Coyote Blog

I know that most non-financial folks, including myself, have their head spinning after this past few weeks' doings on Wall Street.  Doug Diamond and Anil Kashyap have a pretty good layman's roundup on Fannie/Freddie, Lehman, and AIG.  My sense is that their Lehman explanation also applies to Bear Stearns as well.  Here is just one small piece of a much longer article:

The Fannie and Freddie situation was a result of their unique roles
in the economy. They had been set up to support the housing market.
They helped guarantee mortgages (provided they met certain standards),
and were able to fund these guarantees by issuing their own debt, which
was in turn tacitly backed by the government. The government guarantees
allowed Fannie and Freddie to take on far more debt than a normal
company. In principle, they were also supposed to use the government
guarantee to reduce the mortgage cost to the homeowners, but the Fed
and others have argued that this hardly occurred. Instead, they appear to have used the funding advantage to rack up huge profits
and squeeze the private sector out of the "conforming" mortgage market.
Regardless, many firms and foreign governments considered the debt of
Fannie and Freddie as a substitute for U.S. Treasury securities and snapped it up eagerly. 

Fannie and Freddie were weakly supervised and strayed from the core
mission. They began using their subsidized financing to buy
mortgage-backed securities which were backed by pools of mortgages that
did not meet their usual standards. Over the last year, it became clear
that their thin capital was not enough to cover the losses on these subprime
mortgages. The massive amount of diffusely held debt would have caused
collapses everywhere if it was defaulted upon; so the Treasury
announced that it would explicitly guarantee the debt.

But once the debt was guaranteed to be secure (and the government
would wipe out shareholders if it carried through with the guarantee),
no self-interested investor was willing to supply more equity to help
buffer the losses. Hence, the Treasury ended up taking them over.

Lehman's demise came when it could not even keep borrowing. Lehman
was rolling over at least $100 billion a month to finance its
investments in real estate, bonds, stocks, and financial assets. When
it is hard for lenders to monitor their investments and borrowers can
rapidly change the risk on their balance sheets, lenders opt for short-term lending. Compared to legal or other channels, their threat to refuse to roll over funding is the most effective option to keep the borrower in line.

This was especially relevant for Lehman, because as an investment
bank, it could transform its risk characteristics very easily by using
derivatives and by churning its trading portfolio. So for Lehman (and
all investment banks), the short-term financing is not an accident; it
is inevitable.

Why did the financing dry up? For months, short-sellers were
convinced that Lehman's real-estate losses were bigger than it had
acknowledged. As more bad news about the real estate market emerged,
including the losses at Freddie Mac and Fannie Mae, this view spread.

Lehman's costs of borrowing rose and its share price fell. With an
impending downgrade to its credit rating looming, legal restrictions
were going to prevent certain firms from continuing to lend to Lehman.
Other counterparties
that might have been able to lend, even if Lehman's credit rating was
impaired, simply decided that the chance of default in the near future
was too high, partly because they feared that future credit conditions
would get even tighter and force Lehman and others to default at that
time.

A.I.G. had to raise money because it had written $57 billion of insurance contracts whose payouts depended on the losses incurred on subprime real-estate related investments.
While its core insurance businesses and other subsidiaries (such as its
large aircraft-leasing operation) were doing fine, these contracts,
called credit default swaps (C.D.S.'s), were hemorrhaging.   

Furthermore, the possibility of further losses loomed if the housing
market continued to deteriorate. The credit-rating agencies looking at
the potential losses downgraded A.I.G.'s debt on Monday. With its lower
credit ratings, A.I.G.'s insurance contracts required A.I.G. to
demonstrate that it had collateral to service the contracts; estimates
suggested that it needed roughly $15 billion in immediate collateral.

A second problem A.I.G. faced is that if it failed to post the
collateral, it would be considered to have defaulted on the C.D.S.'s.
Were A.I.G. to default on C.D.S.'s, some other A.I.G. contracts (tied
to losses on other financial securities) contain clauses saying that
its other contractual partners could insist on prepayment of their
claims. These cross-default clauses are present so that resources from
one part of the business do not get diverted to plug a hole in another
part. A.I.G. had another $380 billion of these other insurance
contracts outstanding. No private investors were willing to step into
this situation and loan A.I.G. the money it needed to post the
collateral.

In the scramble to make good on the C.D.S.'s, A.I.G.'s ability to
service its own debt would come into question. A.I.G. had $160 billion
in bonds that were held all over the world: nowhere near as widely as
the Fannie and Freddie bonds, but still dispersed widely.

In addition, other large financial firms "” including Pacific
Investment Management Company (Pimco), the largest bond-investment fund
in the world "” had guaranteed A.I.G.'s bonds by writing C.D.S.
contracts.

Given the huge size of the contracts and the number of parties
intertwined, the Federal Reserve decided that a default by A.I.G. would
wreak havoc on the financial system and cause contagious failures.
There was an immediate need to get A.I.G. the collateral to honor its
contracts, so the Fed loaned A.I.G. $85 billion.

Update:  Travis has an awesome post with his own FAQ about what is going on.  Here is a taste:

Lots of financially naive folks think that we can remove all risk,
inflation, etc. by only ever trading apples for chickens on the barrel
head, and doing away with paper money (so that all money is gold) and
doing away fractional reserve banking, so that when I deposit one gold
coin in the bank, the bank can then take that actual physical gold coin
and loan it to someone else. It turns out that the friction involved in
doing things this way is so huge that the effect would make The Road
Warrior look like a children's bedtime story. You want to borrow money
to buy a car? The bank can't just loan money that's been deposited in
someone else's checking account - the bank has to get that person to
sign a note saying "yes, I understand that this money is on deposit
until that dude buying the card pays the bank back IN FULL". And the
lender, if he wants his money out ahead of time, is SOL. And even then,
there can be a flood, and your car gets totaled, and you get
Legionaire's disease, and you can't make the payments.

or this:

Now, for the next complication, let's also imagine that there are
300 million other people watching all of this, thinking "How bad is
this? Should I go down to the gun store, stock up on .223 and 12 gauge
shells, then stop by the veterinarians to see how much antibiotics I
can cadge before heading to the hills" ?

