Intersecting Minds: Education, Business and Technology at the North Carolina State Jenkins Graduate School of Management

Liar’s Poker and Indefensible Men

April 12, 2010
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I started reading a new book last night, although I really don’t have time for it. But it came with a high recommendation from my roommate and assurances that it wouldn’t take too long to read, so I decided to give it a whirl. The book is Liar’s Poker, by Michael Lewis. Anyone very familiar with finance will probably have heard of this book. In it, Lewis chronicles the world of high stakes bond traders at the Salomon Brothers investment bank during the 1980’s.

These were critical years for Wall Street, as Lewis explains, because the Fed Chairman at the time, Paul Volcker, decided to loosen up monetary policy and let interest rates float. As a result of this decision, bond prices began to fluctuate much more than they had at any time in the recent past. At the same time, borrowing exploded on the American scene as the government, corporations and individuals began borrowing at record amounts (this is about when the groundwork began to be laid for the 2007-2008 financial crisis).

Even more interesting than the history though is the culture that Lewis describes. The bond traders and salesmen are made to be almost inhuman. They verbally, emotionally and at times even physically abuse the firm trainees as well as their fellow colleagues. The bluster and bravado described is almost unbelievable. And the sense of entitlement about why these people deserved to make so much money is also somewhat mind-bending. Of course, this was the mid-1980’s, a very different time in American culture, but from what I’ve read about the culture of modern day Wall Street, it doesn’t sound as if the industry had advanced very far.

Yves Smith over at Naked Capitalism had a great post about the very same culture that drove Wall Street over the brink during the last few years. Here’s a key graph from that essay, titled Indefensible Men:

Although the word “entitlement” fits, it’s been used so frequently as to have become inadequate to capture the preening self-regard, the obliviousness to the damage that high-flying finance has inflicted on the real economy, the learned blindness to vital considerations in the pay equation. Getting an education, or even hard work, does not guarantee outcomes. One of the basic precepts of finance is that of a risk-return tradeoff: high potential payoff investments come with greater downside.

The whole essay is much longer, but very much worth the time to read to get some insight on the corrosive culture of Wall Street and how it helped land us in this current mess. Liar’s Poker is also highly recommended. Check out the reviews on Amazon.


Friday Quick Links

February 5, 2010
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Today’s focus remains on jobs:

– The unemployment situation in this country is slightly worse or slightly better depending on how you look at it. First, the jobless rate fell to 9.7%, which is good news.

– But the bad news is that the economy shed another 20,000 jobs in January, deepening the number of unemployed in this country. By some estimates, almost 18% of the country’s workforce is out of a job or can’t find full-time employment. That is a scary number.

– While the numbers indicate that the US economy is poised to start adding jobs again, this graph from Calculated Risk shows just how far we have to go to climb out of the hole (click link for larger version):

– Meanwhile, the US Senate has reached an “impasse” on financial regulation. Reforming the financial system will be a key ingredient to sustaining a long-term economic recovery for the United States.

All in all a rough week, and more signs pointing to the fact that any type of economic recovery will take an extended amount of time to unfold.


Thursday Quick Links

February 4, 2010
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Today is all about jobs, jobs, and the complete lack of jobs:

– The Bureau of Labor Statistics revised the number of jobs lost during the recession up by 824,000 bringing the total job losses to nearly 8 million people. Mike Shedlock has a nice analysis of the BLS’ Birth-Death model and why this happened over at his website, Global Economic Analysis.

Jobless claims also rose to 480,000 in January, another sign that the employment situation is not improving. Employment will be the biggest drag on any type of economic recovery America hopes to experience. If employers don’t start hiring soon, expect this miraculous bull run in equities to end soon enough.

Royal Dutch Shell announced it will cut 1,000 more jobs on slightly disappointing 4th quarter numbers.

Greece’s debt troubles are continuing to worsen, according to the Wall Street Journal.


Wednesday Quick Links

February 3, 2010
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The US economy shed approximately 20,000 jobs in January, just beating forecasts for the month. Following the 5.7% growth in GDP last quarter, many economists expect employers to start adding jobs over the next few months.

– In a separate, but related item, Bloomberg reports that the economy most likely added service jobs over the same time period. This is an important development because services are now the vast majority of the US economy.

– From bad to worse for Toyota. The automaker suffered another blow with more than 100 complaints about the brake pedal in its Hybrid Prius model. Needless to say, the company’s sterling quality reputation will take another hit.

