Connelly on Commerce

Terry Connelly is dean of the Ageno School of Business at Golden Gate University and is frequently quoted on business, financial, and economic issues by Bay Area local, as well as national, news media.

You can bank on Ireland — that is, if you’re an Irish Bank. The Irish Government has bailed out its banks to the extent that makes America’s TARP program seem like little more than a drop in the bucket. And in doing so it has nearly bankrupted the country’s treasury and along the way exposed its citizens’ to the harsh reality of fiscal austerity. Moreover, it has managed to preserve Ireland’s  status as a low-tax location for multinational corporations, with a 12% corporate income tax rate. Mercantilism meets the Tea Party!

The only problem is that good old credit default swaps have called a halt to the Irish sweep-under-the rug-stakes — and the same derivative vigilantes have called the question on the Euromarket leaders (sic) in terms of whether the Irish funding crisis will pull down the whole Euro structure once again as was threatened in the case of Greece before the Germans (aka Europe) and the ECB got together with the bloodhounds from the International Monetary Fund to pony up a big league bailout fund (l’ ‘TARP, c’est moi!) — with strings attached.

It’s hard to see what more austerity the IMF folks can levy on the suffering Irish citzenry, but it’s not hard to imagine what they might do to their banks’ bondholders, who thus far have escaped Scot (should we say Irish?) free. Moreover, it would also seem that in terms of the revenue side of the Irish ledger, the heyday of the low corporate tax rate may be just about up. That’s what the Irish PM and his colleagues may have been fighting to hold on to, but it seems they are now backed into a corner by the comments of their own Central Bank head, who has conceded a bailout of substantial proportions must be forthcoming. The jig is up.

Not coincidentally, the imminent resolution of this Irish Kabuki will put an end to the rumors game the too-short-the-market US hedge funds have been running against the US stock market the past few days. November, as it runs out, isn’t May, even when the Chines coopoerate with a little price-control Kabuki of their own, which turned out to just about food and not about the harder commodities.

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Terry Connelly is dean of the Ageno School of Business at Golden Gate University and is frequently quoted on business, financial, and economic issues by Bay Area local, as well as national, news media.

Here are my thoughts;

1) I agree this election is historically significant already: but in part because its context is really like no other in recent memory given the economic debacle we have been living with since mid-2008: the “breakthrough” election of Obama and the resultant Tea Party backlash (although this aspects is reminiscent of the emergence of the George Wallace movement after the Johnson Civil Rights victories); and the much broader engagement of the electorate in business and economic issues that in past times would have been viewed as arcane or “inside baseball” stuff (recall the level of sophistication back in the Ford White House “Whip Inflation Now” buttons in the 1978 Congressional campaign).

2) Whatever the size of the anticipated swing to the republicans, they will as a Party be “implicated” in the course of the economy for the first time since 2008 — they will be a partner in Government even if they fall just short of House or Senate control — which means “Just Say No” pure obstruction won’t work as a strategy focused towards 2012. The Party has already anticipated that outcome with it’s somewhat half-formed “Pledge to America” that in effect creates a luttle daylight between them and the Tea Party.

3) The Democrats in Congress and especially the White House will have every excuse to put their strident anti-business posture behind them, not only because of electoral losses but even more because we have about “run out of spit” in terms of both fiscal and Federal Reserve ‘stimulus” (although the Fed may give one more shot at stimulating some real inflation) and we will need business leaders to make bold decisions on investment and hiring to drive a real economic recovery.

4) Accordingly, I do NOT foresee, as so many do, two years of utter gridlock in DC on economic issues but rather a situation where deals can get done. Specifically, I believe an informal but strong “centrist caucus” will emerge in both the House and Senate particularly around a pro-business agenda, and that the White House will reach out to them in tis own self-interest. This will be good for investors and middle-class IRA’s and consumer sentiment generally.

