July 18, 2008
The Usual Suspects
Given the recent turmoil in the financial markets, it's a bit hard to keep up with the morality plays and the villains.
After the Enronesque fall of Bear Stearns, the villains of the moment were the two Bear Stearns executives who were indicted for not throwing in the towel timely.
Then, over the past several weeks, speculators who facilitate markets to hedge energy costs became targets of the demagogues.
And now this week, with the demise of Fannie Mae and Freddie Mac, SEC Chairman Christopher Cox issued an emergency order attempting to curtail naked short-sellers of the stock of the embattled government sponsored entities and also the stocks of Lehman Brothers, Goldman Sachs, Merrill Lynch and Morgan Stanley.
What on earth is Christopher Cox, a supposedly sophisticated securities lawyer, doing issuing orders that hinder the efficient functioning of markets?
Folks, the problem is not that stock prices of the GSE's and the investment banks are low because some nasty market manipulators have been targeting them. Larry Summers has a much more rational explanation for the GSE's demise. Instead of rethinking those misguided policies that led to the bubble in the GSE's stock price, Cox is engaging in a classic case of shooting the messenger by attempting to limit a price-setting mechanism for shares of stock.
Short selling -- the act of betting against a stock by borrowing it, selling it and then purchasing the stock later at a lower price to repay the loan -- plays an important role in well-functioning markets. If short selling is repressed, then optimists will dominate in the marketplace, which generally results in stocks becoming overpriced. Stated simply, persecuting the short-sellers contributes to stock bubbles. Larry Ribstein summed up the absurdity of the Cox's action well:
“[I]n our wacky world of regulation, as we step up liability to get out the truth about securities, we stomp down an important mechanism for getting the truth out about securities.”
And in addressing the above question about Cox, Craig Pirrong had an interesting 1993 encounter with the SEC chaiman regarding short-selling (and with Hillary and Bill Clinton, too, but that's a sideshow) that prompts him to make the following observation about Cox:
Given my 1993 experience with Chris Cox, I have my suspicions that the new short selling restrictions aren’t based on any empirical evidence or deep economic reasoning -– instead they are a reflection of Cox’s anti-shorting prejudices (and the prejudices of like-minded folks at the SEC) -– prejudices that he displayed in 1993.
When are we going to learn that knee-jerk regulatory responses such as Cox's latest often do more economic harm than good, not the least of which is the perpetuation of myths that distract investors from prudent risk allocation?
Update: Chron business columnist Loren Steffy agrees with me. And Don Boudreaux today identifies the underlying human dynamic behind such witch hunts:
We humans have a long and embarrassing history of blaming devils for distressing aspects of reality that we don't understand. Droughts, floods, plagues, and erupting volcanoes have all been ascribed to the machinations of unseen super-powerful entities – as ill-defined as they are ill-intentioned – who manipulate a reality to which they are immune but to which we mortals must inevitably bend.
Today's witch hunt for speculators who allegedly are driving oil prices to heights unconnected with the realities of supply and demand is just the latest entry in this pageant of ignorance.
This post from two years ago addressed the same dynamic in connection with the death of Ken Lay. And Arnold Kling chimes in with an absolutely spot-on analysis about the folly of attempting to limit the pricing mechanism of markets:
In the mortgage market, people saw risk-takers outperforming prudent lenders. So they took more risks. There is no simple fix for that. For the foreseeable future, we can count on investors sticking to prudence when it comes to mortgage lending. We don't need any regulations to close that barn door.
But somewhere, some time, in some other market, there will be another outbreak of excessive risk-taking. You can't make the system idiot-proof. They'll just build a better idiot.
Update II: The SEC is already retrenching from its "emergency" order (W$J article here).
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July 16, 2008
Southwest Airlines' legacy of good news
Gosh, it's such a drag reading about business and the economy lately. So, what the heck, let's take a quick look at a perennial source of good news, Clear Thinkers favorite Southwest Airlines.
Southwest's discount model of operation has kept it profitable in the notoriously unprofitable airline business for 35 straight years. Even during these turbulent times, Southwest's aggressive hedging program for its fuel costs and efficient operations have allowed the company to accumulate $3.7 billion of cash and generate a market capitalization of $9.9 billion. That market cap is now greater than the combined market value of the six largest legacy U.S. airlines. WallStrip's Julie Alexander provides a clever overview on one of Texas' true treasures:
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July 14, 2008
Be careful, Mr. Wagoner
General Motors CEO Rick Wagoner made some interesting public comments this past week in Dallas regarding the besieged automaker's bankruptcy prospects:
"Under any scenario we can imagine, our financial position, or cash position, will remain robust through the rest of this year," Mr. Wagoner said Thursday while in Dallas to speak to a business organization. He said the company has plenty of options to shore up its finances beyond 2008, although he declined to outline them.
