Author: Daniel Indiviglio

One of the more controversial financial regulation proposals out there would be a tax on securities trading. The intent with such a tax would be to curb speculative trading and provide Uncle Sam with more revenue. But according to a Bloomberg article from yesterday, such a tax could drastically harm liquidity. It could kill up to 90% of trading volume. If that’s true, then this tax would clearly do more harm than good.

The bill, sponsored by Rep. Peter DeFazio (D-OR), would do the following, according to Interactive Brokers Group Inc. Chief Executive Officer Thomas Peterffy:

DeFazio’s proposal would put a tax of 0.25 percent on stock transactions and 0.02 percent on derivatives including futures, options, swaps and credit-default swaps. A transaction of 200 shares at $40 each would result in a $20 tax, compared with a commission of $1 for active traders at Interactive Brokers, Peterffy said.

That sounds like a pretty severe tax to me. Here’s what he sees as the outcome:

“The mother of all creators of havoc on Wall Street is this looming transaction tax,” said Peterffy, who is also president of the brokerage and automated market-making company, in an interview yesterday. Interactive Brokers is based in Greenwich, Connecticut. “Trading volumes would plunge by about 90 percent, markets would become illiquid and tens of thousands of people would lose their jobs.”

Sending a fee to the government for every transaction would hurt asset managers, brokerages and so-called high-frequency traders, a group that accounts for 61 percent of volume, according to New York-based research firm Tabb Group LLC. Interactive Brokers handles about one-seventh of U.S. options that change hands.

The bill’s sponsors have “no understanding whatsoever” about its likely effect, Peterffy said.

I think that last line is probably true. I went ahead and looked up the bill to see if Peterffy’s interpretation was accurate. It’s hard to tell. The way I read the bill, the tax rate would depend on how much the U.S. government needs in order to recoup the TARP bailout money and Federal Reserve assistance. That still, however, seems like an awfully large tax to impose on trading. So even if Peterffy’s calculation isn’t exactly right, I do agree that it would have a very significant effect on liquidity.

And that’s probably not wise. Liquidity is a good thing. I understand that speculation is looked at very negatively, but speculation is precisely what creates market liquidity. That’s particularly true in the derivatives market. There is often a fine line between a thoughtful investment decision and a speculative bet. After all, even the most thoughtful investment decisions could go awry. It’s impossible to know what the future holds, so all investments have a speculative nature, though some more than others.

So the government faces the question of whether it can stomach the harm this tax could do. If it really wiped out anything near 90% of the trading volume, then mass layoffs across Wall Street would certainly follow. I know everybody hates bankers and traders these days, but is Washington really prepared to unleash thousands of more jobless Americans on the economy to curb some speculative trades? That’s all it would really accomplish, as the tax revenue would end up being far lower than expectations, since it would deter trading so greatly.

Luckily, I would be quite surprised if this tax actually ended up getting through Congress. The idea of passing a bill with the expressed purpose of harming market liquidity shortly after a credit crunch is pretty clearly misguided. If the government wants to recover its bailout money, there are surely safer ways to do so that won’t bring securities trading to a grinding halt.

One aspect of Apple’s introduction of the iPad hasn’t gotten that much attention: its decision to stick with AT&T. Most of the mention of this fact I’ve seen has focused on whether or not AT&T can handle the additional data traffic that the iPad will create. Others are complaining that AT&T didn’t offer additional service providers. I’d make a different observation: it could show that iPhone users’ hopes and dreams that Verizon was waiting in the wings to take over for AT&T later this year won’t be realized.

First, the iPad will technically be “unlocked.” But don’t get too excited. Here’s wirelessinfo.com explaining what that means:

The 3G modem on the device is unlocked: it will work with any GSM network that supports the 850, 1900 and 2100 Mhz frequencies. This means it will work with AT&T, but not with T-Mobile in the USA. Abroad, it will work with most GSM networks.

So even though you don’t technically have to use AT&T, if you want to use its 3G capabilities stateside, then you still have to use AT&T.

In other words, in the U.S., AT&T will be the only wireless carrier profiting from iPad users wishing to utilize its 3G data connection. It’s interesting to note, however, that AT&T is offering data plans with no commitment. Instead, they’re prepaid. That’s a huge departure from what mobile data users are used to — usually you have to sign up for something like a 2-year commitment. But the data still only costs $30 for unlimited usage, the same price as the iPhone data plan, but with no commitment.

So maybe Apple simply chose AT&T because it liked that approach — which customers should love. If no other data providers offered similar pre-paid, no-commitment plans for just $30 per month, then that could have driven Apple’s decision to stick with AT&T.

But if Verizon or other network providers were in late-stage talks to carry the next generation iPhone at some point during 2010, wouldn’t Apple have given them some opportunity to get in on the iPad fun? I would think so. If Verizon, for example, had been announced as the iPad 3G data carrier, then that would have been a clear signal that AT&T’s days as the sole iPhone service provider were likely numbered.

But that’s not what happened. We saw a different signal: Apple’s allegiance to AT&T reinforced. While it isn’t beyond the realm of possibility that we could still get an announcement later this year that Apple is opening up its next generation iPhone to other service providers, I don’t see that as terribly likely given that the company has stuck with AT&T for the iPad.

The Obama administration’s foreclosure prevention effort through the Treasury’s mortgage modification program isn’t going as well as hoped. Last month, I reported that it had a mere 1% success rate thus far. I wish I could calculate its success through December, but as I mentioned in my past post, I can’t. The Treasury has released some new rules this week that it hopes will help the effort. While I’m not convinced it will get its rate of success much higher, it should make for a more efficient process.

No More Lost Docs?

Here’s what the new rules say about how servicers should collect documents going forward:

Supplemental Directive 09-01 gave servicers the option of placing a borrower into a trial period plan based on verbal financial information obtained from the borrower, subject to later verification during the trial period. Effective for all trial period plans with effective dates on or after June 1, 2010, a servicer may evaluate a borrower for HAMP only after the servicer receives the following documents, subsequently referred to as the “Initial Package”. The Initial Package includes:
– Request for Modification and Affidavit (RMA) Form,
– IRS Form 4506-T or 4506T-EZ, and
– Evidence of Income

For starters, it was crazy that these modifications could enter trial period based on verbal information only. That means people who potentially could not have afforded the modification in the first place could have simply claimed a higher income than they could actually prove in order to stay in their defaulted homes a little longer. They could have then lived in that home for months during the trial period before re-defaulting.

