The Wrongologist

Geopolitics, Power and Political Economy

Monday Wake Up Call – September 21, 2015

Are you familiar with the “Bad Bank” strategy? It is a new bank set up to buy the bad loans of a bank that has a significant amount of nonperforming assets. Those assets are purchased at market prices. If the assets remained on the original bank’s books, they would be forced to take big write-downs. So, the “good bank” sells the assets to the bad bank, and clears their balance sheet.

And the “bad bank” goes off to fail, be recapitalized, or liquidated. The shareholders and bondholders of the “bad bank” stand to lose money from this solution but its depositors will be bailed out by the government.

Occidental Petroleum (OXY) made a similar deal last November by spinning off California Resources, (CRC) and since then, most investors that bought into the deal got burned.

CRC held OXY’s oil-and-gas exploration assets in California. CRC is CA’s largest natural gas producer and its largest oil-and-gas acreage holder with operations in Los Angeles, San Joaquin, Ventura, and Sacramento. OXY was the big player in the Monterey Shale formation, which had been hyped as the largest reserves of oil in the US. But, in 2014, the US Energy Information Administration (EIA) downgraded the amount of OXY’s known reserves in CA. From Wolf Richter: (emphasis and brackets by the Wrongologist)

The LA Times spilled the beans last week [May 2014] that the EIA is set to severely downgrade the Monterey Shale in California in an upcoming report. Once thought to hold 13.7 billion barrels of technically recoverable oil, the EIA now believes only about 600 million barrels are accessible. Slashing technically recoverable estimates by 96% could be enough to kill off the shale revolution in California.

Six months later, OXY exited CA shale by spinning off 80.5% of CRC to OXY’s shareholders. CRC’s shares began trading on the NYSE on December 1, 2014. As part of the spinoff, CRC paid OXY a special dividend of $6 billion. To fund the dividend, CRC issued bonds totaling $5 billion and leveraged loans for the remainder. This debt now costs CRC about $330 million a year in interest.

Back in 2014, hedge funds were clamoring for energy spinoffs. They’d buy a big stake in the parent company and push the board to do a spinoff that entailed loading the spinoff up with debt to fund a fat special dividend back to the parent.

“Unlocking value,” is the Wall Street term for this kind of financial engineering. Wall Street then made sure that there were enough unwitting or yield-desperate buyers for the bonds. The hedge funds made their money, and moved on.

Then CRC reported its second quarter earnings, which showed a net loss of $68 million on revenues that had plunged 45% to $609 million. And on September 15, Moody’s slashed CRC’s corporate rating from Ba2 to B1, and the bonds from Ba2 to B2. All of it with “negative outlook”. Moody’s described CRC’s relatively high costs of production and interest costs totaling $31.71 per barrel of oil equivalent. It pointed to low oil prices that it didn’t expect “to improve materially in 2016.”

So in 2014, no investor realized that CRC’s reserves had been cut by 96%? Or, that their break-even cost per barrel was $31+?

This Cali deal is Straight Outta Enron.

Now the question is can CRC survive without having to resort to a debt restructuring, bankruptcy, and a total shareholder wipe-out?

These kinds of deals are best pulled off in a credit bubble. Low interest rates force some investors to chase yield, and the unwitting buyers that have these fruits of Wall Street’s labor in their portfolios are the ones who feel the pain. Wall Street will tell you that the dividend and spinoff were disclosed in advance, so it’s not “fraud” by the company. It’s just “stupidity” by yield-hungry investors.

Why do you care? These securities could easily be in your 401k, or in an ETF that you own directly, assuming that you are among the 48% of Americans that have investment accounts.

So it is time for We the People to wake up to Wall Street’s financial engineering and what masquerades as legalized robbery. To help with the wake up, here is John Lennon’s “Power to the People”:

You will note the nearly completed Twin Towers at the end of the video. For those who read the Wrongologist in email, you can view the video here.


