The GOP's Problem

Want to know why the GOP has lost its way? John Georgiton from Columbus, Ohio, summed it up perfectly in the WSJ (May 7, 2009, Letters to Editor, A16):

http://online.wsj.com/article/SB124165448243293979.html

Government expenditures can be broken down into major categories: the military, Social Security, Medicare and Medicaid. All other government agencies constitute the final 20% of the budget. The GOP has a hands-off policy for the military and it is not politically possible to make large cuts in Social Security, Medicare and Medicaid and still get elected. If the GOP ran for office telling the 80 million people who will rely on these programs over the next 20 years that the GOP plans to cut their Medicare and Social Security benefits by 50% to give wealthy taxpayers tax cuts, it just wouldn't fly.

The author points out that the GOP considers defense spending a sacred cow. Consistent with its small government platform, the GOP should be willing to cut defense spending. We spend $1.2 trillion on defense--more than the next largest fourteen countries combined. The sooner the GOP returns to its glory days of Eisenhower and Goldwater, the better.

Update: the May 8, 2009 WSJ says we will spend at least $550 billion on defense spending in 2010.

Safeway Inc.'s Annual Shareholder Meeting (2009)

Safeway Inc. (SWY) held its 2009 annual meeting at its Pleasanton, California corporate headquarters. Shareholders were offered fruits and other food items on a large table. After the meeting, shareholders received a reusable bag with eco-friendly light bulbs and a box of tissues from Safeway's in-house brand, "Bright Green."

Safeway ran its meeting professionally--there were no glitches, and everyone knew exactly what to do and when to do it. One way to measure a well-run meeting is whether the company allows comments on shareholder proposals. (Google did not, causing problems at its meeting.) Safeway passed this basic test--it allowed shareholders to comment on various proposals prior to closing the polls. It also limited comments on the proposals to two minutes.

General Counsel Robert Gordon handled the business portion of the meeting. He started off with some jokes about politicians and lawyers, drawing laughs. He then moved on to the shareholder proposals.

One shareholder submitted two proposals. The first dealt with cumulative voting. According to the SEC, "cumulative voting is a type of voting process that helps strengthen the ability of minority shareholders to elect a director." Put more simply, cumulative voting allows minority shareholders more power by allowing them to concentrate their votes on a single candidate. For example, let's assume you own 100 shares, and there are two director vacancies. Ordinarily, you could only vote 100 shares for each director; however, with cumulative voting, you could combine your votes and vote 200 shares for one director. This proposal failed.

The second proposal was a shareholder "Bill of Rights":

1. Shareholder proposals should be binding, not merely advisory; after all, shareholders own the company and should be treated as owners, not advisory members.

2. Auditing firms should be rotated every five years, because long tenure tends to dilute independence and vigilance. (After several companies have restated results due to shoddy accounting practices, I sympathize with this idea. Who's the watching the watchmen?)

3. Institutional owners should not be able to vote blocks of shares without express approval from their shareholders. (Shareholder Shelton Ehrlich pointed out this might require shareholders who hold mutual funds to sift through hundreds of corporate proxy statements each year. I've seen similar shareholder proposals, including one that required institutional owners to abstain from voting at all.) This proposal also failed.

The final proposal was submitted by Scott Adams (not related to Dilbert's Scott Adams) of the American Federation of State County and Municipal Employees Pension Plan Fund (AFSCME). I've seen Mr. Adams make similar proposals, seeking to ban "golden coffins." He is very effective because he speaks clearly and entertains his audience with humor and visual props, such as a gold-plated nail. "Golden coffins," which AFSCME wants to ban, reward executives and upper management for dying. (You read that right.) Many CEOs, upper managers, and their families receive cash payments when they die. In this case, Safeway also pays former executives cash if they die when they're not working for Safeway, i.e., during retirement. (Again, you read that right.) The key sticking point is that death benefits are unrelated to executive performance and therefore amount to a giveaway of shareholder money. This proposal received 38% of the vote.

I agree with the proposal. If executives want death benefits, why can't they use their own ample salaries to buy themselves and their families life insurance policies? One would think after being paid millions of dollars, executives could afford a policy or an annuity. More important, there is no "pay for performance" element involved in this executive benefit. Companies offer it because other companies also offer it. It's never a good argument to do something because someone else happens to be doing it. Companies and their compensation committees need to understand that executive compensation has become a lightning rod for criticism. As a result, companies that offer excessive salaries and unnecessary benefits reveal how out-of-touch they are, and no one wants to invest in a company that's out-of-touch.

CEO Steve Burd handled the rest of the presentation. I've never met Mr. Burd before, but I became a huge fan. He doesn't avoid questions, knows his company inside-out, is focused, and projects professionalism and confidence without arrogance. I have no doubt that Safeway would be in much worse shape if not for him. During his tenure, Safeway introduced "O Organics" and handily caught the organic food wave. It is now trying to capture the "green" consumer wave with its "Bright Green" product line. Safeway also offers a line of "Eating Right" products to help consumers eat more healthy food. Safeway's other product lines, like "mom to mom" and "Waterfront Bistro," would benefit from more advertising and promotion, but in time, they may become as successful as "O."

It is easy now to admire the strength of Safeway's in-house products, but it is never easy to establish a brand. Under Mr. Burd, Safeway created its "O" brand in less than three years. That's remarkable.

Mr. Burd was especially proud of how his company has managed healthcare expenses. He said Safeway had "flat-lined" healthcare costs, while its competitors had seen 38% increases in costs. Mr. Burd hasn't seemed to sacrifice quality, either. During the meeting, a Safeway employee and cancer survivor stood up and shared an emotional story about how Safeway helped her fight and beat cancer. Mr. Burd was recently invited to the White House to discuss his success in managing healthcare costs with President Obama.

After going through various slides, Mr. Burd opened the floor to questions. A shareholder asked about Safeway's pension and whether it was underfunded. Mr. Burd said that market conditions had reduced the pension's assets, but under a 2006 law, Safeway has time to correct underfunding and increase contributions. (The law is the Pension Protection Act of 2006, and it appears that companies have seven years to correct underfunding).

I asked questions about Safeway's relationship with its unions. I asked what percentage of the company was unionized (i.e., part of a bargaining unit). I also asked what made Safeway able to do so well while offering substantial employee benefits. I added that Safeway must have a special relationship with its unions because most unionized companies fail, or major tension exists between management and labor. One look at car companies (GM, Ford, Chrysler) and airline companies (Delta, Northwest, etc.) shows that unions tend to harm companies that rely on discretionary consumer spending. Safeway and other grocery companies seem to have dodged the union bullet.

Mr. Burd said 80 to 85% of Safeway's workforce is unionized, and Safeway had "very good" relations with Safeway's unions (he seemed to push back on my assumption that Safeway had a great or "special" relationship with its unions). He talked about having realistic expectations. He said that Safeway competes with several non-union companies, and this competition adds discipline [to negotiations]. He also mentioned Safeway's success in controlling healthcare costs. Having relatively fixed healthcare costs means there is more money for overall compensation. (From my angle, saving money on healthcare because employees are healthier not only frees up more money for shareholders and employees, but also results in a happier workforce.)

I also asked Mr. Burd what he was most worried about in terms of competition. Mr. Burd said he wasn't a worrier. He said, "I worry about my kids [not Safeway]." Coming from anyone else, this response might have seemed flippant or arrogant, but when Mr. Burd said it, he sounded sincere. He said his concern was a variant of the real estate mantra of "location, location, location." In his case, however, it was "sales, sales, sales." He pointed out that Safeway was in a unique position--it could borrow money at "less than 1%" interest.

After a few other shareholders asked questions, the meeting ended.

Before I go into my analysis of the stock, I want to commend Safeway's employees. Whenever I go into a Safeway, I receive excellent customer service. Every single time I've asked a question, a Safeway employee will go out of his or her way to help me. In an era where good customer service and just plain decent manners are declining, Safeway stands head and shoulders above most of its competition. I chatted with a Safeway employee on the way to the meeting, and he said he's worked for Albertson's before. He said Albertson's didn't have a good relationship with its union and its employees. I asked what made Safeway better. His response was classic: "Safeway treats me like a human being." Based on my own limited anecdotal evidence, I feel Safeway is doing exceptionally well when it comes to customer service and employee job satisfaction. The only other grocery store where I get a similar feeling is Nob Hill Foods, a Raley's division.

