Blog Archives

“Too Big to Fail”

Sunday, June 21st, 2009

The concept of “too big to fail” banks is not new.    The concept was that there are a handful of banks in New York that would have catastrophic consequences if they fail, because so they hold so much money and are so integrated into the complete banking system could fail.   As a result, they have been quasi-nationalized banks all along.

For example, CitiGroup is a large operator in what is called Treasury and Cash management services for huge corporations.   Large companies like Wal*Mart have an extremely high velocity of money – when you buy something with a credit/debit card, by the time you’re at the door, the money is already gone from your account and on its way to pay suppliers ot pay for more inventory in the pipeline.  When currency is deposited by the store in a local bank, it is “swept” into a central cash management system at least once a day.   (Stores like to do cash advances because that converts the currency into immediate cash liquidity instead of having to wait for the armored truck to show up). 

If CitiGroup’s operations stopped – even if the customers didn’t ulutimately lose any money, the day to to day operations of their business has become completely integrated with CitiGroup’s cash management system.    By the time they could switch to some other equally large bank offering similar services, the entire inventory and cash flow and payroll processing could be disrupted.   

The Federal Government has encouraged this type of concentrated banking in a few hands by declaring that certain banks are “too big to fail”, and hence this is no risk to having all your corporate eggs in their basket.  Keep in mind that FDIC coverage is capped at $250k even for corporations – so FDIC protection is very limited for corporations.

Single points of failure are a really bad thing.  If you are concerned about survivability, when you become aware of single point of failure, you get rid of them – or if it can’t be gotten written of you take steps to minimize the damage from a failure.   The obvious solution is contained in the name.  If the problem is that a bank is “too big to fail”, you take steps to make the bank smaller and/or keep its hands out of the things likely to cause a failure.  Rather than promoting more and more consolidation into fewer and fewer huge global banks, a thoughtful “intelligent” policy at the U.S. Treasury would strive to dismantle the “too big to fail” banks, or at least break out the functions that are critical to national economic security from the portions of the big banks that might trigger a failure.   Bringing back something like Glass Stegall would be a large step in the direction, although it might be a bit like unscrambling an egg at this point.

1939 World’s Fair – 70 years later

Friday, June 19th, 2009

Glenn Beck talks a lot about the Progressive Movement, and how far back it goes and how deep its roots are in America and that it controls both political parties.   With the demise of General Motors (at least its current incarnation), the thought occurred to me to relook at the 1939 World’s fair again, and remember GM’s role in what we now understand America to be.

In 1939, the country was still mired in the Great Depression after 7 years of FDR’s plan to spend our way back to prosperity.  The country desperately wanted Hope and Change.  To those paying attention, War in Europe was very likely to explode again.  The country needed something to believe in – a view of the future.     The Progressive Movement decided to educate the masses about the Future as they saw it.  A few YouTube videos if you’ve not heard of the 1939 world’s fair or need a refresher…  1 2 3

The Progressive Movement was in its full glory – science and technology would solve all our problems if we just let government handle everything.  The Soviet Union and Italy had large exhibitions showing their view of the future.  The League of Nations would make sure war never happened again if we just let it have more power over nations.  

GM had a vision of a network of super highways – that would ultimately become the Interstate highway system 20 years later, where cars would zip along at 100 mph separated safely from each other by radio controls, people could live out in the country and commute into the city, industrial pollution could be kept away from where people lived.  The Scientific method applied to farming would produce large crops with very little labor. 

Carefully planned cities with engineered and controlled “natural parks” (see: Central Park)  would make living in cities wonderful.   Robert Moses preached the virtues of scientifically planned communities over the chaos of the free market and individual choices.

Robots would do our work.  Figuring out how to spend our leisure time would become our biggest challenge.  Westinghouse showed off a new marvel called “Television” (that would be put on the shelf until after the end of World War two)….

