Coyote Blog

I was listening this evening to the excellent Hidden Forces podcast on Tesla and they said something that really resonated with me -- its hard to discuss Tesla because there is so much crazy stuff going on:  A CEO who in many ways channels Donald Trump's worst characteristics; multiple SEC investigations, an ongoing contempt hearing; a story yesterday about thuggish behavior towards a whistle blower; strategic moves that are made, unmade, and then changed again in just a few weeks; astoundingly high turnover in management ranks, including an esteemed general counsel who couldn't hung around for even 60 days and then purged all reference to Tesla from his CV; fantastically passionate bull and bear communities; expansive promises that are seldom kept; outright fraud -- all in a company valued at $60 billion dollars and whose stock price rose 2% today under a barrage of negative news that would melt companies that have 100-year track records.  I have been meaning to do an update on Tesla but where to start?  How can I even bring readers unfamiliar with the story up to date?  I have started and stopped this article about three times, but now I am going to plow through and get something out.  If it is not entirely coherent and far from complete, my apologies.  If you want more, go to @teslacharts on Twitter as a starting point and you will discover a lot of really smart people who are, believe it or not, even more obsessed by the Tesla train wreck than I.

In the past I have limited myself to two issues.  The first is the outright fraud of the Tesla acquisition of SolarCity, another Musk company that was going down the drain until Tesla bailed it out.  The transaction appeared (even at the time) so transparently self-serving to Musk and his family that it just screamed fraud, and time has only made this clearer.  Musk sold the synergy-less acquisition to Tesla shareholders based on a solar shingle technology he portrayed as ready to go, but that still has not seen the light of day 2 years later.  In retrospect, it is crystal clear the solar shingle was a sham that was fraudulently hyped to make the deal go through.  This fire and forget approach to new product announcements has become very familiar at Tesla -- Musk scored extra subsidies from California with a battery swap technology he demonstrated one time and then has never been seen again, and Musk announced a new Semi truck and harvested a number of deposits for the vehicle and then has not even mentioned the product for months.  Since the acquisition, SolarCity new installations have fallen precipitously every quarter, demonstrating that Tesla had no real commitment to the enterprise, and this is only going to get worse as Musk announced that its last remaining sales channel is going to be closed.

The second Tesla issue I have tangled with is the strategic dead end that Tesla has reached, and the bizarre fact that a company in a capital intensive industry that is valued as a growth company has, over the last 12 months, virtually shut down R&D spending and now does less capital spending for its size than does even staid companies like Ford.  I won't cover all this ground again, I refer you to posts here and here-- If you are new to the Tesla story, start with these.   But in short, Musk made the fateful choice to take what was already destined to be an uphill climb for a new company to penetrate an extraordinarily capital intensive industry and made it an order of magnitude more capital intensive by his strategic decisions.  Specifically, Musk chose not only to start up car manufacturing from scratch, but to also build out his own sales and service network AND build out his own fueling network.  Kia was the last brand I can remember that penetrated the US market, and it only had to worry about investing in building cars -- it relied on third parties like Roger Penske and Exxon to build the sales, service, and fueling networks.  But Tesla is committed to building out all three.

This strategic decision really began to drag on the company in 2018.  Tesla's decision to do its own manufacturing -- in freaking California no less -- held back its growth as it spent years relearning auto manufacturing lessons already well-known to other players.  It has fallen behind in Model 3 production vs. its own stated goals and there is no apparent progress adding manufacturing capacity for a raft of announced but still theoretical products (semi, coupe, Model  crossover, pickup truck, revamped S&X).   A better approach might have been to contract for manufacturing like Apple does with the iPhone, especially since there seems to be a lot of excess capacity right now in Chinese auto production.  Even worse, as their fleet grew with the Model 3 ramp, Tesla was not able to invest fast enough to grow its sales, distribution, and service networks in proportion, leading to a lot of disgruntled customers that had bad delivery and servicing experiences.  The same is true for their charger network, where they have again not been able to keep up with investment and are now falling behind technologically as new entrants have faster charging times, times Tesla can't match without a major investment in upgrade of its network.  More manufacturing capacity, a better distribution network, more sales locations, more servicing capacity, more body shop capacity, more parts production capacity, more chargers and massive charger upgrades -- Tesla fell behind on ALL of these in 2018.

And then the really weird thing happened.  Sometimes growth companies fall behind when they grow to fast, but Tesla seemed to have stopped even trying to keep up with capital needs in the second half of 2018.  Their R&D fell, despite many promised new products that were a long way from delivery.  Their Capex levels fell to barely maintenance levels (what might be expected to just keep current plant running) and were reduced to levels as a percentage of sales that were lower than staid, traditional, non-growth auto makers.  Right when they really needed to make a capex push to make their strategy a reality, they stopped spending.

Tesla claimed, and claims to this day, that any slowdown is just the result of efficiency and responsible management.  But this is crazy.  Growth companies slow down and focus on profitability when the market is saturated and the growth phase is over.  Uber has not slowed down.  Even Amazon 20+ years in has not slowed down.  Slowing down is death for the stock price of a growth company, and Musk is -- if anything -- obsessively focused on the stock price.  Tesla is currently valued north of $60 billion. Without enormous growth expectations, a $20 billion valuation might be too high.  Added to this is the fact that after having the luxury EV market to itself for years, competition is finally coming from nearly every luxury care maker.  Tesla's 10-year moat is down to maybe 6 months.  It needs to be updating the S & X and rushing new products out ahead of competitors.  But they have almost given up on the S & X and Audi has beaten them to the market by at least a year and maybe two with a crossover model (the e-tron), a very popular format in the US right now.

And at first there does not appear to be any reason for this slowdown in spending.  Tesla has a stock that a dedicated group of fans gorge themselves on.  With a $60 billion valuation and a passionate fan base that thinks the company is still undervalued by at least a third, this company should be able to raise billions of capital easily.  They could theoretically raise $5 billion with less than 10% dilution -- Tesla almost dilutes itself that much every few years just from employee stock-based compensation.  Add its lofty valuation to what was reportedly $3.5 billion or so of cash on their balance sheet at the end of last year and consumer demand that the CEO describes as near-infinite, and this does not look like a company that should be slowing down.

How do we reconcile these facts  -- a near halt in growth investments despite lots of cash and a sky-high stock valuation?  Here are a few things going on under the surface:

• While Tesla had over $3 billion in cash, they also had over $2 billion in payables.  The company has a reputation of stretching payables to the absolute limit.  It may well be that the end of year cash number was the result of a lot of window dressing.  In fact, Tesla skeptics have looked at the interest they earned on their free cash in the fourth quarter and have argued that for this number to be as low as it was, Tesla's average cash balance must have been much lower than their end of year reported number.
• Savvy observers (of which I am not one) who know Wall Street argue that Tesla may well have either regulatory (e.g. SEC investigations) or practical (e.g. information they do not want to disclose in a prospectus) barriers to raising capital, and that the lack of a capital raise for many months can only mean that for some reason Tesla can't raise.
• Tesla just had to pay off nearly a billion dollars in convertible bonds when the stock price was not high enough to trigger the conversion
• Demand for Tesla cars in the US has fallen substantially in the first 2 months of this quarter.  Musk liked to portray the huge Model 3 sales ramp in 3Q18 and 4Q18 as the start of an S-curve, but now those quarters look more like a one-time bulge as Tesla blew through over 2 years in orders in just a few months.  Aggressive pull-forwards of demand by Tesla in the fourth quarter as well as the reduction in US and Dutch EV subsidies have also hurt.  [I have to add one note here just for color.  The Tesla fan boys have argued to me on Twitter that Musk has already explained this to their satisfaction -- that Tesla is diverting cars away from the US for their European Model 3 introduction.  This makes ZERO strategic sense.  What company ever enters a new market by giving up hard-won market share in their core market?  There is plenty of evidence that everyone who wants to buy a Tesla in the US is getting one with a very short lead time, implying this is a real demand drop and not Musk's typical supply-constraint story.]

A month or so ago I thought it very possible given these headwinds that Tesla may soon be facing a cash crunch if it cannot do an equity raise.  However, new events that have occurred over the last week convince me that this cash crush is almost a certainty.  There is no way I can explain Tesla's most recent actions as anything but a company desperately trying to stave off a near-term bankruptcy.  These actions include:

• In early March, Tesla's February sales numbers in the US were announced, and they were a disaster.  Within mere hours of this reveal, Musk teased an announcement (on Twitter, where else).  This event turned out to be a quasi-secret invite-only conference call involving what appeared to be hand-selected media members who had historically been generous to Tesla (only a later uproar by bulls and bears alike forced Musk to release a transcript. On the call Musk announced two things --
  1. Tesla would begin taking deposits for the long-awaited $35,000 Model 3 (though delivery dates were hard to pin down).  Musk had said not too long ago that Tesla was not able to make this car yet profitably, and he refused to discuss margins on the vehicle.  Skeptics like myself suspected that the car can't be made right now for a positive gross margin, and instead this was a back-door attempt to gain new financing via customer deposits.  A couple hundred thousand (theoretically) deposits of $2000 each could yield some real money for a cash-strapped company.  The only thing Musk would say about controlling costs on this product was #2:
  2. In a totally unexpected (even to most of Tesla employees and management) announcement, Musk said Tesla was closing its stores and going to an online-only sales model.  This would supposedly save 6% of the cost of the new cheaper Model 3's, ignoring of course that SG&A reductions do nothing to fix a zero or negative gross margin.  Everyone, including most especially Tesla store employees and maybe even the Tesla BOD, was stunned.  Here is a company whose US sales are going over a demand cliff and they respond by ... eliminating their stores and sales force?
• Simultaneously, Tesla has been announcing a series of price cuts on, worryingly, many of their highest margin products including the S and X and high-margin upgrades like paint and autopilot on the Model 3.  Almost no one can see how the company makes any sort of viable gross margin at these prices, and they have the look of desperation.  All these cuts did was aggravate buyers who had just paid the higher prices and who faced a suddenly lowered resale value for their car.
• Within days of the store closing announcement, the WSJ and others published stories about how Tesla was unlikely to see much savings from these closures as their leases all had expensive cancellation clauses that Tesla could still be on the hook for as much as $1.5+ billion.  Incredibly, this seemed to come as a surprise to Musk and helped reveal just how slapdash these announcements were.  Since then Tesla has announced that maybe some stores would stay open and maybe some sales people would not be fired but just have their bonus eliminated.  As I write this, no one really knows what Tesla is going to do, but to many observers this move looks more like what one does in a bankruptcy than in the normal course of growing a business (in fact, bankruptcy is the one time lease cancellation costs can sometimes be evaded).
• Tesla, furthering their management Abbot and Costello act, partially reversed their price cuts saying that prices would now rise a few percent, barely days after they were cut.  The net of the two announcements still result in vehicle prices substantially lower than in 4Q2018.
• In an incredibly bizarre move (and there is a pretty high, or low, bar with Tesla for saying something is truly bizarre), it was recently revealed that Tesla last November bought a trucking company, or really they bought a bunch of trucks, with stock.  Essentially, this is a $60 billion company with supposedly $3+ billion in cash and they are paying their suppliers in stock.  Oh, and by the way, remember when I said above that Tesla had already vertically integrated too much and could not afford their capital needs already?  Well, this is yet another silly vertical integration.  Tesla has no business being in the trucking business, a highly competitive business with a lot of incentives to offer good deals and great service for an incremental bit of demand from a growing company like Tesla.  My sense was always that there is plenty of 3rd party trucking capacity out there, but that truckers just did not like serving Tesla because Tesla pays its bills so slowly and acts so unpredictably and imperiously.
• Tesla continues to produce Model 3's near full volume (around 5500 a week, despite what the nutty Bloomberg model says) even given a fall in demand.  Tesla seems to be building inventory, and certainly the recent price cuts are not a sign they are supply constrained (as Musk continues to insist).  Tesla skeptics believe that Musk has signed a number of supplier deals where Tesla got rebates and price cuts in exchange for volume guarantees, and that Tesla is stuck over-producing cars or it will have to return a lot of money.  [update: @Paul91701736 who goes by Machine Planet on Twitter spends a lot of time observing and researching Model 3 production and says "there's one thing in this piece I can't agree with, a 5500/wk Model 3 production rate. I think ~4700 is the absolute max sustainable rate and it's been well below that most of the quarter"]
• Tesla is asking customers in Europe, as they did late in 4Q18 in the US, to pay Tesla the full price of the car even before they see it or schedule a delivery.  Frankly, I am staggered anyone would buy a car this way, especially with the fit and finish problems Tesla model 3 customers have found on delivery.
• Tesla added about $500 millon to its asset-back bank line of credit and continues to roll over some SolarCity debt.
• When it was obvious that the Model 3 announcement had not created enough deposit activity, Musk then announced they would introduce the long-awaited Model Y crossover, in a reveal set for Thursday afternoon March 14.