The comments failed to boost investor sentiment as GM shares fell 6.2% to $9.69 in 4 p.m. New York Stock Exchange composite trading Thursday. The stock has been trading at its lowest levels in more than 50 years as concerns mount about the company's financial position amid a steep decline in U.S. sales.
GM and other U.S. auto makers are reeling as the slow U.S. economy depresses sales and as high gasoline prices push many would-be buyers to small, more-fuel-efficient vehicles and away from the higher-margin SUVs and trucks. Through June, for instance, GM's U.S. sales slipped 16%, more than offsetting strength in overseas markets.
GM has about $24 billion in cash but is burning an estimated $3 billion a quarter, prompting talk that it will need a significant cash influx to get to 2010.
"We have no thought of [bankruptcy] whatsoever," Mr. Wagoner said in response to an audience question during the Dallas event.
Now, I am not involved with GM, but I have been involved over the past 30 years in my share of big company reorganizations. Contrary to Wagoner's statements, GM has almost certainly "thought" of bankruptcy and GM management probably continues to examine whether a reorganization under chapter 11 of the Bankruptcy Code makes sense for the company, which it just might. Frankly, not to examine such alternatives would be egregious mismanagement. Any seasoned investor knows this and the market is clearly pricing that risk by lowering the company's stock price.
So, despite all that, if GM ends up in bankruptcy, is Wagoner at risk of being indicted for misleading investors regarding the company's ongoing bankruptcy analysis? Stated another way, will Wagoner be indicted for breaching the obligation to throw in the towel?
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July 12, 2008
Incompetence masquerading as demagoguery
University of Houston finance professor Craig Pirrong (blog here) does a nice job in this Wall $treet Journal op-ed on Friday of explaining how speculation in oil and gas markets helps all of us deal with rising energy prices:
Restricting these speculators won't reduce the price of oil -- but they are likely to make consumers and investors worse off. Futures and swap markets facilitate the efficient management of price risks, and speculators are an important part of that process. For instance, a producer of oil may want to lock in the price at which he sells his oil in the coming months in order to hedge against fluctuations in its price. He can do so by selling a futures contract at the prevailing market price. Similarly, an airline can protect itself against price increases next summer by buying today a futures contract that locks in a purchase price for next July.
Producers and consumers who want to "hedge" in this fashion cannot wave a magic wand to make the price risks they face disappear. The oil producer has to find somebody to sell to, and the airline must find somebody to buy from -- and that somebody is often a speculator. Restricting speculation would increase the costs that producers, consumers (such as airlines), and marketers (such as heating-oil dealers) pay to manage their price risks by reducing the number of traders able to absorb the risks they want to shed.
These higher risk management costs would result in higher prices at the pump or the airline ticket counter for consumers, and less investment in new productive capacity -- which would keep prices high into the future.
Participation in these oil markets by pension funds and other investors . . . is also not a problem. By adding commodity futures to their portfolios, i.e., by diversifying, these investors can reduce their risks without sacrificing returns, and without impacting physical inventories (or prices). Consumers are the ultimate winners when risks are borne as efficiently as possible in these markets.
The unprecedented run-up in oil prices is painful for consumers around the world. But the focus on speculation is misguided, and represents a convenient distraction from an understanding of the real, underlying causes of high oil prices -- most notably continuing demand growth in the face of stagnant production, supply disruptions and the weakening dollar.
More restrictions and regulations of energy markets, in the vain belief that such actions will bring price relief, are counterproductive. They will make the energy markets less efficient, rather than more so.
As noted awhile back here, one really need look no further than the most profitable U.S. airline to understand how robust speculation in energy markets benefits a company's employees, its investors and its customers.
However, apparently the CEO of a far less profitable airline -- Craig Steenland of chronically unprofitable Northwest Airlines -- has not noticed how beneficial futures markets can be for his company and its customers. He is busy lobbying Congress to enact strict regulations against precisely the type of markets that Southwest Airlines has used to beat Northwest's performance like a drum over the past five years:
The battered airline industry took its concerns about rising fuel costs to Capitol Hill Monday, urging Congress to address widespread speculation in the energy markets.
Making the case for the industry was Northwest Airlines CEO Doug Steenland, who argued that energy market speculators have pushed oil prices to unprecedented levels and harmed the airlines that saw some recovery in 2007. [. . .]
"I cannot overstate the importance to my company and the entire U.S. airline industry of immediate congressional action to halt excessive speculation in oil futures markets," Steenland said.
Specifically, Steenland sought more regulatory power for the Commodity Futures Trading Commission (CFTC), a prohibition on pension funds from investing in energy commodities and law changes that would remove loopholes and increase oversight of speculators.
Jeff Matthews sums up the absurdity of Steenland's witch hunt on the energy speculators perfectly:
Remember what I said about Mr. Steenland being named CEO of Northwest in October, 2004? Northwest Airlines did not start hedging its jet fuel needs until 2008.