One interesting connection I never would have known before last month.  Just a momentary glimpse in one of the videos of the 1939 fair showed LifeSavers having an exhibit at the fair.  What’s s so significant about that?   In 1943, FDR would force NBC to sell off its Blue radio network.  Sarnoff refused to sell air time to Labor Unions.    The purchaser of the Blue network (which would become the ABC Radio Network) was to Edward Noblel, a Republican who had made his fortune creating the Lifesave candy company, and been FDR’s  UnderSecretary of Commerce in 1939.  He would only get permission from the FCC to acquire ABC when he promised to end the ban on selling air time to labor unions.

The Geithner Effect

Thursday, June 18th, 2009

People tried to warn Geithner and President Obama.  You put restrictions on the earnings of the “best and brightest” in the Financial Services business, or pass 90% taxes for making too much money, the only effect is the people will move to Dubai, beyond your ability to tax or regulate them.

WSJ is reporting today that Mohammed Shroogi, the head of Citigroup’s “Islamic Banking” unit is quitting.  He’s worked for Citi for 30 years and works in the Middle East.  Citigroup is not an “American” bank, it’s a global financial services company.  Mr. Shroogi has been hired by Investcorp, which is located in Bahrain.   He won’t be the last.

Bankruptcy Watch – Eddie Bauer

Thursday, June 18th, 2009

Speciality clothing retailer Eddie Bauer filed Chapter 11 today.   Eddie Bauer had previously been through bankruptcy in 2003.   A buyout firm has made an offer to buy the company, and is urging the bankruptcy court to hold a quick auction to determine if any other firm is willing to pay more.

Bankruptcy Watch – Extended Stay Hotels

Monday, June 15th, 2009

Extended Stay hotels, which operates 680 properties that cater to business people working away from home has filed chapter 11.  Wachovia, Bank of America and Bear Sterns are each on the hook for about $1 billion each.  Extended Stay employs about 10,000 people.

Lincoln Financial in trouble…

Monday, June 15th, 2009

If you have a life insurance policy or an annuity with Lincoln Financial (or formerly Jefferson Pilot Insurance), you need to be paying attention and asking some questions of your state’s Insurance Commissioner.

Lincoln announced today that it is raising capital, including taking TARP funds.  Lincoln is publicly traded and the stock dropped like a rock last September.   The only plausible explanation for raising capital is they are facing questions about the solvency of their insurance funds.

Lincoln also happens to own 15 radio stations, but that’s secondary to the news today.  They are a tiny portion of the assets of the company – last year, the wrote down the value of their Radio licenses by about $200 million.

Poking around in their 10-Q from March, the large majority of their assets are invested in Corporate bonds (think GM or Chrysler, perhaps).  They also have significant investments in residential and commerical mortgages (the really safe stuff that you can never lose money on because real estate always goes up).  Very little of their money is in government bonds.

In January 2009, Lincoln “purchased” a tiny Savings and Loan so that the company could qualify as a Savings and Loan and be eligible to particpate in TARP.

Lincoln’s stock symbol is LNC – the stock has dropped 7.2% today.

Bankruptcy Watch – Six Flags

Saturday, June 13th, 2009

Six Flags has filed Chapter 11.   This bankruptcy has widely been predicted since last summer when the $4+/gallon which resulted in large drops in attendance.   The economic downturn hasn’t helped the situation.   For now, the parks will stay open.

Abusing technology

Tuesday, June 9th, 2009

The Air France crash (and my current belief that the pilot flew the plane right into the storm on autopilot – and possibly a problem with the airspeed detector caused the plane to stall) has provoked me to tell a related life story of a very similar “accident waiting to happen”.

I’m going to overexplain this (which I’m got at) because you probably don’t know or don’t care about the technology, even if it affects you personally.  I’m a public transit geek – or at least I was.   For about a year, I worked in Chicago and rode the “El” to work every day (about an hour each way).  Unlike many other transit systems, on the CTA’s “El”, if you get in the first car, you can sit opposite the motorman/driver and watch him drive the train and look out the front window.   Since I got on the train at the end of the line, it was usually easy to grab that seat.