Tesla has admitted that it still has not even decided where to build the Model Y, much less started building the plant and tooling up for it.  Given that, the car HAS to be 18-24 months away.  So why reveal now?  Remember that Musk and Tesla have a history of using new product reveals as fund raising tools.  The fake solar shingle product got Tesla to buy SolarCity.  The fake battery change demonstration got Tesla millions in added subsidies from California.  The complete vaporware Tesla semi reveal gained Tesla millions in deposits from corporations that probably didn't expect to ever get the truck but wanted to virtue signal their green credentials (Tesla seldom mentions this product and has announced no plans for actually building it).  The announcement in April, 2016 of early reservations for a $35,000 Model 3 which turned out to be over 2 years ahead of it ever being available in volume occurred just ahead of a funding round.  I am sure experienced Tesla observers could list many more examples, but the point is that there is very good reason to believe that the Model Y reveal (and maybe a pickup reveal in the same way the coupe was thrown in on the semi reveal) is a cynical, desperate attempt by Tesla to raise some cash from consumer deposits.  My guess is that it will not work so well -- the recent $35,000 Model 3 announcement garnered few deposits and Tesla had disappointing deposit activity when they opened up Europe.  Surely folks have observed that putting down a deposit does not get one a car any faster, and just makes one an unsecured creditor of the company (and may even, as was the case recently, sign one up to pay a higher price than folks who come in only a few weeks later).

As an aside, you folks know that as a libertarian I do not advocate for a lot of extra regulation so take the following as a prediction rather than necessarily a recommendation.  Tesla has pioneered the deposit-taking, go-fund-me model for new car introductions, and I think that when this all blows up and the dust clears, one of the results will be tighter regulation of how companies handle deposits on their books.  I would expect the SEC to require better transparency on deposit numbers and that customer deposits be escrowed in some way and not co-mingled with general operating funds.  And while we are at it, I will recommend one regulatory / accounting change -- the ability of car companies to leave ZEV credits off their balance sheet entirely and use them like magic pixie dust out of the blue to spice up random quarters needs to end.  These are real assets and need to be disclosed on the books like real assets.

Disclosure:  I am short Tesla via long-dated puts.  Shorting Tesla seems to make a lot of sense but it can be dangerous and harrowing.  Yesterday we were looking at news of Elon Musk acting like a Mafia thug with whistleblowers and still dealing with the fallout of Tesla's rapidly changing and contradictory strategic announcements, and the stock was up 2%.  Be careful.

I discussed the shutdown and its effects on the parks my company operates here (spoiler:  all are still open).  Shawn Regan of PERC has a good article in the National Review on the same subject:

....under new shutdown guidelines established by the Trump administration, our parks have been rightfully spared from serving as pawns in Washington’s partisan budget battles as they did in the past.

Under a contingency plan created by the administration, park officials are allowed to keep sites accessible to visitors during the shutdown with skeletal staffs, rather than being forced to close them as was the case during the 2013 government shutdown presided over by President Obama. That means many important visitor activities and park operations — from snow-coach rides in Yellowstone run by private concessionaires to guided battlefield tours of Gettysburg — can continue yielding economic benefits for the surrounding communities. This week, the National Park Service also announced it will begin tapping unspent visitor-fee revenues to bolster operations at some parks.

These new plans are attracting criticism in the familiar anything-Trump-does-must-be-bad vein. Theresa Pierno of the National Parks Conservation Association slammed the administration’s decision to keep parks open, calling it “unrealistic and dangerous,” even though the NPCA repeatedly called for parks to be reopened during the 2013 shutdown. Representative Raúl Grijalva, the new Democratic chairman of the House Natural Resources Committee, pledged to hold hearingson the administration’s decision to support park operations with fee revenues....

The Trump administration’s approach is sensible. Why unnecessarily ruin visitors’ plans or jeopardize the millions of dollars in revenue that local communities receive from park visitation? If visitation begins to pose significant health or safety concerns, the contingency plan gives park superintendents the option to close areas or shut down parks entirely, as some parks have already done.

He goes on to make the very logical point that the vast majority of BLM lands and US Forest Service lands -- whose acreage dwarfs that under management by the National Park Service -- mostly all remain open in every shutdown.  The large amounts of government staffing on NPS lands are needed to handle large visitor concentrations in small areas, something that really is not an issue in most parks in January.

Folks who have been hunting for pictures of overflowing trash cans to paint the current opening of parks as a bad idea could find just as many in the summertime on government lands when the government is not shut down.  Remember, for all the love folks want to throw at the National Park Service at these times, it is an agency that has allowed many of its parks to fall apart, with perhaps $20 billion in deferred maintenance and very little new investment in the modern infrastructure visitors are demanding.  And it has a labor model that is well suited to counting wolves but poorly suited to efficiently cleaning bathrooms and emptying trash cans even when the government is open.  This shutdown is the least of the problems faced by public recreation lands.

I think people get confused about the purpose of the government shutdown.  It is not a punishment, or a timeout, meted out by the law when Congress can't agree on a budget.  It is a mechanical (and logical) requirement that spending on certain activities stop when that spending is no longer legally authorized.  The media acts like it is supposed to be painful, and that Trump is somehow breaking the rules by making it less so.  I often criticize this President, but this is one area Trump should be applauded.  I think the wall funding issue is a dumb reason to go into budget gridlock, particularly when he had 2 years of Republican Congresses to get this done, but given the fact of the shutdown he should be applauded for attempting to reduce its impact on ordinary Americans.  President Obama, for all his reputation of caring and hope, was to my mind overly callous in explicitly trying to make the shutdown more painful for average people.

There are a lot of reasons a tax can be dumb.  It can be too damn high.  It can create incentives for counter-productive behavior.  But I want to propose another category of stupid taxes -- taxes that cost WAY more to do the paperwork than the tax actually collects.  For this category I propose the dumbest tax award to the property tax many counties charge on business small equipment and moveable property.  Here is one page from a sample county return we have to fill out.

This is just one page of many -- assets have to be reported in multiple classes -- but you get the idea.  Every single business asset down to trivial things like office and cleaning supplies, screwdrivers, etc all have to be individually listed with year acquired and purchase price.  We have nearly 150 locations across the county and waste a staggering amount of time staying on top of this.

AND, the real punch line is it raises about zero dollars in tax.  Take something we have a lot of, a hand push mower.  Let's say we bought a good one at $500 about 3 years ago.  The property tax process generally discounts this -- the taxable value might be $200 or less today.  Then they might charge a half percent annual tax, which would bring in a whopping $1.  So tracking this mower and entering it on this form every year probably costs me more in labor and software we have to license than the tax itself.  I would be willing to pay a higher amount of tax if when they sent the forms they said, "Fill out these forms by March 1 or you can alternatively pay $500 and be done with it."

I understand they want to be able to tax the crap out of the Exxon refinery, but there really needs to be some minimum cutoff.  Florida did this years ago and it is great -- there is a card that you sign to certify your total personal property is under some number and you avoid the process altogether.

PS, we are tired of the old asset management software we have -- if someone out there knows a package that works well for this kind of thing, email me at the link above.

Several readers have been nice enough to write me and ask how my business is doing during the government shutdown.  As background, my company privately operates public recreation areas, mostly campgrounds, under concession contract.  We manage public lands for many different government agencies, but many of the campgrounds we run are in the Forest Service.  Typically the Forest Service (and National Park Service) must close in this and most other shutdowns.  In fact, public parks are often a significant pawn in budget battles, so much so the term "closing the Washington Monument" has become shorthand for using popular public facilities as a leverage point in spending fights (the fact that politicians always threaten to close the MOST popular public services when money is tight rather than the most useless is exhibit A in why we shouldn't trust our money to Congress).

But all the Federal facilities we operate are still open right now through the government shutdown.  The reason for this is that our company does not receive a dime from the government -- all the money goes the other way.  We operate the facilities essentially under a (very restrictive) lease.  We collect visitor use fees and then pay a bid percentage of those fees back to the Feds as our rent -- this is a huge advantage to the government as before our management they typically lost money even after collected visitor fees and now they are gaining money**.  Since the government does not have to fund these locations, and since their daily operation requires no federal employees, the parks we operate are typically not closed during government shutdowns.

Long-time readers will be familiar with one exception -- in 2013 during the Obama Administration we were forced to close during a Federal shutdown.  Originally, the agencies we work with (particularly the US Forest Service which is part of the Department of Agriculture) gave us the usual guidance, that we were to remain open.  Then, suddenly, our company and those like it were told to shut down.  When I and my trade group attempted to protest the decision with whatever official in the agency made the decision, we were told it came from "above the Department of Agriculture," which narrows the field of possible decision-makers pretty substantially.  My hypothesis, though I can never prove it, was that the Obama Administration wanted to put as much pressure on Congress as possible, and closing the Washington Monument doesn't work as leverage if some damn private company is keeping it open.  My competitors and I banded together and took the US Forest Service to court (past articles here) and were in the process of winning our case when the shutdown ended, but ever since then the US Forest Service has allowed us to stay open in shutdowns.  If you have WSJ access, they actually covered our effort here; I made an early morning appearance on Fox & Friends; Reason TV did a nice piece; and Hans Bader of the CEI was all over the story and a big help in getting the issue some visibility.

Christmas and New Years are popular times for folks to visit in places like Sedona and Florida where we run Forest Service recreation areas, and we are happy we have been able to stay open and serve them this time around.

**Postscript: This private concession management model also has a benefit in state and local budget battles, though it is slightly different.  I can tell you from loooooong personal experience that the public really does not like recreation use fees on public lands.  My taxes should pay for that!  But now, and certainly in the future, our taxes go mostly to fund programmed expenses like healthcare and welfare plus our bloated military.  Anything else is going to be starved -- which leads to the estimated $114 billion in deferred maintenance in federal / state / local public recreation areas and parks ($20+ billion in the National Park Service alone).  Seeing this happening, most of the public has become reconciled to user fees for recreation as long as the recreation fee is used to support the local park they are visiting.

