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  1. 9 Predictions for 2009

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    Set forth below are my pre­dic­tions for 2009. Let’s hope that at least some of them come true.

    1. Early in 2009, the banks start lend­ing again

      In Jan­u­ary, the banks will real­ize that they can­not avoid lend­ing for­ever. The Fed­eral Reserve will finan­cially pun­ish any bank that refuses to lend by manip­u­lat­ing inter­est rates so that banks that hoard cash lose money. From the indus­try ashes a bank­ing prophet will emerge who will preach the gospel of pos­i­tive net inter­est spread through respon­si­ble lending.

    2. The Obama Admin­is­tra­tion passes the largest fis­cal stim­u­lus pro­gram in the his­tory of the United States

      The fis­cal stim­u­lus plan will be big­ger, bet­ter and more socially respon­si­ble than any­thing the Fed­eral Gov­ern­ment has ever done before. When the pro­gram starts to kick in James Carville will declare Obama has earned his place in his­tory as “one of the greats” and will sug­gest he should be imme­di­ately added to Mt. Rush­more. Oth­ers will declare that the fis­cal stim­u­lus plan proves that Obama is a Marxist.

    3. GDP falls in Q1, sta­bi­lizes in Q2, begins to rise in Q3 and is in full recov­ery by Q4

      Despite most econ­o­mists pre­dict­ing Depres­sion 2.0 and the “end of the world as we know it”, the econ­omy will begin to recover in 2009. How­ever, the day after inau­gu­ra­tion, right wing talk show hosts will declare the begin­ning of the “Obama Depres­sion”. When the econ­omy starts to do bet­ter, the same right wing talk show hosts will pro­claim that Bush was right when he said the econ­omy was “basi­cally sound” and will give Paul­son credit for engi­neer­ing the recovery.

    4. Defla­tion fears give way to infla­tion fears

      It turns out that the Fed­eral Reserve wasn’t able to un-print money any­more than Eve could un-eat the apple. Econ­o­mists will be relieved that they can pre­dict Hyper­in­fla­tion 1.0 and the “end of the world as we know it”.

    5. Europe and Asia do worse than the U.S.

      If you think it is bad here, just go over there. Jean-Claude Trichet will be exiled to the Island of Elba for start­ing his 2007 pre­emp­tive eco­nomic war on infla­tion. Tichet won the war but lost the econ­omy. Lib­eral EU politi­cians will real­ize that exile is very “19th Cen­tury” and Elba is really kind of nice (good wind­surf­ing, scuba and cute female Elbans). Trichet will escape but will be recap­tured and made to work in the ECB audit depart­ment (after all reg­u­la­tory audit work is worse than exile).

    6. Hedge funds, funds of funds and other money man­age­ment prod­ucts are reg­u­lated and taxed.

      Dis­traught for­mer fund man­agers still won’t be able to accept that Mad­off killed the golden goose. Soon, no one will be able to find an investor that actu­ally admits to ever hav­ing put money in hedge funds; it will be as if the indus­try never existed. A rumor will spread that before the end of the Cold War hedge funds were invented by the Soviet Union to destroy Amer­ica. Ann Coul­ter will say that Democ­rats invented the hedge fund indus­try to destroy the Bush legacy.

    7. Obama makes enforce­ment of secu­ri­ties, bank­ing and con­sumer pro­tec­tion laws a priority.

      Wall Street bankers will burn Sarah Palin in effigy. After all, if she hadn’t blown the Katie Couric inter­view things could have been dif­fer­ent. Aspir­ing white col­lar crim­i­nals will have to deal with pros­e­cu­tors and reg­u­la­tors who actu­ally try to do their job. 20 and 30 year old for­mer invest­ment bankers will be found in bars all around Tribeca try­ing to fig­ure out what to do next. Grad­u­ate school will be out because they will all already have MBA’s and their par­ents will refuse to pay for more school. Some will get “real jobs” and hate it.

    8. Stocks go up then down then up then down then up then down. But, major stock indexes end the year up.

      Investors real­ize that mar­ket ana­lysts don’t have a clue whether indi­vid­ual stocks will go up or down. But, liq­uid­ity cre­ated by the Fed­eral Reserve, a slowly recov­er­ing econ­omy and mas­sive fis­cal stim­u­lus all con­spire to push the Dow, S&P and NASDAQ up by year end.

