Back from a short vacation…

Apr 30 2007

…and once again, I find myself astounded by the institutionalized idiocy of the Transportation Security Administration.

Thanks to Richard Reid, for instance, I still get to experience the silly waste of time inherent in removing my shoes and running them through the scanning equipment. Thanks to the efforts of the 21 alleged terrorists in the UK during the summer of 2006, passenger screening personnel still get to inflict the silly waste of time inherent in depriving passengers of any liquid or gel not contained in a properly sized receptacle, or that receptacle itself not contained in the proper 1-quart see through bag. (See also this item on the Department of Homeland Security’s designation of an entire state of matter as a national security risk)

A screener told me yesterday, with no small hint of pride, that, Yes! We still check all passengers’ shoes! This, in sleepy little Myrtle Beach, SC, where many, though not most, of the flights are turbo-prop or 57 seat commuter jets with presumably low value as flying projectiles, and even lower value as targets for suicide bombings.

The experience reminded me of the many instances in which Bruce Schneier has had occasion to comment on the misguided nature of our government’s reaction to events, including its apparent fetish for adding every new terrorist’s trick to the permanent list of reasons for inconveniencing the traveling public, while adding no safety to the equation at all. Zero. I would direct the curious reader to this list of articles on Mr. Schneier’s site for a thorough review of all that’s wrong with the manner in which our bureaucratic overlords maintain their ridiculous pretense to be adding to our security. He’s rightly called it “Security Theater”, among other things.

At the time of this writing, the link just above produces a list of 244 such articles. They cover the failures of security, the knee-jerk TSA reactions to events, the useless political correctness and abuses of power inherent in current process, and the arguably unconstitutional restrictions on rights to redress for incorrect blacklisting or commentary about the process as you’re having it inflicted on your person. Add to this the gaping productivity hole (estimated at $10 billion/year and up) left by the process, the passengers’ costs for security (you didn’t think the airlines were absorbing that, of course), and factor in a rational cost/benefit analysis (even under the assumption we wanted to guarantee that no person ever died except from natural causes) and it seems clear that security is not just irksome – it’s poorly and stupidly implemented.

Luckily, it’s not yet illegal to parody the process while away from airports.

Uh oh! Bad news!

Apr 24 2007

From an email alert this morning:

Toyota Motor quarterly worldwide sales top General Motors for the first time.

Hide the women and children! To the storm cellar, pronto! The Japs have sold 90,000 more cars than the, (quick – what’s a light-hearted pejorative for Detroit natives?) the Detroit guys!

Hey, wait a minute – so what? That little statistic is even less important than the dates and times at which the Dow Jones Industrials crossed each of the 1,000 point barriers, that is, “not at all”.

Given the fine mess that’s characterized GM these past few years, including poor results, billions of dollars in losses, junk bond ratings on its corporate debt, the jettisoning of the majority of its GMAC finance arm to Cerberus, the bankruptcy of Delphi, which it tried (and failed) to hive off as a separate, self-sustaining entity, and the battles with Jerry York, Kirk Kerkorian, and Tracinda, the fact that Toyota has passed them in sales is neither surprising nor particularly newsworthy.

They’re rather lucky to still be ahead of Ford, itself a company that is, as Monty Python might say “not at all well”.

Xenophobes and Detroit residents may mark this day as one that will live in infamy. More rational sorts will simply see it as the logical end to a progression that Toyota began, 20 years ago, when they started making cars better than General Motors was able or willing to do. Given that my last four vehicles have been made by Toyota, perhaps my objectivity isn’t perfect in this matter.

“Can a Company Be Run as a Democracy?”

Apr 24 2007

Interesting title, from a story in yesterday’s WSJ.

Short answer? “Yes, in some cases, if the company’s really, really tiny.”

Slightly longer answer? “Are you nuts?”

The article centers around the management practices in place at a company called Ternary Software Inc.

During a recent strategy meeting at Ternary Software Inc., a programmer criticized the chief executive’s new incentive plan for employees. An hourlong discussion ensued, in which several participants, including the CEO, critiqued the proposal. Ultimately, all six participants agreed to handle incentives differently.

That part was crucial: Ternary runs itself as a democracy, and every decision must be unanimous. Any of Ternary’s 13 other employees could have challenged the incentive decision and forced it to be revisited.

The 19-person Exton, Pa., company has a policy-setting team of seven people, including two frontline workers elected by their peers. The team is linked to smaller groups through the company that ultimately give all employees a voice. The team meets to set policy for two hours once or twice a month.

The article’s author cites instances of similar management practice, including Honest Tea Inc., of Bethesda, MD and Continuum Inc. from West Newton, MA. She also includes, for comparison, I guess, Google, which

…prides itself on an egalitarian culture that includes weekly updates from executives who field questions from employees.

As though that’s somehow applicable.

