Rich People, Free Links

Two great links:

1. Warren Buffett's financial advice:

http://www.billshrink.com/blog/lessons-wealth-warren-buffet

“Live your life as simply as possible.”

2. Worst financial gurus:

http://www.billshrink.com/blog/worst-financial-gurus

I really, really dislike the book, Rich Dad, Poor Dad. I am ecstatic that someone finally called out Kiyosaki.

Random Thoughts: American Express, Kraft, and MGM

1. American Express (AXP) CEO Kenneth Chenault had these sobering words to say (from American Express's 2008 Annual Report):

The experience of the past year reinforces the principle that people should not spend more than they have the capacity to earn and pay back. And financial services companies should not encourage people to get over their heads in debt. Healthier consumer behavior is better for everyone in the long run. (Shareholder letter, page 9)

You might say Mr. Chenault deserves an obviousness award, except that millions of Americans are currently swimming in mortgage and credit card debt.

The upside is that American Express has plenty of room to grow: "Today, cash is used for about two-thirds of global personal consumption." Every time someone uses a credit card instead of cash, American Express receives a transaction fee. If American Express continues to successfully expand, it will make plenty of money.

On a side note, I don't understand why American Express isn't issuing credit cards with embedded chips here in the States. Almost all American credit card companies are still using the old magnetic strip technology, which is lovely--if you're into identity theft.

Magnetic strip technology makes stealing your credit card information very easy. The Europeans have figured this out and have mostly switched to embedded chip technology. American Express's Blue card used to offer embedded chip technology, but that's apparently been replaced by an ExpressPay system. If you have information about whether the ExpressPay system is more secure than the embedded chip technology, please post a comment.

2.I just realized that all of my lunch items, except for the bread, are Kraft-branded (KFT). This wasn't intentional--I don't care about brand names and usually focus on price. As a result, I was surprised when I peeked in my sandwich drawer and saw a) Kraft cheese (I love Kraft's extra sharp cheddar); b) Kraft mayo (with olive oil); and c) Oscar-Mayer lunch meats. (Kraft owns Oscar Mayer.) As more Americans brown-bag their lunches to save money, Kraft stands to benefit.

Also, Kraft recently provided me with good customer service, which is an important marketplace differentiator. In an era of increasing generic and store-branded competition, customer service matters more than ever. My issue related to Oscar-Mayer lunch meats. I complained that a package of turkey slices went bad too early. Nothing else in the same fridge drawer went bad, not even the other lunch meats. I asked Kraft to double-check their packaging on that particular item. I received a letter from a Kim M that acknowledged my issue, along with a coupon for a replacement pack. Now that's excellent customer service. Kudos to Kraft and Kim M.

3. Some interesting tidbits from MGM Mirage's (MGM) annual report:

Wasn't 2008 Supposed to Be the Bottom?: "Our current expectations for 2009 indicate that operating cash flow will be lower than in 2008." (page 3)

Yield Premiums Gone Wild: MGM issued $850 million of 11.125% senior secured notes due 2017 (page 4). Treasuries currently offer around a 3% yield. When a company has to offer 11%+ secured notes to attract financing, that's scary, isn't it?

Someone Benefited from Hurricane Katrina?: MGM received "insurance recoveries of $635 million which exceeded the $265 million of net book value of damaged assets and post-storm costs incurred...[MGM] recognized $284 million of insurance recoveries in income." (page 8)

I have little sympathy for MGM. During its 2008 annual shareholder meeting, I asked (former) CEO Terrence Lanni how he planned to adjust to the changing economic environment. I suggested he should lower prices and stop charging for basic items like internet access. He disagreed and seemed to mock my concerns. Other than licensing the MGM name, I didn't see any new streams of revenue. I left that meeting stunned that MGM's management didn't seem to feel the need for major changes. And so it goes.

Disclosure: I may own an insignificant number of shares in AXP, MGM, and KFT. The ownership of shares, if any, has not influenced any opinions expressed above.

Are Cities Using Parking/Speeding as Revenue Generators?