And the Feds really don't want 300 million armed folks heading
for the national forests, so they first try to tell everyone who owns a
bicycle "Hey, the value of your bike didn't really drop! It's still
worth $9!".

But no one wants to believe that.

So then they go to the guy who's writing insurance policies on
the value of bikes and they say "if you got $100 million, would that
calm things down a bit?".

I was thinking a bit about Jeff Skilling (former Enron CEO) today.  What must he be thinking as a series of large firms that were supposedly far more stable than Enron go down one after the other to liquidity crises much like that of Enron?  Bear Stearns and Lehman, two firms that should have been rock solid, go down in the blink of an eye in a credit crunch, and all we hear from the media is how the firms fell victim to larger forces beyond their control.  At least at Enron they were up-front with the market about their taking on large risks.  Now, the government is running around in the background trying to match-make these failing companies and helping to save at least a squidge of shareholder equity.  The only thing the government did in the Enron collapse was hound Skilling and others into jail.   

Sure, Skilling may have made some overly optimistic statements about his company as he was trying to stave off the crunch, but no more so that the happy-face statements issuing from Bear or Lehman in their final days.  Executives who find themselves in a credit crunch are in a nearly impossible position.  The best way they can serve equity holders is to downplay or even bury bad news to head off the looming crisis of confidence.  But if they do so, they face presecution for making false statements about the company, ironically under laws meant to protect equity holders.

Megan McArdle writes:

Let's be honest, coastal folks:  when you meet someone with a thick
southern accent who likes NASCAR and attends a bible church, do you
think, "hey, maybe this is a cool person"?  And when you encounter
someone who went to Eastern Iowa State, do you accord them the same
respect you give your friends from Williams?  It's okay--there's no one
here but us chickens.  You don't.

Maybe you don't know you're
doing it.  But I have quite brilliant friends who grew up in rural
areas and went to state schools--not Michigan or UT, but ordinary state
schools--who say that, indeed, when they mention where they went to
school, there's often a droop in the eyelids, a certain forced quality
to the smile.  Oh, Arizona State.  Great weather out there.  Don't I need a drink or something? This person couldn't possibly interest me.

People
from a handful of schools, most of them hailing from a handful of major
metropolitan areas, dominate academia, journalism, and the
entertainment industry.  Our subtle (or not-so-subtle) distaste for
everything from their entertainment to their decorating choices to the
vast swathes of the country in which they choose to live permeate
almost everything they read, watch, or hear.  Of course we don't hear
it--to us, that's simply the way the world is. 

I have written before that I go out of my way not to mention my
double-Ivy pedigree within my business dealings because it tends to cause my
employees (who often have no degree at all) to clam up.  I absolutely
depend on their feedback and ideas, and those dry up if my employees
somehow think that I'm smarter than they are and they start to be afraid to "look stupid."

But McArdle's post causes me to think of another reason not to be snobbish about my eastern degrees.  I meet a lot of rich and succesful people out here in the Phoenix area, and I can't remember the last one that had an Ivy League degree.  I am thinking through a few of them right now -- ASU, ASU, Arizona, Kansas State, Tulane, no college, San Diego State....  Getting uppity about my Harvard MBA around here only leaves me vulnerable to the charge of "Person X went to Montana State and is worth $10 million now -- what the hell have you been doing with that Harvard MBA?"  Here in flyover country, college degrees and family pedigree are not really strong predictors of business success.

This is a reprise of a much older post, but since I have limited time for blogging, I thought it might be timely to reprise it:

I had a conversation the other day with a person I can best describe
as a well-meaning technocrat.  Though I am not sure he would put it
this baldly, he tends to support a government by smart people imposing
superior solutions on the sub-optimizing masses.  He was lamenting that
allowing a company like GM to die is dumb, and that a little bit of
intelligent management would save all those GM jobs and assets.  Though
we did not discuss specifics, I presume in his model the government
would have some role in this new intelligent design (I guess like it
had in Amtrak?)

There are lots of sophisticated academic models for the corporation.  I have even studied a few.  Here is my simple one:

A corporation has physical plant (like factories) and workers of
various skill levels who have productive potential.  These physical and
human assets are overlaid with what we generally shortcut as
"management" but which includes not just the actual humans currently
managing the company but the organization approach, the culture, the
management processes, its systems, the traditions, its contracts, its
unions, the intellectual property, etc. etc.  In fact, by calling all
this summed together "management", we falsely create the impression
that it can easily be changed out, by firing the overpaid bums and
getting new smarter guys.  This is not the case - Just ask Ross Perot.
You could fire the top 20 guys at GM and replace them all with the
consensus all-brilliant team and I still am not sure they could fix
it. 

All these management factors, from the managers themselves to
process to history to culture could better be called the corporate
DNA*.  And DNA is very hard to change.  Walmart may be freaking
brilliant at what they do, but demand that they change tomorrow to an
upscale retailer marketing fashion products to teenage girls, and I
don't think they would ever get there.  Its just too much change in the
DNA.  Yeah, you could hire some ex Merry-go-round** executives, but you
still have a culture aimed at big box low prices, a logistics system
and infrastructure aimed at doing same, absolutely no history or
knowledge of fashion, etc. etc.  I would bet you any amount of money I
could get to the GAP faster starting from scratch than starting from
Walmart.  For example, many folks (like me) greatly prefer Target over
Walmart because Target is a slightly nicer, more relaxing place to
shop.  And even this small difference may ultimately confound Walmart.
Even this very incremental need to add some aesthetics to their
experience may overtax their DNA.

