SAFE, state capitalist?

One of the questions raised by the expansion of sovereign wealth funds – back when sovereign funds were growing rapidly on the back of high oil prices and Asian countries’ increased willingness to take risks with the reserves – was whether sovereign funds should best be understood as a special breed of private investors motivated by (financial) returns or as policy instruments that could be used to serve a broader set of state goals. Like promoting economic development in their home country by linking their investments abroad to foreign companies investment in their home country. Or promoting (and perhaps subsidizing) the outward expansion of their home countries’ firms.

Perhaps that debate should be extended to reserve managers?

Jamil Anderlini of the FT reports that China now intends to use its reserves to support the outward expansion of Chinese firms. Anderlini:

Beijing will use its foreign exchange reserves, the largest in the world, to support and accelerate overseas expansion and acquisitions by Chinese companies, Wen Jiabao, the country’s premier, said in comments published on Tuesday. “We should hasten the implementation of our ‘going out’ strategy and combine the utilisation of foreign exchange reserves with the ‘going out’ of our enterprises,” he told Chinese diplomats late on Monday.

A number of countries have used their reserves to bailout key domestic firms – and banks – facing difficulties repaying their external debts. Fair enough. It makes sense to finance bailouts with assets rather than debt if you have a lot of assets.

But China is going a bit beyond using its reserves to bailout troubled firms. It is trying to help its state firms expand abroad The CIC has invested in the Hong Kong shares of Chinese firms, helping them raise funds abroad (in some sense). And now China looks set to use SAFE’s huge pool of foreign assets to support Chinese firms’ outward investment.

That of course is China’s right.* China clearly has more reserves than it really needs, and thus can take some risks with its reserves.

But it also has consequences. If Chinese firms are explicitly backed by China;s reserves, it gets harder to argue that their expansion reflects a purely commercial calculus. China’s government presumably will deploy its assets to pursue China’s strategic as well as its commercial goals.

In some sense it is surprising that China has decided to be so explicit about its new desire to use its reserves to support Chinese state firms. China’s government could have achieved the same result by quietly putting more foreign currency on deposit in the state banks, and having the state banks lend those funds out to firms looking to expand abroad. See Richard McGregor’s account of how Chinalco financed its initial purchase of Rio Tinto shares.

China’s announcement presumably was directed at a domestic audience – one that is increasingly uncomfortable with China’s growing exposure to the dollar, and one that wants China to use its foreign assets in ways that more obviously help China’s own citizens.

It nonetheless highlights that the state plays a larger role in the economy of the world’s leading creditor nation than in most of the economies that it is investing in. Even now, after the crisis. And China’s state plays an even bigger role in China’s outward investment than in China’s domestic economy. Thanks to China’s exchange rate regime, China’s state has a de facto monopoly on outward capital flows from China.

Creditor countries often end up exporting their own economic model. Or at least trying too.

China may be no different.

And the growing reach of China’s state capitalists, in turn, might end up changing corporate America’s view of China.

* China isn’t alone in using its reserves to support local firms.

Apple sells 5.2m iPhones, most of them recently

Even sceptics would agree, that’s a lot of iPhones: Apple just said it sold 5.2m of them in the three months through June.

True, it’s not as many as the company sold when it introduced the iPhone 3G a year ago, a blockbuster 6.9m units in the initial quarter. But the 3G had just shy of three months to help rack up the overall shipment numbers.

The iPhone 3GS went on sale on June 19, with only 8 days to go in the fiscal third quarter.We still don’t know how many of the phones sold in the quarter just-ended were the new ones, priced at $199 and $299, or the now old-school 3Gs. But the sense is that they sold briskly as well after Apple slashed the price to $99, also in mid-June.

Whatever the mix, it was certainly profitable. The phones were the main reason Apple creamed Wall Street expectations and reported a 15 per cent jump in net income in a terrible economy.