The article goes on to include quotes from several b-school professors, including this from Ryan Quinn, a management professor at the University of Virginia’s Darden School who says:

…these companies typically are willing to sacrifice some short-term profit to pursue innovation or other goals. Mr. Quinn says unorthodox practices can succeed at large and small companies, but says he has never seen a company like Ternary, that strives for unanimous agreement.

Note, he didn’t say that this practice can succeed at large and small companies, just that unorthodox practices can. Like, for instance, having everyone wear a funny hat on alternating Fridays. So, overall, his response strikes me almost as a polite way of asking “Are you nuts?”

An additional bit of insight, from Harry Katz, dean of Cornell University’s School of Industrial and Labor Relations, goes a bit further:

…[he] doubts a system like Ternary’s could work on a large scale. In bigger companies, “there’s an inevitable conflict of interest between managers and employees,” Mr. Katz says.

The article also provides several other instructional views life within Ternary. Two excerpts:

Ternary’s path to workplace democracy wasn’t painless. The company, founded in 2001, first tried to draft a mission statement by consensus in 2004, when it had grown to more than a dozen employees. The meeting lasted two days and ended as participants too exhausted to continue arguing agreed in principle to run the company as a democracy. An attempt the next year to create a salary system by consensus was no better. But Mr. Robertson persevered, guided by two out-of-print books about a Dutch management technique called “sociocracy” or “dynamic governance.” He has dubbed Ternary’s system “holacracy” and has begun marketing it as a managing style.

I’ll let the dripping irony in that passage speak for itself.

The meeting where the incentive scheme was discussed was typically busy. The team rejected Mr. Robertson’s proposal to replace the profit-sharing program with an “ad hoc bonus system” based on performance, formulating a new plan that would keep the profit-sharing program and introduce monthly bonus incentives. The group also assigned the CEO new responsibility for spurring growth, gave the sales manager more authority to negotiate contracts, and decided to bill clients by the day, rather than by the hour.

Technology chief Anthony Moquin, one of the founders of the company, said his gut reaction to the billing change was that it was simplistic. But he accepted it, saying, “We can try it and see how it works.”

That’s a common refrain at Ternary. Managers don’t look for an ideal solution, merely a workable plan that looks like progress. Employees who don’t like the results can seek a seat at the next strategy meeting or ask a member of the policy group to revisit the issue.

(emphasis mine)

Funny when you read it that way, it sounds like it should be a whole lot less interesting to the owners or managers of a company. In effect, it eliminates the value of any management role, including that of the CEO:

“It takes getting beyond your ego,” says Mr. Robertson, who, as one of the founders of the company, has the CEO title but little typical CEO authority.

And it brings into question why you’d even have the title, let alone give it to someone.

The story goes on to explain how the company has benefited, in tough times, from having the flexibility to get all employees to agreement on issues like pay cuts. Quite uplifting, if you’re exceptionally light and aren’t running a for-profit business.

Left unsaid, in the story itself or the comments from the professors, a couple of things.

  • Ternary isn’t Google, and whatever else you might say of Google, you won’t say they’re managerially incompetent or have created a company incapable of growth.
  • Not only does the typical company have conflicts of interest between managers and employees, the typical company, particularly one larger than 19 employees, has conflicts between employees and employees, as well as between managers and managers.
  • It might be horrible to contemplate, and even more horrible to enunciate, but not all employees have as much to add to any given decision-making process as the others.
  • In any event, the dynamics of watering down decisions by making sure they’re universally approved results in watery decisions, catering to the lowest and loudest common denominator.

No offence to managers, employees, or Ternary Software, Inc. itself, but I’ll be anxiously awaiting the future WSJ story about how Ternary grew and found the limits of what is essentially an intellectually lazy, confrontation-free, feel-good management style that doesn’t strive for excellence, instead only for “a workable plan that looks like progress”, and then jettisoned it as laughably unworkable.

Unfortunately, though I think you can already see where I’m going here, Ternary seems quite unlikely to ever grow too awful much, constrained as they are by a system that enforces crushing mediocrity, even in a small company like theirs.

As Professors Katz and Quinn intimated, unorthodox isn’t bad, but there are a lot of things that can work in small companies which would be impossible at scale. Paying for everything on the owner’s personal credit card is an excellent example. Keeping all your invoices and receipts in a shoebox is another. And, with all due respect to the admirable goal of “giving workers a voice”, so is the practice of pretending they’ve each got something crucial and important to say about the company’s direction, or that, in the event of failure, your fallback position is that “at least we all agreed on the strategy”.

Sorry, but not all opinions matter equally, and without accountability for failure, there cannot be success in any non-trivial enterprise, including Ternary’s. The time spent in search of universal approval of all decisions, and of making sure that every last person is happy and contented, is time wasted. And yes, this metaphor can be extended to the broader social and political realm, but I’ll spare you that for now.

(all ellipsis above, mine)

Fear and loathing of private equity?