Corporate DNA acts as a value multiplier.  The best corporate DNA
has a multiplier greater than one, meaning that it increases the value
of the people and physical assets in the corporation.  When I was at a
company called Emerson Electric (an industrial conglomerate, not the
consumer electronics guys) they were famous in the business world for
having a corporate DNA that added value to certain types of industrial
companies through cost reduction and intelligent investment.  Emerson's
management, though, was always aware of the limits of their DNA, and
paid careful attention to where their DNA would have a multiplier
effect and where it would not.  Every company that has ever grown
rapidly has had a DNA that provided a multiplier greater than one...
for a while.

But things change.  Sometimes that change is slow, like a creeping
climate change, or sometimes it is rapid, like the dinosaur-killing
comet.  DNA that was robust no longer matches what the market needs, or
some other entity with better DNA comes along and out-competes you.
When this happens, when a corporation becomes senescent, when its DNA
is out of date, then its multiplier slips below one.  The corporation
is killing the value of its assets.  Smart people are made stupid by a
bad organization and systems and culture.  In the case of GM, hordes of
brilliant engineers teamed with highly-skilled production workers and
modern robotic manufacturing plants are turning out cars no one wants,
at prices no one wants to pay.

Changing your DNA is tough.  It is sometimes possible, with the
right managers and a crisis mentality, to evolve DNA over a period of
20-30 years.  One could argue that GE did this, avoiding becoming an
old-industry dinosaur.  GM has had a 30 year window (dating from the
mid-seventies oil price rise and influx of imported cars) to make a
change, and it has not been enough.  GM's DNA was programmed to make
big, ugly (IMO) cars, and that is what it has continued to do.  If its
leaders were not able or willing to change its DNA over the last 30
years, no one, no matter how brilliant, is going to do it in the next
2-3.

So what if GM dies?  Letting the GM's of the world die is one of the
best possible things we can do for our economy and the wealth of our
nation.  Assuming GM's DNA has a less than one multiplier, then
releasing GM's assets from GM's control actually increases value.
Talented engineers, after some admittedly painful personal dislocation,
find jobs designing things people want and value.  Their output has
more value, which in the long run helps everyone, including themselves.

The alternative to not letting GM die is, well, Europe (and Japan).
A LOT of Europe's productive assets are locked up in a few very large
corporations with close ties to the state which are not allowed to
fail, which are subsidized, protected from competition, etc.  In
conjunction with European laws that limit labor mobility, protecting
corporate dinosaurs has locked all of Europe's most productive human
and physical assets into organizations with DNA multipliers less than
one. 

I don't know if GM will fail (but a lot of other people have opinions) but if it does, I am confident that the end result will be positive for America.

* Those who accuse me of being more influenced by Neal Stephenson's Snow Crash than Harvard Business School may be correct.
**
Gratuitous reference aimed at forty-somethings who used to hang out at
the mall.  In my town, Merry-go-round was the place teenage girls went
if they wanted to dress like, uh, teenage girls.  I am pretty sure the
store went bust a while back.

US Airways has chosen to try to cover rising fuel prices by unbundling their ticket price and charging for services that were here-to-fore free, or built into the base ticket price.  They now charge $15 for the first piece of checked baggage ($25 for the second), and charge for most in-cabin services, including for soft drinks.

I'm not going to argue with them about this.  Airline pricing is a wickedly complex topic, and folks who know more than I do think this is the best way to get incremental revenue.  Really, these charges don't affect me (I almost never check bags, except when on vacation with my family).  In fact, as I write this, it strikes me that the baggage charge is really a price hike mostly on non-business travelers, which is interesting as it bucks the trend of having increasing price spreads over the years between business/last-minute and tourist pricing.

Anyway, the net effect has been to absolutely jam the security screening station this morning.  Every passenger seems to be carrying every bag he or she can on board to avoid the $15 charge.  What a mess.  I can't wait to see what the boarding process is going to be like.  Glad I don't have any bags today.

By the way, a few weeks ago I shipped a 60 pound trunk to my kids' camp for about $16 via UPS.  If these airline bag charges stick, it might be time for UPS to start soliciting the send-your-luggage-ahead business in earnest.  Next time we go skiing or some such place, I am going to seriously consider sending a couple of duffle bags ahead by UPS.

Update: The luggage bins were completely full before the fourth group out of six were called.  There was a fairly long line down the jetway of people gate-checking their bags.  Apparently, the airline is not set up to charge the $15 when they gate-check the bags, so everyone is hauling all of their bags to the gate and either bringing them on the plane or checking them at the gate for free.

This may not be of much interest to regular readers, but is being posted so future recipients of this letter may find this article when searching in Google. 

I got this in the mail the other day (click to enlarge)

It is laid out to mirror the typical format of a state annual report or business license renewal form.  It purports to be from a government-sounding "Board of Business Compliance."  The layout and wording is very similar to the California State required annual report form, as is the $125 fee the letter claims is "now due."  Only in the really fine print near the bottom right does it admit to being a business solicitation. 

Beware.  Despite all their efforts to fool you, filling out this form and filing this $125 fee is not required by any government agency.   I am not sure if you pay money to this group whether you will actually receive any services (I did not pay).  But I will observe that there is absolutely no way that a third party could create a legally meaningful set of minutes for your company based on the information in this form.  Remember, though, that it is important for small corporations to keep their minutes in order -- but I am pretty sure this is not the best way to do it.

Business that must be obtained this way is not worth having, at least in my book. 

Postscript:  One might ask, how can anyone fall for this?  The biggest problem is the government itself.  Doing business in 12 states, 20 counties, and a number of large municipalities, I get literally a hundred "legitimate" forms like this requiring a $50-$150 filing fee from government institutions all the time.  This form, at first, looks more legitimate than say, the application for egg license I get from two states (which are in fact real government requirements). 

PPS:  Don't even get me started on yellow page vendors, directory listing providers, and companies claiming your URL registration is expiring.

