Tuesday, August 31, 2010

S.E.C. settles with the State of New Jersey

Or, why muni-bonds don’t belong in an individual’s portfolio

The S.E.C.’S settlement with NJ is a very curious filing. This posting tries to include the relevant quotes, but the reader can see ORDER INSTITUTING CEASE-AND DESIST PROCEEDINGS PURSUANT TO SECTION 8A OF THE SECURITIES ACT OF 1933, MAKING FINDINGS, AND IMPOSING A CEASE-AND-DESIST ORDER for details.

The actual settlement concerns how NJ disclosed its pension accounting in its bond offerings. The bonds at issue are: “from August 2001 through April 2007, New Jersey issued over $26 billion in municipal bonds in approximately 79 offerings.” Most coverage stresses other aspects of the filing. The story has been covered in national media without much background and with the level of “tisk-tisk” and finger pointing each outlet judges appropriate, often directed at that media outlet’s favorite villain. However, this posting isn’t about the media. It is about the curious nature of the filing. So, what’s so curious about it?

Both the fact that it occurred and the content of the filing are weird to say the least. Let’s start with the curious aspects of the fact that the filing ever occurred.

First, it seems curious that the S.E.C. would think anyone is unaware of the fact that governments make promises without funding them. That is especially true of pension benefits. Are they unaware of the SS and Medicare debates?

Second, most filings involve something where someone contests the substance of the filing. In this case, everyone involved from the unions to the politicians were already on the case. The unions have filed suits against the state, the governor has made so much noise about it that his political opposition has been calling him a bully for bringing it up, and even legislators were on it.

Third, the lack of someone contesting the filing has something to do with who is the aggrieved party and who benefited from the fraud. What follows from that is curious to the point of weird. The aggrieved are supposedly the people who bought the bonds. Without honest, adequate information they MAY have paid too much. Well, who are municipal bond buyers? Clearly, it was people who need the tax-free return, generally the rich. So, the filing is on the behalf of the rich.

Fourth, contrast that with who were the beneficiaries of the fraud. Well, the residents of the state who could have lower taxes and more goodies from state benefited. One important goodie was an initial 9% increase in pension benefits made to seem feasible by the initial accounting change. But, after that initial increase, subsequent accounting changes facilitated additional pension benefits. Suing pensioners for having benefit that are too high seems weird.

So, following that logic, this is a filing on behalf of the rich against the tax payer, pensioners, and citizens of the state. Is that weird or what?

Fifth, the filing got coverage despite a lack of any reasonable way to give it an ideological/ philosophical spin. It’s one government agency filing a settlement with another. It could, and undoubtedly was intended to, enhance one agency’s, the S.E.C.’s, growth prospects. But, it will increase the borrowing cost of another government, the State of New Jersey, thus cramping one vehicle for their growth.

Sixth, it is equally hard to take any speculation about a political motive seriously. The issue raised spans multiple administrations and legislatures of both parties. It was filed by a Democratic S.E.C. against a Republican administration in NJ, but the Republican Governor clearly wasn’t involved in the fraud and had been making waves stressing the same issues. Could it have been a Republican plant? Not likely. It raises borrowing cost for a Republican administration and is nice “tough guy” posturing material for a Democratic administration.

Now let’s address the content of the filing. Remember it is about fraud.

First, are we to believe the S.E.C believes governments don’t lie? Since when has a politician’s lying been a fraud?

Second, every government’s accounting has a level of opacity that would land the heads of any private organization in jail. Is this the start of an S.E.C. crusade to clean up how governments do accounting? But, alas it isn’t the accounting, as such, that led to the settlement; it’s that it wasn’t adequately disclosed. In other words, governments can account however they want, but if it involves a security, then they just have to make their disclosures as convoluted as their books. Or, put simply, simple deception is OK for the masses, but step it up for Wall Street. Wall Street deserves sophisticated and convoluted deception.

Third, while we’re speaking of accounting, this quote from the filing “…the State’s use of the BEFs as part of a five-year ‘phase-in plan’ to begin making contributions to TPAF and PERS; and (4) the State’s alteration and eventual abandonment of the five-year phase-in plan…” sounds familiar. Oh, perhaps I’m confusing BEF with SS trust fund and TPAF and PERS with SS. Governments regularly take money out of the right pocket, put it in the left, and replace it in the right pocket with an IOU from left pocket. Then, after spending the money in the left pocket, they can still claim to be well-funded because of all the IOUs in the right pocket.

Fourth, and still sticking with accounting, the filing for the settlement includes a lengthy discussion of NJ’s pension accounting. It seems the S.E.C. objects to the way the State applied mark-to-market accounting. In particular, they seem to take exception to mark-to-market using a past market high. That seems reasonable except it ignores the fact that if the high wasn’t right, it means the market isn’t always right. That raises serious questions about any mark-to-market accounting. The S.E.C. insists that accepted accounting standards, which include mark-to-market, have to be used by most issuing organizations. There is a contradiction.

There are two logical ways around the contradiction. One is just to say mark-to-market is appropriate sometimes, but not for pensions. That seems reasonable, but it probably applies to most assets not just pension assets. The Hedged Economist has criticized mark-to-market in a variety of contexts. But, the S.E.C. has made mark-to-market, if not the law of the land, at least the law of Wall Street.