A driver was pulled over for going under the speed limit:

http://www.nbcwashington.com/news/local/I-Cant-Drive-65.html

And S.F. issued a citation to a driver who hadn't curbed his wheels...on an almost flat street:

http://www.mercurynews.com/localnewsheadlines/ci_12876699?nclick_check=1

As cities get less revenue from taxes and the state, they may use parking citations and tickets as revenue generators. Beware.

John Mauldin on Globalization and Leverage

From John Mauldin (July 17, 2009):

Globalization is a two-edged sword. On balance, it has brought prosperity to those who have embraced it, with rising lifestyles, better health, longer lives, and more. The more we need each other, the less likely it is that we'll shoot each other. Shooting your customers is not a good business strategy. And while the growth has not been even or smooth, only a Luddite would want to return to the early 1800s or 1900s, or even 1975.

The other edge of that sword? We are connected in so very many ways, far more than most of the world suspected. Who thought that insane lending policies at US mortgage banks would bring the world financial system to its knees, increasing unemployment and leading to a global recession?

I love the statement that killing your customers isn't a good business strategy. Mr. Mauldin also comments on leverage--and it's becoming fairly easy to see that leverage is what killed the golden goose:

In the first few years of the G.W. Bush administration, the banking authorities decided it would be OK to allow five banks to increase their leverage from 12:1 up to 30:1. Which five banks, you ask? Bear Stearns, Lehman, Merrill Lynch, JPMorgan, and Goldman Sachs. How did that work out, just five years later? Three are gone and two survived with large dollops of taxpayer money...Thirty times leverage means that if you lose 3.3%, you wipe out all your capital.

Some stocks fluctuate 3.3% in just one day. Even when I was leveraged just two to one times, I had difficulty sleeping. How did these investment bankers do it? How could they have been so irresponsible, gambling on non-tangible investments? Regular banks are highly leveraged, too, but they usually invest in tangible items like houses.

All this makes me yearn for the good old days--when banks were simple creatures, loaning money at an interest rate higher than their deposit interest rate. Wall Street's unconscionable leverage is exactly why more Americans should look to credit unions for their banking needs.

Note: Barry Ritholtz mentioned the same issue--leverage--in his book, Bailout Nation:

Thus we learn that the tragic financial events of 2008 and 2009 are not an unfortunate accident. Rather, they are the results of a conscious SEC decision to allow these firms to legally violate net capital rules that had existed for decades, limiting broker-dealers' debt-to-net-capital ratio to 12-to-1. You couldn't make this stuff up if you tried. (page 144)

[Update on December 2017: Turns out Ritholtz was wrong. More here: https://willworkforjustice.blogspot.com/2017/09/2008-financial-crisis.html]
If Congress wants to help mitigate the next financial bubble, it needs to pass laws restricting leverage. So far, I haven't seen any proposed bills that attempt to resolve systemic risk in the financial markets. That's a crying shame.

Required blurb: John Mauldin, Best-Selling author and recognized financial expert, is also editor of the free Thoughts From the Frontline that goes to over 1 million readers each week. For more information on John or his FREE weekly economic letter go to:

http://www.frontlinethoughts.com/learnmore

Taxpayers Take Over Delphi's Pensions

From Calculated Risk:

http://www.calculatedriskblog.com/2009/07/pbgc-to-assume-delphi-pension-plans.html

Companies underfund pensions to boost their bottom line, similar to California borrowing education monies to balance its budget. This is perfectly legal. I don't understand why the law allows companies or the state to use accounting gimmicks to project an image of financial health. If companies offer pensions, they should fully fund the pension plan at all times. Otherwise, if the company doesn't do well, eventually the taxpayer is on the hook for the pensions--as in the case of Delphi.

Bernanke's Fed

I know people were going gaga over Bernanke's WSJ article, but I hope everyone realizes they can get better material directly from the Fed's website.

Bernanke's Fed seems more transparent than Greenspan's Fed. I don't remember seeing as much information on the Fed's website several years ago. Anyway, here are some interesting excerpts from the Fed's most recent minutes:

Consumer price inflation was fairly quiescent in recent months, although the upturn in energy prices appeared likely to boost headline inflation in June.

Real personal consumption expenditures rose somewhat in the first quarter after falling in the second half of 2008, and available data suggested that spending was holding reasonably steady in the second quarter.