Mac sales were fine, even up a little from a year ago. But Apple is less and less a computer company in the usual sense of the word. In the third quarter of 2008, Mac sales provided more than half of Apple’s revenue from hardware and songs meant to be played on them.

This quarter, iPhone and music sales easily topped Macs, according to RBC estimates—and when it comes to the bottom line, that’s an enormous boost.

Starbucks gives investors jolt with Q3 2009 earnings

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Long-time investors in Starbucks (NASDAQ: SBUX) have not had a great ride over the past 24 months, in which the stock tumbled to a several-year low, hitting bottom in November 2008 at $7.06. It's a far cry from the growth stock dreams of 2006, where the stock regularly scored in the upper $30s. Today's close, $14.69, is more than double that day in November; but still many investors are likely below water. And while the third quarter 2009 results won't push the stock back toward its 2006 highs, at the very least, it's cracking $16 in after-hours trading.

After the bell today, Starbucks surprised with non-GAAP earnings came in at 24 cents a share after one-time charges associated with store closings, or $151.5 million. Analysts' consensus had been earnings of 19 cents a share. These results are compared to 16 cents a share in Q3 2008. Starbucks registered revenue of $2.4 billion, compared to $2.6 billion in Q3 2008 and $2.3 billion in Q2 of this year. Comparable store sales were down 5% between Q3 2008 and 2009, which Starbucks says was an improvement over Q2 2009, with a nine percent same-store sales decline.

I wrote at length on DailyFinance about Starbucks' third quarter 2009 events and hopes for the future. While analysts seem to be focused on same-store sales and when they'll turn positive (management won't say), my judgment is that it's far more important that Starbucks find a way to connect with consumers' changing desires. Slowly, Americans are losing their brand loyalty and turning more toward authentic, personal experiences; this new experimental series of locally-branded not-Starbucks is a great attempt at capitalizing on that. Whether Starbucks can maintain this focus on consumers' trending desires will determine whether the company's next several quarters continue to reverse its losing trend.

Starbucks gives investors jolt with Q3 2009 earnings originally appeared on BloggingStocks on Tue, 21 Jul 2009 19:00:00 EST. Please see our terms for use of feeds.

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Yahoo’s searchers sit on their wallets

When I caught up with him earlier today, Yahoo’s new CFO, Tim Morse, said he’s certainly open to reshuffling the company’s portfolio of businesses in ways that help it make more money.

He was responding to a question about talks with Microsoft about a search partnership - though, of course, he wouldn’t comment directly on the negotiations themselves.

On the surface, it certainly looks like Yahoo could do with some help with search. Its search revenues, just released, took a tumble this quarter, even as the volume of queries from users held up. Google, which reported numbers last week, did much better.

CEO Carol Bartz brushed off any suggestion that this pointed to deeper problems in search, but as Sandeep Aggarwal, internet analyst at Collins Stewart, says: “In addition to cyclical issues, Yahoo does have RPS [revenue-per-search] problems.”

Of course, it is a debatable point whether Microsoft could do any better. But each incremental piece of evidence showing that Project Panama will not put Yahoo on par with Google adds to the pressure for a deal.


In the days when Harvard’s endowment provided only a fraction of the university’s operating budget, a loss would have been unfortunate, but not tragic. In recent years, however, Harvard’s soaring endowment has become the engine fueling the university’s growth. In 2008 alone, so-called distributions from the endowment were $1.2 billion, representing more than a third of Harvard’s total operating income, up from only 16 percent two decades ago.

During the boom years, it was assumed without question that the value of Harvard’s endowment would keep rising. Trusting in that false certainty, the already profligate university went wild, increasing its annual operating budget by 67 percent, from an inflation-adjusted $2.1 billion in 1998 to $3.5 billion in 2008—this, even as the number of students remained constant. While I was reading through Harvard’s financial reports from the past decade, the word “delusional” sprang to mind. So did “unsustainable.” It was like feeding an addiction, having access to so much quick and easy money.