– The situation in Greece becomes more interesting by the day. The EU has approved a plan from the debt-ridden country to get its fiscal situation under control, but the plan demands heavy cuts from public sector employees. As a result, government workers are preparing to strike next week.

– Both Time Warner and Pfizer announced strong fourth quarter numbers, with each company posting higher profits than the same quarter last year.


Tuesday Quick Links

February 2, 2010
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– The Obama Administration is set to make $30B available to community banks for small business lending. The proposal comes as part of a broader package of ideas to boost job creation amongst small businesses.

– Former Treasury Secretary Henry Paulson explains the necessity of TARP and other government bail-outs in the wake of Lehman collapsing: “We easily could have had unemployment of 20 percent,” he said. “That would have meant millions of additional jobs lost, millions of additional homes lost, trillions more lost in savings. It would have been terrible.” I know I supported the stimulus on this blog, and this is precisely why I did. The alternative was too terrible to contemplate.

– As the global economy improves, more focus will shift to rising oil prices.

McKinsey agrees with me that deleveraging has the potential to be both a very painful process and a long-term drag on our economy.


Some Thoughts on the Economy

January 28, 2010
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Last night, President Obama made his State of the Union speech to the nation, during which he spent nearly 30 minutes talking about jobs, the economy and our financial situation. He also outlined a number of initiatives to help create job and to begin reforming the financial system. Instead of breaking down those proposals though, I’d rather talk a bit about why I’m fundamentally pessimistic about any sort of near-term economic recovery.

It’s obvious to anyone who has been paying attention that the American economy is in real trouble. We are burdened by a debt level that will soon reach 100% of GDP. Unemployment is very high at 10% and not likely to come back anytime soon. The real estate market is still relatively unstable. While the stock market has had a nice bull-run, many analysts believe the Dow is oversold. And there are several advanced foreign economies (the P.I.I.G.S) who are also facing a pile of debt and the real possibility of becoming insolvent.

Lets break these down a bit. The debt in and of itself isn’t a direct or immediate threat to our situation, but as it continues to grow unabated, it will continue to exert more and more pressure on everything the United States wants to do, from funding services to fighting wars. While the debt level does not have an immediate impact on economic recovery, it sets the stage for later points.

The fallout from the financial crisis has devastated the American workforce. These massive lay-offs capped a decade that had net negative job growth. In other words, many of these jobs are gone forever. The manufacturing sector has been pummeled, but other service sectors have shed jobs as well. These jobs aren’t coming back.

Even worse, the financial crisis exposed a hard truth about America. We are broke. At every level of society, we are out of money. The federal government is broke. The states are broke. Individual consumers are broke. One direct consequence of this situation is that consumers aren’t spending money. Consumer spending is the engine behind the American economy, accounting for up to 70% of our economic output. Now people aren’t spending money, and if they aren’t spending money, then businesses can’t grow and hire more people. We are witnessing the deleveraging of 30 years of out of control spending, and it’s not a pretty picture to watch unfold.

This alone would be enough to make me pessimistic, but there’s more. The real estate market is still in a highly volatile state. Once the Obama administration pulls out the tax credits and the Fed stops buying Mortgage-Backed Securities, there will be a vacuum of demand created. Oversupply is still the primary threat to the housing market, and I wouldn’t be surprised to see further falls in real estate prices as those policies expire. Another real estate collapse would have a hugely detrimental impact on the recovery. More homes underwater, and more borrowers trapped with payments they can’t afford.

Finally, activity in foreign economies poses a real threat to our recovery. There are five countries in Europe, Portugal, Italy, Ireland, Greece, and Spain, collectively known as the P.I.I.G.S, whose debt situation has become critical. Greece in particular is dangerously close to declaring insolvency. Spreads on their short-term bonds relative to the German bund have grown to nearly 350 basis points, a clear indicator that the country is in financial ruin. If Greece were to collapse, it would send shockwaves through the financial system. A meltdown in Greece could have a domino effect on other advanced economies featuring a cycle of ratings downgrades, higher yields and even more printing of money to pay for all the interest. Rapid inflation is a real threat in this scenario.

Other advanced economies are in creaky shape too. The UK has a well documented debt problem. And Japan’s debt is now at 220% of GDP, and they have experienced over twenty years of anemic economic growth. This is why our national debt matters. We are more vulnerable now to financial and economic shocks than we have been in decades. It’s a scary situation.

