Andy Kessler

Interviews with Andrew Keen and Techcrunch

Here are parts 2-5:

Part Two: Kessler on The World Economy

Part Three: Kessler on Productivity

Part Four: Kessler on The Next Big Thing

Part Five: Kessler on Where To Invest

DB: Greece is Bear Stearns, (fill in the blank) is Goldman Sachs

http://www.thedailybeast.com/blogs-and-stories/2010-06-19/andy-kessler-on-greece-germany-and-the-euro-crisis/p/

Even a win in the World Cup soccer tournament won’t save Europe. Nor will the G-20 meeting in Toronto this week. With Grecian urns, Irish eyes, Spanish flies, and Portuguese waterdogs all up to their eyeballs in debt, it’s only a matter of time before the whole venture implodes. Even after an almost trillion dollar bailout across Europe, Moody's Investors Service last week downgraded Greece's debt from A3 to Ba1--junk bonds.

We’ve seen this movie before—in 2008, when it was banks, not countries, reeling out of economic control. Once you recognize this pattern—desperate nations behaving just as the desperate banks did—the next 12 months of news will all make sense. Here is a handy guide.

Greece is clearly Bear Stearns. They’ve taken on too much debt, used derivatives created by Goldman Sachs to put off payment well into the future, and aren’t generating enough tax revenue to pay for their bloated expenses. The cost of Greece’s debt financing is skyrocketing, now 8 percent higher than the benchmark German bund. Either Athens defaults, causing more firebombs to be tossed and even larger riots in the streets, or the European Union arranges a takeover by deep-pocketed Germany.

Germany is the JP Morgan of this story. It will provide a lowball 200 billion Euros to Greece and then end up paying 1000 billion, reminiscent of JP Morgan offering $2 and then paying $10 for Bear Stearns. Now wait a second, I can hear you complain, countries can’t merge like companies.

Of course they can, it happens all the time—though usually when tanks roll. Ask Poland. Or Hungary. In this case, Germany won’t legally own Greece, but in reality, it will absolutely be in charge of fixing Greece’s mess. My sense is the Germans will be quite good at tax collection and not so strong at dismantling the welfare state. But Greek debt will be resolved and maybe the Euro will even rally.

But it won’t be over quite yet. That’s because sadly, Spain is Lehman Brothers. With 22 percent unemployment, and loaded with debt and deteriorating real estate prices, who is going to save it? Tongues will wag that defaulting on debts will teach a lesson to countries that live beyond their means. As a huge exporter, the carcass of a bankrupt Spain will be attractive to some country, probably in the Middle East, given Spain’s multicultural history. This country will be to Spain what Barclays was to Lehman, buying the parts of Spain it wants—say Barcelona—and dumping the wine business on France.

France, by the way, is Morgan Stanley; they have so many of their own problems that they can’t truly be part of any solution. Like Morgan Stanley, France will probably take some money from a large Japanese bank and then ignore them.

Italy, which always seems to drag down the rest of Europe, is, of course, Merill Lynch. It is not really good at anything in particular, though it has retail offices in the form of restaurants and pizzerias across the globe. Still, Italy is a net destroyer, not a creator, of wealth. Not wanting to return to the days when it cost 5,000 Italian lira to pay for a cup of espresso, Italy will (again) fall under the ownership and control of the German state, bringing flair and design to Germanic rigidness. A nice match. The Greeks only have islands.

The Euro, by the way, is Fannie Mae and Freddie Mac bonds. Banks around the world owned it because it could never fail. Oops—until it does.

Okay. I can’t believe I’ve gone this far without answering the real burning question: Who is Goldman Sachs? The United Kingdom, of course. Aloof and not really part of all that mess on the continent, the U.K. will probably make money shorting the rest of Europe and then become nervous that Greece and Spain will drag them down as the mess spreads. The U.K. will eventually come around and do what it can to help calm the markets. But it won’t matter. Everyone will still accuse the U.K. of being a giant squid or leech or mosquito, sucking the blood out of Euro-weenies until they cry uncle. Later, when things are more stable, the U.K. will be accused of fraud and benefiting from Europe problems. The U.K. won’t care because its citizens are all paid so well.

I’d like to say that Warren Buffet is Switzerland, but I think I’ve stretched this analogy much too far.

Just be warned. You can bail out Wall Street banks and recapitalize their balance sheets and someday they can start lending again (we’re still waiting). On the other hand, you can’t really bail out a country without massive structural changes, cuts in entitlements, huge reduction in government as a percent of GDP, and a rewriting of the social contract between government and workers. Often, bankruptcy or the threat of it is the only way these nasty tectonic-shifting changes can be pushed through.

