FT : The Colossal US Deficit

Thursday, January 20, 2011


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FT : US Philanthropy

Monday, December 13, 2010

…..The billionaires of the world may be starting to realise that handing over untold wealth to their offspring may not be the best use of their fortunes, or indeed the best public relations strategy. So Bill Gates and Warren Buffett have found some success twisting the arms of the world’s most privileged rich: a further 16 billionaires this week pledged to give away at least half of their wealth, including Facebook founder and chief executive Mark Zuckerberg.  In the Gates philosophy, expertise, the entrepreneurial skills that created these fortunes in the first place, is almost as important as the money. The Microsoft founder’s idea is to use the billionaires’ wealth and wisdom to address grand global problems. His own foundation makes a valiant effort.

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But charities are beset by the same bureaucratic inertia, biases and flawed human decision-making as other large institutions. And the very wealthy do not always aim high; the Helmsley fortune of about $8bn was given over to a trust dedicated to the provision of care for dogs, while the Ikea billions are controlled by a foundation dedicated to promoting architectural innovation.  Why give in to the plea of Messieurs Gates and Buffett to give so much away? Virtue is aided by tax benefits; the US government allows charitable donations to reduce taxable income by up to 50 per cent. The most telling assumption behind the pledge and its signatories is that their billions will endure long enough to join the philanthropic elite. Mr Zuckerberg’s wealth is based upon the putative value of Facebook, which remains private. When Ted Turner pledged $1bn to the UN in 1997, Forbes listed his net worth at $3.5bn. Last year he had a mere $1.9bn left.  But money is absolute. Most of the elite can afford to give away half, because the half remaining is bigger than ever before.

Reference : The Financial Times, Dec 13, 2010

The figures are stark. Livestock produce 18% of global greenhouse gas emissions, more than all the aeroplanes, trains and automobiles combined.  They chomp what grows on 80% of the world’s agricultural land and swallow up, directly or indirectly, 8% of our water.  To feed 6.8bn people, we nourish 1.3bn cattle, 1bn sheep and 16bn chickens. Ruminants such as cows digest grass, a useful ability since we cannot.  But in the process they burp vast quantities of methane, which is 23% more warming to the atmosphere than carbon dioxide.  The world’s appetite for animal produce grows apace, as populations in emerging countries become richer.  In 1980, the average Chinese citizen consumed 12.8kg of meat a year, 2.3kg of dairy products and 2.5kg of eggs.  By 2005, meat consumption per person had risen fourfold to 59.5kg, dairy consumption rose 10-fold to 23.2kg and egg-eating had reached 20.2kg, an eightfold increase.  While China is the most striking example, similar increases in the amount of nimal-based protein consumed are seen in every region of the world where prosperity has risen. Even in developed countries, which top the tables, meat consumption edged up to 82.1kg, despite a trend towards eating white meat in place of red. Only in sub-Saharan Africa did intakes decline, to 13.3kg of meat a year.

Partly in response to surging demand, the livestock sector has undergone an unsung revolution in the past couple of decades, as the United Nations Food and Agriculture Organisation (FAO) showed in its report The State of Food and Agriculture 2009 – Livestock in the Balance. Intensive production and vertically- integrated food processing have developed closer to urban populations, often supplied with feedstuff grown far away.  Though livestock graze a quarter of the world’s surface, they also swallow a third of the crops grown, notably in the form of soya beans in an area of Brazil known as the Cerrado, once renowned as a woodland-savannah. The FAO expects further growth in meat consumption by 2050, and even a belated doubling in sub-Saharan Africa, to 22kg per person each year. Little wonder, then, that tackling the environmental consequences, and above all the emissions, is increasingly recognised as an urgent task by many in the livestock industry, as well as by policymakers and environmental campaigners. Yet, according to the FAO, almost 80% of the world’s 1bn undernourished people live in rural areas, and in many poorer countries up to 60% of rural households keep livestock, providing them not just with food, but also a source of income.