Sunday Cartoon Blogging – July 12, 2015

In recent years, many on the right talk as if they have inside knowledge of what the Creator wants us to think and do. As reported here last week, we have been arguing about the role of religion in our politics since the founding of the Republic. In 1789, George Washington declared a day of “public thanksgiving and prayer.” 12 years later, Thomas Jefferson abruptly canceled the ritual. The First Amendment, explained Jefferson, erected a “wall of separation between church and state.”

But Jefferson’s contractor failed to make that wall strong enough.

So, Wrongo is adding a book to his summer reading list. It is “One Nation Under God: How Corporate America Invented Christian America” by Kevin Kruse. The book tries to explain the religiosity in our politics. Kruse investigates how the idea of America as a Christian nation was promoted in the 1930s and ’40s when industrialists and business lobbies, chafing against the government regulations of the New Deal, recruited and funded conservative clergy to preach faith, freedom and free enterprise. He says this conflation of Christianity and capitalism moved to center stage under Eisenhower’s watch in the ’50s, when the words “Under God” in the Pledge of Allegiance and the phrase “In God we trust” was inserted on the back of the dollar bill.

This week saw the USA Women’s soccer team take Manhattan, the NYSE go dark, Greece on the verge of going dark, the Confederate flag comes down in Charleston and Trump jumps into the lead in Republican opinion polls.

Women’s soccer is America’s new role model:

COW Soccer II

Stock Exchange glitch wasn’t explained clearly, so speculation ensued:

COW Glitch

South Carolina makes something old new again:

Clay Bennett, Chattanooga Times Free Press

Clay Bennett, Chattanooga Times Free Press

Socratic Method not enough to fix Greek quagmire:

COW Socrates

Trump divides Republicans:

COW Trump II

And forces a new strategy:

COW Trump

While W keeps rolling along:

COW W Speech


End Government Subsidies of Private Equity

We have written about taxpayer-funded corporate subsidies this week. Let’s talk about the Private Equity (PE) industry, where profit margins are pretty high. By PE we mean investing in assets that include equity securities and debt of operating companies that are not at the time of the investment, publicly traded. PE is a re-branding of leveraged buyouts (LBOs) which were the way Wall Streeters built wealth in the 1980s.

In the past 35 years, we have seen a finance-led revolution that has generated fantastic wealth for PE managers. PE has in large part, helped create the growing chasm between America’s most wealthy and everyone else. This is shown in the disproportionate numbers of private equity and hedge fund principals in the top .1% of American wealth. That wealth doesn’t only come from just making a killing when the target company goes public or is acquired, it also comes from favorable tax treatments for the PE company principals and investors.

Although the PE industry is often held up as an exemplar of free-market capitalism, it is surprisingly dependent on government subsidies for its profits. In a typical deal, a PE firm buys a company, using some of its own money and some borrowed money. It then tries to improve the performance of the acquired company, with an eye toward cashing out by selling it, or taking it public.

The key to this strategy is debt: the PE firms borrow to invest since, just as with your mortgage, the less money you put down, the bigger the potential return on investment. But debt also increases the risk that companies will go bust, so early on, the amount of debt PE firms employed was conservative.

That has changed in the last 10 years. After using debt to buy them, many PE funds now have their portfolio companies borrow even more. They then use that money to pay themselves “special dividends.” This allows them to recoup their initial investment while keeping the same ownership stake.

Before 2000, big special dividends were not common. But between 2003 and 2007, PE funds took more than $70 billion out of their companies. These dividends created no economic value—they just redistributed money from the company to the private-equity investors.

As an example, in 2004, Wasserstein & Company bought the mail-order fruit retailer Harry & David. The following year, Wasserstein and other investors took out more than $100 million in dividends, paid for with borrowed money. In 2011, Harry and David defaulted on its debt and dumped its pension obligations on the US government. And when an investment goes bankrupt, there are more fees, and maybe more tax write-offs for the PE partners.

Taxpayers are left on the hook. Interest payments on that debt are tax-deductible, and when pensions are dumped, a federal agency, the Pension Benefit Guaranty Corporation (PBGC) picks up the company’s pension liability. That means taxpayers are on the hook for those unfunded pensions.