The other way to eliminate the contradiction is to continue to believe in mark-to-market, but fabricate some rational for why the market is right if some other period is used, but not for a market high. The S.E.C. seems to have fallen into the trap of believing mark-to-market is OK if current period market prices are used. That’s silly. It would imply that at least some of the mistakes the filing highlights would have been OK if they had been made at a different time. For example, the filing states “On June 29, 2001, the State legislature approved legislation (P.L. 2001, c. 133) that, effective November 1, 2001, increased retirement benefits for employees and retirees enrolled in TPAF and PERS by 9.09 percent. In order to fund the enhanced benefits, without increased costs to the State or taxpayers, the legislation revalued TPAF and PERS assets to reflect their full market value as of June 30, 1999, near the height of the bull market.” If the benefits had been increased in June 1999, mark-to-market could well have shown them to be reasonable. Yet, the filing identifies them as one of multiple sources of the funding shortfall.

Fifth, the filing has lots of sound and thunder, but all perched on a very weak straw if accounting is the issue. Accounting isn’t really the issue. The S.E.C. makes the argument that the fund balances aren’t adequate to meet projected expenses. Few people would argue, certainly not the governor or the pensioners’ unions. That the bond offering didn’t adequately provide information to assess that risk is another issue entirely. To assess that risk based on accounting provides far less reliable information than a realistic look at how politicians behave. Yet, not surprisingly the S.E.C. avoids that reality by blowing smoke about accounting.

Sixth, the filing points out that the 9% benefits increase has a lot to do with the current state of the pension fund balances. That’s very curious. It skates real close to saying the S.E.C. should have some say in the level of state and municipal pension benefits for any government that plans to issue debt.

Finally, there is a way around dictating pension levels. The S.E.C. could dictate funding (i.e., tax and/or expenditure levels). But wait, the State already does that.

So, you might ask: “why such a curious filing?” Well, it wasn’t opposed, it could be done without appearing partisan, and it wasn't going it raise ideological objections, yet it let the S.E.C. do something. It let the S.E.C. look like they were doing something without risking making enemies. That's one reason. Further, it was done by a new Municipal Securities and Public Pensions unit. That new unit needed a non-controversial starter case since the threat of an honest look at public pensions has got to be scary for those politicians who will fund the new unit. Finally, the S.E.C. is trying to undo the Tower Amendment which reduced the S.E.C.’s power. This settlement fits into their lobbying quite well. So, if you look to the S.E.C.’s quest for money and power, the filing makes sense. It has nothing to do with NJ or protecting muni-bond buyers. In the muni-market buyer beware is still the rule.

Thursday, August 26, 2010

Fidelity data on 401(k)s, news or not?

Sound and thunder without content

Most of the time the news makes some sense even if it just seems to confirm that the world can be entertaining. But, the coverage of some data from Fidelity just didn’t make sense to me. It got more play than it deserved, and every report seemed to focus on the irrelevant. So, hoping to make some sense of it, two versions of it were sent to some friends whose opinions and comments always make sense. This posting is built around their comments. They’re reported in the order received, which, with this introduction, actually makes a coherent posting.

The data concerned Fidelity 401(k) participants. The two versions sent are:
Fidelity: 401(k) hardship withdrawals, loans up
As 401(k) Levels Rise, So Do Withdrawals
Despite extensive coverage, none of the reports I saw or heard addressed the seriousness of the behavior being reported. They all missed an opportunity to educate as well as inform.


“It might also have been a news conference and a press release....

Interesting interpretations, for sure.....

I was struck, even in hearing the radio version of the AP story, (I never heard the WSJ version on the radio, but am sure WSJ radio did their version), with the relative small number of people doing the redemptions....

I don't think either side is wrong or out of line. The AP story is aimed at getting page one play....that's why it's written that way. The WSJ interpretation leans the other way, in trying to take a positive swing at the increase in contribs......

In my opinion, both are really non stories in relation to the overall economy. The hardship redemptions could be for many reasons other than reductions in take home pay and hours, and the increase in the average account is simply explained by the 18 month run up in the stock market.....

One man's trash is another's treasure.....

PS.....I'm wondering if the AP might have done several stories linked to the same news conference or news release....that is often done where there is just too much in the way of percentage comparisons and number crunching involved......”

The Hedged Economist would add:

We are in agreement that the entire story doesn't say a lot about the economy. It's only relevant to the extent it conveys any information about how people are behaving. That's limited.

Regarding the media, you're right about the WSJ story not being played for page one. It was on an inside page of a Saturday edition. Your suggestion that it is not just a press release is probably right. It may not have been a press release at all. If it is, it isn't easy to find on the Fidelity website. Since different people are quoted in the two stories, any difference in "spin" could be the interviewee.

What seems curious is that it got as much play as it has. It has been mentioned on TV, radio, and in the press. It may be that the coverage is just an indication of how desperate media has become in their effort to support a 24/7 new cycle. It might also indicate how dependent on AP the media has become. This is the sort of thing one use to have to dig to get.

Regarding the stories themselves, you’re right that the increase in balances being partially due to improved markets. But, 15% doesn't say much. Stocks (e.g., S&P) aren't up that much year over year and who knows about foreign stocks and bond funds. The impact of markets depends on what has what weighting in the 401(k)s. As you imply, one has to remember that people made contributions during the year. That would increase the average balance, and is probably more important.

