1-2 Knockout

Thanks, Comrade Paulson

Over at Naked Capitalism, Yves Smith laments over William Butler's "characteristically colorful" piece "Time for comrade Paulson to pull the plug on the Fannie and Freddie charade".  Yves regrets Mr. Butler beating him to the punch over the backdoor socialism movement underway here in America.  It is a topic i have opined on numerous times, but never with the clarity of thought Mr. Butler or Mr. Smith provide.

"But Buiter's beef isn't the operation of the GSEs but the philosophy behind them, the hydra-headed and not fully visible ways the US has socialized real estate (did you know about the Farm Credit Banks, for instance?). He provided a good summary of the history and dramatis personae."

Read both editorials.  They are incredible.

Enjoy your weekend and take a shot (or down a fifth) of Jack for me while you ponder the impending downfall of the American financial system--you've got a front row seat.

(hat tip - ep)

 

Sage Saturday Wisdom

Email from a friend this AM (in response to this article):

I love this: "But this is a once-in-a-lifetime opportunity for valuations, for all financials. When we look back historically, we will be writing about the irrational panic of 2007 and 2008."

 Are you kidding me? A 25% decline in the value of the  US housing market. A near collapse of the financial system as we know it. The second largest bank failure in UShistory. And as per Bloomberg, $410.1 BILLION of writedowns and credit losses.

Yeah, FNM was a once in a lifetime opportunity at $20, BSC at $60.

Amen.

Lake Wobegon Tax Policy

Presented with minimal comment.  From Rasmussen Reports.

The latest Rasmussen Reports national telephone survey found that 47% believe it's most important for tax policy to support economic growth. Nearly as many--44%--believe it's more important to establish a policy in which everyone pays their fair share (ed. best definition of "fair" left in comments wins lunch on me). Most Democrats favor an emphasis on fairness while most Republicans prefer a focus on economic growth. Unaffiliated voters are evenly divided.

The survey also found results reminiscent of Garrison Keillor's world where everyone is above average--most voters believe they already pay more than their fair share of the tax burden. Fifty-three percent (53%) hold that view while 30% say they're not paying more than they should. Voters who earn more than $60,000 annually are more likely than other voters to believe they're paying too much.

Just 45% of voters under 30 or over 65 think they're paying more than their fair share of the tax burden. A solid majority of those aged 40-64 think they're paying too much.

Fifty-nine percent (59%) of voters believe that tax cuts help the economy while just 15% believe they hurt. Looked at from the other perspective, 50% believe that increasing taxes will harm the economy while just 19% disagree.(ed. define cognitive dissonance)

Despite this, 48% would vote for a candidate who promised to raise taxes only on the rich while 41% would vote for a candidate who opposed all tax increases. This clearly reflects the importance of tax fairness rather than a simple focus on economic growth. Voters believe taxes are far more likely to go up with a President Obama rather than a President McCain . However, Obama continuously repeats his claim that he would not raise taxes on anybody making less than $250,000 annually. As a result, neither candidate has a significant advantage when it comes to voter trust on the tax issue.

I do love this idea of "tax fairness", especially since everyone thinks they know how everyone else should be taxed: my legitimate deductions are your tax shields.  You received tax breaks because you're politically well connected and gaming the system; I need the tax breaks to live.

There will never be a rational tax policy now that <50% of Americans pay income taxes.

This Week in "Duh": Domestic Auto Sales = FAIL

I was inclined to just let the title of this post speak for itself, but I've got some time (ha) on my  hands, so what the hell (via CNNMoney)

Ford Motor reported that its U.S. sales tumbled 28% in June, kicking off what could turn out to be the weakest month for auto sales in 16 years.

Oh, realllly?  Go oooonnn!

Ford, the No. 3 automaker in terms of U.S. sales, saw sales of its SUVs plunge by more than half and pickups and other trucks fell more than a third.

Given the company's red-hot vehicle line-up, and the outstanding fleet fuel mileage, this news comes as nothing short of shocking to this author.  Thankfully, the brain trust over in Dearborn is on top of it, nbd:

Even crossovers, a sign of strength in the light truck segment until recently, saw sales off 18% from a year earlier, as buyers went searching for more fuel efficient vehicles in the face of record $4 gas prices. But Ford apparently didn't have the car models buyers were looking for, as its car sales fell 12%.