That’s right.
Unlike, say, Southwest, which hedged most of its jet fuel needs when prices were low, Northwest didn’t bother until oil had spiked to $100 a barrel. [. . .]
Of course, when a big corporate CEO like Mr. Steenland makes a gross error of judgment like not hedging his single biggest cost of doing business, he naturally takes full responsibility and ask shareholders and customers for forgiveness.
We’re kidding!
He blames speculators instead . . .
Northwest emerged from Chapter 11 in May 2007. Northwest equity holders got nothing. Mr. Steenland got a package worth $26.6 million at the time.
Too bad Northwest didn’t use some of that $26.6 million to hedge itself.
I guess the only thing to do now that it's too late to do anything useful is...blame speculators.
Yep, that's the ticket...for an airline that doesn't know much about hedging, anyway.
I rest my case.
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July 10, 2008
Which Starbucks stores are closing?
When Starbucks announced last week that it is closing 600 stores and laying off 12,000 employees, the company did not disclose which stores would be shuttered (got to get those lease buyouts finalized). However, that hasn't stopped word from filtering out into the Web on the location of the shuttered stores. The Seattle Times has already generated this Google map containing a large number of the anticipated store closings.
View Larger Map
However, the question that is on most Houstonians' minds has not been answered. Will Lewis Black's "End of the Universe" cease to exist after Starbucks is finished closing stores?
This clip includes video of the two stores as Black comments on the end of the universe on The Daily Show (H/T Life is a Thrill):
Update: Here is the full list of the stores that will be closing.
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July 9, 2008
The NFL confronts the Mismatch Problem
The pathological way in which National Football League teams annually evaluate college football players has been a common topic on this blog. So, I thoroughly enjoyed this New Yorker video (H/T Guy Kawasaki) of a recent talk by Clear Thinkers favorite Malcolm Gladwell in which he uses the NFL's new-player evaluation process as an example of a hiring practice that is undermined by the "mismatch problem" -- that is, the tendency of an employer to cling to outmoded employee evaluation variables despite the fast-changing nature of the employer's jobs.
Gladwell's point is that the nature and demands of jobs in American society are becoming increasingly complex. That complexity, in turn, drives employers to desire more certainty in making the right employment decision. However, in striving for that certainty, many employers continue to measure the wrong variables in evaluating prospects and finalizing their employment decisions. Gladwell is currently studying the mismatch problem and has some initial observations on how employers can minimize its effects. Check out his talk.
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July 7, 2008
American ingenuity
It's not all bad news out there on the business front.
Over this past holiday weekend, Cirrus Design Corporation successfully completed the first 45-minute flight of the company's innovative "The-Jet" (H/T James Fallows), which is a five-plus-two seat aircraft that many in the aviation industry believe is destined to ignite a revolution in general aviation. Aimed at the market of owner-pilots, The-Jet is simple to fly and includes an efficient single-jet operation in an aircraft that is more flexible than larger and far more expensive aircraft. AVWeb has more pictures of The-Jet's first flight here.
Ready to hail that air taxi yet?
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July 4, 2008
Nice job, but what about that other case?
This Wall Street Journal editorial pats itself on the back justifiably for swimming against the mainstream media tide in opposing from the outset former New York Attorney General Eliot's Spitzer's popular but dubious litigation and propaganda campaign against former New York Stock Exchange chief executive officer, Richard Grasso. The Spitzer-inspired case against Grasso fell apart earlier this week under the weight of multiple negative appellate decisions.
The Journal deserves much credit for standing up to Spitzer's bullying tactics when few others in the mainstream media were willing to do so. But what does the Journal say about turning a relative blind eye toward this even worse prosecutorial abuse?
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July 3, 2008
Public financing of a private boondoggle
The WSJ's Holman Jenkins splashes some cold water on the suggestion that General Motors' Volt automobile will have much of a positive impact either environmentally or on GM's bottom line:
At best, the Volt will be an affluent family's third car. It will have to be plugged in for six hours a day – i.e., it will be a car for a suburbanite with a sizeable garage wired for power. It won't be a car for a city dweller who parks on the street or in a public lot. It will travel 40 miles on a six-hour charge. After that, a small gas motor will kick in to recharge the battery while you drive. Some reports claim the Volt will get 50 mpg in this mode, but that's hallucinatory: If using a gasoline engine to power an electric motor were so efficient, the streets would be full of such vehicles. (Our guess: The car will be lucky to get 15 mpg under gasoline power.)
Notice that, even today, some people continue to buy SUVs capable of hauling eight passengers, the dog and groceries, though they spend most of their time in the car driving alone. Customers value flexibility in their vehicles. For a car with the Volt's narrow usability to sell would require an unlikely revolution in consumer behavior, especially if gasoline prices aren't going to $10 a gallon.