UPDATE: Apparently one of the commenters included contact information at the California AG.  The AG's office has written me asking to have comments and concerns about this issue routed to a different address.  I think poor Mr. Wayne was deluged with a bunch of complaints.  Here is what they sent me as their preferred alternative contact information:

 

Complaints may be filed with the California Attorney General's Office by mail, telephone, fax, the Internet, or email:

 

MAILING ADDRESS:

 

Attorney General's Office
California Department of Justice
Attn: Public Inquiry Unit
P.O. Box 944255
Sacramento, CA 94244-2550

TELEPHONE:   1-800-952-5225 (Toll-free in CA) or (916) 322-3360

 

FAX:   (916) 323-5341

WEBSITE:   http://ag.ca.gov/consumers

 

EMAIL:   piu@doj.ca.gov

Kevin Drum and I seldom agree on business and economics related issues, but we both agree that consumer loyalty programs suck.  Here is Drum on loyalty programs, and here is my extended screed.

Funny video about the 2009 job market.  Ht:  Maxed Out Mamma

Way back around 1985, when I was an entry-level engineer at Exxon, the company had a training session with a writing instructor.  The course, if it had a name, could be called "the art of the business memo." 

Now, I know that you 20-somethings in the world of text messaging and soon-to-be-f*cked internet companies are probably cringing at the thought of learning to write business memos the Fortune 50 way.  But there was something about this course I found compelling.  Since then, I have taken a lot of communications courses, particularly presentation courses, of varying utility.  McKinsey & Company taught me the pyramid principal for organizing persuasive letters and presentations, something that has been so useful to me that I wonder why none of the expensive schools I attended ever bothered to teach it.

To this day, I am still compelled by the perfect business letter.  I know this may seem weird, but I still remember several of my best efforts from years ago.  I sometimes go back and read them lovingly.  I have three lifetimes of projects that I would like to put together, but one fun one would be to put together a book collection of great business letters.  I fell like its an art that should better recognized.

Anyway, I was reminded of all this by this letter that has been linked around the blogosphere a bit this morning.

Everyone wants to blame their industry's poor economics on banks or the oil companies: (via a reader)

Truckers angry about the high price of fuel staged a rolling protest on
Tuesday, using their big rigs to slow traffic to a crawl on the New
Jersey Turnpike.

The protest was part of a loosely organized
nationwide effort by independent truckers to draw attention to the high
prices they face....

"The gas prices are too high," said one of them, Lamont Newberne, a
34-year-old trucker from Wilmington, N.C. "We don't make enough money
to pay our bills and take care of our family."

Newberne said a
typical run carrying produce from Lakeland, Fla., to the Hunt's Point
Market in The Bronx, N.Y., had cost $600 to $700 a year ago. It now
runs him $1,000...

"The oil company is the boss, what are we going to be able to do about
it?" said Rotenbarger, who was at a truck stop at Baldwin, Fla., about
20 miles west of Jacksonville. "The whole world economy is going to be
controlled by the oil companies. There's nothing we can do about it."

Well, we talked the other day about how oil industry profits, even at this historic high, amount to twenty cents of current gas and diesel prices.  But lets take a more direct comparison.  I looked at Google finance for ExxonMobil and Knight Transportation (a large trucker based here in Phoenix).  If you sum up sales and net income for 2006 and 2007, ExxonMobil earned 10.2% of sales.  During the same period, the trucker earned 9.9% of sales.  This is a statistical dead heat.  So it is kind of hard to say that trucking companies are suffering at the hand of oil companies when they earn the same profit margins.

So what might be the problem?  The article gives a big fat hint that it might not actually be an oil company problem:

Jimmy Lowry, 51, of St. Petersburg, Fla., and others said it costs
about $1 a mile to drive one of the big rigs, although some companies
are offering as little as 87 cents a mile. Diesel cost $4.03 a gallon
at the Jacksonville-area truck stop.

I would certainly be willing to believe that trucking companies are paying independent drivers a price per mile that hasn't kept up with fuel costs.   In particular, it may be that the independent truckers have the same problem that Bear Stearns had, ie their revenues are tied into long term contracts while their costs float short term.  I'd certainly be bargaining for either higher mileage rates or a new rate structure with a fuel surcharge.

From the Arizona Republic:

Three day laborers filed a lawsuit Tuesday that seeks to overturn a
suburb's law prohibiting people standing on public streets from
soliciting employment from occupants of cars.

The federal lawsuit alleges Cave Creek's law passed is unconstitutional
because it restricts the free speech rights of people trying to find
work as day laborers.

"Cave Creek does not have the right to pick and choose who has free
speech rights," said Monica Ramirez, an attorney for the American Civil
Liberties Union, one of the group's representing the day laborers. "The
town cannot bar people from peaceably standing in public areas and
expressing their availability to work."

The stated reason for the law is this, but don't believe it:

Mayor Vincent Francia said the law was a response to concerns raised by
residents over traffic being impeded by people congregating on street
corners.

If you followed the genesis of this law, it has less than zero to do with traffic.  It was crafted as a way to prevent people of Mexican birth, with or without the proper papers from the US government, from seeking work in Cave Creek.  Which explains why sheriff Joe Arpaio is so eager to help enforce the law, and why, by some statistical fluke, everyone arrested under the law seems to be of Mexican Latin descent  (the three laborers filing the suit are Mexican and Guatemalan and are in this country legally).

I am happy to see this suit get filed under whatever auspices that it can, and have in the past supported using the first amendment to protect free commerce.  Further, I am thrilled to see the ACLU, given its Stalinist origins, for once actively support the right to publicly advertise and conduct commerce.  However, it is sad to me that Thomas Jefferson and company did not think it necesary to enshrine the right to free commerce as an protected right up there with speech and association.