Some of the weak car sales could be due to growing consumer worries about their jobs and the economy. But automakers also suggested it could be due to the short supply of many fuel-efficient models after a rush to buy those vehicles in May.

"That limited supply we believed had an impact," said George Pipas, the director of sales analysis for Ford

In fairness to Ford's delusional explanation, they weren't the only domestic automaker to feel the pain.  Privately-held Chrysler's overall sales fell 36% in June; interestingly enough car sales were down 49% while truck sales were only down 30%.  That distribution is likely due to the fact that chrysler (when gas was hovering around $2/gallon) enjoyed a fair amount of success with its large vehicles such as the Charger, 300C, etc, which have likely fallen out of favor with national gas prices aroudn $4/gallon, as well as with their aging design.

Crosstown rival GM saw sales drop 18.5% in June, with the biggest single-brand dissapointment coming from (unsurprisingly) Buick, which saw sales drop 41%. 

So, to tally up the scores for the "Big Three" the past month, we have (non-volume adjusted) sales down ~27% from the same month last year.  Strange, when the majority of your revenue comes from gas-guzzler trucks, SUV's, and large cars, that sales take a massive hit when gas prices jump 100%+.

Duh.

(Expect a more detailed discussion of the woes faced by the automakers in another, slightly-less-sarcastic post sometime soon)

I'm Moving to Guatemala

Not that this is news to anyone who, uh, actually reads the news, but the two men running for President of the U.S. are, how to put this gingerly, economically retarded.

Karl Rove did a piece in the WSJ yesterday, calling out these two pandering politicos on their blatant b.s., the most painful example of which may be the idea of taxing "windfall" profits (of course, avoiding any discussion of what, exactly, constitutes said "windfall".  Not to go off on a rant here, but wtf is up with the wind references, "windfall", "headwinds", etc?) 

Rove accurately points out that margins for the current corporate pariah du jour, oil/energy companies such as Exxon Mobil, are amongst the slimmest in any industry.  So, if these populism-promoting politicians aren't defining windfall profits by margins, they must mean by sheer size, right? 

Wrong. 

It's not the profit margin, but the total number of dollars earned that is the problem, Mr. Obama might say. But if that were the case, why isn't he targeting other industries? Oil and gas companies made $86.5 billion in profits last year. At the same time, the financial services industry took in $498.5 billion in profits, the retail industry walked away with $137.5 billion, and information technology companies made off with $103.4 billion. What kind of special outrage does Mr. Obama have for these companies?

It's one thing when the most liberal senator on Capitol Hill blabbers incoherently about things which he clearly does not understand (as a matter of fact, its pretty much par for the course, no?), but when a so-called "Regan Republican" like John MCcain allows himself to sound similar ignorant, its a sign that we're all in serious trouble.

This past Thursday, Mr. McCain came close to advocating a form of industrial policy, saying, "I'm very angry, frankly, at the oil companies not only because of the obscene profits they've made, but their failure to invest in alternate energy."

So yea, about the title of this post.  I'm not kidding.  When the next leaders of the free world (ha!) not only say stupid things, but I fear, will actually follow their rhetoric with action, bad things will happen.  Very bad things.

(Mis)Adventures in Myopia

We're all supposed to 'know' that investors are myopic, that they tend to focus on the present and very-near future while ignoring the long-term.  While this may be a convenient assumption in modern finance, it behooves the prudent investor to look beyond the 'now', so-to-speak, beyond the hype, to find attractive long-term investment success.  Unfortunately, this approach seems to be about as popular as Nick Hogan at a MADD conference.  The sheer amount of evidence is staggering, but I'll keep it light and let Bloomberg do the work:

Retail sales in the U.S. rose twice as much as forecast in May as Americans snapped up electronics, clothes and furniture, evidence that they aren't hoarding their tax-rebate checks or using them just to pay for gasoline.

``It's just amazing -- the American consumer's resilience in the face of everything negative,'' Stuart Hoffman, chief economist at PNC Financial Services Group Inc. in Pittsburgh, said in an interview with Bloomberg Television.