So why is GM placing so much emphasis on development of an auto that is not particularly competitive in the marketplace? The answer: government financing:
GM executives are not nuts. They justify the costs and risks of the Volt as a way of changing GM's image in the minds of consumers and politicians. To commit a pun, the Volt is GM's vehicle for making a bailout of GM politically acceptable.
The company has already started signaling it expects Washington to provide a whopping $7,000 tax credit to Volt purchasers. In Europe and the U.S., under whatever fuel economy and emissions regulations prevail, GM also expects special favoritism for the Volt. The goal is to re-enact the flex-fuel hoax, in which GM receives extra credit for making cars that can burn 85% ethanol, even if they never see a drop of such fuel.
CEO Rick Wagoner last week laid out the case to Barack Obama personally for turning GM into a ward of the state, by way of direct and indirect subsidies to support a transition to "alternative" fuel vehicles. GM has done yeoman's work getting its structural costs (i.e., labor) in line, but shareholders should note that a big part of the company's turnaround gamble consists also of eliciting favor once again from Washington after a period in which the domestic auto makers were nothing but whipping boys on Capitol Hill.
. . . [GM is] betting the Volt will trigger a change in Washington's taste for bailing out a domestic car maker.
Finally, Jeff Matthews channels Hamlet in expressing his skepticism about GM's strategy:
The least helpful call you will get today is so unhelpful that, young as the day might be, we think there is no chance it will be superseded by anything even less helpful as the morning wears on.
This particularly unhelpful call comes from the alma mater of the proprietor of this blog, Merrill Lynch, and it is a downgrade of General Motors stock, from “Buy” to “Underperform.”
The analyst has also lowered his price target on the stock from, and we are not making this up, $28 to $7. Last trade: $11.75.
The reasoning behind the change is not particularly important. Like Hamlet’s recounting of Claudius’ commission for the killing of Hamlet, these things are always “larded with many several sorts of reasons” which all avoid the essential issue: the analyst has been wrong; his clients and his sales force all know he’s been wrong; he can’t take it anymore; and he’s throwing in the towel.
We know: been there, done that.
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June 25, 2008
The Future of Law Firm Advertising?
Clear Lake-area plaintiff's lawyers Ron and Scott Krist use the YouTube video below to explain why helicopter crash victims should hire their firm. Not exactly To Kill A Mockingbird, but pretty darn effective nonetheless. By the way, I wonder who the defense attorney was that Scott got fired?
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June 23, 2008
Clear thinking to begin the week
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June 20, 2008
The obligation to throw in the towel
So, the shoe finally dropped on the two Bear Stearns executives who managed the two Bear hedge funds that imploded in mid-2007. A copy of the indictment is here.
As I read the indictment, the government is contending that Messrs. Cioffi and Tannin were required to disclose to investors immediately in February and March, 2007 that the two of them feared that the two funds might be "toast" even as Cioffi and other Bear executives were fighting market pessimism toward the funds and urging investors to maintain trust in their ultimate financial merit. So, with their careers riding on whether the funds would survive, Cioffi and Tannin were supposed to throw in the towel and light a match to the funds by disclosing to the market their concerns about the heightened risk of a meltdown.
Stated simply, according to the Feds, about the time you think your trust-based business might be toast, it's already too late. Inasmuch as you are required to disclose to the markets that you think the business might be toast, that disclosure will understandably prompt the market to lose trust in your business, which means that your company is kaput. So, the smart thing to do is never to voice (and sure as heck don't write any emails!) your concern to anyone regarding the downside risk of your business. That lack of communication might dampen internal company analysis regarding risk of loss, but what the hell -- at least you won't get indicted for misleading investors when your company fails.
Just another chapter in the twisted policy implications that result from regulating business through criminalizing businesspeople's risk-taking. Larry Ribstein has typically insightful observations along the same lines, while Bess Levin muses over the Feds' suggestion that investors didn't know exactly what they were buying when investing in Bear's funds.
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June 18, 2008
Futures trading 101
As noted many times over the years on this blog (recently here and here), the instinct of most politicians and much of the mainstream media is to embrace simple "villain and victim" morality plays when attempting to explain investment loss. The more nuanced story about the financial decisions that underlie the failed investment strategy doesn't garner enough votes or sell enough newspapers to generate much interest from the pols or muckrakers. That's why we are currently enduring demagoguery regarding speculators and why it's so important that citizens who are not familiar with the function of speculation in markets take a moment to read Mark Perry's primer on the economics of future trading:
In fact, speculators don't determine market forces, they respond to market forces of supply and demand.
Therefore, speculators can't be blamed for high oil prices, because high oil prices are ultimately caused by factors beyond the control of any speculator: rising global demand in places like India and China, and global supply in places like Saudi Arabia, Nigeria and Venezuela. No individual speculator, or any group of speculators has an iota of influence over the demand for gas or oil in Brazil, nor do they have one iota of influence over the amount of oil in Canada or ANWR, or any control over OPEC quotas. Think about it - Exxon Mobil, one of the largest oil producers and private oil companies in the world, has NO control over the world spot price of oil, so how could a small group of speculators?