Even though I like shopping at Safeway, I don't own many Safeway shares, which are trading near a 52-week low. Despite having a great CEO and a decent dividend, Safeway shareholders may have a long road ahead. First, as Mr. Burd mentioned, 80 to 85% of Safeway's workforce is unionized. As a shareholder, it's difficult to justify investing in a company where 85% of its workforce, if unhappy, can strike and bring the company to a standstill. (Although Safeway is doing well overall in labor relations, just a few weeks ago, Safeway workers in Denver, Colorado voted to go on strike.)

But Safeway's biggest problem may be what I call the "curse of the middle." In almost every business catering to Americans, the "middle" players have been crushed because of America's steadily declining middle class. In retail, for example, Neiman Marcus and Tiffany (upscale players) have done reasonably well, as have Walmart (WMT), Ross (ROST), and Target (TGT) (cost-conscious players). Mid-level players, however, like Sears, Mervyn's, and Montgomery Wards, have gone bankrupt or are not major threats. The lesson to me seems simple--you either have to win on volume at the lower end of the scale, or on margin at the higher end.

Safeway is a middle-level company, in size and focus. It's much smaller than Walmart and Target, but bigger than Whole Foods Market (WFMI) and Trader Joe's. Safeway's competition is focusing on specific customer niches to win market share, which may harm Safeway's profits. For example, Walmart and Target are aggressively expanding their selection of food products. Safeway's products are generally priced higher than Walmart's. If Walmart continues to expand its selection of food products, it could take business away from some of Safeway's cost-conscious consumers. Meanwhile, affluent consumers may already be going to Trader Joe's or Whole Foods Market instead of Safeway. Thus, Safeway is caught in the middle and may have to rely on cost-cutting to improve shareholder value. As great as Mr. Burd is, a company can only cut expenses so much, especially when it is heavily unionized.

At the same time, Safeway has many positive factors. Most consumers will not buy their produce or food from Target or Walmart. There seems to be a built-in bias right now against buying food at Target or Walmart. Also, Safeway will remain competitive because it offers better quality, convenience, and service than Walmart, Costco (COST), and Target.

I will continue to keep an eye on Safeway. If it maintains its dividend, it could represent a decent value play. Although Safeway stock probably won't ever be a large percentage of my portfolio, I will be rooting for Mr. Burd. At the very minimum, America can learn from Safeway's experience cutting healthcare costs.

Disclosure: I own fewer than 10 shares of Safeway (SWY).

Update on June 13, 2009: CEO Burd recently wrote an op-ed on cutting healthcare costs:

http://online.wsj.com/article/SB124476804026308603.html

Lawyers Paid Not to Work?

Sounds like the GM jobs bank, doesn't it? Some lawyers are getting paid $80K not to work:

http://finance.yahoo.com/career-work/article/107024/Getting-Paid-Not-to-Work

Before you rush to submit your law school application, remember, these are big, prestigious law firms--there's only about 100 to 150 of them nationwide. Consequently, only the top 10 to 15% of law school graduates get these jobs. If you do some rough math, most law school grads have less than a 10% chance of getting these positions, unless they attend a top twenty law school.

Most lawyers probably work for the government; insurance companies; or insurance-related companies. My dreams of following in Thurgood Marshall's footsteps did not work out exactly as I'd planned. Oh, well. Even if someone had told me back then what I was in for, I wouldn't have listened.

Shareholders of the World Unite: Power in Numbers

This is such a great idea, I can't believe I didn't come up with it myself:

http://features.csmonitor.com/economyrebuild/2009/05/07/one-mans-bid-to-bolster-shareholder-power/

Go to isuffrage.org to learn more.

Update on May 24, 2009: I am now affiliated with this program as a "field agent."

California Dreamin': Fiscal Irresponsibility

This is old news, but still worth sharing, because of California's upcoming special election:

http://online.barrons.com/article/SB123941269948510457.html

Chris Street, treasurer of Orange County, Calif., warns if the federal government backs California's debt, the market for city bonds will be harmed. "Why would anybody buy the debt of a local issuer if they can get federally backed debt sold by the state?" he asks. He should know. The OC declared bankruptcy several years ago. Barron's is too smart not to notice the irony of quoting an OC official about the demand for municipal bonds.

Just in case you forgot--the CS Monitor reminds you that taxpayers back and insure government employees' retirement plans. Ultimately, every dollar that goes to them--the police, firefighters, and teachers--comes out of our pocket. Other states besides California also pay disproportionate amounts for their public pensions, showing the system itself is fundamentally flawed. For example, Illinois had $40.9 billion in future general and special obligation bond debt service as of June 30, 2006 ($22.7 billion principal and $18.2 billion interest). $10 billion of that–almost half of the principal--was tied to public sector pensions. (From http://www.wh1.ioc.state.il.us/fiscalcondition/DebtLevels.htm.)

Meanwhile, in California, things keep getting worse:

San Jose officials said Tuesday that the tanking stock market could force taxpayers to pony up as much as $50 million extra the following year to cover losses in the city's retirement funds.

Things look even worse in the longer term, as city officials say the cash-strapped general operating fund could have to pour tens of millions of additional dollars into the city's two pension programs by 2013.

If it's not painfully obvious by now, the current government retirement system--which is tethered to the vagaries of the stock market--is untenable. It promotes civil war between taxpayers, Wall Street, and government employees. We need to eliminate the special pension plans given to public sector employees and let them have the same retirement plan most private sector workers have--namely, a 401k or a 403b plan. In exchange, taxpayers can boost some government salaries, which are easier to track and not tied to the stock market.

As for the upcoming special election, California's governor wants Californians to vote "yes" on all the measures in the upcoming special election. I've already voted by absentee ballot, but I voted "no" on some measures. I am sick of my legislature not being able to handle basic accounting. When your income declines, you need to cut expenses. Will Sacramento ever learn third grade math?

Bonus: Robert Frank on people buying property.

Bonus II: Steve Malanga on public sector unions:

http://online.wsj.com/article/SB124227027965718333.html

Sarah Jones: Incredible Performance

Lawyers and Dysthymia

Lawyers tend to suffer from all kinds of maladies. Now, we have to worry about "dysthymia," too:

My kind of depression is termed “dysthymia” in the DSM IV (mental health’s diagnostic “Bible”). With dysthymia, a person can still function—after a fashion. However, life’s colors are faded. It’s more difficult to enjoy pursuits that had, not long ago, brought pleasure. We withdraw from our closest relationships.

More here. I think the lesson is not to go into divorce law, aka family law. I used to make appearances for other lawyers in family court, and I got really sad after spending just an hour in court. Many people in family court are self-represented (pro se). It is hard to see people go at each other in public, especially when kids are involved.

Teacher's Unions Suing California

The CFT--California Federation of Teachers (how many teachers' unions are there?)--is suing California to get taxpayers to give them more money:

http://www.mercurynews.com/ci_12328660 (SJ Merc article published on 5/8/09, Sharon Noguchi)

Unbelievable. The timing of the lawsuit makes it appear they're trying to usurp the voters if we go against their funding demands. It's important to try to work with all entities, especially when education is involved, but that's hard to do when California's teachers' unions sue the state. After all, they're really suing the taxpayers.

WH Auden on Mass Media

Attributed to W.H. Auden, one of my favorite poets:

What the mass media offers is not popular art, but entertainment which is intended to be consumed like food, forgotten, and replaced by a new dish. This is bad for everyone; the majority lose all genuine taste of their own, and the minority become cultural snobs.

• "The Poet & The City" (p.83)

Google's Annual Shareholder Meeting (2009)

I attended Google's (GOOG) annual shareholder meeting today, May 7, 2009. As usual, the meeting took place on Google's campus. In the past, meetings were an intimate, casual affair. Larry Page and Sergey Brin, Google's founders, would sit on stools and answer shareholder questions. I loved watching these two young men up-end Santa Clara County's normally uptight corporate culture. Sergey was especially fun to watch, because if he didn't think your question or comment had merit, he'd take you on directly. During one meeting a few years ago, when a shareholder chastised Google for not doing enough to combat China's censorship, saying other companies were being more pro-active, Sergey sneeringly pointed out that Yahoo had just helped China jail a reporter. In any case, I should have known it was all too good to be true. This year, neither founder attended the meeting. The meeting took place in a larger conference hall instead of an upstairs room above the cafeteria. I suppose this development is a natural progression--more shareholders attend the annual meeting, and most companies move away from their founders as they grow. Still, I hope Sergey and Larry come to next year's meeting. It wasn't the same without the two of them sitting up there, jeans and all, ready to answer questions without a corporate-style verbal filter.

