Month: April 2015

Greed isn’t the only game on Wall Street

Posted on by j.giglio

Anyone who has read the surfeit of books on the meltdown of the financial system will know that the burden of patience chiefly falls on the reader. The authors, whose lives were barely buffeted by the Great Recession, seem infinitely addicted to the notion that lust for short-term profits was the major contributing factor in the lead-up to the 2008 financial crisis.

The reason we know this is because they keep telling us.

Greed is always a popular scapegoat when something goes wrong. We assume it’s inherent in human nature; ubiquitous. It’s embedded far more deeply in the American capitalist system than are the benefits that flow from resisting the temptations of immediate gratification..

However inherent greed may be, lost in the frenetic discussion is the notion that it takes particular incentives to make it burst forth in full glory. These perverse incentives are an essential point that is often overlooked.

On a macro level, are government housing policies flawed for providing incentives to borrow too much to buy a home? Do U.S. tax policies promote short-term investment? Are stock option-based executive compensation schemes promoting a fixation on quarterly earnings?

Let’s consider two simple examples. Suppose you hire me to sell your line of Christmas cards door-to­ door and offer me a lucrative commission on the retail price of all the cards I sell. Do I have an incentive to push the cards that generate the highest profits for you or to push the ones that can generate the highest retail sales volume, even if they’re loss leaders?

You already know the answer to that one. Now, let’s switch places.

Suppose we work on Wall Street and I hire you to sell the glitzy derivative securities our brilliant rocket scientists have packaged up from pools of solid and not-so-solid home mortgages. And your year-end bonus -which can often be the largest part of your compensation – is based on the dollar volume of these securities you’ve sold during the year.

Is this arrangement likely to make you act responsibly, to sell high-priced derivatives backed by not-so­ solid mortgages only to savvy investors who understand the risk that accompanies their higher yields, while focusing on selling less-savvy investors the lower-price derivatives that offer modest yields but are backed by solid mortgages? Or does it reward maximizing your sales volume, pushing the high­ priced derivatives across the board by touting their “fabulous yields” without mentioning the risk?

You know the answer to that one, too.

So when judgment day comes and the value of all those risky  high-priced derivatives collapses, leaving stunned investors holding the bag, are you at fault because you gave in to your inherent greed? Or am I the culprit because I gave you an irresistible incentive to push toxic, high-priced derivatives to all and sundry, never mind the consequences?

Many of you remember Gordon Gekko’s “Greed is Good” speech from Oliver Stone’s 1987 movie, “Wall Street.” Greed is a powerful tool; only the desire for more, more, and more and to get ahead generates economic growth. But there’s a much more articulate and compelling defense of greed in Ayn Rand’s classic libertarian novel, “Atlas Shrugged” in which entrepreneur John Galt insists that greed is the only thing we can really depend on to move society forward.

Or is all this just the old story of Satan conning Faust to sell his soul?

Good intentions alone cannot constrain greed. If government and business fail to provide the right kind  of incentives to channel legitimate self-interest, capitalism is as appealing as letting a pack of rabid dogs loose on the American worker. Until the incentives are changed, the hard truth is that most of you should reach for your wallets.
 

originally published: April 25, 2015

General Electric’s shift is a light bulb moment for economy

Posted on by j.giglio

Last week General Electric announced plans to drastically downsize GE Capital, for years a key earnings driver, to focus on its core industrial businesses that range from jet engines to medical devices. The company will shift away from running the diversified financial services firm that wiped billions off its balance sheet during the financial crisis and escape the post-financial crisis regulatory burden that has weighed down GE’s stock price.

A company statement noted that “The business model for large, wholesale- funded financial companies has changed, making it increasingly difficult to generate acceptable returns going forward.” In other words, this business is the financial equivalent of a boxer who has taken way too many shots to the head.

Over the next two years they plan on selling off most of GE Capital, the country’s seventh largest bank holding company with about $500 billion in assets. Part of the strategy involves selling off $165 billion of loans and a $26.5 billion portfolio of commercial real estate investments and loans.