Read the entire post. Part II is here and an additional post on the same topic is here.
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June 13, 2008
Cool Graph Friday
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May 31, 2008
I would have never guessed
That, according to this handy database, this person would have given the most commencement speeches during this current season of university graduation ceremonies.
Similarly, I would not have guessed the city in the world that is home to the most billionaires.
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May 30, 2008
The Bear Stearns lesson
Yesterday brought the final installment of Kate Kelly's extraordinary three-part W$J series on the fall of Bear Stearns (Kelly also contributed to today's story on Bear's final shareholders meeting). My goodness, was Kelly a fly on the wall over at Bear's office during all of this? Dear John Thain has an interesting critical analysis of the series here, here and here, while Larry Ribstein and John Carney point out that Kelly apparently fell for what has become known as "the loophole legend" in regard to JP Morgan's buyout of Bear.
Although all the articles in the series are fun reading, Kelly's most insightful observation comes from the second installment:
It was the beginning of a frantic 72 hours that would bring the Wall Street firm to its knees and threaten the stability of the global financial system. . . . The brokerage's sudden fall was a stark reminder of the fragility and ferocity of a financial system built to a remarkable degree on trust. Billions of dollars in securities are traded each day with nothing more than an implicit agreement that trading partners will pay up when asked. When investors became concerned that Bear Stearns wouldn't be able to settle its trades with clients, that confidence evaporated in a flash. Trading partners, eager to avoid losses, began to disappear almost as quickly. That further fueled rumors of trouble. Some partners, spotting a chance to profit, made bets against Bear Stearns, helping accelerate its demise. . . .
Even after the Bear Stearns lesson, our understanding of the pesky trust-based business model is still not what it should be. Improving the investing public's understanding of how best to hedge the risk of investing in trust-based businesses is a far more productive response to Bear Stearns-type business failures than this.
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May 29, 2008
The instinct against the money-makers
I swear, you can't make this stuff up.
As Larry Ribstein cogently explains, Southwest Airlines has taken advantage of futures markets over the past several years to hedge its fuel costs (previous posts on Southwest's hedging program are here). That hedging program has been one of the major factors in allowing Southwest to remain one of the only profitable U.S. airlines. Along the same lines, Bloomberg's Matthew Lynn explains how such markets provide an essential function in re-directing resources in the overall economy.
Meanwhile, Congress is trying to hamstring the very markets (see also here) that provided Southwest and many other businesses with the platform on which they hedged fuel-cost and other business risk. The wealth and lower prices generated from those hedges is not inconsequential.
Finally, the Justice Department continues its advocacy of an effective life sentence for one of the men primarily responsible for developing the robust markets that facilitate Southwest and others' wealth creation for shareholders and lower costs for customers.
And these folks in Congress and the Justice Department are supposed to be representing our interests?
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May 24, 2008
Opting out with meaning
Earlier this week, the owners of the National Football League elected to opt out of the final two years of the league's Collective Bargaining Agreement with its Players Association. The Mile High Report and Stacey Brook do good jobs of analyzing the impact of the owners' election and neither believe that a lockout or strike is likely before a new deal is struck. My sense is that they are probably right, but I did chuckle when I saw this AmLaw Daily blog post on the owners' decision in regard to hiring counsel for the upcoming labor negotiations:
. . . [The NFL owners] hired L. Robert Batterman of Proskauer Rose. Batterman is well known in labor circles for his National Hockey League work. It was Batterman who presided over the NHL labor negotiations that scuttled the league's 2004-05 season, making it the first North American pro sports league to lose a full year to labor strife. "Batterman bullied [the union] into submission," says one sports labor lawyer who requested anonymity. "If one accepts the conspiracy theory of collective bargaining, this means the NFL must be looking for trouble," says another. [. . .]
No official negotiations have been held. But the hiring of Batterman sent a clear signal to the union. Gene Upshaw, president of the NFL Players Association, told SportsBusiness Journal in April that his "concerns were heightened" when he heard Batterman had been retained, noting that NHL players crumbled before Batterman's hard line. The NFLPA's outside counsel, James Quinn of Weil, Gotshal & Manges, says that the owners "have this bizarre notion that they want to get tough, so they go get Bob Batterman." (Jeffrey Kessler of Dewey & LeBoeuf is also counsel to the NFLPA.)