Vicki Hird, senior food campaigner at Friends of the Earth UK, an environmental group, notes the contrast between obesity and heart disease compounded by excessive animal protein in some countries, and the need for many poor people to consume more of these foods. She argues in favour of a three-pronged approach to the environmental challenge faced by the livestock industry. Production systems should be reshaped, she says, to reduce pressure on farmers to use ever-more-intensive methods that require feedstuffs imported from afar instead of pasture and generate large amounts of waste. Consumption should be a second focus, with western consumers ideally reducing the amount of meat and dairy products they swallow – thereby creating headroom for undernourished populations to increase their meat and dairy intake. Much more research is also needed, she says, into animal breeds, farming techniques and land use, to provide the data on which to take policy decisions that will minimise environmental impacts. Brian Lindsay, chairman of the standing committee on the environment at the International Dairy Federation (IDF), says: “We recognise that there is an issue that we need to deal with.” But there are no simple policy prescriptions, he says. The dairy industry provides more than half the world’s beef, but an FAO study, Greenhouse Gas Emissions from the Dairy Sector, showed huge variations in emissions per kilo of milk product. Emissions from farming in developed cou tries were as low as 1kg of CO2 per kg of dairy produce. In sub-Saharan African they averaged 7.5kg. Mr Lindsay says the IDF has just launched guidelines on standardising emissions data, so that it will become possible to compare mitigation project effectiveness. Though the UK, for example, has set a target of reducing livestock emissions by 25% by 2020, the scope for improvement at individual farms is subject to many variables. Sharing knowledge may have great potential, especially in sub- Saharan Africa, where better feed could unlock dairy productivity and improve emission ratios. But mitigation must be tailored to farms and cultures. And what about consuming fewer animal proteins? “That is a personal choice,” says Mr Lindsay.

Reference : The Financial Times, Nov 29th 2010

IN JANUARY 2007 Creative Artists Agency (CAA), which manages George Clooney, Julia Roberts, Brad Pitt and other film-industry luminaries, opened its new offices on Avenue of the Stars in Century City, Los Angeles.  As famous actors and directors file into the marble-lined entrance to strike lucrative film contracts, even more serious money is being made upstairs.  The 12th floor is occupied by Ares, which has $37 billion of funds invested in private equity, high-yield bonds and other corporate debt. One floor down is Canyon Partners, an alternative-investment firm that manages $18 billion. The CAA building is also home to Imperial Capital, a boutique investment bank. All three firms can trace their origins to Drexel Burnham Lambert, an investment bank that collapsed into bankruptcy in 1990, fatally wounded by an insider-trading scandal.

Twenty years ago next month Michael Milken, Drexel’s most talented and best-paid financier, who was based in Los Angeles, was sentenced to ten years in prison after pleading guilty to six counts of securities fraud. His sentence was later commuted and he was released in 1992 after serving 22 months. He was also forced to pay much of the huge bonuses he earned at Drexel in fines and settlements.  It is rare even in Hollywood to find a star that rose and fell so quickly. For much of the 1980s Drexel was the hottest firm in investment banking, thanks to its dominance of the market for high-yield corporate bonds, of which Mr Milken was king. These bonds were known as “junk” because they were ranked below investment grade by ratings agencies. Drexel used its muscle in high-yield bond trading, which Mr Milken had built up in the 1970s, to push into other areas of investment banking such as mergers and acquisitions and underwriting. By 1986 Drexel, which in its long history had not previously threatened to join the financial elite, was Wall Street’s most profitable firm.  But Drexel slumped under the weight of legal battles and the $650m fine it agreed on with the American government to settle an investigation of alleged securities fraud. When Mr Milken was forced out at the end of 1988, the firm lost its biggest source of revenue. His acumen was missed all the more as the junk-bond market started to implode at the end of that decade. Rising interest rates, defaults on bonds that had been issued too readily in the go-go years and new regulations that forced troubled savings-and-loans to unload their high-yield holdings all conspired to drive junk-bond prices down. This seemed only to validate claims that the junk-bond market was a Ponzi scheme perpetuated by Mr Milken’s tight control of it.  Those claims turned out to be false. Drexel has left three enduring legacies: a junk-bond market that has grown at least sevenfold since the firm’s demise; the firms and industries, from gambling to cable television, that owed their rapid expansion to the investment bank’s junk bonds; and the influence of the “Drexel diaspora”, the young MBA graduates who worked in the 1980s under Mr Milken, on the finance industry in Los Angeles and elsewhere.