It would be interesting to know the impact of the turnover in who is in their programs. That would seem to have a negative impact on average balances since people leaving would by definition have been in the 401(k) and have made contributions. By contrast, new participants have no initial balance.

It also occurred to me that as baby boomers retire they will have had a longer time to have built balances than other groups (even though 401(k)s have only existed since 1981 and were rare initially). That should lower the average balance. It also occurred to me that this year, older people with large 401(k)s can roll them into Roth IRAs. That would tend to reduce the average balance.

Despite all the cross currents, one thing the higher average balance seems to indicate is that there has been growth in the asset side of the balance sheets of 401(k) participants. That’s especially important given the issues discussed with DOC below. It will be a while before we know whether the number of participants grew and whether overall 401(k) assets grew.

The hardship redemptions as well as the maintenance of contributions just sound like how one would manage savings. It is interesting that more people increased elective contributions than decreased. Perhaps it’s a bit more of the savings trend often noted in the press.


“Isn't this normal for the first recession where 401(k)s have been really important stores of household wealth. If you have your retirement money in the 401(k) and home equity, and college funds, etc., how much "savings" do you need? Isn't that entire savings"? These people have tapped their emergency funds, and this is their lowest cost source of capital, especially since credit cards may be full up. All of this sounds normal to me. What is truly troubling is that the average account balance is $61k. (And its up 15% !!! from the year prior!) We're going to see stories again about retirees eating cat food.”

The Hedged Economist

The $61k average balance is probably the most important pieces of data in the release. It is a disturbing number since 401(k)s are probably the mainstay of many people’s provisions for retirement. IRAs, home equity, etc. definitely also have to be taken into considerations as well as the age of the people involved. There are probably some people with other 401(k)s held by other institutions (although one would expect that most would be rolled into IRAs). It is also scary to think that $61k is an average. The median is probably lower since it doesn’t take a lot of big balances to raise the average.

The Federal Reserve Survey of Consumer Finance is probably the best source, but it is only updated every three years. The last one was 2007. In the mean time, snippets like this are what we have.

The other curious figure is the average elective contribution rate of 8%. Granted people can, and should, save in forms other than a 401(k) (e.g., home equity and other capital goods, collectables, cash, IRAs, and financial assets), but 8% for retirement seems low.

It seems incompatible with two rules of thumb for personal finance, although it isn’t definitive. But, save 20% is often thrown out as a target. One would think that would put a cushion that would be used before tapping a 401(k) as the lowest cost source of cash in hard times.

A greater concern is the point you make about retirement and cat food. The old rule of thumb was retirement should be like a three-legged stool. The legs were supposed to be SS, pension, and savings. With pension coverage falling, one would expect to see 401(k) contribution rates growing. It would be an error to substitute a 401(k) for both the pension and other savings. Granted, the 8% figure and $61k reflect the impact of people with pensions and 401(k)s rather than just people totally dependent on 401(k)s.


“I read one of these two last week, too. Frankly, I’m not surprised about the need to withdraw.

While withdrawing from my 401k has never entered my mind (yet), …” The economist, like DOC, then went on to discus when withdrawals would represent rational economic behavior.

The Hedged Economist would add:

A pension or annuity introduces an important consideration. One of the risks that a 401(k) balance can hedge against is longevity (i.e., outliving one’s money). A pension or annuity is an excellent hedge against that risk. But, pensions aren’t that common, and many people who have pensions figure they don’t need to participate in their 401(k). Some don’t because they save elsewhere, but others just don’t want to save.

The caveat is that pensions, annuities, or 401(k)s only protect the participant from that risk to the extent they are funded. One can argue about whether it is easier to assess the adequacy of the funding of a 401(k), a pension, or an annuity. Personally, pensions have always seemed particularly difficult to analyze. They also can introduce concentration risk (i.e., having all one’s eggs in one basket as in having one’s job and retirement dependent on one organization’s management).

Individuals face risks other than longevity. The 401(k) withdrawals make it apparent 401(k)s are being used to hedge other risks besides longevity. Specifically, they are providing liquidity. They’re being used as a rainy day fund, educational fund, home purchase fund, etc.. One can argue about whether that is a good or bad trend, but there isn’t any doubt it is something a 401(k) can do that most pensions’ rules don’t facilitate. Annuities seem to fall somewhere in between, but annuities include such a broad spectrum of products that generalizations don’t apply.

Since there was a time when withdrawals weren’t commonly allowed, 401(k)s haven’t always filled these multiple needs. Nor, was it assumed they should. It seems appropriate to discuss some reason they should only be used for retirement funding.

Withdrawals are often a very expensive way to gain liquidity, (i.e., get your hands on cash). They are designed to encourage participants to give up liquidity. Both positive incentives and penalties are employed. Further, as The Hedged Economist often points out, it is dangerous to use one tool to hedge multiple risks. It is overworking a single hedge.

Two of the major risks arising from the practice of over reliance on a single hedge are illustrated in the articles. First, the right level of hedge isn’t the same for all risks. To illustrate, a rainy day fund of 61k would leave many people feeling quite comfortable. By contrast, 61k won’t produce much income in retirement.

