowd that never grows up and never learns that actions have their consequences. If they lose money, well, then they lose. Hopefully they will be more prudent about future investments, and they are also unlikely to face living on the street as a strong possibility, as are many who the very same investors expect to manage with increased mortgage payments and no greater financial resources.

The Danger of the Real Finanical World

There is a great commentary by Nassim Nicholas Taleb in today's Financial Times (and the whole thing seems to be available, at least I write this, by non-subscribers, so I'd urge you to go quickly and see if it's still up).

Taleb, author of The Black Swan: The Impact of the Highly Improbable is a former trader and risk manager of 20 years experience. In his day, he say many improbably events, culminating in the crash of 1987 (and from what I heard on NPR yesterday, an equivalent sudden drop in market value would be 3000 points on the Dow). His argument is that everyone going through the ranks at business schools is learning modern portfolio theory, an approach to handling risk and investment in which a person or entity handles a mix of investments with varying risk. The concept is that you can plan and diversify your way into financial goals and out of danger. Each asset is a variable, and then you weight the assets, so the value of the portfolio is the combination of those weighted assets. There are expected values of these variables, and expected variances. In theory, you come up with a function that expresses the value of the variable, calculate the variances - how far the value of the variable can be expected to swing - and you can predict the portfolio value.

It's great in theory. However, Taleb points out that this can lead to useless results. Variance depends on historic information, which is fine so long as you recognize the limitation that can impose. (I'd also wonder whether the proponents end up smoothing out data - tossing the scary out-lying values - because it becomes very difficult if not impossible to make calculations with them.) He points to work of mathematician Benoit Mandelbrot, father of fractals, who has tried applying fractal mathematics to the stock market to try and understand the wide swings that happen in short periods, but that probably shouldn't if you use the typical coin toss price goes up/price goes down underpinnings of most stock market prediction. (Here's a Forbes piece on the topic.)

As Taleb writes:

MPT produces measures such as “sigmas”, “betas”, “Sharpe ratios”, “correlation”, “value at risk”, “optimal portfolios” and “capital asset pricing model” that are incompatible with the possibility of those consequential rare events I call “black swans” (owing to their rarity, as most swans are white). So my problem is that the prize is not just an insult to science; it has been putting the financial system at risk of blow-ups.

I was a trader and risk manager for almost 20 years (before experiencing battle fatigue). There is no way my and my colleagues’ accumulated knowledge of market risks can be passed on to the next generation. Business schools block the transmission of our practical know-how and empirical tricks and the knowledge dies with us. We learn from crisis to crisis that MPT has the empirical and scientific validity of astrology (without the aesthetics), yet the lessons are ignored in what is taught to 150,000 business school students worldwide.

Certainly I've seen the 1987 market crash, the dot com meltdown, and more than one major hedge fund collapses (including Amaranth and LTCM, the latter having two Nobel prize winners on its board of directors). Maybe there's something to be said for assuming that the impossible always happens and that current financial models just don't cut it when then meet reality.

Radiohead Continues Free Agent Tango

UK band Radiohead has been doing pretty well, from what outsiders can see, in its bid to sell an online version of its album under a "name your own price" scheme. In fact, I touched on this in my WriterBiz blog.

Now it seems, according to the New York Times, that the online wonder will come out in CD format, but without the help of a major label. The band will license the album, but not to "suitors like Warner Brothers Records, Columbia Records and, at one point, Starbucks, whose corporate label has signed artists including Paul McCartney."

This is potentially a turning point in the music industry. Many musicians have said how they hate the traditional system, because it really feeds on their work and doesn't directly provide a reasonable compensation for it. If music can go this way, why not television? Books? Magazines?

US PTO Mired, but Some Journalists Misinterpret

The Washington Post has a story about examiners at the US Patent and Trademark Office being driven away by production quotas, which haven't changed for decades even as patents have become increasingly complex and difficult to review, and the massive backlog that would take two years of the full time of all examiners to clear up, by which the incoming patents would have buried the office even more thoroughly. And for every two examiners hired, one leaves, according to this Information Week article on the report. But then, if you had to work through your vacations just to get caught up and avoid being fired, you might leave as well. A third of the examiners are apparently leaving after less than one year on the job, and 70% before five years - which, according to USPTO offices I've spoken with recently, is about the time that the examiners really come into their own and can work without supervision. In other words, most of the training the agency provides walks out the door.