Chicago’s subway/elevated lines have what is called “cab controls” on much (but not all) of its lines.   Over the years, there have been lots of accidents involving driver errors (in Chicago and elsewhere – most recently in Boston), where the driver did not obey a stop signal, driving too fast, being distracted by a pretty woman, etc..  and plowing into the train ahead or going around a curve too fast.   So the obvious “fix” to the human problems is to solve it with technology.

The Cab controls prevent the train from going faster than the permitted speed – the train will disengage the motors and put on the brakes.   A separate older system protects the trains from running through a red light.  There is a mechanical trip – if the train proceeds through a red signal, the arm trips the emergency stop on the train and brings it to an immediate halt.  What could possibly go wrong?

Chicago still uses 2 man (oops, person!) operation, which is somewhat rare.  Part of it is probably union rules, part of it is that Chicago’s system is very old.  The cars have doors on both sides because some of the stations have the platform on one side, and some on the other.  The motorman’s job is to drive the train.   The conductor’s job is to open and close the correct set of doors at each station.  The conductor is typically in about the middle of the train.  Late at night after the stations close, the conductor also collects fares if necessary.  They also (in theory) are a deterrent to crime.  They aren’t armed, but they do have a radio.

By splitting one job between two people, that creates a real safety problem.  What happens if the driver starts to move the train and the doors are still open?   What if the train starts moving and at the same time the conductor decides to reopen the doors as someone is running toward the train.   Someone dying is a very probable outcome.  

So technology has the answer – the safety interlock.   To make sure this can never happen, the trains have a built in system to prevent it.   The train will not move if the doors are open, and you can’t open the doors if the train is moving.  Problem solved.

Until you realize that anyone who has ever designed an idiot proof system has not met very many idiots.   The problem is that virtually all of the drivers now let the safety system drive the train.    They just push the power control to max and then let the cab controls push back and slow the train if it is going too fast.  Because the drivers are not in control, they make no judgments about speed (that’s not bad by itself), but that can lead them to become more and more careless about the trains operations.  The only way the train is under manual control is if the operator puts it in manual.  That triggers an alert back at the operations center, and the train is limited to only about 5 mph.  It’s intended to be used only to move trains in and out of the storage yard, or where cab control is not in effect or has failed for some reason.

One day in particular, an operator was doing an incredibly stupid thing – no doubt against the “rules”.     As the train would stop in each station and the doors opened, he pushed the power control to max while in the station with the doors open.   When the doors would close, the safety interlock would disengage, and the train immediately take off at maximum power.  He had taken a safety device meant to protect against a human mistake and converted it into a way to be lazy – introducing a huge risk that if the interlock ever failed, he was likely going to kill some people.   The interlocks frequently failed, but usually the other way – the doors would be shut, but the system thought they were still open and wouldn’t let the train move – the conductor would have to cycle the doors open and closed to get the train to release.

So if you realize how human behavior adapts to not being responsible and in control, it isn’t a big leap to imagine a pilot on plane that can fly itself seeing a thunderstorm on radar and saying “the plane can do a better job than me, it’s flown itself through storms before”…  let’s sit back and let it handle it.

To be clear, I’m not necessarily blaming the pilot.   Had he overridden the computer navigation, he may have had to fly 100s of miles out of the way.  He might not have had enough fuel to land at his destination with an adequate safety margin (extra fuel = more weight = less efficient).  It could be that he would face punishment for doing so.  The Captain is always in charge unless someone else tells him he isn’t.

*** Washington D.C. update ***
6 killed today as one Metro train plows into another that is stopped in a station.   Media reports are blaming a failure of the signaling system, rather than the operator not noticing the impending crash and going into emergency stop.

Just a guess, but the most likely cause of this type of accident is when an engineer overshoots a station, then backs up the train on manual.   That puts the lead train into a “block” that is supposed to be empty.  The following train doesn’t know that because they already went past the green “all clear” signal.   The witness reports all agree that the moving train did not apply brakes at all prior to the crash.   I’ve ridden the Metro, and its cab control is very thorough – the only thing the operator does is to close the doors.  The train controls the acceleration and braking.   It’s very plausible that the operator could have been playing video games on her cell phone and letting the train make all the decisions.