    9. Regional ten­sions rise and coun­tries face inter­nal strife because of the poor global econ­omy. Most of the U.S. is an island of sta­bil­ity.

      Sarah Palin does the ulti­mate mav­er­ick thing and declares that Alaska has seceded from the U.S. and will be its own inde­pen­dent nation. Palin becomes Vice Pres­i­dent (even if it is only Vice Pres­i­dent of Alaska) and Ted Stevens becomes Pres­i­dent. Stevens hopes that by being Pres­i­dent of Alaska he will be able to avoid going to jail. After watch­ing Palin and Stevens, Illi­nois Gov. Rod Blago­je­vich imme­di­ately declares Illi­nois’ inde­pen­dence. Around the same time, dis­senters in China chal­lenge the sta­tus quo (inde­pen­dence isn’t openly dis­cussed because in China exe­cu­tion is the penalty for sedi­tion). Eco­nom­i­cally moti­vated riots break out in Viet­nam and other parts of South­east Asia. See­ing weak­ness in the EU, Rus­sia con­tin­ues to expand its influ­ence. The Mid­dle East remains a prob­lem. But, in a moment of his­toric unity and at a con­fer­ence spon­sored by CNN and Ander­son Cooper, Arabs and Israelis agree that noth­ing has changed and the “world will con­tinue as we know it”.

  2. MINIMUM STANDARDS FOR CEOs OF GLOBAL BANKSWHAT SHOULD THEY KNOW ABOUT LEVERAGE?" rel="bookmark">MINIMUM STANDARDS FOR CEOs OF GLOBAL BANKSWHAT SHOULD THEY KNOW ABOUT LEVERAGE?

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    I have been an out­spo­ken critic of too much lever­age in the finan­cial sys­tem for the past sev­eral years. On CNBC and Fox Busi­ness Net­work I have spo­ken out against the dan­gers of bank and bro­ker­age over lever­age and sug­gested that such over lever­age could cause a repeat of the Great Depres­sion. Like a giant oil slick, the finan­cial ser­vices sec­tor of the United States has been an inch deep and a mile wide for years. Clips of some of those inter­views can be found at http://www.firstcapital.com/financial_news.html. Reg­u­la­tors don’t seem to care about man­age­ment strate­gies that have dri­ven the econ­omy into the ditch and share­hold­ers don’t seem wor­ried about man­agers that lack both com­mon sense and basic finan­cial training.

    The events of the last 12 months have seemed so unbe­liev­able to me that I have started to won­der if there are ANY min­i­mum stan­dards of knowl­edge and train­ing to be the CEO or CFO of a global United States based finan­cial institution.

    Many jobs in the United States have min­i­mum edu­ca­tional and train­ing stan­dards. Doc­tors attend med­ical school and get licensed. Lawyers are trained in law school and take the Bar Exam­i­na­tion. Even the peo­ple that take care of our pets, fix toi­lettes and build our houses have stan­dards that they must meet before they can hold them­selves out as experts.

    But, what about the exec­u­tives of large banks and bro­ker­ages? What are their min­i­mum edu­ca­tional or com­pe­tency stan­dards and do they meet such standards?

    It turns out that pretty much the answer is CEOs and CFOs do not pass any exam­i­na­tion, are not licensed and have no min­i­mum edu­ca­tional stan­dard. Who is qual­i­fied to be a bank CEO or CFO has been pretty much left up to the Board of Direc­tors of each institution.

    With no “national stan­dard” for bank and bro­ker­age CEOs and CFOs I decided that I would cre­ate my own stan­dards and bench­marks for mea­sur­ing com­pe­tence. So, this blog is about the stan­dards that I think should apply to the lead­ers of global finan­cial insti­tu­tions and whether or not CEOs/CFOs meet such standards.