Apr 23 2007

Notwithstanding the cursory brush-off its expression of interest received from DaimlerChrysler, Kirk Kerkorian’s Tracinda remains active in its pursuit of the Chrysler portion of the automaker’s operations.

In an article in today’s WSJ, entitled “UAW Group, Tracinda Discuss Bids for Chrysler“, it’s reported that:

Representatives of billionaire investor Kirk Kerkorian’s Tracinda Corp., which has proposed a $4.5 billion acquisition of DaimlerChrysler AG’s Chrysler Group, met yesterday with United Auto Workers members who have separately proposed an employee-stock-ownership plan for Chrysler, according to people at the meeting.

The pitch? It seems a combination of several things.

First, the UAW, reasonably & predictably, wants to ensure as much control as possible over the source of its members’ employment and benefits. Previous recent deals, such as Sam Zell’s winning bid for the Tribune Co. have relied on employee stock ownership plans, and it’s refreshed the imaginations of those in the M&A game for an old tactic. Such deals don’t always end well, of course – witness UAL, and others, as explained by the WSJ’s Dennis Berman in the video below from several weeks ago:

Perhaps most important, he points out that ESOPs seem often to be used as a single solution to very different sets of problems, experienced by constituencies with very different goals. In the case of the Tribune, some of those problems and constituencies were [Chandler Family/dead money, lack of strategic control], [Stock market/yearning for growth], [Employees/editorial freedom, job security].

What are the problems and constituencies in the Chrysler situation? Quite similar, although substitute the parent company DaimlerChrysler for “Chandler family”, and substitute continued cushy employment terms for “editorial freedom”.

Note: ESOPs can come in several flavors, with varying implementations, one of which, like the Zell deal for Tribune, involves using an ESOP plan to fund the purchase with borrowed money and provides noteworthy tax advantage to the entity simply because the ESOP was the borrower. Tracinda’s approach appears not to rely on the tax advantages attendant to that form of an ESOP, instead relying simply on the benefits of shared ownership between capital and labor. That shared ownership, and the uneven results of it, are really at the heart of all following commentary about ESOPs.

Even given the historically muddy success record of ESOPs in these circumstances, the UAW is still pushing forward on that front, among several others. They appear to realize that the status quo can’t hold, but among the alternatives against which they’re fighting is the involvement of private equity. (WSJ)

The company’s unions generally oppose the involvement of private equity in the future of Chrysler, and UAW President Ron Gettelfinger, whose Detroit-based union represents the largest share of Chrysler hourly workers, plans to argue in favor of DaimlerChrysler hanging on to Chrysler and allowing its restructuring plan to continue. Still, Mr. Zetsche is facing pressure from shareholders who argue that Chrysler, with its $18 billion in unfunded health-care liabilities and its recent skid into operating losses, is a drag on the corporation’s profitable Mercedes-Benz luxury-car business.

Why the opposition to private equity, which, of course, Tracinda’s involvement would also represent? Simple – Tracinda, whatever else its reputation might include, isn’t seen to be the same as the other PE players in this game.

DaimlerChrysler and its bankers have focused on discussions with three potential buyers: Cerberus Capital Management LP, the team of Blackstone Partners and Centerbridge Capital Partners, and auto supplier Magna International Inc.

Tracinda, in its proposal to DaimlerChrysler, said it would consider giving the UAW a stake as part of a new capital structure. The proposal would give the union equity in return for giving up some future benefits. This idea, swapping the retirement health-care debts owed to UAW workers for equity in their employers, is getting increasing attention among Detroit leaders.

Cerberus & Blackstone each has a history of, well, doing what PE firms do – purchase, then restructure, repair, and re-float, generally over a 3-5 year period. Magna is a bit of a wild-card here, but can be lumped into the PE side of the ledger, as they’re partnering in the bid with Onex Corp, a fund with many portfolio companies, most of which are not household names. As an aside, Magna would seem clearly to want to ensure that one of its big customers (15% of sales) doesn’t bite the dust. Magna wants to keep the company intact, with all jobs and operations retained, and has made a bid of between $4.6 and $4.7 billion.

But Tracinda, with its $4.5 billion bid, can reasonably claim to have interest in a longer term investment, having made many such longer-term investments, including in Chrysler itself, in the past. It can also reasonably claim to have the ultimate financial success of the enterprise as its first priority, since it’s not trying to save a customer or to perpetuate its own employment. It also has available to it the services of Jerry York, former CFO of Chrysler, longtime auto-industry participant, and historically expert observer and fixer of corporate ills. Of course, its past investment in Chrysler created enough antagonism with management (at Daimler and Chrysler) that it’s started with a built in speed bump of indeterminate size, but the unions weren’t party to the past difficulties, and may still come down in favor of a Tracinda bid, for whatever that support may be worth.

Why might the UAW find Tracinda interesting, even if one of the guises under which it’s being considered is an ESOP, sketchy history and all? Because it might be the least scary of the lot, and because it’s easily possible to politic against the pure-play private equity options, enflaming emotions both here in the US and within the overly-union-influenced labor market of Germany, the parent company’s home market. Cooperation between the UAW and IG Metal, the union representing DaimlerChrysler workers in Germany, has been part of the defense strategy since the beginning of talks about selling Chrysler.