This change should have two effects. First, I would expect it to take much longer to get trial modifications, since documents must be provided and verified. That, after all, is what’s making permanent modifications so difficult. And that leads to the second effect — it should significantly decrease the number of trial modifications. What we’ll have now is a lower percentage of applicants qualifying for trial modifications, but likely a very similar percentage qualifying for permanent modifications.

Will this eliminate the issue of servicers “losing” documents? I wouldn’t count on it. If this was really a major problem before this week’s changes, it will remain a problem. Now, instead of claiming that documents were lost during the trial period, servicers can just say they didn’t receive or haven’t yet processed all the documents for the trial modification instead. I’m not sure why anyone believes the requirement that these documents are received sooner will suddenly result in servicers acting any more responsibly, if they acted irresponsibly in the past.

Resolving the Trial Period

The second part of the revised rules has to do with all of those modification program participants suck in the trial period. The Treasury wants those 787,231 active trial modifications (through December – .pdf) resolved. After all, of the 902,620 trial modifications offered since the program started last spring, only 112,521 have been made permanent.

It intends to do that by essentially telling servicers to either make the modifications permanent, or end them. If the documentation isn’t up to par, then the trials should fail. But it also relaxes the documentation requirements slightly. For example, if a “Hardship Affidavit” has not been submitted, but the trial is otherwise successful, it can be made permanent.

I think this will have two sort of obvious results: some modifications will be made permanent sooner, but probably more trials will be cancelled sooner. So we’ll see more foreclosures hitting the market more quickly than if these trial modifications had remained in limbo for longer. I think that’s actually a positive outcome, because if these modifications were destined for failure, at least we’ll know that sooner than later.

Overall, these changes to the modification effort appear sensible. But I’m a little doubtful that we’ll see many more permanent modifications overall as a result. If anything, modifications that would have been made permanent eventually will do so more quickly. But the other side of the coin is that we’ll see the failures more quickly too. Still, both those outcomes are more desirable than program participants being stuck in trial modifications indefinitely.

I was working on a post about the Treasury’s new mortgage modification rules (to soon follow) when I noticed something kind of amusing. Last month, I noted that its mortgage modification program was doing incredibly badly in terms of providing permanent modifications to struggling homeowners who requested assistance. In fact, it had a mere 1% success rate through November. Looking at this month’s report, I suddenly realized that I couldn’t make that calculation any more: the Treasury removed the denominator of the ratio from the report.

Here’s what the chart looked like in November’s report (.pdf):

And here’s that chart in this month’s report (.pdf) for December:

Notice anything? In the new format, the Treasury added a few lines, and dropped the top one from November — the number of troubled homeowners who actually applied to the program. Now anyone who reads this report can no longer evaluate how successful it was, based on the total number of applicants.

I looked throughout the rest of the report, and I couldn’t find this statistic included. On one hand, I can’t blame the Treasury. It was really embarrassing. If no one can calculate the program’s success rate, then that should eliminate some of the negative news stories plaguing the program, like those with headlines such as “1% Success Rate For Obama Administration Mortgage Modification Program.” On the other hand, this isn’t the kind of transparency the President promised when criticizing the Bush administration’s opaqueness during the campaign.

Update: (4:38pm) Naturally, I contacted the Treasury about this, and just got a response. They informed me that the latest number (through December) is 3,297,817. The reason they didn’t include it: “there didn’t seem to be much interest in that metric and we’re trying to make the report as user-friendly as possible.” By the way, in case anyone’s interested in that calculation I couldn’t make — it’s now the case that 3% of the requests for financial information sent to borrowers have resulted in permanent modifications. That’s up from 1% in November. So it’s improving!

Over the past few weeks, the media had become very interested in the prospect that Ben Bernanke might not be reconfirmed as the chairman of the Federal Reserve. I had maintained, however, that this was sensationalist “imagine if” journalism. I never bought into the idea that his nomination was in serious jeopardy; and indeed, it passed easily 70 to 30, though it was closer than the vote is historically for the nation’s top central banker. And who made sure that Bernanke got another term? Republicans.

If you dissect the vote, you find something very interesting: had the Republicans chosen to do so, they could have killed the nomination. The numbers come out 48 Democrat ayes, 22 Republican ayes, 12 Democrat nays, 18 Republican nays. Democrats alone did not constitute a majority of ayes. Thus, if those 22 Republicans had voted nay instead of aye, we’d be looking for a new Fed chair right now.

So sensationalists weren’t completely wrong to predict problems for the confirmation: they were right that quite a few Democrats — 12 — would ultimately rebel against President Obama’s nomination. And that is a little surprising, given that their party’s leader, President Obama, nominated him for a second term. But those who worried about the nomination were wrong to think that Republicans would band together to fight an Obama nomination. If they had, they would have succeeded in kicking Bernanke out, thanks to those 12 Democrat nays.

I predicted this result all along. Back in December, I wrote:

How about Republicans? They might love to stick one to Obama, right? Not under this circumstance. If they reject Bernanke, then Obama gets to pick someone new. Remember President George W. Bush appointed Bernanke, who identifies himself as a Republican. Do Republicans really believe they’ll be happier with a different Obama pick than Bernanke? If they do, then they’re kidding themselves. Deep down, they must believe they would be a lot better off with Bernanke than any alternative the President might suggest.

When push came to shove, the prospect of a more liberal, partisan Fed chair with a strict allegiance to the Obama administration must have outweighed the imagined joy of embarrassing the President. Or we can be less cynical and believe that politics had less to do with it, but that those 22 Republicans actually thought Bernanke was the best man for the job. Whatever their reasons for standing behind Bernanke, I’m sure the market breathed a sigh of relief, and the economy will ultimately be better off.

The U.S. Department of Commerce released its preliminary 4th Quarter GDP calculation today. It looks pretty good. GDP grew by a whopping 5.7% annualized pace during the quarter, the fastest growth the U.S. has seen since 2003. That’s the second quarter of positive income growth, and significantly better than the 3rd quarter’s 2.2% growth. Let’s dig into the report.