I missed the lunch, which was held at 12:30PM. (I still managed to get two It's-It ice cream treats and a cold salad to tide me over). The meeting itself started at 2:00PM. David Drummond, Google's Senior VP and Chief Legal Officer (and a Santa Clara University graduate--go Broncos!), handled the formal part of the meeting. During the formal part of the meeting, a Chinese activist [Update: his name is Jing Zhao] wanted to make some comments on a shareholder proposal relating to online censorship; however, Google's procedures do not allow ordinary shareholders to make comments on proposals prior to voting. Google only lets the shareholder who placed the proposal on the ballot to speak for a few minutes. Thus, Google acts as a partial censor at its annual meeting--at least with respect to comments that may impact how shareholders vote on stockholder proposals.

Many shareholders vote their shares in person at the meeting and may be influenced by shareholder comments. Allowing ordinary shareholders to comment on proposals only after voting is closed is tantamount to the American government banning CNN from making political comments until after national election polls are closed. Google ought to limit the time a shareholder can speak on proposals to three minutes and let anyone who wants to comment specifically on a proposal have their say. This change would strike a reasonable balance between allowing activists to disrupt the meeting and restricting the flow of information to shareholders.

As for the person who wanted to speak, his first language isn't English. I've seen him at other shareholder meetings commenting on stockholder proposals relating to China. He is against China's censorship policies, but his broken English makes him difficult to understand. In this case, when he wasn't given an opportunity to speak, he quietly walked out of the meeting. When he tried to speak at Cisco's annual shareholder meeting, the CEO allowed him to speak briefly. After the meeting, a Cisco investor relations representative took him outside and listened to him. Cisco handled the situation much better than Google, but I am confident Google will learn from this experience.

CEO Eric Schmidt handled the informal portion of the meeting. He spoke for about ten minutes. His main points were these:

1. There is no recession in information.
2. Google is making advertising ridiculously easy.
3. Mobile is wherever you are. ["Search" can be part of the person, unrestricted to a place.]

During the Q&A session Mr. David Drummond talked about censorship as being bigger than just China. He said it also took place in non-authoritarian countries. In a really interesting comment, he said that police have visited Google in the middle of the night because Google would not share information. He later mentioned Germany and France as two non-authoritarian countries that apparently engage in some censorship.

A shareholder asked about company morale now that Google's "legendary" perks have been reduced. CEO Schmidt said Google still had amazing perks, including fifteen(!) food options/cafeterias. Mr. Schmidt is correct--Google still has fantastic perks, and the perks aren't limited to tangible items. A casual stroll through Google's offices shows that employees have the freedom to do pretty much anything. One employee, Mr. Tan Chade-Meng, has pictures with lots of famous speakers posted outside his office, and most Google employees decorate their work space as they see fit. I saw a bunch of international flags, stickers from different American states, and even pictures promoting a pirate club. Google even has on-site medical doctors who can prescribe medication, so no employee has to go to the hospital unless something really serious happens. Of course, Google employees still get free food, soft drinks, coffee, and massages (Google gives massage certificates to employees on their birthdays). Google employees may also bring a friend twice a month to the cafeteria for a complimentary meal. In short, I wouldn't worry about Google's employees. They are expected to work hard and are allowed wide latitude as long as their work gets done.

Another shareholder asked Google not to split its stock. He was concerned with market manipulators and short sellers.

Other shareholders commented on how to improve various services, especially Google's language translation tools.

Overall, Google's shareholder meeting was well-done, but not a great experience. It almost felt like the company had matured into just another big corporation. Many shareholders fell in love with Google because of Larry and Sergey's vision. Without them at the meeting, Google risks having a so-so shareholder meeting instead of an annual event on par with Berkshire Hathaway, Apple Inc., and other wonderful companies.

Bonus: here is Eric Savitz's take on the meeting. The picture above is of Eric and me. For those of you who follow his blog, he seems like a really cool guy.

Audiocasts of annual meetings are here. Video of the annual meeting is here.

San Jose Water Company Annual Meeting (2009)

SJW Corp (SJW), otherwise known as San Jose Water Company, held its annual shareholder meeting on May 6, 2009 at its local headquarters. A plate of cookies, coffee, water, and a selection of moist cake slices were offered. About ten shareholders attended, but most of the room was filled with company employees. Most of the shareholders were senior citizens who had probably bought SJW for its consistent dividend. (SJW currently yields 2.8%.)

Norm Mineta, San Jose's former mayor, is on SJW's Board of Directors. It was a pleasure meeting him. If you're ever in downtown San Jose, go to City Hall and go to the second floor (same floor as the Council Chambers). Right outside the elevator is a wall with pictures of San Jose mayors. Mr. Mineta's picture is on the wall of mayors, and it's a fantastic picture, because he looks so young. Mr. Mineta was one of the few government officials who spoke out against racial profiling post-9-11. As a result, many San Joseans--a very diverse lot--are forever grateful to him.

SJW has an enviable business model: one, a captive customer base; two, a product everyone needs, no matter what the business climate; and reasonable government cooperation. With banks and car companies failing left and right, many investors are looking for a stable business. It's worth noting that San Jose Water Company has been around since 1866.

There are some problems, however. The pension is underfunded by around $38 million (See 10K: page 56). With only 324 employees (10K: page 52), that means the pension has a gap of $111,111 per employee. The CFO indicated the pension is less than 80% funded, triggering various IRS rules which activate after various thresholds have been breached. Also, the company is top-heavy--with only 324 employees, it has 101 "executive, administrative or supervisory personnel" (10K: page 53).

The company's CFO addressed some of these issues: first, the $38 million number does not include recent stock market gains; and second, the company recently modified its pension plan, "replacing a defined benefit pension formula with a more portable cash balance formula" (See attachments to letter to shareholders).

I asked whether the company had insurance in case a natural disaster affected operations. The company does not buy insurance--it's too expensive--but has been given permission to set up a fund into which customers will pay for disaster damage through rate increases. SJW's "insurance" is basically its customer base.

I asked whether the company has preferred shares. It does not.

Another shareholder asked why the company was expanding in Texas. (A Board member, Kathleen Armstrong, has been added to assist the company with Texas operations.) The company indicated that Texas was a growing state with a better political climate.

Another shareholder asked whether SJW employees get free water. The company responded that employees within the service district receive discounted--not free--water, and the company only had 324 employees.

Another shareholder talked about accounting problems at a southern California water company. SJW did not want to comment on another company's issues.

It was a short, amiable meeting. I will attend next year to see if I can take a picture with Norman Mineta. I will ask him if the fabled "baseball bat" stories are true. ("Damn government took my bat again" has got to be one of the best quotes ever by a public official.) If SJW has some initiative, it may want to buy a Louisville Slugger and have Mr. Mineta sign it every year at the shareholder meeting. Most companies should be creative when it comes to their shareholder meetings. With a distinguished citizen like Mr. Mineta on its Board, why waste an opportunity to boost company morale?

For more SJW's Q1 2009 earnings call transcript, click here.

Disclosure: I own fewer than 10 SJW shares.

S&P Hits Target

On April 1, 2009, I predicted the S&P would hit 950:

http://willworkforjustice.blogspot.com/2009/04/personal-s-target.html

I later clarified that my prediction was a range between 920 and 950. The S&P hit my range on May 6, 2009. My prediction was correct. From April 1, 2009 to May 6, 2009, the S&P rose 13.3%.

I want to emphasize something. As of May 7, 2009, I am not making any prediction about the future direction of the market. I have no idea what's going to happen. As a result, I am mostly in cash and money market funds, along with some TIPs. I've also opened up two credit union accounts. I'm only earning 1.5% interest there, but it's better than my brokerage's 0.5% rate.

Kudos to the SJ Mercury News

The SJ Mercury News has done a great job exposing excessive government spending--see links below:

http://www.mercurynews.com/news/ci_12116499

http://www.mercurynews.com/business/ci_12119850

Old news, but still worth sharing. I just attended a City Hall event where a Councilmember said that average employee salaries have increased from $78,000 to $117,000.