Unfortunately, the Post reporters apparently spoke just to USPTO director John Dudas and reading a recent GAO report on the agency. Dudas seems to blame the backlog on poor information in the patent applications:

A quarter of applications arrive with no supporting materials and another quarter carry more than 25 references to supporting data, he said. Although an extreme example, Dudas said the agency once received an application that came in 28 boxes, with 2,600 pages per box.

What he doesn't say is that lawyers are afraid of putting themselves and their clients in a legal position of jeopardy. Include a moderate amount of supporting information, and a competing company could try to find so-called prior art that you missed and then claim you were essentially trying to pull one over on the USPTO, which could invalidate the patent. And so you have two schools of thought: provide nothing, so you don't exhibit any selectivity, or provide everything, so you can't be accused of skimping. Dudas's quote of needing "the best material. Not the kitchen sink. And not nothing," shows the problem. What constitutes the best?

By demanding the given levels of productivity, the USPTO is focusing on statistics that might make it look as though the situation is improving. That's understandable, when you need to lobby Congress for your operating budget (and Dudas is skilled at that), but it's really dealing with the symptoms and not the root causes. The European and Japanese patent systems take different fundamental approaches - allowing people a given amount of time to raise objections after the grant of a patent - than the US system.

And the focus that the USPTO makes on essentially blaming the users - and, frankly, some of that is warranted - also acts as a way to deflect attention from the agency's responsibility to find the appropriate prior art. And so the USPTO put into place the new continuation rules - a change in the basic approach to patents, and one that the office is apparently implementing even before their official start date, according to a number of people in the patent community that have found document ion showing this. If a company relies on the US patent system at all, then it will have to reevaluate its own approaches to patents and might possibly have to overhaul its strategic planning. That's how serious the situation now is.

More on the Radiohead "Set Your Own Price" Experiment

There's a bit more information now - of varying quality - on Radiohead's experiment in letting people set their own price for the group's new album. Anyone in the information business - and that's content of any type - has to be keeping a close on on this story. It could offer some insights into how to make the Internet work as a commercial distribution mechanism.

According to a Forbes article, many people are still pirating the new Radiohead album, even though they could go to the site and get a legitimate copy for free if they wanted to:

On the first day that Radiohead's latest became available, around 240,000 users downloaded the album from copyright-infringing peer-to-peer BitTorrent sources, according to Big Champagne, a Los-Angeles-based company that tracks illegal downloading on the Internet. Over the following days, the file was downloaded about 100,000 more times each day—adding up to more than 500,000 total illegal downloads.

That's less than the 1.2 million legitimate online sales of the album reported by the British Web site Gigwise.com. But Eric Garland, Big Champagne's chief executive, says illegal file-sharing is likely to overtake legal downloads in the coming weeks, given that many of those 1.2 million legitimate sales were pre-orders taken during the 10 days between when the band announced the album and its actual release last Thursday.

Garland suggests that the real culprit is habit - they go to their favorite BitTorrent sites and download in the way they're used to doing.

However, even with lots of pirating, consider the economics. According to a London Times article (and we'll get to the main part of the article in a minute), an Internet survey of about 3,000 people who bought the Radiohead album suggested that most paid an average of £4. Although this won't be particularly accurate, it's the best numbers possible: a rough total of £4.8 million on the album, all going to the band. Given the economics of regular record deals and distribution, I think they made a whole lot more this way.

The real test will be whether they do the same on their next album. I also wonder whether a variation on the approach might have worked even better: pay money to get the album, or pay nothing and get some audio ads thrown in, like the free online music streaming sites. That would have increased the perceived value of the paid version and also increased revenue for the group.

Blooming Housing Crisis

All the powers that be in economic circles keep saying that the housing crisis hasn't spilled over yet into the rest of the economy. But this is sounding like so much whistling in the dark - or, perhaps, trying to keep those ever irrational markets from wigging out - and it's not clear that they can keep it up with a straight face. First, the Wall Street Journal Online reports:

In a model of central-banker understatement, Mr. Bernanke noted to the Economic Club of New York that "the past several months have been an eventful period for the U.S. economy." And he recounted the mortgage meltdown, market panic and increase in Fed anxiety about the economy that prompted a reversal of the Fed's risk balance toward growth worries and the resulting half-percentage-point reduction in the cost of borrowed money last month. While members of the Federal Open Market Committee agreed Sept. 18 that "significant spillovers [from housing-market trouble] to household and business spending were not yet evident," the downside risks to both had clearly increased, exacerbated by "somewhat downbeat consumer sentiment, and slower growth in private-sector employment."