— Nina Munk, "Rich Harvard, Poor Harvard," Vanity Fair

Reading Nina Munk's generally excellent and entertaining piece in Vanity Fair on the fallout at Harvard University from the spectacular implosion of its endowment, I was struck by a particularly confusing passage.

In it, Ms Munk explained that Harvard's apparently panicked sale of $2.5 billion of bonds in December of last year—possibly the worst time in the last few decades to try to sell new debt in the marketplace—was necessitated because "it needed immediate cash to cover, among other things, what [her] sources say was approximately a $1 billion unrealized loss from interest rate swaps." Swaps, Ms Munk explained, which "were put in place under Harvard's then president, Lawrence 'Larry' Summers, in the early 2000s, ... to protect, or hedge, the university against rising interest rates on all the money it had borrowed."

But this makes no sense. As of June 30, 2008, Harvard had no more than $1.6 billion identified as variable rate debt on its books, and no more than $4.1 billion in total. If Harvard's swaps were designed to pay fixed and receive floating—which is the simplest and most common way to hedge existing variable rate bonds against increasing interest rates—those must have been some enormous fixed rate payments to trigger a $1 billion loss on the swaps.

In fact, it turns out that Harvard had to raise new funds last December for two primary reasons. First, it faced around $1 billion in margin calls on the depreciated value of the investment positions in its endowment portfolio, positions it either did not want to or could not sell into the falling market. Second, it faced mark-to-market losses on swaps covering not only the $1.6 billion in floating rate debt already on its books but also an additional $2 billion of debt it planned to issue in the future. Bloomberg explains:

Harvard had 19 swap contracts with New York-based Goldman Sachs; JPMorgan Chase & Co.; Morgan Stanley; Charlotte, North Carolina-based Bank of America Corp. and other large banks, according to a bond-ratings report by Standard & Poor’s.

The agreements required Harvard to pay banks fixed interest rates on a total underlying amount of $3.52 billion in exchange for receiving floating-rate payments. Some of the swaps were used with existing floating-rate bonds, essentially converting the school’s cost to fixed rates.

Most of the swaps, signed when Summers, 54, was Harvard’s president from 2001 to 2006, were intended to lock in rates for debt that Harvard expected to issue as far off as 2022, for a 340-acre campus expansion, according to Moody’s Investors Service. In 2006 and 2007, Moody’s warned of risks from those so-called forward swaps, though it said the school’s finances and management experience mitigated them. Summers declined to comment on the record about the matter.

The value of the swaps dropped as the fixed rates charged by banks in exchange for floating rates on new contracts fell below what the university was paying. By Oct. 31, its swaps were worth a negative $570 million, meaning that’s how much Harvard needed to pay to get out of them, S&P said. The losses widened from $330.4 million on June 30 and $13.3 million a year earlier, according to Harvard’s annual report.

Given the continuing plunge in swap prices from the end of October to December 2008, it is not hard to believe that Harvard's cost to exit its interest rate agreements ultimately approached $1 billion.

Now forward swaps, or forward start swaps—which behave like normal swaps except the offsetting fixed and floating rate payments are scheduled to start at a date certain in the future—by themselves count as little more than rank interest rate speculation, specifically in this instance as a bet that short-term interest rates will rise in the future. They can make a great deal of sense when an issuer intends to sell bonds in the relatively near future and when the issuer wants to hedge against budgetary uncertainty by converting floating rate obligations into fixed rate debt. That being said, I have rarely encountered a corporate client who feels confident enough about both their absolute funding needs and current and impending market conditions to enter into a forward swap starting more than nine months into the future. Entering into a forward start swap for debt you do not intend to issue up to 20 years in the future sounds like either rank hubris or free money for Wall Street swap desks.

Of course, the entire article recites a litany of stupidity, arrogance, hubris, greed, and backstabbing bureaucratic infighting which makes the average investment bank look like a Montessori preschool.