To this end, one reason folks are sometimes leery about private management of these lands is they wonder if their fees are being sucked away to some corporate equivalent of Scrooge McDuck's gold vault rather than supporting operations at the park.  It's the reason I keep this chart up on our web site:

In fact, it is the government agencies themselves that often sweep user fees out of the parks and into general revenue funds.  The Arizona legislature did this for years to the state parks agency.  The result in this situation is that the infrastructure crumbles while the user fees that should be fixing these issues actually has just become another general revenue tax.  I think of deferred maintenance in government facilities -- parks, subways, roads, etc -- as a kind of shadow borrowing where government officials borrow against the infrastructure.  This borrowing is almost invisible, at least on an incremental basis, and often the debt is eventually defaulted on as the infrastructure is never repaired and has to be closed or torn down.  By putting parks under concession management, user fees can no longer be swept away from the management and maintenance of the park, and private companies can often be held accountable for poor maintenance more readily than agencies are able to hold themselves accountable.

WordPress 5 changed to an entirely new editor where construction of a post that historically just involved typing now involves pasting together a series of blocks that have to be added, for example, just to have quoted text.  Am I missing something?

This seems ludicrously more awkward than the original editor, which I immediately switched back to by downloading and activating a plugin for that purpose.  My guess is that this functionality is aimed at the large number of folks who use WordPress as a content management system for building websites and not for actual bloggers.  I am guessing that content management for website design is actually a much bigger market for WordPress than blogging, and so development is focusing more on that market.  Maybe someone needs to fork WordPress for a version track focused on traditional bloggers.

Update:  Apparently the WordPress 5 editor is the same as the Gutenberg editor that has been available as a plugin for a while.  A couple of observations.  First, few people every really liked Gutenberg.  It has a 2.5 star rating which is really low for any WordPress plugin with a lot of installs, particularly one WordPress decided to make standard.  And second, this just reinforces my sense that WordPress 5 is a sign that WordPress is leaving the blogging community behind and focusing on CMS.  I have used WordPress as a CMS for our company websites until we mostly switched to ProcessWire, which is an actual CMS from the ground up and not a modified blog engine.  Gutenberg made much more sense as a CMS tool than a blogging tool.

Today I want to come back to a topic I have not covered for a while, which is what I call knowledge or certainty "laundering" via computer models.  I will explain this term more in a moment, but I use it to describe the use of computer models (by scientists and economists but with strong media/government/activist collusion) to magically convert an imperfect understanding of a complex process into apparently certain results and predictions to two-decimal place precision.

The initial impetus to revisit this topic was reading "Chameleons: The Misuse of Theoretical Models in Finance and Economics" by Paul Pfleiderer of Stanford University (which I found referenced in a paper by Anat R. Admati on dangers in the banking system).  I will except this paper in a moment, and though he is talking more generically about theoretical models (whether embodied in code or not), I think a lot of his paper is relevant to this topic.

Before we dig into it, let's look at the other impetus for this post, which was my seeing this chart in the "Southwest" section of the recent Fourth National Climate Assessment.

The labelling of the chart actually understates the heroic feat the authors achieved as their conclusion actually models wildfire with and without anthropogenic climate change.  This means that first they had to model the counterfactual of what the climate could have been like without the 30ppm (0.003% of the atmosphere) CO2 added in the period.  Then, they had to model the counterfactual of what the wildfire burn acreage would have been under the counter-factual climate vs. what actually occurred.   All while teasing out the effects of climate change from other variables like forest management and fuel reduction policy (which --oddly enough -- despite substantial changes in this period apparently goes entirely unmentioned in the underlying study and does not seem to be a variable in their model).  And they do all this for every year back to the mid-1980's.

Don't get me wrong -- this is a perfectly reasonable analysis to attempt, even if I believe they did it poorly and am skeptical you can get good results in any case (and even given the obvious fact that the conclusions are absolutely not testable in any way).  But any critique I might have is a normal part of the scientific process.  I critique, then if folks think it is valid they redo the analysis fixing the critique, and the findings might hold or be changed.  The problem comes further down the food chain:

1. When the media, and in this case the US government, uses this analysis completely uncritically and without any error bars to pretend at certainty -- in this case that half of the recent wildfire damage is due to climate change -- that simply does not exist
2. And when anything that supports the general theory that man-made climate change is catastrophic immediately becomes -- without challenge or further analysis -- part of the "consensus" and therefore immune from criticism.

I like to compare climate models to economic models, because economics is the one other major field of study where I think the underlying system is as nearly complex as the climate.  Readers know I accept that man is causing some warming via CO2 -- I am a lukewarmer who has proposed a carbon tax.  However, as an engineer whose undergraduate work focused on the dynamics of complex systems, I go nuts with anti-scientific statements like "Co2 is the control knob for the Earth's climate."  It is simply absurd to say that an entire complex system like climate is controlled by a single variable, particularly one that is 0.04% of the atmosphere.  If a sugar farmer looking for a higher tariff told you that sugar production was the single control knob for the US climate, you would call BS on them in a second (sugar being just 0.015% by dollars of a tremendously complex economy).

But in fact, economists play at these same sorts of counterfactuals.  I wrote about economic analysis of the effects of the stimulus way back in 2010.  It is very similar to the wildfire analysis above in that it posits a counter-factual and then asserts the difference between the modeled counterfactual and reality is due to one variable.

Last week the Council of Economic Advisors (CEA) released its congressionally commissioned study on the effects of the 2009 stimulus. The panel concluded that the stimulus had created as many as 3.6 million jobs, an odd result given the economy as a whole actually lost something like 1.5 million jobs in the same period. To reach its conclusions, the panel ran a series of complex macroeconomic models to estimate economic growth assuming the stimulus had not been passed. Their results showed employment falling by over 5 million jobs in this hypothetical scenario, an eyebrow-raising result that is impossible to verify with actual observations.

Most of us are familiar with using computer models to predict the future, but this use of complex models to write history is relatively new. Researchers have begun to use computer models for this sort of retrospective analysis because they struggle to isolate the effect of a single variable (like stimulus spending) in their observational data. Unless we are willing to, say, give stimulus to South Dakota but not North Dakota, controlled experiments are difficult in the macro-economic realm.

But the efficacy of conducting experiments within computer models, rather than with real-world observation, is open to debate. After all, anyone can mine data and tweak coefficients to create a model that accurately depicts history. One is reminded of algorithms based on skirt lengths that correlated with stock market performance, or on Washington Redskins victories that predicted past presidential election results.

But the real test of such models is to accurately predict future events, and the same complex economic models that are being used to demonstrate the supposed potency of the stimulus program perform miserably on this critical test. We only have to remember that the Obama administration originally used these same models barely a year ago to predict that unemployment would remain under 8% with the stimulus, when in reality it peaked over 10%. As it turns out, the experts' hugely imperfect understanding of our complex economy is not improved merely by coding it into a computer model. Garbage in, garbage out.

Thus we get to my concept I call knowledge laundering or certainty laundering.  I described what I mean by this back in the blogging dinosaur days (note this is from 2007 so my thoughts on climate have likely evolved since then).

Remember what I said earlier: The models produce the result that there will be a lot of anthropogenic global warming in the future because they are programmed to reach this result. In the media, the models are used as a sort of scientific money laundering scheme. In money laundering, cash from illegal origins (such as smuggling narcotics) is fed into a business that then repays the money back to the criminal as a salary or consulting fee or some other type of seemingly legitimate transaction. The money he gets
back is exactly the same money, but instead of just appearing out of nowhere, it now has a paper-trail and appears more legitimate. The money has been laundered.

In the same way, assumptions of dubious quality or certainty that presuppose AGW beyond the bounds of anything we have see historically are plugged into the models, and, shazam, the models say that there will be a lot of anthropogenic global warming. These dubious assumptions, which are pulled out of thin air, are laundered by being passed through these complex black boxes we call climate models and suddenly the results are somehow scientific proof of AGW. The quality hasn't changed, but the paper trail looks better, at least in the press. The assumptions begin as guesses of dubious quality and come out laundered at "settled science."

Back in 2011, I highlighted a climate study that virtually admitted to this laundering via model by saying:

These question cannot be answered using observations alone, as the available time series are too short and the data not accurate enough. We therefore used climate model output generated in the ESSENCE project, a collaboration of KNMI and Utrecht University that generated 17 simulations of the climate with the ECHAM5/MPI-OM model to sample the natural variability of the climate system. When compared to the available observations, the model describes the ocean temperature rise and variability well.”

I wrote in response:

[Note the first and last sentences of this paragraph]  First, that there is not sufficiently extensive and accurate observational data to test a hypothesis. BUT, then we will create a model, and this model is validated against this same observational data. Then the model is used to draw all kinds of conclusions about the problem being studied.

This is the clearest, simplest example of certainty laundering I have ever seen. If there is not sufficient data to draw conclusions about how a system operates, then how can there be enough data to validate a computer model which, in code, just embodies a series of hypotheses about how a system operates?

A model is no different than a hypothesis embodied in code. If I have a hypothesis that the average width of neckties in this year’s Armani collection drives stock market prices, creating a computer program that predicts stock market prices falling as ties get thinner does nothing to increase my certainty of this hypothesis (though it may be enough to get me media attention). The model is merely a software implementation of my original hypothesis. In fact, the model likely has to embody even more unproven assumptions than my hypothesis, because in addition to assuming a causal relationship, it also has to be programmed with specific values for this correlation.

This brings me to the paper by Paul Pfleiderer of Stanford University.  I don't want to overstate the congruence between his paper and my thoughts on this, but it is the first work I have seen to discuss this kind of certainty laundering (there may be a ton of literature on this but if so I am not familiar with it).  His abstract begins:

In this essay I discuss how theoretical models in finance and economics are used in ways that make them “chameleons” and how chameleons devalue the intellectual currency and muddy policy debates. A model becomes a chameleon when it is built on assumptions with dubious connections to the real world but nevertheless has conclusions that are uncritically (or not critically enough) applied to understanding our economy.

The paper is long and nuanced but let me try to summarize his thinking:

In this essay I discuss how theoretical models in finance and economics are used in ways that make them “chameleons” and how chameleons devalue the intellectual currency and muddy policy debates. A model becomes a chameleon when it is built on assumptions with dubious connections to the real world but nevertheless has conclusions that are uncritically (or not critically enough) applied to understanding our economy....

My reason for introducing the notion of theoretical cherry picking is to emphasize that since a given result can almost always be supported by a theoretical model, the existence of a theoretical model that leads to a given result in and of itself tells us nothing definitive about the real world. Though this is obvious when stated baldly like this, in practice various claims are often given credence — certainly more than they deserve — simply because there are theoretical models in the literature that “back up” these claims. In other words, the results of theoretical models are given an ontological status they do not deserve. In my view this occurs because models and specifically their assumptions are not always subjected to the critical evaluation necessary to see whether and how they apply to the real world...

As discussed above one can develop theoretical models supporting all kinds of results, but many of these models will be based on dubious assumptions. This means that when we take a bookshelf model off of the bookshelf and consider applying it to the real world, we need to pass it through a filter, asking straightforward questions about the reasonableness of the assumptions and whether the model ignores or fails to capture forces that we know or have good reason to believe are important.