One might argue that the enumerated power concept and the 9th amendment should be protection enough, but obviously Jefferson did not think so or he would not have pushed for the Bill of Rights.   And saying the following may just prove that I am not a Constitutional expert, but it strikes me that another problem with the original Constitution that probably wasn't fixable at the time was the fact that the Bill of Rights did not originally restrain the states, only the Federal government.  Only with the beat-down of states rights concepts in the Civil War and the passage and later interpretation of the 14th amendment did the Supreme Court begin to apply the Bill of Rights to states and municipalities as well.  It is good that they have done so, but these protections enforced on states only tend to be the enumerated protections of the Bill of Rights.  In fact, in this context, the 9th is meaningless because it reserves unenumerated powers to the people or the states, so it contributes nothing to reigning in municipalities, only the Feds. 

All that being said, it should would have been nice to have three extra words such as "or conduct commerce" inserted after assembly:

Congress shall make no law respecting an establishment of
religion, or prohibiting the free exercise thereof; or abridging the
freedom of speech, or of the press; or the right of the people
peaceably to assemble [or conduct commerce], and to petition the Government for a redress of
grievances.

I wondered if folks would find my analogy from Bear Stearns to Enron I posted the other day stretched. 

Because Enron's demise came in exactly this sort of liquidity crisis,
and the situations are nearly entirely parallel, all the way up to and
including the CEO telling the world all is well just days before the
failure.  But no one understood Enron's business, so its failure seemed
"out of the blue" and therefore was attributed by many to fraud,
lacking any other ready explanation.   In the case of Bear Stearns, the
public was educated in advance as to the problems in their portfolio
(with mortgage loans) such that the liquidity crisis was less of a
surprise and, having ready source of blame (subprime loans) no one has
felt the need to apply the fraud tag.

Apparently, the Economist sees the same connection (via a reader):

For many people, the mere fact of Enron's collapse is evidence that
Mr Skilling and his old mentor and boss, Ken Lay, who died between his
conviction and sentencing, presided over a fraudulent house of cards.
Yet Mr Skilling has always argued that Enron's collapse largely
resulted from a loss of trust in the firm by its financial-market
counterparties, who engaged in the equivalent of a bank run. Certainly,
the amounts of money involved in the specific frauds identified at
Enron were small compared to the amount of shareholder value that was
ultimately destroyed when it plunged into bankruptcy.

Yet recent events in the financial markets add some weight to Mr
Skilling's story"”though nobody is (yet) alleging the sort of fraudulent
behaviour on Wall Street that apparently took place at Enron. The
hastily arranged purchase of Bear Stearns by JP Morgan Chase is the
result of exactly such a bank run on the bank, as Bear's counterparties
lost faith in it. This has seen the destruction of most of its roughly
$20-billion market capitalisation since January 2007. By comparison,
$65 billion was wiped out at Enron, and $190 billion at Citigroup since
May 2007, as the credit crunch turned into a crisis in capitalism.

Mr Skilling's defence team unearthed another apparent inconsistency
in Mr Fastow's testimony that resonates with today's events. As Enron
entered its death spiral, Mr Lay held a meeting to reassure employees
that the firm was still in good shape, and that its "liquidity was
strong". The composite suggested that Mr Fastow "felt [Mr Lay's
comment] was an overstatement" stemming from Mr Lay's need to "increase
public confidence" in the firm.

The original FBI notes say that Mr Fastow thought the comment
"fair". The jury found Mr Lay guilty of fraud at least partly because
it believed the government's allegations that Mr Lay knew such bullish
statements were false when he made them.

As recently as March 12th, Alan Schwartz, the chief executive of
Bear Stearns, issued a statement responding to rumours that it was in
trouble, saying that "we don't see any pressure on our liquidity, let
alone a liquidity crisis." Two days later, only an emergency credit
line arranged by the Federal Reserve was keeping the investment bank
alive. (Meanwhile, as its share price tumbled on rumours of trouble on
March 17th, Lehman Brothers issued a statement confirming that its
"liquidity is very strong.")

Although it can do nothing for Mr Lay, the fate of Bear Stearns
illustrates how fast quickly a firm's prospects can go from promising
to non-existent when counterparties lose confidence in it. The rapid
loss of market value so soon after a bullish comment from a chief
executive may, judging by one reading of Enron's experience, get
prosecutorial juices going, should the financial crisis get so bad that
the public demands locking up some prominent Wall Streeters.

The article also includes more details of exculpatory evidence that was withheld from the Skilling team and will very likely lead to a new trial.  The Enron prosecution team has not had a very good record in appeals court scrutiny of their actions at trial:

For what it is worth, prosecutors have had a tougher time in the
appeals court with Enron-related cases than in the initial jury trials.
Convictions have been overturned in a case relating to Nigerian barges
that Enron sold to Merrill Lynch. The conviction of the chief financial
officer of Enron Broadband has also been vacated, after two trials. So,
too, was the decision to convict Enron's auditor, Arthur Andersen
(albeit too late to save the venerable firm from liquidation).

Bear Stearns is being bought for a price that is barely indistinguishable from zero:

Just four days after Bear Stearns Chief Executive Alan Schwartz assured
Wall Street that his company was not in trouble, he was forced on
Sunday to sell the investment bank to competitor JPMorgan Chase for a
bargain-basement price of $2 a share, or $236.2 million.

The stunning last-minute buyout was aimed at averting a Bear Stearns
bankruptcy and a spreading crisis of confidence in the global financial
system sparked by the collapse in the subprime mortgage market. Bear
Stearns was the most exposed to risky bets on the loans; it is now the
first major bank to be undone by that market's collapse.

This is what happens to a highly leveraged company when there is a liquidity crisis.  Fears about the company's health caused most lenders to withhold short term capital, which then in turn brought those fears to reality. 