The WSJO continues, calling feedback that the Fed is getting from local bankers and executives "a darker description" than that collected and published before the Fed came out with its Beige Book report, a collection of "anecdotal information on current economic conditions" each branch of the Fed gathers from "key business contacts, economists, market experts, and other sources." The Treasury department is trying to build a coalition that will help stabilize the mortgage markets, August housing starts in Japan were down 43 percent from the same period in 2006, and, according to NPR, the US foreclosure rate is the highest it's been since the Great Depression. At this rate, how can conditions not spill into the rest of the economy. It sounds as thought it already has, only no one has wanted to be the first to say it.

Supply Chain Pressure

The New York Times has an article about the lack of safety monitoring for some heart-related health care products. But this isn't an isolated problem. From the New Jersey importer that had to recall 450,000 light truck tires to some of the recent toy recalls, companies are starting to learn the difficulties of managing an extended supply chain or design chain. The concept says that companies have an interconnecting chain of suppliers and distributors and sellers that all affect product manufacturing, inventory, and distribution.

As companies have taken the standard business advice and focused on their "core competencies," they've extended these chains, having more come from outside sources. But rarely to the companies have any control over their partners. For them it's like going to a big mall and getting this from here, that from there. However, such a hands-off approach isn't going to continue to work. Particularly in an industry that directly affects people's well-being and safety, someone has to be able to guarantee the integrity of what the purchaser gets. That generally comes down to the name on the label.

It may be that many companies are going to have to take a leaf out of Wal-Mart's playbook and get more involved with their partners. As most businesses don't have the big box retailer's resources, it seems that there is a market opportunity here: consultancies that can take the specifications of clients and travel to their business partners, checking on the components they produce. It would probably have to be an organization with global scope, because manufacturing is geographically diverse. But a large management or technology consulting firm might consider this as a useful type of service offering, and one that is bound to get more popular as the number of recalls because of bad ingredients or components rise.

Banks Start Fund for Credit Market

Working with the Treasury department, Citigroup, Bank of America, and JPMorgan Chase are creating a fund that will buy between $75 billion and $100 billion in structured investment vehicles (SIVs) - the mortgage-backed securities that have seen such trouble recently. The New York Times has a story that has yet another piece of the puzzle, which can be hard to grasp if you come at this from the outside, like I do:

The effort is intended to help SIVs that need to sell securities do so in an orderly manner. Bank and government officials are concerned that if these vehicles are forced to dump billions of dollars worth of debt in the coming weeks, it could cause a repeat of the crisis that rattled markets in August and sent the cost of mortgages and other loans soaring.

In other words, these SIVs, like many other forms of financing, come with strings. The people running them have to ensure certain conditions or face serious consequences, like being declared in default (or whatever the equivalent for an SIV would be):

[Christian Stracke of the research firm CreditSights]said that by serving as another buyer of the highest-rated securities, the banks are hoping to ease the immediate strain on SIVs, which could be forced to sell billions of dollars worth of assets in a fire sale if they are not able to raise new financing and when their capital falls below certain thresholds. The effort, however, will not resolve the longer-term problem many SIVs face with more risky mortgage bonds, he said.

The SIVs have financial covenants, and they cannot allow their free capital to fall too much. So they need to sell more short-term debt to keep investing in the long-term debt to get the cash flow to pay off the short-term debt and keep afloat. It sounds, to me, like a legalized version of a Ponzi scheme, but then I'm not a high finance person.

Supposedly the fund - called a conduit - will invest only in top rated securities and won't help the sub-prime area that has most of the fundamental trouble. But then, one of the main problems has been that the rating agencies apparently were favorable in their ratings for the sub-prime. Why should anyone believe that a AAA rating actually means anything, either?