Andy Kessler is a hedge fund manager and author, most recently of Grumby. He has written for the Wall Street Journal, Forbes, Technology Review, The New York Times and elsewhere and has appeared on CNBC, CNN, Fox, NPR and Dateline NBC. He lives in Northern California with his wife and four sons.

WSJ: The iPhone, Net Neutrality and the FCC

AT&T's Picturephone, shown at the 1964 World's Fair, was a huge flop. Apple's new iPhone 4, announced this week, has a front-facing camera for video chats. It might succeed, except that AT&T isn't providing enough bandwidth capacity.

First, the company won't allow two-way video to work over its data network. Second, AT&T just made bandwidth-intensive video expensive by dropping iPhone and iPad's $30 per month unlimited data plans and replacing them with a two-tiered plan of $15 a month for under 200 megabyte usage or $25 for two gigs. Not that I have a problem with AT&T charging me or the 2% of its customers who are heavy data users. I can always sign up with a competitor. Oh, wait. There are none. AT&T has an exclusive contract with Apple.

AT&T can easily build out enough capacity to handle heavy data users. But it may be playing a game of chess with the FCC over its attempt to impose "network neutrality" rules. The FCC (plus Google and friends) wants all users to have free rein to do what they want on the Internet and smart phones. AT&T just wants users to pay for excess bandwidth.

Both are fine and not incompatible goals, except that competition, rather than rules, will best set the right price and make it happen. But without more broadband capacity and much higher speeds, the productivity applications needed to drive the next wave of growth in the economy will be stillborn.

Read the rest here:

http://online.wsj.com/article/SB10001424052748703303904575293021509968904.html

WSJ: The Markets Have Good Reasons To Be Nervous

Nathan Rothschild famously quipped, "Buy when there is blood in the streets," but he never said anything about firebombs thrown at Greek riot police, a trillion dollar easing of the money supply, or synthetic collateral debt obligations.

And so, after facing turmoil in the sovereign debt markets, the Dow Jones Industrial Average is down 5.7% this week—and slightly down for the year. The FTSE and the DAX are down, while Greece's Athex Composite index is off 12.8% for the week and a whopping 25.5% so far this year.

Is Europe really a problem for the U.S.? Is this a buy signal—or is it more like the bank run of the last two years morphing into a run on debt-laden countries?

Read the rest here:

http://online.wsj.com/article/SB10001424052748703338004575230012501499240.html

WSJ: Lessons from a Dow Decade

A year ago yesterday, the world almost ended. The stock market was in free fall, with the Dow Jones Industrial Average bottoming out at 6547, down from its Oct. 9, 2007 peak of 14164. Financials were in a death spiral and there was even talk of nationalization. Citigroup hit $1.05, GE traded at $7.41 and golden Goldman Sachs was given away at $73.95. A bear market extraordinaire.

Read the rest here:
http://online.wsj.com/article/SB10001424052748704784904575111652626885876.html

WSJ: Bernanke's Exit Strategy

http://online.wsj.com/article/SB10001424052748703699204575017462822204340.html

We can end bank panics forever by limiting the ability of lenders to create money out of thin air.

Last week, voting 70-30, the Senate confirmed Federal Reserve Chairman Ben Bernanke for another four year term. So now what will he do?

 Phase one of the recovery is certainly complete. Since September 2008, the Fed has bought mortgage-backed securities and Treasurys, and increased the monetary base to $2 trillion from $850 billion. The flood of dollars has bank profits booming.

Sadly, banks still have all those underwater mortgage-backed securities and derivatives, but Mr. Bernanke is assuming they will just earn their way out of this problem. Banks also are not lending enough to get the job-creation engine rolling again—though sooner or later they will, at which point inflationary pressures will build tremendously. So every currency trader, bond buyer and man on the Street wants to know one thing: "What's the exit strategy, Ben?" Raise interest rates, shrink the money supply and risk cratering the economy, or keep rolling along and risk a collapsing dollar?

My guess? Mr. Bernanke will leave the money out there but restrict banks' ability to create more out of thin air. He'll be called crazy. Crazy like a fox.

The Fed has a once-in-a-millennium opportunity to do away with banking panics. Investors will rejoice, but Wall Street firms are not going to like it one bit.