Second, an overworked hedge is usually a very inefficient hedge. Again an illustration, the average withdrawal is about 8k. That 8k can be reduced by a 10% penalty and taxes at let’s say a 15% marginal rate. (It is a rainy day after all). So, 8k becomes 6k. If the marginal tax rate is 25%, 8k becomes 5.2k.

But, that’s just the start of this inefficiency. To hedge for retirement, the 401(k) should be in investments with a decent return. That means they have some volatility. The 8k current value could have had any historical cost.

Yet, the real cost is the discounted present value of the tax deferral being sacrificed. Given ages of from 35 to 55 for the people making withdrawals and the likelihood taxes will go up, that’s probably the biggest cost.

But, cost is only one dimension of the inefficiency. There is analytical cost as in the time an effort that should go into figuring out whether a withdrawal makes financial sense. The illustration above could be reversed by employer matches, exceptional investment performance, changes in the participant’s tax rate over time, etc.. They would all have to be considered. Compare that to the efficiency of having a separate rainy day fund, in this example a 5.2k to 6k rainy day fund.


The pensioner started with a fictitious, tongue-in-cheek “everyman” rant. Entertaining, yes, but to clarify the pensioner’s point I paraphrase: People are overly focused on today, overly influenced by banks (financial service industry ads), overly influenced by favorable tax treatment as a short run fix but insensitive to them when a longer run consequence is involved, feel entitled without feeling personally responsible, and put a lot of faith in other people fixing their problems. But, the pensioner’s comments are below since paraphrasing always undermines the tone of a statement:

“I have to have a flat screen, cable, several cars, vacations, and more... So I used my house as a credit card and why not? Home equity loans gave me a tax deduction and why not? My "double wide" was growing in value at 10 to 25 percent a year. And my favorite banks would encourage a re-finance to free up even more cash. True, they made a lot on fees, but I got free money. There were years I made more money just sleeping at home than going to work.

Well, the house is now under water. I am no longer going to work. The cable bill is due, the kids want a nice private college in New England, and the wife wants a newer BMW.

This is no problem. Those wonderful laws and bankers that got me home ownership benefits also put me into some great tax avoidance savings accounts. And those accounts were all mine and perhaps the secretary in accounts payable. No equal property here. But now out of work, I no longer take her to lunch. And with the market downturn, the 401(k) was perhaps not all great an idea. Just get me some money. I am planning a come back.

So why not take your money out. Pay the 10% penalty. Get whacked on the taxes. Who really does care about retirement when your BMW is due for service now? Surely, all the days of my life, Obama will protect me. He knows this is all the work of Bush, and not the weakness of the American consumer or government’s failed economic policy. And now more than ever we need to be creative to support our personal entitlement to spend, spend, spend. I told that little tramp in Accounts' payable I wanted the $3,500 I loaned her for a boob job. Time to call in your chips. I have another 8 years to rebuild my retirement savings.

(And with social security and a 401(k) of about $61,000 my retirement would have me drinking hooch and eating wet cat food only on Sunday)

Brother can you spare a dime, Obama days are here again......”

The Hedged Economist would add:

The focus on short-run consumption isn’t just an everyman issue. It seems to be a national obsession. As baby boomers age, it will get worse.

Interestingly, all the other people who commented above, at one time or another, have alluded to people being overly influenced by the financial service industry. Especially as it relates to the structure of cash-out refi’s during the housing boom. Yet, at the time, cash-out refi’s were viewed by many as just rational strategies for credit management. Very few people will second guess the public’s consumption verses savings decisions.


“What both of the stories fail to discuss is that these withdrawals are for ‘hardship.’ I wonder how much due diligence the bankers do before releasing the money.”

The Hedged Economist would add:

Disappointment with the abbreviated discussion of how a hardship loan or withdrawal is defined was my initial reaction. Mainly because of where it leads as explained in comments in response to another comment from the pensioner. But first, because of where it leads, a discussion of the relevant IRS definition of hardship follows:

Like loans, hardship withdrawals are allowed by law, but your employer is not required to provide for them in your plan. Like loans, most companies do, but some don't. The cost of administering such a program can be prohibitive for many small companies. Like loans, your employer must adhere to some very strict and detailed guidelines. My guess is that plan administrators have a set of forms one has to fill out in order to make a withdrawal.

The IRS code that governs 401(k) plans provides for hardship withdrawals only if: (1) the withdrawal is due to an immediate and heavy financial need; (2) the withdrawal must be necessary to satisfy that need (i.e. you have no other funds or way to meet the need); (3) the withdrawal must not exceed the amount needed by you; (4) you must have first obtained all distribution or nontaxable loans available under the 401(k) plan; and (5) you can't contribute to the 401(k) plan for six months following the withdrawal. Under the provisions of the Pension Protection Act of 2006, the need of the employee also may include the need of the employee's non-spouse, non-dependent beneficiary.
The following items are considered by the IRS as acceptable reasons for a hardship withdrawal:
1. Un-reimbursed medical expenses for you, your spouse, or dependents.
2. Purchase of an employee's principal residence.
3. Payment of college tuition and related educational costs such as room and board for the next 12 months for you, your spouse, dependents, or children who are no longer dependents.
4. Payments necessary to prevent eviction of you from your home, or foreclosure on the mortgage of your principal residence.
5. For funeral expenses.
6. Certain expenses for the repair of damage to the employee's principal residence.
Hardship withdrawals are subject to income tax and, if you are not at least 59½ years of age, the 10% withdrawal penalty. You do not have to pay the withdrawal amount back.
A hardship distribution may not exceed the amount of the need. However, the amount required to satisfy the financial need may include amounts necessary to pay any taxes or penalties that may result from the distribution.


