Sunday, November 29, 2009

Baseline Scenario -- A Good Read

(c) 2009 F. Bruce Abel

Just getting around to reading this from The Baseline Scenario earlier this week. The second article covering Morgan Stanley's analysis makes clear sense to me and is easy on the mind, unlike many other good pieces.

The Baseline Scenario
What’s on TV
Posted: 24 Nov 2009 10:00 AM PST
Frontline has a program on tonight about the credit card industry, which may be a useful accompaniment to the regulatory reform debate. They include this juicy paragraph in their press release:
“They’re lower-income people-bad credits, bankrupts, young credits, no credits,” Mehta [former CEO of Providian] says. Providian also innovated by offering “free” credit cards that carried heavy hidden fees. “I used to use the word ‘penalty pricing’ or ’stealth pricing,’” Mehta tells FRONTLINE. “When people make the buying decision, they don’t look at the penalty fees because they never believe they’ll be late. They never believe they’ll be over limit, right? … Our business took off. … We were making a billion dollars a year.”
Rings true to me.
By James Kwak

Morgan Stanley Speaks: Against Relying On Capital Requirements
Posted: 24 Nov 2009 03:26 AM PST
Just when momentum was starting to build for increased capital requirements as the core element of an approach that will reign in reckless risk-taking, Morgan Stanley effectively demolishes the idea.
In “Banking – Large & Midcap Banks: Bid for Growth Caps Capital Ask,” (no public link available) Betsy Graseck, Ken Zorbo, Justin Kwon, and John Dunn of Morgan Stanley Research North America dissect the coming demands for more bank capital.
“In short, we think the demand for growth and access to credit will trump desire for unprofitable capital levels…
For the large cap and midcap banks, we expect normalized median common tier-1 ratios to come in at 8.4% and 10.0% respectively.”
That’s less capital than Lehman had just before it failed – 11 percent. (If you doubt this, read the transcript of the final Lehman conference call – link is in this piece or try this direct link; see p.7, for example)
The Morgan Stanley logic is strong, up to a point – they are carefully anticipating the likely outcome of the national and G20 regulatory process that will address capital standards in detail over the next two years. This research report also makes explicit a great deal of the current thinking on Wall Street and explains much – including the attitude towards bonuses.
“Banks need and investors require banks to earn a positive return over their cost of equity to fund them…
These capital levels [8.4% and 10%] driven median ROE [return on equity] estimates of 13.7% and 12.0%, sufficiently over normalized cost of equity of 9-12% to attract investors.”
In other words, if you don’t allow banks to leverage (the flip side of keeping capital low), they won’t be able to attract investors and won’t be able to make loans – so you’ll get less growth and fewer jobs.
This may sound like blackmail but it is not – this is the economics of banking, with spin. And just to make sure you get their bigger point, Morgan Stanley drives it home:
“Contrary to perceptions about [Sheila] Bair’s statements, we do not think there is any willingness to remove implicit support [for big banks]. In particular, we expect the discount window is unquestioned for banks, and TLGP [Temporary Liquidity Guarantee Program] type programs could exist in future crises. Regulators recognize the need for banks to make returns high enough to attract capital.”
And in case you are wondering about the talking points they give their lobbyists and now press upon the White House,
“Even with appropriate leverage, the taxpayer has occasionally paid for the benefit of growth when financial shocks occurred. Repayment comes with subsequent growth.”
The bottom line, translated: let us adjust our balance sheets (downwards to some degree) and continue with our existing business models (including unconstrained bonuses), and we will bring you back to growth eventually. If you mess with us, unemployment will stay high for a long time. And any future crises that may befall us are just a cost of doing business, and making us whole is just what you have to do.
But this is all wrong. The essential premise of the Morgan Stanley reasoning (heard much more widely on Wall Street) is that the size of our biggest banks cannot be constrained – because it would raise the cost of equity for these smaller units. This misses three points:
If you are sufficiently small, you can take more risk without jeopardizing the system. So the expected risk/return combination can attract investors and be fine for society. Most successful venture capital funds, hedge funds, and private equity funds are in the right size range from this perspectives and don’t have trouble attracting capital – except when the big banks blow up. As long as you are small enough to fail, go for it.
Morgan Stanley’s pricing of risk model implicitly assumes that big banks still exist as a comparison point and an alternative for investors. But if you put a size cap on the largest banks (e.g., assets cannot exceed 1% of GDP), this defines the asset class available – so investors don’t choose small vs. medium vs. large; they choose small vs. medium. Yes, this removes a choice for investors, but we routinely constrain investors ability to put money into activities that are potentially dangerous for society (e.g., try proposing a “new” high risk/high return approach to nuclear power).
There will always be financial shocks, but these do not always need to have such devastating effects. Our financial system worked fine in the post-World War II period, with a great deal of risk-taking and much nonfinancial innovation – our biggest banks were much smaller, in absolute terms and relative to the economy. The notion of “let us take any risks we want and, if it all goes bad, bail us out so we can make it up to you later” is simply preposterous and completely at odds with the historical record of US economic development.
The big banks’ bonuses undermine their legitimacy. Every time these banks CEOs speak or write in public, they just underline their hubris and the danger this poses to financial system stability. And their own research strengthens the case for breaking up the megabanks.
By Simon Johnson

Saturday, November 28, 2009

Baseline Scenario

(c) 2009 F. Bruce Abel

Especially read "More on Goldman and AIG:"

The Baseline Scenario

· Is It 1999 All Over Again?
· More on Goldman and AIG
· Data on the Debt
Is It 1999 All Over Again?
Posted: 25 Nov 2009 07:17 AM PST

The New York Times’ Bits blog has a post on Trefis, a Web 2.0 startup that apparently makes it easy for you to create your own valuation model for public companies. They give you starter models using public information, and you can then tweak the assumptions to come up with your own valuation. The pitch is that this puts the tools used by research analysts and professional investors in the hands of the retail investor. “Perhaps these new tools will put some added pressure on the sell-side professionals – many of whom are notorious for creating overly optimistic takes on the companies they follow.”
Or maybe they will make retail investors think they have an advantage that they really don’t. Advantages in stock valuation have to be based on superior information, which you can get by doing lots of market research (like some old-fashioned hedge funds do) or by having privileged access to company insiders. Superior information can include superior forecasting ability, so if you have some ability to predict the market size for routers better than anyone else, you can make money from it. But neither of these are things you get from models; they are things you plug into models. I’m sure the founders of Trefis don’t see it this way, but this feels to me like a great way to lure people into individual stock-picking, and thereby a boon to stock brokers everywhere.
Update: The post also links to an article about KaChing, which makes even less sense to me (except as a smart business idea that preys on people’s willingness to believe in the existence of stock-picking genius). According to the article, hundreds of thousands of investors manage virtual portfolios in KaChing, which effectively grades them according to risk-adjusted return and other criteria. Then you can subscribe to someone else’s portfolio, so that you make the same trades that she does (there is a monitoring mechanism to make sure that people are putting their money where their mouth is, according to the article), for which you pay an investment management fee to KaChing and presumably a brokerage fee to KaChing’s partner.
This is what confused me. Marc Andreesen, an investor in KaChing, said, “The concept is great — the ability to tap into not just the wisdom of the crowd, but to be able to identify and invest with the particular geniuses in the crowd that stand out.”
Market prices already reflect the wisdom of the crowd. If you create a small crowd and it doesn’t agree with the market, which crowd do you go with? As for particular geniuses, isn’t this just a clever way of marketing the coin-flipping phenomenon?
This is clearly why I will never make money investing in stocks.
By James Kwak