In 1990 the outstanding stock of junk bonds (estimated by subtracting redemptions from new registered issues since 1970) was about $150 billion. Now the total is over $1 trillion. Around two-fifths of all outstanding corporate bonds in America are rated as “speculative”, or below investment grade (BB+ or lower), according to Dealogic, a financial-data firm. Even better-class bonds are not as pukka as they once were: much of the non-junk issued since 1992 has been rated BBB-, the lowest investment grade.  Like all other credit, the junk-bond market was badly damaged during the recession. But it has bounced back, just as it did in the early 1990s and early 2000s. This year new issuance has surged: with around $200 billion raised in America already, the total for 2010 is sure to be a record (see chart 1). The revival is in part driven by a renewed search for yield by investors disappointed with the poor returns on cash or Treasuries: the interest premium they demand for holding junk has tumbled (see chart 2).

The reopening of the junk-bond market has also afforded medium-sized firms access to credit again. The businesses that have tapped the market are a cross-section of corporate America: airlines, clothing manufacturers and retailers, health-care providers, drug firms, restaurant chains, oil-exploration firms and semiconductor manufacturers. Some of the new issuance is by firms looking to lock in long-term financing on good terms.  The market’s revival has been helped by fewer defaults on high-yield bonds. The default rate on junk bonds stayed above 8% for 14 months in 2009-10, according to CreditSights, a research firm. That compares with 20 months in the previous two recessions.  Junk bonds, once despised, are now mainstream. “Milken and Drexel took high-yield bonds from a cottage industry to one of the cornerstones of the financial industry,” says Howard Marks, one of Mr Milken’s early customers and now chairman of Oaktree, a Los Angeles firm that manages around $75 billion in funds, much of it in high-yield bonds and related investments.

In the 1970s the market for such bonds was tiny. It comprised “fallen angels”, the securities of former investment-grade companies that had fallen on hard times, which changed hands infrequently and at big discounts to face value. While a student at Berkeley in the late 1960s, Mr Milken came across empirical support for his hunch that a portfolio of these high-yield bonds would outperform an investment-grade portfolio, even taking into account the higher likelihood of default. He found it in a study by Braddock Hickman, a central banker and student of corporate finance, which showed that even during the Depression there was a high rate of return on non-investment-grade bonds. The interest-rate spread over supposedly safer bonds was more than enough compensation for the higher expected losses.  When Mr Milken began to trade junk bonds at Drexel from the early 1970s, his pitch to his growing band of clients and followers was always the same: junk was a better bet than investment-grade bonds, which had only one way to go: down. High-yield bonds proved to be resilient in the mid-1970s recession. Such was the meltdown in financial markets that in 1974, when the value of equities fell by half, some bonds could be purchased for the price of their coupon. Yet remarkably few junk bonds went bad and investors achieved high rates of return.

This set the stage for the opening of a sizeable market for new junk issues in 1977. From then on fallen angels would be traded alongside “ascending angels”: the bonds of firms whose prospects were better than their lowly status suggested. Interest rates were volatile and firms wanted to fix their cost of capital. They were wary of relying on banks, which had cut lines of credit to firms at the nadir of the recession to preserve their capital.  In April that year Drexel underwrote its first junk-bond issue when it raised $30m for Texas International, a small oil-exploration company. Other issues followed that year but other investment banks initially took a larger share of this new market. That lead did not last (see chart 3). Mr Milken’s preaching of the high-yield gospel secured him a loyal and growing customer base, mostly among insurers and thrifts, with an insatiable demand for low-grade securities. He helped his customers make money. If they did well, they came back for more and in time they built their businesses on the supply of securities from Drexel.