It's reassuring to see that Wall Street doesn't have the market for organizational dysfunction cornered, after all.

© 2009 The Epicurean Dealmaker. All rights reserved.

“Bernanke’s Bold Prose”

Mohammed El-Arian says Ben Bernanke can talk all he wants, but the credibility of his message about inflation depends upon the actions of fiscal authorities and is thus largely out of his hands:

Mohamed El-Erian on Bernanke’s bold prose, FT Alphaville: From Pimco’s chief executive…

While it may not rank quite as high as his appearance on the US news show ‘60 Minutes’ a few months ago, Chairman Bernanke’s Op Ed in today’s Wall Street Journal is nevertheless notable and important. It represents a bold attempt by the Federal Reserve to reach out broadly and pre-empt mounting concerns about the challenges facing monetary policy.

Bernanke’s bottom line is clear:  “Overall, the Federal Reserve has many effective tools to tighten monetary policy when the economic outlook requires us to do so.”   ... Bernanke is signaling that the Fed is aware of the need to re-assure markets of its ability to strike that delicate balance between deflationary and inflationary concerns. ...

While ... this is important, it does not constitute major news as such.  Indeed, Bernanke has today confirmed a view that has increasingly prevailed in financial markets:  there will be no early hike in interest rates; and when the time comes to tighten monetary policy, the sequence will involve dealing first with the excess reserves. Yet this is not sufficient to ensure that the US is indeed able to balance well deflationary and inflationary risks.

To move from a necessary condition to one that is both necessary and sufficient, one must also consider what, increasingly, is the large elephant in the room when it comes to policies — namely, the design and conduct of fiscal policy.  This is an area where challenging short and longer-term imperatives need to be reconciled over time, and at several level of local, state and national governments. ...

After being heavily involved in stabilizing a highly disrupted economy, the Fed is transitioning from the driver seat to the passenger seat.

By virtue of its greater flexibility and responsiveness, the Fed ended up assuming the main role in responding to the crisis, with fiscal and other agencies (including the FDIC) playing important support roles. It is now the turn of the fiscal agencies to assume the main role, with the Fed and others playing the support roles.

Bottom line:  we have now entered the phase where fiscal policy is the more important determinant of the ability of the US to balance the risks of deflation and those of inflation. And, here, the jury is still out.

If we fail to make the changes in health care reform that are needed to bring the long-term budget into better balance, there will come a time when the Fed faces a choice about whether to monetize the debt and create inflation, or to refuse to monetize the debt potentially send interest rates very high causing the economy to stall. So it's not completely out of their hands. The Fed has faced this choice before, and its independence allowed it to send a message to fiscal authorities that it was willing to take whatever steps are necessary, including causing a recession, to prevent monetizing the debt and creating an inflationary environment. As Thomas Sargent notes in his book "Dynamic Macroeconomic Theory":

A game of chicken seemed to be occurring in the United States from 1981 to 1985 because the Fed announced a policy that is feasible only if the budget swings toward balance in a present value sense, whereas Congress and the President set in place plans for government expenditures and taxes that imply prospective net-of-interest deficits so large that they are feasible only if the Fed eventually creates more inflation. In such a situation, something has to give.

And, due to the degree of independence that it had, it wasn't the Fed that eventually gave in. With a less independent Fed, I'm not sure we get that outcome. (I should note that people such as Jamie Galbraith argue that fighting inflation during this time period was the wrong policy to pursue - one part of the the argument is that it suppressed wages and made workers worse off - but this is a point on which we disagree, and the general view within the profession is that the Volcker Fed acted wisely.)

Investors Coming Off The Sidelines

The most notable headline we saw today came in Bloomberg's coverage of Blackrock's (BLK) earnings conference call. During the call CEO Larry Fink noted that: This marks an important shift from six months ago when cash was, for most investors, the only acceptable option. While some could interpret this statement as a sign that sentiment is turning too bullish, we...

