Tuesday, March 25, 2008

Caught with Her Hand in the Cookie Jar

Hilary Clinton is getting a lot of flak for making a speech were she claimed that on a trip to Bosnia, her plane landed under sniper fire, and she had to make a run for the motorcade. Unfortunately, television coverage of the event shows nothing of the kind. Hilary and Chelsea wave frm the plane, saunter down the ramp, and go through a welcoming session right there on the tarmac, complete with little girl handing over a bouquet of flowers. About the only attack taking place is possibly an allergy attack from the pollen.

Today HRC admitted that she "misspoke." To paraphrase, I guess that depends upon what the definition of "misspoke" is.

Okay, look. Yesterday my production manager and I had a disagreement about whether total employment at our company had peaked at 98 employees or 101 employees in 2007. After pulling payroll records, I had to agree that I was wrong when I claimed only 98, instead of the correct 101. That's misspeaking.

If I had claimed that the extra 3 employees didn't count, because they were actually extraterrestial aliens who had landed a flying suacer at the company picnic and applied for jobs, that would be a little more than misspeaking. That would be making up events out of whole cloth.

If Hilary had said that she came under sniper fire in Bosnia, but it was actually Dafur, that would be misspeaking. But other than the start of deer season in Arkansas, when is it even remotely possible that she was shot at? And if she hasn't been shot at, how could she have come up with the story that she had?

Also interesting is that in a later interview she claimed "Last week for the first time in twelve years or so, I misspoke." She actually knows that its her first mistake in 12 years. I can't even be sure what I had for dinner last Wednesday, but she's sure that she hasn't made a false claim in over a decade. It makes you wonder what she could have said that made such a strong impression.

"Don't worry, Bill. I forgive you."

Monday, March 24, 2008

Bad Law I, Starbucks 0

Here's a quiz for you: Next time you pop into Starbucks for an infusion of caffeine and ambience, take a fast look at the staff working the store. Now, quick: who's the boss? Is it the person running the expresso machine, the person running the register, or the person grinding coffee in the back? Thinking back on my recent visits to my favorite coffee emporium, I honestly couldn't tell you. Sometimes I've gone in and found only one person working the store. I guess that he's the one in charge on those occasions.

This matters because in California, there is a law that says that members of management cannot share in pooled tips. Last week a judge in San Diego ruled that Starbucks had violated this law because they had allowed shift supervisors to share in the tip pool. The judge slapped the company with a fine of...$100 MILLION dollars (when I say that I'm tempted to touch my pinkie to the corner of my mouth, ala Dr. Evil).

I think this decision is wrong for a couple of reasons. First of all, it perpetuates the us versus them view of the workplace that runs contrary to the way a lot of top performing organizations function these days. Think back to your experience of Starbucks. If you cannot tell who the boss is, it's because everyone is working. There's no foreman there behind the counter. Think of a football team. The quarterback may run the plays, and he may get paid better than the linebackers. But no one ever gets confused that the quarterback isn't playing the game as a member of the team.

I don't know many specifics about how Starbucks runs their stores, but I suspect that the shift supervisors are not really what I would consider management anyway. Managers have hire and fire authority. Managers schedule the associate's work shifts, and formally review the other team member's work performance. If the Starbucks shift supervisor does not do these things, it is hard to consider that person as a manager.

Finally, this judge's decision irritates me because it takes away my ability to make up my own mind. When I'm standing there with a latte in one hand and my change in the other, thinking about whether to put the change in the tip jar or back in my pocket, just who am I tipping? More often than not, I'm rewarding the worker who jumped in where needed to keep the line moving, or the worker who showed the newbie how to run the coffee grinder. Before last week, I didn't even know that Starbucks had shift supervisors, but I'll bet there the ones who set the tone for the whole experience.

And this judge just ruled that I shouldn't be allowed to tip them.

Let's hope Starbucks wins on appeal.

Wednesday, March 19, 2008

Bear Stearns: RIP, Part II

In my last post I talked about the collapse of Bear Stearns in terms of liquidity. What happened was an old fashioned run on the bank. But the other half of the story was leverage.

Leverage is a measure of the ratio of debt to equity, equity being the cash money that investors put in to a company. The use of debt allows you to "lever up" the rate of return on equity. Let's work through an example to illustrate how this works.