The key to their loyalty was Mr Milken’s commitment to buy or sell on demand the bonds that Drexel had underwritten: he thus offered them a liquid market and a way out of investments they no longer wanted. That liquidity attracted mutual funds into the junk arena. Mr Milken’s skill as a marketmaker was rooted in his knowledge of the bonds issued (which allowed him to price them accurately) and his extraordinary recollection of his clients’ holdings (which helped him find new buyers for junk that others wanted to unload). And he stuck around when other banks retreated from the junk market during the early 1980s recession.  This fresh junk became an important weapon for the corporate raiders and leveraged-buy-out (LBO) firms that came to prominence in the 1980s. Drexel’s ability quickly to raise hundreds of millions of dollars in “mezzanine” debt (so called because it ranks between secure bank loans and at-risk equity in the capital structure) made the threat of buy-outs credible and forced many big companies to slim costs and increase returns to shareholders to stave off the threat of takeover.  Drexel found much of the mezzanine financing in 1989 for the $25 billion purchase by Kohlberg Kravis Roberts, a buy-out firm, of RJR Nabisco, a cigarette-and-biscuit conglomerate. It was an example of both Drexel’s daring and the muscle the firm had at its peak. “We sat around and said if every one of our existing customers buys the maximum amount they have ever bought of one issue, we could get $3 billion,” says Dana Messina, once a high-yield salesman at Drexel, now the chief executive of Steinway Musical Instruments. Drexel comfortably raised $6 billion to finance the deal.

Junk-bond issues also offered a new way for many small but growing firms, which had been starved of capital by stodgy commercial banks and sniffy investment banks, to finance themselves. “The bread-and-butter business was catering to guys like Craig McCaw or Steve Wynn or John Malone or Ted Turner,” says Mr Messina.  These entrepreneurs saw the growth potential in their respective industries. Mr McCaw was head of McCaw Cellular Communications, an early entrant to the mobile-phone business, which had 2m subscribers by the time AT&T bought it in 1994 for $11.5 billion. Drexel also funded Bill McGowan’s MCI, the firm which successfully challenged AT&T’s fixed-line telephone monopoly. Drexel financed Mr Wynn’s Golden Nugget casino in Atlantic City and the Mirage in Las Vegas, replete with a fake volcano. His firm now owns several luxury hotels in Las Vegas, a city whose rapid growth owed much to high-yield finance. Mr Malone’s Tele-Communications Inc became the biggest cable-TV firm in the world. Its growth was financed by Drexel-issued junk. Mr Turner pioneered 24-hour news television at CNN, a channel powered by junk. Rupert Murdoch was another media client.

“None of the firms we financed were pure start-ups,” says Ken Moelis, who worked in Drexel’s corporate-finance team in Los Angeles and who started Moelis & Co, an investment bank, in 2007. Rather Drexel found money for small firms which had enough cashflow to meet interest payments to grow bigger. Some industries were not well-suited for debt finance: the mobile-phone business did not generate much upfront cash and cable-TV firms had big start-up costs before subscription revenue flowed. One solution was to “over-fund” firms, to raise more capital than they needed so that they could make their initial interest payments. Another trick was to use zero-coupon bonds, on which interest payments are deferred until the principal comes due.  Not all Drexel’s corporate customers were thrilled with the price extracted for this service. Some felt that Drexel cut too good a deal for itself and for Mr Milken’s loyal junk-bond investors. Drexel’s fees on junk issues were 3-4%; less than 1% was typical for investment-grade bonds. Drexel’s bankers often demanded equity warrants for themselves and their buyers to sweeten the deal.  Yet lopsided pricing is a feature of “two-sided markets”, in which one side benefits if there are lots of customers on the other side. For instance, clubs that act as matchmakers for lonely hearts often levy higher charges on men than on women, judging that single men will be keener to join clubs with lots of female members. In a similar way, Drexel was able to charge an enviable fee for access to a scarce investor base. Most firms were willing to pay. “For a lot of issuers, it wasn’t the cost of money. It was the cost of not having it,” says Kyle Kirkland, who was one of the last MBA graduates hired by Drexel’s Beverly Hills office in the 1980s.