The Fed has a once-in-a-millennium opportunity to do away with banking panics

Our banking system has changed little since the days of Elizabethan goldsmiths writing more gold receipts (aka banknotes) than they had gold in their vaults. This "fractional reserve banking" system has caused every major panic in this country—I've counted at least 16 of them since 1812.

Whatever the era, the story is always the same. Banks keep small reserves, and then invest in supposedly safe "sure things" to generate profits beyond the interest paid to depositors.

Sure things can be real-estate loans, home equity, credit card and commercial debt. But bankers are terrible investors. There are no sure things.

Thus modern banking is protected by the twin pillars of the Fed and the Federal Deposit Insurance Corporation (FDIC). The Fed, founded in 1913 out of the failure of Knickerbocker Trust when it tried to corner the copper market, finally learned after the banking crisis of 1930 that it is the lender of last resort. And the FDIC was established in 1933 to insure depositors against losses in case the bank is so bad at investing that there is nothing left for the Fed to lend to.

The end of bank runs? Mostly. Panics? Hardly. And Paul Volcker's proposal to restrict proprietary trading won't change a thing. Banks write bad loans at the top and dump them at the bottom.

Here is some recent history. The 1988 Basel accords set minimum bank capital at 8%, meaning banks could leverage their capital at ratio of 12.5 to 1. As long as their investments didn't fall by 8%, they stayed solvent. In 2001, U.S. minimum capital was set at 10%, more or less, but banks were allowed higher leverage if some of their capital was AA or AAA rated mortgage-backed securities. The rationale was that these instruments could never possibly drop more than 5%, let alone 10%. Oops.

Under the 2004 Basel II accords, so-called shadow banks (which don't take deposits) with $5 billion in capital were exempt from these regulations. So institutions such as Goldman Sachs, Morgan Stanley, Merrill Lynch, Lehman Brothers and Bear Stearns regularly used 20 to 1 or even 30 to 1 leverage. This allowed these firms to effectively print money, inflate the housing bubble, and then watch those same AA and AAA mortgage securities fall by 70%-90% in value.

To sum up, the Fed creates a monetary base and the banks can create $10 for every $1 of monetary base. Wall Street firms created $20 for every Fed $1. In other words, the Fed only seeds the market. Beyond crude instruments like interest-rate policy, it has little control over how much actual money supply exists. In good times banks lend too much. And in bad times, such as today, they don't create enough money because they lend too little.

Perhaps the lesson Mr. Bernanke drew from 2008-09 is not that we need more regulation but that financial firms should not be allowed to generate money out of thin air to write soon-to-be-bad loans. To seal his legacy, it is fractional reserve banking that he can rein in. Limit leverage and you take away the hot air from these bubbles.

Free marketers blanch at the idea of more regulation. But banking isn't a normal market. Banks create money when it did not previously exist. We've built a regulatory structure around this sleight-of-hand and each time are astonished that banks still fail. I doubt we will ever get to no leverage, a dollar loan backed by a dollar of capital, but I think Mr. Bernanke could be headed in that direction. One potential target is a 5 to 1 leverage limit—he could increase reserve requirements by 1% per year until it hits 20% by 2020. With credit dear, perhaps banks will do a better job of deciding what is a "sure thing."

You do need lending for an economy to function, but you don't need all that much leverage. Increased reserves may be the best financial reform we can hope for without politicians mucking it up. No need for pay czars and repressive rules.

Even a whiff of lower leverage and increased reserves will create a dollar rally, as inflationary fears—that banks will create too much money when the economy gets going again—subside. Oil at $50? Gold at $700?

If I'm right, banks and Wall Street are going to scream bloody murder at their new shackles. But so what, they've had plenty of time to recapitalize themselves and show record profits and compensation, a gift of Mr. Bernanke's zero-interest-rate policy.

Tighter control of money supply would mean the Fed no longer has to guess if banks are creating too much or too little. Lower leverage would keep bubbles from forming in the first place. Crazy.

WSJ: Put Down That Shovel!

Forget old-fashioned infrastructure. Here are six government projects to foster a lasting economic recovery.

The House has passed a $154 billion jobs bill, and the administration has announced a plan to spend $50 billion of repaid TARP money to "create" jobs—this time its green jobs, "shovel ready" infrastructure projects ($27.5 billion for highway construction and repair) and a tax credit for small businesses.

More infrastructure? Recycling Great Depression-era projects is lame. My advice? Put down that shovel! It's time to try something else.