“My employer has a deferred comp plan for employees, which works like a 401(k) (i.e., the money goes in and is not taxed). The plan had to agree to follow hardship rule in order to keep the IRS tax exemption. The Treasury department reviewed requests for money to insure that it was within the guidelines. If Treasury rejected the request, the employee could appeal to the deferred comp board, which I sat on for about four years. Most of the time the people came in and we granted their request. However we did the due diligence to protect others who use the plan and want the IRS tax break. Most all requests were made by people who were working for the State, and had a regular pension.

It was a very eye-opening experience about how people had very poor money management skills."

The Hedged Economist would add:

The data provided the media with an excellent opportunity to delve into a discussion of personal money management. Other than abbreviated references to how hardship is defined in the relevant IRS regulation and some potential tax implications, the articles seem to focus on things with supposed global implications. They passed up a potential opportunity to contribute to public understanding of an issue we all have to address. What a shame!

DOC has commented that 401(k)s gave people a ton of responsibility without any relevant education. But, that doesn’t say whether it’s education on asset management (i.e., investing) or personal money management that is missing, or both. Nor does it say which is more important. What this closing comment by the pensioner points out is that personal financial management plays an important role.

The Hedged Economist would close with the comments: this blog often takes an unorthodox approach to investing viewing every investment as a hedge against some risk. Combined with a good grounding in personal financial management, it works. My opinion is that money management is probably the more important than investment prowess, and it definitely makes asset management easier.

Friday, August 20, 2010

Worth repeating and, yes, gold again

But first my comments

Two previous postings tried to put gold in perspective. “Gold: Be sure you know what you’ve hedged” (April 5) and “Gold again” (May 15) seemed to say all The Hedged Economist had to say about gold. But, “Gold again” mentioned relative performance of an example stock over the first half of 2010. Six months seemed relevant to the short-run interest that is characteristic of much of what is said about gold, although people seem to pick a period based on how well it supports their recommendation.

The article from which the excerpt below is taken provides comparisons for a variety of other periods. It also mentions some different example stocks. Thus, it lends some perspective. The perspective makes it worth repeating.

Is this some sort of recommendation? Not hardly. Recommendations are overrated. It is far better to have insight that allows one to make one’s own decisions. After all, one has to live with one’s decisions. Having someone to blame for mistakes doesn’t change that. If the reader wants recommendations, go to the source for the article, TechTicker (http://finance.yahoo.com/tech-ticker), but be forewarned; the article right before “Buying Gold is a Mistake” encourages gold purchases. Such are recommendations. Better one should just be sure one knows why one owns or doesn’t own gold. In “Gold: Be sure you know what you’ve hedged” you’ll find the only reason that will make sense over time.

Buying Gold Is a Mistake -- Stocks Offer Better Returns, James Altucher Says
Posted Aug 19, 2010 02:24pm EDT by Peter Gorenstein in Investing, Recession
Related: gld, gdx, gold, fcx, jnj, pg, mcd. SOURCE; http://finance.yahoo.com/tach-ticker
Through the tumult of the last two years, few assets have held up better than gold. That, however, is no reason to buy the shiny metal, says James Altucher.
"It's had its run because we've had enormous fear in the market," says the Formula Capital founder in this clip. "Whenever there's such huge investment uncertainty, like we've had for the past decade, gold is going to go up."
It sure has.
Gold has increased five-fold in the last decade and currently trades for more than $1,200 an ounce. But, compared with stocks, gold is a laggard, he writes in a recent Wall Street Journal column:
"Gold reached its peak in 1980 when it reached $800 an ounce, which is $2,000 in today's dollars. So in real terms, gold has lost about 40% of its value since 1980. In the meantime, the stock market has gone up about 500% in real terms.
"Some other time frames for comparison: From 1975 (post the U.S. getting off the gold standard) to now, gold is up 500%. The Dow is up 900%. Gold was worth about $20 an ounce in 1800. Since then it's averaged a 2% gross return. Subtract out the costs of mining and storing gold, and what you have is basically a worthless rock that has a net negative return as an investment."
Besides, "gold will never write you a check," he says, comparing gold to dividend-yielding stocks. Altucher would much rather buy stocks that "consistently grow earnings and dividends over time." Not only will stocks like McDonald's, Procter & Gamble and Johnson & Johnson pay a dividend, they, like gold, act as a hedge on the U.S. dollar, thanks to their large and growing international businesses.

Tuesday, August 17, 2010

An interesting article regardless of which gossip is true.

Some gossip has implication regardless of whether it’s true

So, according to the article below, Mark Hurd was the victim of the jealousy and resentment of employees and the board. Perhaps it wasn’t the jealousy of the small minds of the scandal mongers after all. Chief executives who realize they work for shareholder don’t seem to be real popular with either. Nor for that matter with most journalists. But, people who hope to retire might want to view it differently.