And the PE firms, plus largely non-unionized Magna, have worked hard to sell their proposals to the Unions. From the April 3, 2007 Detroit News (prior to Tracinda’s Apr 5 bid):

CAW President Basil “Buzz” Hargrove said Monday he has heard sales pitches from all three potential bidders — Canadian supplier Magna International Inc. and private-equity firms Blackstone Group and Cerberus Capital Management.

But Hargrove, like his counterparts in the American and German unions, remains concerned about the impact on workers of a Chrysler deal involving private-equity buyers.

“They were saying, ‘we are not as bad as some people say we are,’ ” Hargrove told The Detroit News.

“I don’t buy that.”

UAW President Ron Gettelfinger has criticized private-equity firms for “stripping and flipping” troubled companies such as Chrysler. Two labor members of DaimlerChrysler’s supervisory board have also spoken out against private-equity ownership.

As private equity continues its moves into larger chunks of the industrial infrastructure in the US and elsewhere, expect to see more creative finance, more politicking, and more attempts at union involvement in shaping the outcome.

Will such events slow down the currently-in-vogue move from public market to private equity financing? Quite possibly. Other potential inducements for such a slow down would include several of the current swath of private equity financed deals imploding from their own weight and poor structure, as well as a rethinking on the part of public company managers about how best to structure, and in some cases restructure, their existing businesses.

Will a large number of now-public firms be privately owned in the future, reducing the importance of public stock ownership itself? Not likely – one of the exit plans for PE owners is re-floatation. But the PE process has a goal – wealth creation through more intelligent management and deployment of capital. When the public markets can meet the same goal just as well, private equity loses its appeal.

But don’t hold your breath wating for that time to come.

If imitation really is the sincerest form of flattery…

Apr 20 2007

We ought to also consider the possibility that disingenuousness is the most obsequious form of lying.

fake-chinese-bmw-x5.jpgFound while catching up with my overload of simultaneously delivered Economist issues, a story entitled “Counterfeit cars in China“, and subtitled “The sincerest form of flattery”.

Of course, there have historically been regular instances of copyright, trade secret, and patent law violations in China. (Google search links, returning 1.3M, 287K, and 981K document hits, respectively). An argument can be made that such infringement is how third-world and emerging economies grow to become full players in the global market. That argument would ring true, however offensive the concept that “all you need to do to grow is to steal and learn”.

COPYING in China goes far beyond fake DVDs, watches and handbags. “We can copy everything except your mother,” goes a saying in Shanghai. Soy sauce with fizzy water passed off as Pepsi, fake Cisco network routers (known as “Chisco’s”) and mobile phones that look like the latest offerings from Nokia can all be easily found. So, too, can fake blood plasma.

Aside from the blood plasma (which I don’t understand how one might fake), the rest of it is all old news. Counterfeiters of high-value manufactured goods should be restrained by to the barriers to entry, including “huge capital investment”.

Of all the products to copy, however, a car is surely the most complicated. Cars consist of around 6,000 precisely manufactured components made from a range of different materials. For a car to be cheap, reliable and long-lasting, says conventional industry economics, these parts need to be put together in factories with huge volumes, lots of expensive machinery and many well-trained engineers.

Turns out that in China’s case, that’s not as true as might be hoped:

So it came as a surprise when counterfeit cars started to appear in China eight years ago. Early VW look-alikes were soon followed by the infamous Chery QQ. It appeared six months ahead of the car it copied, the Chevy Spark, because a Chinese firm somehow got hold of the blueprints.

All quite troubling, and it goes beyond the Chevy/Chery, affecting many other established manufacturers.

Yes, it’s part of emerging economies’ growth path, and yes, once they get to the point where they’re creating more intellectual property than they’re stealing, balance will be restored in many areas, including balance of trade, manufacturing costs, and living standards. But that doesn’t happen overnight, and at some level, the imbalance causes pain in the trading system, yielding such things as (in the US) calls for trade protectionism.

Aside, however, from any arguments about whether, when, and how balance will be restored, it seems reasonable to expect some honor among thieves, no? Honor of the sort I’m considering would be that, if you’re going to steal, at least don’t lie about it, and if you’re going to lie about it, at least put in the effort to make the lie plausible, if not believable.

What’s triggered this mild outburst of mine on the subject? This:

Shuanghuan Automobile got into trouble for copying Audi’s famous four-ring logo a few years ago. It then copied the design of Honda’s CR-V, called it the SR-V and appears to have won the subsequent legal tussle. Last month the firm won an export licence, and it plans to start shipping another model, the CEO (pictured)—a sport-utility vehicle with a striking resemblance to the BMW X5—to Romania and Italy.