First, a disclaimer: 4th quarter GDP may not have been 5.7%. In fact, it’s very likely it wasn’t. This is just the first estimate, and there are two more revisions to come before the number is final. You may recall that 3rd quarter GDP started at 3.5% in its first estimate, only to be revised downward twice, to eventually settle at a much more mild 2.2% rate.

So let’s look at what makes up the 4th quarter’s growth. As it turns out, personal consumption actually did worse in the 4th quarter than the prior. It made up 1.4%, versus 2.0% in the 3rd quarter. Within that, goods did worse than services, adding 0.6% and 0.8% growth, respectively. As for those goods, Auto sales actually brought down the quarter’s GDP by 0.6%, compared to adding 1.45% in the 3rd quarter.

Gross private domestic investment played a huge role, accounting for 3.8% of the growth. That compares to a measly 0.5% rate in the 3rd quarter. The largest component comes from the change in real private inventories. It made up 3.4% of the 5.7% growth. That’s a vastly larger contribution than in the third quarter, when this component made up just 0.7%. Businesses didn’t liquidate their inventories as much in the 4th quarter as in the 3rd. This means that final sales made up the other approximately 2.2% of the 5.7% growth.

Another thing to note about the investment contribution: it had more to do with nonresidential than residential fixed investment. Business investment added 0.3%, up from a decline of 0.2% in Q3. Meanwhile residential investment accounted for only 0.1% — that’s down from a 0.4% contribution in the 3rd quarter.

Net exports were positive, accounting for 0.5% of the quarter’s GDP. This is also better than Q3, when they resulted in a 0.8% decline.

So this is good news, but, again, we don’t know what the final number will actually be. I would also suggest holding off on popping the champagne to celebrate a robust U.S. economy. Most economists predicted a healthy rate of GDP in Q4-2009, but expect that to decline from there to more moderate levels through 2010. And unemployment is also expected to hover near double-digits throughout the year.

Jobs programs helping to alleviate 10% unemployment are great. But what’s not so great? Slow-moving jobs spending on initiatives that are likely to be money losers in the long-run and mostly benefit foreign companies. In light of that, how should we think about President Obama’s announcement of new high-speed rail initiatives? I think there are a few things to consider.

Here’s the news about the two most major projects, via Reuters:

The largest of the $8 billion in rail grants, which originated in last year’s economic stimulus package, will go to major corridors, with more than one-quarter of the funds dedicated to California.

The state will get $2.25 billion for a 400-mile connector between Los Angeles and San Francisco, with trains designed to travel up to 220 miles per hour (354 kph), U.S. transportation officials said.

Florida will receive $1.25 billion to develop an 84-mile link between Tampa, Orlando and Miami. Trains would reach 168 mph (270 kph).

To be clear, these aren’t commuter rails. They are for regional travel between large metropolitan areas. That means they will be used primarily for business travel and some leisure travel. So, in order for these rails to be successful, there would have to be a great deal of demand for business travel between the cities they serve.

For the Los Angeles-San Francisco route, that may be the case, but I’m not entirely sure. According to the rail website, it will be significantly slower than the flight. For example, the LA-San Fran route takes one hour and 15 minutes by plane, but two hours and 40 minutes by train. But from San Diego to San Francisco, a flight would take just an hour-and-a-half. It would take the rail about four hours. So it depends on how many travelers will prefer to spend more time on a train than they would have in a plane. And the further south you get from Los Angeles, the less likely you’re willing to make that tradeoff.

Florida has an even worse problem. It has far less business and industry than California. Now you’re talking about Miami, Tampa and Orlando having enough business travelers to satisfy the demand for the rail. I think that’s highly unlikely. It may get more leisure travelers than the California rail, given the Orlando theme parks, but I’m not so sure. It helps to have a car in Orlando. Moreover, if it’s a family trip, will there be any cost savings by buying 4 or 5 round trip train tickets versus the gas to drive to Orlando? It’s not that far a drive from either location.

I am also a little troubled by this from the Reuters article:

Many of the companies are based overseas since the U.S. virtually abandoned rail development in the 20th century to focus on highway development.

Transportation officials say companies with potential commitments on the table include: General Electric Co’s transportation unit; Canada’s Bombardier Inc; French consortium Alstom; Germany’s Siemens; Lockheed Martin Corp; Korea’s Hyundai Rotem Co, Hyundai Motor Co’s heavy industry unit, and Japan’s Nippon Sharyo Ltd.

So what you’re saying is that, of the seven most major companies that will profit from this government-sponsored endeavor, five are foreign-based? I’m not a protectionist by any stretch of the imagination, but I would have liked to have seen more U.S. government stimulus money going towards an industry where American companies would more likely benefit.

Finally, I also worry about how long it will take to break ground on these rails. The government will have to acquire or seize additional land to build the routes and stations. There will be permits involved and lots of logistic headaches to be had. After all, it’s been nearly a year since the stimulus passed, and we’re just now hearing the announcement of these initiatives. The projects are hardly shovel-ready.

I’m not convinced these rail initiatives are the best use possible of stimulus money. But here’s hoping that I’m wrong: I’d be very happy to see these projects quickly create thousands of jobs, benefit mostly U.S. companies and turn out to be wildly popular. While I love the idea of a high-speed rail, I am not persuaded that these U.S. cities have high enough population density to make the rails profitable.

Yesterday capped the end of the week’s pretty ugly housing market data. December was a terrible month for new and existing home sales, despite the government’s expanded home buyers credit. Foreclosures, defaults and delinquencies continue to rise. Meanwhile, the Obama administration’s mortgage modification effort looks like a stinker. Banks are also reluctant to allow the housing market to hit bottom, which merely prolongs the agony. We could be in for a very, very slow recovery in residential real estate.

First, let’s take a look at the last of the week’s data: new home sales. Recall, existing sales were down 17%, seasonally-adjusted. New sales didn’t do quite as badly, but were pretty awful too, as the Washington Post reports:

In December, new-home sales fell 7.6 percent from the previous month, to a seasonally adjusted annual rate of 342,000, according to the Commerce Department. Sales were down 8.6 percent compared with the same period a year earlier.