Charlie Munger on NBR

Here's a recent NBR interview with Charlie Munger (Susie Gharib, May 1, 2009):

http://everythingwarrenbuffett.blogspot.com/2009/05/nightly-business-review-susie-gharib.html

We can't have a modern civilization without strong financial companies. But we don't need them as swashbuckling and as crazy and as venal as they've been.

More here from Munger:  http://willworkforjustice.blogspot.com/2010/05/wisdom-from-charlie-munger.html

Update: I replaced the link below, because it no longer worked: http://www.pbs.org/nbr/site/onair/gharib/charlie_munger_of_berkshire_hathaway_090501/

Resources Lifespan

The New Scientist has a great chart showing the finite span of certain resources. See full chart here.

Environmental implications aside, I'm going to check what SLV is selling for these days.

Munger on Economics

In honor of Berkshire Hathaway's recent meeting, here is a 2003 speech Charlie Munger gave in California: [warning: PDF file]

http://www.tilsonfunds.com/MungerUCSBspeech.pdf

Here's a fun snippet:

I think that economists would be way better off if they paid more attention to Einstein and Sharon Stone. Well, Einstein is easy because Einstein is famous for saying, “Everything should be made as simple as possible, but no more simple.” Now, the saying is a tautology, but it’s very useful, and some economist – it may have been Herb Stein – had a similar tautological saying that I dearly love: “If a thing can’t go on forever, it will eventually stop.”

Sharon Stone contributed to the subject because someone once asked her if she was bothered by penis envy. And she said, “absolutely not, I have more trouble than I can handle with what I’ve got.”

Also, Munger saw our financial problems well in advance:

[Question]: …financial destruction from trading of derivative contracts. Buffett said that the genie’s out of the bottle and the hangover may be proportionate to the binge. Would you speculate for us how that scenario can play out? [The question was garbled, but the person asked about derivatives, which Buffett has called “financial weapons of mass destruction.”]

Munger: Well, of course, catastrophe predictions have always been quite difficult to make with success. But I confidently predict that there are big troubles to come. The system is almost insanely irresponsible. And what people think are fixes aren’t really fixes. It’s so complicated I can’t do it justice here – but you can’t believe the trillions of dollars involved. You can’t believe the complexity. You can’t believe how difficult it is to do the accounting. You can’t believe how big the incentives are to have wishful thinking about values, and wishful thinking about ability to clear.

Running off derivative book is agony and takes time. And you saw what happened when they tried to run off the derivative books at Enron. Its certified net worth vanished. In the derivative books of America there are a lot of reported profits that were never earned and assets that never existed.

If you're interested, my review of Munger's 2008 shareholder meeting is here.

Random Thoughts of the Day: Widows and Signs of the Apocalypse

First, a big thank you to federal Judge Christina A. Snyder. The United States government was attempting to deport foreign-born women who married American men and moved to America. In some cases, these widows had U.S.-born children with their husbands. "60 Minutes" did a story on this potential tragedy several months ago. I wrote a letter to Senator Diane Feinstein's office about this issue. Her office sent me an email a few weeks ago. Senator Feinstein supported the widows. Here is her email:

I want to thank you for writing to share your concerns regarding the so-called "widow penalty," which affects the immigration status of legal permanent resident spouses when the sponsoring U.S. citizen spouse dies.

I have great compassion for foreign nationals whose applications for legal permanent status are put into question when the sponsoring American spouse passes away. Under current immigration laws, an individual may only continue to seek adjustment of legal status if he or she was married for at least two years prior to the U.S. sponsor's death. If a couple is married for less than two years prior to the U.S. citizen sponsor's death, a foreign national cannot continue the adjustment of status process and faces the possibility of deportation.

I am an original co-sponsor of S. 815, which Senator Bill Nelson (D-FL) introduced on April 2, 2009 to ensure that surviving spouses of deceased U.S. citizens are not unfairly penalized. This bill would allow spouses who have been married for less than two years at the time of the U.S. citizen's death to continue to petition for status adjustment as an immediate relative, as long as they can prove that they entered into their marriage in good faith and not for the purpose of obtaining immigration benefits. This legislation has been referred to the Senate Judiciary Committee, on which I serve. It is my hope that this legislation will move forward in this Congress.

Judge Snyder ruled that the Dept of Homeland Security could not reject the foreign-born widows' residency applications merely because the Department failed to process the residency paperwork before the American spouses died. In case America needed more evidence that the Dept of Homeland Security is, in fact, the Dept of Douchebaggery, this story ought to be the nail in the coffin.

I hope Congress passes Senator Nelson's proposed legislation.

Second, did anyone want to slap the homeowners mentioned in this SJ Merc story? ("Sellers of high-end Silicon Valley homes put dreams on hold," 5/2/09)

Basically, a local homeowner is upset that the house she bought decades ago isn't selling for the millions she thinks it's worth. She's lowered the price from $2 million to around $1 million. She wants to move to Puget Sound, and gosh darn it if local homebuyers aren't cooperating with her well-laid plans. So what does she do? She compares her situation with the Great Depression:

"I called my mom and asked her what it was like in the Depression," said Negler, who owns the Victorian. She realized, though, that she "sounded pretty selfish. We stopped looking at ourselves as the center of the universe."

I guess she should get some credit for calling herself "selfish"--it shows she has some self-awareness that her comparison to the Great Depression is off-kilter.

Update on Trading: FXM

I bought FXM last week, believing it had dropped too much. FXM went up 4% today. I sold my shares. The trading took place in a retirement account, so I don't suffer a tax hit. For some reason, my record on short-term price movements is much better than my long-term predictions.

Banks: an Immodest Proposal

Jamie Dimon's shareholder letter inspired me to evaluate ways around another banking crisis. The primary reasons for our current economic crisis are as follows: one, too many banks had lax lending standards; and two, financial and corporate institutions were interlinked to such an extent that conservative behavior was not appropriately rewarded.

In attempting to fix our current problems, we may have sown the seeds for another banking collapse. Currently, too few financial institutions hold too much of consumers' assets. This problem has gotten worse as concerned consumers have withdrawn their assets from smaller entities and placed them in larger institutions. In addition, the government has allowed large banks to take over smaller banks' assets. This has benefited large banks by giving them more assets but has also increased systemic risk. Whenever fewer players exist in any game, power becomes concentrated and competition decreases, which hurts everyone on the outside, i.e. consumers. Right now, Wells Fargo (WFC) currently holds over a trillion dollars in assets. But in 1950, Wells Fargo's combined assets were less than $3 billion. In 1985, the number increased to $50 billion. Prior to the Wachovia acquisition, it held $610 billion, still well short of its current $1.5 trillion. JP Morgan (JPM), after its WaMu acquisition, is now the largest credit card issuer in the nation. There is some good news--after the recent financial turmoil, several investment banks, such as Goldman Sachs (GS), have become mere banks, falling under broad government regulation for the first time. Even so, with fewer financial institutions holding more assets and liabilities, it is unclear whether derivatives and other risky contracts have been sufficiently curtailed, or whether the new assets given to the larger banks have allowed them to maintain the previous system, which led to our current banking collapse.

In 2002, one bank, J.P. Morgan Chase, accounted for $26 trillion of derivatives all by itself. (Again, that's $26 trillion, not $26 billion.) Thus, it's fair to say that JP Morgan knew about the massive risk inherent in its derivatives in 2002--or at least five years before systemic risk spiraled out of control, causing our current economic collapse. Yet, JP Morgan survived through 2009 and appears to be one of the last standing well-managed banks. You can draw two conclusions from this result. One, derivatives or increased financial regulation is unnecessary. JP Morgan being able to extricate itself from derivatives to avoid collapse shows that individual decisions matter, not regulation. Or, two, even though JP Morgan and other banks knew about the massive danger of derivatives in 2002, the system allowed this massive risk to continue unabated for years. As a result, other banks continued to trade derivatives and caused the entire banking sector to suffer, leading to a recession affecting all banks, not just poorly-managed ones. Ergo, we cannot rely upon all banks having excellent CEOs, so we must strictly regulate banks to avoid systemic collapse.

Even if you ascribe to the second conclusion, you must still draft reasonable regulation. To this end, I offer the following:

1. No individual financial institution shall hold more than $75 billion of consumer [non-business individual] assets.

2. No individual financial institution that holds consumer assets shall have liabilities, including derivatives contracts, of more than $1 trillion.