And the money that PE dealmakers earn is taxed at a much lower rate than normal income, thanks to the US tax code’s carried interest loophole, which permits that income to be taxed at capital gains rates.

Most do not know that the single largest source of investment capital in PE funds is government pension funds. According to Preqin, a database company that tracks investment in PE, approximately 30% of capital in US PE funds is contributed by government pension funds. Government pension funds are usually called “public” pension funds, administered by government employees and governed by officials who are directly elected by the public or appointed by elected officials.

A key point about the power and reach of PE. They have more than $3.5 trillion under management. Assuming normal leverage (30% equity) that gives them $11.7 trillion in buying power. That’s about 40% of the value of publicly-traded firms in the US. Think about the political clout they have by investing government pension money. Not only do PE firms own a huge portion of America’s productive businesses, unlike the diffuse ownership of public companies, they control them outright.

So, PE is a government-sponsored enterprise, both via tax subsidy and via funding. We taxpayers are helping them to fabulous paydays, thanks to our Congress Critters.

If PE firms are as good at remaking companies as they claim, they shouldn’t need tax loopholes to make their money. If we capped the deductibility of corporate debt, and closed the carried-interest loophole, it would not prevent PE firms from buying companies or improving corporate performance.

But it would add to our tax revenues, and that might keep a bridge or two from falling into a river during rush hour somewhere in America.

The American Dream: You have to be asleep to believe it.” -George Carlin


Monday Wake Up Call – April 6, 2015

Today’s Wake up is for the Republican Chicken Hawks who think that Iran is the Greatest Threat To America™. They are denouncing the possible nuclear Iranian deal because Bibi says, or because they think it takes the military option off the table, or they think that Iran got too good a deal, or all of the above.

Here, from the Atlantic, are some specific details from Harvard’s Belfer Center for Science and International Affairs. The table below summarizes the new framework accord and analyzes differences between where Iran stood before negotiations, and where it will be, if, or when, the accord becomes reality:

Iran Before after Accord

By eliminating 12,000 centrifuges and five bombs’ worth of low-enriched uranium, the accord extends the breakout timeline for Iran to produce enough highly enriched uranium for a bomb to one year. By requiring the reconfiguration of Iran’s planned plutonium-producing reactor at Arak, the accord essentially closes the door to a plutonium-based Iran bomb. And by agreeing to establish a new mechanism that will allow unprecedented access for the International Atomic Energy Agency (IAEA) to suspicious nuclear sites anywhere in Iran, the accord makes it much more difficult for Iran to cheat.

It’s time to ask critics of the proposed deal, particularly those running for president in 2016, exactly where they stand, and what they would do if an agreement is reached.

Wouldn’t you think after Iraq, the American people would want to debate this, and emphatically say that war with Iran is such a stupid idea that no one advocating it should get within a mile of the White House, the State Department, or the Pentagon? Everyone, (Republican chicken hawks included) should want to negotiate peace as our default position.

But, it has been a whole twelve years since we started a war, and given the history of the last few decades, we’re past due. So who’s the big, brave Republican running on an Iran war platform? Everybody.

Wake up Chicken Hawks. Here to help rouse you from your neo-con wet dream, a song by The Lone Bellow, a Brooklyn NY-based group with three-part harmonies and great melodies. This is “Then Came the Morning” from their 2nd Album of the same name. Here they are on WFUV, Fordham University radio:

Sample Lyrics:
Take my words, breathe them out like smoke
Burn every single letter that I wrote
Let the pages turn to ash, I don’t want them back
Everything you always said to me

Monday’s Hot Links:

Tesla made an April fool’s announcement and investors were pissed:

PALO ALTO, Calif., April 1, 2015 – Tesla today announced a whole new product line called the Model W. As many in the media predicted, it’s a watch. That’s what the “W” stands for.

In the following minute, the stock jumped $1.50. Nearly 400,000 shares traded in that time, and it was the heaviest one minute of trading volume in the stock since the first minute after the IPO on Feb 12. Sadly, there is no watch. People bought the stock because they were introducing a thing called the Model W. They didn’t read beyond the headline, and thought whatever it was, would be big. Invest wisely, grasshopper.