“For me, this is more of a P.R. blitz,” he said. The banks are “saying, it’s not just that we are doing this on an ad hoc, individual basis. Rather, we have a plan and consortium in cooperation with Treasury, which gives it a veneer of respectability.”

But the institutions themselves have lost tremendous credibility because of culpability. Maybe people will forget, or maybe the new investments are actually sound. The question is who will bet on that?

Foreclosures Up, Income Increases Uneven

The problem with focusing on only the "big picture" issues of the economy is that you miss the little guys who, collectively, are the real driving force. According to the Financial Times, U.S. home foreclosures doubled last month:

The number of foreclosures jumped to 223,538 in September, 99 per cent higher than the number last year, though down 8 per cent from August, according to RealtyTrac, which compiles housing data. California had the largest number of foreclosures, with 51,259, and Florida was second, with 33,354.
Nevada, which has seen explosive housing growth around Las Vegas, had the highest rate of foreclosures, with one for every 185 households. The overall foreclosure rate was one for every 557 households.

Countrywide Financial, the nation's largest mortgage lender, said "The number of foreclosures jumped to 223,538 in September, 99 per cent higher than the number last year, though down 8 per cent from August, according to RealtyTrac, which compiles housing data. California had the largest number of foreclosures, with 51,259, and Florida was second, with 33,354. Nevada, which has seen explosive housing growth around Las Vegas, had the highest rate of foreclosures, with one for every 185 households. The overall foreclosure rate was one for every 557 households."

RealtyTrac said the foreclosure jump was due in part to sub-prime borrowers being unable to make payments after rates went up. Countrywide Financial, the nation's largest mortgage lender, has seen deliquencies as a percentage of unpaid loans go to 5.85 percent, versus 4.04 percent a year ago. Its issuance of ARMs has dropped by 76 percent. Daily mortgage loan applications are down by 39 percent. This is alarming news.
And now factor in what the New York Times reports:

"New data shows that after adjusting for inflation, 95 percent of Americans reported smaller incomes to the tax man in 2005 than in 2000."

People had a bit more in their pockets due to the tax cuts - from about $20 a month for those in the bottom half of income to $5,400 a month for those in the top 1 percent. And only those in the top 5 percent of income saw higher incomes both before and after taxes. More than three-quarters of all taxpayers make less then $5,400 per month. When the bulk of the little guys are getting hit hard, the entire economy will follow. And I think the signs of this are getting clearer than I'd like. This is one of those times that I sure hope I'm completely wrong.

Good Story on Women in Senior Management and Performance

The Financial Times has an interesting piece on a new McKinsey study suggesting, at least in Europe, a correlation between having a high proportion of women in leadership roles and superior financial performance.

The report, launched at the Women’s Forum for the Economy & Society in Deauville, France, finds these companies do better than their sector in terms of return on equity, operating result and share price growth. The management consulting firm also reports that companies around the world where a third or more of the senior team are women score higher, on average, than those with no women on nine criteria of “organisational excellence”. These criteria include accountability, innovation and work environment.

Apparently, there has been research in the U.S. showing comparable results among the Fortune 500. McKinsey points out that this is an issue of correlation and not causality - there is no proof that senior women cause the improved performance. It could be that the presence of female senior managers helps change the corporate culture in ways that make higher performance more likely, or it could be that a culture that brings in a significant number of women happens to be the type of corporation that does better. I'd provide a link, but this is a subscription-only source.

Is Making Money Self-Defeating Strategy?

This is one of those times that I wonder if I'm slipping off the edge of reason. But in a number of articles I'm currently working on, I keep coming back to various people in a range of financial fields making the same point: there's too much capital. Money's supposed to be good for economies, you'd think, but when you have a surplus of cash, the results are interesting. Too much money is one of the big reasons, apparently, that the credit crunch came about. Because so many nations, corporations, and wealthy individuals are trying to invest at a time when companies are not necessarily expanding, or when adding value might be comeing up with new code (low capital investment) rather than building new plants (high capital investment), we have one of the oddest examples you might find of high supply and low demand.

Risky credit became cheap becuse so many entities wanted to put their money into something, and stays cheap because companies don't need to expand. To need to expand, there would have to be wealth spread among a greater number of people who could then generate sufficient demand. In short, by having money concentrate at an ever greater level among a small group of people, there is less demand for investing that money, because most people don't have the money to spend on the things that drive business investment, and there aren't enough of the super wealthy to make up for it. So the accumulation of capital seems to limit its own growth potential, which makes some sense. But, my, who would have ever thought that capitalism could be its own worst enemy?