Here’s new home sales in a chart:

While alarming, this information is not surprising. If there’s excess inventory and lackluster demand, then existing home sales should attract more sales than new homes through better deals to be had — especially if foreclosure auctions and short sales are taken into account.

Yet, that excess housing inventory doesn’t even reflect how many foreclosures we should be seeing, given the trouble in the housing market. I’ve commented on shadow foreclosure inventory problem a few times. Those are the homes based on defaulted mortgages that banks hold back from hitting the market. Two posts by Mike Konczal note that banks aren’t particularly eager to foreclose, as this chart he provides shows:

What’s the holdup in closing these foreclosures? Part of it is modification efforts. In also commenting on Konczal’s work, Felix Salmon notes:

The key thing to note here is the bottom, darkest line: while delinquencies and initiated foreclosures have been rising, there’s a limit to how many foreclosures can actually be completed, and that limit seems if anything to be falling.

What this says to me is that while we aren’t going to see a wave of foreclosures, we are going to see a large and more or less constant number of foreclosures for the foreseeable future — with all the gratuitous value destruction that implies.

I think that’s exactly right. And the modifications aren’t working for two reasons. First, many troubled homeowners now have no income stream, so there’s no payment amount they can currently afford. But even for those who still have a job, banks can only lower the interest rate so much or extend the term so long. At some point, you would have to lower the principal, which banks are quite uncomfortable doing.

Banks don’t want to lower principal amounts for two reasons. First, it’s logistically difficult when these loans are part of a securitization. But possibly more importantly, they can’t stomach lots of mortgage losses at once. By prolonging the agony, at least they can absorb those losses more slowly, as borrowers re-default or remain in a defaulted home for a period of months or years.

This should make for a very slow-to-recover housing market. That initial jump in demand we saw last spring, summer and fall probably had more to do with government incentives pulling demand forward than a true housing rebound. Recent data indicates even that may be exhausted. Meanwhile, credit is becoming harder to get for potential home buyers. The housing inventory probably can’t shrink much, because banks can only hold onto these defaulted homes for so long before having to foreclose.

I take this to all indicate that housing appreciation, on average, should remain very low, if positive, over the next several years. Looking at the chart above, I can’t see any reason to believe that foreclosures will decline dramatically for years. I don’t know how a housing market recovers if that’s the case.

What’s going on with autos? It seems the industry’s world has been turned on its head — and quickly. The traditionally less dominant are dominating, while the traditionally strongest are stumbling. We learn today that Ford had an incredible year, while GM’s bankruptcy troubles nabbed many 2009 headlines. Hyundai’s performance last year was tremendous, and Toyota is in the midst of a huge, embarrassing product recall. Are we in for a new auto industry paradigm?

First, the news. Here’s a blurb on Ford’s impressive success, via CNN Money:

Ford Motor reported its first full-year profit since 2005 and said it expects to be profitable again in 2010.

The automaker, which has outpaced the turnaround at both its domestic and some overseas rivals, said Thursday that it earned $2.7 billion in 2009.

How big a reversal is that? This big:

And Hyundai just keeps gaining market share. MarketWatch says:

Hyundai Motor Co. Thursday reported its net profit nearly quadrupled in the fourth-quarter from the year before, as improving economic conditions and tax incentives by various countries boosted vehicle sales in and outside South Korea. Net income for the quarter-ended December surged to 945.5 billion won ($814 million), according to reported figures, beating analysts’ median estimate of 828.6 billion won in a Factset Research survey. Sales grew 9.3% to 9.65 trillion won.

I’ve written about Hyundai’s recent success a few times. It’s partially because consumers in this bad economy are looking for bargains, and few can beat Hyundai’s prices. But its more recent push for higher quality has also alleviated many people’s fears about its vehicles’ dependability.

Then there’s Toyota. It’s recalling millions of its autos due to bad gas pedals. How widespread is this problem? The Detroit Free Press reports:

Toyota and its dealers face the daunting prospect of being unable to sell models that made up 58% of Toyota’s U.S. sales last year for an unknown period of time until the company and the U.S. government agree on a way to prevent Toyota’s accelerator pedals from sticking.

And I don’t even need to get into GM, because everyone is familiar with its problems. Until the company is released from the government’s control, people will be very wary about purchasing its vehicles.

So what does it all mean? That this is the perfect time for Ford and Hyundai to eat into the enormous market shares of GM and Toyota. And that’s exactly what’s already beginning to occur. I’d expect more of the same in 2010. We should see an even more competitive auto market going forward.

Yesterday, Apple introduced its revolutionary new iPad tablet device. The iPad is neither an eReader nor a laptop. It’s somewhere in-between. It’s kind of like an iPhone and Kindle had a baby, and pumped it full of steroids. While the new device is undeniably cool and sooo pretty, I worry that its uniqueness, toy-like nature and price tag will hold it back from widespread success.

A Little Too Revolutionary?

I don’t think anyone doubts that the iPad is a brand new kind of device. It’s different from anything else out there. But is it too different?

People who want laptops won’t really want one: it isn’t as functional as a full-fledged computer. People who want eReaders won’t really want one: it’s got way more features than a simple eReader, at a much higher price tag. So Apple has to conjure up consumer demand for a totally new kind of product. It isn’t easy to create interest in something new out of thin air.

But what’s worse: I don’t know what kind of consumer it will appeal to. Obviously Apple fanatics who can afford one will definitely want it. But that’s a relatively small segment of the population. The other consumers who it could theoretically appeal to might be PC folk who are heavy media users and love their iPhones, but also love books, Internet surfing and magazines. I happen to be a life-long PC user obsessed with my iPhone (to the point that I think my fiancé gets jealous sometimes). I also work for a magazine, am a news junky and spend countless hours online. I’m also a tech toy enthusiast. I perfectly describe that consumer. Yet, I have no intention of getting an iPad. Even if it were half the price, I wouldn’t consider it. If it doesn’t appeal to me, who will want one?

It’s A Toy

A fundamental problem that I see for the iPad is that it’s really just a toy. It’s a non-essential device that consumers don’t have a serious need for. That contrasts greatly with mobile phones and laptops. In this day and age, each are essential. In talking through this point with my colleague Derek Thompson, he noted that MP3 players were also non-essential before the iPod gained widespread popularity. That’s only sort of true. Before the MP3 player, everyone had Walkmen, portable radios, car stereos, etc. MP3 players just made listening to music more convenient.