Funny thing is that with HP, the people who should care are people with pensions or 401ks. It sounds similar to GE when Jack Welch left; that set retirement back a bit for a lot of people as the stock fell hard without his management. GE was widely held directly in IRAs (it was after all considered a widows’-and-orphans’ stock), and indirectly in mutual funds and pensions. With HP, big institutional holdings by mutual funds and pension funds are well documented.

It is a great shame that pension funds and mutual fund managers don’t take a more active role in insisting companies advance shareholders’ long-run interests. It would go a long way toward insuring a more secure retirement for pension and 401k holders as well as people with mutual funds in an IRA.

If Commons had written INSTITUTIONAL ECONOMICS after the growth of benefits during World War II and the post-war period, his observations about the chummy nature of institutional money and corporate management would be interesting. However, let’s directly address the question: “Is this the Capitalism that will bring America back?” Not likely. Nothing will bring the past back except the fog of memory. Will it do? The problems it highlights aren’t new. Neither jealousy of the rank-and-file nor in the board room is new. Commons was writing about the difference between managements’ and capital providers’ interests in the 20’s and 30’s. The challenge going forward will be figuring out how to manage the managers regardless of whether they are managing a corporation, government, union, community interest group, or non-profit. If we figure that out, yes it will do, but it won’t bring back the past.

Date: Mon, 16 Aug 2010 17:03:34 -0400
Subject: Is this the Capitalism that Will Bring America Back?
Source THE NEW YORK TIMES (http://www.nytimes.com/2010/08/14/business/14nocera.html?pagewanted=1&_r=1&ref=joe_nocera)
August 13, 2010
Real Reason for Ousting H.P.’s Chief
The resignation of Mark V. Hurd last week from his seemingly secure post as chief executive of Hewlett-Packard has got to be one of the great head-scratchers in recent times.
Here’s a guy who walked into a very troubled situation, replacing Carleton S. “It’s All About Me” Fiorina, and oversaw what appears to be a magnificent turnaround. In his five years at H.P., every metric Wall Street uses to judge companies had gone in only one direction: up.
Its 2009 revenue was $115 billion, up from $80 billion when he took over. Four years ago, H.P. even leapt past mighty I.B.M. in revenue, making it the country’s biggest technology company. Its average annual 18 percent profit increases were remarkable given the company’s mammoth size. And the stock price more than doubled on Mr. Hurd’s watch.
Stories about Mr. Hurd lavished praise on his no-nonsense style. H.P. under Mr. Hurd has “become the benchmark for efficiency in an industry known more for its whiz-bang appeal than its operational excellence,” wrote Adam Lashinsky of Fortune in 2009. Four months ago, Forbes put Mr. Hurd on its cover, attributing H.P.’s success to “dramatic cost-cutting” and “a brutalizing culture of accountability.” Even Mr. Hurd’s temporary replacement, the chief financial officer, Cathie Lesjak, who seemed to go out of her way to diss him, said in the press release announcing his resignation that “our ability to execute is irrefutable.” That could never be said during the reign of Queen Carly.
And then, on Aug. 6 — poof! — he was gone, brought low by a sexual harassment scandal.
Or was he? In the press release, H.P. noted that while a claim of sexual harassment had been made, an investigation had cleared him of the charges. Instead, the company alluded vaguely to “violations of H.P.’s standards of business conduct.”
When pressed, H.P. said that Mr. Hurd had fudged some expense reports. (It also said that his relationship with the woman, a small-time H.P. contractor, was a conflict, even if no sex was involved.) On his way out the door, the board handed Mr. Hurd a severance package said to be worth between $40 million and $50 million, which would seem to undercut the notion that he had done something bad.
H.P. says its board should be applauded for not letting Mr. Hurd off the hook. But this is just after-the-fact spin. In fact, the directors should be called out for acting like the cowards they are. Mr. Hurd’s supposed peccadilloes were a smoke screen for the real reason they got rid of an executive they didn’t trust and employees didn’t like.
The stand-up thing would have been to fire Mr. Hurd on the altogether legitimate grounds that the directors didn’t have faith in his leadership. But of course Wall Street would have had a conniption if the board had taken such a step. So instead, it ginned up a tabloid-ready scandal that only serves to bring shame, once again, on the H.P. board.