Yes!  Long live consumer whoredom!  Maybe we can spend our way out of this 'recession' after all, no?  Hell, the S&P Retail Index is off its year lows (although well-below its highs), and, as Bloomberg points out, retail sales were up TWICE as much as expected!!!  The rest of the article above takes this tone, that the worst of our problems are already behind us.  But, lest we prematurely jump to any conclusions, the very last paragraph reminds us of that which so many seem to be overlooking:

The bulk of the tax rebates will probably be spent from July through September, giving third-quarter growth a lift, before the economy decelerates again in the last three months of the year, the Bloomberg poll also showed.

Oh.  So they're saying that, Aeropostale isn't going to keep increasing same-store sales 20% every quarter? That people are going to have to decide between filling the tank in their Escalade or buying a new XBox?  HOGWASH!  I bet next you're going to try to tell me that defaults on auto and other consumer loans are on the rise, ha!  Rubbish!

And so, sarcasm aside, despite what by all measures is an inevitable storm of difficulties for the economy - especially the consumer discretionary sector - the S&P is already up almost 10% from the lows reached only 3 short months ago.  It seems daily, the so-called pundits, experts, and talking heads in the media are trying to convince us that the worst is already behind us, that the economy is strong.  It is certainly possible that we may be further along towards absorbing the negative affects of the subprime mortgage fiasco, but we've only begun to scratch the surface of the secondary and tertiary effects of a slowing, or receeding economy.  Trading in November, 2008 CBOE Volatility Index (VIX) options strongly support this thesis, as there is massive open interest all the way up to $37.50, implying that some market participants are seriously hedging their bets (or betting outright) should things tank over the next 2 quarters.

It seems, especially in the retail and discretionary sectors, that results have been heavily influenced by the receipt of tax refunds and "stimulus" checks.  While most of the relevent data has yet to come out, early indications suggest that consumers were spending more of their "free" money at the malls, instead of paying off their ever-increasing debt load.

Higher commodity and energy prices, ever-increasing consumer (and government) indebtedness, and a generally downward turning business cycle do not bode well for the state of the U.S. (nay, Global) economy in the itermediate-term.  Unfortunately, it seems that our human nature (or the nature of crowds), the predisposition towards unbridled optimism - even in the face of mounting evidence to the contrary - has been, and will continue to overpower logic and reason. 

Only time will tell, but as I write this and overlook the menacing clouds hovering over the East River, I can't help but think of the storm cloud of consequences from our irresponsible and short-sighted decision-making, threatening the economic well-being of the entire Country as a whole.  Hopefully I'm just letting my predisposition towards cynicism get the best of me, but until I see substantial evidence that my worst fears are only that, I'll be cautiously taking the other side of your long America trades. 

Disclosure: Anal_yst is short Aeropostale, but really long America (at least in heart, but less in portfolio, or something).  Anal_yst is not a creative writer (clearly).

Said Nextel, "Let Them Eat Cake"

Over at tech uber-blog Engadget, there is an interesting story that Sprint/Nextel waived early-termination fees (the other ETF) for Government employees/agencies.  This is especially interesting, since Chris Cox, chairman of the FCC is trying to push the mobile carriers to come to some sort of agreement to chill out with the ridiculous ETFs.

Thats all well-and-good, and I'm sure theres some yet-to-be-explored angle there, but I'm more interested in the discussion that followed in the comments section on Engadget.  As could be expected, many decried the CRAZY early termination fees as usurious extortion by the carriers.  Some tried (and failed) to kind-of explain, but even the most 1/2 hearted attempts fell on deaf ears.  I also tried (and failed) to lend some reason to the debate, but the kind folks at Engadget refuse to recognize my logon/password, even though I copied it directly off the automated confirm sent to my email when I first signed up.  Alas, I shall not be ignored!

I put together a quick & dirty (spreadsheet ) to illustrate a simple example of the cell phone retail business model, but to summarize, it goes something like this: 

• Step 1. Subsidize cost of phone (i.e. sell as loss-leader)
• Step 2. Amortize the loss/make $$ by locking customers into long-term contracts.
  • Step 2.5. Charge mucho dinero to customers for walking away from said contracts.