I know we see a lot of this in climate:

A chameleon model asserts that it has implications for policy, but when challenged about the reasonableness of its assumptions and its connection with the real world, it changes its color and retreats to being a simply a theoretical (bookshelf) model that has diplomatic immunity when it comes to questioning its assumptions....

Chameleons arise and are often nurtured by the following dynamic. First a bookshelf model is constructed that involves terms and elements that seem to have some relation to the real world and assumptions that are not so unrealistic that they would be dismissed out of hand. The intention of the author, let’s call him or her “Q,” in developing the model may be to say something about the real world or the goal may simply be to explore the implications of making a certain set of assumptions. Once Q’s model and results become known, references are made to it, with statements such as “Q shows that X.” This should be taken as short-hand way of saying “Q shows that under a certain set of assumptions it follows (deductively) that X,” but some people start taking X as a plausible statement about the real world. If someone skeptical about X challenges the assumptions made by Q, some will say that a model shouldn’t be judged by the realism of its assumptions, since all models have assumptions that are unrealistic. Another rejoinder made by those supporting X as something plausibly applying to the real world might be that the truth or falsity of X is an empirical matter and until the appropriate empirical tests or analyses have been conducted and have rejected X, X must be taken seriously. In other words, X is innocent until proven guilty. Now these statements may not be made in quite the stark manner that I have made them here, but the underlying notion still prevails that because there is a model for X, because questioning the assumptions behind X is not appropriate, and because the testable implications of the model supporting X have not been empirically rejected, we must take X seriously. Q’s model (with X as a result) becomes a chameleon that avoids the real world filters.

Check it out if you are interested.  I seldom trust a computer model I did not build and I NEVER trust a model I did build (because I know the flaws and assumptions and plug variables all too well).

By the way, the mention of plug variables reminds me of one of the most interesting studies I have seen on climate modeling, by Kiel in 2007.  It was so damning that I haven't seen anyone do it since (at least get published doing it).  I wrote about it in 2011 at Forbes:

My skepticism was increased when several skeptics pointed out a problem that should have been obvious. The ten or twelve IPCC climate models all had very different climate sensitivities -- how, if they have different climate sensitivities, do they all nearly exactly model past temperatures? If each embodies a correct model of the climate, and each has a different climate sensitivity, only one (at most) should replicate observed data. But they all do. It is like someone saying she has ten clocks all showing a different time but asserting that all are correct (or worse, as the IPCC does, claiming that the average must be the right time).

The answer to this paradox came in a 2007 study by climate modeler Jeffrey Kiehl. To understand his findings, we need to understand a bit of background on aerosols. Aerosols are man-made pollutants, mainly combustion products, that are thought to have the effect of cooling the Earth's climate.

What Kiehl demonstrated was that these aerosols are likely the answer to my old question about how models with high sensitivities are able to accurately model historic temperatures. When simulating history, scientists add aerosols to their high-sensitivity models in sufficient quantities to cool them to match historic temperatures. Then, since such aerosols are much easier to eliminate as combustion products than is CO2, they assume these aerosols go away in the future, allowing their models to produce enormous amounts of future warming.

Specifically, when he looked at the climate models used by the IPCC, Kiehl found they all used very different assumptions for aerosol cooling and, most significantly, he found that each of these varying assumptions were exactly what was required to combine with that model's unique sensitivity assumptions to reproduce historical temperatures. In my terminology, aerosol cooling was the plug variable.

When I was active doing computer models for markets and economics, we used the term "plug variable."  Now, I think "goal-seeking" is the hip word, but it is all the same phenomenon.

Postscript, An example with the partisans reversed:  It strikes me that in our tribalized political culture my having criticised models by a) climate alarmists and b) the Obama Administration might cause the point to be lost on the more defensive members of the Left side of the political spectrum.  So let's discuss a hypothetical with the parties reversed.  Let's say that a group of economists working for the Trump Administration came out and said that half of the 4% economic growth we were experiencing (or whatever the exact number was) was due to actions taken by the Trump Administration and the Republican Congress.  I can assure you they would have a sophisticated computer model that would spit out this result -- there would be a counterfactual model of "with Hillary" that had 2% growth compared to the actual 4% actual under Trump.

Would you believe this?  After all, its science.  There is a model.  Made by experts ("top men" as they say in Raiders of the Lost Ark).  Do would you buy it?  NO!  I sure would not.  No way.  For the same reasons that we shouldn't uncritically buy into any of the other model results discussed -- they are building counterfactuals of a complex process we do not fully understand and which cannot be tested or verified in any way.  Just because someone has embodied their imperfect understanding, or worse their pre-existing pet answer, into code does not make it science.  But I guarantee you have nodded your head or even quoted the results from models that likely were not a bit better than the imaginary Trump model above.

I will begin by saying that few things in government aggravate me more than corporate relocation subsidies.  They are an entirely negative sum game.  I believe that subsidies are misguided and lead to a misallocation of capital, but at least things like EV subsidies create an EV industry, even if it is uneconomic.  But relocation subsidies are payments to create nothing -- their entire purpose is to move economic activity that would happen anyway across some imaginary line on a map.  Locally, we had a $100 million subsidy to a developer to move a mall approximately 1 mile.  Pure insanity.

However, it is hard for me to blame the managers of public companies who seek these subsidies.  I own my own company and can easily eschew such pork (if it were ever offered to me) but the CEO of a public company would be failing in their fiduciary duty to their shareholders to not accept government money that the drunken sailors in government are so gleefully trying to stuff in corporate g-strings.

With this money so available, it is important that corporate management make location decisions considering these subsidies but not solely focused on them.  The contrast between Amazon and Tesla (including the former SolarCity) helps explain my point.

In finding new headquarters locations, Amazon's most important considerations were likely

• Ability to attract great management and developer talent who seem to be more attracted to hipster areas with lots of Starbucks and sushi more than to areas with low cost housing.
• As they incur regulatory scrutiny, closeness to national government
• Access to domestic and international partners
• Access to capital

Note these criteria do not include access to low cost labor and real estate.  These do not really matter much for its headquarters offices.  These DO matter for distribution centers and warehouses, which is why these are located not in the center of high cost cities but in low cost suburban or rural areas.  In this context, then, splitting its headquarters between New York and Washington DC make a ton of sense.

Now let's think about Tesla.  Tesla was looking for manufacturing locations for solar panels and cars.  This is in an era when few even consider anywhere in the US a viable long-term option, but Tesla selected New York state and southern California.  I can tell you from sad personal experience that both these places are among the most expensive and hardest places to do business in the country.  Seriously, in SoCal Tesla took over a facility that Toyota couldn't make work.  These make absolutely no sense as long-term locations for manufacturing, but Tesla came here none-the-less in part for big fat subsidies and in part to ingratiate two powerful sets of state governments (in addition to subsidies, California reciprocated by giving Tesla a special sweetheart deal upping its zero emission vehicle credits).

I am reminded of this because Bloomberg has the whole, sad tale of Tesla in New York here.

I am not much on memes but I thought I would try my hand just this once...

I really like the Soul of Enterprise podcast, and was thrilled that they had me on for a full hour last week.  You can listen to the whole thing here.  We covered a lot of ground, from private management of public recreation to climate to health care and even to Elon Musk a bit.  Fair warning though, I am not sure that this sort of interview is really my best milieu, which is why I write most of the time.  These guys get some amazing guests and also cover some interesting topics.  I really liked the bit they did on the subscription model a week or so ago.

For years I have been mocking attempts to "prove" negative climate trends from a single data point. Too often a single event (e.g. strong hurricane landfall) is treated as "proof" of a trend, though how anyone who styles themself as "scientific" can claim a trend from a single data point is beyond me.  Every time someone claims a trend in, say, hurricane strength or drought or crop yields, I never can see any trend in the actual archived data for those phenomena.

So I am soliciting real medium and long-term trend data that points to some sort of negative climate trend.  To save folks time, I know of and have the data for several already:

• Increasing worldwide average temperatures, as measured both on the ground and in the lower troposphere by satellites
• Increasing number of record high nighttime low temperatures (yes, I know, this is always confusing)
• Arctic (but not Antarctic) sea ice extent, at least over the last 50 years
• US heavy rainfall events
• Sea level rise

Note that at this point I do not care if the trend is natural or manmade or if you can really specify a difference (which I would argue you likely cannot).  For example the sea level rise trend of 2-3mm a year goes all the way back to before 1850, and thus is hard to ascribe totally to man-made CO2 which has mostly been produced in the latter half of the 20th century.

Here are some rules:

• Must have a link to original data source or at least the original chart source (some groups are terrible about archiving the actual data), which can be a study or a group that actively measures the phenomenon.
• It can't just be for a limited geography.  North Carolina is too small.  The Antarctic Peninsula is too small.  The US is really too small but I will accept it because the US temperature data is some of the most complete in the world.  But don't send me a limited geography when the same data is available for a larger geography (ie only hurricanes in the Indian Ocean when we have hurricane data for the whole globe).
• It needs to be for as long of a time period as possible, and if you cut off early or late data there has to be a reason.  large changes in measurement approach can be a valid reason for leaving out data -- for example, small tornadoes before the advent of doppler radar and moder tornado tracking are likely undercounted.  Ditto hurricanes.
• It can't be based on a model.  It has to be actual readings, not model estimates.  Have a care on this -- many pieces of historical data that are presented as actual measurements are actually model results.
• It needs to be a weather or climate metric.  If you want, you can send me potentially derivative variables and I might present these in another section, but they tend to be suspect because the causality extends beyond climate.  An example of this is forest fire acreage burned, which can relate to climate but also can relate to forest management, forest health and insect threats, and firefighting philosophy as well.  Other similar metrics include crop yields, disease rates, refugees, wars, and a zillion other things that get attributed in some study to climate change.

Anything that passes these rules will get posted, though I reserve the right to comment.

Update:  Comments section is OK, but email is better.  Click the contact link up at the top.

The media will breathlessly promote stories about any weather event in tail of the distribution curve.  I have written many times that this creates a false impression that these events are becoming more common.  Another element of this selection bias is what gets left out.  Does anyone doubt that if we were having a record-heavy tornado season, this would be leading every newscast?  If but if a record-heavy year is newsworthy, shouldn't a record-light year be newsworthy as well?  Apparently not:

source

Which reminds me of this chart Kevin Drum had the other day as "proof" of man-made climate change

I am not going to bother to go to their data source and pick it apart, though my guess is that I could.  But without even looking at the data sources I know this is garbage.  Think about places where there are large natural disasters in the US -- two places that come to mind are California fires and coastal hurricanes.  Do you really think that the total property value in California or on the US coastline has grown only at inflation?  You not only have real estate price increases, but you have the value of new construction.  The combination of these two is WAY over the 2-3% inflation rate.  This effect is magnified by the nature of the metric, which is not total losses but losses over some threshold.  This sort of threshold metric is easy to game, and says nothing for the total losses which would be a better measurement.

By the way, I am wondering how he automatically blames all of these natural disasters on manmade climate change.  Take the most recent, disastrous fires that hit the Redding, California area this year.  That fire started on BLM (federal) land.  When it was small, California State Fire (CalFire) personnel showed up to put it out.  The BLM told them to go away.  The chance to put the fire out when it was small was lost.  How do you blame a fire that was really due to moronic intergovernmental rivalry and bad forest management policy on climate change?

I won't repeat the charts but this post has charts on many extreme weather events and shows that, with the exception of large rainfall events, there is no trend in any of them.