As GE CEO Jeff Immelt explained in a CNBC interview, “You really have a perfect market to be selling financial service assets … you’ve got slow growth, low interest rates, lots of liquidity, people searching for yield.” He added: “We think it’s good for the regulatory world, it’s good for investors and that’s been more or less recent. Now’s the time to do it.”

After the 2008 financial crisis, GE began surgically pruning GE Capital, which was founded in 1933 as a subsidiary of the General Electric Co. to provide consumers with credit to purchase GE appliances. The firm sold its domestic consumer finance business last year and earlier this year it sold its lending units in Australia and New Zealand.

Last fall, Immelt announced that the firm planned to reduce the size of GE capital to represent about 25 percent of the company’s earnings, down from nearly half at its peak. Under the new plan, GE Capital will account for less than 10 percent of profits by 2018.

But the company plans on retaining key units like GE Capital Aviation Services, Energy Financial Services, and Healthcare Equipment Finance. These financial operations provide GE with an advantage over its global competitors in these market segments by helping customers finance equipment purchases from the company.

For example, customers want GE CT scanners, MRI equipment and other medical devices because they are high-quality products that offer cutting-edge technologies. But they also want GE’s Healthcare Equipment financing arm to help fund a large capital outlay because it can give customers cheaper access to money. Each GE business benefits from the ability to provide customers with tailored financial solutions.

The firm is reshuffling GE Capital’s financing portfolio with an awareness that certain financial resources are integral to the success of its core businesses.

The firm also announced that it will pass some of the proceeds from scaling back GE Capital on to shareholders in the form of a share buyback program.

The company believes that buying back up to $50 billion of its own shares will help rejuvenate its moribund stock price and regain favor with investors, who have been complaining that GE’s stock has been stagnant for over a decade.

Investors loved the strategic move and sent shares up 11 percent. But even after the bump, GE’s stock price is down 22 percent over the past decade while the market as a whole is up 73 percent.

These returns are a far cry from those delivered so brilliantly during Jack Welch’s two-decade tenure as CEO, when he captured Wall Street’s fancy by delivering a 23 percent per annum total shareholder return and increased the firm’s market capitalization from $18 billion to over $500 billion. As the good times rolled, this performance made GE the most valuable company in the world-by 2000.

Only that great sculptor Time will tell if GE’s latest strategic shift will yield similar returns.

originally published: April 8, 2015

Fast food food fight

Posted on by j.giglio

Fourteen years after the publication of “Fast Food Nation” by Eric Schlosser, with its fierce indictment of the industry, consumers prefer a healthier brand of fast food. This is especially true of millennials, those 18-to-34-year-olds who have increasingly busy work lives and eat out a lot.

This spells trouble for traditional fast food restaurants like McDonalds, which need to make up for lost time when it comes to adjusting to new customer preferences.

In addition to wanting the convenience of paying for purchases with mobile devices, this generation’s preference is for locally and humanely sourced meats, seafood, and produce; natural ingredients; and freshly prepared, bespoke food.

Fast food behemoths such as McDonald’s have dominated the fast food landscape for decades with an industrial model defined by providing cheap and convenient food in a way that maximizes volume and reduces costs.

McDonald’s has been around for more than 60 years and operates more than 36,000 restaurants worldwide, of which about 14,000 are in the United States. The company feeds nearly 69 million customers in over 100 countries each day. While the beef and potatoes may not be locally sourced, more than 80 percent of their restaurants are franchised, owned and operated by independent local business persons.

McDonald’s named a new CEO last month amid a worsening sales slump. In 2014, the firm posted one of its worst performances in years. Revenue fell 2.4 percent to $27.44 billion as net income declined 15 percent to $4.76 billion. It was the first time both measures have declined in the same year since 1981. Its same-store sales, a key metric for restaurant chains, fell by a stunning 4 percent in the United States and 1.7 percent worldwide, which suggests that interest from existing customers is declining.

One major factor contributing to McDonald’s disappointing performance is its failure to evolve with a new generation that has different attitudes about what they buy and how they buy it. The changes add up to a new playing field for traditional fast food firms. Being slow to respond to changes in customer tastes has created an opening for so-called fast casual restaurants that have responded to changing expectations of what fast food can be.