5) The Report of the Deficit Commission in December, just a month after the election, will not be just “‘put on the shelf” like so many commissions before but will rather serve as a “safe harbor” for politicians (especially the “centrist caucus” I mentioned above) to open dialog about formerly ‘third rail” budgetary issues — this also will hold true for the President, although in reality it will imply that we will raise some taxes in some way on the middle class or at least begin to chip away at some sacred cows they hold dear like mortgage interest deductions up to $1 million. While I expect no ‘grand bargain’ before 2012, I do believe there will be more pro-business actions emerging from the Administration and Congress in 2011. For example, a deal on repatriation of over $1 trillion in corporate overseas earnings in exchange fora minimal tax payment and commitments on hiring and investment, and some sort of regulatory check and balance process..

6) There may even be progress on skilled immigration, as business knows the dirty secret that by the middle of the next decade, our national problem will be too few workers for the jobs we need filled, not the present high unemployment that effectively masks this long term competitiveness problem. Politicians may begin to gingerly concede that China is eating our lunch in terms of driving its economy purposefully and effectively (Howard Dean tried to suggest this in 2004 but was shouted down even in his own Party — by late 2011, it will be a mantra a many Presidential aspirants — the ‘missile gap” of 2012!

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Terry Connelly is dean of the Ageno School of Business at Golden Gate University and is frequently quoted on business, financial, and economic issues by Bay Area local, as well as national, news media.

As we follow the projected path of the latest Atlantic hurricane just after the Bernanke speech last Friday in hurricane-proof Jackson Hole, consider that  the “cone of uncertainty” weather forecasters use to frame the potential path of the storm up the US East Coast is an apt metaphor for the state of the US economy.

And just as this week we will learn the actual path that the hurricane will take, for good or ill, this week we will learn economic statistics that will set the tone for the month of September in the financial markets: the Challenger report on August corporate downsizing; the ADP report of payrolls, the weekly new jobless claims, and unemployment and net job creation for the month of August.

While some of these numbers are enlightened guesswork and especially the last listed is prone to later revisions, if the economy goes “0 for 4″ on these key measures of return toward growth, we will be in for a rough week in equities and a stellar week in bond-bubble-land.

We have already been rocked by downward revision of the GDP estimate for Q2: however, bear in mind that the “final” revision for Q1 turned out to be about 30% wrong to the downside  — we learned just four weeks ago that Q1 was actually a 3.7% growth period, not 2.7%. Imagine what the equity market would have done with that news had it been delivered the last week of April instead of the last week in July!

As it was, that disappointing but wildly erroneous number set the stage for the market swoon pushed on by the frightening (and equally erroneous) cries of doom in May from the merchants of pessimism about European sovereign debt: Greece was going to default, followed by Spain; Germany was going to pull out of the Euro; the Euro was going to parity with the US dollar.

NONE of this came to pass, but US businesses clearly pulled in their investing and hiring horns in response to the story line (as did US consumers): they all took the summer off at the beach, with predictable results in terms of the economic data for June, July and August.

So we have now once again proven to ourselves that the “Big Lie” — or at least the “Big Hedge-Fund , CNBC driven Panic Rumor” — can knock stock prices silly.

No surprise, then, that individual investors have fled the equity market, given  May’s “”flash crash” and the constant ideologially-driven drivel from the usual suspects CNBC rounds up every day to use the latest faulty economic “data” to bash the Obama Administration and tout a Republican victory in November.

No argument from this quarter against CNBC trying to emulate Fox News — but one wonders why a network dependent on individual stock market investors for its audience would be intent on eliminating that particular species from the food chain?

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Terry Connelly is dean of the Ageno School of Business at Golden Gate University and is frequently quoted on business, financial, and economic issues by Bay Area local, as well as national, news media.

Let’s imagine a new business offering a service, priced significantly higher than many available alternatives, that somehow manages to get the US Taxpayer to front-up its operating costs in the form of loans to its customers up to 90% of total revenue, and then uses that Federal subsidy to fund not only the basic service cost but in may cases an even greater amount of spending on all manner of advertising to drown out its competitors with expensive national media campaigns and call center operations rivaling the heyday of the sub-prime mortgage industry with misleading sales tactics recently uncovered by Federal agents shopping in disguise. To top it off, the taxpayer is stuck with any default losses on those customer loans, which  must be repaid even if the customers don’t get the full economic benefit of the services they paid for up-front. And let’s add that this taxpayer- underwritten business model generates profit margins about 300% higher than the typical Federally-funded defense contractor.