A detail as you look at the pictures and read the accounts – you’ll see 4 tracks, with the Metro train on the inner track.   The outside tracks are NOT metro – they are the Amtrak line that runs into Union Station.   That probably greatly complicated the crash scene and the risk that an Amtrak train could have plowed into the wreckage – fortunately that didn’t happen.

Taxing Inflation

Tuesday, June 9th, 2009

The last time Democrats lost control of the economy was those wonder days of the Carter era, which it appears some are nostalgic for.  My first mortgage in 1980 was 16 3/8 percent on a 20% down payment conventional loan.  CD rates were approaching 20%.    President Carter was telling us in 1977 we were running out of natural gas and oil, and the world would exhaust all proven reserves by the end of the 1980s.. Text here.  

There was a wide spread belief that Jimmy Carter’s plan, based on the advice of his economic advisors, was to let inflation go wild with two goals.   

First, it would decrease the real cost of paying for the existing national debt.   We would be paying off US Treasuries in the future with dollars that were worth less.  Screw the greedy people who had bought our US Treasury Bonds.  (sound familiar yet?)

But more insidious was that uncontrolled inflation creates a windfall of tax revenue to the Federal government.  Because the tax brackets are tied to income, inflating wages and expenses moved people into higher tax brackets without the government having to “raise taxes”.     The second windfall was on capital gains – if you bought a house for $50,000 and sold it 10 years later for $200,000, you had to pay taxes on $150,000 “profit”, despite the fact that in real terms your house wasn’t really worth any more than it was 10 years ago. (*Yes, I know you could defer the capital gain if you bought another house).

So deliberately creating inflation can create a windfall for the government – or so the theory went.   The problem of course is it’s only a theory.  Unpredictable future inflation, and horribly high interest rates substantially slowed  new investment.   When Ronald Reagan slammed the brakes on this foolishness, it created a significant economic downturn in 1981 and 1982, but we got through it.   Markets can fix themselves if they believe the future will be predictable.

Tim Geithner and Barack Obama were teenagers in the late 1970s.  Perhaps they wish to repeat the mistakes of their fathers.  

By the way, the head of the Federal Reserve starting in 1979 was a man named Paul Volker, who just coincidentally is heading Barack Obama’s Economic Recovery Advisory Board.

A day of change

Friday, June 5th, 2009

US Treasury Interest rates are starting to accelerate up. The Geithner/Bernanke/Obama “let’s spend our way out of this” isn’t working. As interest rates go up, the fear will start to feed on itself.

If Interest Rates go up very much, companies that have sold Interest Rate Swap contracts are in serious trouble. Companies holding Interest Rate Swap contracts to protect themselves from increasing interest rates will be in serious trouble if their counter party fails. (think AIG)

The biggest loser today in the S&P 500 is ICE (Inter Continental Exchange), which is the place that trades in derivative contracts. ICE has been designated as the “magic pill” by Geithner as a the place where Swap Contracts can be turned into a tradeable commodity, backed by a central clearinghouse. But there is no entity that can possibly “guarantee” $562 Trillion in contracts – not even the U.S. Treasury. It isn’t going to work.

Acting in the way you would expect, as interest rates start to go up, money is starting to come back into the United States, and the dollar strengthened substantially after losing a lot of its value over the past few weeks.

And finally, the rule of law officially ended today . As was widely expected, the US Appeals Court refused to step in front of the speeding Chrysler “rescue”, and told the secured creditors to go pound sand.  100 years of procedures governing bankruptcy and property rights is out the window – Tim Geithner gave the company over to Fiat and the UAW for essentially nothing, plus threw in a big pile of money from the US Treasury,

*** Update ***

The pension plans have filed an emergency appeal to the U.S. Supreme Court to extend the stay at midnight Saturday night.   The Supreme Court has until 4 PM Monday to slam on the brakes.   The Fiat deal was deliberately written as an “emergency” that if it doesn’t happen on Geithner’s schedule, Fiat gets a financial windfall.   I hope we learned something from the $700 billion emergency last fall.