Mr. Hurd’s sudden departure from H.P. can be traced, in truth, to the last time the H.P. board did something shameful. That was the infamous “pretexting” scandal, which burst into public view about a year and a half into Mr. Hurd’s tenure. The essential allegation was that the company, led by its board chairwoman, Patricia C. Dunn, had gone way over the line in investigating a series of damaging leaks, including hiring investigators who used false pretenses to obtain phone records of people suspected of being the leakers.
According to “The Big Lie: Spying, Scandal and Ethical Collapse at Hewlett-Packard,” an authoritative account by the former BusinessWeek writer Anthony Bianco, Mr. Hurd was very involved in H.P.’s efforts to hunt down the leakers. After the scandal broke, he hijacked H.P.’s internal investigation, hiring an outside law firm and ordering it to report directly to him, instead of the board, which is the normal practice.
“There is plenty of evidence from H.P.’s own documents that he had a much bigger role in starting the investigations and carrying them out than he ever let on,” Mr. Bianco said. “H.P. security had a SWAT team to root out the leakers. They were clearly trying to please him.”
Ms. Dunn, according to “The Big Lie,” knew about the effort to finger the leakers, getting regular updates from H.P. managers. But she wasn’t the driving force. She wound up taking the fall because the board member who revealed the pretexting, Thomas J. Perkins, the former venture capitalist, had it in for her. So the allegations were skewed to make her look bad.
Ms. Dunn stepped down as chairwoman, replaced by Mr. Hurd. Then, Mr. Hurd forced her off the board entirely, threatening to resign if she stayed. In October 2006, Ms. Dunn, who was also being treated for cancer, was indicted by the California attorney general on identity theft and fraud charges, only to have them tossed out of court five months later.
“There was a residue of mistrust because of the pretexting scandal,” said Mr. Bianco, who added, “I conclude in the book that he lacks the moral character to be C.E.O.”
Then there were the company’s employees. The consensus in Silicon Valley is that Mr. Hurd was despised at H.P., not just by the rank and file, but even by H.P.’s top executives. (Perhaps this explains why Ms. Lesjak was so quick to denigrate him once she took over.) “He was a cost-cutter who indulged himself,” was one description I heard. His combined compensation for just his last two years was more than $72 million — a number that absolutely outraged employees since their jobs were the ones being cut.
Rob Enderle, a well-known technology consultant, noted that in recent internal surveys, nearly two-thirds of H.P. employees said they would leave if they got an offer from another company — a staggering number. “He didn’t have the support of his people,” Mr. Enderle said. Although he was good at “holding executives’ feet to the fire, he seemed to be the only one benefiting from H.P.’s success,” Mr. Enderle continued. “He alienated himself from the people who might have protected him.”
After Mr. Hurd’s resignation, an anonymous H.P. employee wrote on the Internet: “Mr. Hurd cares about one thing, how much money is in it for him. As an H.P. employee I see it every day. We don’t have the tools to do our job, but he isn’t doing without anything, and doesn’t care.”
Charles House, a former longtime H.P. engineer who now runs a research program at Stanford University, openly rejoiced when he heard that Mr. Hurd was leaving. “I think the sexual harassment charge was a total red herring,” Mr. House told me. He didn’t care. “I was delighted,” he said.
Mr. House’s brief against Mr. Hurd went well beyond his outsize compensation and penchant for cost-cutting. As Mr. House saw it — indeed, as many H.P. old-timers saw it — Mr. Hurd was systematically destroying what had always made H.P. great. The way H.P. made its numbers, Mr. House said, was not just cutting any old costs, but by “chopping R.&D.,” which had always been sacred at H.P. The research and development budget used to be 9 percent of revenue, Mr. House told me; now it was closer to 2 percent. “In the personal computer group, it is seven-tenths of 1 percent,” he added. “That’s why H.P. had no response to the iPad.”
Mr. House was also offended by Mr. Hurd’s dictum that H.P. executives had to resign from all civic boards, as well as his decision to cut off many of H.P.’s philanthropic activities. “H.P. has always been a model corporate citizen,” Mr. House said.
Plus, he said, Mr. Hurd was “incredibly rude and demeaning, and relied on the fear factor.” Mr. House summed up the Hurd era this way, “He was wrecking our image, personally demeaning us, and chopping our future.”
Are any of these firing offenses? They probably should be, but they’re not, not in the culture we live in. That is especially true when the leader who is busy chopping the future is also posting fabulous short-term profits. And, to give Mr. Hurd his due, H.P. after Ms. Fiorina was a place where the executives’ feet needed to be held to the fire.
Ah, but if you just whip up a personal scandal — make sure it has a little sex in it! — then you can get rid of your failed leader on the grounds that he “violated the company’s standards.” The world is full of imperfect people; if everyone who ever fudged an expense report or flirted with an outside contractor were fired, there wouldn’t be many people left in the American work force.
This is not to say that Mr. Hurd should be let off the hook for, in his words, failing “to live up to the standards and principles of trust, respect and integrity that I have espoused at H.P.” (Note, by the way, that he doesn’t concede that he violated H.P.’s standards of business conduct.) But a firing offense? Really?
On the other hand, putting up dazzling short-term numbers that have the effect of enriching himself while robbing H.P.’s future — isn’t that what a C.E.O. should be fired for? Firing Mr. Hurd for that reason, however, would have taken courage, something that has always been in short supply on the H.P. board.
One thing I found surprising this week was learning that to many H.P. observers Ms. Fiorina no longer seemed quite so bad. It was actually her strategic vision that Mr. Hurd had executed, I heard again and again. Her problem was that while she talked a good game, she lacked the skill to get that big, hulking, aircraft carrier of a company moving in the direction she pointed. Mr. Hurd was a brilliant operational executive, but had the strategic sense of a gnat, and knew only how to cut costs.
What H.P. needs in its next leader, Mr. House told me, is “someone with Carly’s strategic sense, Mark’s operational skills, and Lew’s emotional intelligence.” (Lewis E. Platt preceded Ms. Fiorina as C.E.O.)
That is a tall order, but not an impossible one. It is certainly plausible that the H.P. board can find such a person. Given its recent track record, though, don’t hold your breath.