    • Edu­ca­tion. I think that edu­ca­tional stan­dards fly in the face of this country’s “Hor­a­tio Alger” ethic and are “elit­ist”. After all, Abe Lin­coln only had about 1 year of for­mal edu­ca­tion and was per­haps the great­est Pres­i­dent of the United States (http://showcase.netins.net/web/creative/lincoln/education/glance.htm). Lin­coln prob­a­bly could have run a bank or bro­ker­age (after all he ran a civil war). Vin­cent McMa­hon, CEO of World Wrestling Enter­tain­ment, is able to run a large and suc­cess­ful cor­po­ra­tion and he prob­a­bly doesn’t have any for­mal edu­ca­tions (other than per­haps in phar­ma­col­ogy). If McMa­hon can run wrest­ing he can run a bank. George Bush went to col­lege (and grad­u­ate school) but pre­tends that he didn’t. Pres­i­dent Bush runs a whole coun­try!! And, Howard Hughes didn’t grad­u­ate from col­lege even though he was pretty smart. I am cer­tain Mr. Hughes could have been a banker in today’s environment.

       

      And, since col­lege isn’t required nei­ther should knowl­edge of eco­nom­ics, finance, account­ing or eco­nomic his­tory. Nor will require­ments include higher level math such as Alge­bra, cal­cu­lus or sta­tis­tics. CEO/CFO can­di­dates shouldn’t be expected to mas­ter more than basic addi­tion, sub­trac­tion, mul­ti­pli­ca­tion and divi­sion (with a calculator).

       

    • Work expe­ri­ence and/or appren­tice­ship require­ments. Abe Lin­coln didn’t have a lot of exec­u­tive expe­ri­ence before being Pres­i­dent, so nei­ther should bank CEOs/CFOs. Hedge fund man­agers, i.e., the “Kings” of cor­po­rate finance, don’t need any prior expe­ri­ence (and many of them don’t have any). So why should a higher stan­dard be imposed on CEOs/CFOs of global finan­cial insti­tu­tions?

       

    • Min­i­mum read­ing and gen­eral knowl­edge and where to find it. There are some stan­dards that I think should apply in terms of gen­eral knowl­edge and min­i­mum read­ing mate­r­ial. How­ever, given no real edu­ca­tion, work expe­ri­ence or appren­tice­ship require­ments, these stan­dards need to be “rea­son­able”.

      After reject­ing the local pub­lic library as a source of read­ing mate­r­ial for high level finan­cial exec­u­tives (remem­ber I want to have rea­son­able stan­dards for our nation’s finan­cial lead­ers and most books in the library have “big words”), I decided to go to Barnes and Noble. If it is impor­tant to know it is prob­a­bly found in the exten­sive selec­tion at Barnes and Noble.

    In the busi­ness sec­tion of Barnes and Noble I found two busi­ness books that seem per­fect. Nei­ther book used big words or a required lot of math, and to under­stand them an advanced degree (like an Associate’s Degree from Palm Beach County Com­mu­nity Col­lege) wasn’t required.

    The first book I chose, The Lit­tle Book of Value Invest­ing is part of the “Lit­tle Book” series pub­lished by Wiley.

    In the dust cover the pub­lish­ers ask “Do you care about your money?” Well, bank and bro­ker­age CEOs and CFOs are sup­pose to care about money. The pub­lish­ers claim that that only an IQ of 125 is nec­es­sary to under­stand the book. In fact, The Lit­tle Book of Value Invest­ing says that that any IQ greater than 125 is “wasted.” Well, an IQ require­ment was a new con­cept but one that I decided is rea­son­able. But what “sealed the deal” for The Lit­tle Book was the fact that the pub­lish­ers claim that the reader will “[learn] to put your money to work like a banker” (and since we are search­ing for proper stan­dards of knowl­edge for bank CEOs and CFOs….). And, for read­ers that have trou­ble read­ing, there is an audio ver­sion of this book. Barnes and Noble fea­tures The Lit­tle Book of Value Invest­ing on their web site at http://search.barnesandnoble.com/booksearch/results.asp?WRD=the+little+book+of+value+investing.


     

    The sec­ond book, Value Invest­ing for Dum­mies, is even more nat­ural for money cen­ter bank CEOs/CFOs. Value Invest­ing for Dum­mies claims to teach how to “detect hid­den agen­das in finan­cial reports.”, “under­stand finan­cial state­ments” and “assess a company’s value”. The book explains “fun­da­men­tals and intan­gi­bles”, has “tear-out cheat sheet(s)” and fea­tures “a dash of humor and fun”.