Intel’s results point to a tech, global recovery

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I'm Reiterating my Buy rating for Intel Corporation (NASDAQ: INTC), first recommended on March 30, 2009 at a price of $14.72.

No longer a get-ahead-of-the-pack play, strictly speaking, Intel is now a run-with-the-pack play: the institutional investors have been adding to their INTC positions for months, and you should too, if you'd like a chance at out-sized gains.

Continue reading Intel's results point to a tech, global recovery

Intel's results point to a tech, global recovery originally appeared on BloggingStocks on Tue, 21 Jul 2009 18:30:00 EST. Please see our terms for use of feeds.

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Evening Reading: Why Is Bono Shilling for Palm Rival BlackBerry?

What Is Bono Doing? Bono is a partner with private-equity firm Elevation Partners. Elevation Partners owns 40% of Palm. Yet Bono is shilling for Palm rival BlackBerry in a new television advertisement. That causes Dan Primack to ask: “Can you imagine Facebook investor Jim Breyer (Accel Partners) appearing in an advertisement for MySpace? How about Blackstone boss Steve Schwarzman, whose firm owns Hilton Hotels, promoting Marriott? Or George Steinbrenner calling to ask if you’d like to buy Red Sox season tickets?”

Party like it’s 1999: It seems the venture capitalists who have been calling for investment to shrink to 1999 levels are getting what they wished for. Bits reports that in the second quarter, venture capitalists invested $3.7 billion in start-ups, down from $7.6 billion in the period a year earlier. Now guess when the industry saw numbers like that? that’s right, 1999.

When referees start fielding their own team: What’s the problem when the government regulator becomes a market player, too? The typical objection to the government player is that it is a bad manager. But the Harvard Law School Corporate Governance Blog writes: “recent evidence suggests it might not be so bad as a manager. And when the government meddles with or replaces failed managements–viz. the American auto industry–it’s not replacing America’s most admired management teams, but its worst. The bar for it to clear is not all that high.”

Roll Call!!! Roll Call Group has agreed to acquire Congressional Quarterly from Times Publishing Co., creating a Capitol Hill powerhouse combining two of the Beltway’s most-followed publications. Roll Call is a wholly-owned subsidiary of The Economist Group, which was represented by Morgan Lewis. Congressional Quarterly was represented by The Jordan, Edmiston Group

“Three Myths about the Consumer Financial Product Agency”

Elizabeth Warren responds to some of the worries about creating a Consumer Financial Product Agency:

Three Myths about the Consumer Financial Product Agency, by Elizabeth Warren: I’ve written a lot about the creation of a new Consumer Protection Financial Agency (CFPA)... Today, though, I’d like to post specifically about some of the push back that has developed on this issue.  In particular, I’d like to focus on three big myths – myths designed to protect the same status quo that triggered the economic crisis.

MYTH #1:  CFPA Will Limit Consumer Choice and Hinder Innovation

At a recent hearing on the CFPA, Rep. Brad Miller challenged an industry representative to identify one consumer who chose double-cycle billing to be included within the terms and conditions of his or her credit card contract.  It was a great moment.  If the status quo is about choice, then explain why half of those with subprime mortgages chose high-risk, high-cost loans when they qualified for prime mortgages.  ...

The truth, of course, is that no consumer “chooses” to accept the tricks and traps buried within the legalese of financial products.  ... The CFPA will not limit consumer choice.  Instead, it will focus on putting consumers in a position to make choices for themselves by ... making financial products easier to understand and compare. ...  Once consumers can understand the risk and costs of various products – and can compare those products quickly and cheaply – the market will innovate around their preferences.

Daniel Carpenter ,,, at Harvard University ... has written a great deal about the modern pharmaceutical industry.  While anyone with a bathtub and some chemicals could be a drug manufacturer a century ago,... drug companies were willing to invest far more in research and development ... once FDA regulations drove out bad drugs and useless drugs.  Good regulations support product innovation.