Christmas in October

According to the New York Times, a number of retailers are extending their holiday marketing back into early October:

Shattering records for an early start, Wal-Mart is cutting prices on toys in mid-October, but the company is not calling it a holiday sale. L. L. Bean has started advertising free shipping — but it is shying away from the H word. And Toys “R” Us is marketing a temporary store in Manhattan, but consumers have to study ads to find the name: Holiday Express.

According to the article, what has pushed them back this far is the expectation of a lackluster holiday shopping period. So much for the day after Thanksgiving. This offers more evidence that there could be a broad economic slowdown, I think, or at least for a lack of business confidence, which can become the same thing. I see why retailers are about holiday sales, as many see 60% of their business from September to December. But I don't see a logical reason why worries transform into a strategy of starting the sales earlier. When you have the sales start so early, you lose the chance of getting anyone to pay higher prices at all. The result is a self-fulfilling prophesy of lower dollar sales and lower margins.

You can't solve a problem that stands outside the realm of efforts you currently make by doing more of the same. maybe retailers need to do something completely different and find a way to deliver value that isn't offering goods for less. Why not offer a shopping service, where people can call teh store, say what they want - maybe even get gift suggestions - and have all the stuff put together for them so they can simply pick it up? That does sound suspiciously like an online shopping facility, which is fine. Just add a little bit extra service and position it as what it is - a way of getting what you need done without getting strung out. Let a number of retailers work together on a holiday season gift registry, so you don't have to guess what Aunt Mildred wants, and you don't have to go to a particular store. Have a recovery zone in stores, where consumers can sit, rest, and get a free cup of coffee and cookie or other snack.

I won't expect to see any of this from now to the end of December. Businesspeople seem wed to continuing things they way as they have always gone, or to treat sales as a zero sum game, where the benefits go to either you or the customer. And zero is exactly what happens.

Branding and USA Network

I've been finding that the USA cable network has a sophisticated and effective approach to branding - a good example for almost any business. It goes beyond the more typical method of choosing some slogan and then publicizing it. the channel's "characters welcome" actually embodies much of its programming, to start. Shows like Law & Order Criminal Intent, Monk, Burn Notice, Psych, House - whether new or in reruns - are quirky takes featuring unusually strong characters that are well acted. (In fact, I think with lesser actors who wouldn't pull out as much of the characterization, many of these series would become insanely dull.)

And then the network extends its branding into its own commercial spots by doing them in such a way as to underscore the characters and an off-beat approach. Having Law & Order CI detectives wondering what is going on around them as movers come in and take dead bodies, set pieces, and props, to signify the show's move to USA? It's genius because the approach uses such classic marketing techniques as showing, not telling - the show is moving to USA, the characters that the audience likes will be found there, and it's all done in such a way that the quirkiness turns the network itself into one of the characters. USA at the moment should become an object of study for those who would like to learn how to market effectively.

New York Times Reporter Makes Assumptions, Waves Hands

Hand waving is a term I picked up in my college years taking classing in math, engineering, and science. It refers to talking quickly and waving your hands about in the air as a way of distracting people from realizing that you aren't proving your assertions. I saw a great case of this in a Hillary Chura piece in the New York Times called Dealing With the Damage From Online Critics. I agree with the concept that consumers can use the Internet to cause public relations strife for businesses. However, Ms. Chura writes the following:

Business is not alone in such frustrations. Politicians like Hillary Rodham Clinton, authors like Patricia Cornwell as well as other public and private individuals find themselves in the cross hairs of commentators emboldened by the anonymity of cyberspace. But such postings can do more than just irritate; financial damages can reach millions of dollars or shut down a business entirely.

That would be fine if she actually brought up examples of corporations pushed out of business or where the measurable financial damages hit the millions, but she never does. Instead, she immediately jumps to how companies can and do respond. To me, this errant paragraph is actually the premise for the entire article. So, why didn't the editors catch this piece of flummery?