    The Dum­mies series of books are well known ref­er­ence books for dis­cern­ing read­ers and learn­ers. After all, the Dum­mies series has mas­tered such eso­teric and dif­fi­cult top­ics such as sea­sonal addic­tive dis­or­ders in their Sea­sonal Addic­tive Dis­or­ders for Dum­mies (a must read for all men­tal health pro­fes­sion­als), the conun­drum of the human genome in their ground­break­ing Genet­ics for Dum­mies work (I under­stand it is required read­ing at most med­ical schools), the mys­tery of the 1980s per­sonal com­puter in their newly revised DOS for Dum­mies (finally an easy to under­stand ref­er­ence book for peo­ple with a com­puter pho­bia) and how to kill time while wait­ing in an air­port in the sem­i­nal work Su Doku for Dum­mies (if only I had this on my last trip to Asia). The most author­i­ta­tive list of Dum­mie books can be found on the Barnes and Noble web site at http://browse.barnesandnoble.com/browse/nav.asp?visgrp=nonfiction&n=1000005131&ne=1000005131&Ns=SERIES_NUMBER.


     

    So, what about those min­i­mum stan­dards for the global finan­cial leaders?

    What should they know about leverage?

    Accord­ing to The Lit­tle Book of Value Invest­ing quite a bit.

    In the “Lit­tle Book” chap­ter titled “Sift­ing Out the Fool’s Gold” I learned

    The first and most toxic rea­son that [com­pa­nies don’t do well] is too much debt. In good times, com­pa­nies with decent cash flow may bor­row large amount of money on the the­ory that if they con­tinue to grow, they can meet the inter­est and prin­ci­pal pay­ments in the future. Unfor­tu­nately, the future is unknow­able, and com­pa­nies with too much debt have a much smaller chance of sur­viv­ing and eco­nomic downturn.”

    The Lit­tle Book chap­ter titled “Give the Com­pany a Phys­i­cal” con­tin­ues to teach and illu­mi­nate in terms that every­one can understand.

    Much as a doc­tor con­sults patients’ charts to see what con­di­tion they are in, look to the bal­ance sheet to see what shape the com­pany is in. The doc­tor needs to know all the vital signs to make a diag­no­sis. A bal­ance sheet is effec­tively a company’s med­ical chart….”

    Read­ers are told that they

    ….want to make sure that the com­pany is not overly bur­dened with debt, and that there is enough cap­i­tal to stay in busi­ness dur­ing bad times.”

    Lever­age trends are iden­ti­fied as impor­tant in the Lit­tle Book when it con­tin­ues to state

    …it is use­ful to observe trends over the past few years. Are lia­bil­i­ties grow­ing faster than assets? This could be an indi­ca­tion that the com­pany has to bor­row more and more money just to stay afloat…”

    How­ever, Mr. Browne (the author of the Lit­tle Book) appears to be a purest (which is per­haps a con­tro­ver­sial posi­tion) when he states that he

    …prefer(s) to sub­tract intan­gi­ble assets from [equity]” when cal­cu­lat­ing the amount of debt to equity because equity less intan­gi­bles gives him “…a bet­ter pic­ture of how much actual equity there is in a com­pany that could poten­tially be real­ized if needed.”

    The Lit­tle Book of Value Invest­ing con­tin­ues to warn

    In gen­eral a high debt-to-equity ratio means that a com­pany has been financ­ing its growth by bor­row­ing. Lever­ag­ing the com­pany by increas­ing debt lev­els is a double-edged sword….there is a real dan­ger of default and bank­ruptcy down the road. The less debt on the bal­ance sheet, the grater the mar­gin of safety.”

    In con­clu­sion the Lit­tle Book points out

    A strong bal­ance sheet is a good indi­ca­tor of a company’s sta­mina, its abil­ity to sur­vive when the going gets tough.”

    Value Invest­ing for Dum­mies has sim­i­lar lessons for CEOs/CFOs when in “Fun­da­men­tals for Fun­da­men­tal­ists” it asks and answers the “age old” ques­tion of “How much [debt] is too much?”