Derek also wrote a while back about a concept that I think is worth noting here. In a post a while back, he said:

Computers are the ideal procrastination machine because they hold both our work and a million ways to procrastinate from it. This is different from television, where turning the cable box on signals to your brain: Power off. Work time over. If Apple is building a flat, personal entertainment tablet, it’s counting on consumers to want a laptop that’s less like a computer and more like a television: A device that we’ll only power on when our minds are ready to power off.

In other words, it’s a toy that you can do a little work on. No one will be drafting business documents on the iPad. It’s just not feasible given the small screen space once the keyboard is on-screen.

A Very, Very Expensive Toy

Don’t get me wrong: people do like toys. And if the iPad were relatively inexpensive, then it might be able to get past its toy status. But it isn’t. It’s actually very, very expensive. The cheapest non-3G version starts at around $500. You could buy two-and-a-half iPod touches for that price. The version with 3G access starts at $629. You could buy six-and-one-third iPhone 3Gs (with contract) for that price. In fact, for a few hundred more dollars, you could get a full-fledged Mac laptop with a 250GB hard drive.

But let’s compare it to some other popular devices. How about netbooks? You can get seriously nice netbooks for less than $400 — $100 less than the iPad. And you can do work on netbooks, as well as enjoy media. Heck, you can get great PC laptops these days for less than $500.

As for the eReaders, they’re much cheaper too. Take the more expensive Kindle, priced at $489. That includes 3G access. The 3G iPad starts at $629 — $140 more expensive. And you have to pay for monthly 3G access, unlike with the Kindle. For two years, that adds another whopping $720 for unlimited data!

I’ve seen estimates prior to the announcement of the iPad that predicted Apple could sell as many as 3 million tablet devices in its first year on the market. I think that’s wildly optimistic now that we know more about the iPad. I’d be very surprised if it sold more than 1 million during year-one. I just can’t see that many people willing to spend such an enormous amount of money on a toy. And given the economic conditions consumers will have to endure in 2010, I think even fewer people than usual will be willing to fork over that amount of cash in the iPad’s first year. Apple will certainly sell some, but I would be shocked if it found widespread success without its price coming down significantly.

Still, it’s a super-cool toy. And if anyone (like Apple) wants to buy me one, I would be happy to play with it. Check out the official video below:

I listened to the AIG bailout hearing yesterday. The testimony of those involved, including current and former Treasury Secretaries Tim Geithner and Hank Paulson, mostly focused on the same message. Yes, we hated having to do the AIG bailout, but it was utterly necessary to save the U.S. economy. I actually agree. Unfortunately AIG was too interconnected to simply fail. But that doesn’t mean that the situation couldn’t have been handled better.

First, a brief background, for those who aren’t up to speed on the situation. When the U.S. government decided to bailout AIG, it agreed to pay its obligations. Some of those obligations included swap derivatives. Because of those swaps, lots of big banks, including Goldman Sachs and a few foreign banks, got billions of dollars of bailout cash.

Many people complained about this for a number of reasons. First, it looked a lot like a sort of back-door bailout for banks. If they were the ultimate recipient of billions of dollars, then the government could have just wiped out those obligations and given the banks that money directly with the usual strings attached. Second, some complain that the government should have forced the banks to accept less than par for those swaps. For example, if AIG had gone into bankruptcy instead, it’s very unlikely that the banks would have gotten 100 cents on the dollar, but would have been forced to take a haircut.

As for that second complaint, the banks, particularly Goldman, claim that they were hedged anyway — so it wouldn’t have matted if the government didn’t pay them. As for why the government paid the obligation in full, it claims that it had no choice. There was no authority by which the government could have demanded banks accept less through a bailout.

This problem would have been more easily solved had there been a resolution authority in place to wind down AIG with the authority to distribute the firm’s assets quickly and cleanly. Unfortunately, there wasn’t one, but with any luck Washington’s regulatory effort will correct that.

But I was struck when Rep. Darrell E. Issa (R-CA) asked Special TARP Inspector General Neil Barofsky:

Had we used other means to underwrite AIG, such as we’ll buy assets at a discount, or we won’t buy them. We will guarantee or buy at a discount — you decide whether you want our triple-A rating — versus actually getting the transfer at a time when these banks wanted a transfer. If any of these other techniques that you are now aware of could have that logically been used, would we be in as bad a situation of not getting paid back as we are?

Okay, so I don’t really understand much of what Issa is talking about in his specific suggestions, as they aren’t particularly comprehensible. But the inquiry he’s making here — could we have done things better — is a good one. I think they could have.

In a purely logistic sense, AIG could have failed. The problem would have been the fallout. Its failure would have created incredible economic uncertainty. The firm would have to undergo bankruptcy proceedings. How much will swap counterparties get? What about creditors? And how will that affect those who AIG’s clients do business with? What about the consumer insurance products? Disaster. It could take months or years to get answers to all of that, while the market collapses under the weight of the unknown.

But what if the government had publicly stated (as bankruptcy was imminent): “Okay, AIG: you fail. But in the course of bankruptcy, after handing out whatever assets you’ve got left as the court dictates, we will help to make some of your customers, creditors and counterparties, whole. Specifically, we’ll guarantee all of your consumer insurance products (think life and health) in full. Your creditors will get, say, 50-cents-on-the-dollar for the debt you owe. Your counterparties will get, say, 80-cents-on-the-dollar for the obligations you have with them. Etc. And by the way, any current TARP recipient that we ultimately provided a net cash infusion to based on this guarantee will have to pay us back just like it must with the other bailout money it borrowed from Uncle Sam.”

I just made up some numbers here to give an example, but the point is that this wouldn’t have been a bailout for AIG. It would have been a situation where the government let AIG fail, but assured anyone the firm did business with that they wouldn’t lose everything owed. Instead, it would give them a concrete floor for their losses and that cash infusion they needed. After all, if AIG’s assets turned out to be sufficient to cover more than the minimum the government guaranteed, then its customers, creditors and counterparties could ultimately do even better.