Doesn't sound exactly as if the NFL owners are preparing to play nice, now does it? ;^)
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May 22, 2008
Houston's solid housing market
One of the under-appreciated benefits of living in the Houston metropolitan area is its varied and reasonably priced housing market, which is the subject of this Federal Reserve Bank of Dallas report. The report notes that Houston's housing market has resisted the boom-and-bust syndrome that has been experienced in many other U.S. housing markets recently:
Given that Houstonians had access to the same new types of mortgages as the rest of the country and that Houston has had greater population growth than other large metros, we might expect price appreciation to be stronger in Houston than elsewhere. However, the opposite has been true.
Houston’s large supply of land means that demand growth primarily results in more construction, not higher prices. Construction levels are limited by the availability of two kinds of developable land: the previously undeveloped, generally found on a metro’s outskirts, and the redeveloping, usually in a city’s interior. In both cases, Houston’s policies are relatively permissive, making the metro friendly toward development.
The most fundamental difference between Houston and other cities lies in how they provide (or in Houston’s case, do not provide) water, sewer and drainage to developments on the urban fringe. In Houston, developers can create a municipal utility district, or MUD, to provide these services on their properties and can finance these with tax-free bonds. Houston requires developers to build MUDs in such a way that they eventually could be connected to the city’s corresponding infrastructure, but they begin as self-sufficient enterprises.
In other cities, developments must be connected to the city’s water and sewer lines, confining new projects to nearby or adjacent land since the cost of building lengthy lines is prohibitive. In metro Houston, by contrast, virtually any large parcel of land can become a new suburb, especially given the metro’s expansive highway system. Experience bears out this conceptual framework, with significant Houston suburbs like Katy and Spring developing and prospering before many closer-in areas.
But Houston does not just have a larger supply of available land on its outskirts. Unlike all other large U.S. cities, Houston lacks zoning laws restricting industrial, commercial and residential construction to specific neighborhoods. Many inner-city Houston neighborhoods protect property values through deed restrictions diligently enforced by private neighborhood associations, and the large, planned suburban communities operate similarly. But much of the land in metro Houston is not assigned a specific use.
So much land is available in Houston that the cost of each incremental unit rises slowly and keeps the average cost below that of more restrictive metros. Even in the face of significant population growth, this large supply keeps land prices in Houston stable, which over time contributes to lower home prices. . . .
Indeed, Houston and other metros such as Dallas and Atlanta that have relatively more permissive development policies have lower housing prices than more restrictive places do.
At $155,800, Houston’s median house price is the third lowest among the 12 largest U.S. metropolitan areas and is less than half the average for these cities. Houston’s median price is lower than even the national average, which includes inexpensive rural areas.
By comparison, the median house price in metropolitan San Francisco, where zoning laws and building codes are very strict, is $825,400.
This result—more zoning bringing higher prices—is a robust one. Economists Edward Glaeser and Joseph Gyourko find that house prices across the country are positively related to the degree of zoning and regulation. Even in Houston, there is evidence that houses in deed-restricted neighborhoods or in zoned cities within the metro area are more expensive than comparable ones outside these areas. But with plenty of unzoned neighborhoods remaining, Houston house prices, on the whole, are restrained near construction costs.
In summary, Houston’s low-and-slow home prices have made real estate a relatively accessible and safe investment for the area’s residents even as other cities’ markets have become expensive and volatile. The early phases of the current housing downturn—the boom and bust in prices—were barely felt in Houston.
The article goes on to point out that the crisis in the sub-prime mortgage markets has reduced the pool of available homeowners in the Houston market, which is contributing to a downturn in the local housing market. However, the report also notes that that Houston's housing policies and local economy place it in a strong position to weather the downturn.
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May 5, 2008
Chron: Sacrifice the local economy for the polar bears
Given the editorial slant of the Houston Chronicle over the past several years, it's not particularly surprising that the editors ran this editorial calling for polar bears to be declared an endangered species under the federal Endangered Species Act.
Unfortunately, it's also not surprising that the Chron editorial failed to mention that the oil and gas business -- a key source of jobs and wealth for Houston and the nation -- is likely to suffer considerable financial damage as a result of the polar bear listing push, which Hugh Hewitt notes "is not only an abuse of the ESA's original intent but also unsupported by the facts concerning the ice and the polar bears."
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April 28, 2008
What to do about airline service?
Putting aside for the moment airline industry's seemingly intractable financial problems, lousy airline service has become such an issue that even Judge Posner and Gary Becker are trying to figure out what to do about it. At least painful airline service provides the fodder for this amusing segment of Brian Regan's stand-up comedy show:
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April 26, 2008
Conited Airlines, finally?
The NY Times is reporting that the on-again, off-again merger negotiations between Houston-based Continental Airlines and Chicago-based United Airlines are coming to a conclusion and that a definitive merger deal is likely to be announced by the end of next week.
Continental, the nation's fourth-largest carrier based on traffic, has long been the natural merger partner for United, which is the No. 2 airline. If they strike a deal, the merger would produce the world's largest airline, bigger even than the combined Delta-Northwest and significantly outdistancing American, which is currently No. 1.