Copying DaimlerChrysler’s small two-seater Smart car seems to have become especially popular. In January Shuanghuan launched an electric version, called the Dushi Mini. It followed in the tracks of Shandong Huoyun Electromobile, a firm that makes golf buggies, which launched its own version last year and announced plans to sell the car in Europe for less than half the price of the original. After Daimler threatened to sue, the car was temporarily withdrawn. A spokesman for the Chinese firm said he had been surprised by the way his car resembled the original, explaining that the company had simply copied a toy car.

A toy car? Excuse me? Who’s their spokesman, I wonder? Tommy Flanagan? Baghdad Bob?

Growing up to achieve a seat at the adult table in international trade would seem to preclude such blatant disingenuity. In the circumstances, the spokesman could have been expected to be at least a little sheepish after such an utterance.

Absurd aftermaths in the Va Tech massacre

Apr 19 2007

This evening, I caught a bit of Paula Zahn’s show on CNN. She was doing a segment on the Virginia Tech shootings, and while I missed the first portion, the part I saw included her coverage of the views and concerns of South Koreans. It included this teaser:

And will there be a backlash against Korean Americans? Some Virginia Tech parents are telling their sons and daughters, come home now.

That struck me as incredibly overbaked thinking on someone’s part, and so intrigued, I went to the transcript of the show which I found at the CNN website, and it is the source of virtually all of the excerpted comments below.

ZAHN: And as Matthew Chance reported a little bit earlier tonight, many South Koreans consider the massacre to be a national disgrace. They are shocked and ashamed because the gunman, Cho Seung- Hui, was born there. And today, a South Korean diplomat told CNN that the Korean community is extremely worried about a possible backlash right here in the U.S. It’s very much on the minds of Korean Americans on the Virginia Tech campus.

I have trouble understanding why the South Koreans would consider the massacre to be a national disgrace, or more properly, why they would think that it is a national disgrace for South Korea. There are elements of the story that could lead the excitable to think it a national disgrace for the US (more on that in a bit), but Cho’s actions were his alone, and not those of his country of birth, or its other citizens and expatriates. He was a psychotic, disaffected loser, one who should have been institutionalized for his own and society’s good, if there had been a legal basis to have done so.

The concern mentioned near the top of her show, the fear of backlash against Koreans…

No, not “Korean Americans”. Cho was demonstrably not a Korean American, he was a Korean with a green card. And not all of the people of Korean extraction interviewed in the show were necessarily anything other than Korean Visa Holders, and calling them “Korean Americans” is as politically correct, meaningless, and silly as going to Zimbabwe and, for fear of offending someone by innocuously and logically referring to them by a physical trait or nationality, reflexively calling them African Americans, to peals of laughter from anyone paying actual attention.

…seems as equally ill-founded as the South Korean feeling this tragedy is a national disgrace to their country. Cho, a resident alien, had moved to the US at the age of 8. His afflictions don’t seem to have had anything to do with his South Korean-ness, his overall Korean-ness, or even his ultimate Asian-ness. And the possibility that they did would never have even occurred to me until it was brought up on Ms. Zahn’s show.

Perhaps (no offense intended, honestly), this is something that’s part of that entire “Inscrutable Asian Mystique”.

ANDREW LAM, VIETNAMESE AMERICAN WRITER {…} Well, right after the shooting, there was only one designation, and that was Asian. Everybody called me, Chinese, Korean, Pakistani, and they were all saying the same thing. Please, please, let it not be one of us.

Perhaps I missed it, but back in 1995, when Timothy McVeigh blew up the Alfred P. Murrah Federal Building in Oklahoma City, I don’t recall anyone from Ohio (my home at the time) saying “Gosh, I hope it’s not an Ohioan who did this!” Geography has nothing to do with insane acts (except perhaps in North Korea), and no rational non-Asian person would think to blame Asians as a group, or of any group, for the actions of one insane man. I hope that the only reason CNN covered the story as they did was out of concern for the backlash fears related to them by Asians.

The alternative, by my argument, would be that CNN and Ms. Zahn are irrational, which might be true, but which I don’t assert. If such a backlash occurs, I will be equally shocked and almost as sickened by it as I was the news of the massacre itself. I think such concerns are utterly misplaced, and that the members of the Korean community should allow themselves to calm down and get on with their lives and educations.
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Another private equity head-scratcher

Apr 17 2007

Not nearly as ripe for overanalysis as Sallie Mae, but still interesting is the news from this morning that Intelsat is on the block. Garden variety stuff, you’d think, except that private equity is rumored to be the buyer.

The firm’s present owners include Apax Partners Worldwide LLP and Permira Advisers, two London based firms that are relative mysteries to me. I’ve heard of both, but neither frequently, nor in connection with a lot of large deals. A quick look at the Apax portfolio companies informs me that there are precisely four that I’ve ever heard of, including Intelsat. Likewise, Permira, whose list of transactions (a superset of current holdings) also contains only four companies I’ve ever heard of, two of which they’ve exited already, and two of which are also on Apax’s list. I’m sure that both Apax and Permira are huge and influential, and my ignorance of their specifics is due to their primarily European focus.