More on Goldman and AIG
Posted: 25 Nov 2009 06:51 AM PST

Thomas Adams, a lawyer and former bond insurer executive, wrote a guest post for naked capitalism on the question of why AIG was bailed out and the monoline bond insurers were not (wow, is it really almost two years since the monoline insurer crisis?). He estimates that the monolines together had roughly the same amount of exposure to CDOs that AIG did; in addition, since the monolines also insured trillions of dollars of municipal debt, there were potential spillover effects. (AIG, by contrast, insured tens of trillions of non-financial stuff — people’s lives, houses, cars, commercial liability, etc. — but that was in separately capitalized subsidiaries.)
The difference between the monolines and AIG, Adams posits, was Goldman Sachs.
Apparently while all the other banks were paying monoline insurers to insure their CDOs, Goldman wasn’t, because the monolines refused to agree to collateral posting requirements (clauses saying that if the risk increased and the insurer was downgraded, it would have to give collateral to the party buying the insurance). Instead, Goldman bought its insurance in the form of credit default swaps from AIG, which was willing to agree to collateral posting requirements, as we all now know. This is one way in which Goldman was smarter than its competitors. Another way, which we also all know, is that at some point in 2007 Goldman began shorting the market for mortgage-backed securities — which would given extra incentive to make sure that they were fully insured.
Until, suddenly in September 2008, it turned out that maybe Goldman wasn’t that much smarter than everyone else, when it seemed like AIG might not be able to post the collateral it owed. And so:
“I hate to get sucked into the vampire squid line of thinking about Goldman, but the only explanation i can think of for why AIG got rescued and the monolines did not is because Goldman had significant exposure to AIG and did not have exposure to the monolines.”
There’s more.
Yves Smith points out (in an update) another possible difference between AIG and the monolines — AIG’s business in swaps allowing European banks to reduce their capital requirements, which meant that big European banks had a lot of exposure to AIG.
Another difference might be timing — AIG hit the fan at the same time as Lehman and a week after Fannie and Freddie were taken over. Another difference might be raw size: even if the monolines together were as big as AIG, that’s precisely the point — their problems could be spaced out over time, allowing the markets more time to adjust, while AIG would go bankrupt in one big lump.
By James Kwak

Data on the Debt
Posted: 25 Nov 2009 03:00 AM PST

So far, my foray into the world of the national debt has consisted of this:
Don’t try to scare people with hyperinflation unless you have some basis for doing so.
The recent deterioration in the projected debt situation is mainly due to the financial crisis and recession, not some kind of runaway spending under the Obama administration. (See Econbrowser for the deterioration over the last eight years.)
One of the curious things about the debt scare that is building in the media is that it is happening at a moment when long-term interest rates are very low. In other words, it’s based on a theory that the market is wrong in its collective assessment of the debt situation. I’ve heard this blamed on “non-economic actors” (that is, foreign governments that buy U.S. Treasuries not as a good investment, but for political reasons), or on a “carry trade” where investors are exploiting the steep yield curve (free short-term money, positive long-term interest rates), as Paul Krugman discusses here.
Menzie Chinn crunches some numbers. He takes a model that he and Jeff Frankel created several years ago to estimate the impact on interest rates of inflation, the future projected national debt, the output gap (economic output relative to potential), and foreign purchases of Treasuries. That last term is important, because the oft-heard fear is that foreign governments will suddenly stop buying our debt.
Using the future growth in the debt projected by the CBO, this model predicts that real interest rates will … go down by 7 basis points over the next year, assuming foreign purchases of debt are constant. The reason the impact of the debt is so small is that it’s already priced in; since the looming debt is no secret, it should already be showing up in the data.
The counterargument is that it hasn’t shown up in the data because of the “flight to safety” and foreign governments’ irrational purchases of Treasuries. So Chinn also looks at what would happen if foreign purchases of U.S. debt fell to zero, nada, zilch (which is an extreme scenario). In that case, interest rates go up by 1.3 percentage points. That’s not nothing, but it still keeps interest rates at reasonable levels by historical standards. In addition, the CBO is already incorporating higher interest rates into their forecasts; they expect the 10-year Treasury bond yield to go from 3.3% in 2009 to 4.1% in 2010, 4.4% in 2011, and 4.8% in 2012-13, and that’s built into their projections of future interest payments.
So I’ll say again: none of this is good. But if we’re going to make important policy decisions based on fear of the debt, we should have a rational way of thinking about the impact of that debt rather than just fear-mongering.
As for me, this is far from my area of expertise, but the first thing that comes to mind as far as a solution is some kind of binding commitment (or at least as binding as out government can make it) to raise taxes (or undo the Bush tax cuts) when the economy has fully recovered according to some objective metric like the output gap. That and, of course, fixing the health care system.
Updates: Whoops! Link fixed. Also, a reader says I should include the caveat from Chinn’s post:
“These estimates were obtained using data that spanned a period without extraordinary Federal Reserve credit easing, and in the face of an unprecedented financial collapse. And, the relationship is not precisely estimated.”
This implies that the model may not be accurate. On the broader issue, it’s not as if quantitative easing is a secret, nor is it a secret that it’s going to end sometime in the next few years. So this isn’t something that investors in 10-year bonds don’t know about.
By James Kwak

Sunday, November 22, 2009

Funds and Their Lies

(c) 2009 F. Bruce Abel

This is pretty good:

Fund companies' biggest lies
12:01 pm ET 11/22/2009 - MarketWatch Databased News
BOSTON (MarketWatch) -- My friend Keith works for a big mutual fund company and assumes I hate mutual funds because, he says, I "always write about the things we do wrong."
He insists that fund companies don't actually do much wrong, because they follow the proscribed rules and regulations and they'd get in trouble if they violated those standards.
While he's right from a legal standpoint, Keith ignores the simple truth that the rules leave fund companies a lot of ways to fudge the statistics, and the meaning of the numbers. What's more, industry practices let fund companies and research firms hype red herrings, information that's attractive but not necessarily meaty and important.
In our recent discussion, I laid out for Keith what I considered the most misleading statistics and data in the fund world. The longer the conversation ran on, the more I realized that most fund investors don't necessarily know how this information can be used against them.
If these points factor into your investment decisions, you may want to look more closely at their meaning:
1. Past performance, Part I: The candy of the mutual fund world, past performance is where a fund "tastes great" and there are no consequences for indulging. Fund executives publish fine-print warnings that past results are not a reliable indicator of what to expect going forward, but that's always below the large-type hype using those results as a big reason why you should buy a fund now.
So long as investors use past performance to frame future expectations and make it the key reason for buying a fund, management will promote a statistic that they know is bad for you.
2. Past performance, Part II: Some funds achieve their record the old-fashioned way: through shenanigans and financial engineering. Fund companies routinely merge away their bad track records. If XYZ Growth is a laggard but XYZ Large-Cap -- run by the same management team -- has reasonable performance, the growth fund will get the axe and the strong record will survive. Never mind that many investors had a lesser experience -- or that management has shown an ability to underperform -- the snapshot view looks good.
Similarly, fund companies pitch new funds as their "best new ideas." What they don't say is that they "incubate" funds, creating a bunch of new issues using house money. The best performers -- and their newly minted track record -- go public. You get the fund that sticks as opposed to the one that stinks, but you might have judged the new fund differently if you knew it was merely the best of a bad crop.
3. Past performance, Part III: The long-term annualized average record looks good but ignores the question "What have you done for me lately?" Some funds live off great past performance; they haven't been solid for years, but big numbers produced in the distant past make them look ironclad.
4. Average cost: While there is no guarantee that cheap management is good management, costs matter. That's why many investors base their purchase on the average cost for the type of fund they want. The average expense ratio is roughly 1.3% for stock funds and about 1% for bond funds.
In general, investors think that "below-average" is sufficient. What they don't know is that the average is skewed dramatically by the way it is calculated. A "dollar-weighted average" -- so that a fund with $10 billion in assets affects the average more than a fund with $10 million -- drops the "average" expense ratio significantly, so that the typical costs for investors in stock funds drops below 1%. (That's good, because it means investors gravitate to low-cost funds.)
Sadly, it's not just investors who don't look at dollar-weighted average expenses; it's fund directors too. By using the bloated numbers that overemphasize tiny and obscure funds, a board can keep costs high without, theoretically, letting them go much "above average."
5. Returns aren't adjusted for taxes: The fund company doesn't pay Uncle Sam; you do. Funds tell you what they earned, when what's most important is what you get to keep.
6. Time-weighted performance measurement: This boils down to "your mileage may vary." The typical pattern for a hot mutual fund is that the assets flow in after a period of great performance; in other words, investors tend to buy at the high points. If the fund suffers thereafter and the shareholder bails out, they have sold low.
Meanwhile the average performance numbers can continue to look pretty good.
What the fund does after your money arrives is all that matters. Funds that have feast-or-famine performance can look good when performance is annualized or smoothed out over several years, but the real question is whether investors actually got what the fund claimed to deliver. You'll need independent research -- Morningstar Inc. measures this -- to know for sure, because fund companies won't tell you.
7. Manager tenure: Studies show that managers with years on the job have better performance than their short-term brethren. Still, manager tenure has no effect on what happens next; it's not like a manager who has a decade at the helm automatically gets a 1% edge on future performance. Plenty of experienced managers got crushed in 2008; experience was no cushion.
Next week: The biggest mistakes fund investors make.

Saturday, November 21, 2009

Duplicate Bridge and Options Players

(c) 2009 F. Bruce Abel

From November 11, 2009 CNBC clip on duplicate bridge and Bill Gates and Warren Buffett.

Interview with Barry Rigal, who, it turns out, has a British accent, or else he is weird.

Heating Audit

(c) 2009 F. Bruce Abel

This article in today's paper on heating audits of homes is well worth reading as we head into the winter heating season.

Energy audit discovers sneaky leaks
By Amy Howell Hirt • • November 21, 2009

Sue Mackey's Loveland home is leakier than a log cabin - at least her log cabin in Michigan.

After buying the house a year and a half ago, she's had a chance to see the challenges of heating the various segments and floors of the home - originally built in the 1800s, then expanded in the mid-1900s and in 1992 - and paying the propane bill.
"I just feel like our bills are outrageous," Mackey says.
Energy leaks hide in inconspicuous places
But she was still shocked to feel cold air rushing in through recessed can lights when energy raters Dale Dennis and Gerard Brauckmann audited her home.
"I would've never thought about that," Mackey says.
While many homeowners with older homes assume their money is going out the windows, only 10 percent of conditioned air is lost through windows, according to the Department of Energy, while leaks in the ceilings, walls and floors account for 31 percent.
That means that, as long as a home has double-pane windows in good condition, sealing a home against air infiltration will reap a faster return - in monthly bills and comfort - than other costly upgrades.
"They always advertise geothermal heating systems and new windows, but I'd rather have good ductwork," Dennis says.
Dennis' recommendations for Mackey - air sealing, adding basement insulation, upgrading attic insulation, replacing the furnace, replacing the recessed lights and running return ductwork to the second floor - could total $7,000 to $8,000, if Dennis and Brauckmann do the work, but would cut her annual utility costs in half to $2,200, Dennis estimates.
"A lot of these things are very low-cost," he says. "Air sealing is one of the best high-payback improvements you can make. Even if you hire someone (to do the work), it's a three- to five-year payback. If you do it yourself, it's a year or less."
That's immediate gratification compared with the 100-year payback on upgrading from double-pane to triple-pane windows, Dennis says.

Friday, November 20, 2009

Krugman -- A Must-Read Today

(c) 2009 F. Bruce Abel

This article by Krugman is important. Why did the government allow AIG to pay off 100 cents on the dollar? What a windfall for the likes of Goldman Sachs.

Tuesday, November 17, 2009

Implants -- Dental

Natural Gas is Not Like Oil

(c) 2009 F. Bruce Abel

My very first blog on this site (you can check it out) was the topic Natural Gas is Not Like Oil.

Now, see how prescient I was?

Read on from this excellent site today:

Nov 16, 2009
The Gas Oil Link
In UK natural gas prices, 2009 has seen a paradigm shift, a game changer and a revolution.
The paradigm shift has been the drop in energy consumption. Although the recession had a big part in this, energy consumption of oil, gas and electricity started to go down in 2005 in what are called "developed" economies which signifies that the "recovery" if it ever shows up, does not mean a return to the bad old days.
The revolution has been shale.
The game changer is the globalisation of natural gas prices, primarily deriving from the sudden emergence of shale reserves pointing toward a future permanence of prices divorced from a link to oil prices.
The gas oil link has always been controversial among UK end-users but had been considered permanent due to the power of the link's big fans at Gazprom and Algeria's Sonatrach among others.
The link is over 50 years old and in Europe started out in the Netherlands. At the time, natural gas was a disappointment; the real prize was oil. Natural gas didn't have anywhere near the infrastructure or popularity it does today and gas had to compete with oil. Gas was naturally cheaper than oil, but had to remain priced in comparison to oil. This made sense when comparing gas versus oil in fuel switching at generators or as feedstock in chemicals or for very large end users. It wasn't very rational in pricing at small users - no one we know has dual fuel central heating. The link was logical in the days when oil was plentiful and carbon was a non-issue. Today, gas has two major advantages to oil: it has 31% less carbon content and doesn't have any of the supply issues, actual or imagined, that surround oil.

Is this permanent? Via the FT's Energy Source Blog, we asked Fatih Birol, chief economist of the International Energy Agency the following. I've highlighted some key points:
The link between oil and natural gas prices is getting very frayed. Do you see it breaking permanently?
A. Dear Nick Grealy, in Europe and Asia-Pacific, gas is imported mainly under long-term contracts, which, in most cases, link the price of the gas to changes in the prices of oil under what are called indexation formulae. The original logic behind this arrangement is that gas competes against oil products, though increasingly gas competes more against other fuels, including coal and electricity. For now, the exporters and many importers are happy to stick with oil indexation. But the glut of gas that is building up does could put increasing pressure on both sides to adjust their pricing terms and even move towards an alternative pricing system, the most obvious of which would be direct indexation to spot or future gas prices. Russia’s Gazprom and Algeria’s Sonatrach – the two biggest external suppliers to Europe – have lost market share over the past year to cheaper spot LNG. They may decide at some point that enough is enough, and opt to move away form oil indexation, though they have made it absolutely clear that they have no intention of doing so for the time being. And the big importers may also start asking for it, as the gap between the price of cheaper spot gas and the price of gas under their long-term contracts widens. For now they don’t want to upset the status quo, but again that could change – especially if their confidence in pricing on the basis of spot markets increase. Certainly, the gas glut proves a window of opportunity for Europe and Asia to move to a more rational system of market-based pricing

So I'm setting up a new label: natural gas is not like oil

So it is easier to see just my blogs on this topic.