Speaking of the Delta-Northwest deal, those partners this week reported an astounding, combined first quarter loss of $10.5 billion, reflecting that the two airlines are now worth far less than when they emerged from bankruptcy a year ago.
Two drunks holding each other up is rarely a good idea. ;^)
Update: The Chron is reporting that Continental's board has decided to reject any merger proposals "at least for now." The NY Times reports that Continental backed off because of United's worse-than-expected first quarter losses.
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April 21, 2008
Remember Refco?
Amidst the current turmoil in the financial markets, the recent conviction on criminal fraud charges of a former Refco Inc executive barely registered on the radar screen. The details from the meltdowns from years past are just old news now.
However, the criminal conviction and plea deals arising from the Refco affair still leave a troubling question unanswered -- why did Refco's owners take it public in the first place?
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April 16, 2008
Ripples of the Delta-Northwest deal
The merger agreement between Delta Air Lines and Northwest Airlines (they were meant for each other) announced yesterday not only would create the world’s largest carrier if approved, but it has renewed talk (see this W$J article, too) in Houston over the fate of one of the city's largest employers, Continental Airlines.
Continental's future has been the subject of conjecture over the years. This post from a couple of months ago summed up the current situation in anticipation of the Delta-Northwest merger. Unfortunately, Continental's most likely merger candidates -- United Airlines and American Airlines -- are not particularly attractive partners at this point. As airline consultant Adam Pilarski noted in this Scott McCartney/W$J column, "There's no history of anything good that happens in [airline] mergers. Two drunks holding each other up is not a good idea." The W$J's Holman Jenkins speculates as to why this is the case in the chronically-profitless airline industry, which Richard Anderson and Doug Steenland, CEOs of Delta and Northwest, argue the contrary position.
The proposed Delta-Northwest merger would create a behemoth company with more than $35 billion in annual revenues, a mainline fleet of almost 800 planes and a combined workforce of 75,000 people. Interestingly, the most successful US airline is the polar opposite of that structure.
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April 11, 2008
Remember Kelo?
Check out this recent Second Circuit decision (H/T to Robert Loblaw) as an example of how the appellate courts are applying the U.S. Supreme Court's controversial 2006 decision in Kelo v. New London. Kelo allows the state to seize private property to facilitate private re-development as a legitimate form of "public use" under the U.S. Constitution.
Kelo has been widely criticized for creating perverse incentives for politically well-connected real estate developers to exercise their political clout where negotiation with private property owners didn't generate the developers' desired result. The Second Circuit case involves the huge redevelopment plan in downtown Brooklyn that will primarily benefit Bruce Ratner, a wealthy New York real estate developer. In addition to the ubiquitous office buildings and high-rise condos involved in such deals, the redevelopment will include a new arena for the New Jersey (soon to be Brooklyn) Nets NBA basketball club. Although most of the property to be contributed to the development is public land, the redevelopment plan also requires the state to seize several tracts of private property through exercise of its eminent domain power.
The private property owners sued and argued that the state's claim of public benefit is a facade, as the Second Circuit puts it, "to benefit Bruce Ratner, the man whose company first proposed it and who serves as the Project’s primary developer. Ratner is also the principal owner of the New Jersey Nets. In short, the plaintiffs argue that all of the 'public uses' the defendants have advanced for the Project are pretexts for a private taking that violates the Fifth Amendment."
The Second Circuit upheld U.S. District Court dismissal of the property owners' claims, explaining that the massive private benefits to Ratner do not trump the state's judgment that the project will also benefit the public. Moreover, even though the costs to the property owners may far outweigh the public benefits, the Second Circuit concludes that type of cost/benefit analysis is irrelevant under Kelo:
At the end of the day, we are left with the distinct impression that the lawsuit is animated by concerns about the wisdom of the Atlantic Yards Project and its effect on the community. While we can well understand why the affected property owners would take this opportunity to air their complaints, such matters of policy are the province of the elected branches, not this Court.
Given such dubious "public" ventures as this, the implications of the foregoing interpretation of Kelo are downright frightening.
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March 30, 2008
Icahn on settling Pennzoil-Texaco with Jamail
This blog is mostly about business and law, so Carl Icahn's activities have been a frequent topic. Likewise, this blog also centers on Houston, where the Pennzoil v. Texaco case from the mid-1980's is a part of the city's storied legal lore. Consequently, the video below of Icahn doing his equivalent of a standup comedy routine describing how he settled the Pennzoil-Texaco case with famed Houston plaintiff's lawyer Joe Jamail is an absolute classic for this blog. A very big hat tip to John Carney at Dealbreaker for the link to the Icahn video.