Suppose you buy a slightly run down house in a decent neighborhood for $110,000. You put another $10,000 into fixing the house up over six months, then list the house for sale. Six months after that you sell the house for $135,000. So your profit is $15,000 (you put in $120,000 total, and got out $135,000). The rate of return on equity is profit/equity, or in this example, .125 or 12 1/2%. Which is okay, but not spectacular. Don't quit your day job.

Now let's see what leverage can do for you.

Work the same example, but assume we buy the house with $10,000 down and an interest only loan of $100,000 at 7%. Same $10,000 to fix the house, same $135,000 sale at the end of the year. The first thing you do is pay off your loan, so reduce the sales price by $107,000. Your profit is lower, because you got $28,000 less the $20,000 you put into the house. So your total profit is only $8000, versus $15,000 in our first example. But look at rate of return on equity. In this case, return is 8/20, or 40%. Houchee mama! By using 5 to 1 leverage, we've increased our rate of return by a factor of three. Why wouldn't you want to use leverage? Let's play this game again!

Well, the problem is that leverage can work against you as well as for you. Remember, the guy who holds the debt always gets paid back first. Let's run our second example again, only this time we'll assume that the real estate market is tanking, so instead of selling the house for 12.5% more than we put in, we sell for $107,000, or about 11% less than what we put in. We pay back our loan for $107,000, leaving us with...zip, nada, bubkus. Your equity of $20,000 got wiped out. Game over.

That's with 5 to 1 leverage. Bear Stearns had $11.5 billion worth of stockholder's equity. They had leveraged that to control $395 billion worth of assets on their balance sheet. When you are leveraged at 34 to 1, it only takes a three percent drop in value to wipe out your equity. Game over.

Monday, March 17, 2008

Bear Stearns: RIP

The big business news this Monday is the acquisition of Bear Stearns by J P Morgan Chase over the weekend. At the close of the market last Friday, Bear Stearns was valued at $30/ share. When the deal was announced on Sunday, Morgan was only paying $2 per share. In addition, the Federal Reserve agreed to loan Morgan $30 billion dollars, taking as collateral mortgage backed bonds in Bear's portfolio. Basically, the Fed (by which I mean the taxpayers) took the bonds most likely to go into default off JP Morgan's hands.

This looks like a steal for JP Morgan. They're paying $2 a share for a company with a book value of $80 a share. Even if it is written down by half, the assets would still be worth 20 times what Morgan is paying for them. The real estate held by Bear Stearns alone is worth about four times the purchase price.

Bear Stearns was one of the five largest US investment banks. The employees owned 30% of the stock. Their stake is now valued at less than $5500 per person. The Chairman of Bear Stearns, John Cayce, was one of the richest Wall Street executives, with holding in BS stock worth oven $1 billion less than a year ago. What could have convinced the management of Bear Stearns to take a deal that essentially wiped them out?

In a word: liquidity.

Liquidity is a measure of how easy it is to convert assets into cash. Cash is always the most liquid asset of all. Normally, stocks are almost as liquid as cash. Call your broker, tell him to sell, and you can have cash within a couple of hours. If you have a store that has inventory, you will usually liquidate the inventory every couple of months. Anyone who has ever tried to sell a house in a down market knows that real estate can be one of the most illiquid forms of asset.

Bear Stearns ran their financial trading operations using a lot of borrowed money. Some of the money was given to the firm by it's clients. Some by other banks. What happened last week was that these parties started to pull their loans from Bear Stearns. In order to keep operations going, Bear Stearns would have had to sell assets from their portfolio. The problem is that right now, no one is buying mortgage backed assets. That market will probably come back in a few months, but Bear Stearns needed money right now.

Basically, the brightest minds in finance became part of a panic driven run on a bank. And a Wall Street titan that survived the Great Depression is no more.

Thursday, March 13, 2008

Weak dollar, strong exports?

The dollar continues to show weakness against other currencies, falling to new lows against the euro today. Interestingly, most of the media coverage I have read talks about this development in terms of the inflationary effect. "Look at how expensive imports have gotten."

I have seen very little news coverage about how a weaker dollar boosts exports. My guess is that this is partly due to the fact that increases in export sales lag the drop in currency, while currency driven increases in import prices are immediate. When Mercedes imports cars into the US, they're paid in euros, so the price goes up in dollars almost instantly as the exchange rate shifts. On the other hand, if Cadillac wants to start selling cars in Europe to take advantage of a weak currency, it takes time to ship cars over, plan an advertising campaign, and start getting sales.