We're in a knowledge economy now; we use high-tech tools to efficiently and effectively design, make, market and sell. Building roads and bridges willy-nilly won't make us more productive; and without increases in productivity and the associated corporate profits, there can be no sustainable job creation, no increase in standards of living, and no real economic recovery.

Given that real tax cuts are off the table and a new stimulus (even if it isn't called that) is inevitable, the best we can hope for is to use the power of the government to clear a path that private enterprise can't, via one-off projects that end and disband. Stop thinking concrete and massive construction projects. Think small—photons, electrons and proteins. Here are six ideas:

• Climb poles for wireless. Every street light in the country can be fitted with a wireless access point. Lots of companies, including Google, have tried to roll this out. But dealing with thousands of state and local governments to get access to poles and power is a nightmare. A stroke of the pen can create the Local Wireless Corps, with unfettered access to street lamps, telephone poles and utility sheds to create a massive wireless network to deliver Internet access—10 megabit, even 50 megabit speeds—to both homes and next generation mobile phones. AT&T and Verizon will complain about the competition, but so what—they're hardly hiring.

• Dig fiber ditches. Even faster wireless is too slow. If, as the Federal Communications Commission states, broadband is a priority, let's open up the right of way to a Local Fiber Corps to lay fiber-optic strands to every one of the 120 million U.S. residences (even the 10 million empty ones). The goal is gigabit speeds. It's attainable now. New applications like YouTube are bandwidth hogs. It's hard even to imagine the types of applications possible in a 100 meg or gigabit per second speed world. The only one way to find out? Build it. Then sell the fiber along with the wireless lamp posts to the highest bidders. More than one in each town will keep competition alive. And with so much bandwidth, arguments over things like network neutrality will magically disappear.

• Sequence proteins. In 1971, Richard Nixon declared a $100 million campaign to find the cure for cancer. We spend 5,000 times that much every year treating the disease. We may not be able to cure cancer, but we can find it much earlier when treatments are simple.

Scientists today shove cancer samples into mass spectrometers, in order to identify unique proteins for tens of thousands of types of cancer. The goal is that some day we can all be screened for those proteins as early warning signals. With so many college graduates among the unemployed this cycle, 100,000 of them can dust off their knowledge of biology and we could sequence every known cancer type for $50 billion. Medicare would save two to three times that much each year on cancer treatment due to early detection.

• Lighten backpacks. My son's backpack is 20 pounds. And he's only in the fourth grade. My high school son's backpack is even heavier, loaded with textbooks and cans of Red Bull to keep him attentive as his teachers drone on. A Textbook Corps can scan these books, put them on a reader like the Amazon Kindle, link them to high-tech projectors called SmartBoards that are going into many schools. We can instantly change education, not to mention saving many sprained backs.

• Scan medical records. The administration has talked about the time and money this would save, but doctors, hospitals and insurance companies don't want to go through the expense and hassle of digitizing all of our records. Only the feds, threatening to withhold Medicare payments until digitization takes place, could ram this through. Workers would knock on the door of every doctor's office, armed with scanners and Web software.

• Require TOU meters. It's funny how the "I don't work for the electric company" trick to get our kids to turn off lights has morphed into kids shaming parents into "saving the planet." Yet we still pay flat rates, though utilities need to build plants for peak periods, usually summers from 2-5 p.m.

With price signals, households would shift electrical usage to cheaper times. The technology is starting to roll out (with some stimulus money) in the form of Time of Use (TOU) meters replacing those ugly glass bulbs with spinning disks. Coupled with wireless in-house devices that show appliance electrical usage in real time and clever software at utilities, I'd bet peak usage would drop 30% and educate a million workers on the workings of the future smart electric grid. Beats subsidies for caulking windows.

For a $14 trillion economy, each 1% in productivity is $140 billion of additional output. Forget roads and bridges and shovels. It's a virtual infrastructure of ubiquitous bandwidth and digitized information that will require permanent workers and create a sustainable growth economy, a lot faster than shovels.

Dow Jones vs. the Monetary Base Chart

Updated again: October 30, 2009 (added 2008-2009 chart to 2009 only chart)

This chart ran along with The Bernanke Market piece that ran in the Wall Street Journal back in July. I thought it was worth updating. The market seems to be following the Fed's money creation. I suspect the market will give out well before the Fed stops printing money.

The monetary base data is from this page at the St. Louis Fed. WSBASE is defined as the "Sum of currency in circulation, reserve balances with Federal Reserve Banks, and service-related adjustments to compensate for float."