I think something like this would have been completely legal and still would have eliminated most of the uncertainty that a regular bankruptcy would have caused. Now Goldman Sachs, for example, would know it was getting 80-cents-on-the-dollar for its swaps with AIG. Would this scenario have still cost taxpayers money? Possibly. But they wouldn’t have owed 100-cents on the dollar for all of AIG’s obligations, with little hope of recovery, as they essentially did.

Of course, hindsight is 20-20. But it’s a little disturbing that policymakers weren’t creative enough to try to think up some alternatives to forcing taxpayers to foot the bill for all of what AIG owed, and still ultimately keep the company afloat. In the future, I hope there’s a resolution authority in place that has tailored wind-down plans for big firms like AIG so such creativity isn’t necessary. And that wind-down should also be prepaid by firms as a sort of failure-cost insurance fee, so that taxpayers won’t be on the hook for any of the associated costs. But even without such an authority in place, I find it hard to believe that those who engineered the AIG bailout couldn’t have done better.

The Federal Reserve’s Federal Open Market Committee released its January meeting statement this afternoon. Little of it was shocking, but some of it was notable. It intends to go ahead with its plan to end most of the credit facilities, created during the financial crisis, in the first quarter. It also continues to see the economy strengthening. I have a few observations.

Here’s what the FOMC says about the economy:

Information received since the Federal Open Market Committee met in December suggests that economic activity has continued to strengthen and that the deterioration in the labor market is abating.

I suppose it does look like the labor market’s deterioration is abating, but I worry that could be seasonal. I’d like to see what happens over the next few months to see if the layoffs are really almost over. As I noted this morning, it doesn’t appear that way. They also say that inventories are coming into line with sales, but lending continues to contract.

As for its decision to go ahead with closing its credit facilities: I remain skeptical. The Term Asset-Backed Securities Loan Facility will be closed as of February 1st. That’s in a few days. To my knowledge there have been very, very few successful securitization deals since the financial crisis that did not utilize the TALF. Can the securitization market really function without it at this time? I’m unconvinced, but according to the FOMC:

The Federal Reserve is prepared to modify these plans if necessary to support financial stability and economic growth.

So its plans aren’t written in stone. If credit suddenly starts contracting, then it could bring these facilities back. That action, I think, would be very, very dangerous. It could scare markets a lot. That’s why I wonder if it would have just been wiser to let them continue a little bit longer, just in case. The last thing you want is financial panic when everyone realizes that the credit markets still can’t fully function on their own.

Possibly the biggest surprise was that it wasn’t a unanimous vote. The statement says:

Voting against the policy action was Thomas M. Hoenig, who believed that economic and financial conditions had changed sufficiently that the expectation of exceptionally low levels of the federal funds rate for an extended period was no longer warranted.

I take that to mean that he wanted to raise rates. I’m relieved he’s the only dissenter, but astonished that there was even one. I think that’s madness. If you want to essentially ensure a double dip recession, then you should raise rates. Inflation continues to be exceptionally low, and even if it does creep up a tad over the next year, that’s a small price to pay to make sure that unemployment doesn’t jump to 13% or so by year’s end.

The New York Times has an article today about how banks are choosing to reward its employees more than shareholders. This phenomenon has been noted before, particularly in the case of Goldman Sachs. There, some shareholders have complained about the amount of compensation. The Times article, in delightful chart format, shows exactly why shareholders should be so unhappy.

The NY times says:

Roughly 90 cents out of every dollar that these banks earned in 2009 — and sometimes more — is going toward employee salaries, bonuses and benefits, according to company filings.

And here’s a chart with some more detail:

The chart on the left, in particular, is kind of amazing. Despite all the complaining about Goldman Sachs, their shareholders should be happiest. Their bankers are getting below 50% of the profits. Compare that with Citigroup. Its employees are getting nearly 150%! The Times notes:

To compete with well-heeled rivals, banks like Citigroup are giving their employees an unheard-of cut of the winnings. Citigroup paid its employees so much in 2009 — $24.9 billion — that the company more than wiped out every penny of profit. After paying its employees and returning billions of bailout dollars, Citigroup posted a $1.6 billion annual loss.

So Citigroup literally posted a loss due to bonus compensation. That’s insane.

But more generally, are the bank shareholders right to complain? I think so. The employees were the ones who got these firms into trouble, while the shareholders were the ones who had all the equity risk. So the idea that the vast, vast amount of profits from most of these banks is going to the employees, and not the shareholders, does seem to put the risk-reward relationship on its head.

Shareholders should demand that banks revisit the relationship between profits and employee compensation. I think their voices would prove louder than populist complaints about excessive pay.

I’m watching the TARP oversight hearing right now on the AIG swap payment disclosure fiasco. I’m shocked at how aggressively the Congressmen are grilling Treasury Secretary Timothy Geithner. Back during the AIG bailout, he was the President of the New York Federal Reserve, which was intimately involved in the bailout. Few of them appear to believe that Geithner would have known nothing about the NY Fed’s decision not to disclose the detail of how banks would benefit from AIG’s bailout as swap counterparties.

Republicans are absolutely tearing Geithner apart. Rep. John Mica (R – FL) even called for his resignation. Some Democrats are also very, very angry. In thinking about the timeline, they have some reason to be annoyed.

As early as November 3rd, 2008 Geithner was aware of the banks who would receive bailout money from NY Fed, and fact that the banks would not be forced to take a haircut on what AIG owed. On November 11th, there was an internal memo saying:

As a matter of course, we do not want to disclose that the concession is at par unless absolutely necessary.

Geithner responded that he was not involved in decisions about what information to disclose. Yet, as President of the New York Fed, wouldn’t he be at all concerned about what Congress and the public knew about this historically unprecedented bailout? Even if he wasn’t involved in the decision, couldn’t it be argued that he should have been, as a responsible head of the NY Fed?

Now, Geithner likes to use the excuse that he was recused from AIG dealings once President-elect Obama nominated him as Treasury Secretary on November 24th. Yet, that was well after he could have made sure full information about the AIG swaps was disclosed. He didn’t.