What Dogs and Cats Write in Their Diaries

Excerpts from a Dog's Diary......

8:00 am - Dog food! My favorite

9:30 am - A car ride! My favorite thing!9:40 am - A walk in the park!
favorite thing!

10:30 am - Got rubbed and petted! My favorite thing!

pm -

Lunch! My favorite thing!

1:00 pm - Played in the yard! My favorite

3:00 pm
- Wagged my tail! My favorite thing!

5:00 pm - Milk Bones! My
favorite thing!

pm - Got to play ball! My favorite thing!

8:00 pm - Wow!
Watched TV with the
people! My favorite thing!

11:00 pm - Sleeping on the
bed! My favorite

Excerpts from a Cat's Daily Diary... Day 983 of my
captivity...My captors
continue to taunt me with bizarre little dangling
objects. They dine lavishly on
fresh meat, while the other inmates and I are
fed hash or some sort of dry
nuggets. Although I make my contempt for the
rations perfectly clear, I
nevertheless must eat something in order to keep
up my strength.The only thing
that keeps me going is my dream of escape. In
an attempt to disgust them, I once
again vomit on the carpet.Today I
decapitated a mouse and dropped its headless
body at their feet. I had hoped
this would strike fear into their hearts, since
it clearly demonstrates what
I am capable of. However, they merely made
condescending comments about what
a 'good little hunter' I am. Bastards.There
was some sort of assembly of
their accomplices tonight. I was placed in solitary
confinement for the
duration of the event. However, I could hear the noises and
smell the food.
I overheard that my confinement was due to the power of
'allergies.' I must
learn what this means and how to use it to my
advantage.Today I was almost
successful in an attempt to assassinate one of my
tormentors by weaving
around his feet as he was walking. I must try this again
tomorrow -- but at
the top of the stairs.I am convinced that the other prisoners
here are
flunkies and snitches. The dog receives special privileges. He is
released - and seems to be more than willing to return. He is
retarded.The bird has got to be an informant. I observe him
with the guards regularly. I am certain that he reports my every
move. My
captors have arranged protective custody for him in an elevated cell,
so he
is safe.
Be kind whenever possible. It is always possible............
Dalai Lama

Saturday, November 14, 2009

Primary Care Doctors -- Worth Reading!

Duke Energy Transcript re 2nd Qtr Results and Implications for Aggregated Municipalities

(c) F. Bruce Abel

This implies that an arm of Duke stands ready to lower prices to meet competition.

Recently we have seen increased competition in Ohio. The decrease in wholesale power market prices has prompted questions from many of you about customer switching as current market prices are below the standard service offer price in our ESP. Additionally, some of our competitors in Ohio have recently announced intentions to aggressively target customers in Southwestern Ohio.
Historically, our service territory has experienced a lower level of customer switching activity than other areas in Ohio. However, as a result of the competitive pressures I just mentioned, we experienced an uptick in customer switching during the second quarter of 2009.
Overall, the percentage of customers who have switched[Author ID1: at Tue Aug 4 21:47:00 2009
rose from 4% at the end of the first quarter to 10% as of June 30th, and as of that date, the breakout by customer class was approximately 5% residential, 6% commercial, and 20% industrial. The financial impact of customer switching during the second quarter was not significant.
As competition throughout the state of Ohio intensifies, we are responding to the increased risk of customer switching. Our competitive retail arm, Duke Energy Retail Services, is positioned to help preserve our Ohio native customer base. We are also competing to supply power outside of our service territory. This is evidenced by our recent participation in the FirstEnergy auction. We were the winning bidder of 5% of the retail generation needs of FirstEnergy's Ohio operating companies. We will supply those needs from June 1st, 2009, through May 31st, 2011 at a final wholesale price of $61.50 per megawatt hour.

From No Hot Air

Nov 13, 2009
An Independent view on Ofgem and prices
Leading article in today's Independent newspaper makes our view of Ofgem appear charitable. We almost feel sorry for them. Almost, but not quite.
Such profiteering is little short of scandalous. And yet Ofgem, the most useless of the government's regulators, has done almost nothing about it. Instead it parrots industry PR about how since privatisation two decades ago prices have fallen in real terms and customers' bills have been reduced by £1bn per year. The truth is that privatisation has been a failure because public monopoly has been replaced only by private oligopoly. The number of suppliers has fallen from more than 20 in the late 1990s to six dominant conglomerates today. Bodies that big, and that few, do not need to collude; they have a confluence of interest which creates market failure. Their 4,000 different tariffs renders meaningful comparison – and therefore true competition – impossible.The job of Ofgem should be to ensure that retail prices in the industry track international energy prices. To that end it must enforce greater transparency on the industry about how prices are calculated so consumers can tell whether they are being offered value for money set against the international market price. Instead, it seems to accept industry blandishments without question. It needs massive and immediate reform.
Posted at 11:33 AM in Prices and Politics Comments (0) TrackBack (0)
Gas Glut and prices
November has seen prices collapse. This is the 13 month curve in just the past two weeks. One key lesson here is how depending on the curve for price prediction is rather foolish. December 09 is now the cheapest month. If the market depends on supply and demand for prices, why should the lowest demand month of July be lower than the second highest demand month of December?
The quick answer is that curve prices are not very liquid, that is that there aren't a lot of buyers and sellers. Liquidity cascades from Within Day to Day Ahead, Month Ahead, M+1 etc to the point where prices for two years or so away are effectively not traded - in other word the market simply guesses.
This shows the ultimate pointlessness of buying on Fixed Terms, and larger end-users increasingly don't bother.
But what about those who don't have a choice? Floating Prices are not available from most suppliers for most size of end-user. Smaller users are forced to take prices made on guess work, and that includes domestic users. The rationale where December next year should be 72% higher than this year shows the insanity here. Even assuming some recovery of UK demand due to a recovery that may or may not show up, that month and winter 2010/11 seems divorced from any possible reality.
But SME's have another issue. They are often advised by energy brokers who have a vested interest in scaring them into shortage scenarios, and not only the press, but Ofgem enable them in this. What value is "security" of a fixed price when the default option of pricing against day ahead or month ahead indices provides much lower prices? The reality is that end-users aren't told about the difference between fixed and index prices since it is not in consultants interest to tell them.December 09 dropped another .05 while we were writing this.