When I put all these pieces together in my mind, I see a bleak situation. These are not short-term problems that can be worked out in a matter of months. Paying off debt takes time. Building new economic sectors that can provide real long-term job growth takes time. Letting the oversupply on the housing market readjust will take time. The 2000’s were a rough decade, but the 2010’s could be even worse.


Thursday Morning Quick Hits

January 28, 2010
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Following the President’s State of the Union last night, a look around the business economic community

Ford Motors posted an annual profit for the first time since 2005. While the numbers were boosted by special items, this is a huge step forward for the American automaker after it took a beating during the second half of the last decade.

Durable goods orders in the United States rose 0.9% last month, another positive indicator that the American economy is showing signs of life. Unfortunately, this news was buffeted by a greater than expected number of jobless claims, a sign that labor market improvement is coming along more slowly than hoped for.

– I mentioned yesterday that Toyota was forced to recall over a million vehicles from the US market. Now that recall has extended to Europe and China as well in another blow to the automaker.

– And oh yeah, the President gave some State of the Union speech last night. The Wall Street Journal has a nice recap.


Wednesday Morning Quick Hits

January 27, 2010
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An exciting day lined up:

Apple is making a big announcement at the Yerba Buena Center in San Francisco later today. Many expect Steve Jobs to introduce the Tablet computing device. According to CNN, Jobs has been heard to say that this is, “the most important thing I’ve ever done.” Pretty big news.

The debt situation in Greece continues to worsen as spreads on Greek 10-year notes have reached new highs. This is definitely a situation to keep an eye on as Greece defaulting on its debt would send financial shockwaves throughout the global markets.

The Federal Reserve may consider halting its program to buy mortgage-backed securities in March. If this happens, it would be a huge test of the strength of the economic recovery.

– Toyota is dealing with a major body blow to its earnings recovery after announcing an unprecedented stoppage of US sales due to a faulty gas pedal. The recession hurts, but self-caused failure hurts even more, especially for a company whose reputation is built on quality.

– And oh yea, the President of the United States is delivering some little speech tonight. I think it’s called the State of the Union?? You can bet I’ll be watching that closely, and you probably should be too!


Tuesday Morning Quick Hits

January 26, 2010
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A mixed bag of news today:

S&P warned that Japan’s debt rating could be cut. This comes after the agency downgraded Greece’s debt earlier this year. Concern is growing that several advanced economies, including the United States, are in a bad situation with the amount of debt they are facing.

– On the bright side, Ford announced that it is adding 1,200 jobs to a plant in Illinois to gear up for production of its 2011 Explorer model.

– Also on the good news side, consumer confidence in the US is rising over hopes that the job market is improving. As the Bloomberg article notes, increased consumer confidence generally leads to increased consumer spending, a major driver of the economy.

– And on the downside, Verizon plans to cut 10,000 jobs after missing analyst’s fourth quarter sales expectations.

– Continuing with the jobs theme, Senate Democrats are considering a second jobs-focused stimulus bill valued at $80B. Of course there is controversy on whether or not the bill will actually create any jobs.


New Stimulus Poll

January 25, 2010
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CNN has a new poll out showing that roughly 3 in 4 Americans believes the stimulus has been a massive waste of taxpayer dollars. Sigh. Joe Klein over at Time Magazine has a slew of good points about the stimulus: the inclusion of $275-300B of tax cuts to 95% of Americans, the $250B of direct aid to states, and the lack of shovel ready projects that haven’t come online yet. Klein concludes with these two points:

1. The Obama Administration has done a terrible job explaining the stimulus package to the American people…especially since there have been very few documented cases of waste so far.

2. This is yet further evidence that Americans are flagrantly ill-informed…and, for those watching Fox News, misinformed.

The other point that Klein doesn’t mention is where we’d be without the stimulus and bailouts of various corporate entities, stuck in the middle of the second Great Depression with unemployment somewhere between 15-20% and credit markets completely frozen. While the vast majority of economists agree on this point, it seems that 3 in 4 Americans don’t grasp just how bad things would have gotten without the stimulus.

This is a classic case of damned-if-you-do, damned-if-you-don’t policy by the Obama administration. As such, both Bush and Obama deserve credit, not scorn, for pulling us back from the brink. And Obama certainly deserves more patience than he has been given so far in this debate. The stimulus helped save us from an economic catastrophe, and now it’s slowly but surely distributing funds to projects around the country.

Patience, America! Patience.


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