Over the course of the week, I’ve noted a disturbing trend. Large companies Wal-mart and Verizon both said that they would continue cutting jobs this year. You can add Home Depot to that list. It will eliminate 1,000 jobs as it closes some underperforming stores and cuts labor costs. As more layoff news comes in, the hope of an employment recovery looks grimmer.

MarketWatch reports:

The stores, affecting about 100 jobs, are a small-format store in Wilson, N.C.; a temporary hurricane-recovery outlet in Waveland, Miss.; and a clearance outlet in Austell, Ga. The company said it has no plans to close its orange big-box stores.

Approximately 900 other jobs being cut relate to the company consolidating its human-resources, finance, real-estate and construction functions, including centralizing its HR structure mostly back to its Atlanta headquarters instead of having a field-team structure by districts, company spokesman Ron Defeo said. Finance will now have a pool support structure instead of dedicated support teams previously.

Don’t get me wrong: these cuts all sound like sound business. But that isn’t particularly reassuring in the context of 10% national unemployment. After a two-year recession, companies should already be finished with such cuts. Sure, 1,000 is less than 1% of Home Depot’s workers, a much smaller portion than Verizon’s planned 11% cut mentioned yesterday. But it still indicates that the job market may still be moving in the wrong direction.

What’s most troubling is that we aren’t just hearing that companies don’t think they’ll hire much — they’re still planning on firing additional workers. If most big companies are still seeking to make their operations leaner throughout 2010, then I worry an employment recovery may not be in the cards.

Politics is a funny thing. Even the most brilliant, cool and collected policymakers get stupid and frantic when faced with broad public disapproval. I guess that makes sense from a job security standpoint, but unfortunately the public isn’t always right. In fact, it’s often wrong. And that underscores a fantastic post from yesterday afternoon over at the Economist’s Free Exchange Blog. It begins by noting that the IMF’s global forecast warns governments against a “premature and incoherent exit” from economic stimulus. Of course, that’s exactly what appears to be happening in the U.S.

The Economist begins with the thesis:

Partisans have aimed their poison at the Federal Reserve and at the government’s fiscal policy choices but what, exactly, do they want? The logical implications of their complaints are contradictory at best and dangerous at worst.

The author, G.I., then goes on to explain how monetary and fiscal policies are both leading macroeconomics astray. I couldn’t agree more.

The Bernanke reappointment situation is extremely undesirable. The sort of best-case scenario I can see there is that Bernanke gets reconfirmed, and then ignores policymakers completely from that point forward. As they whine about the Fed’s balance sheet for the next year, he needs to plug his ears and hum. I have grave fears for anyone Congress puts in his place, because I think that new chair could be far less independent-minded than even Bernanke.

Unfortunately, I agree with the Economist post, which fears that the Fed will do too much to rein in credit too quickly. I am particularly worried about the credit markets once some of its financial crisis-driven programs like the TALF and mortgage-security purchase program end in March. Even if it doesn’t touch interest rates, it can do serious harm if it withdraws credit markets’ life support too quickly.

As for fiscal policy, many are freaking out about President Obama’s spending freeze proposal. I’m less worried because a) I think Congress will kill it — they couldn’t even establish a deficit commission and b) even if it passes, it doesn’t cut spending by very much — just by whatever inflation turns out to be and only for discretionary spending. Is it an incoherent policy during a time of recession? Probably. But I view this as a pretty small measure in the grand scheme of the budget and economy.

So I see the Fed’s potential misadventures as a greater threat than what we’re seeing so far on the fiscal policy front. But with any luck, Bernanke will be reconfirmed and work harder at economics than politics.

But make no mistake: policymakers on both sides of the aisle are screwing up here. They need to take a time-out from reading public opinion polls and study some basic Great Depression economic history.

Somehow, this article escaped my gaze on Friday. The extremely influential Financial Services Committee Chairman Barney Frank (D-MA) says that he wants Fannie and Freddie abolished. This is a interesting assertion from Frank, of all people. He has been widely criticized by conservatives as too supportive of the government-sponsored mortgage companies. Let’s look at exactly what he said.

According to the National Journal’s CongressDaily:

“I believe the remedy is abolishing Fannie Mae and Freddie Mac in their present form and coming up with a whole new system of housing finance,” Frank said.

Here, here! I’ve been arguing for this for some time. It’s nice to hear someone of Chairman Frank’s stature and side of the aisle also seeing this seemingly obvious fact. Though, he claims this is no revelation:

“We’re sorting out the function of promoting liquidity in the market and also the secondary market in general, and also doing some sort of subsidy for affordability. I do not think they should be necessarily combined,” Frank said. “I don’t think [I know] anybody who thinks Fannie and Freddie should continue as they are. … I’m surprised anyone thinks that’s news.”

First here’s why it’s news: because of the few thousand pages of financial reform proposals making their way through the chambers of Congress, none address Fannie and Freddie. So if Frank doesn’t think “anybody” believes Fannie and Freddie should continue as they are, why has nobody offered a solution to wind down the troubled quasi-public firms? Shouldn’t that be a part of financial reform, given that many economists believe that Fannie and Freddie had a major role in the financial crisis and cost taxpayers billions?

I sort of agree with Frank’s assertion. If the government thinks that some housing subsidy is desirable from a policy standpoint to encourage home ownership among poorer Americans, then it can establish a separate agendy for that. It would have an extremely small exposure and (I hope) no more than a few billion dollars in funding. In the meantime, it doesn’t need another government-backed firm guaranteeing about half of the U.S. mortgage market.

But why would the government stay in the role of promoting liquidity in the mortgage market? The private market doesn’t need Fannie and Freddie for liquidity. Assuming the securitization market comes back, that should be enough to account for ample mortgage origination funding. Indeed, all the existence of Fannie and Freddie did over the past decade was to ensure that the mortgage market had too much easy money, resulting in a bubble.

In any case, it’s nice to see Frank state that he wants to wind down these awful institutions. I hope his colleagues will allow him to lead the charge in doing so. I just worry that, in the process, they’ll create a new firm with another name, but the same intention to use government support for mortgage market liquidity. That, of course, would be a meaningless reform, as it would lead to precisely the same bad consequences as Fannie and Freddie.