The fundamental determinants of consumer demand appeared to have improved a bit: Despite the ongoing decline in employment, real disposable personal income rose in the first quarter and posted another sizable gain in April as various provisions of the American Recovery and Reinvestment Act of 2009 boosted transfer payments and reduced personal taxes. In addition, equity prices recorded substantial gains in April and May, reversing a small portion of the prior wealth declines. Measures of consumer sentiment, while remaining at levels typically seen during recessions, improved markedly from the historical lows recorded around the turn of the year.

The steep decline in the demand for new single-family houses seemed to have abated....The apparent stabilization in housing demand was likely due, in part, to the improvement in housing affordability that resulted from low mortgage rates and declining house prices.

Although recent increases in oil and other commodity prices were likely to raise headline inflation over the near term, most participants expected core inflation to remain subdued for some time...A few participants were concerned that inflation expectations could continue to rise, especially in light of the Federal Reserve's greatly expanded balance sheet and the associated large volume of reserves in the banking system, and that as a result inflation could temporarily rise above levels consistent with the Committee's dual objectives of maximum employment and stable prices. Most participants, however, expected that inflation would remain subdued for some time...The prices of energy and other commodities have risen of late. However, substantial resource slack is likely to dampen cost pressures, and the Committee expects that inflation will remain subdued for some time.

Interesting stuff, no? It looks like the Fed is cautiously optimistic. Surprisingly, inflation doesn't seem to be a major concern.

China and the U.S. Dollar

From the Wilson Quarterly (Summer 2009):

You want to know why China won't dump the dollar? It has almost no choice, unless a new worldwide currency is created. Robert Aliber, a University of Chicago professor, explains how America's rising debt has limited both China and America:

By 1980, [America's] net foreign assets (assets minus liabilities) were larger than those of all other creditor countries combined. But the next 20 years brought a reversal of unprecedented proportions. By 2000, America's net foreign liabilities had become larger than those of all other debtor countries combined, and its liabilities were still growing rapidly as foreign savings surged into Treasury bills and other dollar-denominated securities. The shift was amazing rapid. (pps. 56-57)

[Even so,] Beijing is not likely to let market forces determine the value of its currency. And if it were to begin buying many more yen or euros instead of dollars...politicians from Tokyo to Paris would go ballistic. They would accuse the Chinese of following a classic "beggar-thy-neighbor" policy, keeping the value of the yuan artificially low and thus increasing China's exports to their countries. So China's leaders will continue to buy dollars, even as they complain loudly that the United States' trade and fiscal deficits are too large. (pp. 58)

Meanwhile, from 1981 to the present, the Chinese population's savings rose from 20% of China's GDP to more than 50%. (See WQ, pp. 60) Basically, the Chinese started saving more money and had to put the money somewhere. Interest rates were fairly high from 1981 to 2000 in the United States, so America was a natural destination for deposits. How much are the Chinese saving? By some accounts, up to 2.5 trillion dollars per year.

What does it all mean? Probably three things: one, the United States must manufacture more products foreigners need, desire, and can afford; two, the United States may subsidize some types of manufacturing through tax credits to counteract China's currency protectionism; and three, at least for the foreseeable future, the American dollar will remain the world's "least worst" currency, but may still have to increase interest rates sometime this year to mollify investors.

Contrary to public belief, increasing interest rates isn't all bad. Higher interest rates encourage more Americans to save and minimize the risk of inflation; therefore, higher interest rates have positive benefits. I am very upset that my T. Rowe Price money market fund (PRRXX) is giving me near 0% interest; however, I am unsure whether to transfer the money into a Ginnie Mae fund. If the Federal Reserve raises interest rates, the value of the Ginnie Mae fund's shares should decline, so waiting until mid-2010 to invest may be a more prudent path. Absent some clear signal from the Federal Reserve regarding its future interest rate decisions, I bet many Americans will remain on the sidelines, upset but unwilling to make any major moves.

Update on April 30, 2011: on the other hand, consider this question from Caroline Baum, Bloomberg: "A dollar today buys only 45 cents worth of the goods and services it bought in the early 1980s, according to the Bureau of Labor Statistics. Can you explain why, in a time when prices are supposedly stable, the dollar has lost half its purchasing power?"