GDP Nonsense

The Buzz has a degree in economics but was stunned to find the GDP includes government spending. In the private sector when an employee is paid $100 and produces a $0.07 pencil, we say that the addition to GDP is $0.07. But when a government worker is paid $100, we say that GDP has grown by $100. That makes no sense; especially as a measure of production. Of course, how do we measure government production? We don’t. It doesn't produce; not even in the same way that other service jobs produce. Everyone from waiters to accountants charge for what they do; the market responds by paying them what they are worth and we call what they are paid by the market, not by their employer, production. Every model should work in the outliers or it is flawed. If Government spending belongs in GDP, let’s just borrow another $14 trillion and spend that this year; we’ll be rolling in 100% GDP growth right up until we file bankruptcy.

-- Paul Marotta

Lending

We love that scene in It’s a Wonderful Life where Jimmy Stewart explains, during a run on his Savings & Loan, that one person’s money was loaned out to another person, and isn’t sitting in the vault. We have believed for awhile that lending should be based on more knowledge than mathematically calculated credit scores. After all Freddie and Fannie both used their expert algorithms to only buy “safe” loans and how did that work out? You would think that others might reexamine this too in light of where our mathematical models led us recently. Well, someone has. Tufts University economist Amar Bhidé argues in a recent book that especially small business lending should be based on a deep understanding of the borrower’s situation, not on rules and algorithms. He argues that an academic argument that all risk can be quantified was embraced and all non-quantifiable stuff was called marginal and unimportant. So whether you had known the borrower for 15 years or whether he had just showed up in town didn't matter. We once met a sharpie who claimed a credit score of 900 (the actual highest is 850) as if that was all we needed to know about him. Maybe getting to know the borrower isn’t such a bad idea and Bhidé is on to something.

-- Paul Marotta

Airlines and Oil

With oil prices around $100 a barrel it’s not a good time to be a mass consumer of fuel. A recent chart we saw illustrated that 20% of airline revenue is spent on fuel; another 20% for labor costs, and airlines only enjoy about 6.5% in profit. A FOTB (Friend of the Buzz) told us that someone (the Oracle of Omaha?) had analyzed airlines and found that collectively there had been no return on capital from that industry since its inception. The chart also included showed 15% in federal taxes and fees (is there anything these guys won’t take a piece of?), and about 10% for costs of planes (Is that all?; that’s kind of scary; upgrade your planes guys). The remaining 28.5% was for a slew of miscellaneous things. One thing is for sure, as fuel prices rise, so will tickets. We’re sure most airlines engage in all kinds of fuel arbitraging but eventually there will be nowhere to hide as prices go up over a long term. A chart we saw has United winning the fuel cost control war with average price per gallon of $1.75 in 2009, reduced from $3.54 in 2008. Well, even those days are over with the recent oil price hikes in 2011. But as what goes up, then comes down, airlines should benefit. Oil prices are declining right now in the wake of settling of Middle East unrest and airlines are benefitting. American’s loss is expected to be lower than previously estimated and others might actually make a profit. Whoa!

-- Paul Marotta

Crew Sues

On March 1, 2011 41 million shares, or about 64%, of J. Crew voted in favor of a $3 billion LBO by two private equity firms, TPG Capital and Leonard Green & Partners. 13 million shares were voted against, and the sales process was called flawed by some. Only a couple of dozen people attended the special shareholder’s meeting and it was over in four minutes. And a group of shareholders sued claiming breach of fiduciary duty in not analyzing the bid properly. Well, now, J. Crew has sued those same shareholders, including the New Orleans Employees Retirement System, claiming that they breached a settlement agreement. Following the original shareholders case, J. Crew had agreed to extend a shop period to see if there was a better offer available (as well as paying the shareholder’s and their lawyers $10 million and reducing a break up fee if the deal didn't close). No better bids arose. Most targets in acquisitions don’t sue their own shareholders so this is a bit of a novelty. Now, J. Crew is asking the court to enforce a memorandum of understanding claiming that the shareholder’s lawyers are trying to change the deal at the last minute despite their earlier agreement. It looks to us like the lawyers figured out belatedly that their payday wasn’t big enough. Boo!