Yesterday, I noted Walmart’s decision to cut around 11,000 Sam’s Club jobs. Today, with Verizon’s fourth-quarter earnings release, we get more bad news on the employment front: the telecommunications giant also plans to cut more workers this year — 13,000. I don’t like the trend that appears to be forming here.

Dow Jones Newswires reports:

“The economy won’t help us as much as we thought,” said Chairman and Chief Executive Ivan Seidenberg, adding that he doesn’t see a significant improvement until the end of the year. As a result, the company plans to shed another 13,000 jobs in 2010, roughly the same amount cut in each of the past two years. The latest represents 11.1% of its total work force of 117,000.

I take that to mean that Verizon thought that the economy would turn out better than it has. In other words, that awful 10% unemployment that the U.S. is suffering from might not be high enough to reflect how bad things actually are. So Verizon will cut a whopping 11% more of its workforce this year to save additional costs.

This is actually much worse news than the Walmart announcement. At least some of those jobs would be saved by the consultant the company is hiring. But Verizon’s cuts appear to be outright losses. And it seeks to increase unemployment by approximately the same portion as it did in the past two years. That’s an ugly prospect. I can hardly imagine a world where all companies did the same in 2010 — 12.6% unemployment by year’s end.

Realize this isn’t a little company saying that it probably won’t hire in 2010. This is one of the largest in the U.S. — one of the 30 Dow Jones Industrial Average components — saying it will endure deep job cuts again this year. According to Forbes, Verizon is the 35th largest company in the world by market value.

This is so disturbing because job growth will likely have to start with larger firms. They have an easier time securing financing through the capital markets than small business. They’ll feel the economic winds changing first through their diversification. If they aren’t turning around, then I find it hard to believe that small business will either. If companies like Wal-mart and Verizon continue to layoff workers in 2010, I’m not sure how we can expect unemployment to decline nationally.

Saab enthusiasts saddened by the 72-year-old company’s apparent demise have reason to be cheer today. General Motors has struck a deal with a Dutch automaker Spyker Cars NV to save the brand. This sounds like a good deal for all parties involved.

Here’s the news blurb, via Bloomberg:

Spyker agreed to pay $74 million in cash and $326 million in preferred shares in the company that would emerge from the deal, according to the Dutch company. The transaction, subject to Sweden agreeing to guarantee a 400 million-euro ($563 million) European Investment Bank loan for Saab, is expected to close in February and Saab will exit an orderly wind-down process in line with the timetable.

This is after a deal failed to sell Saab to Koenigsegg Automotive. Initially, GM would have gotten nothing out of that deal, but eventually would have been paid $150 million capital if the new Saab turned a profit. So this deal looks quite a bit better for GM. It gets a cool $74 million in cash, plus a sizable ownership stake. And it was about ready to simply wind-down the brand. So from GM’s perspective, this is a no brainer. U.S. taxpayers can collectively celebrate.

As for Spyker, the Saab acquisition marks a new direction and expansion for the 10-year-old auto company. Up to now, it has specialized in very expensive, high-performance sports cars. It only offered a handful of models of those cars too.

So the big question is whether Spyker can make Saab a winner again. It won’t be easy: Saab is riddled with debt, so it starts at a disadvantage. The creative minds at Spyker have to redefine Saab, improving on its current models to appeal to more consumers. But it probably also wants to preserve its legacy as a respected maker of moderately-priced luxury automobiles. It won’t be easy, but given Saab’s loyal fan base and rich history, it shouldn’t be impossible either.

Back in October, I wrote a few posts about the pending Ticketmaster-Live Nation merger, then under review. Britain seemed concerned with the union. So did the U.S. Justice Department. But its worries have been alleviated with some relatively weak concessions on the part of Ticketmaster. Consequently, the DOJ has pushed the merger through. I think this is a disappointing result and shows that the Obama administration’s Justice Department won’t be as strict as some thought.

Here are the conditions of the merger, via Reuters:

The U.S. Justice Department required Ticketmaster to license its primary ticketing software to a competitor, sell off one ticketing unit, and agree to be barred from retaliating against venue owners who use a competing ticket service.

And here’s what one analyst from S&P thinks:

“The conditions seem to be relatively benign,” said Tuna Amobi, equity analyst at Standard & Poor’s. “There are no major divestitures required. I don’t know that is going to create the kind of even, competitive field that was intended.”

I agree. Recall, that this merger gives the new mammoth an approximately 80% control of the ticket market for concert ticketing and promotion. So it needs to spin off a division called Paciolan. According to a Reuters article about Ticketmaster’s acquisition of the company back in 2008, here’s what Paciolan does:

Privately held Paciolan serves 190 clients in North America, including college and professional sports teams, performing arts groups and museums.

So if the worry is for concert ticket sales and promotion, then how will selling Paciolan help? From what I understand, its business specializes in several aspects of ticketing, but not the kind of concerts or venues that Live Nation specializes in. So even without Paciolan, the new firm would easily have the concert ticketing and promotion market utterly cornered.

The software licensing requirement is also amusing. So let me get this straight: Ticketmaster will license its software — meaning its competitors who use it have to pay the firm a fee. So it will profit from it, at worst. That doesn’t sound too bad to me.

And I certainly hope they aren’t talking about Ticketmaster’s online ticket purchase system, because I don’t know why anyone would want to obtain that software anyway — the system is absolutely horrendous. One of the reasons I find this merger so troubling is because it makes for a world where it’s less likely that some software innovation will occur to make for an easier and more effective ticketing process. With virtual monopoly control, Ticketmaster has no need to improve its operations, and the barrier is too high for competitors to have much impact on innovation.

As for the retaliation constraint, first it’s hard to monitor. There are ways to subtly stick it to a venue without it being clear, outright retaliation. But more importantly, I don’t think Ticketmaster has to really worry about venues using other services — it will completely dominate the market already. This isn’t a level playing field, where there are several big firms competing for business. This is like a town having eight Wal-marts and two mom and pop retailers. Wal-mart would hardly be concerned with its competitors: their days are clearly numbered.

At any rate, this development is very disappointing. It should make for a less competitive ticketing market where consumers are forced to pay whatever prices/fees Ticketmaster/LiveNation pleases for concerts. Not to mention how awful Ticketmaster’s customer service will continue to be with no significant competitor out there to offer a favorable alternative.