While I suspect that we may find a lot of stupid blunders (at least in hindsight) and poor decisions, my sense is that this has nothing to do with fraud of any sort.  Which raises some interesting questions about Enron.  Because Enron's demise came in exactly this sort of liquidity crisis, and the situations are nearly entirely parallel, all the way up to and including the CEO telling the world all is well just days before the failure.  But no one understood Enron's business, so its failure seemed "out of the blue" and therefore was attributed by many to fraud, lacking any other ready explanation.   In the case of Bear Stearns, the public was educated in advance as to the problems in their portfolio (with mortgage loans) such that the liquidity crisis was less of a surprise and, having ready source of blame (subprime loans) no one has felt the need to apply the fraud tag.  (It also did not help that Lay and Skilling kept a higher profile than Schwartz at Bear Stearns, so that they were an easier target for vilification. 

I never really had the time to fully understand all the charges against Skilling at Enron (though I do think he deserves a new trial) but I always thought that it was unfair to try to ring either Skilling or Lay up for fraud because they were out trumpeting the health of the company shortly before its collapse.  Because it is clear from the Bear Sterns collapse that liquidity crises have everything to do with confidence, and you could see the Bear Stearns CEO out there in the last few days trying to boost confidence.  Was that fraud?  Or was that his very legitimate duty and obligation given his fiduciary responsibility to shareholders?   Why is Schwartz at Bear Stearns fighting for shareholders when he is trying to build confidence in the company in a liquidity crisis but Lay and Skilling at Enron defrauding shareholders when they were doing exactly the same thing? 

Travis writes about how a customer of his web service tracked him down at home at gave him a 40-minute earful -- and why he was very lucky the customer did so, in that it revealed some problems in his delivery process of which he was not aware.

Ditto here.  I was just about to write about a very similar experience on Friday, where a customer of ours ran into a new manager who was just hell bent on collecting an extra $4 he thought we were owed -- four lousy dollars -- and this employee managed to progressively anger, then intimidate, and then outright scare a customer, up to and including trying to reach in and grab stuff out of the customer's car.  The father of a woman in the car contacted us absolutely irate -- as well he should have been.  After about 2 hours of patient listening, we got dad and the other unfortunate customers calmed down.  They will all be getting some nice freebies in the mail, and apparently we will end up with a laudatory rather than hostile customer letter, as the customers ended up being impressed that our regional VP and the out-of-state owner would spend so much time with them trying to figure out what was wrong.  I will say it was easy to be sympathetic, as I was horrified by the story.  I felt personal shame that such actions were taken in my name  (if this sounds silly or exaggerated, think again.  I have talked to a lot of people who have built successful service companies, and every one shares stories of experiencing similar shame for boneheaded actions taken by employees on their behalf.)

Unfortunately, the manager in question had to go -- this was the second time in a very short period where the manager had shown poor judgement in customer service situations.  The manager was a nice person who interviewed great and did a lot of things well, but my experience is that if you don't have good judgement on such customer service interactions, you are not suddenly going to get it next week.  So, like Travis, we were lucky to head off a potential problem before it got worse, and we were lucky to be given a chance to turn around the customers' experience.

The frustrating thing for me is that this manager had just been to my personal customer service training.  At this training I lecture several times over two days fairly passionately about customer service issues, and in fact I cover situations almost identical to the one here.  I even say in the training "I don't want you or your employees going to battle with customers over small amounts of money."

We have found that there are certain people who simply cannot put their ego aside when dealing with a customer.  If these type people get it into their head that the customer is somehow trying to get over on them or the company, even for $4, they will dig in their heals and refuse to let the customer come out on top.  In their mind, the customer is a "bad" person and does not deserve to win, and there is no way they are going to take the ego hit in letting the "bad" customer have a small victory at their expense.  But as I tell employees all the time -- if you refuse to apologize to the customer, you are not counting coup on the customer, all you are doing is delegating the task to Warren (the owner) because he is certainly going to give that customer an apology.  And likely a bunch for free camping as well.  And do you know what some employee's reactions are to my giving that customer an apology and some freebies?  They get mad at me, for not backing them up and letting that "bad" customer get away with whatever they think he is getting away with!

While absolutely predictable that some people will act this way, I have found it nearly impossible to screen for this in the interview process, and totally impossible to train this characteristic out of people.  The best we can do is watch for the first signs of these traits and let folks who evidence them go as soon as possible.  That is also why we try to make it a hard and fast rule that we never hire managers directly from outside the company, we only promote managers from field service employees who have shown good judgment on the front lines.  Once in a blue moon we ignore this rule, as we did when hiring the managers I had to fire on Friday.  Which just goes to show that it is probably a pretty good rule for our business.

Bravo, Don Boudreaux (responding to the typical anti-libertarian attack that we are just "shills" for large corporations:

If I were a shill for industry...I would oppose free markets. Free markets, after all, are markets open
to competition that invariably keeps the profits of existing firms from
remaining excessive and, often, even bankrupts firms once thought to be
invincible industry leaders. Existing firms almost all deplore
competition in their industries. They seek government regulations that
hamstring rivals and potential rivals. And, of course, firms are
forever pleading for "protection" from foreign competition.

I just wrote a book ("Globalization") in which I make a strong and
principled case for completely free trade - not free trade sometimes,
for some firms, under some circumstances, with some qualifications, but
free trade always, for all firms, under all circumstances, and with no
qualifications.

Whether my book's case for unalloyed free trade is correct or not,
it is surely not the sort of book that causes the heads of many
corporate CEOs to nod in eager agreement. The typical reaction of
business people whenever they hear or read me make my case for
genuinely free trade is to say something like, "Professor Boudreaux,
you don't understand the peculiarities of my industry." And then each executive launches into a laundry list of excuses for why Congress should protect his industry from foreign rivals.

I just got a 15,000 page bid package (yes your read that right) to the shipper, and so my hell period of the last week is pretty much behind me.  In my business, I bid to be a private operator of public and private recreation facilities, usually on a concession basis ().  In this case, the government body we were bidding with required 16 copies of the bid, so really the bid was only about 900 pages long copied 16 times, but even generating 900 pages of business strategy and operations plans is tiring.  Not to mention the logistics of making 14,000 copies.