Wednesday, August 4, 2010

An article about a fiction and the employment report

Skip the fiction, look at the employment report

In an article “A Grand Unified Theory of the Jobless Recovery” by Derek Thompson in THE ATLANTIC, the author goes to great lengths to explain why “In most recessions in the last 60 years, jobs recovered soon after the economy healed. But in the last three downturns -- the early '90s, the early '00s, and today -- companies continued to slash jobs and hold off hiring for months, even years, after profits returned.” He then proceeds to look for whom or what to blame. He trots out his pet set of villains. So far, so good, that’s what journalists do.

Problem is he never bothers to show whether “companies continued to slash jobs and hold off hiring for months, even years, after profits returned” is anything new. It’s not. Recoveries don’t come from having the same set of employers hire back people. Recoveries have always come mainly from new or different companies hiring. Interestingly, it tends to be smaller companies and often start ups from the current or the last cycle. But alas, facts don’t fit his story, so he ignores them.

The author of the article makes a fairly common mistake. When people discuss the lag in employment recoveries, they often analyze a fictitious and meaningless relationship. For example, they’ll look at or include a totally meaningless graph. They’ll show a chart of employment growth plotted against the months since the end of the recession. To have any relevance one has to assume that 1) recession dating is accurate at the monthly level, 2) there has been no change in how quickly we can recognize recession endings, and 3) profits automatically recover with GDP.

Let’s examine each of these. First, one reaction to monthly recession end dates is an incredulous; “you’ve got to be kidding.” Why, even the monthly employment pattern is not perfect. Granted, shifting employment growth numbers generally stay consistent with the overall trajectory, but not always. But, neither the data nor the state of the ART of recession dating justifies the attention the relationship gets. Think about how often GDP gets revised and how significant GPD revisions are. It’s fiction to think we know exactly the month when a recession ends. Further, changing the start date for the recovery significantly changes the patterns of recovery.

Second, it is ridiculous to assume no change in recession dating. Economist would like to think there is some progress in the discipline, but one doesn’t have to rely on what economists would like to think. (However, it’s interesting to note that using recession end dates gets real close to relying on what economists would like to think). One would also think someone from the chattering class might also be aware that there is more, and, in some cases, better data available over time. Further, one would have to be asleep not to recognize it is disseminated faster and more broadly.

Third, the faster and greater data availability provides a nice transition to the aspect of the relationship that makes it meaningless. Employment doesn’t increase because recessions end. There are numerous owners of bankrupt and defunct businesses that wish it were so. In fact, as owners of Fannie and Freddie, we all should wish it were so. However, profits drive employment growth. Profits require a viable business model and good management.

Since existing companies have a vested interest in their existing business model, their role in the recovery of employment is limited. This process of churn, or “creative destruction” to use the term Schumpeter made famous, isn’t something journalists or even governments can stop. They can impede it rather than facilitate it. Perhaps that has something to do with jobless recoveries.

So, to be interesting, the analysis should focus on the recovery of profits. Keeping with the data avalanche theme, should it be pretax or post tax profits; profits measured by general accepted accounting practice or tax accounting practice; profits of all businesses including partnership and proprietor income or just corporate profits, or estimate quarterly profits or the actual end of the fiscal year “real” profits? That would certainly be more interesting, but it still wouldn’t be meaningful. As anyone who has ever made a business decision knows, it is estimates of FUTURE profits that lead to hiring and investment.

As the article’s author notes, “Something's not right.” Perhaps rather than grand unified theories that target pet peeves, investing some time in collecting some facts would be a better use of time. Take Friday’s jobs report as an example. In previous postings, The Hedged Economist pointed out that at this point in a healthy recovery there is usually a “noticeable” divergence in the growth of employment as reported from the household survey verses as reported from the employer survey. The household survey captures people who become self employed, start businesses, or are hired by small companies. They generally aren’t counted by the employer survey.

By “noticeable” I mean more that measurable. The media, knowing they live by “if it bleeds it leads,” should by now, have to be explicitly dismissing the household numbers to support their disaster scenarios. But, they haven’t had to. “Something's not right.” However, to support grand unified theories of what’s not right, one has to ignore the facts. The facts are, something is different this time. It is this time, not some grand unified theory, which needs to be understood.

The picture isn’t pretty. The evidence that the needed churn isn’t happening is there. In addition to the behavior of the two different measures of employment, Friday’s report included other data with telling implications: namely, the revisions. The BLS is aware of the limitation of the employer survey (i.e., not adequately representing new and small businesses). It tries to adjust the data to correct for the undercount using what is called the business birth-death model. That adjustment has its primary impact on the last few months of data. The data is then revised when better, some would say real, data become available. Those were the months for which the employment data was revised down. The unavoidable implication is that fewer jobs are being created by new and small business than they expected. This absence of churn among employers deserves more attention.

If the churn is necessary for recovery, perhaps more organized study of how people change jobs would help. There’s a good chance that the people who stay unemployed are those who keep looking for a job doing what they use to do. If what they use to do was so valuable, they’d still be doing it. Just as employers churn, the skills and knowledge that leads to successful employment churn. If that’s the case, learning to learn and equipping people with multiple skills, not unified theories, are the solution.