Posted at 10:27 AM in Energy Prices Comments (0) TrackBack (0)
Nov 12, 2009
No surprise
From PA:
British Gas parent Centrica has said its residential utility arm was on track to see profits soar by an expected 43% this year, despite a 7% fall in energy consumption.
Seven per cent drop in sales, 43% increase in profits. Why can't the rest of UK industry do this well? Probably because they don't have an as blind, toothless and incredibly naive regulator as Ofgem.
Ofgem believes, solely because the Big Six told them so, that they simultaneously had the misfortune (ours, not theirs evidently) to buy July, August and September 2009 gas during the highest prices ever recorded in July 2008. Ofgem has resisted calls to have an open book investigation of suppliers on the grounds of commercial confidence.
Unless the Big Six are complete morons, they would have contracted for that gas at the time, with the price set at the prices in effect on the wholesale markets at the time of delivery. They would have perhaps bought an option to buy the gas at that price, or any number of derivatives to protect themselves but they probably didn't bother. This was the time of $143 oil, and everyone knew which way that was going.
Wholesale prices today are up to 70% lower than they were last year. And that is the price that the big six are paying, which explains how they increase profits even as sales decrease. Ofgem is naive on the verge of incompetence if they believe, with no proof, that suppliers bought into iron clad agreements last year.
Utility bills are as unavoidable as taxes. Utilities are essential a tax for modern life. And they have a similar impact as taxes. If they are higher than they could or should be, they have a macro economic impact that should take precedence over the narrow interests of Big Six shareholders. Better economists than I can say what the £50 a month that the average user over pays would be equivalent to: It would surely be equivalent to a point or two on income tax or VAT. Energy bills are an incredible downward drag on consumption and may explain why the UK is doing worse than other economies. I don't believe this is deliberate, as it imputes competence they don't have , but the net impact of Ofgem sabotages the recovery. That £50 a month could be going from energy payers, which is just about everyone who also pays taxes (and those who don't like the unemployed and pensioners) into retailer tills, or paying down debt or even investing in companies like Centrica.But we can do something about those who raise taxes. We can't do anything about energy bills, because Alistair Buchanan says that British Gas's prices are just fine with him. The Tories are allegedly planning to ditch Ofgem.
What"s the betting that Alistair Buchanan ends up on one of the boards of the Big Six sometime in the future?
Posted at 09:16 AM in Current Affairs, Energy Prices, Prices and Politics Comments (0) TrackBack (0)
Nov 11, 2009

Heating Degree Days -- December, January & February & November Too

(c) 2009 F. Bruce Abel

This schedule used to be free on the Weather Bureau's website. Now it is hard to find. But it's good forever once you have it.

Now you can figure out how many ccf of natural gas per day you will use for each day of a normalized winter heating season.

Friday, November 13, 2009

Meaning of Phrase "Go Forth Without Day"

My early mentor James G. Headley would put this in at the end of an Affidavit or pleading on behalf of a corporate defendant.

"Further Affiant Sayeth Naught"

"Prays that he may go forth without day."

The meaning?

Morgenson -- Good From The Past on Auction Rate Securities

(c) F. Bruce Abel

Auction Rate Securities -- do you have any? Are you sure? This article by one of my favorites, Gretchen Morgenson, is from 2008 but the problem still obtains, I believe.

Published: November 28, 2008
LIFE is unfair, as the saying goes, but for investors still stuck in auction-rate securities, the inequities keep on coming.
Times Topics: Gretchen Morgenson
Auction-rate securities, you may recall, are preferred shares or debt instruments with rates that reset regularly, usually every week, in auctions overseen by the brokerage firms that originally sold them. They have long-term maturities or, in the case of the preferred shares, no maturity dates at all. The securities are issued by municipalities, student-loan companies, closed-end funds and tax-exempt institutions like hospitals and museums.
Brokers that peddled these securities told buyers that they were cash equivalents, easy to get out of and relatively safe. But the promises of liquidity turned false last February when buyers for the securities disappeared and the auctions began failing. The $300 billion market for auction-rates ground to a halt, entrapping thousands of investors both large and small, sophisticated and novice.
Officials in Massachusetts, New York and other states came to the rescue earlier this year, striking settlements with some of the bigger brokerage firms in the arena.
But while some of the larger firms agreed to redeem the securities, not everyone is covered by those agreements. A group of people, size unknown, has fallen through the cracks in the settlements, and for several quirky reasons. They remain frozen in the securities and understandably upset.
Irene Scharf, a professor of immigration law at the Southern New England School of Law, in North Dartmouth, Mass., is one of them. Back in 2005, she invested $75,000 in several auction-rate securities backed by municipalities. The money was earmarked to pay college tuition bills for her two sons.
Ms. Scharf says she bought the auction-rate securities at the suggestion of her UBS broker. When that broker joined Smith Barney last year, she moved her account with him to the new firm. Unfortunately, that sequence of events disqualifies her from participating in the redemption of her securities as dictated by the various state settlements.
The terms of the Massachusetts settlement with UBS, for example, require it to redeem auction-rate securities of those clients who bought them from the firm between Oct. 1, 2007, and Feb. 13, 2008, and who moved to other firms, as well as those clients who were holding any auction-rate securities at UBS on Feb. 13. The settlement covers $19 billion in securities; UBS neither admitted nor denied wrongdoing.
The agreement struck by Smith Barney states that it will redeem auction-rate securities that were bought by its customers directly from the firm before Feb. 11, 2008. The deal, in which the firm neither admits nor denies wrongdoing, covers $7.3 billion of securities.
That leaves Ms. Scharf, however, out in the cold. Making matters worse, the college bills that her securities were supposed to cover are coming due.
“We lived very frugally for years so I would not have to take out loans when my kids went to college,” Ms. Scharf said. “I was not informed of any risk; my broker kept assuring me nothing was safer. When I asked about redeeming them, he said I’d only need to give him two or three days’ notice to redeem.”
She said she has tried to get help from authorities in her home state of Massachusetts, in Texas and also at the Securities and Exchange Commission. She has received sympathy but little else.
A spokeswoman for UBS confirmed that former clients were not all covered by the settlement agreement it struck with regulators.
“Investors who moved their relationships away from UBS while liquidity for auction-rate securities was still available through the auction process are not eligible for our settlement offering, as they were no longer using a UBS financial adviser for investment advisory or brokerage services at the time that auctions failed,” said Karina Byrne, the spokeswoman. “We believe our settlement covers more auction-rate securities holders because it covers all UBS clients who were holding the securities, regardless of where they purchased them, and our settlement is the only one that covers retail, corporate and institutional holders.”
This article has been revised to reflect the following correction:
Correction: December 7, 2008 The Fair Game column last Sunday, about investors who have been unable to redeem their stakes in auction-rate securities, misstated the terms of a settlement between UBS and the state of Massachusetts on buying back such securities. The settlement covers securities bought from UBS between Oct. 1, 2007, and Feb. 13, 2008, regardless of whether the securities were moved to other firms, and securities held at UBS on Feb. 13, 2008, whether bought there or not. It is not limited to securities still held by UBS.

Thursday, November 12, 2009

American Energy Newsletter -- Good as Usual

(c) 2009 F. Bruce Abel

American Energy Monthly Newsletter usually has a few good nuggets. Here it is, sort of hot off the press.

Even if I posted it backwards:

Kristof -- So Good it's Deserving

(c) 2009 F. Bruce Abel

This by Kristof is so good that it's deserving on this blog, which is turning into my bulletin board on aggregation of electricity. The topic is "choice."