Restaurants like Chipotle and Panera offer fresh ingredients and customized food at prices that are higher, but still affordable. While these restaurants still make up a much smaller portion of the market than their traditional fast-food counterparts, they have grown very quickly, spreading like kudzu across the land. A food fight is brewing for sure.

The three largest segments of the restaurant industry are full service, fast food and fast casual. While the fast casual segment is the smallest of the three, it accounts for $34 billion of the overall $710 billion restaurant market. It is also the fastest-growing segment, with an 11 percent growth rate. And while the average McDonald’s customer spends about $5 a visit, the average Chipotle customer spends more than twice that amount.

McDonald’s and the other traditional fast food firms will have to make some difficult decisions if they hope to attract regain their historical rate of revenue growth Millennials, that fast-growing demographic of young, single, health conscious professionals who earn above-average incomes and eat out twice a week or more, represent a gold mine of sales and profits. Appealing to such new market segments may well require McDonald’s to develop its own fast casual concept in the United States.

One thing is for sure, when it comes to satisfying changing consumer tastes and expectations, announcements like those recently made by the McDonald’s new CEO that all the chicken served at its restaurants will be free of antibiotics used to treat humans and that the 120 menu items in its 14,000 United States restaurants will be rationalized are unlikely to do the trick.  

originally published: April 4, 2015

An inconvenient fix to America’s immigration problem

Posted on by j.giglio

Most of the discussion about our broken immigration system centers on those who enter the country illegally over the porous 2,000-mile southwest land border that stretches over four states. But that is only a partial picture of illegal immigration in the United States.

Overlooked in the discussion are the security risks presented by the estimated 40 percent of the 11 to 12 million unauthorized residents who came here legally, then stayed after their student, business or tourist visas expired. In other words, these immigrants did not jump a fence, cross a river, or pay to be smuggled into the country. To borrow Vice President Biden’s words, “This is really a big deal.”

The number of visitors who come to the United States legally each year but pose a potential national security or public safety threat is unknown. Under current law, those who overstay their visas are committing only a civil violation of federal law, while those who sneak across the border are committing a federal crime.

Addressing the large number of foreign visitors who have entered the United States legally but then overstayed has been a long-standing challenge. Tracking the arrival and departure of foreign visitors is an essential part of protecting Americans from those who would do us harm.

While the Department of Homeland Security takes fingerprints and photos of foreigners who enter the United States, their ability to track immigrants who stay past their visa expiration in real time is severely limited, especially when you consider that any state with an international airport is a border state.

Perhaps it is time to simply issue people American Express cards because they seem to have no problem tracking their customers. The persistent problems of visa overstays are not given the same priority in allocating resources as efforts to blockade the border states. It may be because overstays don’t make for good 10-second sound bites like those who cross the Rio Grande river in search of a better life do. These Mexican immigrants are building houses, not bombs.

The government has known for some time that the visa process is vulnerable to terrorist exploitation. The General Accounting Office has reported that 36 of the roughly 400 people convicted of terrorism­ related charges since 2001 overstayed their visas.

In 2007, Hosam Smadi arrived from Jordan on a 90-day tourist visa but never left. Two years later he plotted to blow up a Dallas high-rise with a car bomb.

Another tourist, 29-year old Moroccan Amine El Khalifi, overstayed his visa and conspired to detonate a bomb at the U.S. capitol in 2012.

Lest Americans forget, on 9/11, 19 foreign terrorists came right through America’s front door on legitimate visas, hijacked four planes and murdered almost 3,000 innocent people. On the day of the attack, four of them were living in the shadows even though their visas had expired.

Fifteen of the 9/11 terrorists were from Saudi Arabia, but that did not dissuade the federal government in January 2013 from adding the country to the U.S. Global Entry trusted traveler program, which streamlines the airport screening process.

With the United States at war against terrorism, it may be time to consider Michael Corleone’s  11th commandment: Protect your family at any cost. Even if it means antagonizing those such as the airlines and tourism industry concerned about reduced travel to the United States or those who worry about the privacy issues involved in cracking down on visa overstays with increased monitoring of visitors.

If the United States is ever going to get serious about fixing our broken immigration system, we need to be willing to take on some of the interests who might be inconvenienced by the fix.

originally published: April 1, 2015