3. Financial institutions may have liabilities of more than $1 trillion only if they meet two conditions: a) they must not hold any consumer assets or consumer loans, such as credit card debt or home mortgages; and b) they must buy insurance covering at least 75% of their liabilities. (This regulatory framework shifts the burden to insurance companies, not the government, to determine appropriate risk pricing. One problem with this framework is that the government must rely on Moody's (MCO) and other ratings agencies to act as ethical middlemen, but the government can more easily regulate ratings agencies than financial institutions. The government can also create its own financial ratings agency, like a "ratings USPS," while Moody's and S&P become FedEx and UPS. You're probably wondering how this framework would prevent another AIG bailout. It wouldn't, but if ratings agencies do their job and evaluate risk properly, an AIG won't ever happen again. The real issue is eliminating conflicts of interest in the ratings agencies, which probably shouldn't be publicly traded companies. Ratings agencies should be focused on prudent accounting, not increasing growth and profits per share.)

4. The FDIC insurance cap on all financial accounts (not investments) shall be raised from $250K to $650K permanently. (On January 1, 2010, FDIC deposit insurance for all deposit accounts—except for certain retirement accounts—will return to at least $100,000 per depositor.) This change may encourage Republican support, because it would help one of their core constituents, the rich. It would also help blunt cries of socialism, because again, this change helps mainly rich people. What rich person wouldn't want the government to insure all of his or her personal accounts up to 650K? This change may also cause the rich themselves to spread their wealth among different banks--increasing overall systemic health--instead of having their money with just one or two financial institutions.

5. Financial institutions that fall under these new regulations shall have five years to comply. The government stresses that there is no single way to comply with these new regulations. For example, financial institutions may spin off new entities to shareholders; they may sell assets to other entities to meet their new threshold; or they may use other methods to fall under the new threshold amount.

6. The Federal Reserve shall, in its sole and independent discretion, have the authority to raise the "trillion dollar" liability threshold once every calendar year, but if it wishes to increase the existing threshold by more than $750 million, it must receive Congressional approval.

Credit unions would benefit from this new legislation, and rightfully so. Did anyone notice that no consumer credit unions have collapsed? (Two corporate ones have collapsed, but these are different from credit unions that serve consumers.) Financial institutions which stayed true to their bread-and-butter business--making conservative loans and paying consistent dividends to shareholders--did well. Why not encourage them instead of the bad banks like Citigroup (C) and Bank of America (BAC)?

As for the inevitable lawsuits, the government would be acting under its anti-trust authority as well as its general welfare powers. No "taking" occurs here. Banks have five years to create a safer framework that maximizes shareholder value in any way they see fit. Most shareholders would end up owning shares in multiples companies and banks, not just one. There is no reason the value of their assets/shares must decrease--in fact, it may increase. As a result of the banks' complete discretion on how to spin off or create other entities and the long time period they have to do so, any "taking" is speculative and financial institutions cannot reasonably make such an argument under the 5th Amendment.

More specifically, the economic impact of the regulation is reasonable because a) the government is not violating or voiding any contracts, and to the extent it is doing so, such contracts may be re-negotiated in three to five years to produce a reasonable result; and b) the government is not taking anyone's property. It is simply ordering financial institutions to modify their own businesses to prevent massive systemic risk--it is not telling them how to do it. This is just like telling a restaurant it cannot have more than 1000 people dining in a certain square footage area. The government isn't taking the restaurant's customers--it's just telling them to modify their practices to prevent a fire hazard. The same principle applies with the proposed banking regulations.

The regulation's impact on investor-backed expectations is also negligible. No investor can reasonably argue he or she is entitled to create massive systemic risk when a) the government is not gaining any money whatsoever; and b) the investor does not necessarily lose any money if the banks handle the transition properly.

The more I think about it, the more I believe that "too big to fail" ought to be "too big to exist." Perhaps the government will come to this conclusion before the next financial crisis happens. I doubt it, though. The main people who would benefit from these new regulations would be average Americans. Unfortunately, Congress stopped listening to them a long time ago.

Bonus: another perspective, from Bob Wilmers:

At the shareholder meeting, Wilmers emphasized the performance of the "good" banks, the more conservative "community banks" that did not become players in the "virtual casino" of our financial markets. He also dissed the bank regulators, including the useless, dim-witted Office of Thrift Supervision. He calls OTS the "place to go ... if management of an institution wanted to be an aggressive player in the banking industry with a minimum of supervision."

Update: I can't believe I missed this Glenn Greenwald post:

Senator Richard Durbin (D-IL): "And the banks -- hard to believe in a time when we're facing a banking crisis that many of the banks created -- are still the most powerful lobby on Capitol Hill. And they frankly own the place."

JP Morgan's Annual Shareholder Letter

I don't know how I missed this. Jamie Dimon lays out a summary of the banking crisis so well, his letter should be required reading for all investors and business students:

http://investor.shareholder.com/jpmorganchase/annual.cfm

From page 23: We believe our nation can and should be able to provide health care coverage for all. It is the right thing to do, it will help us build a stronger nation, and, if done properly and efficiently, we believe it ultimately will be cheaper than the current course we are on.

I love the fact that Dimon is for subsidized health care coverage. Almost anything seems better than our current system, which has created massive future entitlements while failing to cover millions of Americans.

Let's not forget--according to most reports, Sandy Weill, the former CEO of the now-disgraced Citigroup, didn't get along with Jamie Dimon. Mr. Dimon should be quite happy how things have turned out.

More on how to avoid another banking crisis here.

My Facebook Debate on Torture

Here is an ongoing debate about torture I'm having on Facebook. Tom is from Dallas, Texas, the state that elected George W. Bush several times. Sean has an advanced physics degree and works for a government lab. I don't know Evan.

Sean: Mr. Obama claims the enhanced interrogation techniques are a "recruitment tool that Al Qaeda . . . used to try to demonize the United States and justify the killing of civilians." However, the 1993 World Trade Center bombing, the Khobar Towers bombing, the African Embassy bombings, the Cole, and 9/11 all happened before George W. Bush waterboarded Khalid Sheikh Mohammed, Abu Zubayda, or Abd al-Rahim Al Hashiri.

Evan: What an amazing perspective. So, you're trying to say that chronology matters when discussing these issues? Hmmm.... Bold. Very bold.

Me: The fact that some terrorists were anti-American years before 9/11 does not preclude the idea that our inhumane conduct towards prisoners increased the size and the intensity of terrorist threats. Look at it this way:

1. I've hated apples since 2001.
2. Yesterday, an apple truck dumped applesauce all over my lawn, causing me to pay 100 dollars to clean it up.
3. Now, I hate apples even more, and thanks to the apple company's negligence, it's easier for my neighbors to see why I hate apples, and also harder for pro-apple people to defend their product.

Under your theory, you would argue the apple company's negligence had no impact whatsoever on sentiment, credibility, and the safety of the next apple truck. Common sense tells us otherwise. And you're not seriously arguing that Abu Ghraib had no impact whatsoever on anti-Americanism and the terrorists' ability to influence more recruits, are you?

Evan: I would ask you, what did you do to Apple farmers to get the truck dumped all over your lawn? Did you, you know, go kill an apple farmer's whole family? Burn down his house? If you did neither, than your analogy falls apart. If you did either, or something similarly horrific, either your neighbors will see why it happened or are likely to also share your hatred and support your horrific acts.

I mean... seriously, neither 9/11 nor any of the actions and policies taken against Muslim extremists were accidents. But, one was first. And, actually, saying 9/11 was first is not even correct, as pointed by Sean in the original comment.

These extremists are not rational, either. So, using standard analogies on them is really fruitless as well. It just doesn't hold up. Next thing I bet we hear is the people who went after the financial funding of the terrorist orgs will be prosecuted, because the terrorists have kids too and those kids are hungry and the UN doesn't want kids being hungry.

Tom: Suppose you know the apples are coming for your lawn again. You have a senior apple in custody at a time when apple chatter is similar to the apple chatter that preceded the last major lawn event. You have reason to believe the senior apple has information that will save lawns. Shouldn't you squeeze that information out of the senior apple, if it is the best you can get and it will save lawns?