In the area of industrial components, the sales cycle can take a really long time. For engineered components, it can easily be eightteen months from first sales call to first production shipment. So for the kind of product that my company makes, it could be a long time before we pick up any sales increase due to a weak dollar.

In the meantime, prices for basic commodities (in my case, brass and steel) have jumped, because commodities are priced on global markets. This is true even though domestic demand is down. As a purchaser of those commodities, my costs have increased at the same time my sales volume has decreased. My company makes subassemblies for the major appliance industry, which is tied in to housing starts.

So far, the weak dollar has not helped at all.

Monday, March 10, 2008

Balancing Act

In my formative years, back when dinosaurs ruled the earth, the common metaphor for retirement planning was "a three-legged stool." The idea was that your company pension was one leg of the stool, helping to support your retirement. Social Security was the second leg of the stool. Balancing out the stool was the third leg: private savings. Whenever I heard this metaphor used, it was always combined with an exhortation to increase private savings. Relying on pension and Social Security wasn't enough for a secure, comfortable retirement.

In the years since I first encountered this metaphor, the importance of private saving has grown by leaps and bounds. I passed up on my chance to acquire a traditional defined benefit pension when I left the Army in 1985. For the last 20 years I have worked for companies that do not offer a pension benefit. So that leg of the stool has been sawed out from under me.

Let's consider the second leg of the stool: Social Security. The Social Security trust fund goes into deficit mode in 2018, only 10 years from now. As the number of retired baby boomers increases, the ratio of employed workers paying into the system to retirees pulling out of the system is projected to shrink. Since the federal government currently needs Social Security taxes to help fund the deficit, I don't see where the money is going to come from to pay promised benefits to all the people scheduled to retire in the next ten years. My retirement planning assumptions don't include any Social Security. If the politicians can figure out a plan to pay all the benefits promised, great. But I'm not making that assumption as part of my personal retirement planning.

Now we've sawn off two of the three legs of that stool. The private savings leg is going to have to take up all of the slack of carrying me in retirement. That going to be quite a balancing act.

Wednesday, March 5, 2008

NAFTA: Scourge of Ohio?

In their shameless pandering for primary votes, both Barack Obama and Hilary Clinton have attacked NAFTA. The North American Free Trade Agreement is the treaty that largely eliminated tariffs and trade barriers between Canada, the US, and Mexico. Obama's/Clinton's attacks on NAFTA were particularly strong in Ohio, which has suffered serious job losses in the manufacturing sector.

I can understand why Ohioans would be interested in increasing jobs in manufacturing. Those jobs tend to pay more and have better benefits. Also, manufacturing has higher multiplier effects on a community's economy. That is to say, that to produce a dollar of sales, a manufacturing company will have to buy more from their suppliers, who in turn will have to buy from their suppliers, and so on. Manufacturing job are good.

The only problem is that repealing NAFTA will not do anything to help Ohio.

The real threat to American manufacturing is product imported from China, NOT Mexico. Through October of last year, the trade deficit with Mexico reached $4.8 billion. Not good, but largely driven by rising oil prices. Meanwhile, the trade deficit with China was $20 billion. For October alone. For the first ten months of 2007, our trade deficit with China was over $200 billion.

In my previous job, I worked for a job shop company. We made components that other companies used in their assemblies; parts for everything from cars to cosmetics. Over the years several of our customers set up operations south of the border. In every case the purchasing decisions were still made in the US, and we continued to hold those contracts. We shipped components to Mexico for assembly, and then the products were shipped back across the border for sale.

Starting in the late '90's a different trend emerged. Product started coming in from China. Sometimes we would make one or two shipments of parts across the ocean before being told "thank you, we have local sources now, we will not be buying any more parts from you." More often we were just told that our customer was closing his doors.

To an American manufacturer, China is a threat, Mexico is an opportunity.

But let's say repealing NAFTA would bring jobs back to the US. That still wouldn't help Ohio. Why not? Because if companies move operations back to the States, they will move them back to Tennessee, Alabama, or Missisippi, which is where the foreign automotive plants and their suppliers are setting up shop. Ohio has a high tax, union friendly business environment, unlike the more probusiness states of the Southeast.

Maybe Ohioans should look at themselves, before buying the line that their problems lie south of the border.