This is the, uh, whateverth installment in a series on using your common sense to fact check data, even when the data is tantalizingly useful for the point one is trying to make.

For the last decade or so, global warming activists have used major fires as further "proof" that there is a global warming trend.  Often these analyses are flawed, for a variety of reasons that will be familiar to readers, e.g.

• A single bad fire is just one data point and does not prove a trend, you need a series of data to prove a trend
• There is no upward trend in US acreage in fires over the last 10 years, but there is in the last 20 years, which gives lots of nice opportunities for cherry-picking on both sides
• Acres burned is a TERRIBLE measure of global warming, because it is trying to draw global trends from a tiny fraction of the world land mass (western US); and because it is dependent on many non-climate variables such as forest management policies and firefighting policy.
• The better more direct metric of possible warming harm is drought, such as the Palmer drought severity index, which shows no trend (click to enlarge below)

• An even better metric, of course, is that there IS an actual upward trend in temperatures.  There is not, however, much of an upward trend in bad weather like drought, hurricanes, or tornadoes.  In this context fire is a third order variable (temp--->drought---> fire) which makes it a bad proxy, particularly when the first order variable is telling the tale.

AAAAaaaand then, there is this chart, much loved by skeptics, for long-term US fire history:

I am pretty sure that I have avoided ever using this piece of skeptic catnip (though I could be wrong, I can have moments of weakness).  The reason is that nothing about this chart passes the smell test.  While it is true that the 1930's were super hot and dry, likely hotter in the US than it has been this decade, there is absolutely no reason to believe the entire period of 1926-1952 were so much higher than today.  Was there a different fire management policy (e.g. did they just let all fires burn themselves out)?  Was there a change in how the data was recorded?

Here is my rule of thumb -- when you see a discontinuity like this (e.g. before and after 1955) you better have a good explanation and understanding of the discontinuity.  This is not just to be a good person and be true to good scientific process (though we all should) but also from the practical and selfish desire to avoid having someone come along who DOES know why the discontinuity exists and embarrass you for your naivete.

I have never trusted this chart, because I have not really understood it.  This week, the Antiplanner (who before he focused on transit focused most of his writing on the Forest Service and forest policy) has an explanation.

The story begins in 1908, when Congress passed the Forest Fires Emergency Funds Act, authorizing the Forest Service to use whatever funds were available from any part of its budget to put out wildfires, with the promise that Congress would reimburse those funds. As far as I know, this is the only time any democratically elected government has given a blank check to any government agency; even in wartime, the Defense Department has to live within a budget set by Congress.

This law was tested just two years later with the Big Burn of 1910, which killed 87 people as it burned 3 million acres in the northern Rocky Mountains. Congress reimbursed the funds the Forest Service spent trying (with little success) to put out the fires, but — more important — a whole generation of Forest Service leaders learned from this fire that all forest fires were bad....

This led to a conflict over the science of fire that is well documented in a 1962 book titled Fire and Water: Scientific Heresy in the Forest Service. Owners of southern pine forests believed that they needed to burn the underbrush in their forests every few years or the brush would build up, creating the fuels for uncontrollable wildfires. But the mulish Forest Service insisted that all fires were bad, so it refused to fund fire protection districts in any state that allowed prescribed burning.

The Forest Service’s stubborn attitude may have come about because most national forests were in the West, where fuel build-up was slower and in many forests didn’t lead to serious wildfire problems. But it was also a public relations problem: after convincing Congress that fire was so threatening that it deserved a blank check, the Forest Service didn’t want to dilute the message by setting fires itself.

When a state refused to ban prescribed fire, the Forest Service responded by counting all fires in that state, prescribed or wild, as wildfires. Many southern landowners believed they needed to burn their forests every four or five years, so perhaps 20 percent of forests would be burned each year, compared with less than 1 percent of forests burned through actual wildfires. Thus, counting the prescribed fires greatly inflated the total number of acres burned.

The Forest Service reluctantly and with little publicity began to reverse its anti-prescribed-fire policy in the late 1930s. After the war, the agency publicly agreed to provide fire funding to states that allowed prescribed burning. As southern states joined the cooperative program one by one, the Forest Service stopped counting prescribed burns in those states as wildfires. This explains the steady decline in acres burned from about 1946 to 1956.

There were some big fires in the West in the 1930s that were not prescribed fires. I’m pretty sure that if someone made a chart like the one shown above for just the eleven contiguous western states, it would still show a lot more acres burned in real wildfires in the 1930s than any decade since — though not by as big a margin as when southern prescribed fires are counted. The above chart should not be used to show that fires were worse in the 1930s than today, however, because it is based on a lie derived from the Forest Service’s long refusal to accept the science behind prescribed burning.

There you go, the discontinuity seems to be from a change in the way the measurement is calculated.

By the way, I work closely with the Forest Service every day and mostly this partnership is rewarding.  But I can tell you that the blank check still exists for fire suppression costs and results in exactly the sort of inefficient spending that you would imagine.   Every summer, much Forest Service work comes to a halt as nearly every manager and professional gets temporarily assigned to fire -- something FS employees love because they get out of the grind of their day job and essentially get to go camping.

NY City workers used project housing for orgies while being paid overtime.

Update:  As many of you know, my company privately operates public recreation areas.  One of our sales points vs. public management is, honest to God, that when we have a bad employee we can just fire them.

I promised I would not post any more Tesla for a while, and to some extent I am keeping that promise -- no updates here on the SEC investigation or the 420 tweet.  But since I have been critical of Tesla in the past, I thought I would acknowledge that there are good things in Tesla that could and should be saved.  The problem is that Tesla is saddled with a bunch of problems that are NOT going to be solved by going private.  In fact, going private could only make things worse -- given that Tesla already has too much debt and its debt is rated barely above junk bonds, piling on more debt just to save Elon Musk from short sellers is not a good plan.  Here is what I would suggest:

1. Find the right role for Elon Musk.  Musk HAS to be part of the company, without him its stock would go to about zero tomorrow.  But right now he is CEO, effective head of media relations, factory manager, and chief engineer.  Get him out of day to day management (and off Twitter) and hire real operating people who know what they are doing
2. Get rid of the dealerships.  Tesla tried to do something different, which is own all the dealerships rather than franchise them out.  This is fine if one has some sort of vision for doing sales and service differently, but Tesla really doesn't.  It does the same things as other car dealerships but just slower since it has not been able to build out capacity fast enough.  And this decision has cost them a tons of growth capital they desperately need, because they have had to build out dealerships most car companies get for "free" because the capital for the dealerships is provided by third-party entrepreneurs.  Also, the third-party entrepreneurs bring other things to the table, for example many of them tend to have experience in the car sales business and a high profile in their local markets with government and media.
3. If possible, find a partner for the charging network.  All traditional car companies get their fueling networks for free because the network is already built out by the oil companies.  Tesla is building its own, and again this is sucking up a lot of capital.  It is also dangerous, because Tesla has chosen to pursue a charging standard that may not become the industry standard (this is already happening in Europe) and Tesla risks being stuck with the betamax network.  Tesla should see if it can shift this to a third party, perhaps even in joint venture with other EV companies.
4. Do an equity raise.  To my mind, it is absolute madness Tesla did not do this earlier in the year.   Their stock was trading at $350 and at a $50+ billion valuation at the same time they were burning cash cash at a rate of $3 billion or so a year.  Musk says he can skate through without more capital but he has said this before and it was not true.  Given the enthusiasm for his stock, there is just no reason to run cash poor when there are millions of Tesla fanboys just waiting to throw money at the company.  Even a $5 billion raise would have been only 10% dilution.  Musk says he wants to burn the shorts but ask any Tesla short out there what they would most fear, and I think they would all say an equity capital raise.  $3-5 billion would get Tesla at least through 2019 no matter how bad the cash burn remained and give the company space to solve its operational problems.
5. Get someone who knows how to build cars building the cars.  I have written about this before -- it is always hard when you are trying to be a disruptor of an industry to decide what to disrupt and what industry knowledge to incorporate.  In retrospect, Musk's plan to ignore how cars are built and do it a different way is not working.  Not only are the cost issues and throughput issues, but there are growing reports of real quality issues in model 3's.  This has to be fixed ASAP.
6. Bring some sanity to the long-term product roadmap.  This may be a bit cynical, but Tesla seems to introduce a new product every time Musk needs to divert the public's attention, his equivalent of yelling "Squirrel!"  There is the semi, a pickup truck, a roadster and probably something else I have forgotten about.  Even the model 3 lineup is confusing, with no one really knowing what Tesla is going to focus on, and whether the promised $35,000 model 3 will ever actually be built.  This confusion doesn't work well with investors at all, but Tesla has been able to make it work with customers, increasing the buzz around the company because no one ever seems to know what it will do next.  But once real competitors start coming out from GM, Volvo, Jaguar, BMW and others, this is not going to work.  Customers that are currently captive to Tesla will have other options.    Let's start with the semi.  The demo was a beautiful product, but frankly there is no way Tesla is going to have the time or the money to actually produce this thing.   Someone like Volvo is going to beat them to the punch.   They need to find a JV partner who can actually build it.

Update:  If I had a #7, it would be: Invent a time machine and go back and undo the corrupt SolarCity buyout, in which Tesla bailed out Musk's friends and family and promptly proceeded to essentially shut down the company.  Tesla shareholders got nothing from the purchase except a lot of debt.

You may not see much Tesla coverage here for a while, despite a lot of breaking news.  Here is why:

The dominoes are all lined up, and that was an interesting story (the dominoes include:  Tesla's poor management of a good product, its lack of adult supervision, its repeated failure to meet targets, its utter contempt for being held accountable to targets, its paranoid worldview, its past near-corrupt actions like the insider SolarCity purchase, Musk's irrational hatred of shorts, its running out of cash without any plan for a capital raise, the fanboys who would eat any dog food Musk served up, etc.)

The first domino has been tipped over (Musk's outright lie that he had funding secured for a $420 buyout when he had not even talked to bankers or his board yet, just to tweak the shorts for a few hours in one day).

Now, I am not sure that I find further falling dominoes that interesting -- after all, it is just inevitable physics at this point.

Note:  The crash is likely to be much slower than at Enron.  Once confidence failed in Enron, the crash came almost at once because Enron was like a large bank that was investing long and borrowing short.  Once the short-term borrowing window was closed for them, it was over.   Tesla can likely make it 6 months before they start scraping bottom and/or their debt covenants.

Update:  For the Tesla fanboys who seem super-excited about the loss of liquidity moving to a private company, here is what being a minor shareholder in a private company is like:

Three of Tinder's co-founders and several other current and former senior executives are suing the dating company's parent organizations, Match Group and IAC. According to a complaint published online, the lawsuit seeks billions of dollars in damages for allegedly manipulating financial information in order to reduce Tinder's valuation and illegally take away employees' stock options.

The complaint explains that Tinder was supposed to be valued in 2017, 2018, 2020 and 2021; On those days, employees should have been able to exercise their stock options. Instead, the lawsuit alleges that parent company IAC/Match Group inaccurately lowballed Tinder's valuation in July 2017 at $3 billion, the same as it did two years ago despite the dating app's substantial growth. Then, the parent company secretly merged Tinder into Match Group, which meant employees earned far less in stock options. Then, IAC threatened to terminate anyone who revealed how much the company was actually worth, the lawsuit claims.