Me: Some radicals think they have plenty of support for a "blowback" theory--the overthrow of the Shah, support for Afghanistan fighters during the Cold War, "bribe" money to Egypt, Jordan, and Israel, etc.--but I wasn't referring to a "blowback" theory. Anyone can point to an event at a certain point in time and use it to further his or her agenda. Intelligent people look beyond chronology to determine whether an action or response makes sense.

Torture (squeezing the apple) has not been shown to produce viable information. The FBI has already said this (see Ali Soufan). Thus, if you are pro-"squeezing the apple," you're going against the current U.S. administration, the FBI, and the U.N.--in other words, you're on the fringe, b/c credible people with more information than you are telling you torture doesn't work.

http://www.nytimes.com/2009/04/23/opinion/23soufan.html

Me: Oops, meant overthrow of Mohammad Mosaddeq, not the Shah (see "Operation Ajax"). Anyway, on a separate note, check out the story of Iran Air Flight 655. Neither example is necessarily relevant to 9/11, b/c the 9/11 attacks were caused mainly by Saudi/German residents.

http://www.history.com/content/militaryblunders/iran-air-shot-down

Tom: Thanks for pointing out what intelligent people do and think. It is beyond consideration that anyone who disagrees with you might also be intelligent. Please pass the word that anyone who plans to think a thought should pass it by you before wrapping themselves in the mantle of intellect. Thank you, great one. Please continue to protect us from ourselves.

Sean: I don't believe for one moment that even a single Al Qaeda recruit ever decided on news of waterboarding at Guantanamo to pack his bags and head for the nearest training camp. They have a preexisting proclivity to hate us. They despise the United States for our culture and envy us for our power. The United States is a constant reproach to them: We are rich to their poor, strong to their weak, vigorous to their idle, can-do to their sit-and-wait. If we were weak, we would not be hated. If we were poor, we would not be hated.

Furthermore, this notion that the enhanced interrogation techniques applied to Khalid Sheikh Mohammed, Abu Zubayda, or Abd al-Rahim Al Hashiri didn't produce actionable intelligence and foil plots to kill Americans is a shibboleth of the left.

Did anyone else notice the Mr. Obama failed to rebut Mr. Cheney's point about what the enhanced interrogations yielded? All indications are that they were spectacularly successful.

Now that he has declassified and released details of the enhanced interrogations themselves, Mr. Obama should declassify and release the results of those same interrogations so we can all judge for ourselves whether or not they are worthwhile.

Tom: Furthermore, assuming Khalid Sheikh Mohammed was water boarded 183 times (as erroneously and repeatedly reported; there were up to 183 'pours' that occurred in about 20 sessions) I have a hard time finding a problem with it. If the first instance was the only fruitful one, and the rest were for sport, he was still a planner of the 9/11 attacks. I don't care if he was gang raped by giraffes 183 times. Don't try to mess up my cities.

Evan: The 'aggressive interrogation is not proven to get accurate information' is a tough pill to swallow. Interrogation is, really, an art, not a protocol. It is an extremely personal and emotional task, something that is difficult to actually study. And, when you mix in the counterintelligence that Bin Laden's followers have been trained to deploy, and it gets very murky. Show me a sample group for that study that matches up well to the Jihadists that we're up against. I'm going to guess that the 'aggressive interrogation doesn't work' data comes from po-dunk cops that went overboard. Our guys trying to get info to save our country from Jihad are so far beyond your everyday cop.

Also, remember, there are journalists who have volunteered to be waterboarded. They probably saw video of it and figured "wow... that's mean, but I could handle it"... you don't see journalists volunteering to have their eyes poked out or legs broken, repeatedly. Waterboarding is different.

Me: A couple of quick points--first, chronology itself is not meaningful without studying the actual details of the events themselves. For example, if I kicked you ten years ago, it may have nothing or everything to do with whether you kick me fifteen years later. More information is necessary to determine the relevance, if any, of the events, especially when reviewing events that occurred years apart. [i.e.,] Details of events themselves are necessary to determine the relevance of the dates of the events. This statement seems so clear, it is surprising anyone even tried to refute it. Tom, I notice you attacked me personally on the issue of chronology and didn't address the actual points I made regarding the actual issue--and no else did, either. Tom, I make no comment regarding your intelligence--your own failure to address the actual content of my statement speaks for itself.

Let's move on to Evan and Sean. First, I agree with Sean that the American people should be able to review the results of the interrogations at some point, hopefully soon. But Sean, your next statement--"All indications are that they were spectacularly successful"--is based on speculation. No one here knows whether the interrogations were successful or unsuccessful because we don't have evidence. We do know, however, that an FBI agent and our administration have told us torture does not yield good information, and the administration has access to the interrogation results. I also notice that no one commented on the NY Times article I linked to.

Evan, you make an excellent point; however, other countries have used torture against terrorists for years--just look at Egypt, Syria, and Israel. These countries haven't published/disclosed results of their interrogations. Without evidence, we cannot speculate. There is a reason speculation is inadmissible in a U.S. court of law. I agree that interrogation is an inexact science. But what we've done--waterboarding, dogs, insects, stripping, etc.--seems designed more to humiliate than to get information. That makes no sense to me. I want good information, and most interrogation experts agree torture doesn't work. Threatening torture against a weak, disconnected individual might produce some information--but there are miles between a threat and the actual torture itself. Here's a good article on interrogation--note the absence of waterboarding, insects, etc:

http://www.theatlantic.com/doc/200310/bowden

There is a diff btw torture and coercion. Where do we draw the line?

Sean: I'm pretty sure the line is drawn between what Syria, Iran, Saddam's Iraq and Egypt do and what we do. I think that's one way to tell the difference between torture and intense interrogation.

Tom: It was not a personal attack to simply note your arrogance. I didn't comment on chronology, as you seem to be arguing a specific point that is both simplistic and inconsistent with the original point of the status. Chronology is important. No claim was made that nothing else was important. Therefore, strenuous arguments about how chronology is not the only thing to consider are largely irrelevant. Consequently, my disregard was mistaken for the absence of a meaningful response.

Evan: I say +1 with Tom... And, about the FBI agent and the administration. The FBI is always straightforward, and the Administration, this administration, is obviously straightforward on everything. That's why the whole administration spent the day covering the disaster that is Biden's mouth... Yeah, that administration. I think there is proof that the... Read More interrogations were successful in the fact that we haven't been attacked since 9/11, even though we've been 'provoking' people to do just that with our 'horrible foreign policy' (I use quotes because I believe provoking is actually preventing, and 'horrible foreign policy' is actually a strong foreign policy) Once again, the chronology seems to add up.

Me: The American people have voted against Bush and the very policies you support. I am just sad it took eight years and an economic collapse to get there. At the end of the day, we are all Americans, and I think most Americans can at least agree that the last eight years have been torture :-) While I cannot understand people who advocate torture/waterboarding, I am quite pleased we are able to have a civil discussion that may, in time, cause us to broaden our horizons.

Update: the debate continues, and now it's reached 61 comments. I will include the most recent snippets:

Me: The next time an American soldier gets captured and tortured by foreign enemies, I will contact all three of you and ask you to write an apology to the families of the Americans. You ideology will hurt Americans. If I ever contact you, don't shirk away--man up and apologize for indirectly hurting Americans and for directly harming America's reputation, which has served us so well from Eisenhower until Clinton. Traitors don't know they're traitors. No traitor ever does. That's why it's important to analyze one's beliefs and evaluate whether they will harm the nation, its civilians, and its soldiers. Over 4,000 Americans have died in Iraq post-9/11, fighting in a country that had no connection to 9/11. We fought a war based on what we now know were speculative threats. We engaged in torture in Abu Ghraib as a result of Americans like you playing around with the definition of torture. Americans are now less safe, if only b/c the economic consequences of war have harmed us.

Evan: You are calling me a traitor? Unbelievable. You seem to have a very narrow definition of diversity. It's beginning to be very offensive.

Me: I did not call you a traitor. Read my comment carefully. It's a general comment, not a specific one, and it could conceivably apply to myself. There's at least one thing, however, that definitely separates us--the next time an American soldier gets tortured, waterboarded, beaten, and deprived of sleep, I will have the moral ground to protest--you won't. That doesn't mean you're a traitor--it does mean your beliefs indirectly endanger Americans by blurring the line between acceptable conduct and unacceptable conduct. Your refusal to condemn torture and its inevitable slippery slope during times of war means you have no standing to protest or condemn anyone when abuse of American soldiers occurs. You are consciously trading off America's right to condemn torture of its soldiers in exchange for having a pro-torture policy that *might* produce relevant information. I refuse to make that trade-off when no reliable study has shown that torture produces reliable results.