While this may seem to be surprising, it is exactly this type of sales process that attracted me, in part, to this business.  Yes, I know, most of you want to barf just thinking about preparing such a document.  However, I knew myself well enough at the age of forty when I got into this to know that I am really, really good at this type of complicated written presentation and that I am really, really bad at face-to-face cold-call selling. 

Postscript: So far, the business has been fun to run and we have had some real victories in privatizing public recreation, and new opportunities open up every day, as California threatens to close its parks.  We do a fair amount of private work now, as well.  I can't say that dealing with the government, particularly as a libertarian, is always fun, but so far the business has continued to be a pretty fair straight-up bid process with the best bid winning.  However, the moment I start seeing evidence that the bid process is shifting to lobbying and rent-seeking, I'm out of here.  I can't even muster up even the smallest desire to play that game.

Update: TJIC writes:

It's fascinating how modern technologies let introverts (or, at least,
people who aren't skilled or interested in traditional glad-handing)
thrive in fields that are thought to require exactly that sort of thing.

He was right the first time.  I am an introvert.   And this very blog is another great example of his point.

The California labor board has ruled, in its infinite wisdom, that my company is responsible* for the unemployment insurance payments to an employee who got hurt when he wrecked his motorcycle on his own time and was physically unable to work.  So an employee gets hurt in his off time and leaves us in the lurch when he can't work during our busiest season, and we owe him money for staying home?  Other issues I have with California unemployment here.  The original post about the ruling I was trying to appeal is here.

* Being responsible means that these payments go into the calculation for our unemployment insurance premiums.  Effectively the premiums we pay this year are calculated to match the payouts to our employees (or ex-employees) last year.

I had a really bad day today. 

I have a 18,000 page proposal (actually 18 copies of a 1000 page proposal) due next week.  I had a new color printer ordered from IKON Office Solutions scheduled to arrive last week.  When I got in town this morning, I found no copier, even a week after it was promised.  No call, no warning -- just no printer.  I called and my sales guy had no idea what was going on, despite the fact that I had been adamant that I needed to hit this date.  Apparently, he never even bothered to check the schedule.

Anyway, he promised an immediate call back but never called.  I called him again on his cell at noon and he acted like he had forgotten to check and promised to talk to his boss.  An hour later it was confirmed -- I was not getting my equipment in time for this bid.  I told them they could therefore keep it, and I would call Xerox.  I absolutely cannot stand companies that require me to do constant checking and expediting in order for them to deliver on their promises.  I can't tell you how many times I have been promised an immediate call-back from IKON "within the hour" for service only to have to call again and again over the following days to get any response.  I would not have contracted for this new machine in the first place if I wasn't already locked in an IKON lease they won't let me out of -- this would at least have gotten me a better machine for the money.

In the mean time, I prepared to do the proposal mostly in black and white with bits of color from the laser printer.  I was going to use my high speed B&W copier I had under lease from IKON, and which we were planning to replace with the new machine that never showed up.  I had a technician from IKON out just last week to check it so I knew it was in good shape.  WRONG.

Within minutes of use, the machine began spitting out horrible copies.  Looking inside, it was clear something in the heat-finisher was unraveling and very broken.  I called service and was given an emergency designation and assured of a call in one hour.  Nothing.  So I called again, and was again assured that I would definitely hear from a technician in one hour.  Nothing.  Now, everyone has gone home, and the messages all say they will get back to me on Monday, when it will be too late.  I called my sales person on his cell phone tonight (the one that was begging me a few hours earlier, asking me what he could do to save my business) and was told there was nothing he could do and he had no way of getting in touch with a dispatcher or any real human service person until Monday.  Right, they are willing to do anything for me except what they are supposed to do.

So here I am, with a thousand dollar a month copier that doesn't copy, a color copier that is not here, and the prospect of spending all weekend and a couple grand at Kinko's to get my proposal out.

IKON has been informed that they are now in breach of their service contract and may come by any time and pick up their boat anchor.

There is a false rumor going around that I may be sane.  Wrong.  As proof, I offer the following.

I recently read that among retail stores, mattress stores have the highest customer conversion.  By "conversion" I mean the percentage of people who actually make a purchase once they walk in the store.  Brookstone and Sharper Image, for example, have close to the lowest conversion ratios because they get so many people just looking at the gadgets with no intention of buying.  Anyway, having read that mattress stores have a sky-high conversion rate  (I seem to remember 80+% of people who walk in the door buy something) I have now taken to walking into any mattress store I encounter, say in a strip mall, looking around a bit, and just walking out.  I figure with the sky-high conversion rates the sales staff must be conditioned like Pavlov's dogs to equate the ringing of the doorbell with a sale, so I like to mess with them.

TJIC points out a dynamic in coffee houses I have also observed at work among restaurants:

"¦Strange as it sounds, the best way to boost sales at your
independently owned coffeehouse may just be to have Starbucks move in
next-door.

That's certainly how it worked out for Hyman. Soon after
declining Starbucks's buyout offer, Hyman received the expected news
that the company was opening up next to one of his stores. But instead
of panicking, he decided to call his friend Jim Stewart, founder of the
Seattle's Best Coffee chain, to find out what really happens when a
Starbucks opens nearby. "You're going to love it," Stewart reported.
"They'll do all of your marketing for you, and your sales will soar."
The prediction came true: Each new Starbucks store created a local
buzz, drawing new converts to the latte-drinking fold. When the lines
at Starbucks grew beyond the point of reason, these converts started
venturing out - and, Look! There was another coffeehouse right
next-door!

One wonders if smaller niche book stores, who complain about Borders and Barnes & Noble, have had any similar experiences.