Would The Wall Street Journal  not rail against this model as  a classic, Fannie Mae case of privatizing gains and socializing losses? Would the WSJ not conclude that paying the taxes on such extraordinary earnings is the least this business could do to compensate the taxpayer for taking the risk of funding its marketing campaigns? Would the Journal not lecture us that separating economic risk from reward is particularly inconsistent with your core free-market principles?

Yet this is the very same business model followed by many of the for-profit colleges and universities you conclude are being unfairly scapegoated by the Obama Administration. Would taxpayers not be far better served by focusing their subsidies on customers of public (and private) educational institutions that charge lesser (or even equivalent prices) for educational services where the vast bulk of the public money (and risk) supports the cost of education rather than a crescendo of questionable advertising?

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Terry Connelly is dean of the Ageno School of Business at Golden Gate University and is frequently quoted on business, financial, and economic issues by Bay Area local, as well as national, news media.

The U.S. taxpayer has unwittingly been the lead underwriter of the
tremendous marketing success of the for-profit higher education sector but
bearing most of the downside risks with few rewards.

Over the past three decades, for-profit colleges have designed a most
successful business model, growing their enrollment at six times the rate
of all universities.

Our future economy will need at least 40 percent of its citizens to earn
college diplomas, but we are producing graduates at a rate of less than 30
percent of the population – and taking six years to do so. To their
credit, the for-profits have made important progress in addressing the
nation’s graduation gridlock by catering to working adult students while
traditional universities have made only modest efforts to accommodate
them.

For-profits have thrived by turning the long-standing operating model of
U.S. universities virtually upside down: treating higher learning as a
business, students as customers and traditions as disposable; creating
year-round schedules and online degrees convenient for students with jobs
and families; and adopting a cost-efficient instruction program featuring
contract professors and a centralized course design.

The for-profits have attracted substantial equity investment by their
willingness to innovate as well as because their consumers are
preconditioned to annual tuition price increases even above the inflation
rate, for essentially the same product. Most importantly, their healthy

operating margins are underwritten by federal student loan programs, which

shift the credit risk from the school to the U.S. taxpayer.

For-profit college revenues are generally about 90 percent tuition-driven,
and many operate close to the limit of 90 percent revenue dependence on
federal education aid.

The question of whether for-profit colleges prepare students for “gainful
employment,” as required by federal student loan rules, raises fundamental
policy issues beyond the concern of about their high loan default rates
(which are close to 25 percent).

Annually, about 25 percent of for-profit colleges’ government-subsidized
tuition revenue is spent on aggressive student recruitment programs.
Taxpayers are thus financing not just educational expenditures but
expensive advertising campaigns and sophisticated call centers.

The University of Phoenix spends nearly $1 billion annually on promotion.
It used its federally subsidized profits to purchase naming rights to a
sports stadium. Bridgepoint Education reported spending 28 percent of this
year’s first-quarter revenue on promotion, compared with only 25 percent
spent on instruction costs and services.

There are many lessons traditional colleges can learn from the successes
of the for-profits. But imagine taxpayers’ reactions if traditional
schools decided to divert a quarter of their already constrained budgets
away from the classroom to carry out massive self-promotion campaigns.

Just as Congress and the administration are paying attention to the
percentage of subsidized health insurance premiums that go to actual
medical care as compared with administrative costs, they would do well to
consider the appropriate relationship between for-profits schools’
marketing expenditures and their investment in learning content and
delivery.

Surely the taxpayer is not intending to subsidize their ability to provide
“gainful employment” primarily for the advertising industry.

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Terry Connelly is dean of the Ageno School of Business at Golden Gate University and is frequently quoted on business, financial, and economic issues by Bay Area local, as well as national, news media.