The desire to maintain Mr Milken’s hold on high-yield marketmaking may explain why Drexel’s bankers were loth to share deals with other investment banks. If competitors issued lots of junk bonds, that would undermine Mr Milken’s sense of who held what bonds and make control of the market harder. The firm gloried in thwarting rivals and in stealing business from under the noses of a Wall Street “elite” it viewed as snooty and indolent.  The firm had plenty of enemies who welcomed its downfall. The firm’s ability swiftly to raise vast sums for LBOs struck fear into the heart of corporate America. The job losses that often followed a junk-financed buy-out, as hitherto inefficient firms were sweated for cash, created a lot of political fury. (That far more jobs were created by the small firms that Drexel financed than were lost in LBOs is often overlooked.) “Junk bonds, junk people” was the sneer from Wall Streeters who loathed the upstart bank. Drexel’s retort, that its rivals would prefer to sell investment-grade bonds on their ratings, rather than put in the hours of analysis needed to hawk junk, was hardly endearing. Drexel also provided a useful scapegoat for the savings-and-loan crisis, because some thrifts were keen buyers of junk bonds.

Yet unloved as it was, Drexel changed the face of corporate finance and of Wall Street. “These days with firms, such as Google and Apple, everyone takes dynamism for granted,” says Mr Moelis. “But Mike Milken started out in the 1970s when capitalism was struggling. In those days, there was very little innovation. Along comes Drexel, a firm with a visionary purpose, and suddenly you could get capital.” Before 1977, when new junk-bond issues took off, says Mr Marks, non-investment-grade bonds were thought of as “bad” investments, at any price. Nowadays a bad credit can be considered a prudent investment if it is available at the right price.  Drexel’s third legacy is in the mark it left on the finance industry, particularly in Los Angeles. That Drexel’s most profitable division was based so far from its headquarters in New York is largely down to the accident of Mr Milken’s birth. Born and raised in the San Fernando Valley, Mr Milken returned to Los Angeles in 1978 (taking 20 or so traders with him) to be closer to his family. Since he was the main source of the firm’s profits at the time, his masters could scarcely refuse him.

With Mr Milken at its centre, Drexel’s Beverly Hills operation became a magnet for the best business-school graduates in the late 1980s. That cohort of financiers is still active. Many of them stayed in Los Angeles after Drexel folded. Almost all have now moved to the asset-management side of the business, although the sell-side skills they developed at Drexel are useful in bringing in money to manage or in arranging outside co-financing for private-equity deals. Los Angeles no longer has a big “money centre” bank or a big broker. What stayed was an innovative strain of Drexel-style “next-stage” finance. Local financiers say they are free of the herd mentality that can take hold in New York. The weather and the quality of life help too: firms say they find it harder to recruit, but easier to retain, good staff.  Some Drexel alumni are found today in New York. Rich Handler, a junk-bond trader in Drexel’s Los Angeles office, moved with 35 or so colleagues to Jefferies, a local investment bank; they took their knowledge of high-yield bonds and investors with them. Mr Handler is now Jefferies’s chief executive but the bank has long outgrown its Los Angeles and high-yield roots. In 1990 it had 400 employees. It now has around 3,000, of whom 200 are based in Los Angeles: the headquarters these days are in New York. Another alumnus is Leon Black, founder of Apollo, a corporate-credit firm with $55 billion under management. Apollo is based in New York, where Mr Black also spent his Drexel years.

Drexel’s financiers were not altruists; they were dealmakers. But in their search for profit they also brought about a democratisation of credit. Firms that previously had to rely on conservative banks or expensive equity were given access to fixed-interest funds in capital markets by the investors that Mr Milken and his junk-bond traders had cultivated. This was a boon to the American economy: limiting capital to investment-grade firms limits economic progress. If a firm can pay the rate for its risk, it should get the money it needs. Los Angeles is perhaps a curious home for a group of financiers with such a focus on high-yield credit. The Hollywood business model is a search for a blockbuster that will pay for all the turkeys. High-yield bond investment is a different art: the trick is to avoid the losers; then the winners will take care of themselves.