 

 

Marketplace Radio: Reform won't change Wall Street pay

Marketplace Radio

12:00 minute mark.

WSJ: Bank Pay Controls Aren't the Answer

In his weekly radio address on Saturday, President Barack Obama said that "we cannot allow the thirst for reckless schemes that produce quick profits and fat executive bonuses to override the security of our entire financial system and leave taxpayers on the hook for cleaning up the mess." A day earlier, Treasury Secretary Tim Geithner told the New York Times that "you don't want people being paid for taking too much risk."

So now the administration wants to control the pay of employees of banks and Wall Street investment firms.

Kenneth Feinberg, the administration's "pay czar," is being tasked to oversee employee compensation at firms that took bailout money from the government's Troubled Asset Relief Program (TARP). The Federal Reserve will require thousands of bank holding companies and state banks to submit their compensation plans for approval.

The administration has it wrong. It wasn't reckless schemes and excessive risk that sunk banks and Wall Street; it was excessive leverage. And thanks to cheap money and twisty regulations, risk was extremely undervalued. Banks owned huge portfolios of real-estate loans and mortgages specifically because they, and regulators, didn't think they were taking much risk at all.

Outlaw pay and pay will only go to those outside the reach of the law

Populist pay limits are squarely aimed at Wall Street, not local banks, yet for the most part Wall Street doesn't take much risk. Highly profitable investment banking and sales and trading are agency businesses, doing work for customers for a fee. Of course bad trades happen, and there are the rare rogue traders like Barings' Nick Leeson, who hid losses and sunk the firm, or Jérôme Kerviel, the young trader who lost $7 billion for the French bank Société Générale. But Wall Street firms are quite good at managing day-to-day trading risk.

The unwritten deal between public Wall Street firms and their shareholders is that employees get half of revenues as compensation. Yes, half. Shareholders, after expenses of phone calls and computers, get the rest, usually around 20%. In other words, Wall Street is a 70% profit-margin business. And Goldman Sachs, with the help of 0% interest rates, continues to knock the cover off the ball.

As competition and electronic trading ate into the agency businesses and profits in the early 2000s, the firms redirected their capital to invest in mortgage-backed securities, pocketing the 2%-3% difference between mortgage rates and their cost of short-term capital. This was the easy trade, the safe trade—not a "thirst for reckless schemes."

Bear Stearns, Lehman Brothers, Morgan Stanley, Citigroup, Merrill Lynch, Goldman Sachs and others believed the mortgage-backed security was the low-risk investment, and so it couldn't hurt to use leverage—i.e., borrow far more than the capital they had on hand, 20 times or even 30 times as much, to make additional investments in these securities. The firms raised huge sums of money—from other banks, money-market and mutual funds—so they could multiply 2%-3% gains into those large 70% profits and compensation. It wasn't risk but leverage that did in the financial system. Without that leverage, we'd have had an investment-banking profit crisis, not a credit crisis.

Yet if politicians still insist on limiting pay, there are only a few ways to do it:

• Limit risk? Good luck defining it. Great traders know that what looks low risk is often the scariest trade. You can't legislate market smarts.

• Pay Caps? So do you limit executive pay to $250,000? $1 million? $100 million? Who picks, how, and what are the effects? Not all Wall Streeters are equal. If oil trader Andrew Hall can't get paid $100 million after making Citigroup shareholders money, he is going to set up shop across the street and do it himself. Sure, he'll have to scrounge for his own capital, and maybe not borrow as much. But to evade the regulators' pay handcuffs, people will simply not work for a regulated company. Outlaw pay and pay will only go to those outside the reach of the law—whether they move to a hedge fund in Greenwich, Conn., or to an investment banking firm in London.

• Raise the cost of insurance? After overextending themselves with excess leverage while doing supposedly low-risk trades, Wall Street firms and banks got bailed out by a combination of low-cost capital from the Treasury, guaranteed debt by the Fed, and deposit insurance by the FDIC. It is clear in hindsight that Wall Street and banks have been underpaying for the twin pillars of the Fed as lender of last resort and the FDIC to limit bank runs. And so, yes, it is time to find a formula that adequately values that risk and charges Wall Street firms for this bailout insurance. There are market mechanisms today, in the form of derivatives, that price the risk of doing business with specific firms. Transparency is what will let the Fed and the FDIC use the market to protect the market. If done right, the increased costs will eat into the employees 50% take and therefore limit compensation.

But the knee-jerk reaction—to squeeze "greedy Wall Streeters" who nearly sunk the economy—is misguided.