The next two links contrast a big business solution to a big problem, with an open-source solution to a big problem. The big business solution is elegant, expensive and patented. The entrepreneurial solution is elegant, cheap and free:

The latest technology for removing salt from seawater, is developed by Lockheed Martin, and will be a game-changer. Desalination technology is all over the world, but it is inefficient, using lots of energy to force salt water through a filtration system. That makes it expensive. Lockheed has developed a special filter that doesn’t need as much energy to push water through the filter. Its made out of Graphene. If this scales up, where do we put the excess salt? Or, if you really are thinking, If Lockheed can strain salt ions out of water, then why not gold ions? Invest at your own risk.

Ever hear of Liter of Light? They are a charity that makes a skylight-type light using a used liter plastic bottle, filled with water and a little bleach that is placed through tin roofs in the 3rd world. They then added an LED light and a 1 watt solar collector, for light at night. All of this started in the Philippines. Liter of Lights now has chapters in 53 countries, and has installed 350,000 daytime lights and around 15,000 night lights. Watch a video here. Please, you won’t regret it.

According to UNESCO, more than 1.5 billion people around the world currently have no access to electric light, and around 1.3 billion of them must spend up to half their income to light their homes at night. The fact that the technology is not patented, or owned by a large, multinational corporation, like Lockheed, who owns the Graphene filter, makes this a sweet place to send some of your excess money, Wrongsters. Do not expect a financial return.


Retail Store Closings Reflect Middle Class Income

Today, we take a business trip!

The retail sector of the US economy is not doing so well. The Census Bureau tracks retail sales in the US, and sales decreased 0.30% in September, compared to the previous month. Retail Sales month over month in the US gained an average of 0.37% from 1992 until 2014, reaching an all-time high of 6.71% in October of 2001.

This week, NCR, the maker of point-of-sale devices for the retail industry who call themselves “the global leader in consumer transaction technologies”, announced disappointing third quarter results. NCR blamed particularly the “challenging retail market” for its debacle. CEO Bill Nuti explained it this way:

Market conditions within the retail industry worsened in the third quarter, as evidenced by weak same store sales comparisons and financial results. This resulted in our retail customers spending more cautiously than anticipated and further delaying solution roll-outs…Additionally, ongoing retail consolidation continues to be a factor impacting our performance.

NCR has noticed that brick-and-mortar retailers are cutting back. “Ongoing retail consolidation,” Nuti called it. And some, like Radio Shack, are likely to use bankruptcy courts to do it. The structural problems in the brick-and-mortar retail industry include Sears, which is closing 300 Sears stores and 80 Kmart stores.

Some of us wonder why anyone still buys there. Retail chains, large and small, have announced an epidemic of store closings in 2014. Here are the “Top 20? announcements of store closings. For these 20 chains, the total number of stores to be closed exceeds 4,200. The number of closed stores is the first column:

US-announced-retail-store-closings-2014Store closings add up: Jobs are lost, consumer spending weakens, and fewer tax revenues are paid to states and the federal government. This process has been going on for years. As a side note: when all this washes out, who is going to fill the vacant retail space in our malls? That’s one of the many secondary effects of the troubles in the American retail industry.

Hopefully, you haven’t invested in those Shopping Center Trusts.


Source: Wolf Richter

Yet, some box store retail continues to grow. Starbucks is opening another 1400 stores in the US by 2017, a 13% growth rate. They prove there is a market for things that can’t be ordered and delivered hot over the Internet. But, the openings of new retail locations for 2014 will not offset the closures. Much of domestic retail expansion in 2014 is about discount stores. Between Dollar General, Family Dollar and Dollar Tree, more than 1400 new discount stores will be opening, using the original Walmart expansion strategy. At the same time, Walmart is abandoning its own strategy. The New York Times reports that: (brackets by the Wrongologist)

Walmart’s woes [are causing] a change in corporate strategy. Walmart will slow store openings in the United States next year, opening 60 to 70 supercenters, compared with 120 this year…The Company is shifting its focus toward smaller Neighborhood Market grocery stores, and it said it would open 180 to 200 of them next year. It is also accelerating its online offerings…

Auto sales (mostly at retail box stores) have been booming, Reuters reports that: (brackets by the Wrongologist)

The annualized sales rate slowed to 16.4 million [units]…above last year’s 15.4 million, but well below the 17.5 million [annualized] pace in August.