Now, some people have a hard time with these fees, which can be as much as $250 (if not more).  My first reaction is generally somewhere along the lines of, "READ THE CONTRACT BEFORE YOU SIGN (idiot)."  Of course, we all know the average person's ability to read (nay, comprehend) contracts is not so good ("hey, who wants a no-doc, stated-income jumbo option arm mortgage?"), so this response is pretty much a waste of breath. 

In reality, people need to understand that they simply cannot have their cake (i.e. affordable handsets) and eat it too (no/low early termination fees). Thats just how the world works.  Deal with it.

In this example, I assumed a 2-year contract period, on which the carrier takes a loss (subsidy) of $200 on the handset at purchase, a contract costing $50 monthly, and an annual interest rate of 9% (semi-arbitrary).  The NPV to the carrier over the life of the contract is about $900.  However, if there we assume a hypothetical situation where there is no early-termination fee and the customer were to cancel after only 12 months, the NPV drops down to about $375, almost a 60% drop in profit.  To the layman, this may seem silly, as the company is still 'making a profit', but that only captures a small part of the picture, running a mobile communications company is an awfully expensive proposition.  Thus, the "profit" generated by long-term mobile contracts enables the company to conduct business, that is, it doesn't simply trickle down to the bottom line uninterrupted.

We'd be delusional, of course, to expect every Joe and Jane Doe understand the complex business model of a wireless carrier, and we'd be similarly delusional to expect the fervor surrounding early-termination fees to die down any time soon. 

Lets assume that the FCC and the carriers come to some sort of agreement limiting the ETFs, avoiding the possibility that Cox & Crew will bow to the anti-capitalist cries from the masses and mandate they be eliminated entirely.  How, then, will the carriers account for the increased uncertainty of future cash flows from service contracts?  One thing is certain:  The carriers are absolutely not going to roll over and play dead.  I'd imagine they'll play ball, so-to-speak, and give up some restrictions on early-termination, but where they're losing money (and the attendant certainty of that money) they'll make up for it elsewhere.  I'd expect they'll keep up with the practice of heavily subsidizing handsets as their main sales driver, and reducing ETFs should definitely increase sales, as people can upgrade their phones more often. 

Its important to keep in mind that not only are the carriers losing out on previously-certain future cash flows, but they'll also suffer a hit to their gross margins as higher handset sales directly increase their CoGS.  To offset this, I'd expect the carriers will increase the cost of service contracts to even-out the PV calculation, and changing the structure (i.e. tenor) of the service contracts they offer.  I think the most obvious solution is that there will be a shift towards 1-year contracts, reducing the likelihood that a customer will switch carriers or upgrade their phone before the contract expires. 

Of course, the trade off is that the shorter-duration contracts will most likely cost more per month than the traditional 2-year variety, but as I said, you can't have your cake, and eat it too.

Welcome to Economics 101, n00b

Every now and then I read something so obscenely dumb, I can't help but respond.  This was one of those times:

DJ Mark to Market: How Much Would You Pay For an iPhone?

By Jim Murphy
A DOW JONES NEWSWIRES COLUMN

...For those readers who don't remember it, the iPhone initially cost $599, but
Mr. Jobs is not concerned about a backlash from existing iPhone customers,
disappointed that they paid significantly more for their cell phones than
future users, the WSJ reported. "This is the way the technology markets work,"
he said.

This is not a revolutionary thought: People should be charged what something
is worth, not whatever the highest possible amount of money the provider of
that something can squeeze out of them.

Oh, duh!  Lets just sell a product for what its worth, my god its so obvious now!  Ok, enough sarcasm, but lets get serious folks, the above statement, and its normative language is in-itself ridiculous, but to make such a claim based upon some arbitrary, unexplicable ideal is at-best painfully ignorant.  I'd have less of a problem (but still one regardless) if the author had presaged the statement with some sort of disclaimer admitting his point doesn't exactly make much sense, or if he'd elaborated as to how one is to determine this mystical idea of "worth."  To be fair though, that statement is far from the most eggregious failure of financial understanding I've seen to-date, it just happened to catch my eye when it could stand to take no more; it was the proverbial straw that broke the camel's back. 