Restaurant Review: Chaat Bhavan

I really liked a new Indian vegetarian restaurant, so I wanted to share it with my readers. It is located at 5355 Mowry Ave, Fremont, CA 94538 (510-795-1100). Its website is www.chaatbhavan.com (the site loads slowly initially, so be patient). If you're vegetarian, you will love this place; if you're not, you will still love this place.

I ordered the following items:

Dahi Bateta Sev Poori, which is basically crispy noodles with yogurt and chutney.

Bateta Vada, which is potato balls with spices and chickpea flour.

Pav Bhaji with Papad, an orange-colored dish with steam cooked vegetables.

Raita, which is yogurt with different vegetables and spices.

With those four dishes, my friend and I left feeling full, all for less than 35 dollars.

Disclosure: I have no ties whatsoever to this restaurant and have not been given anything in exchange for this post.

Party Like It's 1931?

The CS Monitor's New Economy blog has an interesting post today. I'm not sure past comparisons offer much value today, but when no one knows the future of the market, all they can do is look backwards.

I am in mostly cash right now, even in my retirement funds. I may miss a rally, but real property and cash seem safer than stocks right now. Also, I don't have to keep my cash in low-yielding American dollars. I recently bought the Mexican peso (FXM) and will be looking to buy the Australian dollar (FXA) as well.

Founding Principles: a Majority Shall Not Engage in Tyranny

From Hon. Judge Michael W. McConnell's majority opinion, INITIATIVE AND REFERENDUM INSTITUTE v. WALKER, 450 F.3d 1082 (10th Cir 2006):

One of the Fathers' cardinal concerns was that democratic government not lead to tyrannical rule by a majority over a minority. "When a majority is included in a faction, the form of popular government . . . enables it to sacrifice to its ruling passion or interest both the public good and the rights of other citizens." The Federalist No. 10, at 106 (J. Madison) (Hamilton ed. 1868). The Founders did not think the problem of majority abuse of minorities was limited to those in government: they were particularly worried about the ways in which a majority of the people could impose their will impose on a minority. "The prescriptions in favor of liberty, ought to be levelled against that quarter where the greatest danger lies, namely, that which possesses the highest prerogative of power: But this is not found in either the executive or legislative departments of government, but in the body of the people, operating by the majority against the minority." James Madison, Speech of James Madison to House of Representatives (June 8, 1789) in Daniel A. Farber & Suzanna Sherry,A History of the American Constitution 227, 229 (1990).

Or, we can just quote someone who once said, "Democracy is two wolves and a lamb voting on what to have for lunch." I'll leave you with an amusing spinoff from that quote:

A Democracy: Three wolves and a sheep voting on dinner.

A Republic: The flock gets to vote for which wolves vote on dinner.

A Constitutional Republic: Voting on dinner is expressly forbidden, and the sheep are armed.

Federal Government: The means by which the sheep will be fooled into voting for a Democracy.

Freedom: Two very hungry wolves looking for dinner and finding a very well-informed and well-armed sheep.

Small Things (a poem)

Small Things

Swine flu is in the air.
CNN promises not to fear-monger as the word “pandemic”
flashes across the screen.
I think of the Mexican peso first, then of the Mexican people dying.
It occurs to me my priorities are screwed up.

But then I realize that’s the point--the constant scramble
to survive
to make money
to take care of your family,
It re-arranges everyone’s priorities,
forces people to think ahead, not backwards,
and it seems to work, until it doesn’t.

President Obama’s on the screen now,
talking about that flu again.
I think of the Mexican people first this time.
I think about the American schools shutting down,
and American kids happy to stay home.
I think of how a small thing can multiply into a big thing
and make its way up here without warning.

And then I realize a good thing can also multiply
And come here,
Something we’d never thought about before
until it came here
and changed our lives.

Small things, like six-year old Pierre Omidyar,
arriving in America from France,
his parents from Iran,
Not knowing their little boy would create eBay.

Small things, like Paul and Clara Jobs
adopting a little half-Syrian boy
born in Milwaukee
and bringing him to Mountain View, California,
where he would grow up and give us Apple Computers.

Smaller things, too, like 27 dollars loaned by a man in Bangladesh
who spoke at Stanford in 2003
and caught the ears of Matt and Jessica Flannery,
who then founded Kiva.org.
Soon came millions of dollars to help the poor.

Small things become big when they cross borders
undeterred by risk, failure, or fear.
They come, these small things,
flu particles, yes, but also the seeds of a bright future,
Burrowing their way forward.

(2009)

Wells Fargo Shareholder Meeting (2009): the Age of Uncertainty

I attended Wells Fargo's 2009 annual meeting today in San Francisco, California. Wells Fargo (WFC) did not seem to anticipate such a large crowd attending its meeting. It had to scramble to set up more chairs in an adjacent viewing area where shareholders could view the meeting on a large video screen. In a scene reminiscent of a Friday night club, some shareholders (including myself) had to wait downstairs before security allowed us to take the elevator to enter the meeting. Per its conservative image, Wells Fargo did not offer any coffee or refreshments. I asked an employee whether Wells Fargo had served coffee or refreshments at last year's meeting, and she said she didn't remember Wells Fargo serving food or drinks at any annual shareholder meeting.

Chairman Richard "Dick" Kovacevich spoke first and appeared in a good mood, making several well-received jokes. He earned my respect for being forthright in this earlier speech, where he stated, "We [the financial sector] really caused this crisis."

After the formal portion of the meeting had concluded, he turned the meeting over to President and CEO John Stumpf. First, let me give you some visuals. Mr. Kovacevich is a tall man who exudes confidence in a friendly way. Mr. Stumpf, on the other hand, is shorter, more intense, and much more brusque. I would almost compare them to Robert DeNiro and Joe Pesci (Goodfellas or Casino, take your pick)--effective men, each in his own way.

Mr. Stumpf delivered a short presentation. He began by rattling off all the names of failed financial institutions--AIG, Bear Stearns, Countrywide, Fannie Mae, Lehman Brothers, Merrill Lynch, and WaMu. These are "difficult times," he said. He went through some slides showing that Wells Fargo had made money and continues to grow. One slide was confusing--it showed WFC reporting $0.70 of diluted EPS, but had a shadow area that added $1.51 in EPS, which assumed the inclusion of credit reserves. Including the credit reserve build, the additional EPS would have brought the numbers in line with previous earnings. I did not understand what the additional EPS meant, and even after I asked Mr. Stumpf to explain it again during the Q&A, I still didn't fully understand it. (My current understanding is that Wells Fargo had set aside billions of dollars to cover expected future loan losses, especially due to the Wachovia acquisition, and had it not been forced to account for its expected losses, its earnings per share would have increased.)

Mr. Stumpf talked about the dividend and the "difficult decision" to cut it. He indicated WFC would increase the dividend when "practicable" to do so. Wells Fargo's cutting of its dividend signals a tectonic shift. If you go back to a time when banks were staid creatures, people would buy banking shares for the dividend. They expected that a bank would slowly and conservatively increase deposits and make more loans over time, allowing the bank to steadily increase its dividend. As a result of their consistent dividends, banking stocks were called "widows and orphans" stocks--held by husbands to protect their families when they died. That age is over. Banks have lost the public's trust, and with it, we have entered a new world of uncertainty. This change is shocking because even banks that acted conservatively, like Wells Fargo, had to cut their dividends, breaking their implicit promise to maintain steady payouts. If there is one unfortunate lesson to be learned from this crisis, it's that being good didn't pay off. As a result of widespread and creative financial engineering, the good banks got sucked into the morass created by bad banks like Citigroup (C) and Bank of America (BAC). Now, senior citizens looking for income have few places to invest. Even preferred shares are suspect.

Mr. Stumpf returned to his theme of consistent growth. He said that even during this tough time, WFC "grew revenues by 6%" while reducing expenses by 1%. He said the amounts loaned also increased, although most of that increase came from the commercial and wholesale areas, not the consumer. Deposits also increased as a result of the "flight to quality."