Reference : http://www.economist.com/node/17306419/print

BBC Business Daily : Regulating Banks

Sunday, August 22, 2010

Prof. Charles Goodheart on the BBC Business Daily program.


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FT : Customers Are Overrated

Thursday, March 25, 2010

I recently commissioned some market research and, as is too often the case, it told me what I already knew or was obvious.  I paid the bill of several tens of thousands of pounds, consoling myself with the fact that the work at least confirmed my prejudices – always a satisfying sensation.  But I also sensed I had received very poor value; and in talking to other clients of research companies, I realise quite a few feel the same way.  As Michael Skapinker wrote yesterday , the idea that the customer is always right has become an accepted truth in business. Unfortunately, customer desires are often wholly unrealistic – because of cost, technology or legislation.  As Henry Ford said at the launch of the Model T: “If I’d asked the customer, he’d have asked for a faster horse.”  I remember Peter Boizot, founder of PizzaExpress and my predecessor as chairman, telling me how, in 1965, customers in his Soho pizzeria felt uncomfortable with authentic Italian pizza – and demanded chips.  But he stuck to his vision and guided their tastes to the genuine product.  I have also experienced data blindness over research studies.  Consultancies supply blizzards of material – far more than could ever be useful. Wordy, sprawling PowerPoint presentations compensate for a lack of incisive thinking.  One can end up paralysed with indecision, buried in e-mails too large to even download.

Great breakthroughs in fields such as new product development are frequently achieved by avoiding surveys and committees altogether.  Constant testing can lead to blandness and safety-first choices.  In creative affairs, corporate brainstorming sessions usually end up with groupthink dullness, all originality squeezed out because of the fear of failure or through the influence of office politics.  As Steve Jobs said: “It’s really hard to design products by focus groups.  A lot of times, people don’t know what they want until you show it to them.”  At Channel 4, many of the most brilliant and distinctive programme ideas during my time as chairman were pioneered by eccentric independent producers who were championed by renegade commissioners.  Meanwhile expensive, mainstream concepts often flopped.  Over the decades since I worked in advertising, I have sat in many focus groups and wondered about the quality and effectiveness of such qualitative research.  After all, who submits to a two-hour discussion about brands of washing-up liquid?  All too often, the answer is the lonely, the old, the unemployed, students and, most worrying of all, serial participants in search of the small stipend and free tea and biscuits.  It is very hard to persuade a normal working person to attend such panels, but they are usually the target subjects.  I worry that researchers who appear to succeed are too often the snazzy firms who trade in sexy stereotyping.  They use phrases like “Inner City Adversity” and “Twilight Subsistence” to categorise and supposedly understand various imagined socioeconomic and demographic groups.  I am unconvinced that this terminology and philosophy is especially practical and relevant for many companies.  In my restaurants, the people who know our customers are not researchers but branch managers, who serve the public all day, every week.  Our staff may not have the slick patter, but they have the frontline, first-hand knowledge.

Another unfortunate byproduct of the growth of research has been the increasing use of surveys by political and charitable organisations in their campaigns.  Almost every day a pressure group gets publicity by publishing selective and scary conclusions about poverty, health, discrimination or other controversial issues.  Journalists rarely question the study methods or validity of the results.  Even if there were no errors in the sampling techniques, questionnaires or systems used, the media often over-simplify and exaggerate outcomes.  Over-reliance on researchers means owners and managers are separated from the consumer.  Successful entrepreneurs I know put more effort in talking to customers themselves, than they do working with costly experts who tell them what they should have learned long before.

Reference : http://www.ft.com/cms/s/0/b36f6642-36e5-11df-bc0f-00144feabdc0.html

Bloated Governments

Saturday, December 26, 2009

Surprised to see Singapore listed with some “not so good” countries.


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