Wednesday, November 11, 2009

First Energy Giving Stimulus Grants to Communities Who Can Aggregate

(c) 2009 F. Bruce Abel

Could it happen in Duke's territory?,1021000.shtml

Valuable Presentation of PUCO History for Duke Energy Throughout This Decade Through Early 2009

(c) 2009 F. Bruce Abel


see pp. 15 ff for discussion of Rider FPP

Valuable Presentation of McNees Wallace to Group in Pennsylvania

Eagle Energy LLC

(c) 2009 F. Bruce Abel

This is the renewal application for Don Marshall to be an aggregator in Ohio:

What the Industrials Are up to in Columbus

(c) 2009 F. Bruce Abel

IEG-Ohio cares about the rates of DP&L. Does that mean that they are still on the DP&L system and not taking from competitors?

Aggregators -- Ohio

Aggregation -- Key 2nd Qtr Transcript of Duke Energy

(c) 2009 F. Bruce Abel

Herein lies the truth -- that those who do not switch pay the price. So once a town or village aggregates a lower price obtains. And Duke's other company, its sales arm, can come back in and meet the competitor. A lot of "going around the barn."

Tuesday, November 10, 2009

Rider FPP

(c) 2009 F. Bruce Abel

This is for those who have been following the excellent special meetings of Symmes Township, which can be viewed on ICRC this week (the second meeting) and on the ICRC website (first meeting; supposedly the second meeting but my computer hangs up on this one).

Here is what was missing from these meetings, and this is important:

No one from Duke Energy appeared to tell about Rider FPP, which is essential to evaluating any competing offer regarding electricity. (Search "Rider FPP" on my blog herein for explanation).

Without this data a fixed three-year electric contract is a gamble.

No one was there from Duke Energy Retail Sales, which is different from Duke Energy. They (Duke Energy Retail Sales) are there to match whatever the competitor is offering, whereas Duke Energy is not, and will not even refer us to "Duke Energy Retail Sales."

Also missing was Don Marshall of Eagle Energy, the most knowledgeable of the middlemen ready to serve the southern Ohio, Duke territory.

Instead in attendance you had brokers who have served northern Ohio, whose situation is quite different from southern Ohio. Nevertheless, they had valuable presentations.

The best single negotiating observation from the two special meetings:

"In most cases you must multiply the competitor's offer per kwh by 1.065 because there is a 6 1/2 percent sales tax that applies to that competitor's offer."

Of interest is the transcript of Duke's last conference call to Wall Street and other investors:

This covers the 3rd quarter. The 2nd quarter transcript, on first glance, is more informative on our topic. i refer to this 2nd quarter in an earlier blog.

Monday, November 9, 2009

Aggregation -- Natural Gas From No Hot Air, a British Blog

(c) 2009 F. Bruce Abel

You have to twist your mind from the UK to here, but the principle dramatically demonstrated in "No Hot Air" is the same. Aggregation for natural gas in today's market cannot beat the default price.

A fixed price is basically the projected monthly volume multiplied by the monthly price. November is roughly 10% of an annual heating load. If one fixed a price in September 2008 for one year, November was £1 a therm. The lowest possible price one could pay for November in advance was on 32.05 in early September. But the wholesale index price for System Average Price has been below 25 this month.
In English: Consultants cannot beat the default price, the price of doing nothing. So what are people paying them for?

Krugman -- American Ungovernable

(c) 2009 F. Bruce Abel

Today's posting by Paul Krugman about the takeover of the Republican Party by Rush Limbaugh et al, deserves special study. Is America turning Californiaized? And ungovernable during its crisis?

Sunday, November 8, 2009

Buffett's Subtle Bet Against the Dollar

(c) 2009 F. Bruce Abel

From Baseline Scenario and Simon Johnson himself, not Kwak. This article is huge.

The Baseline Scenario
Warren Buffett And The G20
Posted: 07 Nov 2009 03:53 AM PST
The G20 Finance Ministers and Central Bank governors are meeting today in St. Andrews, talking about the data they will need to look at in order to monitor each other’s economic performance and sustain growth (seriously).
The underlying idea is that if you talk long enough about the US current account deficit and the Chinese surplus, stuff happens and the imbalances will take care of themselves – or move on to take another form.
Warren Buffett seems to agree.
Buffett’s big investment in railroads looks like a shrewd way to bet on growth in emerging markets – which is where most incremental demand for US raw materials and grain comes from. It’s also a polite way to bet against the dollar or, even more politely, on an appreciation of the renminbi.
When China finally gives way to market pressure and appreciates 20-30 percent, their commodity purchases will go through the roof. You can add more land, improve yields, or change the crop mix of choice (as relative prices move), but it all has to run through Mr. Buffett’s railroad.
Of course, Buffett is nicely hedged against dollar inflation – this would likely feed into higher inflation around the world, and commodities will also become more appealing.
And Mr. Buffett is really betting against the more technology intensive, labor intensive, and industrial based part of our economy. If that were to do well, the dollar would strengthen and resources would be pulled out of the commodity sector – the more “modern” part of our production is not now commodity-intensive.
The G20 will stand pat, waiting for the recovery and hoping for the best; “peer review” will turn out to be meaningless. But this raises three dangers.
China will overheat, with capital inflows fuelling a giant credit boom. Books with titles like “China as Number One” and “The China That Can Say No” will appear. The boom-bust cycle will resemble that of Japan in the 1980s – you don’t need a current account deficit in order to experience a costly asset price bubble. Other emerging markets may follow a similar pattern (think India, Brazil, Russia.)
US and European banks will be drawn into lending to China and other emerging markets, directly or indirectly. In a sense this would be a re-run of the build-up of debt in Latin America and Eastern Europe in the 1970s, leading to the debt crisis of 1982 (remember Poland, Chile, Mexico). Banks with implicit government guarantees will lead the way.
We hollow out the middle of the global economy – with a few people doing ever better and most people struggling to raise their living standards. Increasing commodity prices hit hard at poorer people everywhere (recall the effects of the relatively mild run-up in food and energy prices in the first half of 2008). Global volatility of this nature helps big business but at the cost of undermining the middle class.
By betting on commodities, Mr. Buffett is essentially taking an “oligarch-proof” stance. Powerful groups may rise to greater power around the world, fighting for control of raw materials and driving up their prices further. As long as there is growth somewhere in emerging markets, on some basis, Mr. Buffett will do fine.
As for the G20, they are already a long way behind the curve.
By Simon Johnson

Saturday, November 7, 2009

What Duke Energy is Doing In Bloomington, Indiana

(c) 2009 F. Bruce Abel

Just came across this. This is the wave of the future in electricity?

Thursday, November 5, 2009

Aggregation -- The Default Option

Aggregation -- Symmes Township

(c) 2009 F. Bruce Abel

Today, for electricity, the default option does not appear the best option over the next year. A contract with a supplier that benchmarks the NYMex is the best. No guarantees. Little chance of buyer remorse. Little chance of second-guessing. In 2008 what was once a larger spend in electricity could now be a smaller spend - fixed or index -- with Dominion Retail, Inc.

Middlemen are moving down the value chain to target inexperienced smaller gas and electricity users because at today's prices they make serious money from fixed contracts - the longer the better.

But they won't make any money selling end-users the default option. Even they haven't figured out a way to make money by advising clients to do nothing.

Wednesday, November 4, 2009

Baseline Scenario

(c) 2009 F. Bruce Abel

Do smart, hard-working people deserve to make more money? A continuation of a fascinating theme.