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March 27, 2008
Thinking about Bear Stearns
Michael Lewis -- author of Moneyball and The Blind Side: Evolution of a Game (previous post here) provides this particularly lucid Bloomberg.com op-ed regarding the implications of the Bear Stearns affair to investors generally:
All of this raises an obvious question: If the market got the value of Bear Stearns so wrong, how can it possibly believe it knows even the approximate value of any Wall Street firm? And if it doesn't, how can any responsible investor buy shares in a big Wall Street firm?
At what point does the purchase of such shares cease to be intelligent investing, and become the crudest sort of gambling? [. . .]
To both their investors and their bosses, Wall Street firms have become shockingly opaque. But the problem isn't new. It dates back at least to the early 1980s when one firm, Salomon Brothers, suddenly began to make more money than all the other firms combined. (Go look at the numbers: They're incredible.)
The profits came from financial innovation -- mainly in mortgage securities and interest-rate arbitrage. But its CEO, John Gutfreund, had only a vague idea what the bright young things dreaming up clever new securities were doing. Some of it was very smart, some of it was not so smart, but all of it was beyond his capacity to understand.
Ever since then, when extremely smart people have found extremely complicated ways to make huge sums of money, the typical Wall Street boss has seldom bothered to fully understand the matter, to challenge and question and argue.
This isn't because Wall Street CEOs are lazy, or stupid. It's because they are trapped. The Wall Street CEO can't interfere with the new new thing on Wall Street because the new new thing is the profit center, and the people who create it are mobile.
Anything he does to slow them down increases the risk that his most lucrative employees will quit and join another big firm, or start their own hedge fund. He isn't a boss in the conventional sense. He's a hostage of his cleverest employees.
As noted in this earlier post, nothing is wrong with having compassion for Bear Stearns employees who lost much of their net worth as a result of the firm's demise. But the reality is that the ones who suffered large losses in their nest egg when Bear Stearns failed were imprudent in their investment strategy. They should have diversified their holdings or bought a put on their shares that would have allowed them to enjoy the rise in the company's stock price while being protected by a floor in that share price if things did not go as planned. Even though most of those Bear Stearns investors carry insurance on their homes and cars, relatively few of them elected to hedge the risk of their more speculative Bear Stearns investment. Most likely, many of these investors simply did not understand how Bear Stearns created their wealth in the first place. Absent a better understanding of investment risk and how to hedge it, such investment losses will continue in the future, regardless of whatever ill-advised regulations are devised in an attempt to prevent them.
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March 16, 2008
That pesky trust-based business model
Over the weekend, we learned that the Fed had bailed out New York-based investment bank Bear Stearns during this unsettled time in the financial markets.
Almost seven years ago, a much larger company that shared many characteristics with Bear Stearns -- Houston-based Enron -- did not even generate serious consideration for a Fed bailout before it went under in the turbulent post-9/11 financial markets.
In between those two events, one of the world's wealthiest insurers and another company that is similar in many respects to Bear Stearns and Enron -- American Insurance Group -- barely escaped a similar fate by cutting a deal with the now-disgraced former Governor and Attorney General of New York to cut loose the executive primarily responsible for creating AIG's vast wealth.
The fact of the matter is that Enron was -- and Bear Stearns and AIG are -- trust-based businesses that fundamentally depend on the trust of the markets to sustain their value. Once that trust is lost, such companies lose value quickly and dramatically (a case in point -- JP Morgan Chase's proposed $236 million purchase price for Bear Stearns comes just hours after Bear's market cap was $3.5 billion this past Friday and $20 billion as of January, 2007). Although unfortunate for the owners of such companies, such a dramatic loss of wealth does not necessarily mean that any criminal conduct caused or was even involved in the loss. Rather, such loss is simply one of the risks of investing in a company based on a trust-based business model. The sooner we all recognize and understand this risk -- and avoid the mainstream media's promotion of myths about them -- the quicker we can put a stop to injustices such as this while advancing the discussion of how best to hedge the risk of such potential losses.
Posted by Tom at 6:52 PM | Comments (0) | TrackBack (0)
March 2, 2008
Landry's is worth more because of what?
Did I read right what Steve Scheinthal, general counsel of Houston-based Landry's Restaurants, Inc., said in this Chronicle article?:
Landry's is . . . facing a handful of shareholder suits seeking class-action status in the wake of CEO Tilman Fertitta's bid to take the company private.
Fertitta made an offer on Jan. 27 to buy out the company at $23.50 for each unowned share. The $1.3 billion deal, including debt, is being reviewed by a special committee of the Landry's board. [. . .]
Scheinthal dismissed the shareholder suits as standard in a going-private transaction.
"Absent Mr. Fertitta's offer, the likelihood is that the company's stock would be trading well below the current market price," he said.
Landry's stock closed Friday at $17.73 a share, down 38 cents.
Fertitta's offer for Landry's was made without a financing commitment in a tough credit market. Yet, the company's general counsel is claiming publicly that such a speculative offer is all that is propping up the company's stock price?
I wonder what the boys over at Long or Short Capital will think about that?
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