More Credit Fall-Out

I don't have a lot of time today, but here's some round-up of the ongoing credit crisis - which, I think, it really an economic crisis because while Alan Greenspan might think the worst is over, I suspect he's talking strictly of liquidity issues. The impact on consumers and, therefore, business has got to last for years, unless lenders go back to the same risky behaviors that got us here in the first place, and that would be tragic, simply compounding the impact farther down the line.

• Deutsche Bank's investment bank unit is expecting "a third-quarter pre-tax loss of up to €350m (£242m), after €2.2bn of charges relating to leveraged loans, structured credit products and trading," according to the Financial Times. That's about $493 million in loss and almost $3.1 billion in charges in US dollars, according to the XE.com conversion calculator.


• The same article said that Merrill Lynch's fixed income trading practice will see a loss of $1.5 billion in the third quarter. The company has sacked the heads of fixed-income trading and structured credit products. Sounds like scapegoating to me - the company got greedy, didn't exercise oversight and prudence, and now wants to blame someone.


• Bears Sterns is cutting its workforce by another 310 jobs.


• The European Central Bank is keeping its interest rate at 4 percent, while the Bank of England is staying at 5.75 percent. Although I'm far from an expert in high finance and economics, I'd wonder if this might influence the Fed to not go for another rate drop, the expectation of which, according to analysts, is fueling the renewed optimism (notice I'm not saying strength) in the U.S. stock market. If so, a surprise could spell an unpleasant drop in the the DOW and NASDAQ by November.


• According to another FT story (love that paper), a McKinsey Global Institute study suggests that "[g]lobal financial markets face a permanent shift in power from traditional money managers to opaque groups such as petro-dollar investors, Asian central banks, hedge funds and private equity groups." Their holdings apparently represent 5 percent of the world's financial assets. If current trends continue, that could become three-quarters the size of the global pension markets. That's influence and power among people who are out of the reach of global regulation.

The big story, I think is the last one. There are seismic shifts in business as usual. The entire global financial structure is undergoing a restructuring in reasonable assumptions and perceptions. That is going to affect how every company has to consider its financing options, which means reconsidering its business.

Martin Wolf on Securitization

Securitization - or written with an s instead of the z, as the Brits do - was all the rage in the financial world, until the sub-prime markets slipped. Companies like the idea of bundling loans or receivables into financial instruments that they can sell to investors, gaining cash and spreading risk around (otherwise known as getting it off their books). Martin Wolf, writing in the Financial Times, had an interesting column on the topic that started with a John Maynard Keynes quote:

A sound banker, alas, is not one who foresees danger and avoids it, but one who, when he is ruined, is ruined in a conventional way along with his fellows, so that no one can really blame him.

How unfortunately true. The risk that appears all too often to interest them most is the risk of embarrassment, not the risk to capital. The problem here is that bankers made bad loans that they figured they'd move on to someone else - in any other circles called a con job. According to his figures, and an interesting chart, US "asset-backed paper contracted by 21 per cent between August 8 and October 1." A brutal ouch. Wolf was taken aback:

What I am surprised by is how toxic securitisation of subprime mortgages has turned out to be for the financial markets. I admit that I thought securitisation had attractive features: it should allow banks to remain in the mortgage business as originators and intermediaries without taking too much of the interest-rate, term and liquidity risks on to their own highly leveraged books; it should allow banks to transfer those risks on to investors who want longer-term, higher-yielding assets; and, in the process, riskier borrowers should have access to more credit than before.

And he was right in theory, I think. As he notes, there were two main reasons for the crash. One was "all-too-familiar euphoria," as he puts it, though I'd term it historic and economic ignorance. Depending on rising prices to make everything work out, and to let people get out of the trap of credit priced too high for them, is as foolish as thinking that any type of market has an infinite size and can allow unlimited growth as long as someone might like.

The other reason, which I'd call duplicity and naivete, both in borrowers, lenders, and investors, comes about because of a change in the relationship between borrower and money source:

As Robert van Order of the universities of Aberdeen and Michigan points out, securitisation necessarily creates a chain of transactors where bank lending interposes just one institution between the borrower at one end and the depositor at the other. Such chains depend on trust or, as he puts it, "reliance on originators and servicers to originate good loans and service them properly". The trust proved misplaced and has duly vanished: credit means "he (or she) believes". Alas, he no longer does.