Several media commentators and reporters have recently raised the question (even at president Obama’s press conference) why the US Government has not commandeered a fleet of supertankers to proceed to the Gulf of Mexico  and siphon-up the oil spill into their gigantic holds  before it reaches the shores of the Gulf states and the wetland breeding ground for endangered fish and waterfowl. They point out that this method was used in the case of a massive spill in MidEast waters by the Saudis, with considerable success.

No direct answer has been forthcoming, from the President or anyone else in authority.

The reason may be that the vast majority of the world’s supertankers are already floating around the world full to the brim with oil purchased for future delivery by commodity traders betting on a rise in future spot prices. Most of these traders took their position, of course, prior to the BP spill in April. But even though the price of oil in today’s  market has declined over 10% e from its 2010  peak due to concerns of about global economic growth being stunted by the European debt crisis that emerged full-blown this May, the traders bets still look pretty good given the prospect of substantial curtailment of offshore drilling activity in US coastal waters for what the Federal Reserve might call ‘an extended period”.  The longer the spill goes on, the more valuable the oil in the holds of the worlds’ supertankers may become.

So the traders who own the oil already fuilling the tankers have no interest in bringing that oil to port just now so that the ships can be emptied for a Gulf of mexico clean-up operation.

And guess who has been one of the biggest speculators in oil for future delivery: that’s right, Goldman Sachs, led by  premier commodities trader Lloyd Blankfein, out there doing God’s work on God’s ocean.

So could one of those inquiring commentators of reporters put in a call to Goldman headquarters and a number of other well-known traders in oil futures to see just who is holding what oil in what tankers parked idly somewhere on the Ocean Blue (or that part which remains blue) waiting for oil prices to head back-up after the ‘offshore shortage’ that is bound to come?

Is it possible that Goldman and others are holding out on the President when his folks call about maybe borrowing the supertanker fleets they have chartered to hold their crude?

Or is it possible that the folks at Goldman could be so  ”crude’ as to be holding out for, you guessed it, some sort of “trade”? Like, we’ll let you have a tanker or two if , say, the SEC could be persuaded to  let us off on a “lesser charge”?

Someone should at least get an answer as to why the  supertankers that are merely storing oil for suture price speculation cannot somehow  be pressed into national service.

blank bounty?

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Terry Connelly is dean of the Ageno School of Business at Golden Gate University and is frequently quoted on business, financial, and economic issues by Bay Area local, as well as national, news media.

Like all tools, high frequency trading is subject to abuse both at the hands of humans and by the ghosts in the machines. That said, sometimes in life speed is truly of the essence, and as we saw last Thursday, sometimes a pause  does not refresh but actually retards resolution of an imbalance in orders. 

 Relatively small scale moves at the same instant on the futures market can trigger geometrically larger reactions on the broad tape, but there have been times when such moves have been highly salutary –as in the case when several large Wall Street firms conspired (with Fed encouragement) to stop the market rout during the 1987 crash (albeit at a distinctly human speed). Imagine if the events of Thursday had occurred (as they might have) on a rousing “up’ day on the Dow rather than during a not-unwarranted sell-off: would we be as equally engaged in today’s “glitch hunt”? The right answer is “Yes”, but not the probable one. 

 Ordinary folks like you and me cannot possibly play the markets at the warp speed of Goldman Sachs, which chooses to use the electronic tools at their disposal to compete in a nano-paced league with their digital trading peers.  In most cases, however, their private game tends more to perfect than distort the price you and I pay or receive on the slower-paced executions we rely on. 

 The best way to protect ourselves is with limit orders (which, by the way, also can be abused), and to protect our markets with cross-market circuit breakers that effect all trades equally  –  not by a futile attempt to reverse the processing pace of the modern semiconductor. Time-outs are a necessary response when events spin seemingly out of control, but they must apply to all players simultaneously.  

 When we do have a crash in the high-frequency system, however, we need to engineer a (forgive the phrase) “black box” recording like on airliners that will yield a much more precise sense of the causes of the breakdown that we have been able to glean from the latest episode. High frequency is no excuse for claiming that the tracks of trading tragedies are too complex to tease out, and only a clear sense of what actually went wrong will allow appropriate remedies to be applied to adjust trades that resulted from system malfunctions rather than wrong bets on market direction.