    [The] exces­sive use of debt sig­nals poten­tial dan­ger if things don’t turn out the way a com­pany expects them to. Lever­age is a good thing when things are going a company’s way. Debt financ­ing can be used to pro­duce more ….profit and, in the end, a big­ger business….But as every­one knows, this can work the other way….Industry stan­dards and com­mon sense apply to debt-to equity ratios.?”

    Later in Value Invest­ing for Dum­mies the reader is again warned that

    Finan­cial lever­age can be a good thing – to a point, and as long as things are going well.”

    So, how do the CEOs/CFOs some lead­ing banks and bro­ker­age firms stand up the stan­dard of know­ing and apply­ing the infor­ma­tion found in The Lit­tle Book of Value Invest­ing and Value Invest­ing for Dum­mies?

    Let’s start with the man­age­ment team from Bear Stearns. As it turns out, when it failed Bear Stearns had the high­est debt lev­els of any of the major bro­ker­age firms. At 33.53 to 1 at the end of 2007 Bear Stearns was mas­sively over­lever­aged and appar­ently didn’t under­stand that with so much debt “there [was] a real dan­ger of default and bank­ruptcy down the road.” (from The Lit­tle book of Value Invest­ing). And the trends for the past 5 years of lever­age were bad. Man­age­ment didn’t real­ize that they were increas­ing the risk of a fail­ure and up until the very end had lit­tle idea of the trou­ble that they were in. More­over, com­mon sense would sug­gest that when the com­pany was “burn­ing down” play­ing tour­na­ment bridge prob­a­bly wasn’t the best crises man­age­ment strat­egy. Clearly, the man­age­ment team at Bear Stearns needed to spend some time at Barnes and Noble hon­ing their skills and as a result failed the com­pe­tency test (not a big surprise).

    The Lehman Broth­ers team in place dur­ing 2007 also failed the com­pe­tency test. With lever­age at approx­i­mately 30.70 to 1 (and hav­ing added mate­r­ial amounts of addi­tional lever­age dur­ing 2005, 2006 and 2007) they only seem to have a mar­gin­ally bet­ter under­stand­ing about risk and lever­age than the Bear Stearns team (maybe that is why Lehman Broth­ers almost failed like Bear Stearns). How­ever, Lehman’s new CFO Erin Callan seems to pass the com­pe­tency test. Since she took over as CFO the firm has been reduc­ing its debt bur­den while at the same time increas­ing its equity and improv­ing its “Net Lever­age” ratio by almost 25%. By the way, Erin under­stands that when cal­cu­lat­ing Net Lever­age she is sup­posed to deduct good­will and other intan­gi­bles from equity as sug­gested by The Lit­tle Book. Erin appears to be the star of the Lehman Broth­ers exec­u­tive suit.

    At Cit­igoup the team headed up by Chuck Prince clearly didn’t
    know what was in either the Dum­mie or the Lit­tle Book series and were appro­pri­ately ter­mi­nated. How­ever, the new team lead by Vikram Pan­dit seems to have the “right stuff.” He is rais­ing cap­i­tal and reduc­ing debt as fast as humanly pos­si­ble. I guess his team has been hang­ing out at the Starbuck’s in his neigh­bor­hood Barnes and Noble.

    What about First Cap­i­tal? First Cap­i­tal oper­ates at a Net Lever­age Ratio of about 3 to 1 (which is about 1/10th of Lehman Broth­ers’ ratio after Ms. Callan began to per­form her magic and 1/15th of Citigroup’s Net Lever­age Ratio at Decem­ber 31, 2007). We didn’t increase our lever­age over the last 5 years and are care­ful to man­age both debt and equity to main­tain what is con­sid­ered to be a “fortress” bal­ance sheet. I guess we pass the lever­age com­pe­tence test.

    In future blogs I will dis­cuss addi­tional CEO/CFO com­pe­tency tests using cri­te­ria found in The Lit­tle Book of Value Invest­ing and Value Invest­ing for Dum­mies. I am con­fi­dent that First Cap­i­tal will con­tinue to pass the test but less con­fi­dent about others.