This performance was partly due to cheap money, long financing terms, and a focus on subprime customers. Jim Lentz, US chief executive at Toyota Motor Corp:

We are seeing more ‘subprime,’ which is good.

In one report, a 71 year old Queens NY woman on food stamps got a $16,000 loan on a used car:

After two test drives and about two hours, the dealership found her a loan: $16,000 financing for a used 2014 Ford Fiesta. There would be a bank fee of about $4,000, and she would have an interest rate of 20.23%

Subprime, indeed. As for the role of consumer spending in our economy, American consumers are stressed. Many have had to curtail their spending, or make up the difference with borrowed money. Closing retail stores may be the canary in a coal mine for our consumer economy. For some business owners, considering some retail store analytics might provide insight into how to keep their stores open.

The best measure of economic security is ownership of wealth. Yet, using Median Wealth as a yardstick, the middle class in the US ranks only 27th in the world. Here is how we rank against two of our allies:

#27 USA: $44,911 ? hardly enough to pay for an operation in a US hospital
#1 Australia: $219205
#6 United Kingdom: $111,524

Global wealth has reached a new all-time high of $241 trillion, up 4.9% since last year and 68% since 2003, with the USA accounting for 72% of the latest increase.

Perhaps the solution in the US is to not to tax based only on income, but to tax based on income and assets. If you own or control 80 to 90% of the assets of this country, and the country’s resources are securing, maintaining, and protecting your assets, it stands to reason that you should also be bearing the majority of the tax burden of the country.


Sunday Cartoon Blogging – October 19, 2014

Your thought for the weekend is from the movie, The Birdcage:

Senator Kevin Keeley: Louise, people in this country aren’t interested in details. They don’t even trust details. The only thing they trust is headlines.

Well, CNN headline writing is as bad as their broadcast. Is that Helvetica?

COW two Fonts

Since it is Nobel Prize time, here is an anecdote by Walter Gilbert (1980 winner in Chemistry) about what happens when you travel with your medal:

When I won this, my grandma, who lives in Fargo, North Dakota, wanted to see it. I…decided I’d bring my Nobel Prize. It was uneventful, until I tried to leave Fargo, and went through the X-ray machine. I could see they were puzzled. It was in my laptop bag. It’s made of gold, so it absorbs all the X-rays—it’s completely black. And they had never seen anything completely black.

“They’re like, ‘Sir, there’s something in your bag.’
I said, ‘Yes, I think it’s this box.’
They said, ‘What’s in the box?’
I said, ‘a large gold medal,’ as one does.
So they opened it up and they said, ‘What’s it made out of?’
I said, ‘gold.’
And they’re like, ‘Who gave this to you?’
‘The King of Sweden.’
‘Why did he give this to you?’
‘Because I helped discover the expansion rate that the universe was accelerating at.’
At which point, they were beginning to lose their sense of humor. I explained to them it was a Nobel Prize, and then their question was: ‘Why were you in Fargo?’”

How corporatists fight Ebola in Texas:

COW Ebola War

The truth is, everyone is infected by the headlines:

COW Ebola Fear

And the headlines gripped Wall Street:

COW Wall Street


Sunday Cartoon Blogging – October 12, 2014

Be afraid. Be very afraid.” In 20 letters, it’s the platform and program of the GOP:

COW Ebola Imports













Complete version: Be afraid of Africans, Hispanics, Democrats, Liberals, Muslims, Atheists, Foreigners, Gays, etc. If fact, be afraid of just about everyone except the GOP. Because those OTHERS will take your money, take your job, take your gun, infect you with diseases, break into you house, rape your women folk, strengthen and enlarge your government, spend your taxes, use your resources, raise your prices, insult your God, hurt your feelings (saying ‘Happy Holidays’ instead of ‘Merry Christmas’), corrupt your children, impoverish your descendants, enlarge your government, make life in your suburb or your condo no better than that of a slave on a plantation… and did we say enlarge your government?