-- Paul Marotta

SECex

Some facts have been released concerning the SEC internet pornography club. It turns out that 31 SEC employees were found to be surfing internet porn in 2010. They were paid between $100,000 and $225,000 a year, but they have not been fired and their names have not been released despite a FOIA request. One senior lawyer admitted to watching up to eight hours a day of porn in his office, while a Division of Corporate Finance employee surfed smut for 5 hours a day. And these are the guys that missed Bernie Madoff and the Fannie Mae debacle. Our advice is whatever else you do, don’t look to this gang of crooked shooters for any help. Caveat Emptor might be a more useful tool than spending more money on this bunch.

-- Paul Marotta

Justice

We were glad to see UBL dead but we questioned a TV news crawl that said that he had been “brought to justice.” When discussing with a FOTB (Friend of the Buzz), he pointed out that justice is the absence of injustice and once an injustice has occurred there is no justice, only things like vengeance. To whose justice had UBL been brought? Well, they say that the victors write the history books. But why not question those history book writers to keep them honest? We’re as glad as anyone to see UBL dead, but he was apparently shot in the head; not brought to some mythical justice. He certainly worked hard to deserve being shot in the head and he certainly did deserved to be shot in the head. But honest reporting would report that he had been shot in the head because we were mad at him for running the group that flew planes into buildings killing thousands of innocent people. It just sounds more straightforward. Why do we have to dress it up so that we can feel good about “bringing him to justice,” when what we did was kill him.

-- Paul Marotta

Gold Bug Judge

We read with interest an article about a judge that filed a lawsuit in 2008 for a pay raise. You might look askance at what at first looks like another public servant pension grab, but she had an interesting theory. Judge Judith Kaye, former Chief Justice of the New York Court of Appeals [the highest New York court, trial courts being called “supreme courts” (don’t ask)] filed a lawsuit claiming that her pay package had been illegally debased. She pointed out that the dollars in which she was paid used to command 1/35 of an ounce of gold, and now they only command 1/1,300 of an ounce of gold. Since Mad Old King George had made judges dependent on him for their tenure and salary, our Constitution provided in Article 3 that judges were appointed for life and that they were to “receive for their Services a Compensation which shall not be diminished during their Continuance in Office.” If only we were all so protected. So Judge Kaye argued that her salary had been “diminished” through systemic inflation. She was really fighting for 1,300 NY judges and argued that raises had been promised and that promise broken several times over a decade of increasingly meager pay. We’re not sure about arguments advanced by most “gold bugs” but we also think a government controlled fiat currency monopoly can’t be good for us. How did things work out for Judge Kaye? She retired in 2009 and joined a big law firm.

-- Paul Marotta

MIT

MIT is 150. The Buzz’s oldest brother is an MIT grad where he played soccer. The Buzz thought that by osmosis this might qualify for admission to the patent bar but no such luck. The Commonwealth of Massachusetts approved a charter in 1861 for the “Massachusetts Institute of Technology and Boston Society of Natural History.” The name was subsequently shortened. MIT grads founded over 26,000 companies including everything from publisher of Guitar Hero and Bose to Intel and HP, and those companies collectively would constitute the 17^th largest economy in the world. Grads include everyone from Click and Clack of NPR’s CarTalk to Buzz [no, no relation] Aldrin to Benjamin Netanyahu to I.M. Pei. Its first woman instructor was Ellen Henrietta Swallow Richards, the first American woman to earn a degree in chemistry, who also studied at MIT in 1870. A founder of the American Association of University Women, Richards died almost exactly 100 year ago. There is no truth to the rumor that MIT has no Division I football team because other schools protested that MIT’s student’s ability to work calculations on the fly concerning ballistics would be unfair to other schools. We say, when visiting, watch out for smart attacks!

-- Paul Marotta

Hold ‘Em

Since its inception, the Internet has been shaking things up due to its global reach. We predict that it will continue to do so in stronger and stronger ways. Beware repressive governments; your people see freedom across the border. The latest example is the unfortunate indictment of the founders of three leading gambling websites. These are legal businesses located in other countries, but which take bets from US citizens. The US has seized their domain names and bank accounts, charged them with wire fraud, and sued them in a civil action for $3,000,000,000, all for conducting a legal business in the country in which they are located. The US is in a minority of countries that have made online gambling illegal. As the Buzz’s father used to say, “The Government prosecutes the Mafia because it hates competition.” The regressive tax on people bad at math called the lottery is OK but not online gambling. The US has even gone so far as to arrest gambling site execs as they visit the US. We guess multiculturalism is bad only when it involves things you decided to make illegal.