Mr. Stumpf then talked about Wells Fargo's two major events: Wachovia and the government's $25 billion investment in Wells Fargo. He said the Wachovia acquisition was going well, and Wells Fargo would pay back the government as soon as practicable. He said companies fail when they confuse their mission with the results. WFC's mission was to help people succeed financially, and the result was that "we make money." Bad companies, he said, mix these up and focus on making money over serving their customers. Mr. Stumpf ended his presentation by pointing out Wells Fargo's charitable contributions, which were impressive.

The Q&A session was longer than usual, and most shareholders had interesting questions. One thing about Mr. Stumpf, though--if he doesn't like your question, he'll give you a quick answer and expect you to move on. Several times, he avoided answering questions by using humor to deflect the question (Those of you who remember my Joe Pesci comparison can start visualizing him saying, "Funny? Funny how?").

One shareholder asked about Citibank's (C) lawsuit against Wells Fargo (which relates to the Wachovia acquisition). Mr. Stumpf said Wells Fargo would defend itself vigorously.

I asked whether the government forced Wells Fargo to take TARP money. After all, if Wells Fargo didn't need it, why didn't they reject it? Mr. Stumpf tried to avoid answering the question, so I asked Mr. Kovacevich directly for an answer. He said government negotiations were confidential, but added, "We did not ask for the money." He said he took the money because it was in the best interests of the company at the time.

Another shareholder talked about a personal issue. Apparently, Wells Fargo had increased his interest rate. The shareholder complained about Wells Fargo's customer service. At first, Mr. Stumpf asked whether the shareholder had a question. (At this point, I started thinking Mr. Stumpf might take a bat to this guy's knees.) After the shareholder meekly said, "I guess I don't have a question," Mr. Stumpf wisely turned on the charm. He said, "I'm sorry," and directed the shareholder to a specific Wells Fargo employee for further assistance.

Another shareholder praised the bank. He was a former employee who had held Wells Fargo shares since at least 1998.

Another shareholder talked about zombie banks and whether nationalization would be a good idea. Mr. Stumpf replied, "We are solvent" and "clearly not a zombie bank." He said his understanding was that the President and Congress had rejected nationalization.

Another shareholder asked whether Wells Fargo anticipated raising its capital base, thereby diluting its common equity shareholders. In a telling sign of how uncertain the current environment is, Mr. Stumpf refused to comment one way or another. When you strip down the optimism, no one really knows. Look at page 78 of Wells Fargo's 10K:

Under SOP 030-3 (Accounting for Certain Loans or Debt Securities Acquired in a Transfer), we recorded at fair value all credit-impaired loans acquired in the merger based on the present value of the expected cash flows...using assumptions about matters that are inherently uncertain.

Essentially, Wells Fargo itself admits its numbers are "inherently uncertain." The only thing we know for sure is that Wells Fargo's earnings received a boost from a recent loosening of the mark-to-market accounting rules. Still, regardless of any accounting changes, at the end of the day, no one really knows anything, because there are too many unknown variables. That's why Wells Fargo accepted $25 billion of our money--it doesn't really know, either, and if it did, it would have paid back the government already. [Update: some banks have already paid back TARP funds. See here.] So of course the CEO can't promise to avoid further capital injections. Of course the CEO can't promise to avoid diluting the common equity shareholders. Like everyone else, he doesn't really know what's around the corner. When historians study this current time period, the honest ones will admit no one really knew anything. It's sheer hope and faith that's driving many Americans, and, by extension, the banks to which they owe money.

I went up to the mic one last time. I told Mr. Stumpf some people think that "too big to fail" should be "too big to exist." I implied that we weren't addressing any of the root causes of our current problems and that this crisis could happen again. I said it was frightening to see the stock market go up and down based on the appearance of the banking sector's good or bad health. I indicated that banks, a relatively small group, had tremendous power over the average Joe's 401k. I said that Wells Fargo had spoken against some regulation, such as executive pay restrictions (see also 10K: page 78), but it hadn't talked about what regulation it favored. I asked Mr. Stumpf to talk about what regulations he favored so that we could avoid another crisis.

Mr. Stumpf had a two-part answer. He said that only 22% of financial assets are held in commercial banks. He said most financial assets are held by unregulated entities, such as AIG (and others who thought credit default swaps were a great idea). At this point, his answer became somewhat confusing. From what I understood (and discussed with an Aussie couple after the meeting), Mr. Stumpf implied that we should expand financial regulation, but without adding another government agency. He did not favor the current situation, where multiple regulatory bodies cover select financial entities while excluding other major financial players. (Or, according to the Aussie gentleman, "Don't go swimmin' without your trunks"--demand everyone have some covering if they want to play in the pool.)

Mr. Stumpf also suggested we should try to minimize systemic risk. He seemed to indicate that all of the banks' assets should come under one umbrella so that the overall risk of the banking sector could be easily ascertained. Again, I am not certain this is what he said, because Mr. Stumpf talks quickly. While he clearly understands complex financial terms and ideas, he seems to have a hard time communicating those ideas to the general public. (This is why WFC needs Mr. Kovacevich--his easygoing, amiable style balances Mr. Stumpf's abrupt demeanor.) From what I heard, however, it sounded like even the banking sector's head honchos acknowledged that greater transparency and governmental involvement were necessary to minimize systemic risk. Perhaps thinking he'd said too much, Mr. Stumpf stopped. That's when I realized the point and theme of the meeting was to project confidence, because at the end of the day, that's what America needs, especially from the banking sector. I think Wells Fargo did an admirable job at the meeting, but again, no one knows anything. Only time will tell whether America exits this banking crisis stronger.

The AP's Michael Liedtke's review of the meeting can be found here. As of the record date, I had 9000 WFC shares. I used margin and felt uncomfortable with the volatility, selling all my shares at around $14/share. Investors who bought Wells Fargo stock recently and had the fortitude to hold on have been rewarded. As I wrote here earlier, an investor could have made 46% had s/he timed the market properly.

Random fact: Warren Buffett owns approximately 7.4% of WFC common shares. See page 13 of Wells Fargo's 2009 proxy statement.

Bonus: The Economist has an interesting article (May 14, 2009: "Three trillion dollars later...") on banking:

http://www.economist.com/opinion/displaystory.cfm?story_id=13648968

Institutional Analysts are Almost Worthless

On December 18, 2008, I bought Maxim at 12.00/share and told my readers about my buy. Maxim is now selling for $13.70/share--a 14.1% increase in four months. The S&P 500 declined 3.1% during this same time period.

At the time I bought Maxim, JP Morgan disagreed with me. On December 16, 2008, JP Morgan's Christopher Danely downgraded Maxim stock to "underweight." In response, I wrote, "Almost all these these analyst downgrades come after the bad news has already been released. Consequently, when a major firm issues a 'sell' or 'underweight' rating, that's when contrarians and value investors should take a closer look at a stock."

My call was obviously correct, but what's really frustrating is that now, after the run-up in the stock price, several analysts are recommending Maxim.

On March 14, 2009, Canaccord Adams upgraded Maxim. Maxim's stock price was $14.05/share.

On March 15, 2009, Citigroup (C) upgraded Maxim. Maxim's stock price was $14.12/share.

If you had listened to these two analysts, you would be losing money right now. I don't disagree with the analysts' upgrades, assuming a long term horizon. I still think Maxim is somewhat undervalued, but I have considerably reduced my holdings and am waiting to re-enter at a lower price.

I continue to be skeptical of institutional analysts and their ratings. We need an independent website that ranks firms and their analysts based on their actual performance over three, twelve, and twenty four month horizons. The website should follow various analysts and rank them based on stock performance following an upgrade or downgrade. Hedge funds or well-off investors have access to such information, but the ordinary public is left in the dark when ascertaining analysts' credibility. That's a shame, because the public's relatively short term memory allows most analysts and their firms to avoid accountability. The Motley Fool has tried to create something along the lines of what I've suggested, but it doesn't track professional analysts.

I have been told that FusionIQ's proprietary software does rank analysts. I have been given complimentary access to the software, but have not had the time to actually sign on and evaluate it. I hope to provide a report on FusionIQ at some point in the future.

Disclosure: I own Maxim shares, and a family member works for Maxim.

Mexico Peso Devaluation

Holy cow, Mexico's currency declined 4.59% against the U.S. dollar in one day. That swine flu...

You can buy Mexico's peso through CurrencyShares Mexican Peso Trust (FXM).