Apax & Permira have (presumed minority, based on the wording of the Bloomberg story) partners in Intelsat, including Madison Dearborn Partners LLC and Apollo Management LP, based in Chicago and New York City, respectively. These firms are more well known in the US, and both have excellent reputations for competence in the field. The consortium of the four paid a reported $515 million (addendum: equity portion) for Bermuda-based Intelsat, apparently starting in 2004. (Apax-2004, Permira-2005, MDP lists Intelsat as a portfolio company at its web site, without a date, and Apollo, famously in the industry, has no web presence).

Smart guys, the lot of them, I’m certain.
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Private equity giveth, and private equity taketh away

Apr 16 2007

Rumored for a while, but announced only today, a private equity consortium including J.C. Flowers, Friedman Fleischer & Lowe, Bank of America, and JPMorgan have offered to buy Sallie Mae (SLM), the largest student loan provider in the US, for $60/share, or approximately $25 billion. (Press release here)

Flowers and Friedman will together own 50.2% of the newly private entity, with the two banks owning half each of the remaining 49.8%. Additionally, JPM and BofA have committed to providing a $200 billion backup line of credit to ensure that, even if the debt market becomes closed to SLM, they’ll still be able to do business.

When transactions like this occur, my normal initial response is to lean back in slack-jawed wonderment, trying to determine what it is that the PE players (ignore the banks – more on that in a bit) saw in the deal that the public market didn’t, causing them to offer a price that’s a 50% premium to the price of just last Thursday, April 12. (ignore the fact that I skipped Friday’s price – more on that in a bit) A $20/share premium? Was that really necessary?

(Yahoo) SLM price chart

Might as well deal now with the price jump on Friday, from Thursday’s close of $40.75/shr to Friday’s of $46.76/shr – clearly, word of the deal was leaked, and speaking of slack-jawed wonderment, I’m also impressed when the market rumor mill that can generate a one-day 15% gain, up $5 on the open. Of course, it’s possible that nobody traded on the news before the 8:30 reporting Friday by, surely among many other places, at the WSJ Deal Blog. But I’m sure that, in their spare time, the NYSE, SEC, and perhaps most importantly, the SEC’s options watchdogs, will be piecing together the tapestry of who bought and sold what, when. Once the regulators start sniffing around, there may be a perceptible increase in pucker factor. Or not, but it should be interesting to watch either way.

As you can see from the chart up there, this thing has been taking on water for some time, and there are reasons for that. First, there’s the matter of the recent investigations into student lending practices, conflicts of interest, and other skullduggery. SLM paid a fine as part of a settlement in the matter of deceptive sales practices with NY A.G. Andrew Cuomo’s office.
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Professor Blinder’s views on free trade

Apr 11 2007

When the news broke (WSJ, subscr. req’d for fulltext, preview otherwise) several weeks ago that Dr. Alan Blinder had become skeptical of the benefits of free trade, I was quite disappointed to hear about it. As intimated elsewhere on this site, I can’t find a way to agree with trade protectionism of any kind, and Dr. Blinder’s writings, among many others, have provided the basis for my views on the matter. For a particularly succinct statement of his views as they stood at the time, see the (undated) article entitled “Free Trade” at the Library of Economics and Liberty. An excerpt:

Americans should appreciate the benefits of free trade more than most people, for we inhabit the greatest free trade zone in the world. Michigan manufactures cars; New York provides banking; Texas pumps oil and gas. The fifty states trade freely with one another, and that helps them all enjoy great prosperity.


A slogan occasionally seen on bumper stickers argues, “Buy American, save your job.” This is grossly misleading for two main reasons. First, the costs of saving jobs in this particular way are enormous. Second, it is doubtful that any jobs are actually saved in the long run.

Many estimates have been made of the cost of “saving jobs” by protectionism. While the estimates differ widely across industries, they are almost always much larger than the wages of the protected workers. For example, one study estimated that in 1984 U.S. consumers paid $42,000 annually for each textile job that was preserved by import quotas, a sum that greatly exceeded the average earnings of a textile worker. That same study estimated that restricting foreign imports cost $105,000 annually for each automobile worker’s job that was saved, $420,000 for each job in TV manufacturing, and $750,000 for every job saved in the steel industry. Yes, $750,000 a year!

(ellipsis mine)

The WSJ article that started all the huffing and puffing even included this snippet:

“Like 99% of economists since the days of Adam Smith, I am a free trader down to my toes,” he wrote back in 2001.

I’ve earned no MS Econ from LSE, I possess no PhD from MIT, and I’m clearly no professor of economics at Princeton, but pardon me anyway for the conceit of agreeing completely with his thinking above. He, like most in his profession, has both logic and past history on his side when taking the side of free trade over protectionism.