There are still some advantages for everyone if the system works well, but if it depends on trust, it could be years before it comes back. How long did it take for people to consider junk bonds after their time of dalliance in the 1980s?

Stock Market High Evidence of High Investors?

I shake my head, looking at the new Dow record: 14087.55. With Citigroup and UBS melting down, with other financial services firms only showing strength when the financial reports don't include the late summer, with housing taking a beating and Wal-Mart and Target and Home Depot feeling the pinch, with the Supply Management index being weaker than was expected (though still just above the contraction level), you might not think this was a time to be betting on stock market prices sitting at high levels. But, even as top grade bonds are doing well, so are equities. The Financial Times has an "explanation" from an analyst:

“Everyone’s expecting bad news but, once it’s out, it’s either not as bad as everyone thought or at least it’s out in the open,” said Richard Sparks, senior equity analyst and equity options trader at Schaeffer’s Investment Research.

“The expectation is still that there will be a rate cut when the Federal Reserve meets at the end of this month. The market has decided that it is going to happen.”

If ever there was proof that people are completely and unrepentantly nuts, this is it. There will be a Fed rate cut at the end of the month because the market has decided that there will be a Fed rate cut at the end of the month. If Sparks is right, then investors are walking right past investing, long beyond betting, and walking into the heart of the Faithful. Look at what the analysts are saying (again from the FT article):

The most significant economic data to come are the September payrolls figures due at the end of the week. Investors expect a rebound in job creation after the decline of 4,000 for August – the first fall in four years.

“We continue to expect overall payroll employment to be up 125,000 in September and look for little change in manufacturing jobs,” said Ted Wieseman, economist at Morgan Stanley.

Homebuilder stocks rose sharply on Monday after an analyst at Citi Investment Research said recent share price falls meant it was time to buy into the sector.

When you make your living leading the Faithful, I guess you can't afford to show doubt, even when that oncoming light in the tunnel is getting larger, and rounder, and there's the sound some equate to the roar of a tornado. The train is coming.

Some Fallout From Sub-Prime

Some of the results of the sub-prime credit markets are coming in, and they aren't looking good. According to the Financial Times, Citigroup will see a third quarter decline in net earnings of about 60 percent compared to last year. In fact, here's the Citigroup press release:

"Our expected third quarter results are a clear disappointment. The decline in income was driven primarily by weak performance in fixed income credit market activities, write-downs in leveraged loan commitments, and increases in consumer credit costs," said Charles Prince, Chairman and CEO of Citi.

Ouch. here are some of the sources of revenue reduction, according to the release:

• Write-downs of approximately $1.4 billion pre-tax, net of underwriting fees, on funded and unfunded highly leveraged finance commitments. These commitments totaled $69 billion at the end of the second quarter, and $57 billion at the end of the third quarter. Write-downs were recorded on all highly leveraged finance commitments where there was value impairment, regardless of the expected funding date.


• Losses of approximately $1.3 billion pre-tax, net of hedges, on the value of sub-prime mortgage-backed securities warehoused for future collateralized debt obligation ("CDO") securitizations, CDO positions, and leveraged loans warehoused for future collateralized loan obligation ("CLO") securitizations.


• Losses of approximately $600 million pre-tax in fixed income credit trading due to significant market volatility and the disruption of historical pricing relationships.


• An increase in credit costs of approximately $2.6 billion pre-tax versus the prior-year quarter due to continued deterioration in the credit environment, organic portfolio growth, and acquisitions. Approximately one-fourth of the increase in credit costs was due to higher net credit losses and approximately three-fourths was due to higher charges to increase loan loss reserves

And then there's the FT story, published yesterday, that UBS AG is writing down its fixed income portfolio by $4.3 billion, mostly due to US sub-prime investment losses. There has been some recent good news, but only when you don't look at it in context:

In recent weeks, Lehman Brothers and Goldman Sachs reported better-than-expected results and Bear Stearns, the bank seen as most exposed to the US mortgage market, still recorded a profit. However, all those banks reported results for the three months to the end of August, allowing them to include profits from June, before the downturn began.

Top investment officials at UBS and Warren Spector have lost their jobs. How many more will? Probably only a fraction of the total number of people when all the intricacies of the problems finally play out over the next few years.