The Baseline Scenario
Do Smart, Hard-Working People Deserve to Make More Money?
Britain To Break Up Biggest Banks
Note to Congress: You Are Not the People You Serve
CEO Statements That Should Make You Worry
Do Smart, Hard-Working People Deserve to Make More Money?
Posted: 02 Nov 2009 04:00 AM PST
Last weekend Yves Smith posted a story of a family that was down on their luck and struggling with high credit card bills, including plenty of fees. Yesterday she posted a follow-up. Apparently the story triggered a wave of vindictive snobbery from commenters. Here’s one example:
“Sounds like someone doesn’t know how to manage their money. I would bet they are making car payments and eat fast food at least 3 times a week. Probably have cable T.V. and deluxe cell phone plans. They probably get a new car like every two years. What happened to her reenlistment bonuses?”
Here is Yves’s response:
“I think quite a few readers owe her an apology. But I am also sure those readers are so locked into their Calvinist mindset that they will find some basis for criticizing this family. Some people seem constitutionally unable to admit that success and prosperity are not the result of hard work alone.”
First, I want to agree completely. There is the obvious fact that a person’s income as an adult is highly correlated with his or her parents’ income. (There was a recent debate about why in the blogosphere, but as far as I know no one contesting that this was the case.) But beyond that, we all owe a tremendous amount of whatever fortune we have to luck, pure and simple. Where would Bill Gates be if IBM hadn’t decided to outsource development of the operating system for the first IBM PC? Rich, no doubt, but $50 billion rich? I have worked hard at enough things, and failed at enough things, and succeeded at few enough things, to know how much luck is involved.
Second, I want to go beyond that to another point that seems obvious to me, but that some will probably find controversial. Even if differences in outcomes were entirely due to differences in abilities and effort (which they’re not) — would that make it OK? I think most people would say that it’s fine for smart people to make more money than other people. But why? Why are smart people any more deserving than anyone else? It’s true that in many jobs being smart can make you more productive and valuable, and as a result for many high-paying jobs being at least somewhat smart is a prerequisite. But the fact that a capitalist economy functions this way doesn’t make it morally right that the “winners of the genetic lottery” (a phrase I picked up from some basketball announcer talking about Tony Parker) have better outcomes than the losers.
Surely at least people who work hard deserve to do well. In the hierarchy of American moral virtues, hard work must be right at the top. But I’m not convinced of that, either. The ability to work hard is something that you either inherit from your parents or that you develop in your early childhood as a function of the environment around you. Either way, whether or not you have it is as much a matter of luck as is your IQ. Again, it’s obvious that working hard increases your productivity and therefore the wages you will be paid, all other things being equal. A small part of that differential seems “deserved,” since you are forgoing leisure for work. But the differential goes far beyond that. For example, doctors don’t just make more money than other people to compensate them for studying hard in school and working 36-hour shifts in residency; studying hard and 36-hour shifts are hurdles to clear in order to become a doctor and make a lot of money (if you’re a specialist, that is — some people do go through all the work and then make comparatively little).
Take me, for example. I’m smart and hard-working. I don’t know if it’s because of my genes, or because my parents brought me up right. But whatever the cause, I didn’t do anything to become smart or hard-working. And that’s the reason why I was able to go to good schools, get a good first job, and make more money than the average person, at least for a few years there (before quitting to go to law school). When I was young and frankly immature, being smart gave me a sense of entitlement. Now I just feel sort of lucky (“sort of” because I’ve learned that there are many more important traits than intelligence).
I’m willing to acknowledge that morality simply isn’t a factor when it comes to compensation. Seen from a utilitarian perspective, whether hard-working people deserve more than other people is a distraction. The key issue is that to maximize output in a more or less free market system, it has to be that way, since labor is supposed to be paid its marginal product. But there are still two implications of realizing that everything — even your initial endowments — is a matter of chance, not something you deserve.
The first is that you shouldn’t look down on other people (1) because their parents weren’t as rich as yours, or (2) because they aren’t as smart as you, or even (3) because they don’t work as hard as you. I think most people agree with (1); I think you should agree with (2) and (3), too.
The second is that the moral argument should be on the side of redistribution. I am willing to listen to utilitarian arguments against redistribution (e.g., high marginal tax rates reduce the incentive to work, blah blah blah blah blah); I may not agree with them, but they are a plausible position. However, I have little patience for the idea that rich people deserve what they have because they worked for it. It’s just a question of how far back you are willing to acknowledge that chance enters the equation. If you are willing to acknowledge that chance determines who you are to begin with, then it becomes obvious (to me at least) that public policy cannot simply seek to level the playing field, because that will just endorse a system that produces good outcomes for the lucky (the smart and hard-working) and bad outcomes for the unlucky. Instead, fairness dictates that policy should attempt to improve outcomes for the unlucky, even if that requires hurting outcomes for the lucky. But given that society is controlled by the lucky, I’m not holding my breath.
By James Kwak

Britain To Break Up Biggest Banks
Posted: 02 Nov 2009 02:46 AM PST
The WSJ reports (on-line): “The U.K.’s top treasury official Sunday said the government is starting a process to rebuild the country’s banking system, likely pressing major divestments from institutions and trying to attract new retail banks to the market.” The British style is typically understated and policymakers always like to play down radical departures, but this is huge news.
Pressure from the EU has apparently had major impact – worries about unfair competition through subsidizing “too big to fail” banks are very real within the European market place. Also, strong voices from within the Bank of England have helped to move the consensus.
The US position on protecting everything about our largest banks is starting to look increasingly isolated and out of step with best practice in other industrialized countries. Time to start planning for the break-up of Citigroup.
By Simon Johnson

Note to Congress: You Are Not the People You Serve
Posted: 01 Nov 2009 08:00 PM PST
From a Washington Post article on proposed legislation to regulate overdraft fees:
“Rep. Spencer Bachus (R-Ala.) said he avoided overdraft fees with a credit line and asked if many of the problems could be eased with consumer education.”
Good on you, Spencer. You have a credit line — which many of your constituents can’t get — and you have it linked to your checking account — which many of your constituents wouldn’t even know how to ask for.
Nessa Feddis of the ever-helpful American Bankers Association added that “most consumers can easily avoid the fees by keeping track of their balances.” (That’s a quote from the Post article describing her testimony, not from her testimony itself.) Hear that everyone? Keep track of your balances, and just in case, get a credit line and link it to your checking account. Problem solved.
The people who are financially sophisticated already know how to track their balances and turn off overdraft protection if they don’t want it. They are not the people that financial regulation is supposed to serve. You can’t discharge your duty as a representative of the people just by wishing that the people were more like you.
By James Kwak