@Elonmusk is facing real blowback for his management buyout by tweet the other day, in particular for two words:  "funding secured."  Many, including myself, doubt he really had tens of billions of dollars of funding secured at the time, particularly since all bankers and likely sources of funding as well as most large Tesla shareholders had never heard of any such transaction when contacted by the media.  The SEC is now looking into this and other Musk corporate communication practices.  If he lied in the tweet, perhaps to get revenge on the short-sellers he hates with an irrational passion, he could be in deep, deep legal poop, up to and including jail.

Let's play a game.  Let's assume he did NOT have funding secured at the time he tweeted this, and now is running scared.  What can he do?  One ace he has is that the board is in his pocket and (I hate to be so cynical about this) will likely lie their asses off to cover Musk.  We already saw the dubious letter the other day, from "members of the board" rather than officially from the board, attempting to provide cover for Musk's tweets.  This is not just a crony thing -- it is entirely rational for the company to defend Musk.  He is, in my opinion, a terrible executive but he is the avatar that drives the fan boys and the stock price.  The day that Musk leaves is the day that the company can really get its operational house in order but it is also the day the stock trades under $75.

So what can Musk do?  Well, the first defense might be to release a statement like "when I said funding secured, I was referring to recent conversations with ______ [fill in blank, maybe with Saudis or the Chinese, call them X] and they told me that if we ever were looking for funds they would have my back."  This is probably the best he could do, and Tesla would try to chalk it up to naivete of Mr. Musk to accept barroom conversation as a firm commitment.  Naivite, but not fraud.   I don't have any experience with the Feds on this kind of thing but my guess is that the SEC would expect that the CEO of a $50 billion public company should know the rules and legally wasn't allowed to be naive, but who knows, the defense worked for Hillary Clinton with her email servers.

But this defense is MUCH MUCH better if, in the next day or so, Tesla can announce a deal with X on paper with signatures.  Then Musk can use the same defense as above but it has much more weight because he can say, see, they promised funding and I believed them when they said they had my back and here they have delivered.

The problem with this is it would be really a deal being crafted for tens of billions of dollars on a very short timeframe and with limited negotiating leverage (X will know that Musk NEEDS this deal).  As a result, the deal is not likely to be a very good one.  X will demand all sorts of extraordinary provisions, perhaps, for example, a first lien on all Tesla IP and a high breakup fee.  I picture this more like the negotiation for bankruptcy financing, and in fact the IP lien was part of the financing deal Theranos made when it was going down the drain.  But put yourself in Musk's shoes -- jail or bad deal?

And likely his conscience would be clear because this deal would be killed quickly by shareholders.  That would be fine, because the purpose of the exercise would be to keep Musk out of jail, not to actually buy the company.  Tesla shareholders will still get hosed, probably having to pay some kind of break-up fee which any sane investor X would insert as the price for participating in this farce.  And we will go back to the starting point of all this, which is Tesla being public and focusing on operational improvement in what may be the most important operational quarter in its history.

Disclosure:  I have in the past been short Tesla but have no position in it now (I did short when trading reopened the other day after Musk's announcement but covered this afternoon).  I am not in any way, shape, or form giving any financial advice you should spend actual money backing.

UPDATE:  I had the wrong link.  The call is Wednesday but at 2:30 Pacific after the market closes, which makes more sense.  Like many companies, Tesla likes to dump the quarterly financials, dozens of pages in 8 point font, just seconds before the conference call.

If you are sitting in your office this week and need to be entertained in a way that looks like you are working, consider the Tesla investor conference call Wednesday at 2:30 PDT.  I can't guarantee anything but past conference calls have been a circus.  Normally I would expect the Tesla Board or the corporate counsel (who is Musk's divorce lawyer, lol) to bring adult supervision to the party, but so far that has not happened in any Tesla communications to date.  Expect potential discussion around:

• Tesla's immediate external capital needs, given that they are burning cash faster than you could actually physically burn it (Musk claims zero is needed but everyone else in the free world thinks its >$2 billion, with a huge part of Tesla's existing debt also expiring and needing to be rolled over soon)
• Model 3 order blacklog (this was the question in the last call that caused Musk to tell the experienced Wall Street analyst to shut up and then he switched to taking questions from a Youtube fanboy
• Model 3 production rates and quality issues
• Gross margins.  They HAVE to get higher for survival.  Particularly since Telsa has chosen to eschew traditional dealer networks so corporate bears all the cost of service and support.  This demands Tesla not only get its gross margins as high as other auto makers, they need to be higher.
• Expiration of tax subsidies -- the $6500 government tax credit for Tesla customers slowly disappears once their 200,000th EV has been sold in the US, which has happened.
• The disappearance of the $35,000 Model 3 from the web site (this is the promised car that generated a lot of the Telsa hype in the first place)
• Disappearance of all those other teased products (coupe, semi) that were released to great fanfare and have not ever been mentioned again
• ZEV credits (these are credits it gets from states like CA that other car makers have to buy to do business in those states with gasoline vehicles).  These are odd ducks as they have a lot of value but for some reasons do not show up anywhere on the balance sheet, so one doesn't know they even exist until Tesla chooses to sell them for a LOT of money.   They can flip a single quarter positive by saving these and exercising them at the same time.  Most folks see this happening in a bid to make Q3 profitable.  (By the way, anyone out there that understands by what accounting rules these valuable assets don't get put on the balance sheet are encouraged to email me the answer).
• Introduction of competitive products (Jaguar, Volvo, and pretty much everyone else soon)
• Pending lawsuits from both shareholders and whistle-blowing employees
• Implosion of SolarCity (now part of Telsa) such that new installations are on a trend line towards zero
• (unlikely but someone should really ask) Musk's silencing of critics
• (unlikely but someone should really ask) Musk's social media demeanor, including calling the Thai rescue hero a pedophile because he did not use Musk's goofy submarine

Tesla is a train wreck I cannot take my eyes off.  Unlike Theranos, which combined a product that didn't work with a screwed up management, and which operated in the dark, Tesla combines what has been a really good product with a screwed-up management, and operates in an absolute blaze of publicity.  I have never seen any stock where sentiment was so polarized between bears and fan-boy bulls (Herbalife, maybe?)

I have a personal metric of sentiment and volatility I invented but I am pretty sure has been used since before I was born.  Anyway, I look at the sum of the price of an at-the-market put and at-the-market call for the stock about 6 months out.  I then divide this combined price by the share price.  For Tesla January options, this comes to 31%.    This is really a huge number.  Take ExxonMobil, which has a lot of split sentiment right now (a historically fabulous company that keeps screwing up its quarters recently) this metric sits at 9%.

Disclosure:  I am in and out of short positions on TSLA, typically selling around 350+ (usually after Musk has honeytrapped the fan boys) and covering in the 290-300 range (usually after real news or a Musk meltdown).  This strategy has been profitable for 2 years but I think that is coming to an end.  TSLA is either going to fall more or stay high based on what it does in the 3rd quarter.

The title was my first thought when I saw this over at Kevin Drum's:

The Gates Foundation has spent about $200 million since 2010—in addition to other sources who kicked in about $400 million—on an education initiative designed to increase student performance:

The school sites agreed to design new teacher-evaluation systems that incorporated classroom-observation rubrics and a measure of growth in student achievement. They also agreed to offer individualized professional development based on teachers’ evaluation results, and to revamp recruitment, hiring, and placement. Schools also implemented new career pathways for effective teachers and awarded teachers with bonuses for good performance.

They helped out all teachers; fired bad teachers; promoted good teachers; and paid bonuses to effective teachers. So how did it work out?...

Long story short, there was no improvement at all in student achievement, despite the fact that funding was far greater than it would be in any real-life reform of this nature. There may have been some other successes in this program, but if the ultimate goal is better students, it was a complete failure. Whatever the answer is, rewarding good teachers and firing bad ones sure doesn’t seem to be it.

The organizations around these teachers must really suck because no reasonable person would expect that, in a service business, increasing employee accountability and upgrading the employee base would have no effect on customer service.

I have written before about how bad, senescent organizations destroy the value of good employees.  For example, in the context of the General Motors bankruptcy:

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.  ...

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.

Postscript:  From some experience with private schools, I would say the biggest difference is that private schools set higher expectations.  Even starting in kindergarten, my kids were doing WAY more advanced work than in public schools.  I understand that public schools are public and thus tasked with teaching everyone, so there is pressure to pace the work to the slowest student.  But the slow pace of public school starts even in the early grades before the school reasonably knows who the slowest kids are.  Public schools that have low expectations for student performance are not going to be suddenly improved by better teachers.  Putting Gordon Ramsey behind the counter at a Long John Silver fast food restaurant is not going to make the food suck any less.

I am, perhaps surprisingly to many readers, NOT going to go on a rant about the Supreme Court's decision yesterday that states can collect sales tax on interstate sales over the Internet, at least I am not going to rant about taxing internet sales per se.  Realistically, it was never realistic to think the government would keep its hands off this piggy bank, especially as Internet sales have skyrocketed.  However, this decision creates absolutely enormous practical problems for small businesses and Congress needs to act quickly to mitigate some of these.

The problem is the management problem this presents, particularly for many small retailers, and I don't think most consumers understand this.  Sales taxes seem simple from the consumer point of view -- say your sales tax rate is 7%, the cash register collects 7% and it all seems to be handled automatically.  But even at your local store, things can get complicated.  Your food purchases may well be taxed at a different rate (perhaps even 0%) than your other purchases.  You probably don't notice, but if you go over the city limits into a neighboring town or unincorporated area, the rates may suddenly be different.

Take Arizona, which seems from my experience to be roughly average.  The sales tax rate table is 18 pages long in a small font.  There are 29 separate rate categories which each have different rates in each of Arizona's 15 counties.    My business is in 6 counties and we have 3 rate categories that apply, or 4 if you consider items with no tax as another rate category.  This is 24 different state/county sales tax rates we charge.  But that is the easy part.  Because then there are, in addition to county taxes, 92 different towns and cities that have their own rate tables with up to 29 different rate categories that add to the base state/county rate.  Other states such as Washington (rule of thumb -- if the state has no income tax then it has a LABYRINTHIAN sales and business tax systems) have additional overlay taxes such as for transit and stadium districts.

When my company opens a new location, we have to spend hours on the Internet and with maps trying to figure out what sales taxes to collect, and even with good due diligence we sometimes get it wrong and find in an audit we are actually just inside or outside some line where the rate changes (we once had a location 30 miles outside of Seattle on a long dirt road where we found we had to collect the Seattle Rapid Transit tax).  Thatcher, AZ is a town of like 4000 people but has its own special sales tax rates -- do you know where the town line is?  Well neither do they, because last time I checked they did not have any sort of online lookup system to tell one automatically if the address is inside or outside the town and its sales tax district.

So it's a hassle for my business, but a one time hassle when we open a new location.  Now imagine that you are a small retailer on the internet selling fruit cakes.  You don't go out and establish sales tax locations, in some sense the location comes to you.  John Smith wants to buy a fruitcake and has an address that says Thatcher, AZ, but in the rural world one can easily have a town's name in your address but live outside of the town  (we have a campground with a Grant, Alabama address that is well outside of the city and tax limits of Grant but the town fathers come after us every year or so trying to see why we are not collecting their sales tax).  What sales tax do I collect from this customer?  Is there even a tax on food in that location?  If there is, there might be separate rates (as in California, for example) for prepared vs. packaged food.  What kind of food is my fruitcake?