-- Paul Marotta

The Face Book

We were glad to see the Winklevoss’ lose, finally, in their second battle against Facebook, after settling once for tens of millions of dollars and then changing their minds about how much they got. Raw ideas are cheap while good execution is critical, and rare. An unpatented idea is worth very little. But Facebook faces another suit from an alleged investor who bought half “The Face Book” for $1,000. He might be late to the party since he waited seven years to bring suit. He claims that he forgot about the deal, but with Facebook and its value broadcast across the globe you’d think he would have paid more attention, earlier, had the deal been real. Facebook claims it is a fraud, but Paul Ceglia, the Plaintiff, is back with new and improved lawyers who claim they’ve vetted his claims and who, we are sure, are on a contingency. You can read the amended complaint here. This time Ceglia has produced emails between Zuckerberg and himself. At one point Zuckerberg complains that a provision giving Ceglia an additional 1% ownership for each day delay in launching the site is unfair because Ceglia could have an ownership stake of over 80%. This battle may last a while due to the amount at issue.
-- Paul Marotta

Signs Of The Times

If we knew what was going to happen, we’d likely be trading whatever it was we knew about. So we wear our ignorance of the future proudly. But we were interested recently in two events that might point in the same direction, and not a good one for business. First, the Pimco Total Return fund cut its holdings of US government debt to zero. The largest bond fund in the world at $237 billion has no US government debt in its portfolio any more. In a March investment outlook letter Pimco said that it thought the Fed was buying 70% of government debt since QE2 was sprung, which it likened last year to a Ponzi scheme. The Fed is now buying treasuries at $100 billion a month. Pimco said rates may have to go much higher in order to attract buyers. Second, Carl Icahn is returning investor money and said he is unwilling to manage money through another downturn. He is apparently joining Chris Shumway who is returning $8 billion of investor cash and Oaktree Capital which is returning $3 billion of $10 billion it raised. In a letter to investors Icahn said that he did not wish to be responsible to limited partners through another possible market crisis. “While it may sound ‘corny’ to some, the losses that were incurred by investors in our funds in 2008 bothered me a great deal more, in many respects, than my own losses.” We say bully!
-- Paul Marotta

Whoops!

Everyone has sent emails to the wrong person, and if you are sending your email to the people you intend to sue beware. But more surprisingly you need to beware if you read the email sent by your future nemesis. In Terraphase Engineering, Inc. v. Arcadis, the court actually disqualified the layers who read a wrongly sent email message. The former employer of a group of departing employees believed the employees had stolen trade secrets and the departing employees thought the employer was interfering with their customers. The former employees sue first. But in preparation for that suit, their lawyer sent an email to an old email address at the defendant. The defendant’s in-house and outside counsel read the email and an attachment discussing their strategy. When the employees complained, the court took their side disqualifying the employer’s lawyers who read the email message, citing a lawyer’s ethical obligation to not read privileged documents. We think there is some moral hazard created here, and the opinion went too far protecting a sloppy lawyer. The message: If you want to disqualify opposing counsel, send them a bunch of secret emails and hope they read one. We say, “Boo.” -- Paul Marotta

“People’s IPO’s”

Former Soviet satellite Kazakhstan is planning some People’s IPO’s, as state owned firms are sold off and the wealth shared. In part to fight claims of a corrupt ruling elite (pardon our cynicism, but which country doesn't have one of those?), and in part to benefit its citizens, certain state owned companies are to be floated. For example, the production subsidiary of the state owned oil company will float 5% of the company on the Kazakh stock exchange. It is already listed on the London exchange. Said Kazakhstan president Nursultan Nazarbayev, “This is an event of paramount importance to the state...the whole world is earning money on stock markets and citizens of Kazakhstan should also learn how.” The actual wealth comes from hard work, smart decisions, good business, and a good investment climate, but a stock exchange certainly has a part to play in wealth creation. Although we find it ironic that we have yet another politician trumpeting the sale of the people’s asset to the people who already supposedly own it. Maybe another way to do this could have been for the state to divest itself he oil company in favor of the Kazakh citizens who then could have sold or kept their shares as they saw fit and elect professional management rather than politicians to make these business decisions. We won’t hold our breath.
-- Paul Marotta