CEO Statements That Should Make You Worry
Posted: 01 Nov 2009 06:00 PM PST
“Our distinctiveness is we connect the world better than anyone else. We have a great capability of building a business around that. And we are in the process of building a culture around that.”
That’s Vikram Pandit on his company, Citigroup, as reported in The New York Times. What does it mean? Your guess is as good as mine.
What does it mean to “connect the world?” Sure, Citi is in a lot of places. But it is largely a retail bank — you know, the kind that you go to on the corner to take money out of your ATM. Most of its customers don’t move around the world very much. How do you “build a business” around connecting the world? This isn’t Cisco we’re talking about. And how do you “build a culture” around connecting to the world? To build a culture, you need to put together a group of people who understand the world, approach problems, and treat each other in a similar way. A new slogan won’t do it.
CEOs do have to speak in vague platitudes occasionally, but note that this was in an interview with reporters who were writing a feature article about the challenges facing Citigroup.
What Citigroup needs is a strategy. I can’t believe I’m saying this; after working at McKinsey, I thought that “strategy” was by far the most overused word in business. But what I mean is it needs some kind of story about what its customers need and what it can do well (better than its competitors), and that story has to somehow relate to what it is today. Think Lou Gerstner in the 1990s focusing IBM on services, or Larry Ellison deciding he would just buy all of his competitors and be done with it. If you’re making money, people will overlook the fact that your company doesn’t make any sense; if you’re struggling, like Citi is, they won’t.
Without such a story, it’s just a tangled mess of bad acquisitions that have no reason to be together. Now, the usual course of action in situations like this is to try to come up with a story that somehow justifies all the various bits and pieces, which gives you a story that is so weak as to be meaningless. The better answer is to come up with a story first, and then reshape the company to support that story. But that’s hard work.
Instead, a year after the crisis that would have put it out of business without extraordinary government assistance, instead of a strategy, all Citi has is a pro forma financial statement: the arbitrary division between “Citicorp” and “Citi Holdings.” As other people observed at the time of the split, there was no sound logic for how the company was split up. For example, North American retail banking and credit cards are on one side, but mortgages, auto loans, and student loans are on the other. So their plan is to run a retail bank that doesn’t lend money to households? Oh right — they’ll take the deposits and invest them in CDOs.
By James Kwak

Baseline Scenario

The Baseline Scenario
Peter Fox-Penner Replies
Posted: 03 Nov 2009 09:22 AM PST
On October 24, we published a guest post, “Patchwork Fixes, Conflicting Motives, And Other Things To Avoid: Some Lessons From the Regulated Non-Financial Sectors,” by Peter Fox-Penner. Below is his response to some of your more than 200 comments.
As a stuck-in-the-last-century guy, I’m remiss in not replying to the many comments to my guest post. As an I-O (industrial organization) economist, I learned a lot more than I contributed reading the many colloquies. Here are just a few general observations stimulated by the discussion:
To start off, there seems to be agreement on the difficulty of measuring risk, either because there is no transparency and/or the instruments are so darn complex. Incidentally, the best short piece I’ve ever read on the emerging science of systemic risk measurement is Andrew Lo’s Senate testimony; perhaps all of you have other good pieces. The one thing I learned from Andrew’s piece is that we are a long way from knowing how to do it.
Many folks agreed that if you can’t measure – it you can’t regulate it. Bond Girl and others worry that regulation will stifle innovation. In my view, there is no question about it. There is no free lunch. Regulation reduces the variance in outcomes in a market – that’s its job. Innovation increases them and even disrupts the distribution. When disruptive events have large economic fallout, or violate our norms for justice, the cost of diminishing these risks via regulation outweighs the costs of reduced innovation.
More practically, however, this is not a question of zero innovation versus zero regulation. All regulation allows for innovation – it just reduces and controls it. New drugs are introduced – lots of them. New electric power pricing approaches are approved. And thank you, James Kwak, for reminding commenters that I don’t say “ban derivatives”, I say “oversee them properly.” Furthermore, it is not just the regulated products that evolve – it is also regulatory processes themselves. There is a steady stream of regulatory decisions that find their way into the courts precisely because the regulator did something different this time around and one party challenges whether this (dare I say it) innovation is consistent with the regulatory agency’s legal charter.
Every regulator allows innovation – some even encourage it. But under prudent regulation, you don’t allow a product to be introduced in widespread ways that might undermine the whole goal of your regulatory scheme. Financial regulators did – though it was partly because their authority was balkanized so that new products had no natural regulator. In the end, that’s Joskow’s point and mine as well. Mind the gap, as they say in the London tube.
Redleg asked a simple, fair question: “Doesn’t simplifying the regulatory system simplify how one might compromise it?” In my own limited experience: “No.” Simpler systems are harder to compromise because many more people understand them and can therefore police them, formally or informally. Regulatory agencies don’t need as high a level of skill. So let’s be clear: regulation should be as complex as is necessary to do a good job, but not more so, and regulators MUST have the resources (educational and otherwise) necessary for their job.
Regulatory capture is unquestionably a huge and generally not solvable issue. It is an unavoidable aspect of regulation that civil society must seek to minimize. There is a century of experience with mechanisms that reduce capture: overlapping terms of regulators, requirements for political balance, revolving door rules, and so on. This is the hugely important day to day work of regulatory practitioners and legislative overseers.
Finally, Uncle Billy makes a number of points about Commissions, including the Pecora Commission. In the current ultra-polarized legislative climate, I think these commissions are extremely important and I have high hopes for what I will now call the Angelides Commission.
As to my background and motivation, my vita is posted on the Brattle website at and more is at No Brattle client (or anyone else) knew that I was doing this post, much less reviewed it, much less paid for it. (However I do genuinely like Rowe and Joskow). See the disclaimer at the start of the post. And yes, we are proud to consider Simon a senior advisor to our firm. I sought out Simon to contribute to the discussion and he consented, not the reverse.
By Peter Fox-Penner
Peter is a leading expert on regulation at The Brattle Group. The views expressed here are his alone.

Ackermann vs. Hoenig: Take It To The WTO
Posted: 03 Nov 2009 05:31 AM PST
Josef Ackermann, chief executive of Deutsche Bank and chairman of the Institute of International Finance (an influential group, reflecting the interests of global finance in Washington) is opposed to breaking up big banks. According to the FT, he said,
“The idea that we could run modern, sophisticated, prosperous economies with a population of mid-sized savings banks is totally misguided.”
This is clever rhetoric – aiming to portray proponents of reform as populists with no notion of how a modern economy operates. But the problem is that some leading voices for breaking up banks come from people who are far from being populists, such as the UK authorities (in the news today) and the US’s Thomas Hoenig.
Hoenig is an experienced regulator, who has dealt with many bank failures. He is also currently President of the Kansas City Fed and an articulate voice regarding how banks became so big, why that leads to macroeconomic problems, and how consumers get trampled (answer: credit cards, issued by big banks; p.6). He supports a resolution authority that would help deal with some situations, but also says (p.9):
“To those who say that some firms are too big to fail, I wholeheartedly agree that some are too big. However, these firms can be unwound in a manner that does not cause irreparable harm to our economy and financial system but actually strengthens it for the long run.”
Mr. Hoenig is, if anything, a little too polite. There is no evidence that huge banks, at their current scale, provide any social benefit. When these same banks were much smaller, in dollar terms and as a percent of the economy, the global economy functioned no worse than today.
Mr. Ackermann and his colleagues are pursuing a purely self-serving line. Reasonable centrist opinion is turning against them. Either the big banks need to shrink voluntarily or they will potentially face consequences that they cannot control.
Building on ideas from the Kansas City Fed, the Bank of England, the UK Financial Services Authority, and the European Commission, the consensus is moving towards the view that state-supported banking (i.e., operating through implicit guarantees on Too Big To Fail banks) constitutes an unfair form of protectionism. Financial services in this guise do not currently fall within the remit of the World Trade Organization, but it would be a simple matter to extend its mandate in this direction.
In any reasonable judicial-type process, involving relatively transparent weighing of the evidence, Mr. Ackermann would be most unlikely to prevail.
By Simon Johnson