Terry Connelly

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Terry Connelly is dean of the Ageno School of Business at Golden Gate University and is frequently quoted on business, financial, and economic issues by Bay Area local, as well as national, news media.

Let’s try this:

1)  Does the SEC have a good case against Goldman Sachs/ Better than a lot of commentators think. Of course sophisticated private buyers knew that short sellers were on the other side of the trade, and GS was not an underwriter but just a placement agent; BUT GS should have disclosed that the securities were picked from deck supplied by a known short-seller — that looks like an omission of a material fact, because that information would have made a difference to a reasonable buyer at least on PRICE, if not on the decision whether to buy at all.

2) Is Goldman’s (or any other investment bank’s) basic business model as a financial intermediary unethical because they don’t “put the client first”? NO: by definition, a financial intermediary has two clients — one a buyer and one a seller– GS has an obligation to deal with them each fairly and above board, but how can they pick just one to “put first’” — you can’t be a fiduciary for both sides of a trade. And remember some clients want to take risks. One of the long-taught lessons to apprentice investment bankers is — “if the client wants a red suit, sell them a red suit” … and in 2007, a whole lot of folks wanted to go long the mortgage markets, because they didn’t perceive it was a “red suit” waiting to happen. Goldman apparently did perceive that, but if it had refused to sell the mortgage products then and there, the business would have just gone someplace else (say Bear Stearns, and the risk profile of the financial industry (and the US taxpayer) would have wound up the same.

3) BUT what about when Goldman trades for it’s own account against the interests of its customers? Well, here it gets interesting. Sometime a firm like GS will take a position for itself just because it likes the bet  — it has a view of the market informed by its day-to-day experience. But other times it takes a position onto its own book to accommodate a client or to facilitate making a market, like after an IPO, which means its taking a risk on that security, and if it hedges that risk, it is in a real sense protecting its “own account”. The proposed “Volcker rule” says that a deposit-taking institution can’t just trade for its own account because it puts taxpayers at risk, but where do you draw the line for the situation just mentioned where it starts with accommodating a client?

4) What about derivatives: if they are “instruments of mass financial destruction” or whatever Warren Buffet called them why does he use them and ask Congress to exempt his from the new rules?  Well, derivatives have legitimate uses (airlines hedging the price of jet fuel; farmers hedging their crop return) the clearly should be bought and sold through a “clearing” house, which would mean that both sides would have to put up enough collateral to be sure they can pay off. Banks are really trying to fight off another step which would require them to be traded through a public exchange (most of them would be done in Obama’s hometown Chicago companies)…this would make their pricing transparent, and banks have been making a boatload of money on derivatives precisely by keeping the trades private and this not transparent, so only they know the true market price.

5) What’s really going on here: Look, we are in the middle of a fight about proposed legislation which will set the framework for the financial industry for the next two or three decades at least. There is a lot at stake, and the lobbying is fierce, and firms like Goldman have a lot of lobbying power at their disposal (and a lot of friendly media, too. Obama has been quite clear about wanting the banks to call off their dogs in this fight, and it would be that the case vs. Goldman and leaks about Justice Department investigations are what we know if baseball a s “brush-back” pitch in the Ninth Inning of a close World Series seventh game. If I’m right, the folks who think Obama is a “weak sister” who can’t play hardball have got another think coming: and remember that Goldman definitely knows how to play hardball. So maybe all that’s really going on is a process of evening up the odds. The contra view, of course, is that Obama is clearly playing hardball just to push some of Wall Street’s business over to Chicago!

6) Why don’t we have a “product recall’ practice for Wall Street securities that go sour just like we have for Toyota’s and Tylenol? NOW There’s a Good Idea! We do have some securities Act provisions about recession, but they are cumbersome and not used: but would the earth stop spinning for a moment if some investment bank one day admitted to the buyers what it tells itself in e-mails — namely, that this deal we did stinks to high heaven, and we’re going to recall it, and fix it or eat it ourselves! Maybe then, Goldman Sachs would rate as high as Johnson & Johnson in public respect, and even keep its stock price up, too.

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