The WSJ article in question, entitled “Pain From Free Trade Spurs Second Thoughts”, has occasioned much chatter in the media and elsewhere (~37,900 articles as of this writing, many-though-not-all of which thinking they’ve found fodder for protectionist acts) about the fact that he’s changed his mind on free trade, and has embraced “fair trade” (as defined by its proponents). There was so much glee from those whose short-term view of economies leads them to believe ours should be closed that I was almost unable to avoid shouting into the void (here, with my still miniscule readership) about the stupidity and wrong-headedness of it all.

Picking just the one article from the first page in a Google search for “Alan Blinder”, I found a posting at Dr. Brad DeLong’s site. I haven’t followed his most recent site, but have read DeLong’s writing in the past, and while we’re at opposite ends of the political spectrum (he claims to be “100% Reality Based”, with all the silly things that connotes), he’s an unquestionably intelligent gentleman. His post on Dr. Blinder’s pronouncement, simply entitled Alan Blinder on “Offshoring”, really does nothing more than excerpt the WSJ article, and then throws the floor open for comment. The vast majority of his commenters offer a hearty “Amen!” to Dr. Blinder’s move to the protectionist’s side of the aisle. Though I choose to infer agreement on his part with the views of many of his commenters, Dr. DeLong’s views are largely left unwritten, aside from a lead-in comment to the excerpt that Dr. Blinder

“…has very smart things to see about “outsourcing”

No less illustrious “student of economics” than Dr. Greg Mankiw took the time to write, in “My Father is Darth Vader” (about how Blinder has been “lured by the dark side of the force”), that he

…believe[s] Alan is terribly wrong-headed about this topic.

His article is no hatchet job, of course, and contains some valid criticisms, but seems slightly to be missing the point.

Unlike the commenters at Dr. DeLong’s site, the very first respondent at Mankiw’s got right to the point:

Someone please correct me if I misunderstood the article, but I didn’t take Blinder to be saying that globalization is detrimental on the whole to America. I don’t see the controversy.

Having read the WSJ article myself, though somewhat after the fact, I’m forced to agree with the commenter at Mankiw’s site, excerpted directly above. Most controversially, Blinder “guestimated” in an article at Foreign Affairs, that because of the changes wrought by the onset of the electronic communication age, and the increase in the number of “tradeable” goods and services, “between 42 million and 56 million jobs were potentially offshorable.” More than a year after the Foreign Affairs article, he’s now the toast of the Democratic Party establishment, who, I think, see something different in his message than what he actually said.

Reading the WSJ article again, it seems quite clear that the arguable points he’s made are related to magnitude of the potential change, and the societal response required to deal with what he sees as the fallout. Note well that he doesn’t propose anything like protectionism, but instead wants consideration of a better safety net (retraining, etc.) for workers with displaced jobs, as well as the urgent improvement of the US education system to prepare workers for the jobs of the future. Specifically, he said in his paper:

Most obvious is what to avoid: protectionist barriers against offshoring. Building walls against conventional trade in physical goods is hard enough. Humankind’s natural propensity to truck and barter, plus the power of comparative advantage, tends to undermine such efforts — which not only end in failure but also cause wide-ranging collateral damage. But it is vastly harder (read “impossible”) to stop electronic trade.

Sorry, but to me, that doesn’t sound like a guy who’s gone over to the dark side.

Of the two “arguable points”, the only one worth serious thought seems to be the first – is the magnitude really as great as he says? The most concise argument (though not necessarily the best, or even the most true, but it could be both) I’ve seen is encapsulated at Daniel Drezner’s site:

…Blinder assumed that any job that could be done over the electronic transom:
a) Will be done electronically;
b) Will be done electronically by someone living outside the United States;
c) This job shift will happen incredibly quickly;
d) The U.S. economy will fail to create new jobs or job categories in response.

I agree with Drezner, perhaps simply because I’ve got faith in the US market’s ability to adapt, as it always has. And yet I still don’t think all the fuss made over Blinder’s original comments was justified, other than by people reading it to fit their existing biases against free trade.

Aside from what I think are the excellent counterpoints to Blinder’s potential overestimation of the problem scope, listed just above, there’s another issue people seem to forget; one that can be seen simply by looking at US history. As we grew richer (from trade, by the way), our standards increased – living standards, occupational standards, development standards, and perhaps most importantly, income standards. Is it outrageous to think that those exact same pressures will occur in India, China, and elsewhere as their wealth grows? Of course it’s not. And when such standards change, so too will the comparative cost advantages those markets presently enjoy for some (not all) tradeable goods and services.

Take for example this excerpt, from Tyler Cowen’s “Marginal Revolution”:

I think that China is due for a crack-up and India will soon bump up against its horrible legal and educational systems. I saw that economists are listed as among the most threatened groups, but I doubt if the United States can look forward to the liberation of so much talented and witty labor. I also think that corporate welfare is a bad idea, and that universities should not train everyone to be a small town divorce lawyer. Teaching reading and writing would be a good start.