As to the part about "When the lines
at Starbucks grew beyond the point of reason," I can say from my limited observations as a non-coffee drinker that there are a lot of things wrong with the Starbuck's model, particularly vis a vis lines.  First and foremost seems to be that their production process doesn't make a lick of sense.  I'd have been laughed out of the room in almost any operations course if I had proposed the production process they use to deliver coffees.  At some point, people are going to realize that waiting in lines does not have to be part of the coffee experience, and then Starbucks is in trouble. 

For years, the Einstein's Bagels near me had the worst production process I had ever seen.  People had to criss-cross one another constantly behind the counter just to complete one order, and the assembly line, from ordering through payment, always had a horrible bottleneck somewhere, thought the bottleneck moved around as they played with staffing.  Every Saturday morning the line and wait would be awful.  I pretty much had given up on them when they suddenly closed for three weeks.  When they reopened, they had a new layout behind the counter, new electronics, and a whole new process.  Since then, I have never seen a line longer than 2 people even in peak periods.  And look at Southwest Airlines.  They have reinvented their boarding process for about the third time  (and I like the changes).  Is it really possible that no one at Starbucks has thought about re-engineering the coffee delivery process?

I was tempted to title this post "markets in everything", but I just couldn't steal that moniker from the Marginal Revolution folks.  USA Weekend has a story about the Alibi Network, which will, for a price of course, create an alibi for you:

Whether you
are looking to skip a day of work or to secretly leave town for the
weekend, Alibi Network can provide fake airline receipts or phone calls
to your boss explaining your absence and even mock up an entire
itinerary for a bogus conference you were "attending." Rarely has lying
been so creepily airtight.

The
Chicago-based company charges from $75 for a simple phone call to
thousands of dollars for extensive lying, on top of a $75 annual fee.
The most popular service is the "virtual hotel," in which the fibber
can provide a boss or family member with the phone number of a hotel
where he's supposed to be. The number rings to one of Alibi's phones,
which are staffed by actors who will answer as if a particular hotel
has been reached. The incoming call then can be forwarded to the
fibber's cellphone, making it seem as if he's in a certain city even
though he's not. (We use "he" here, but half of Alibi's members are
female.)

Some
requests involve a creative solution. One working stiff asked the
service to get him out of a boring, week-long training class that was
mandated by his office. The solution: Alibi hired an actor to dress up
as a courier and barge into the class, informing the man that his house
had been robbed and he needed to go home right away. Another request
involved a married woman with small children who longed for a relaxing
weekend away from the kids. Alibi concocted a story that the woman had
won a free spa weekend in a prize drawing and hired an actor to call
her home and leave a voicemail message informing her of her "win."

For those of you of need of such services, perhaps on January 2 nursing your hangover, their web site is here.

Update:  Tyler Cowen informs me that I am waaaayyy behind the times, and that this company actually was the first entry in "Markets in Everything" several years ago.  That's what I get for trying to take a break from blogging.

A couple of posts ago, I wondered how Radio Shack still survives when CompUSA is now dead.  Thanks to a reader, I find that the Onion has already plowed this ground:

Despite having been on the job for nine months, RadioShack CEO Julian
Day said Monday that he still has "no idea" how the home electronics
store manages to stay open.

"There must be some sort of business model that enables this company
to make money, but I'll be damned if I know what it is," Day said. "You
wouldn't think that people still buy enough strobe lights and extension
cords to support an entire nationwide chain, but I guess they must, or
I wouldn't have this desk to sit behind all day."

The retail outlet boasts more than 6,000 locations in the United
States, and is known best for its wall-sized displays of
obscure-looking analog electronics components and its notoriously
desperate, high-pressure sales staff. Nevertheless, it ranks as a
Fortune 500 company, with gross revenues of over $4.5 billion and
fiscal quarter earnings averaging tens of millions of dollars.

"Have you even been inside of a RadioShack recently?" Day asked.
"Just walking into the place makes you feel vaguely depressed and
alienated. Maybe our customers are at the mall anyway and don't feel
like driving to Best Buy? I suppose that's possible, but still, it's
just...weird."

I give up.  But the whole Onion article is very funny and worth reading.

CompUSA is apparently closing shop, something that is not too surprising observing the follies at my local store.  I can understand how CompUSA was killed by the likes of Best Buy and Fry's Electronics  (not to mention Newegg.com, which is my favorite source).  What I cannot understand is how Radio Shack continues to plod along and survive.  I buy a couple of things a year there (usually something like a transformer replacement or some kind of oddball splitter) but I am always kind of surprised to still find them there -- its like finding a Woolworth's in the local mall.  Though it still seems to make money, with a TTM after-tax margin of about 5%, which is not bad for a retailer.

Update:  here

"This prehistoric pet interacts and behaves like a one-week-old dinosaur."

Uh, right.  Based on substantial observational data, I am sure.  More correct statement:  "This toy behaves just like the baby dinosaurs you saw that were so cute in that Spielberg movie."

Dear Customer Service Departments:

In my recent call to your service center, I was forced to navigate a nearly interminable set of menu options (which I listened to carefully since I had been assured that they had recently changed).  After I navigated these options, your automated system then gathered data from me.  It asked me to give my name, then my telephone number, and finally my account number, which I did.

Here is the reason for my letter, and my advice to you:  Once you have collected all my information via an automated system, it is just going to piss me off when your human operator picks up the line and proceeds to ask me for this same information again.  I know this seems to be the current industry standard, as practiced by every company from Citibank to Domino's Pizza, but I can assure you it is incredibly annoying and, perhaps worse for you, introduces me to your organization with the initial impression that you do not know what you are doing.  So, either find a way to put the information you have gathered up on the customer service agent's screen, or don't have an automated system gather it.

Thank you.

PS-  By the way, if you really, really want to start our conversation off on the wrong foot, then you should  make it nearly impossible for me to find a menu option that gets me to a real person.  You can get double extra credit for disabling "0" as an immediate route to the operator.  Oh, and make sure all menus are preceded with long-winded customer service notices that have nothing to do with my problem.

Update