If the above makes sense to you, then vote the Republican ticket in November. The GOP won’t accomplish anything, but they will validate your paranoia, and that will feel so good!

Stock Market gives back all of the year’s gain in one week:


COW Bad Week on Wall Street

The Supremes non-decision causes a wedding:

COW Shotgun Wedding

Malala winning the Nobel makes many parents jealous:

COW Slacker

ISIS recruiting steals American Slogan, “E Pluribus Unum”:

COW Out of many One


Stock Buybacks: Who Benefits?

Bloomberg reported this week that companies in the S&P 500 are poised to spend $914 billion on share buybacks and dividends this year, or about 95% of their corporate earnings. Data compiled by Bloomberg and S&P Dow Jones Indices show that money returned to stock owners exceeded profits in the first quarter and may again in the third quarter of 2014.

The proportion of cash flow used for stock repurchases has almost doubled over the last decade while it’s slipped for capital investments. So, who is benefiting? From Bloomberg: (emphasis by the Wrongologist)

Buybacks have helped fuel one of the strongest rallies of the past 50 years as stocks with the most repurchases gained more than 300% since March 2009. Now, with returns slowing, investors say executives risk snuffing out the bull market unless they start plowing money into their businesses.

The S&P 500 Buyback Index (yes that is a thing) is up 7.5% percent this year through October, compared with the 6.5% advance in the S&P 500. It did better in the past, beating it by an average of 9.5% since 2009. Excluding the two years in which we had a recession (2001 and 2008), dividends and stock buybacks have represented 85% of corporate earnings since 1998. So, there has been little reinvestment in the business going on. Stock repurchases have helped buoy the bull market since 2009 by about $2 trillion.

Consider that corporate revenues have had an average growth rate of 2.6% per quarter in the past two years, while per-share earnings grew at 6.1%, more than twice as fast, says Bloomberg. Since earnings per share (EPS) is the ratio of the total earnings divided by the number of shares outstanding, you can either increase the numerator or decrease the denominator in order to grow EPS.

Corporate America has decided it is easier to reduce shares rather than to grow earnings.

This translates into bad long-term corporate strategy. During the same period, the portion of earnings used for capital spending has fallen to about 40% from more than 50%. This use of cash to fund buybacks has left US-based companies with the oldest plants and equipment in almost 60 years. Bloomberg says that the average age of fixed assets reached 22 years in 2013, the highest level since 1956, according to annual data compiled by the Commerce Department.

Today, shareholders are the most mobile of corporate stakeholders. The days of “buy and hold” investing are over; it is now just for the smallest of investors. For example, high frequency trading (HFT) represents 70+% of trading by volume. The HFT “investors” often hold share ownership for fractions of a second. The HFT firms are in bed with professional fund managers who own large chunks of equity in public companies. Together, these shareholders ONLY want corporate strategies that maximize short-term profits and increasing dividends. Coupled with the growing trend of limited, or little, voting rights for stock ownership by the public, professional managers have a free hand to get wealthy without responsibility for longer term corporate performance. This plays into the hands of CEOs and other C-level managers who derive most of their compensation from increasing value of stock. Equilar, an Executive Compensation firm, reports that about 63% of S&P CEO compensation is in the form of stock.

This is not managing a business, it is liquidating a business. While it may be in the individual executive’s short-term interest (company stock appreciation and bonuses) ultimately, it will kill the US economy. Look for more complaints about the American workers when they are unable to compete, using worn out, or obsolete equipment.

We need different ideas to inform our effort to steer the ship of state to higher GDP growth and full employment. How about tying executive performance to adequate return targets for all STAKEHOLDERS rather than to a maximized return to shareholders who no longer buy and hold shares?

You can only go so far with financial engineering before you actually have to improve your business with real revenue and profit growth. Companies have done about all that they can in terms of maximizing the ability to do these buybacks.

What would be wrong with trying some new ideas?