Admittedly, everything after the first sentence above is included not because it supports my point, but because I enjoyed reading it. But China has issues related to managing its growth, and also managing the expectations of its billion+ people related to the quality of their lives.

Likewise India, including issues not mentioned by Cowen above, as seen in the article by Vish Goda entitled “Open Market Choking Roads” at AlwaysOn:

…what concerned me most during that visit was the uncontrolled proliferation of automobiles on Indian roads, so much so that nearly every street in Bombay or Pune was full of parked cars unable to go anywhere at all. And the visibile pollution extended way past the city, dumping clouds of soot and dust onto fields of rice and wheat.

I’m instinctively leery of his suggestion that government get involved and clamp down on the free market in India, forcing an earlier solution to the massive infrastructure problems in that country than the market would on its own. However, the sooner India starts paying the price in societal underpinnings required to match their prominence in the world economy, the sooner the flow of investment and purchases from the US to India will regain balance.

Ditto China, and the Philippines, Vietnam, Russia, or any other country about which, one day soon, China and India will be complaining for having hollowed out their service industries. In economics, as in many crucial spheres of human interaction, the world neither begins nor ends this week, this month, or even this decade. Not for nothing are they called “economic cycles”, and they’re quite a bit longer than the blink of an eye, so they should be examined and dealt with over the long haul.

Oh, and apropos nothing much, in case it seems odd that, two weeks after the initial uproar about this issue, I’d be pontificating on the matter, I’d like to add that the impetus for my rousing the effort to put my thoughts into words was an interview I heard on my way to the gym this evening, on the local PBS station’s broadcast of Marketplace.

In the fifth segment of that show, entitled “We may be taking some hits from free trade”, the host, Kai Ryssdal interviewed Dr. Blinder. (audio & transcript available at link above). The important clarifications I heard from the professor included:

BLINDER: Electronic communications means that a whole range of services that we used to think of as not tradeable between countries now is becoming tradeable. And India is the . . . it’s not the only one, but it’s a major source now of skilled, English-speaking labor.
So far, this is still a relatively small phenomenon — although for the people that are already impacted by it, it doesn’t seem very small at all. But I believe that as the electronic communications continue to improve, as they’ve been . . . and as countries like India, China, the Philippines and many others educate more and more people and get more and more businesses involved in this off-shoring process, it’s gonna be a very big deal indeed.

RYSSDAL: You know, if you go to an economists’ convention and you survey a room full of ‘em, they’re probably gonna say, most of them anyway, that free trade is a good thing. And that it generally advances the economic well-being of most of the people in the world. Are they all wrong?

BLINDER: No, no, they’re all right — and I’ll be in that convention voting the same side. Absolutely. Let me give you a large-scale analogy: suppose you were privileged in the year 1802 to walk into President Jefferson’s office and say, “You know what, President Jefferson? Right now, 83 percent of Americans earn their living on farms. In 150 years, that’ll be about 3 percent.” You know, Jefferson might have asked you, “Well, what will the other 80 percent do?” And of course, you wouldn’t have known, and nobody would have known. But they found better things to do than working on farms. And so in the end, I think we’re gonna have huge gains from this process. What I’m worried about is getting from here to there.
…I think we have to get used to the idea that if we want to stay the richest country in the world — which I presume we do — we can’t try to hang on to sunset industries. We have to specialize in sunrise industries. That’s again, not a news story, it’s been the story of the United States for decades now. And we’re pretty good at it, frankly.

(ellipsis mine)

And that’s all this is about – getting from here to there. Dr. Blinder is right to remain a free market economist, and is also right be talking about that journey.

Addendum – For the record, according to Arnold Kling, another MIT Econ PhD:
Alan Blinder is not Boring
Alan Blinder is Not Stupid

Just in case you were still forming an opinion.

Clarity, of a sort, on the work of securities analysts

Apr 10 2007

Michael Moe has an interesting post up on the subject of securities analysis, at AlwaysOn.

A snippet:

One of the bizarre realities of Wall Street is the generally random process security analysts use to evaluate investment opportunities. I was an analyst at Lehman Brothers when it had the number-one-ranked research department on Wall Street. I was Director of Global Growth Research at Merrill Lynch when it was ranked #1. I was Director of Growth Research and Strategy at Montgomery Securities when that firm did better research than the other two top ranked firms. And at all three places, the instructions were essentially the same: ”Here’s a laptop. This is your industry. Go write research and recommend companies.”


But it’s not their fault because they haven’t been given a process. If Starbucks hired kids off the street and told them, “Go make a latte” very few people would have ever heard of Starbucks.

(ellipsis mine)

Before your next opportunity to rely heavily on the work of an analyst with whom you’ve got no history, I’d recommend spending a minute or two and reading Mr. Moe’s “Think 10 Commandments” philosophy, and deciding whether your analyst shares any of its tenets.