(1-2 chime in)

That being said, the pricing scheme Apple has embarked on makes perfect sense.  It is simply a well executed version of third-degree price discrimination.  By setting the price high for the early adopters (who he arguably didn't charge enough judging by the opportunity cost forgone those who lined up for hours on end to wait for the phones release proved...well maybe their opportunity cost just wasn't that high).  It is the same principal as using coupons to segregate segment customers by price elasticity.   Those who are willing to hunt for coupons are obviously more price sensitive than those who don't care to search through newspapers daily, thus they are charged less.  These are the same people who are now being charged less for second generation iPhones (the price sensitive group), while the inelastic purchasers (early adopters) were charged a price that was able to extract more of the consumers' surplus.

However, it remains to be seen what kind of demand destruction this quickly shifting price structure has.  This is obviously more a branding question with economic impacts than a straight economics question, but if people don't trust that their new iGadget will retain its value for longer than six month they may just not buy first generation products.   It is a careful balance to strike, but perhaps Jobs has it just right.

 

Either way, this was not a benevolent break by Steve Jobs. 

This is a perfect application of price discrimination...the good kind.

This Week in "Duh": Facebook's Groundbreaking Advertising Strategy

As 1-2 pointed out a while ago, and even I wrote about 2+ years ago (gotta find the link to my old blog), facebook has an invaluable amount of user-volunteered, mostly-accurate information from which to glean user's interests (ya know, in the field labeled "interests").

Unfortunately, their advertising platform is an utter failure, and as anyone who's been paying attention can attest, does an utterly nightmarish job of delivering targeted ads.

Finally though, someone in the Facebook bunker has had the Eureka! moment, the epiphany that will finally fulfill Chef Zuckerberg's promise of the future of social advertising.

Cnet (via some other blog) reports that Facebook is now allowing some users to not only simply rate ads, but describe why they did/didn't like them.  The rocket scientists over at Cnet had this invaluable analysis to ad:

It's also a way that Facebook can make its ads more targeted by learning about user preferences: if you repeatedly give the thumbs-down to dating ads, for example, Facebook could stop showing them so much. Or if you're in the New York regional network on Facebook and are disapproving of Mets ads, Facebook could show you Yankees ads instead.

Good try, but no.

Instead of this round-about, midly-retarded way of finding out user's real interests, Facebook could, oh, I dunno, use the data all its users already provide to say - and bear with me here - deliver a Yankees ad to the guy who says he likes the Yankees in his profile? 

Duh.

Sage Wisdom from Reason

From Matt Welch's article The Golden Collapse via Reason Magazine:

But what turned out best of all, and what has the most relevance to today’s various economic busts, was the regulatory response to the [2000] technology crash: a grand, collective shrug.

Like the subprime collapse of 2008, the dot-com bust of 2000 took place during a heated presidential campaign. Yet the tech bubble didn’t merit a single mention in any of the presidential or vice presidential debates that fall. The Federal Reserve responded to the 2000 contraction by using the main mechanism at its disposal: repeatedly slashing interest rates (a move, many say, that helped inflate the next bubble). The Fed is responding to 2008, on the other hand, by proposing vast new mechanisms for itself, including regulatory oversight of investment banks, new rules for credit rating agencies, and authority over such far-flung sectors as insurance and commodities trading....

...The only substantial “reform” that came in the wake of that crash was the disastrous Sarbanes-Oxley Act of 2002, a make-work program for accountants that was more a reaction to the shoddy internal reporting of Enron, Adelphia, and WorldCom than it was to the fantasy-based price/earnings ratios of fill-in-the-blank.com.

What were the nefarious effects of the surprisingly laissez-faire attitude toward tech stock de-listings and baby boomer NASDAQ wipeouts? The Dow Jones recovered its 2000 highs by 2006, and even tech-heavy NASDAQ has more than doubled its value since post-crash lows in October 2002. The United States, led by the ongoing information revolution, has continued to innovate and thrive, with only a few minor macroeconomic hiccups in 15 years of robust growth.