MYTH #2:  The CFPA Will Add Another Layer of Regulation and Increase Regulatory Burden

Current regulations in the consumer financial area are layered on like pancakes...  Today, seven different federal agencies have some form of regulations dealing with consumer credit.  The result is a complicated, fragmented, expensive, and ineffective system.  With consolidated and coherent authority, the CFPA can harmonize and streamline the regulatory system—while making it more effective.

But the real regulatory break-through for the CFPA would be the promotion of “plain vanilla” contracts that would likely meet the needs of about 95% of consumers.  These contracts would have a regulatory safe harbor.  By using an off-the-shelf template for a plain vanilla contracts..., a financial institution can legally satisfy all its federal regulatory requirements—no need to do more. ...

A streamlined new regulatory regime would have a serious impact on the credit industry.  Today’s complicated disclosure system favors big lenders that can hire a legion of lawyers to navigate the rules—and spread the costs among millions of customers.  Those complex rules fall much harder on a smaller institution that must navigate the same regulatory twists and turns, but with far smaller administrative staffs.  Plain vanilla contracts will be particularly beneficial for community banks and credit unions that will be able to divert fewer resources toward regulatory compliance and more toward customer service and innovation.

MYTH #3:  Prudential and Consumer Regulation Cannot Be Separated

Make no mistake: This is a fancy claim for the status quo.  If the CFPA can be left with the current bank regulators, then it can be smothered in the crib.  For decades, the Federal Reserve and the bank regulators (the OCC and the OTS) have had the legal authority to protect consumers.  They have brought us to this crisis by consistently refusing to exercise that authority.

The agencies’ well-documented failures ... are largely the result of two structural flaws.  The first is that financial institutions can now choose their own regulators.  By changing from a bank charter to a thrift charter, for example, a financial institution can change from one regulator to another.  The regulators’ budget comes in large part from the institutions they regulate.  If a big financial institution leaves one regulator, the agency will face a budget shortfall and the agency will likely shrink.  Knowing this, financial institutions can shop around for the regulator that provides the most lax oversight, and regulators can compete by offering to regulate less.  Regulatory arbitrage triggered a race to the bottom among prudential regulators and blocked any hope of real consumer protection.

The second structural reason that prudential regulators failed to exercise their authority to protect consumers is a cultural one: consumer protection staff at existing agencies find themselves at the bottom of the pecking order because these agencies are designed to focus on other matters. ...  Consumer protection issues are—at best—an afterthought.  The CFPA would create a home in Washington for people who wake up each morning thinking about whether American families are playing on a level field when they buy financial products.  ...

In 2001, Canada created an independent agency much like the proposed CFPA.  I recently spoke with some Canadian economists, and they not only said the system works, they also expressed bewilderment about the idea that prudential and consumer regulation would be combined.  ...

At the end of the day, industry lobbyists try hard to invent myths and make things sound confusing to intimidate the public and to keep policymakers from acting.  ...  The CFPA would put someone in Washington—someone with real power—who cares about customers.  That’s good for families, good for market competition, and good for our economy.

PepsiCo earnings preview

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Pepsi Earnings PreviewSo far this has been a pretty decent earnings season, and soft drink giant PepsiCo, Inc. (NYSE: PEP) gets its turn to impress Wall Street tomorrow morning when it releases its second quarter numbers.

The company will be announcing its second quarter earnings before the market opens tomorrow, and analysts are expecting to see earnings of $1.00 a share from the world's second largest beverage maker. For the same period last year PepsiCo posted earnings of $1.03.

Continue reading PepsiCo earnings preview

PepsiCo earnings preview originally appeared on BloggingStocks on Tue, 21 Jul 2009 18:00:00 EST. Please see our terms for use of feeds.

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