But it actually gets even worse.  Because now all I have done is collect some amount of tax.  That is the easy part!  The hard part is registering with all the sales tax authorities to collect and pay the tax.  Well, you say, I guess I have to grit my teeth and register 50 times, which I can tell you is a gigantic pain in the ass because every state manages the process differently.

But even after registering in all 50 states, you are STILL not done, because many states don't have a fully unified sales tax collection system.  In Arizona, for example, the larger cities require their own registration and monthly reporting.  Each of these towns in AZ require a separate registration and monthly report:

Apache Junction,
Avondale,
Chandler,
Douglas,
Flagstaff,
Glendale,
Mesa,
Nogales,
Peoria,
Phoenix,
Prescott,
Scottsdale,
Sedona,
Tempe,
Tucson

Douglas, Arizona is a town of freaking 16,000 people but make sales there and you have to have a separate local registration and reporting.  And this list is for one not-very-urban state.  Currently my company does business in 9 states but we are registered and pay sales taxes to about 25 different authorities -- and we are mostly a rural business, so we are not in the larger urban areas that are more likely to have their own sales tax systems.

By the way, you might be thinking, "well, if I am a small business, I can just file with such and such authority in the months I have a sale there." Wrong.  Once you register and file once, you will be expected to file every time, even if they are zero reports.  The one source of relief is some states allow less frequent reporting.  It used to be there were states where I had low volume we filed once a year, but that seems to be a thing of the past.   Most states seem to have a minimum of quarterly reporting, no matter the volume.  Politicians want their money NOW (last sentence should be pronounced using Veruca Salt voice).

This is why businesses tend to have to sign up for very expensive sales tax management services.  But even that is not the end of difficulties, because registering for sales tax in an authority also forces one to register and pay other taxes and fees.  For example, Tennessee has another tax called the state and county business tax, which is essentially a revenue tax.  Even if you are an out of state company, you must file and pay this tax on any revenues.  If you sell in all of TN, that is one additional state registration and 95 different county registrations and 95 different county tax forms  (our company has to do about 8).  But wait, there is more!  Because a business also has to register with any of about 200+ cities in TN for payment of city business tax.  If you are selling all over TN, that is another 200+ registrations and 200+ annual reports (if this seems all very complex in TN, remember that TN has no income tax and note what I said earlier about the sales and business tax systems of states with no income tax).

I have written many times that regulation tends to benefit larger companies at the expense of smaller companies.  Who is more likely to be able to comply in this world I have described, Amazon or the fruitcake company?  Jeff Bezos is turning handsprings today because a) this kills a lot of his competition and b) to survive, many small venders will have to move to larger retailing platforms that can do some of the sales tax work, of which the largest and best is.... Amazon.

Congress needs to act.  It is going to have to be a compromise, because states are going to be putting a lot of pressure to let this situation stand because they want the money.  I would propose a national sales tax system on interstate retail sales that preempts any state sales taxes.  It will be hard to keep it from growing out of hand but it would be nice to establish a principal in law that the tax would be some sort of weighted average of the states' internal sales taxes.  The Feds would add a percent or two for themselves and there would be one registration for all -- as easy for me to do as it is for Bezos.  Yes, I know all the problems with this, but I don't think the status quo is tenable and I don't think Congress has the votes to go back to the old untaxed system, so this is the best we can expect.

Two years ago, I wrote about the acquisition of SolarCity by Tesla.  I thought this represented near-criminal self-dealing at the time and there has been little since to convince me otherwise.  As I wrote then:

This is honestly one of the weirdest acquisition proposals I have seen in a long time:  Elon Musk's Tesla offers to buy Elon Musk's Solar City.

This makes zero business sense to me.    This is from the press release:

We would be the world’s only vertically integrated energy company offering end-to-end clean energy products to our customers. This would start with the car that you drive and the energy that you use to charge it, and would extend to how everything else in your home or business is powered. With your Model S, Model X, or Model 3, your solar panel system, and your Powerwall all in place, you would be able to deploy and consume energy in the most efficient and sustainable way possible, lowering your costs and minimizing your dependence on fossil fuels and the grid.

I am sure there are probably some hippy-dippy green types that nod their head and say that this is an amazing idea, but any business person is going to say this is madness.  It makes no more sense than to say GM should buy an oil production company.  These companies reach customers through different channels, they have completely different sales models, and people buy their products at completely different times and have no need to integrate these two purchases.  It is possible there may be some overlap in customers (virtue-signalling rich people) but you could get at this by having some joint marketing agreements, you don't need an acquisition.  Besides, probably the last thing that people's solar panels will ever be used for is charging cars, since cars tend to charge in the garage at night when solar isn't producing.

One might argue that some of the technologies are the same, and I suppose some of the battery and electricity management tech overlaps.  But again, a simple sourcing agreement or a battery JV would likely be sufficient.

So what do these companies share?

I went on to discuss several possible reasons for the deal but settled on this one as the best explanation:

I have no inside information here, but this is the best hypothesis I can put together for this deal.  SolarCity has huge cash needs to continue to grow at the same time its operating margins are shrinking (or getting more negative).  They are having trouble finding investors to provide the cash.  But hey!  Our Chairman Elon Musk is also Chairman of this other company called Tesla whom investors line up to invest in.  Maybe Tesla can be our investor!

The reason I call this two drunks propping each other up is that Tesla also is also burning cash like crazy.  It is OK for now as long as it has access to the capital markets, but if it suddenly lost that, Tesla would survive less than 6 months on what it has on hand.  Remember, SolarCity was a golden child just 3 years ago, just like Tesla is today.  Or if you really don't believe that high-flying companies that depend on access to the capital markets can go belly up in the snap of a finger when they lose their luster with investors, I have one word for you:  Enron.

Essentially, I saw the SolarCity deal as a bailout of Musk's and his friends' and family's investments in SolarCity by Musk-controlled Tesla.  Nothing that has happened since has convinced me this is wrong.  The most prominent evidence has been the dog that never barks -- SolarCity, or Tesla Energy as it is called, is almost never mentioned in conference calls and investor communications by Tesla any more -- certainly the rooftop business is not.  The only thing that ever seems to get a mention are a few big standby battery installations in Australia.   Turns out there was a reason (via Seeking Alpha):

This was a dying business when Tesla bought it an insiders all knew it.

Disclosure:  I tend to short Tesla when it reaches the 350/360 level and cover when it drops into the 200's.

Update:  Here is a great timeline of the whole sorry history of the SolarCity acquisition by Tesla.  This paints an even worse picture than I was aware of.

The International House of Pancakes announced the other day that they are changing their name to International House of Burgers, or IHOb.   I am 99% certain that this is just a marketing gimmick, a way to get social media buzz, after which they will "as a result of public pressure" go back to the old name.  A sort of intentional version of what Coke did years ago by accident with New Coke.

So far, I would judge it to be successful.  They were talked about on several national radio shows that I listen to (on sports talk radio, no less) and got a day's worth of media coverage (and presumably another day's worth when they change back).  This is a LOT of free advertising for a brand I have heard absolutely nothing about for years (except from my 21-year-old daughter who still makes me take her there from time to time for funny face pancakes.)

Brand strategy has really evolved a lot from when I was in B-school.  In the 1990's my wife was a brand manager at Frito-Lay and brand management at the time seemed incredibly conservative.  There were very defined, tightly-spaced rails that circumscribed what you could do with a brand.  But that is so boring it gets nowhere on social media.  "Fritos! They are... uh... everything they always have been."  This IHOP gimmick (and Budweiser's temporarily changing its name to America) demonstrate a lot less risk-aversion with core brands in a social media era where one has to be outrageous to get attention.

Postscript:  I was in Santa Monica the other day and saw something where they had a really lame, forgettable tag line for the city.  I wanted to help them with some catchier phrases.  Like, "Santa Monica:  World's Nicest Homeless Shelter" or "Santa Monica:  Watch Out For That Scooter!" or "Santa Monica:  You Want HOW MUCH for Rent??"

My wife's cousin is in management of a beautiful resort (Mauna Kea / Hapuna)  on the Kohala coast of the Big Island of Hawaii.  I was asking him if it was OK to visit and you can feel the frustration of a resort executive in his reply:

Absolutely ZERO impact from Volcano….

Volcano is 120 miles away and has zero impact on MK. Since it has been rumbling we have had nothing but beautiful sky, perfect air and perfect water temperature.

Web site with air quality… http://www.hiso2index.info/ MK is about the same as Kihei in Maui… Kona occasionally gets not great with some Vog… So Kihei and MK are both at 14 right now. Kona is the worst at 46 on the west side (Still good) Phoenix is at 71; St. Louis right now seems the worst in the nation at 119. Worst are on the Big Island right now is Ocean View a little south west of the lava flows at 82.

Unfortunately, CNN makes it seem like everyone is wearing a gas mask and there is acid rain falling all over the place. The volcano is limited to a tiny area on the south-east coast and all Island in Hawaii and 90% of the big island and all of the Kohala Coast are not impacted. The impact from the Volcano for me is the same as you in Phoenix… ZERO….. Also no matter what it does it will not impact us… It is a shield volcano, not Mt. St. Helene so it can’t blow up and there is not enough lava in the chamber to cause any big issues other than right at its base…

The only time to “pay attention” is if Mauna Loa or Hualalai started to rumble. Both of those could have an impact on the west side of the island.

I am mostly going to leave highways out of this post.  Most evidence I have seen is that the numbers do not actually show highway infrastructure to be getting worse.  To the extent highways are underfunded, in my mind it is because gasoline taxes paid by drivers and meant for highway repair and construction have been shifted to grand projects like light rail that get politicians excited but carry at least an order of magnitude fewer passengers per dollar spent than do highways.

But in worlds I am more familiar with - government transit agencies and parks agencies - there has been a real deterioration of infrastructure.   Systems like the Washington Metro clearly are falling apart and most public parks and recreation areas have huge deferred maintenance accounts that are growing every year.  California State Parks and the National Parks Service alone have deferred maintenance tallied well into the tens of billions of dollars.

Most of these agencies will argue the problem is -- wait for it -- that they are underfunded by their legislatures.  But this is not the case in my experience.  My company routinely takes over public parks that some government agency said were too expensive to remain open and profitably reopens them to the public -- not only keeping up with the maintenance but paying to catch up on all the maintenance the agency let slide when it was operating the park.

The problem is that most agencies, whatever their stated public purpose and mission, tend to be run for the benefit of their employees.  I understand some but not all the reasons for this, but it is simply an observable fact that this happens time and time again.  This means that the priority is to build up large staffs with good pay and large benefits and retirement packages.   Worse, the preference is usually to build up headquarters and administrative staff, rather than staff that actually does stuff like serve the public or fix things.  When cutbacks need to occur, the priority order always is: cut maintenance first; cut field staff actually doing useful things second; cut administrative staff only in case of the apocalypse; cut benefits packages never.

Deferred maintenance is the way that agency's can borrow without transparency and without any outside authorization to do things like maintain staff in the face of cutbacks.  In effect, the agency is borrowing against the infrastructure the public has built to help fund staffing levels and benefits.  What is deferred maintenance?  It is all kind of things.  It is having one out of three toilets in a bathroom break and just roping it off rather than fixing it.  It is allowing potholes to multiply in the road without repair.  It is constantly chasing more and more leaks in an underground water line and not just replacing it.  It is an acknowledgement that all manmade things have a fixed life.   Take picnic tables.  Let's say a type of picnic table in a campground, of which there might be hundreds, lasts about 10 years.  That means a responsible person should budget to replace 10% every year.  But what if we skip a year?  No one will probably notice if some old tables slide from 10 to 11 years old, and we save some money.  But really we are only borrowing that money, because we will need to do twice as many next year.  But then we do it again the next year, to borrow more, and the bill just increases for the future.  Before you know it, the NPS has $12 billion in deferred maintenance, a $12 billion debt for which there is little transparency and no legislative approval -- and the interest on which all of us in the public pay when we have to live with these deteriorating public facilities.

I have written about this many times, but here is what I wrote about Arizona State Parks several years ago:

At every turn, [Former Arizona State Parks Director Ken] Travous made decisions that increased the agency's costs.  For example, park rangers were all given law enforcement certifications, substantially increasing their pay and putting them all into the much more expensive law enforcement pension fund.  There is little evidence this was necessary -- Arizona parks generally are not hotbeds of crime -- but it did infuriate many customers as some rangers focused more on citation-writing than customer service.  There is a reason McDonald's doesn't write citations in their own parking lot.

What Mr. Travous fails to mention is that the parks were falling apart on his watch - even with these huge budgets - because he tended to spend money on just about anything other than maintaining current infrastructure.  Infrastructure maintenance is not sexy, and sexy projects like the Kartchner Caverns development (it is a gorgeous park) always seem to win out in government budgeting.  You can see why in this editorial -- Kartcher is his legacy, whereas bathroom maintenance is next to invisible.  I know deferred maintenance was accumulating during his tenure because Arizona State Parks itself used to say so.  Way back in 2009 I saw a book Arizona State Parks used with legislators.  It showed pictures of deteriorating parks, with notes that many of these locations had not been properly maintained for a decade.  The current management inherited this problem from previous leaders like Travous, it did not create it.

So where were those huge budgets going, if not to maintenance?  Well, for one, Travous oversaw a crazy expansion of the state parks headquarters staff.    When he left, there were about 150 people (possibly more, it is hard to count) on the parks headquarters staff.  This is almost the same number of full-time employees that were actually in the field maintaining parks.  As a comparison, our company runs public parks and campgrounds very similar to those in Arizona State Parks and we serve about the same number of visitors -- but we have only 1.5 people in headquarters, allowing us to put our resources on the ground in parks serving customers and performing maintenance.  None of the 100+ parks we operate have the same deferred maintenance problems that Arizona State Parks have, despite operating with less than a third of the budget that Travous had in his heyday.

Arizona State Parks has a new Director, but its the same old story.  They have complained about deferred maintenance in the parks for years, but when times are good (and I can tell you all of us in public recreation are having visitation records the last few years) they use the extra money to add headquarters staff and pay headquarters staff more.

State Parks, which receives no state general-fund money, saw a record 2.78 million visitors come to its parks for the fiscal year that ended June 30. The agency generated nearly $17.9 million largely from park fees, another record.

The result: Black has been generous with pay for people she has brought on staff. Some salaries are up to 32 percent higher than what her predecessor paid for the same positions. And she has approved raises of up to 25 percent for some carry-over staff as more money rolls into the agency's coffers....

Meanwhlile, records show [former director Bryan] Martyn's top two deputies were paid $110,250, while Black pays her top assistant $142,000 — 29 percent more. Black brought in a new development chief at nearly $105,000, a 32 percent bump over what the position paid under Martyn.

Black also boosted the pay of the natural-resources chief, who also worked for Martyn, by 25 percent, to $84,000 a year.

State Parks payroll records show Martyn, around the time he left, had 41 staffers making more than $50,000 [incredibly this is apparently personal staff, not the total headquarters staff]. Black had 58 staff members in March making more than $50,000. Black also brought in staff at higher salaries than what Martyn paid, giving some holdovers significant raises.

An agency spokeswoman said Parks is increasingpay to recruit and retain talent, and staffers are dealing with more visitors.

Black said she also has increased the pay of those in the field.

So, as we see some really good years in public recreation, Arizona State Parks is using the extra money to pay staff rather than address fundamental infrastructure issues.   Anyone want to guess what will happen when the next downturn comes?  Will administrative pay be cut?  Will headquarters staff be cut?  Or will maintenance be cancelled and parks closed?  Place your bets.

When companies or other entities get into debt holes they cannot climb out of, their debt is restructured and perhaps partially forgiven or even bailed out, but rules are put in place to ensure more responsible financial behavior in the future.  The same needs to be true of infrastructure spending.  These agencies got themselves into the deferred maintenance holes they are in.  They cannot get out without a bailout, but we should understand that it is a bailout of these agencies and there need to be conditions attached to the funding tied responsible maintenance spending by the agency itself.

I really thought this article (editorial? letter?) by Donna Brazille in Politico was fascinating.  First, it is not that often that partisans of either flavor air their internal dirty laundry in public.  And second, it is a pretty interesting story.  Apparently Obama left the party deeply in debt (that is probably not unusual after a campaign, since politicians do the same thing with public budgets when they actually hold office).  Debbie Wasserman-Schultz "had outsourced a lot of the management of the party and had not been the greatest at fundraising" and thus was doing little to pay down the debt.   Eventually, Wasserman-Schultz and a few other party leaders turned to the Clinton campaign to bail them out, which they did -- over a year before the convention when Clinton became the actual Democratic nominee -- in exchange for an agreement that:

Hillary would control the party’s finances, strategy, and all the money raised. Her campaign had the right of refusal of who would be the party communications director, and it would make final decisions on all the other staff. The DNC also was required to consult with the campaign about all other staffing, budgeting, data, analytics, and mailings.

Apparently Wasserman-Schulz could not be reached for comment in her current location under the bus.

My relatively snarky post on hedge fund fees and passive management got a lot of response, including a few of challenging emails from friends and acquaintances.  So I wanted to cover a few followups here.

One of the interesting features of passive investment management is that it doesn't work if everyone does it.  I vaguely remember there is some name for this in the game theory world but I can't for the life of me remember.  Anyway, passive investment is based on the theory that the market for financial products is relatively transparent and efficient.  While one stock will certainly perform better than another, it is almost impossible (or at least really expensive) in a mostly-efficient market for a regular investor, or even an average fund manager, to parse this out.  As a  result, high fees or expenses one might incur to find these opportunities generally don't pay for themselves, and it is better to just invest in a broad basket of securities and accept the average market return.

But note that this is predicated on the assumption that someone, somewhere is actively managing.  Someone must be looking for good stocks and bad stocks and buying the former and selling the latter.  Without these folks actively managing, it would not be an efficient market.  [I am reminded at this point of the old joke about a man walking down the street with an economist.  The economist steps right over a $100 bill on the sidewalk without stopping.  The man asks the economist, "why didn't you stop and pick up that money?" and the economist answers, "in an efficient market it can't really be there."]

I remember a while back reading economic research about shopping.  What percentage of customers have to be active price-shoppers to make a market efficient?  I personally don't price shop for the small stuff.  If I need a bunch of cheap bulk stuff, I just run to Wal-Mart or Costco and buy it with confidence I am getting a pretty good price.  But why can I do that?  Because I trust these large corporations to honor their promise for low prices?  Hah!  No way.  What I trust is that there are people who clip coupons and price every dang item to the penny, and it is these folks who keep Costco and Walmart honest.  Government interventionists like to talk about the free rider problem all the time, but most all of us are free riders on these hard core shoppers.

The same is true with us passive investors.   I like to get snarky about the fees certain active investors charge, but I am still dependent on their work.  And I don't particularly doubt that there are hedge funds and private equity firms that make consistently above market returns, but I do think they are a minority.  I would equate it to max-contract players in the NBA.  No one doubts Lebron James merits a max contract -- any of the teams in the NBA would sign that deal in five seconds.  But a max deal for, say, Chandler Parsons?  Joakim Noah?  The problem with hedge funds is that the few of these folks who merit the two and twenty max contract have very likely been closed to new investors for years, in the same way it is impossible to get LeBron James to play for Memphis.  It is frustrating for me to see public and private institutions chasing yield and continuing to pay 2 and 20 to folks with an unproven algorithm and a marketing plan.  If I am going to pay 2 and 20, its more likely to be to someone in private equity or an LBO fund who is doing more than stock picking.  That's because I do think that stocks are generally well-valued on the market based on their current management, investment plans, culture, etc.  But they may contain opportunities for smart people who can come in and, for example, apply different management and culture and strategy to the people and assets.  A box that is half Kale and half candy corns might not sell for a good price because no one wants the combination, so value can be created splitting it up.

A couple of other thoughts that came up in discussions since yesterday:

• I am willing to believe that passive investing looks so good vis a vis active investing because central banks have inflated assets and compressed volatility.  If all the boats are rising with the tide of state actions that are raising the tide, then one is less likely to be fussy about which boat he is on.  What's the point of value investing when the market treats stocks as commodities?  But I can certainly see that in markets like the late 70's or pre-market-boom early 80's that stock pickers might have had more room to differentiate themselves.
• I am also willing to concede that passive investing may turn out to be a terrible trend for corporate governance.  If all your shareholders are just holding your stock as part of a basket of 500 stocks, who is going to hold you accountable?  It is very awkward for a Vanguard agitate for changes in a company, even when they might be the largest single shareholder.  Also, ironically, passive investing may be opening the door for single lone wolf activist investors to impose their will on companies, sometimes to the other shareholders' detriment.  If one person with 5% cares a lot and the other 95% are passive, that one person might be able to raise a lot of hell.

As a final note, I am a screaming hypocrite on the whole passive investing thing, since with most of my net worth I am the ultimate in active investors.  I have most of my savings in one company, the one I run.

From the WSJ:

Some $333 billion moved into all U.S.-listed ETFs [exchange traded funds] in 2017 through September, a figure that eclipses last year’s $288 billion all-time high with three months yet to be tallied, according to Morningstar.

Of that amount, 73% has gone into ETFs that boast expense ratios less than or equal to 0.2%, or $20 per $10,000 invested, according to Morningstar data through September. Such low-fee funds account for just 15% of the more than 2,000 exchange-traded funds and notes on the market....

The market for low-cost funds, long dominated by BlackRock, Vanguard Group and State Street Global Advisors, is getting increasingly crowded as other players attempt to muscle in. State Street last month slashed management fees on more than a dozen of its funds. Franklin Templeton Investments, a unit of Franklin Resources, this week announced 16 ultra-low-cost foreign stock ETFs that will undercut the management fees of nearly every rival product currently on the market.

“It’s become insanely competitive,” said Ben Johnson, head of ETF research at Morningstar.” Mr. Johnson said that advisers and other intermediaries are feeling the pressure to emphasize the lowest prices available. “This has upped the ante for providers of products that have really been commoditized.”

If you are a typical investor, you too are likely investing in lower-cost funds, and for most of us that is a great choice.  But large public pension funds are still the #1 largest investors in hedge funds, whose absurd 2 and 20 (2% of the assets invested, 20% of the gains, 0% of the losses) fee schedules still exist, incredibly, despite their systematic under-performance of the market.  I have always wondered how these fees don't get competed down.  But beset by under-funding, public pension funds are so desperate for yield to try to close the gap that they will still fall for the hedge fund pitch.  Which is why your local public teacher pension fund probably helped build a number of the mansions in Greenwich.  You do have to sort of respect folks who figured out a financial model for profiting in direct proportion to government fecklessness.  Talk about hitting the mother load!